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Part Two
Design
The blue dotted line in Figure 6.8 shows this effect. The two other blue lines show similar
curves for a 600-unit plant and a 1,000-unit plant. Figure 6.8 also shows that a similar relationship
occurs between the average-cost curves for plants of increasing size. As the nominal
capacity of the plants increases, the lowest-cost points at first reduce. There are two main reasons
for this:
Economies of scale
Diseconomies of scale
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The fixed costs of an operation do not increase proportionately as its capacity increases.
An 800-unit plant has less than twice the fixed costs of a 400-unit plant.
The capital costs of building the plant do not increase proportionately to its capacity. An
800-unit plant costs less to build than twice the cost of a 400-unit plant.
These two factors, taken together, are often referred to as economies of scale. However,
above a certain size, the lowest-cost point may increase. In Figure 6.8 this happens with plants
above 800 units capacity. This occurs because of what are called the diseconomies of scale,
two of which are particularly important. First, transportation costs can be high for large
operations. For example, if a manufacturer supplies its global market from one major plant
in Denmark, materials may have to be brought in to, and shipped from, several countries.
Second, complexity costs increase as size increases. The communications and coordination
effort necessary to manage an operation tends to increase faster than capacity. Although not
seen as a direct cost, it can nevertheless be very significant.
Scale of capacity and the demand–capacity balance
Large units of capacity also have some disadvantages when the capacity of the operation is
being changed to match changing demand. For example, suppose that the air-conditioning unit
manufacturer forecasts demand increase over the next three years, as shown in Figure 6.9,
to level off at around 2,400 units a week. If the company seeks to satisfy all demand by building
three plants, each of 800 units capacity, the company will have substantial amounts of
over-capacity for much of the period when demand is increasing. Over-capacity means low
capacity utilization, which in turn means higher unit costs. If the company builds smaller
plants, say 400-unit plants, there will still be over-capacity but to a lesser extent, which means
higher capacity utilization and possibly lower costs.
Figure 6.9 The scale of capacity increments affects the utilization of capacity