What Is the Minimum Efficient Scale – MES
In economics, a company's minimum efficient scale (MES) represents the lowest point on a curve where it can achieve the economies of scale—in terms of supplies and costs—necessary for it operate efficiently and competitively in its industry. In other words, MES seeks to identify the point at which a firm can produce its goods cheaply enough to offer them at a competitive price in the marketplace. In classical economics, the MES is the lowest production point that minimizes long-run total average costs (LRATC). LRATC represents the average cost per unit of output over the long run, where all inputs are variable.
Minimum Efficient Scale
How Does a Minimum Efficient Scale Work?
For companies that produce goods, it is critical to find an optimal balance between consumer demand, production volume, and costs associated with manufacturing and delivering goods. A range of production values may express a minimum efficient scale, but its relationship to the size of its market—or the degree of demand for the product—determines how many competitors can effectively operate in the market.
Real World Example of Minimum Efficient Scale – General Motors
To understand how a minimum efficient scale works, perhaps it’s best to remove it from the abstract realm and consider a historical example.
From the 1970s to the 1990s, General Motors Company (NYSE: GM) was on an upswing. Production was great, and the exports were plentiful. In 1970, GM switched its assembly methods from mostly manual to mostly automated production. Around that time, GM enjoyed an approximate 60% share of the U.S. automobile market. Since the 1950s, U.S. families had grown increasingly dependent on the automobile, and many families owned more than one car. Consumer demand, increased production, and lower materials costs allowed economies of scale to tip in GM's favor, and the company achieved a maximum, minimum efficient scale.
Diseconomies of Scale
Although GM's switch to automation was to some extent cost efficient, in the 1990s imports began to encroach upon the U.S. auto market. So, during the next decades, diseconomies of scale proved fateful for GM. The company began to experience heavy losses, closed many plants, and entered a period of slow decline. A combination of factors contributed to GM's downturn.
First, foreign cars were less expensive to produce, which put American automakers at a major cost disadvantage. Also, new U.S. government fuel regulations steered consumers to more economical vehicles. So, automakers that produced cars smaller than General Motors's usurped a large portion of GM's market share. At the same time, foreign luxury cars like Mercedes and BMWs were becoming popular, which pinched market share from GM's Cadillacs and Lincolns. Finally, production costs surged, and GM teetered on bankruptcy.
A Sad, Then Happy Ending for GM
On June 1, 2009, General Motors filed for what was the largest industrial bankruptcy in history. However, on July 10, 2009 (in a mere 40 days) the new GM exited bankruptcy protection—the result of a masterful plan, along with government assistance.
Chasing Changing Variables
General Motors had a happy ending. However, some companies might not. If a company cannot manage to maintain a balanced MES, it could fail. A healthy minimum efficient scale consists of numerous factors, which are continually shifting. So, MES needs to be recalculated frequently to reflect these changes; likewise, a business may need to adjust its production to keep hitting the mark. When assessing minimum efficient scale, it's important that a business keep abreast of changes in the external variables that could affect production—such as, storage, shipping, and labor expenses; cost of capital, competition, customer base, consumer demand; size of market, wage increases and employee turnover; and government regulations.