MES is the location at the LRAC curve where a company can operate profitably and efficiently with the least cost per unit. A minimum efficiency scale may also refer to an output range for which the business receives consistent returns and the lowest unit cost feasible.
Understanding Minimum Efficient Scale
For businesses that manufacture products, it is essential to establish an equilibrium between the demand of consumers as well as the volume of production and the costs involved in producing and delivering products. There are a variety of production costs involved in establishing an efficient minimum scale; however, its relation to the size of its market, that is, the market demand for the product, will determine the amount of competition that can be able to compete. That is, MES seeks to identify the level at which a business can produce its goods at a low cost enough to offer the same product at a reasonable price on the market.
MES and Economies of Scale
MES is the point at which the unit price has reached its lowest value while the company produces its goods efficiently. MES helps a business be more competitive by producing its products at the lowest cost per unit. Economies of scale achieve MES.
Economies of Scale
The term "Economies of Scale" refers to the fact that an organization reduces its cost per unit of production while also increasing production. As production numbers increase, the overall cost is divided over the greater amount of units produced. Scale economies can improve the efficiency of a company and increase its profits. But, the lower cost will also permit a company to pass on savings to customers with reduced prices, which can increase the company's competitive edge.
Internal Economies of Scale
Businesses can realize internal scale economies through improvements to their internal processes. For instance, Henry Ford improved Ford's production capacity by setting up an assembly line that moved. The steps in the process of assembly were split into sections so that each worker had an assigned job.
Before the assembly line, one worker could finish all the tasks and be inefficient as it required more skilled workers and increased labor costs. Ford expanded its manufacturing at an affordable cost per unit because it could hire untrained labor to do specific jobs. The minimum efficient scale of a company is the level of productivity at which the internal scale of its operations generates output that is as efficient and affordable as possible. This MES is the point on a firm's long-term average cost curve at which its internal economics of scale are exhausted, and continuous returns have started.
External Economies of Scale
There are also External economies of scale, when an external influence increases the scale of the entire industry, like an industry-wide tax break. For instance, the government could offer a tax break to businesses that buy new equipment, benefiting every company in the sector.
Diseconomies of Scale
When returns are constant, the U-shaped curve is straight (see the earlier chart) until the diseconomies of scale start to appear and the costs rise even without input. As businesses grow more complex, they may experience increased costs and lower economies of scale. This is often the case when managing a larger organization becomes difficult, leading to inadequate communication between employees and management, which can increase the cost of a long-term unit.
Example
XYZ business is a manufacturer and maker of mobile devices. It was looking to increase its production capacity to increase revenues while also reducing the cost of production.
Internal Economies of Scale
The company decided to purchase new equipment to replace obsolete machinery and technology. The latest technology-enhanced the quantity of production and speed of making goods, which reduced the average cost over the long run per unit. Because this new machine was much more effective, it utilized fewer input items and raw materials during the manufacturing process.
While the new technology requires some cash investment, XYZ company achieved higher profit margins through internal economies of scale. The company could boost its sales because the new machinery could handle greater production volumes and lower input costs, making it easier to reduce the variable costs of manufacturing mobile devices. Because of the increased production and sales volumes, XYZ could acquire the raw materials needed in larger quantities or bulk at a discounted volume. The bulk purchase also decreased the cost of production over time per unit.
Minimum Efficient Scale
In the end, a minimum efficiency scale was introduced, and the latest technology did not reduce costs any further, even as production increased. This meant that XYZ company could achieve continuous returns to scale, so the savings from internal economies of scale were exhausted.
