1.4.1a Business objectives

Objectives guide a firm's price and output choices

1. Two firms facing the same costs and the same customers will name different prices if they want different things.
2. Market share is a share, so a firm can sell more units than last year and still lose share when the whole market has grown faster than it has.
   1. Sales growth asks how big the firm is getting, while market share asks how big it is getting compared with its rivals.
3. A firm can hold several objectives at once and rank them, chasing share in a city it has just entered while taking profit from the towns where it is already established.
4. Shareholders who own a large company want a return on their money, while the salaried managers who run it are judged on how large the business has become.
   1. That split is why a firm's stated aim and the aim its decisions reveal are not always the same one.
5. Every objective is limited by the revenue and cost figures behind it, because the firm still has to cover its costs from somewhere.

Each objective suits a different kind of firm

1. Profit suits a firm that answers to outside owners, because Tesco has to hand its shareholders a return, and profit is also what pays for new stores and new machinery.
2. Sales growth suits a firm whose product travels well, because Greggs has grown by opening more shops rather than by charging more in the shops it already had.
   1. Selling more units also spreads the rent and the bakery equipment over a larger output, which brings the cost of each item down.
3. Increasing market share suits a firm in a crowded market, because a bigger share gives ASOS more weight when it negotiates with the brands that supply it.
   1. A larger share also makes it harder for a new rival to get a foothold, since customers who already have somewhere they shop rarely go looking for another.
4. Survival comes first for a new or struggling firm, so it holds its price low enough to keep money coming through the till, which is why so many independent shops cut prices rather than shut in a bad year.

Chasing one objective means giving up another

1. Cutting the price to win market share sacrifices profit now, because every unit sold brings in less money while costing exactly the same to make.
2. Growing sales quickly raises costs before the extra sales pay for themselves, since the new shop, the extra staff and the longer delivery round are all paid for in the year they are added.
3. Survival gives up profit and investment together, so a firm that holds its price down for too long has nothing left to modernise with and slips further behind its rivals.
4. Market share bought with discounts is easily lost, while share won by a better product or a more convenient location is far harder for a rival to take back.
5. The conflict is a matter of degree rather than a straight choice, since a firm can accept less profit this year to hold the share that earns its profit next year.

Whether profit dominates depends on the firm's position

1. It depends on who owns the firm, because a company answering to outside shareholders is judged on the return it hands back each year, while an owner run corner shop can settle for a comfortable living.
2. It depends on how long the firm has been trading, because a firm in its first year has to survive before it can maximise anything.
3. It depends on the time period you look at, because the share bought with this year's discounts is what makes next year's profit possible.
4. It depends on how crowded the market is, because a firm with many close rivals that pushes its price up to the profit maximising level simply sends its customers to the shop next door.
5. It depends on who actually takes the decisions, since managers rewarded for the size of the business lean towards growth even where the owners would rather have the profit paid out.

Judge an objective by actions, not statements

1. A firm cutting prices and opening branches while earning very little is pursuing growth or market share, whatever its annual report claims.
2. A firm raising prices and closing its weakest branches is pursuing profit, trading customers away for a wider gap on the ones it keeps.
3. A firm holding a price that barely covers what each unit costs to make is surviving, picking the smaller of two losses rather than the larger one.
4. Look at what the firm did with the money it earned, because profit paid out to owners points one way and profit spent on new outlets points another.

1.4.1b Types of costs and revenue

Fixed costs stay constant; variable costs rise with output

1. Fixed costs are fixed in total and not per unit, so the same £600 of weekly rent is 60p on each of 1,000 items and 15p on each of 4,000.
2. Which of the two a cost belongs to depends on the time period, since that shop cannot walk away from its lease this month but can choose not to renew it in three years.
   1. Keep the periods matching too, so weekly fixed costs go with weekly output, or the average means nothing.

