Lecture8 Organisation of Production Wk8

7/30/2019 Lecture8 Organisation of Production Wk8

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ORGANISATION OF PRODUCTION

UG Business Economics

Lecture 8

Abhijit Sharma

MAN0101M


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UG Business Economics: Lecture 8 1

Learning outcomes

After the lecture you should understand:

Efficiency drives changes in the boundaries offirms

Definitions of horizontal, vertical, and diversifiedgrowth

The differences between horizontal, vertical anddiversified growth


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Black box economics

Goods

and

Services

Labour

Land

Capital

Enterprise

The Firm


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Firms are profit maximisers

Firms organize production so that

MPL MPK PL PK

Firms can experience economies of scale

Switching on the light?

=


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How do firms organize production?

Why are some intermediate goods made internally,whilst others are purchased externally?

Why are workers paid a salary, not commission?

Who decides the firms objectives?

Why do firms exist?

The need for more light


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Growth strategies

Horizontal growth occurs at the same stage ofproduction

Vertical growth occurs along the value chain(upstream or downstream)

Diversifiedgrowth occurs when a firm moves into anunrelated market


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Means of growth

Organic firms growing through internal expansion

Merger two firms agreeing by mutual consent tomerge their existing operations

Acquisition one firm purchasing another firm eitherthrough a hostile take over or through mutual consent


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Benefits of horizontal growth (I)

Revenue advantages through:

Reduced competition Merger or acquisition reduce competition, fall in

price elasticity, making price rises easier

Market growth Organic, merger or acquisition enable a firm to

exploit customer growth opportunities


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Benefits of horizontal growth (II)

1

2 2

3 33

AC LRAC

1

2

3AC1

AC2

AC3


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Cost reductions through:

Economies of scale

Rationalisation of the business

Learning curve effects with cumulative output

Benefits of horizontal growth (III)


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Boundaries of the firm - vertical growth

Production

Suppliers

Retailers

Production Production

Suppliers Suppliers

RetailersRetailers

Production

Suppliers

Retailers


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Reasons for vertical growth

Reduces production costs through location benefits

Technological interdependence

Avoids problems from monopoly control of a productionor distribution stage


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The missing cost

COST OF PRODUCTION

Labour Land Capital

Enterprise

COSTS OF ORGANISING

Writing contracts Dealing with complexity

Minimizing shirking Avoiding adverse selection


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Transaction costs (I)

Contracts

Complexity

Output

Low

Complete

Objective

High

Incomplete

Subjective

MARKET TRANSACTION

Lowcost Highcost


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Transaction costs (II)

Transaction costs increase with:

Complexity

Uncertainty

Monitoring

Enforcement

Reduction of transaction costs through make or buy

High transaction costs associated with buying the

good or service through the market, then makethe good or service internally


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REASONS

Activities can be undertaken at lower cost outside the

firm than within

Stemming from a reduction in market transaction

costs

EXAMPLES

Hospitals outsource laundry and catering services

McDonalds restaurant franchising

Insurance companies using external sales forces

Vertical disintegration


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Conglomerate integration - diversified growth

Diversification involves a company to expand itsoperations into related or unrelated markets

Benefits of economies of scope - synergies

Cost (A) + Cost (B) > Cost (A+B)

Diversification and risk reduction

Diversified portfolio of activities Uncorrelated business activities

Off-setting income streams


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Key learning points

You have been introduced to:

Efficiency drives changes in the boundaries offirms

Definitions of horizontal, vertical, and diversifiedgrowth

The difference between horizontal, vertical anddiversified growth

Documents

Lecture8 Organisation of Production Wk8