omidsa wrote:
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 scaleD. 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
OG2017 RC449-453 P 390
Passage: Economies of Scale
Question: Infer Advantage
The Simple StoryManufacturers do have to build big plants (tangible capital) to achieve economies of scale, but doing so isn’t enough. The intangible capital (knowledge, experience, etc.) is at least as important. In fact, mastering the intangibles can lead to such great economies of scale that the company develops a market-dominant position, making it very hard for other competitors to join the market.
Sample Passage MapHere is one way to map this passage. (Note: abbreviate as desired!)
P1. Econ of scale: Yes, need large plants. Also need good throughput.
Tangible (facilities) vs. Intangible (know-how, experience)
P2. Invest in Int.: important
1st to master Int. = dominate
Step 1: Identify the QuestionThe word
suggests in the question stem indicates that this is an
Inference question. Specifically, what can you infer regarding what a manufacturer must do in order to gain a
decisive advantage?
Step 2: Find the SupportOverall, the correct question should go along with the main idea that it is important to invest in intangible capital, not just tangible capital (in which everyone already invests).
Where does the author talk about competitive advantage? Primarily in paragraph two:
“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.”
It isn’t necessary to be the first to build a plant, but it is important to be one of the first to maximize the full potential of a plant. What is the full potential? It has to do with maximizing economies of scale. From paragraph one:
“ … 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.”
Step 3: Predict an AnswerIt’s crucial, then, to be among the first to figure out how to achieve economies of scale (aka, minimum efficient scale). If so, then you may be able to dominate the market.
Step 4: Eliminate and Find a Match(A) This choice may be tempting because it copies language from the passage exactly, but the underlying message contradicts the passage. The important thing is not necessarily to be the first to build up that plant; rather, it’s important to be among the first to achieve economies of scale.
(B) The first paragraph does mention fixed and sunk costs, but does not do so in the context of competitive advantage in particular.
(C)
CORRECT. This choice matches the predicted answer: the first company or companies to achieve economies of scale can dominate the market.
(D) This choice sounds great in the real world (quality must be important, right?) but the passage does not address quality as a factor in gaining competitive advantage.
(E) The first paragraph does discuss the importance of ensuring a steady flow of raw materials, but does not do so in the context of competitive advantage in particular. (And note that a steady flow is not the same thing as stockpiling.)
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