Add costs for total, divide for average

1. A variable cost is nearly always handed to you per unit, so turn it into a total first: $variable\; cost=cost\; per\; unit\times output$.
2. The other two lines then follow:

$$total\; cost=fixed\; costs+variable\; costs$$ $$average\; cost=\frac{total\; cost}{output}$$

One bakery's costs, worked at one output

1. A high street bakery has fixed costs of £600 a week covering its rent, business rates, insurance and the lease on its oven.
2. Each sausage roll it bakes adds 40p of variable cost in pastry, filling, packaging and staff hours.
3. Work one output level right through before touching the others, because the same three lines then repeat at every level.

Average cost falls as fixed costs spread thinner

1. The £600 is spread over more rolls at every step, so the fixed cost carried by each roll falls from 60p at 1,000 rolls to 15p at 4,000.
2. The variable cost carried by each roll stays at 40p throughout, because every extra roll needs the same pastry and filling as the one before it.
3. Average cost is those two figures added, which is why it falls from £1.00 to 55p while total cost climbs from £1,000 to £2,200.
   1. The bakery is spending more money in total and less money on each roll, and those are two different quantities.
4. Each fall is smaller than the one before, since sharing £600 over 3,000 rolls rather than 2,000 saves 10p a roll while sharing it over 4,000 rather than 3,000 saves only 5p, so a drawn average cost curve slopes down and flattens as it goes.
5. Average cost stops falling once the bakery has to pay overtime or fire up a second oven, because the variable cost on each roll then starts to climb.

Multiply price by quantity for total revenue

1. The two lines of arithmetic are these:

$$total\; revenue=price\times quantity$$ $$average\; revenue=\frac{total\; revenue}{quantity}$$

1. Average revenue equals the price whenever every unit sells at the same price, so a question can hand you the price and expect average revenue back with no working at all.
2. It drops below the shelf price as soon as some units go at a discount, so an end of day price cut pulls the average down without the shelf price changing at all.
3. Multiply price by quantity and never add them, since £1.20 and 3,000 rolls are measured in different units.

A falling price makes total revenue rise then fall

1. When every unit sells at the same price, average revenue stays equal to that price and total revenue rises in step with the quantity sold, which is the bakery case the article's own arithmetic uses.
2. When a firm has to lower its price to sell more, the price it can charge at each quantity is what demand shows, so its average revenue is the same thing as the demand it faces, which is what "AR = D" means.
3. In that second case total revenue rises at first, reaches a peak and then falls. The reason is price elasticity of demand, which is covered in 1.3.5c: while demand is price elastic the extra units sold outweigh the lower price and revenue rises; once demand is price inelastic the price cut costs more than the extra units bring in, so revenue falls.
4. The peak is where those two effects balance.

What is left once total costs are taken off total revenue is section 1.4.1c.

The same bakery's revenue, at one price then two

1. The bakery sells its rolls at £1.20 and, at the output levels in the cost table, sells everything it bakes.
2. The second scenario is a week when it clears the last 1,000 rolls at a 60p end of day price, which is where average revenue parts company with the shelf price.

Work forward from whichever figure you are given

1. Given fixed cost and variable cost, add them for total cost and then divide by output for average cost.
2. Given total cost and output only, divide for average cost and do not try to split the total back into its fixed and variable parts.
3. Given average cost and output, multiply to recover the total: $total\; cost=average\; cost\times output$.
4. Given total revenue and quantity, divide for average revenue, and given the price instead, average revenue is that price already.
5. Check the revenue side by multiplying average revenue back by quantity, which should return total revenue.

1.4.1c Calculating profit

Profit is revenue left after total costs

1. Both figures have to cover the same period, so a year of revenue goes with a year of costs and a week with a week.
2. Profit is the reward an owner takes for putting money at risk, and it is also the money the firm reinvests in machinery, premises and staff.
3. A firm whose revenue exactly matches its total costs earns neither a profit nor a loss and is still paying every bill, so a year at zero is not the same as failing.

How total revenue, total cost and average cost are each worked out is section 1.4.1b.

