Impact of New Technologies on Scale in Manufacturing Industry

* Report: The Impact of New Technologies on Scale in Manufacturing Industry: Issues and Evidence. By Ludovico Alcorta. UNU/INTECH Working Paper No. 5, June 1992

URL = http://archive.unu.edu/hq/library/Collection/PDF_files/INTECH/INTECHwp05.pdf

Contents

"The paper will proceed as follows. The next section will present a simple conceptual framework examining the relationship between technical change and unit costs and how it may lead to ’de-scaling’ or ’scaling-up’. The paper will then briefly review the literature on the nature of the technological changes that are affecting manufacturing industry. The following section will look into the question of whether NT are ’de-scaling’. It will do so by examining the arguments put forward by ’de-scaling’ authors, as well as the empirical evidence supporting those views. It will focus on the relationship between costs and technological change in each dimension of scale. Inter-industry differences will try to be accounted for. In a fifth section, some other options that NT allegedly open for small firms will be discussed, namely the possibilities of producing in ’new’ industries and of networking. The paper will end with some comments on the impact of NT on the potential for development of small-scale firms." (http://archive.unu.edu/hq/library/Collection/PDF_files/INTECH/INTECHwp05.pdf)

Summary

From the introduction:

"Developments in the fields of microelectronic, information and organisation technologies have led to a host of innovations which seem to be radically changing the nature of manufacturing industry. The increasing replacement of mass production, specialised, single-purpose, fixed equipment by computer aided design and engineering capabilities (CAD/CAE), robots, automatic handling and transporting devices, flexible manufacturing systems (FMS), computer aided/integrated manufacturing (CAM/CIM), cellular manufacturing, just-in-time (JIT) techniques, materials resource planning (MRP) and telematics has allowed firms to produce a larger variety of outputs efficiently in smaller batches and less time. The greater flexibility of new technologies (NT) is also believed to have important implications for the level of ’optimal’ scales. Contrary to the previous ’mass production’ technological paradigm where increasing scales were crucial to cost reductions, NT’s flexibility is said to provide "opportunities to switch production between products and so reverse the tendency towards greater scale" (Kaplinsky, 1990a, pg. 154). A similar view is put forward by Acs et al (1990), who argue that flexible production means that the "optimal size of plant and firm declines and entry occurs by small-scale-flexible producers" (pg. 146). This ’de-scaling’ view is shared by a large proportion of the economics, management and engineering literature that focuses on the impact of recent technical change on scale in manufacturing production.

’De-scaling’ in manufacturing industry could have at least five important related consequences for smaller scale firms and industrialisation.

First, it would increase the efficiency of small-scale production (Dosi, 1988).

Second, it may decrease the importance of plant-related economies of scale that were the source of productivity growth before NT were introduced (Dosi, 1988).

Third, insofar as scale is a barrier to entry to other firms (Bain, 1956), more entry and competition by smaller firms could be expected. Furthermore, it could reduce barriers to entry in international trade in some sectors and facilitate the establishment of national industries where it was previously not feasible.

Fourth, it may ease the ’infant industry’ process that has complicated industrialisation in many developing countries (United Nations University, 1987). Smaller scales may allow for a more widespread impact of the various forms of learning associated with experience and of the ’externalities’ resulting from the acquisition and use of new knowledge.

Finally, it is likely to reduce the importance of ’world factories’ producing on a global scale and therefore change the pattern of location of industry (Kaplinsky, 1990a). It could pave the way to new patterns of decentralised industrialisation based on small production units located outside the large urban centres (United Nations University, 1987).

The potential impact of ’de-scaling’ on plants, firms, industries, and countries clearly warrants careful examination of the issues involved. Accordingly, the main aim of this paper is to examine critically the literature on the relationship between NT and scale. It will address the question of whether and to what extent NT reduce the optimal scale of production units, a phenomenon we shall describe as ’de-scaling’. Insofar as optimal scale may take place at different dimensions: product (batch size), plant (total plant output), and firm (total firm production), and that each one could be affected differently by technology, the discussion will be done separately for each of these levels.

The main argument will be that, although NT may have a significant scale reduction effect at product level, it is not clear they would have a similar impact at plant level.

Furthermore, the impact at firm level may be ’scaling-up’ rather than ’de-scaling’.

Although the overall impact of NT on scale is very difficult to gauge at this stage, as some of the newest technologies have not completely ’diffused’ and little research has been done on the topic, it seems that the trend, if any, will be towards larger firms and organisations rather than smaller ones. This statement, however, does not mean that smaller firms are doomed nor that opportunities are totally closed for them. Small firms will continue to emerge, as they have always done, catering for specialised markets or by selling service-linked products. NT will offer small firms the possibility to improve quality standards and to coordinate and share fixed costs." (http://archive.unu.edu/hq/library/Collection/PDF_files/INTECH/INTECHwp05.pdf)

Excerpts

Scale and Scope

By Ludovico Alcorta:

"Scale refers to size of output or capacity of production units; economies of scale refer to reductions in unit costs due to increases in size of output. Economies of scale are said to exist if total cost rises less proportionately than output, and optimal scale occurs at the point where any increase in output no longer reduces but raises unit costs.

