Scope Of Enterprise/Production Unit

Economies of Scale

Definition: Economy of scale: Economy of Scale simply means that, theoretically, as one produces more, the cost per unit produced decreases.

Click here to view a video that explains economies of scale.

In production, economies of scale mean that as an enterprise grows and the number of tons produce produced increases; the enterprise would have a chance to decrease the cost of producing each ton of produce. The same would apply to a packhouse operation or any activity involving inputs and outputs.

Economies of scale are achieved through:

• Buying inputs in bulk, such as fertiliser, pesticides or nursery trees/ livestock.
• Spreading the cost of expensive inputs, such as specialised staff and technical specialists, over an increasing number of tons produced.
• The application of better and more efficient organisational skills and structures.

Just like there are economies of scale (ES), there are also diseconomies of scale (DS) (R. Heakel, Investopedia). This occurs when management inefficiencies result in rising average costs and production is not able to keep pace with the proportional increase in inputs. Inefficient management of labour can, for example, lead to the employment of additional staff whose output is not necessarily higher than it was with a smaller staff number.

There are also external economies of scale. These occur outside of the enterprise itself within the industry, for example using collective bargaining for lower freight costs of commodities out of a region or country. There is a strong case for growers to work together in making more efficient use of packing, transport, and other logistical services. This principle is the basis of fruit cooperatives or companies comprising a number of growers producing fruit etc. in close proximity to one another, and sharing infrastructure and facilities.

Factors Determining the Size of the Enterprise

The size of a production enterprise depends on:

• The availability of fixed and mobile resources, including suitable land in the right climatic area, sufficient good quality soil and water, capital, and skilled and unskilled labour.
• The targeted return on capital, and therefore the possibilities for optimising return on investment through economies of scale.
• The availability and condition of existing facilities, equipment, machinery and infrastructure, such as pump-houses, suitable roads, dams, offices, pack houses, spray machinery, tractors, trailers, animal handling facilities, sheds and vehicle maintenance units.
• The market demand for the range of cultivars that can be produced on the available land. If for, example, there is high demand for a cultivar/ breed which is suited to the area, but the market window is very short, care will have to be taken to ensure that the cultivar/breed is not over-produced, thus stretching the capacity of the resources over a short period of time.

Evaluation of the Factors Determining Enterprise Size

Of the factors listed above, a few taken in combination are critical in determining the size of a production enterprise:

The Trade-Off between Production Efficiency and Market Demand

The ideal situation is to be able to produce large volumes of all the commodities the market most wants. This is however seldom possible, because at a single locality the climatic conditions suited to one favoured commodity may be unsuited to others.

It may for example be possible to produce high quality, early-maturing Star Ruby grapefruit in an area with a hot climate, which may be a winner on the market. It is however not possible under these same climatic conditions to produce one of the other market favourites, such as high-quality late-maturing seedless mandarins.

In livestock production such as beef, there may be high demand and price for beef but the climate of the region may only be able to support smaller breeds like Ngunis or Afrikaners and larger breeding types like Charolais will not be able to adapt.

The grower in the hot area should therefore focus on producing grapefruit. He can do this effectively and efficiently, getting high yields of excellent quality fruit. The grapefruit harvest season however only lasts eight weeks. The principle of economies of scale says that he should plant other later maturing cultivars to spread his risk and his costs. But these cultivars may not be ideally suited to the region and so his overall or average production efficiency will not be optimal.

The breeder in an area less suitable for beef production has to choose a breed that will be able to withstand the climate and give a profitable yield of beef.

Sometimes growers are faced with the contradiction of being in a region where they are able to successfully produce those cultivars that only have a fair market demand while struggling to produce those cultivars that are in high demand on the market.

Clearly, a balance has to be struck and very careful planning has to be put into deciding on the ratio and overall quantity of the different cultivars to produce, given the market opportunities and the characteristics of the area.

It is this that plays an important role in determining the overall size of the enterprise: The greater the opportunity to produce a range of market-desired products well, the lower the chances of outright failure in a particular season (risk), the larger the likely return on investment, and thus the larger the enterprise can afford to be.

The Trade-Off between Cultivar Suitability and Costs

Market forces will normally dictate that the more suitable a region is for the production of the greatest diversity of market-desired products, the more expensive the land and other resources will be. For example, the Western Cape is a region that has access to the full range of available export markets. Climatically it is also a region that can support the production of high-quality fruit and wine of the most desired cultivars. However, land for planting is scarce and expensive.

Here too, careful analysis is required to decide on the final size of the enterprise, taking all of these factors into account.

There will be circumstances where it will make sense for a grower to invest in two or even three production units located in different regions so that the full range of cultivars can be produced and packed under one brand name.

There are also instances where, for technical reasons, it may pay to focus all attention on just two varieties, so as to exploit the inherently high yield and quality factors related to the climatic conditions that best favour both of them.

It should be clear from the information given above that deciding on the size of a production enterprise is a complex issue that is dependent on the interaction of various factors. The ability to produce high yields of a spread of market-desired products coupled with the availability of key resources, of which capital is critical, are the defining factors. The financial or business plan that is able to interactively compare the merits of various options is a vital planning tool in this regard.