One workshop's profit in a good and bad year

1. A workshop building bicycle frames has fixed costs of £30,000 a year for its unit, its business rates and the lease on its machinery, and every frame adds £15 of variable cost in steel, paint and welders' hours.
2. It sells frames at £25 and made 4,000 of them last year, then found orders down to 2,500 this year at the same price.
3. The £30,000 falls due either way, which is what makes the two years look so different.

Two routes raise profit: lower cost, higher revenue

1. Reducing average cost widens the gap from below, since every pound taken off what a unit costs to make stays inside the firm.
   1. A firm does it by buying materials more cheaply, by getting more output from the same workers, or by spreading its fixed costs over a larger output.
   2. Nissan's Sunderland plant is the standard UK example, because building hundreds of thousands of cars on one site spreads the cost of the press shop and the paint line very thinly indeed.
2. Increasing revenue widens the gap from above, by selling more units, by charging more where buyers will stay, or by doing both at once.
3. Selling more units pulls both routes together, because the extra output also spreads the fixed costs and so drags average cost down on its own.
4. Neither route is free, since a cheaper supplier can mean a worse frame and a higher price can send buyers to a rival.
5. They can also pull against each other, as cutting the price to shift more units only raises revenue if the extra sales more than make up for the lower price charged on every unit.

Both routes, worked on the same workshop

1. Start from the good year again, 4,000 frames at £25 with £30,000 of fixed costs and £15 of variable cost a frame, which gave the £10,000 of profit.
2. Change one thing at a time, so the movement in the profit figure can be traced to the route rather than guessed at.

Rising revenue does not mean rising profit

1. Revenue is the money coming in at the top and profit is what survives the costs, so the two move together only while costs stand still.
2. A firm can raise its price yet cut its variable cost by so little that a rival undercuts it, or hold its price steady while overtime and rush deliveries push costs up faster than the extra sales pay for.
3. So a firm announcing record sales has told you nothing about whether it made money, and a change in profit is always the difference between two changes.
4. Drawn against output, profit is the vertical gap between the total revenue line and the total cost line, wherever revenue is the higher of the two.
5. The two lines cross where the firm breaks even, which for this workshop is 3,000 frames, and below that output it loses money however hard it works.

1.4.1d Profit as an incentive to produce

Profit decides whether a producer bothers at all

1. Nobody in a market economy is obliged to produce anything, so something has to make it worth a producer's while to commit resources.
2. That something has to be substantial, because a producer takes a risk, paying wages, rent and materials before knowing whether the output will sell.
3. Profit is also the source of the money for expansion, since profit kept back in the business pays for extra machines, vans or premises without borrowing.
4. Loss making activity cannot go on indefinitely, because the owner is covering the shortfall out of savings or debt.
5. The strength of the incentive depends on the size of the gap between price and cost per unit, which is why the same firm expands one product line while closing another.

How total costs, total revenue and profit are calculated is 1.4.1b and 1.4.1c; this section takes those figures as given.

A higher price widens profit if costs hold steady

1. A higher price means more total revenue from exactly the same quantity sold, because every unit now brings in more money.
2. If the cost of producing a unit is unchanged, all of that extra revenue becomes extra profit per unit, which is the price minus the cost of producing a unit and exactly the number a producer looks at.
3. A modest rise in price can multiply profit per unit several times over, because what widens is the narrow gap between price and cost rather than the price itself.
4. The condition matters as much as the chain, because a price rise that is caused by rising costs leaves the gap no wider and brings no extra output.

Wider profit per unit is why supply slopes upward

1. Expanding output costs money, so a producer only does it when the extra revenue expected is bigger than the extra cost.
2. A wider gap between price and cost per unit means more of the expensive extra output becomes worth making, such as overtime shifts, older machines or poorer land.
   1. Overtime is paid at a higher hourly rate, so an extra hour is only worth buying when the price of the output covers it.
3. Existing firms therefore raise the quantity supplied as price rises, and new firms enter because the higher price now covers the cost of setting up.
4. Expansion also takes time, since planting a crop, training staff, restocking a flock or building a factory cannot be done in the week the price moves.
5. A higher price only widens profit per unit if costs are unchanged.

