Rolls Royce, Cadillac, Moving Assembly Line, Economies of Scale, VCR, Cell Phones and HD Plasma Television

Posted by PITHOCRATES - January 1st, 2013

History 101

The Moving Assembly Line allows GM to Divide their Costs over more Units than Rolls Royce

Rolls Royce automobiles are very expensive luxury cars.  Of impeccable quality.  It may be the finest automobile ever built.  And I say built not manufactured.  For they build a Rolls Royce by hand to ensure that high quality.  By some of the most experienced and skilled artisans to ever hone metal, wood and leather into an automobile.  Because of this they can’t make a lot of them a year.  They set a record sales total in 2011.  By selling 3,538 hand-crafted automobiles.  The entry price for a Rolls Royce?  Around $250,000.

By contrast GM sold 152,389 Cadillac luxury automobiles in 2011 in North America.  These are not hand-crafted.  The Americans build them on moving assembly lines.  Which is why they can build 43 times as many Cadillacs than they can hand-build Rolls Royces.  The entry price for a Cadillac?  About $33,100.  While a top of the line may cost you around $63,200.  Now Cadillacs are nice.  The name has become synonymous with high quality.  The best quality is the ‘Cadillac’ of something.  The quality may not be Rolls Royce quality but few will complain about that quality when sitting behind the wheel of a Cadillac.  They are glad to settle for a Cadillac over a Rolls Royce.  Especially when it costs 7.5 times as much to get into a Rolls Royce than into a Cadillac.

Why are hand-crafted Rolls Royce automobiles so much more costly than Cadillacs manufactured on a moving assembly line?  Economies of scale.  The higher production levels of the mass-produced cars allows GM to divide all of their costs over many more units.  Bringing the unit cost down.  And the selling price.  With fewer sales the unit cost for Rolls Royce is much higher.  As is the selling price.

As Demand grew Manufacturers were able to Bring Prices Down thanks to Economies of Scale

Rolls Royce pays a price for their commitment to quality.  They can’t sell cars as inexpensively as some of their luxury rivals.  But that’s okay for them.  As the market for hand-crafted luxury cars is large enough to keep them in business doing what they love.  Building the finest quality automobile in the world.  And those who want the best can afford to pay a quarter of a million dollars for an entry-level Rolls Royce.  So they do.  Which is why Rolls Royce doesn’t have to worry about economies of scales to compete against their competition.

Before Henry Ford built the moving assembly line cars were too expensive for the working man.  Henry Ford changed that.  Once they started manufacturing the new driving machine on the moving assembly line Ford was able to reach an economy of scale that greatly increased production rates.  Bringing down the unit cost.  And the selling price.  As new products entered the market place they were typically unaffordable to all but the rich.  But then as demand grew manufacturers were able to bring prices down thanks to economies of scale.  Like Henry Ford did with the automobile.

The first commercially viable video tape recorder was the Ampex model VR-1000 in 1956.  It cost $50,000 (about $421,000 today).  It was the size of a kitchen stove.  And about the only place you found them were in television broadcast studios.  From this early beginning came the technology for the video cassette recorder (VCR).  By the mid to late Seventies schools had one they rolled from room to room.  It cost approximately $5,000 (about $19,400 today).  About a decade later you could buy a smaller unit that could do more for around $2,000 (about $4,000 today).  Just before the DVD player and the digital video recorder made them obsolete you could get a nice one for about $100.  They were so small and so inexpensive that you bought one for every television in the house.

Bringing these Prices Down are State-of-the-Art High-Tech Manufacturers throughout Asia

When the first cell phones came out we called them car phones.  Because they were so big and had no real battery life that they were permanently installed in a car.  Connected to the electrical system of the car.  The first real portable cell phone was something that looked like a brick and weighed in around 2 pounds.  The battery gave you maybe an hour of talk time.  And it cost $3,995 in 1982 (about $9,600 today).  By 1993 the price was down to $900 ($1,400 today) but still weighed in at 2 pounds.  By 1996 the weight dropped to about 3 ounces.  It cost about $1,000 ($1,400 today).  By 2002 you could buy a flip-phone with a built-in high resolution camera for $400 (about $510 today).  And so on until they got smaller and more powerful with longer battery lives.  Today you can often get a pretty nice phone free when you sign a contract for service.

Things people like and demand can accelerate this process of quality improvement and lower prices.  For half a century the television has been a fixture in most American homes.  So technology buffs with money were always ready to spend a lot of money on the next best thing.  And when high-definition plasma televisions hit the market it didn’t take long for economies of scale to bring prices down as demand exploded for these beautiful things.  A Panasonic 42″ high-definition plasma television cost around $2,500 in 2004 (about $3,000 today).  About 4 years later you could get a slightly better set for about $700 (about $750 today).  Today you can buy an even better 42 inch plasma set from Panasonic for as little as $400.

