Increasing or Decreasing Returns to Scale
Categories: Econ, Financial Theory
Why is Costco so beloved among middle class families? Because of that bulk pricing, baby!
Bulk pricing is a thing because of increasing returns to scale. Increasing returns to scale is when output grows at a faster rate than inputs in production. For instance, a one-baker bakery might be able to produce 10 baked goods an hour, while a three-baker bakery might be able to produce 40 baked goods an hour.
While the input tripled, going from one baker to three, the output quadrupled.
Increasing returns to scale is the reason larger companies sometimes take over the market share of smaller companies. Often, larger companies can produce more output per input than smaller companies, which means some of those savings can get passed on to consumers, outpricing the smaller businesses (sorry, guys).
The buck does stop somewhere, though. If companies get too big and isn't managing all of those inputs very well, things could easily go down the "decreasing returns to scale" route. Decreasing returns to scale is the opposite of increasing returns to scale, when adding more inputs actually decreases output made per input added.
For instance, if we add five bakers to that bakery, and there’s not enough room and ovens for them all, they are able to produce only 45 goods per hour. That’s only five more baked goods from two more bakers in the kitchen...literally too many cooks in the kitchen. Something’s gotta give if the additional output isn’t worth the additional input.
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Finance: What does it mean to "scale"?57 Views
Finance allah shmoop What does it mean to scale Well
here's a squid eyeball from space fifty miles away and
here's a squid eyeball from our boat the pesca squid
alia's from a mile away and here's a squid eyeball
from the view of our iphone we just dropped in
the water when the squids when right beneath the boat
scaring the crap out of us literally at one scale
we could barely see the ocean At another scale We
saw way too much eye ball scale and business has
the same kind of dramatic effect as operations come into
play That is it's One thing to serve lemonade drinks
to one hundred people a week It takes one stand
a permit grocery store visits worth of supplies it's completely
Another thing Toe serve a million drinks a week for
the latter You need infrastructure trucks storage and armies of
servers to you know serve Yeah that's what they do
someone's gotta get lemonades to the people So when a
company scales it means that they have gone from a
modest few million dollars of sales to sales of maybe
one hundred million and then a billion Some like that
The skill set for the former is a vastly different
set than for the ladder and some people are able
to do both Howard schultz founder and ceo of starbucks
We're looking at you well starbucks started off is just
one store in seattle in like five minutes later there
were a gazillion of them all over the world thinking
of coffee in any language So yeah that's How a
company scales from you little toe Big big Incidentally you'll
want to stay off the scale if you consume venti
caramel frappe with whip on a daily basis but on 00:01:44.897 --> [endTime] there so good