Falling profit runs the chain backwards

1. Firms cut output first, by ending overtime, dropping a shift or running one production line instead of three.
2. Exit comes last, when the price no longer covers costs at any output the firm can produce, as it did for the nearly thirty small UK energy suppliers that failed in 2021 and 2022 while the Ofgem price cap held their price below the wholesale cost they were paying.

1.4.1e Moral and ethical considerations

The cheapest way to produce is not always right

1. The conflict exists because the groups a firm affects are not the group that owns it, so a cost the firm avoids usually lands on somebody else.
2. Cutting a cost is the same action whatever the cost happens to be, so the pressure that pushes a firm to waste less packaging also pushes it to pay less and inspect less.
3. Nothing in the profit calculation charges a producer for the harm it causes, which is why the law and the regulators have to do it instead.

How profit itself is calculated is 1.4.1c, and why the prospect of profit drives producers to expand is 1.4.1d.

Cutting labour or environmental costs lifts profit

1. Wages and working conditions are the largest cost most producers control, so holding pay at the legal minimum, using insecure contracts or pressing a supplier for a lower price per garment raises profit per unit directly.
   1. An independent review of Boohoo in 2020 found serious failings in its Leicester supply chain, including workers paid below the minimum wage, and the same cost pressure sits behind fast fashion prices at Primark and its rivals.
2. The environment is cheaper to damage than to protect, since dumping waste, using single use plastic packaging and burning the cheapest fuel all cut the producer's cost while the cost of the damage falls on everyone.
   1. English water companies have repeatedly released untreated sewage into rivers and the sea rather than spend on treatment capacity, and Ofwat has fined them for it.

Misleading customers boosts revenue, squeezing suppliers cuts cost

1. Honesty towards consumers: advertising that overstates what a product does, charges that only appear at checkout and vague environmental claims all raise revenue without raising cost.
   1. Greenwashing is the version the Competition and Markets Authority now polices, where a product is sold as recyclable, natural or carbon neutral on evidence that will not stand up.
2. Suppliers: a large buyer can squeeze the price it pays a small supplier, and UK dairy farmers have at times been paid less per litre than the milk cost them to produce, which is why the Groceries Code Adjudicator exists.
3. Animal welfare: cheaper eggs, chicken and pork come from more intensive systems, so a producer choosing free range is deliberately choosing a higher cost per unit.

Acting ethically can also raise profit

1. Reputation is an asset, so a scandal that reaches the news costs a firm sales for years while a clean record supports a higher price.
2. Some consumers will pay more for a product they trust, which is why Fairtrade chocolate, free range eggs and British sourced meat sell alongside the cheaper versions instead of being driven out by them.
3. Penalties are avoided, so a producer that meets environmental, safety and advertising rules escapes fines, clean up orders and the management time an investigation swallows.

Whether profit and ethics conflict depends on the market

1. It depends on how well informed consumers are, because a shopper who cannot see how a product was made cannot reward the firm that made it well, so the ethical producer carries the cost for nothing.
2. It depends on whether consumers will pay more, since a household on a tight budget buys on price, which is why the ethical premium shrinks when incomes are squeezed.
3. It depends on how tight the regulation is, because a rule enforced with real fines turns an ethical cost into an unavoidable cost for every firm at once, so no rival gains by ignoring it.

Regulation and information close a genuine conflict

1. The law sets a floor under every producer, through the National Minimum Wage and National Living Wage, health and safety law and environmental permits.
2. Information does the rest, since labelling, published audits and investigative journalism let consumers act on what they now know.

1.4.2a Production versus productivity

Production is a total; productivity is a ratio

1. Production is counted in units of output, such as 4,800 loaves a week or 500,000 cars a year, and says nothing about how many workers it took.
2. Productivity is a ratio, so it always carries its input and its period, as in loaves per worker per week.
3. Labour productivity divides the total by the workers who made it: $labour\; productivity=\frac{total\; output}{number\; of\; workers}$.
4. Dividing by hours worked instead gives output per worker per hour, the measure the Office for National Statistics uses to compare the UK with other countries.
5. Any input works the same way, so output per machine, output per hectare and sales per shop are all productivity measures.

