CIMA BA1 Syllabus B. Microeconomic And Organisational Context Of Business - Impact of long run costs on industry structure - Notes ^{3 / 9}

Minimum efficient scale is the lowest level of output at which a firm can achieve its minimum average cost.

If a firm is producing at quantities below the MES, its unit costs of production may be higher than those of its bigger rivals.

This means it will be at a competitive disadvantage.

If Company 1 is producing at Q1 it will have unit costs of C1.
It has not reached minimum efficient scale.

Company 2 is producing at Q2 and has unit costs of C2, the minimum feasible cost in the industry.

Company 2 might seek to set market price at PO to cause losses of C1 — PO per unit on Company 1 whilst making profits per unit of PO - C2 itself.

This could have the effect of driving Company 1 from the industry.

The level of the MES will vary in different industries.

In industries where:

Fixed costs are low
- then the MES will be low
eg software, apps
Fixed costs are higher as a percentage of total costs
- then MES will be high
eg aircraft manufacture, mining

= The percentage of market share taken up by the largest firms.

It could be a 3 firm concentration ratio (market share of 3 biggest) or a 5 firm concentration ratio.

Concentration ratios are used to determine the market structure and competitiveness of the market.

eg the five-firm concentration ratio for UK supermarkets is approximately 66%

Tesco – 24%
Asda 13%
Sainsbury’s 13%
Morrisons 12%
Co-op 5%

Companies can increase the scale of their operations by:

Internal (organic) growth
— investing to build the company's own capacity to enable higher production levels so that internal economies of scale can be generated.
Acquiring other companies
— a strategy of buying another company may be referred to either as an acquisition, merger or as an integration strategy.

Involves the acquisition of a rival firm in the same line of business

eg Volkswagen acquired Skoda

Horizontal integration is likely to create internal economies of scale and to reduce competition.

The acquisition of a firm that operate at different stages of production.

Backward vertical integration is where a firm merges with a supplier.

Forward vertical integration is where a firm merges with a customer

eg Booker, a food supplier, acquired Budgens and Londis (food retailers).

Also called diversification, this involves the acquisition of a firm in a different line of business.

Sometimes there may be a link between the two businesses

eg Lenovo (computers) acquisition of Motorola (mobile phones).