Bringing these prices down are state-of-the-art high-tech manufacturers throughout Asia (Japan, South Korea, etc.).  They can mass produce cell phones and televisions and other high-tech goods at remarkable production rates.  Filling ships with their goods to export around the world.  They bring together high-skilled labor and the best in automated production equipment.  They can retool and begin new production so fast that they can fill the demand for the next big thing without missing a step.  And quickly ramp up to an economy of scale wherever they see growing consumer demand.  Bringing down unit costs.  And prices.  Making a lot of happy consumers around the world.

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Economies of Scale

Posted by PITHOCRATES - December 31st, 2012

Economics 101

Employers are very Reluctant to hire Additional Employees because Labor Costs are their Greatest Costs

When it comes to running a business there is nothing more costly than people.  Employee salaries and wages.  Payroll taxes.  And benefits.  People need a large paycheck to live on and will go to the employer that offers the highest pay.  Government has imposed costly taxes and regulatory costs.  And to further entice good workers employers have to sweeten the deal with some fringe benefits like health insurance, paid vacation time, holiday pay, paid sick days and retirement plans.  It adds up.  Something like this:

As you can see the amount of pay employees are familiar with (the working pay above) is far less than the total cost to the employer.  The employee doesn’t see the 63.1% markup on their working pay that their employer has to pay in addition to paying the employee.  As a business hires more employees these costs add up.  A small factory with 15 workers on the factory floor can cost the employer $1.6 million.  Which is why labor costs are the greatest costs of most businesses.  And why employers are very reluctant to add additional employees.

The more Productive you are the Lower your Unit Cost and the Lower the Selling Price in a Store

Besides labor costs a business like a factory will have material costs, too.  These are variable costs.  They’re variable because they vary with varying levels of production.  The more production there is the more variable costs there are.  In addition to variable costs businesses have fixed costs.  Often simply called overhead.

Factories make things.  Like things you can pick up off a store’s shelf.  Things with low prices on their price tags.  But when it can cost a small manufacturer $1.6 million JUST for its labor costs how can they sell things with such low prices?  By making a lot of those things to sell.  As much as they possibly can with their variable and fixed costs.  What we call economies of scale.  And the more they can make for their given costs the lower the unit cost is for each thing you can buy off a shelf at a store.   As you can see here:

Assuming a factory can produce anywhere from 1,250,000 to 2,750,000 units with a given labor force operating the same production equipment in a factory you can see how the unit cost falls the more they produce.  Which is why there is so much talk about productivity.  The more productive you are (the more you can produce for a given cost) the lower your unit cost.  And the lower the selling price in a store.  Increasing productivity could mean moving an assembly line a little faster.  Or replacing some people with machines.  Things that workers don’t like.  But things consumers love.  For they like low prices when they go shopping.

Employers are very Reluctant to Hire New Employees and Prefer Increasing Productivity with Automation

If you crunch these numbers for the labor costs of 16 and 17 workers you can see how unit costs rise as an employee or two is added to the production floor.  At an annual production of 2,000,000 units the unit cost increases $0.05 (4.6%) going from 15 to 16 workers.  Adding two workers increases the unit cost $0.11 (10.1%).  Doesn’t seem like a lot.  But we notice when something we once bought for $0.99 now costs $1.04.  And we don’t like it.  But business owners like it even less.  Here’s why.

Business may be booming.  Those on the factory floor may be working a lot of overtime to produce at a rate of 2,000,000 units per year.  And are growing unhappy with all of that overtime.  They keep demanding that the owner hire another person.  The owner does.  Increasing unit costs by $0.05.  But the owner hopes the booming economy will continue.  And that they can even increase the production rate.  For if they can sell an additional 250,000 units the unit cost can actually fall $0.07 to $1.02.  Making the addition of a new worker on the factory floor not increase costs.  As the increase in production will make costs fall greater than that increase in labor costs.

But it doesn’t always work like that.  Economic booms don’t always last.  When too many factories increase production to meet booming demand they bring too much supply to market.  Causing prices to fall.  And forcing factories to cut back on production rates.  So instead of increasing the production rate they may find themselves cutting back.  Perhaps going from 2,000,000 to 1,750,000.  A fall of 250,000 units.  Increasing the unit cost $0.21 (19.3%).  Which could very well raise the unit cost above the prevailing market price.  Requiring layoffs.  To get the unit cost back down to $1.09.  Allowing them to sell at the prevailing market price.  And at a production rate of 1,750,000 units that may require letting go more than just one worker.  Maybe even more than two.  Which is why employers are very reluctant to hire new employees.  And prefer increasing productivity with automation.  For it is far easier to make machines increase or decrease production rates than it is to hire and lay off people.  Making it easier and less costly to reach great economies of scale.  Which makes low prices.  And happy consumers.

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