Production can rise while productivity falls

1. Hiring raises the top and the bottom of the fraction at once, so productivity moves whichever way the larger percentage change points.
2. If output rises by a smaller percentage than the workforce, output per worker falls even though the firm is making more than it ever has.
3. That is the normal result of crowding extra staff into the same premises, because the newcomers share machines, tools and supervision.

Redundancies reverse the arithmetic, so neither proves the other

1. Redundancies work in reverse: total output falls, but if the least productive work is what goes, output per worker rises.
2. So record output is not proof of higher productivity, and falling output is not proof of lower productivity.

The distinction decides what a figure actually tells you

1. Only productivity tells you whether the same land, labour and capital is being used better, which is what makes a firm cheaper to run rather than simply bigger.
2. It is also the only fair comparison between firms of different sizes, since total output merely tells you which is larger.
3. It is not a measure of how hard people work, because better machines, training and organisation raise output per worker without anyone working harder.
4. A country works the same way, since an economy can raise total output just by employing more people, and raising output per worker is what lets pay rise without prices rising to match.
   1. UK output per hour has grown unusually slowly since 2008, which is why weak productivity is blamed for weak growth in real pay.

What raises productivity, and what a firm and a country gain from it, is 1.4.2b.

1.4.2b Factors and benefits of productivity

Training, capital and motivation each lift output per worker

Production, productivity and the difference between them are 1.4.2a. This article takes output per worker as given and asks first what moves it, then what it is worth.

1. Education and training: a trained worker finishes the task faster and scraps less material, so output per worker rises without a single extra hour being worked.
   1. Nissan's Sunderland plant runs continuous on-the-job training alongside team working, and became one of the most productive car plants in Europe measured by cars per worker.
2. Capital investment and technology: a faster machine, a robot or better software hands each worker more output in the same time, and this is the single largest source of productivity growth.
   1. Self-service checkouts let one Tesco colleague supervise six tills, though the investment has to be paid for before any of that saving appears.
3. Worker motivation: fair pay, bonuses, sick pay and decent conditions raise the effort a worker chooses to put into hours the firm is already paying for.
   1. Motivation also cuts absence and staff turnover, so fewer hours are lost and fewer new starters are working at learner speed.
4. Management quality: good managers plan the layout, schedule maintenance and have materials waiting where they are needed, so less of each paid hour is spent waiting.
   1. Weak management is why two factories with identical machines and equally skilled workers can differ sharply in output per worker.
5. Specialisation and the division of labour: splitting a process into separate tasks lets each worker repeat one until they are expert at it, with no time lost switching between tools.
   1. A Greggs shop works this way at lunchtime, with one person on the counter, one on the ovens and one on drinks.
6. Infrastructure and the quality of inputs: roads, rail, broadband and reliable electricity decide how much of a worker's day is productive, which is why congestion and slow connections show up as lower output per worker.
   1. Better components matter too, since a worker reworking faulty parts turns fewer hours into finished output.

Benefits: more output, lower unit costs

1. Wages, rent and machine costs are largely fixed across a week, so if the same bill produces more units, the cost of each unit falls.
2. That cost per unit is the average cost, and it sets both the lowest price the firm could charge and the margin it earns at any price it does charge.
3. A lower average cost hands the firm a choice: cut the price to win customers, hold the price and take a wider margin, or split the gain between the two.
4. Nothing here needed the firm to get bigger, since the saving comes from using less input per unit rather than from producing on a larger scale.

