Price is determined by the amount the buyer is willing to pay and the amount the seller is willing to accept. It is the foundation of a commercial transaction that large businesses have mastered. If you choose to compete on price against a national competitor’s economies of scale, you have set yourself up for failure.
Either identify through the 7-P Framework how you can compete against a business with the economies of scale advantage, or you will go out of business.
Overview
Another practical theory from microeconomics involves Economies of Scale. Businesses that achieve it have a cost advantage obtained through their scale of operation, leading to cost per unit of output decreasing with increasing scale. Businesses that fail to achieve economies of scale will always be at a cost advantage to competitors that have achieved scale in their operations from their ability to maximize sales.
Small businesses are unlikely to achieve economies of scale. They are unable to match a larger business’s ability to achieve economies of scale by increasing production to lower costs. Your long-run average cost is a function of costs being spread over a larger number of goods. Lower your costs, and you lower your average cost. Increase your output, and you reduce your average cost. Do both, and you are going to make more money.
Any small business competing against a large business must understand the laws associated with economies of scale. This understanding begins with recognizing that larger businesses will have a distinct competitive advantage over their smaller competitors through the cost savings their scale produces.
Below is why economies of scale give rise to lower per-unit costs:
- Specialization of labor with integrated technology boosts production volumes.
- Bulk orders from suppliers, larger advertising buys, and lower cost of capital lower per-unit costs.
- Spreading indirect costs across more units produced and sold helps to reduce the average overhead costs for the business.
The good news for small businesses is that there are dis-economies of scale. Businesses with highly dedicated equipment and people experience higher set-up costs. As a result, they are less likely to embrace more processes, making it difficult to switch to small runs
Outsourcing functional services versus staffing to perform the work makes costs more similar across businesses of various sizes. Commonly outsourced functional services include accounting, human resources, marketing, treasury, legal, and information technology.
Most potential customers are unwilling to pay more for a similar product sold by a small company that they can readily get from a larger business. You have to know what problem your product or service solves so that you can position it away from price, or you will lose sales. Counter this by applying the 7-P Framework to your business profit model to determine how susceptible you are to being put out of business by a large competitor.