According to Scherer et al (1975) and Scherer and Ross (1991), scale and economies of scale are better analysed in terms of three dimensions: product, plant or firm. Product scale alludes to the volume of any single product made. Product-scale economies may arise from unit cost reductions due to the division of labour and specialisation of workers and equipment. Longer production runs allow for the separation of tasks and for workers to do their individual jobs rapidly and precisely, while avoiding the loss of time and effort associated with moving from one task to another. They also allow for the use of more efficient, specific-purpose machinery and mechanised production processes. A second source is the learning potential of long production runs. Where intricate operations and complex process adjustment are involved, unit costs may fall if workers learn by doing. A third source is the indivisibility or lumpiness of capital equipment. Machines are normally only available in a limited number of capacities and their price tends to increase less than proportionately with rises in capacity.

Another important source of product-scale economies, and particularly relevant to our subsequent discussion, is the cost of changing and setting-up the equipment for performing a particular batch or product run (Carlsson, 1989a; Kaplinsky, 1991; Pratten, 1975, 1991; Scherer et al, 1975; Silberston, 1972). Batch or lot size is the number of equal items or products treated in a certain process or sequence of operations. It refers to the total life of each production run, which could last hours, weeks, months or even several years.

The larger the batch or lot size --or the longer the production run-- the lower the unit costs due to refitting each machine with the appropriate tools, resetting the equipment, and/or changing the whole production line over from the previous item to the new one, and, therefore, the greater the incentive to continue producing the same item or product, although it may also mean keeping a large inventory of inputs and final goods to deal with short-term variations in demand.

Within a given production capacity and technology, the setting-up or change-over costs and the nature of demand are the key factors in determining when or whether a new product is manufactured (Ayres, 1991; Morroni, 1991). The classical example is Ford’s replacement of the model T car by the model A car, which required closing down the factory for nine months in 1926 (Abernathy, 1978). The car industry has always been under immense pressure not to change car model and hence why some models remain several years in the market. According to Carlsson (1989a), in many operations in the metalworking sector the ’typical’ set-up time was 20-30% of processing time. In other industries, such as printing, the initial typesetting costs can be so high that they sometimes make the publication of specialised or academic books or journals economically unfeasible. Very few books print as many copies as the Bible or Porter’s ’Competitive Advantage’.

Plant scale, in turn, is normally associated to the total output of an entire plant in process or ’fluid-flow’ industries, such as oil refining, chemicals, steel and cement, for a given period of time --normally one year. In addition to any relevant source of economies of scale already mentioned, plant-related economies may also emerge from the technical volume-surface relationship known as the ’0.6 rule’. The cost of construction of any container increases in line with its surface area, whereas the capacity increases with volume. Since the area of a sphere or cylinder varies as the two-thirds power of volume, the cost of building some process-industry plants rises roughly as the two-thirds power of their capacity. Another source of economies of scale at plant level arises from what is called the ’economies of massed reserves’. Larger plants can reduce the impact on unit costs of keeping reserve machines or spare parts for breakdowns or to replace those undergoing servicing. Cost savings can also arise from the fact that the number of staff required for maintenance and service increases much less than proportionately than output (Scherer and Ross, 1991; Pratten, 1975, 1991).

Although very little discussed in the traditional analysis of scale, plant scale also applies to discrete multi-product plants. Reality seems to be extensively populated by production facilities manufacturing many different products. Producers of garments, textiles, consumer electronics goods, home appliances, engines and machine tools, constantly have to switch models or manufacture according to varying technical specifications to satisfy differentiated demand. In these cases, plant scale alludes to the aggregate output of the plant.

Producing more than one good implies not only considering the setting-up, change-over and investment costs but also the potential cost effects of joint-production. Baumol et al (1988; see also Bailey and Friedlaender, 1982) have addressed this issue and have developed the concepts of scope and economies of scope which they consider a complement to the traditional concepts of scale and economies of scale.

Scope basically stands for product range; economies of scope arise when the cost of making goods jointly is less than making the same total quantity of the same goods separately.6 Economies of scope arise from the sharing or joint utilisation of inputs. It occurs when a given factor or input is imperfectly divisible, so that the production of a specific product or number of them may lead to under-utilisation of that input. It also happens when using inputs that may have some properties of a public good, so that when purchased for one production process they may be freely available to another (Baumol et al, 1988; Bailey and Friedlaender, 1982).

Turning to the firm dimension of scale --i.e. the total output of the firm-- economies of scale and economies of scope arise from both the ’fixed’ and ’shared’ nature of certain ’intangible’ investments, such as research and development (R & D), marketing and management.

