Chap 3 CM: SCALE AND SCOPE WITHIN AN INDUSTRY

1. By : Candra Wahyuni P Ery Ardono S Heru Agung P AP 14 MM UGM 2010 Chap 3 CM:SCALE AND SCOPE WITHIN AN INDUSTRY

2. A dimensions of scope Value Chain geography Product Market

3. 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 A dimensions of scope : expansion within an industry

4. 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

5. 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 : experience curve

6. 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. Economies of Scale : difference

7. 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 Limit to Scale and Experience

8. 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 When they exists?

9. 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 Economies of Scope

10. Advantage of scope economies Corporate Scope production marketing Shared facilities, logistic, and purchasing Common technology Shares operating skills Common customer Common channels Brand value Business unit competitive advantage *Lower cost *hingher quality

11. 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 Network Externalities

12. 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

13. 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

14. 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 Obstacles to Exploiting Scale and Scope

15. 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

16. 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 The Search for Scale and Scope Effects

17. 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 Identifying Scale and Scope Effects

18. 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 Using the Value Chain

19. Value Chain for Household Thermostats Firm infrastructure Support activities Human resource management margin Technology development : attractive product appearance user friendly controls procurement Primary activities Inbound logistics Operation : automated mass production 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 market service margin

20. Value Chain for Industrial Thermostats Firm infrastructure Support activities Human resource management margin Technology development : one of kind customized design R&D intensive / large pool of engineers procurement Primary activities Inbound logistics Operation : built to order Strict adherence to design specs Outbound logistics : direct installation Marketing and sales : sold by in house of engineers Service : extensive customer support margin

21. 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 Using the Value Chain

22. 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 conclusion