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Minimum efficient scale (MES) is a term used in production sector to denote the lowest output that a plant or an organization can manufacture such that the average costs are minimized in the future. In other words, the smallest quantity of production a business can achieve while still taking full benefit of economies of scale with regards to materials and expenditure. In traditional economics, the least efficient level is defined as the lowest manufacturing point at which long-run total average costs (LRATC) are minimized. It is the output for a business in the long run where the internal economies of scale have been fully exploited such as greater than before labour supply, enhanced specialization, better technology, and innovation of new resources.
The MES is hardly ever a solitary output – more likely it is a range of production levels where standard cost is minimized where the firm achieves regular returns to scale. It varies from industry to industry depending on the type of the cost structure in a particular segment of the market. When the proportion of fixed to variable costs is very elevated, there is huge potential for dropping the average cost of production.
Significance in the competition
The minimum efficient scale may be expressed as a variety of production standards, but its connection with the whole market size or demand will conclude how many competitors can successfully function in the market.
If the minimum efficient scale is comparatively diminutive compared to total market size many companies can survive in the same space for example computer software companies. In other industries where the minimum efficient scale is quite large due to high fixed costs, only a few major players dominate the market place for example telecom and other basic materials.
There is also likely to be enormous potential to take advantage of technical economies of scale. As a consequence the MES may be a high quantity of entire market demand. There may be an opportunity merely for single business to completely exploit the economies of scale obtainable in the industry. It is presumed for a natural monopoly that the long-run average cost curve falls constantly over a very great range of output. This is illustrated in the diagram below.
Companies are able to exploit the market when the range of their minimum efficiency scale is high as this applies a barrier to entry. The higher the barriers to entry, the greater the ability of established firms to raise price above the long run average costs without letting the new firms enter the market this includes foreign competition too. Although production cost barriers are faced by both local and foreign companies, the foreigners face an additional barrier of tariffs levied by the government.
As the manufacturers expand their scale of production, average costs decrease to minimum efficient scale that is to the optimal point. As they expand further than that, they become incompetently large, and face increasing average costs. Hence if we assume they increased too far, and finally settled at the minimum efficient scales they have oppressed all Economies of Scale, and Diseconomies of Scale, in manufacturing.
Big firms can have lesser per-unit costs due to purchasing at bulk discounts example parts, indemnity, real estate, marketing, etc. and can also bound competition by buying out competitors, setting proprietary industry values. Looking at further examples, an automobile maker can buy millions of tons of steel at one point for use in forming engine blocks and store it for an indefinite period, if this will get a superior price. On the other hand, a florist can’t buy millions of tons of matured flowers to put up for sale as they will shrivel before they are sold. This results in disparate interpretations of economies of scales for diverse types of companies.
The size of a business may also alter over time, as industry and marketplace circumstances change. If a dealer finds a way to produce small batches of a major part at prices similar to the large batch price, this will aid little firms more than large firms. A farming society will tend to have small firms, as cultivation has a limited economy of scale due to limited refrigerated storage facilities. A service-based market will once more support smaller firms, as services have a limited economy of scale but this is open to exceptions such as the Microsoft which is a known service provider.
High excellence and low quality firms have unusual cost curves and dissimilar minimum efficient scales of function. This leads to the inconsistent outcome that the low quality firms can be working at MES which is suitable for their quality level, while the high quality firms are still determined to attain MES although they are normally much larger than the low quality firms even as both types of firms participate in the same universal market. These conclusions have significant implications for firms’ advertising strategies and it is likely that more low quality regional competitors will exist than high quality firms who will strive to achieve an improved level of minimum efficient scale.
Looking at the example of one of the most successful automobile firms, between years 2001 and 2005, Toyota’s worldwide sales increased from 5.5 million units to 8 million units. Within the industry, Toyota had an outstanding equilibrium of cost-effectiveness and quality. Although recent recalls may have affected their standing, they did not blow financial results. In the year 2005, Toyota was one of only two production organizations being a part of the “$10 billion club” – exposing a net income in surplus of $10 billion. With this act, Toyota is extensively seen as the most flourishing automobile company and has become the yardstick for the global automotive industry due to its efficient production methods and exploitation of advanced technology.
The minimum efficient size is the bare minimum size of corporation necessary for the lowest cost production. Beneath the minimum efficient scale there are diseconomies of scale due to the small size of the company. In this region, as the scale of productivity rises the business becomes more proficient and experiences growing economies of scale. Over the minimum efficient scale there are also diseconomies of scale as the size of the company increases, the management becomes less well-organized, and the typical costs rise. Therefore, there is pressure on any company to increase until it has reached the dimension of minimum efficient scale. Thereafter, a company may still expand through merger, acquisition or invasion but this will be dictated by corporate objectives as much as the need to realize minimum efficient scale.
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