the factors that influence the scale of a business

9.1 Location and Scale – Scale of Operations

Learning Objective

To understand:

• What determines the scale of a business and how it is measured;
• How internal and external economies and diseconomies of scale operate;
• How scale influences strategic choices about growth, location, off‑shoring/reshoring and risk.

1. What is “Scale of Operations”?

The scale of operations describes the size of a business in quantitative terms. It can be measured by a range of metrics, each of which is more appropriate for certain types of business.

2. Factors that Influence Scale

2.1 Internal Factors

• Economies of Scale (internal) – Cost advantages that arise when output rises, causing average cost (AC) to fall.
• Technical economies – Use of specialised, high‑capacity machinery (e.g., Toyota’s assembly line).
• Managerial economies – More efficient planning, control and coordination by a larger management team (e.g., Tesco’s national logistics hub).
• Financial economies – Access to cheaper long‑term finance because of a larger asset base (e.g., Apple’s cash reserves enabling plant upgrades).
• Managerial capacity – The ability of senior managers to oversee larger, more complex operations.
• Financial resources – Internal cash, bank loans or equity that can fund expansion.
• Technology & innovation – Automation, ICT systems or new processes that raise output without a proportional rise in cost (e.g., Amazon’s robotics in fulfilment centres).
• Organisational structure – Need for more formal structures (divisional, matrix) as the firm grows.

2.2 External Factors

• Market size & demand – Larger or growing markets can absorb higher output (e.g., expanding Indian middle class driving FMCG growth).
• Competitive environment – Intense price competition may force firms to enlarge scale for cost leadership (e.g., Walmart’s bulk purchasing).
• Government policy & regulation
  • UK R&D tax credit encouraging larger research facilities.
  • EU “Green Deal” subsidies for low‑carbon production.
  • Brexit‑related tariff changes influencing off‑shoring decisions.
• Location & infrastructure – Proximity to ports, highways, utilities and skilled labour determines the optimal scale of a plant.
• Supply‑chain constraints – Availability of raw materials, logistics capacity and supplier reliability (e.g., global chip shortage limiting automotive output).
• Economic conditions – Inflation, interest rates and exchange rates affect the cost of expanding capacity.
• External economies of scale – Benefits that arise from the wider business environment rather than the firm itself.
• Examples:
  • Supplier clustering in Shenzhen reduces transport costs for electronics manufacturers.
  • Well‑developed transport networks in the Netherlands lower distribution costs for multinational firms.
• Globalisation: off‑shoring & reshoring
  • Off‑shoring to lower‑cost countries to achieve cheaper unit costs (e.g., Apple moving part of iPhone assembly from China to Vietnam).
  • Reshoring to reduce lead‑times, mitigate supply‑chain risk or avoid tariffs (e.g., U.S. car makers bringing battery production back to the USA).
  • Risks to consider: political instability, exchange‑rate exposure, customs duties, and loss of control over quality.

3. Economies and Diseconomies of Scale

3.1 Definitions (Syllabus Requirement 9.1 2)

3.2 The Average‑Cost Curve

Average cost (AC) = Total Cost (TC) ÷ Output (Q). As output rises, AC falls (economies) until the firm reaches an optimal output; beyond that point AC rises (diseconomies).

3.3 Internal vs. External Economies – Quick Reference

4. Advantages & Disadvantages of Different Scales (Stakeholder Impact)

5. Decision‑Making Process for Determining the Optimal Scale

The process mirrors the Business Decision‑Making stages (identify options, evaluate, select, implement) required by the syllabus.

1. Identify the strategic objective – e.g., increase market share, reduce unit cost, enter a new region.
2. Analyse market demand & growth forecasts – use sales data, demographic trends and competitor analysis.
3. Assess internal resources – finance, technology, managerial capacity and current organisational structure.
4. Estimate cost curves
   • Plot a simple average‑cost diagram (see Figure 1) to locate the output level where economies turn into diseconomies.
   • Identify the “optimal scale” – the output at the lowest point of the AC curve.
5. Examine external constraints – location, infrastructure, regulatory environment, supply‑chain reliability and macro‑economic conditions.
6. Identify and evaluate risks
   • Over‑capacity risk – producing more than the market can absorb.
   • Exchange‑rate exposure – especially for export‑oriented scale.
   • Regulatory risk – changes in trade policy or environmental legislation.
   • Supply‑chain risk – disruption, off‑shoring/reshoring implications.
7. Conduct a weighted scoring matrix – compare small, medium and large scenarios against criteria such as cost, revenue potential, risk, flexibility and stakeholder impact.
8. Select the optimal scale – choose the option with the highest weighted score.
9. Develop an implementation plan
   • Timelines, capital investment, staffing plan, location choice.
   • Monitoring mechanisms – periodic review of actual AC against projected curves.

6. Linking Scale to Location Decisions

• Transport hubs – Larger scale justifies locating near major ports, airports or rail terminals to minimise distribution costs (e.g., a car‑manufacturing plant near the Port of Rotterdam).
• Industrial clusters – External economies of scale encourage locating in zones where suppliers, utilities and skilled labour are concentrated (e.g., electronics firms in Shenzhen).
• Off‑shoring & reshoring
  • Off‑shoring is driven by lower labour or tax costs, but adds supply‑chain and political risk.
  • Reshoring can reduce lead‑times, improve quality control and mitigate tariff exposure, but may increase unit costs.
  • Decision‑makers must weigh cost savings against risk, brand perception and stakeholder expectations.
• Regulatory & trade environment – Brexit‑induced customs duties, EU environmental standards or UK R&D incentives can tip the balance between domestic expansion and overseas production.

7. Quantitative Tools Used in Scale Analysis

• Cost‑curve modelling – Plotting total, average and marginal cost against output to locate the optimal scale.
• Weighted scoring matrix – A simple decision‑making tool that assigns scores (e.g., 1‑5) to each option for criteria such as cost, revenue, risk and flexibility, then calculates a total weighted score.
• Break‑even analysis – Determines the output level at which total revenue equals total cost, useful for assessing the viability of scaling up.

8. Key Takeaways

• The scale of a business is shaped by a mix of internal capabilities (economies of scale, finance, technology, management) and external conditions (market size, competition, government policy, infrastructure, supply‑chain and globalisation).
• Internal and external economies of scale lower per‑unit costs; diseconomies arise when a firm becomes too large, causing average costs to rise.
• Strategic decisions about scale must balance cost efficiency with flexibility, stakeholder impact and risk, and they are closely linked to location choices (transport hubs, clusters, off‑shoring/reshoring).
• Effective analysis combines quantitative measures (output, employees, capital, geographic spread), cost‑curve modelling and a structured decision‑making framework (options → evaluation → selection → implementation).