Lower unit costs benefit consumers, workers and the economy

1. Consumers gain where competition forces the saving into the price, so the same income buys more.
   1. Where a firm has few rivals it can keep the saving as profit instead, so the gain to consumers is never automatic.
2. Workers can be paid more, because a bakery getting 1,000 loaves from each baker instead of 800 can raise pay and still pay less in wages for every loaf.
   1. This is the only way real wages can rise right across an economy without prices rising to match.
3. Firms become more competitive, since a lower cost per unit lets them undercut rivals on price or spend more on quality at the same price.
4. International competitiveness improves the same way, so UK exporters can win orders against German or Chinese rivals on cost rather than needing a weaker pound to do it.
5. Profit can rise even at an unchanged price, and that profit funds the next round of investment and training, which raises productivity again.
6. The economy produces more from the same land, labour and capital, which is real economic growth rather than simply more people being employed.
   1. Higher output per person is what lifts average living standards, which is why the UK's slow productivity growth since 2008 has gone hand in hand with slow growth in real pay.

The benefits are real, but neither automatic nor instant

1. The gain has to be paid for first, since machines, training and reorganisation all cost money before they save any.
2. It can be shared unevenly, so shareholders may take it as profit while pay and prices stay exactly where they were.
3. Raising output per worker can cost jobs in the short run, because the same output now needs fewer people to make it.
   1. It need not cost jobs overall, since lower prices raise the quantity demanded and the money saved is spent elsewhere, creating work there.
4. Some ways of raising the figure damage other things, so cutting breaks or pushing line speeds lifts output per worker while raising accidents, defects and turnover.
5. Measured productivity can also rise for the wrong reason, since making the least productive workers redundant raises the average without anything actually improving.

1.4.3a Economies of scale and business behaviour

Higher production can lower the cost per unit

1. The formula puts output underneath: $average\; cost=\frac{total\; cost}{output}$, so average cost falls as output rises whenever total cost rises by proportionally less than output does. This is the one sentence 1.4.3b and 1.4.3c both build on.
2. Fixed costs are the clearest route, because rent, machinery, insurance and head office are paid whatever the output, so every extra unit carries a smaller share of them.
   1. Section 1.4.1b sets out fixed, variable, total and average cost in full, so all you need here is the single division.
3. Total cost almost always rises as output rises, since more flour, more electricity and more hours are used, which is why the saving can only be seen per unit.
4. The gain is captured only when the larger output is actually made and sold, because a half empty factory spreads its fixed costs over fewer units, not more.

Cheaper units change how firms behave

1. Growth becomes an objective in its own right, because a larger output is the only way to reach the lower average cost, so firms open branches, buy rivals and chase volume they do not immediately need.
2. A large firm can undercut a small one and still profit, since a price leaving 10p on each of its units can leave a loss on each of the smaller rival's dearer units.
3. Some firms cut price deliberately to win volume, because the extra sales lower average cost further, which pays for the next price cut, and Aldi has used that loop to take share from far larger grocers.
4. The cost gap works as a barrier to entry, as a new firm necessarily starts small and so starts with a higher average cost than the firms it is trying to beat on price.
5. Industries where the saving is large end up concentrated in a few big producers, which is why car assembly, water, electricity networks and groceries are dominated by a handful of names.
   1. Where the saving is small, as in hairdressing, plumbing and independent cafes, thousands of tiny firms survive side by side.
6. Firms redesign what they make, favouring standard products in long runs, because standardisation is what makes the big machine and the long run possible in the first place.

Growth brings lower costs, market power and finance

1. Lower unit costs are the benefit AQA cares about most, and can be taken as a lower price to win customers or as a wider margin at the old price.
2. Market power grows with size, so a bigger firm can press suppliers for better terms and raise its own price with less fear of losing customers.
3. Finance becomes easier and cheaper, because a large firm has more assets to offer as security and can raise money by issuing shares or bonds, which is closed to a corner shop.
4. Risk is spread once the firm sells several products in several places, so a bad year in one market no longer threatens the whole business.
5. Survival improves, since a firm with lower average costs can trade through a price war or a recession that bankrupts higher cost rivals.

