Minimum Efficient Scale

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What is the 'Minimum Efficient Scale'

The minimum efficient scale is the smallest amount of production a company can achieve while still taking full advantage of economies of scale with regards to supplies and costs. In classical economics, the minimum efficient scale is defined as the lowest production point at which long-run total average costs (LRATC) are minimized.

!--break--Based on finding an optimal balance between consumer demand, production volume and costs associated with production and product delivery, the minimum efficient scale identifies a point where the costs of production result in being able to offer a product at a competitive price. The minimum efficient scale may be expressed as a range of production values, but its relationship to the total market size or demand determines how many competitors can effectively operate in the market. Current consumer demand can help determine the level of production that can occur in the industry without resulting in a large surplus inventory.

Applicable Costs

When examining costs related to the product, a business must consider not only the cost of production but the cost of storage for any inventory that has not been sold. Additionally, shipping costs, marketing costs and certain public relations actions may also be included.

The costs involved in determining the minimum efficient scale may vary based on shifting market conditions. For example, rising material or shipping costs may alter the ideal point. Changes in demand can also impact the calculation, as well as changes in any applicable laws or regulations that impact production methods. In cases where employee wages change suddenly, as with the institution of a new minimum wage, associated labor costs must also be considered to properly compensate for the rise.

The constant shifting of the variables involved requires the minimum efficient scale to be recalculated frequently and may lead to certain production changes for a business to remain both profitable and competitive within the marketplace. In cases where the costs of production prevent a product from being offered at a competitive price, the business may fail.

Market Size and Competition

Businesses working in a particular market compete against each other for the same finite customer base. If the minimum efficient scale is relatively small compared to total market size, many companies can exist in the same space. In other industries, such as telecom and basic materials, the minimum efficient scale is quite large due to the high ratio of fixed costs to variable costs. In these types of industries, only a few major players tend to dominate the space.

BREAKING DOWN 'Minimum Efficient Scale'