CHAP 3 CM:SCALE AND SCOPE WITHIN AN INDUSTRY

By :Candra Wahyuni PEry Ardono SHeru Agung P

AP 14 MM UGM2010

A DIMENSIONS OF SCOPEValue Chain geograp

hy

Product Market

A DIMENSIONS OF SCOPE : EXPANSION WITHIN AN INDUSTRY

For most firms, expansion begin within their original industry, by increasing the scale of out put, vertically integrating, producing closely related products, or entering new geographies

Firms often pursue such expansions proactively, to increase their size and enhance their competitive positions. In other cases, the same moves are taken reactively, to defend a firm’s position as others move to exploit scale and scope advantages

ECONOMIES OF SCALE Economies of scale exist when the average cost of producing each unit

declines as more units of a good or service are produced. Single site economies often accur in physical production processes and

are related to the size of the manufacturing unit Scale allows specialization, which may be of considerable benefit to a

firm. Multiple site economies are dominant firms that operate more than one

plant or establishment. There are more likely to be found in R&D and marketing than in the phisical production process

Multiple site firms may also benefit from economies of risk spreading and lower capital cost. Larger organization may be more successful in attracting and holding highly talented people, the cost of which can be spread across a larger volume of out put.

ECONOMIES OF SCALE : EXPERIENCE CURVE

Economies of scale refer to cost reductions that company increase in total current out put, experience curve refers to cost reductions that occur as cumulative volume rises

Experience curves emerged out of a manufacturing environment or service firms. The other factors that contributed are ongoing engineering and technical improvements

ECONOMIES OF SCALE : DIFFERENCE Scale : can be quickly replicated by

building a large plant experience : must built through time,

effect are classic examples of path dependency, difficult to transfer knowledge across location even within a firm, extent that competence of first hand experience if individual.

LIMIT TO SCALE AND EXPERIENCE Cost decline indefinitely as scale and experience

doesn’t continue to rise. Some time it is posible, but many not smooth fuctions. Physical properties often limit efficiency gains beyond certain level

There are also strategic risks to consider. Exploiting scale economies requires considerable investment, often specialized assets, if taste change, these sunk investment may lock a firm into an unattractive strategy and not be recovered

It is not unusual fot the magnitude of scale economies to shift over the life of an industry

WHEN THEY EXISTS? Network externalities exist when customer’s

valuation of a product increases as more customers buy or use the good or service

Economies of scale exist when average cost declines as good or service is produced or sold in larger volume

Economies of scope exist when the cost of producing and selling multiple products together is lower than the cost of producing and selling the same quantity of goods individually

ECONOMIES OF SCOPE The size and scope of a firm is influenced not only by the

scale economies of various activities, but also by the presence of the cost saving across functions or units

Economies of scope exist when it is less costly to combine two or more product lines in one firm than to produce them separately

Economies of scope may be occuring in activities that are not directly related to the physical production process, including research and development, sales marketing, distribution, transportation, and overhead.

The role intangible resources in scope economies has recently received considerable attention. Example : firm’s reputation, umbrella branding, creation of competences

ADVANTAGE OF SCOPE ECONOMIESCorporate Scope

Shared facilities, logistic, and purchasingCommon

technologyShares operating

skills

Common customerCommon channels

Brand value

Business unit competitive advantage *Lower cost

*hingher quality

production

marketing

NETWORK EXTERNALITIES Network externalities is a source of

advantage that encourages a firm to expand within an industry.