Growth costs control, flexibility and safety

1. It becomes harder to manage and coordinate, because decisions one owner used to take alone now pass through layers of managers, and each layer adds delay and salary.
2. Flexibility and personal service are lost, since a plant built for long runs cannot switch quickly to a new design and a national chain cannot know its customers the way a single shop does.
3. Borrowing rises, and the interest is owed whether the extra output sells or not, so a firm expanding on debt into a falling market can be pushed into losses.
4. Diseconomies of scale become a real risk, meaning average cost turns back upwards past a certain size, which is 1.4.3c.
5. Growth by takeover is expensive in itself, because the buyer pays a premium for the target and then has to merge two workforces, two computer systems and two sets of habits.

Whether growth pays off depends on the firm

1. It depends on the industry, because scale is decisive where machinery is huge and products standard, as in car assembly or cement, and worth almost nothing to a plumber whose job differs in every house.
2. It depends on whether the extra output can be sold, since a firm that produces more cheaply and then cannot shift the units has raised its costs and its stock, not lowered them.
3. It depends on how the growth is paid for, because expansion funded from retained profit can be slowed if demand disappoints, while expansion funded by borrowing carries interest that cannot.
4. It depends on how well the firm is organised, as splitting a large business into divisions with their own budgets can hold average cost down at sizes that would otherwise become unmanageable.
5. It depends on whose interests you are judging, since owners collect the lower unit costs while customers gain only if competition forces the saving into prices, and workers may face a less personal employer.

Growth pays off until average cost stops falling

1. Average cost sits on the vertical axis and output on the horizontal axis; the curve falls as economies of scale are captured, then reaches a minimum.
2. That minimum is the output a firm chasing lower costs is aiming for; beyond it the curve turns upward into the U shape covered in 1.4.3c.

1.4.3b Types of economy of scale

Five routes lead to the same lower cost

1. Section 1.4.3a established that an economy of scale is a fall in average cost as output rises, so the work here is to name the route and trace it to the cost of one unit.
2. A growing firm usually collects several routes at once, since the supermarket ordering more stock is also buying bigger lorries and hiring specialist buyers in the same year.

Managerial, purchasing and financial economies come from organisation

1. Managerial: a small firm's owner has to be accountant, buyer, marketer and production manager at once, and is unlikely to be good at all four. Only at high output is a full-time specialist for each worth their salary, and then average cost falls twice over: better decisions waste less, and the salaries are divided between a very large number of units.
   1. Tesco employs separate directors and whole teams for buying, logistics, property, technology and people, and their pay spread across billions of pounds of sales adds a fraction of a penny to each item; the same salaries in a corner shop would be impossible.
2. Purchasing: a supplier shipping one large order instead of forty small ones spreads its own delivery, invoicing and selling costs over more units, so it can charge less per unit and still profit. Materials are often the buyer's largest single cost, so its average cost falls with them.
   1. The NHS buys medicines and equipment for around 1.5 million staff and the whole of England at once, securing prices no single hospital could negotiate, and Aldi's narrow range of about 2,000 lines means each line is ordered in huge volume.
3. Financial: a bank judges a large, established firm less likely to fail and has more assets to seize if it does, so it lends at a lower rate, and a large firm can skip the bank altogether by issuing shares or bonds. Interest is a cost like any other, so cheaper money on the same machine lowers average cost at every level of output.
   1. Tesco can borrow by selling bonds to investors while the independent grocer down the road negotiates an overdraft, and the gap between the two rates of interest is the economy.

Technical and risk-bearing economies come from scale

1. Technical: a large machine or production line only repays its purchase price at high output, but once running it makes each unit more cheaply than smaller equipment can, and high output also makes it worth breaking production into specialised stages so each machine and worker repeats one task.
   1. Larger containers, lorries and ships cost less per unit of what they carry, because doubling the size of a tank costs far less than doubling the metal around it.
   2. Nissan's Sunderland plant runs robotic body and paint lines that only make sense at roughly 300,000 vehicles a year, and JCB machines digger parts on dedicated lines rather than general purpose tools.
2. Risk-bearing: a firm with one product in one town loses everything if tastes move, while a firm with twenty products in ten countries loses one twentieth of its sales.
   1. That steadiness lowers cost without any supplier cutting a price, since lenders and insurers charge less for a business whose income is steady, the firm can afford to test products that may fail, and it can hold less idle cash against a bad month.
   2. JCB sells many machine models into dozens of countries, so a construction slowdown in one market no longer threatens the whole firm, and Tesco spreads risk across groceries, clothing, banking and several countries.

