For
my example of economies of scale I decided to choose the sewing industry as the
industry which I know the best. First let’s look at the industry as a whole. It
is labor-intensive industry where the qualification of the workers plays a key
role. The mass production there is very well established and the numerous big
existing companies tend to create difficulties for the new companies to enter
the market. And is a result of intense use of economies in scale the minimum
efficient scale is at very low prices and huge outputs. And when asking if it
is possible to do it in today’s Canada the answer would be “No” in 99%. Why? Simply
because Canada’s high level of life and small population created high-paid jobs
and labor-intensive industries cannot compete successfully in our very
competitive world especially because the small population of the country
creates small market and for the success the company would need to export its
production to bigger markets.
But
are there any other possibilities? Yes, the niches. The product should be very
unique, innovative and there should be the demand for it but not in large
quantities. All that would give the opportunity to reach the minimum efficient
scale at prices high enough to get the profit. It is illustrated in the graph
below where LRAC1 is long-pun curve for big mass production companies and LRAC2
is long-run curve for small custom-oriented companies.
One
of those products would be the custom theatre and dance wear, school uniforms,
corporate clothing for small local restaurants etc. The potential customers are
not powerful enough to order large amounts of products, all the products must
be unique but with some possibility of labor division and this local market
would exist for long time without big fluctuations in size. The tricky part
would be to determine the right size for the future company. To cut-out the
fixed costs I would start from home-operated business and devoted most of my
time to advertisement. There are a few local websites where for relatively
small cost I can advertise my business. For better productivity I would spend
some money on quality equipment keeping in mind that the labor wages is the
biggest input and increased productivity would cut a big piece of average
variable costs. In attempts to use a division of labor the most I would hire a
good sewer and do all patterning on myself. The reason would be to reduce the
explicit costs at the beginning when the cash flow is low while keeping the high
quality of the work my company is doing. On the graph it illustrates AVC1 and
AFC1 curves.
After
some improvements in cash flow I would rent the space in crowded neighborhood
with relatively high average family income and easy transportation access for
my shop. To keep my costs down I could make the size of the shop big enough to accommodate
just few more workers. In my decision how many people I should hire I would
calculate the marginal cost of hiring new person, buying new equipment and
approximate decrease in average total costs with the output increased. If the
marginal cost would be higher I would stop hiring. And I would try to implement
the economy of scope by taking side orders of alterations, repairs etc. That
would help to fill in the gaps in between the big orders. And at the same time
I would build the base for people willing to take the contract work for simpler
parts. It would help me to get done big orders without involving many permanent
workers and keep fixed costs lower. Also I would hire the receptionist to meet
and greet visitors and do all high-paid accounting and design work on myself to
cut variable average costs and keep all company cash flows under my control. Definitely
while calculating the profit I would use the economic approach to figure out
how well or bad I am doing and instantly trying to get my total average cost
lower or at least same when the minimum efficient scale achieved. It is
illustrated on the graph above by AVC2 and AFC2 curves. Please note that though
the AFC2 is higher than AFC1 the total AVC2+AFC2 is less than AVC1+AFC2 because
of greater specialization and bigger output (Q2 compared to Q1). All that
demonstrated as well in long run LRAC curve where AC1 are total costs for AC1
and AC2 are costs for AC2.
Next
step would be to get enough profit to hire good designer and accountant. That
is desirable but sometimes it is something that can lead to bankruptcy as the
owner gets more time and loses the day-to-day possibility to influence in the
company. That leads to increased bureaucracy and diseconomies of scale develop.
Small businesses are very sensitive to that and the profit can diminish
quickly. On the graph it illustrates AC3 curve and AC3 costs that are higher
despite increased output.
My
example of successful business would be the Lily’s Fashion Creatures-small
designing studio in NW Calgary. Successful policy in achieving minimum
efficient scale helped the owner to expand from one shop to two shops one of
them in downtown. The owner is very active and never gives up in the attempts
to find the ways to get new and more customers. Though she is not fully uses
the Internet recourses she is well-known through word of mouth.
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