Budgets for the development of new products and processes are normally ’rule of thumb’ amounts, reached on the basis of previous years’ sales, levels of retained profits, the expenditure of potential competitors, minimum threshold considerations, the average allocation of the industry and the emerging technological opportunities (Freeman, 1982; Hay and Morris, 1991). Marketing and distribution expenditures are also set amounts resulting from similar factors. For advertising to be effective there are certain minimum threshold levels of messages that have to be transmitted. Consumer durables and office automation industries necessarily require specialised dealer networks and after sales service. Operating a sales force requires investment in training and specialised equipment (Scherer and Ross, 1991). Management costs are also pre-set and depend on a minimum number of functions and hierarchical levels --and therefore managers-- and of specialised equipment that are required for the normal operation of any firm (Koutsoyiannis, 1980). Scale gains arise, therefore, from the possibility of spreading all these ’fixed’ costs among larger total volumes.

As far as economies of scope at firm level are concerned, they emanate from exchanging and pooling the information and knowhow available from several projects being undertaken simultaneously (Teece, 1980), and from using marketing, distribution and management facilities for more than a single product." (http://archive.unu.edu/hq/library/Collection/PDF_files/INTECH/INTECHwp05.pdf)

ARE NEW TECHNOLOGIES ’DE-SCALING’?

"The capacity to produce flexibly is also said to have profound implications for optimal scale. One passionate, populist and popular, but rather absurd and unfounded view, is that NT will finally make Schumacher’s ’small is beautiful’ dream a reality:

- "Rather than pushing decisions up through the hierarchy, microelectronics pulls them remorselessly down to the individual. This is the law of the microcosm. This is the secret of the new American challenge in the global economy. The new law of the microcosm has emerged, leaving Orwell, von Neumann, and even Charles Ferguson in its wake. With the microprocessor and related chip technologies, the computing industry has replaced its previous economies of scale with the new economies of microscale." (Gilder, 1988, pg 57).

A second, more serious approach, put forward by authors like Acs and Audretsch (1989, 1990a, 1990b), Acs et al (1990), Carlsson (1989b), Dosi (1988), Kaplinsky (1984, 1990a, 1991) and Perez (1985), argues that, although the application of NT will result in an overall trend towards optimal scale reduction, ’de-scaling’ will not necessarily affect equally every dimension of scale."

After examining in detail the potential effects on the following dimensions:

• 4.1 The Product Dimension of Scale 15

• 4.2 The Plant Dimension of Scale 17

• 4.3 The Firm Dimension of Scale 24

... the author concludes that:

"The ’de-scaling’ argument is based on a number of confusions and misconceptions. It confuses product with plant scale, greater divisibility of capital and reductions in employment and physical size of plants with reductions in optimal scale, product differentiation and decentralisation with ’de-scaling’, and, more generally, supply and demand factors. It also assumes that firms will respond to capacity under-utilisation problems by reducing capacity and output, rather than by adjusting product range, especially if the capability to do so is available. It also fails to see the links between the product, plant and firm dimensions of scale.

The evidence reviewed showed that there has indeed been a reduction in setting up times and change-over costs and that this is one of the main factors explaining a relatively larger variety of products. However, at plant and firm level, the evidence tilted strongly in the direction of increases in optimal scale mainly due to the fixed capital investment, R & D, marketing and management requirements associated with NT. In other words, to achieve flexibility at product level and hence reap economies of scope, plant and firm scales have to increase. Although there are a number of intermediate solutions to reduce these costs, the complementary nature of the NT and the emerging competitive pressures, particularly in science-based and mass consumption industries, may make any alternative other than full automation a source of competitive disadvantage.

That plants and firms adopting NT will scale-up does not mean that there are no opportunities left for small scale firms. One specific advantage of NT is that they allow small firms to reduce quality differentials with large ones, traditionally a limitation on competition by small firms. In industries where cost differentials with larger firms are not too high, then smaller high-technology firms may be able to compete successfully by improving on service. In addition, NT are giving rise to some ’new industries’, which, at the initial stages, offer entry opportunities for small scale firms. However, it was also stressed that some of the flexible capabilities of small firms have also been made available to larger firms.

Opportunities for cooperation, communication and coordination of small firms may also be heightened by the adoption of NT. This may help them overcome some of the problems related to the very high costs of R & D and marketing and enhance their competitive capacities. However, the possibility of generating a dynamic small-scale sector and whole regions based on small firm production that play an important role in local industrialisation and national growth may require some preconditions that are at the very essence of the process they want to initiate.

In sum, NT are neither a blessing nor a curse for small scale firms. They open some opportunities for their development but at the same time create new constraints on them.

As always, the most innovative and successful small scale firms will grow to overcome their initial size. The others will have to continue to rely on product differentiation and quality of service as their main competitive weapon."