Impact on Costs and Sales Revenue

Impact on Average Costs

Productivity, capacity utilisation and lean production are three ways to get more output from the same resources. Each one lowers average cost, the cost of making one unit (unit 1.6.1):

• Higher productivity: each worker makes more → the wage bill is shared across more units → lower labour cost per unit (unit 2.3.1).
• Higher capacity utilisation: more output from the same premises and machines → fixed costs are spread over more units → lower fixed cost per unit (unit 2.3.2).
• Lean production: less stock, scrap and rework → fewer materials and less time wasted → lower cost per unit (unit 2.3.3).

A lower average cost then reaches the firm in one of two ways:

• It cuts its price: lower average cost → a lower price with the same margin → more units sold → higher sales revenue, if demand is price elastic.
• It keeps its price: the same price, lower cost → a wider margin on each unit → higher profit to reinvest, even though revenue has not changed.

Which works better, and how much the firm gains, depends on:

• Price elasticity of demand: a price cut only raises revenue when demand is price elastic. With inelastic demand, keeping the price and taking the wider margin earns more (unit 2.2.1).
• Rivals' response: if rivals cut their costs and prices too, nobody gains market share, and the saving passes to consumers.

Minimising Waste of Resources

Waste is anything a firm pays for that adds nothing to what the customer buys: materials thrown away, faulty products that are scrapped or reworked, staff and machines standing idle, energy used heating empty space, and goods made that nobody buys.

Firms cut waste with lean methods, products designed to use less material, energy-efficient equipment and more accurate sales forecasts, so they make what will sell.

• Costs: less material and energy used per unit → lower variable cost per unit → lower average cost.
• Sales: a name for cutting waste and packaging → appeals to customers who care about the environment → more sales, and sometimes a higher price.

The gain depends on:

• The up-front cost: new equipment or a redesign pays off only if the savings last long enough.
• Trade-offs: cutting stock to the minimum saves waste but raises the risk of running out, and greener materials can cost more than the ones they replace.

Short Product Development Lead Times

Product development lead time: the time between starting work on a new product and putting it on sale.

A short lead time gives a firm a competitive advantage:

• First to market: the firm launches before rivals → no direct competition at first → it can charge a high price (price skimming, unit 2.2.2) → higher revenue and profit until rivals arrive.
• Keeping up with tastes: a clothing retailer turns a new design into stock in a few weeks → it sells what is in fashion now → fewer unsold lines and fewer discounts.
• Lower development costs: fewer months of paying designers and engineers → lower costs, and the R&D spending is earned back sooner (unit 2.1.3).

How much a short lead time is worth depends on:

• The market: it matters most where products and tastes change fast, such as clothing and toys. A firm selling salt gains little.
• Quality: rushing a product out raises the risk of faults, recalls and a damaged brand.