Spotting which type a question is describing

1. Ask what the firm bought or hired, since machinery and vehicles point to technical, materials and stock to purchasing, and managers to managerial.
2. Ask who charged less, because a lender charging less is financial while a supplier charging less is purchasing, and candidates lose marks by swapping the two.
3. Ask whether the saving came from safety rather than from a bill going down, since risk-bearing works through spread and steadiness rather than a visible discount.
4. Then name the type, give the firm that shows it, and finish with the same sentence every time: the cost of each unit falls, so average cost falls.

1.4.3c Diseconomies of scale

Beyond a point, more output raises unit costs

1. Section 1.4.3a followed average cost downwards as a firm grew, and diseconomies are simply what happens on the far side of the lowest point.
2. The trigger is the same rise in production, so the two ideas differ in effect rather than in cause.
3. Average cost sits on the vertical axis and output on the horizontal axis: the curve falls, hits a minimum, then rises again, the characteristic U shape.
4. The output at that minimum is the optimum output: growing towards it lowers average cost, growing past it raises it.

The causes are organisational, not technological

1. Communication breaks down: a message in a firm of tens of thousands passes through several layers of management and arrives late, incomplete or changed, so decisions are made on stale information.
   1. In an Amazon UK fulfilment centre of several thousand staff, a change to a picking rule that reaches one shift and not the next produces a day of wasted work that still has to be paid for.
2. Coordination and duplication get expensive: more sites, product lines and departments need more managers, meetings and monitoring, and none of that adds a single unit of output.
   1. The NHS employs around 1.5 million people across hundreds of separate organisations, and two trusts buying the same equipment on different contracts raises the cost per patient treated.
3. Worker motivation weakens: a worker who never meets a manager, and whose effort makes no visible difference to a business of this size, has little reason to push, so lower output per worker, more absence and higher turnover all mean the same wage bill buys fewer units.
4. Management layers turn into bureaucracy: each new layer of managers, forms and approvals is a salary and a delay, and waste is harder to see from the top, so departments duplicate each other's work and nobody is answerable for the total.
5. Quality gets harder to monitor: checking standards across roughly 2,600 Greggs shops or hundreds of Tesco stores costs money, and every batch thrown away or replaced is paid for out of the same output.

Diseconomies depend on organisation, not just size

1. It depends on how the firm is structured, because splitting a business into divisions with their own budgets and targets restores the short lines of command that made it cheap when it was small.
2. It depends on how well information moves, since shared stock and sales systems let a head office see every store in real time, which is why national grocers can run thousands of shops without losing control of them.
3. It depends on how workers are managed and paid, as bonuses, team working, promotion from the shop floor and giving staff real decisions all recover motivation that sheer size takes away.
4. It depends on how far past the optimum the firm has gone, because a small overshoot costs pennies a unit while a firm that has doubled past its best size may have given back every economy it ever gained.
5. It depends on the industry, since a firm assembling a standard product on one site can grow very large before coordination bites, while a firm whose service is delivered face to face runs into the limit far sooner.

Diseconomies limit growth but do not stop it

1. Notice what is not being claimed: output is still rising past the optimum, sales may still be rising and total profit may still be rising, and only the cost of each unit has turned.
2. A firm can therefore choose to accept a higher average cost to win a bigger market, which is why the largest firm in an industry is rarely the cheapest per unit.
3. The decision is whether the extra volume is worth more than the pennies added to every unit, which is exactly the weighing up of the costs and benefits of growth in 1.4.3a.