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HomeBusiness TheoryStrategyRelationship between size risk and profit

Relationship between size risk and profit

Photo by Nataliya Vaitkevich: pexels

In the 1970s and 80s size was very important to a successful business. Large organisations sought to benefit from economies of scale in order to be more efficient than the competition. Today size is still very important in global industries and companies like Coca-Cola, Nestle, Corus and Cadbury Schweppes are some of the biggest in the world. However, these companies have to accept that to stay big they have to act small – i.e. they have to be flexible and build the sorts of relationships with customers that we traditionally associate with small companies. Every enterprise must aim for the scale of production which suits the business best. This level of output is achieved when unit costs are the lowest for the output produced.

Economies of scale come from a number of sources:

Technical economies relate to using techniques and equipment more effectively to produce large outputs. For example, by developing a huge super factory like those that BIC is developing around the world it is possible to produce very efficiently. Large retailers are able to reduce costs such as rate and rental charges per square foot by selling from large retail units.

Large companies are also able to benefit from employing specialist managers.

Commercial economies relate to being able to buy and sell in vast quantities so as to spread out costs per unit.

Marketing economies are concerned with being able to market to very large audiences. For example companies like McDonald’s and Coca-Cola benefit from launching advertising campaigns with a global message.

Financial economies are concerned with the ease of borrowing money and the low cost of raising capital for large when compared with small companies.

Large-scale producers are also able to spread their risks by producing in lots of markets and producing a range of different products.

Economies of scale

However, despite the advantages of large-scale operations, there are also some diseconomies which provide some advantages of being small. Small companies often supply large companies with components and have the ability to provide specialist goods at low overheads. Small firms are also important in areas such as haulage, agriculture, retailing, building and professional services. In these areas, it is possible to start with a relatively small amount of capital, make rapid decisions, compete with firms of similar size and provide for the personal requirements of customers. Large organisations are more difficult to manage and these inefficiencies are known as diseconomies of scale. These disadvantages of large-scale production are an important factor in encouraging many businesses to remain small.

Economies of scale are the advantages of being large which enable big companies to produce large outputs at low unit costs. Diseconomies of scale result from being too large or expanding too quickly.

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