‘Economies of scale were the main drivers of corporate gigantism in the 20th century. They were fundamental to Henry Ford’s revolutionary assembly line, and they continue to be the spur to many mergers and acquisitions today. Frederick Herzberg, a distinguished professor of management, however, suggested that companies should not aim blindly for economies of scale.’ Source: Adapted in part from The Economist, 20 October 2008. Comment upon the economic issues raised in the above statement
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One economic issue that is raised by this statement is the issue of what constitutes an economy of scale and how economies of scale come about. Economies of scale occur when average total costs of production decline as the amount produced increases. This typically happens in industries where fixed costs make up a large portion of the costs of production.
The second issue raised has to do with why “companies should not aim blindly for economies of scale.” At some point, diseconomies of scale tend to occur and costs actually increase as a company tries to get bigger. This usually happens due to problems with managing really large corporations. Diseconomies of scale can occur when a company gets too big and there are too many layers of management. As the layers of management multiply, the fixed costs rise (because management gets paid the same regardless of how much production is happening). This can cause average total costs to rise. In addition, excessive layers of management can lead to a lack of coordination in the company as a whole. Orders from the highest levels of the company can become garbled as they work their way down the bureaucracy. Managers with their own ideas and agendas can ignore or try to work around orders from above that they do not like. In these ways, the company can become less efficient, causing average total costs to rise.
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