Manufacturers have to do more than build large manufacturing plants to realize economies of scale.
It is true that as the capacity of a manufacturing operation rises, costs per unit of output fall as plant size approaches “minimum efficient scale,” where the cost per unit of output reaches a minimum, determined roughly by the state of existing technology and size of the potential market. However, minimum efficient scale cannot be fully realized unless a steady “throughput” (the flow of materials through a plant) is attained. The throughput needed to maintain the optimal scale of production requires careful coordination not only of the flow of goods through the production process, but also of the flow of input from suppliers and the flow of output to wholesalers and final consumers. If throughput falls below a critical point, unit costs rise sharply and profits disappear. A manufacturer’s fixed costs and “sunk costs” (original capital investment in the physical plant) do not decrease when production declines due to inadequate supplies of raw materials, problems on the factory floor, or inefficient sales networks. Consequently, potential economies of scale are based on the physical and engineering characteristics of the production facilities—that is, on tangible capital—but realized economies of scale are operational and organizational, and depend on knowledge, skills, experience, and teamwork—that is, on organized human capabilities, or intangible capital.
The importance of investing in intangible capital becomes obvious when one looks at what happens in new capital-intensive manufacturing industries. Such industries are quickly dominated, not by the first firms to acquire technologically sophisticated plants of theoretically optimal size, but rather by the first to exploit the full potential of such plants. Once some firms achieve this, a market becomes extremely hard to enter. Challengers must construct comparable plants and do so after the first movers have already worked out problems with suppliers or with new production processes. Challengers must create distribution networks and marketing systems in markets where first movers have all the contacts and know-how. And challengers must recruit management teams to compete with those that have already mastered these functional and strategic activities.
1. The passage suggests that in order for a manufacturer in a capital-intensive industry to have a decisive advantage over competitors making similar products, the manufacturer must
A. be the first in the industry to build production facilities of theoretically optimal size
B. make every effort to keep fixed and sunk costs as low as possible
C. be one of the first to operate its manufacturing plants at minimum efficient scale
D. produce goods of higher quality than those produced by direct competitors
E. stockpile raw materials at production sites in order to ensure a steady flow of such materials
2. The passage suggests that which of the following is true of a manufacturer's fixed and sunk costs?
A. The extent to which they are determined by market conditions for the goods being manufactured is frequently underestimated.
B. If they are kept as low as possible, the manufacturer is very likely to realize significant profits.
C. They are the primary factor that determines whether a manufacturer will realize economies of scale.
D. They should be on a par with the fixed and sunk costs of the manufacturer’s competitors.
E. They are not affected by fluctuations in a manufacturing plant’s throughput.
3. In the context of the passage as a whole, the second paragraph serves primarily to
A. provide an example to support the argument presented in the first paragraph
B. evaluate various strategies discussed in the first paragraph
C. introduce evidence that undermines the argument presented in the first paragraph
D. anticipate possible objections to the argument presented in the first paragraph
E. demonstrate the potential dangers of a commonly used strategy
4. The passage LEAST supports the inference that a manufacturer's throughput could be adversely affected by
A. a mistake in judgment regarding the selection of a wholesaler
B. a breakdown in the factory's machinery
C. a labor dispute on the factory floor
D. an increase in the cost per unit of output
E. a drop in the efficiency of the sales network
5. The primary purpose of the passage is to
A. point out the importance of intangible capital for realizing economies of scale in manufacturing
B. show that manufacturers frequently gain a competitive advantage from investment in large manufacturing facilities
C. argue that large manufacturing facilities often fail because of inadequate investment in both tangible and intangible capital
D. suggest that most new industries are likely to be dominated by firms that build large manufacturing plants early
E. explain why large manufacturing plants usually do not help manufacturers achieve economies of scale