Network externalities increase demand for the product or the service of the large player and or early mover

Effect of network externalities are positive feedback, winner takes all, system is open or closed

OBSTACLES TO EXPLOITING SCALE AND SCOPE

Simply increasing the volume of a business in no sense guarantees that firm’s cost structure will improve

Combining two related business lines does not mean that product quality will improve or cost will decline

OBSTACLES TO EXPLOITING SCALE AND SCOPE

Some firms simply miscalculate the size of scale or scope benefits that a given strategy may yield. Exploiting scale economies can substantially increase the size of organization, complicating administrative functions and producing buureaucratic inefficiencies. Scope economies often require profound changes in organizational structure and system because they depend on sharing of resources and some level of coordination across previously separate units

OBSTACLES TO EXPLOITING SCALE AND SCOPE

Firms can also fail to exploit scale ar scope economies that emerge in an industry because they locked into a given way competing

Institutionalized capabilities can lead to inertia as the experience of two companies. The double edged quality of resources : on a firm’s ascedancy, they can shield the firm from competition and make it difficult for rival to close in on its lead, but when strategy in eventually challenged, they can block the firm’s own ability to respond

THE SEARCH FOR SCALE AND SCOPE EFFECTS

Firms often expanding into market segments that appear to be related to their existing business, but in fact are quite different.

Firms tend to make this mistake when they define relatedness on the basis of product characteristics rather than on resources

Segment in an industry can have different key success factors that prevent the exploitation of scale and scope economies

THE SEARCH FOR SCALE AND SCOPE EFFECTS

First, identified managerial impediments t the achievement of scale and scope economies

Observe the failure of scale and scope effect to materialize because management misjudged their potential from the start.

This often occurs when expansion is based on an impressionistic assessment rather than a more careful analysis of the source and magnitude of expected cost savings

IDENTIFYING SCALE AND SCOPE EFFECTS

Data driven analyses of the effect of scale. Such careful work can go a long way to quantify the extent of scale economies in a business

Experience curves can be constructed and their slope calculated from data on the past out put of a firm or industry

To evaluate the potential for scope economies between two or more business segments, manager also need a systematic process. This analysis focus on the specific resources and activities that, through combination, may lead to advantage

The value chain, which divides a firm’s activities into discrete process, provides a useful starting point for such an analysis.

Listing all the discrete activities in the value chains of two business or segments under consideration allows for an accurate identification of those that are similar enough to be subject to scope economies

Potential for scale and scope economies will differ among the various activities. Identifying and isolating activities where their effect is greatest is an important step

USING THE VALUE CHAIN The value chain use as a tool for identifying

scope economies. Eg. Industrial thermostat company decided to expand into household thermostats.

At first in glance, this might appear to be straightforward example of expansion across industry segment. The firm would remain a thermostat producer only offering an additional product line. Looking closer, however one can see that fit between the two business was not at all close

VALUE CHAIN FOR HOUSEHOLD THERMOSTATS

Firm infrastructure

Human resource management

Technology development : attractive product appearance user friendly controlsprocurement

Inbound logistics

Outbound

logistics : bulk

shipments to

product warehouses and

DIY stores

Marketing and sales :

sold by industry

representatives

Brand merchandising network

In store advertising

Service : no after m

arket service

Operation : automated mass production

margin

margin

Support

activities

Primary activities

VALUE CHAIN FOR INDUSTRIAL THERMOSTATS

Firm infrastructure

Human resource management

Technology development : one of kind customized design R&D intensive / large pool of engineersprocurement

Inbound logistics

Outbound

logistics : direct

installation

Marketing and sales : sold by in house of

engineers

Service : extensive custom

er support

Operation : built to orderStrict adherence to design specs

margin

margin

Support

activities

Primary activities

USING THE VALUE CHAIN The value chains for the two businesses

reveal these critical differences. When placed side by side, it is clear

that the resources needed to support these businesses are very different, and that there are few possibilities for scale or scope economies

CONCLUSION Vague discussion scale and scope effects are not only

unhelpful, they can be very misleading. General statements such as “substantial cost savings are

expected in overhead and marketing” are exceedingly difficult to quantify and do not provoke the kinds of questions that help managers expose inconsistencies in their thinking.

Systematic analysis and explicit effort to assess scale and scope benefit are required

As above ilustrate, scale and scope economies have no value in abstract

They create value only when they translate into material advantages for the firm