Practise explaining economies and diseconomies of scale, and evaluating how production size affects unit costs, flexibility, and business decisions for IB Business Management SL.
EkoLogiczne Ltd. (EL)
EkoLogiczne Ltd. (EL) is a packaging company owned 60 % by Marek Kowalski and 40 % by his father. EL is a private limited company. Marek founded the company when he realized that the rise in e-commerce would mean the demand for packaging would always increase.
Originally, Marek imagined that EL's unique selling point/proposition (USP) would be to offer recyclable packaging. However, the eco-friendly market was dominated by one large company, Big Boxes (BB), which enjoyed economies of scale. Marek reimagined his USP: EL would have small factories that enabled customized orders to be fulfilled quickly.
Over time, EL opened four factories across Poland and the Czech Republic. Its customers, which included online retailers and small manufacturing companies, placed orders online; if the factory nearest the customer was too busy with other orders, the order would be shifted to another factory. Many customers chose EL rather than BB for this reason. With growth, however, EL began to experience diseconomies of scale and increasingly failed to fulfil orders on time.
Marek is now considering bidding on a large five-year contract for all the packaging solutions for WszystkoMart (WM), a huge traditional retailer trying to expand its e-commerce presence. The contract would require building a huge factory and focusing almost exclusively on keeping costs low. In terms of scale, EL would be almost as big as BB, the large company dominating the eco-friendly packaging market.
To finance the new factory, Marek would either have to sell many shares and reduce his and his father's combined ownership to 40 % or take a 30 -year loan from a bank.
Explain two diseconomies of scale that EL may have experienced.
EL's decision to have four small factories rather than one large factory allows the company to be responsive to customers and, when possible, manufacture the product in a factory geographically close to the customer. This operating model, however, can cause several diseconomies of scale:
- managerial diseconomies of scale, as each factory must have its own plant manager;
- organizational diseconomies of scale, as coordination of the four factories consumes time and money;
- communication diseconomies of scale. As EL now has multiple factories in two countries where different languages are spoken, communication becomes more challenging and could be more costly by slowing operations down.
- technical diseconomies of scale, at times, according to the stimulus, individual factories are working at full capacity, which can lower productivity because of overcrowding;
- purchasing diseconomies of scale: too much stock in each factory. Stock can also become spoilt, obsolete or unfashionable.
Candidates may state financial or capital diseconomies of scale, with some explanation. However, given the stimulus, there is no opportunity for application. Thus, the maximum a candidate could get for either financial or capital diseconomy of scale is [1].
Accept any other relevant diseconomy of scale.
Mark as [2] + [2].
Award [1] for each diseconomy of scale identified and an additional of [1] for a development with respect to EL. Award a maximum of [2].
[2] cannot be awarded per diseconomy of scale if the response lacks either explanation and / or application.
For example:
For explanation of a diseconomy of scale with no application [1].
For explanation of a diseconomy of scale and application [2].
Discuss whether EL should enter into the contract with W M if they have the winning bid.
EL has many compelling reasons to enter the five-year contract with WszystkoMart (WM):
- WM is a major retailer and in terms of growth for EL this opportunity is special. EL would benefit from WM's experience and from synergies;
- EL could quickly become one of the largest eco-friendly packaging companies;
- the prestige of getting a contract with WM would also presumably enhance EL's reputation;
- the five-year contract would virtually guarantee profits in the first five years;
- it will be able to reduce diseconomies of scale.
EL also has many compelling reasons not to enter the five-year contract with WM:
- Getting in large-scale manufacturing competing on price ("focusing on keeping costs low") would be inconsistent with the USP EL had built;
- The contract would require building a huge factory (huge investment) and neither method of financing the new factory is altogether satisfactory;
- With the debt option, EL would have to take out a 30-year loan but gets only a five-year contract.
- with the equity option, Marek and his father would no longer have a controlling interest (will lose control and power) in the company.
Accept other relevant judgments, if justified.
Marks should be allocated according to the markbands on page 3 with further guidance below. N.B. The marks listed in the far right column are maximum awards.
Maximum award
One argument for entering the contract, very limited application. Lacks balance
[3]
Either two arguments for or against entering the contract, but no balance
OR
One argument for, one argument against entering into the contract.
[4]
Two arguments for a position and one argument against.
[5]
At least two arguments for and two arguments against. No real conclusion.
[6]
At least two arguments for and two arguments against. A conclusion with judgments.
[7-8]
At least two arguments for and two arguments against. A conclusion with judgments. Rich use of business language. Response shows depth of understanding and nuance.
[9-10]