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Explain the meaning of Economies of Scale and Scope. Discuss the main strategic implications for the boundaries of the firm arising from Economies of Scale and Scope.(using Tesco as an example only) Essay

Economies of Scale5

Economies of Scale & Scope

Economies of Scale

There is all the required evidence that points to stiff competition in the current market. As a result, firms ought to seek means of ensuring that they remain productive even in those competitive markets. One way of dealing with competition is embracing economies of scale in the production process of goods and services. In this case, economies of scale are achieved if indeed the average cost of production reduces with the increase in total output. This is to imply that the organization produces goods and services at reduced rates when producing in large volumes. Another way of dealing with competition is embracing economies of scope. This is where the firm is in a position to save on the cost of production as a result of choosing to produce a variety of goods and services. The firm that is able to successfully inculcate the two approaches to production is better placed to save on the cost of production and hence increasing its profitability.

By using Tesco as an example, it is easier to illustrate the use of economies of scale and scope by firms as a means of increasing competitiveness. Tesco is a general merchandise retailer operating in many countries around the globe. The company adopts different approaches in relation to production that have proven effective in the current market environment. In the process of embracing economies of scale and scope, horizontal and vertical boundaries define the extent to which the firm can exploit the economies of scale and scope. In Tesco’s case, just like in any other firm, horizontal boundary defines the volume to be produced. One way through which the company has achieved economies of scale is through inventory management. The company has put measures in place to reduce stock-out cases by properly managing the inventory. The company holds what it considers to be adequate stock for the demand of the various products.

In addition, the firm attains economies of scale as a result of advertising. Tesco spends a lot of its revenues on advertising. As a matter of fact, statistics point to general merchandise retailers like Tesco as huge spenders when it comes to advertisement. Nevertheless, the firm achieves economies of scale since the average cost per unit of advertisement reduces with the increase in advertisement costs. In the same way, the company enjoys bulk purchasing. This is very common for all players in the retail industry across the globe. A lot of savings are made as a result of bulk purchasing. This can be due to cash discounts chargeable on bulk purchases and other related benefits.

Apart from the horizontal boundaries in the production of goods and services, there are also vertical boundaries. Vertical boundaries arise with the possible savings identified as a result of methods involved in the production process. In the production process, there are stages where the cost of production is minimized through either outsourcing the service or handling it internally (Krugman & Wells 2008, p. 308). This is solely defined by the overall cost of savings made at the end of it. For instance, there are products that Tesco has chosen to produce in order to meet its demand. An example is bread, cakes and related snacks which are produced by the firm and supplied to its outlets as well as sold to other retailers. In the same way, there are so many other products which are sourced directly from producers because it is cost effective to buy than to produce.

In conclusion, the economies of scale and scope are indeed key elements when it comes to production of goods and services. It is important for firms to ensure that careful evaluation is done so as to understand the source of savings. There are situations where the firm is better placed to produce than to source from other producers (Varian 1992, p. 385). In the same way, there are situations where it is more feasible for the firm to buy from other producers. This understanding will enable firms to understand how to apply economies of scale in the production process.

References

Krugman, P. & Wells, R 2010, Microeconomics, Worth Publishers, New York, pp. 312-321.

Krugman, P. & Wells, R 2008, Microeconomics, Worth Publishers, New York, pp. 187-478.

Varian, H 1992, Microeconomic Analysis, W. W. Norton & Company, New York, pp. 375-416.