DOS’s prevalence—and the IBM PC’s—bred further prevalence, and eventually the DOS/IBM combination came to dominate a considerable portion of the market. What can you do to capitalize on the increasing returns at your disposal? It needs to reinvent its purpose, its goals, its way of doing things. The market would be shared by many plantations, and a market price would be established at a predictable level—depending on tastes for coffee and the availability of suitable farmland. What would happen if Marshall’s diminishing returns were reversed so that there were increasing returns? But each contender should have access to whatever degree possible to the same technologies, the same open standards, so that all are lined up behind the same starting line. It means there is always some idle capacity in factors of production which is deliberately kept by the organizers to expand its production. Our mission is to provide an online platform to help students to discuss anything and everything about Economics. And adaptation never stops. Novell recognized that NetWare’s success depended on attracting software applications to run on NetWare—which was a part of the ecology outside the company’s control. Once users invest in this training—say, the maintenance and piloting of Airbus passenger aircraft—they merely need to update these skills for subsequent versions of the product. With the application of the next unit, average cost comes down to Rs. In a word, genteel. They are mechanisms of positive feedback that operate—within markets, businesses, and industries—to reinforce that which gains success or aggravate that which suffers loss. Curve IR shows the increasing returns. The market place is the number one area to look for opportunities. Not five-year plans. The additional workers allow even greater opportunities for specialization, but because they are operating with a fixed amount of capital, each new worker adds less to total output. And, a fall in cost of production means the operation of law of the diminishing cost or the law of increasing returns. For a year or two, it was by no means clear which system would prevail. Because bulk processing is repetitive, it allows constant improvement, constant optimization. As more and more units of the commodity are produced, the cost per unit goes on steadily falling. In bulk processing, a set of standard prices typically emerges. The marginal and average production of the fourth unit will be 10 and 7 respectively. At first, each modest increase in resources results in a corresponding increase in production. Often there are several such mechanisms—interbraided, operating over different time frames, each needing to be understood, observed, and actively managed. America Online, Compuserve, Prodigy, and Microsoft Network have all ceded dominance of the on-line computer networking market to the Internet. As a result, Weighted average cost of capital (WACC) represents the appropriate "cost of capital" for the firm as a whole. Institute a Layaway Program And they are exciting. But typically, if these companies try to expand, they run into some limitation: in numbers of consumers who prefer their brand, in regional demand, in access to raw materials. This will help us determine the required return for our investment projects. What has to happen if we want to convert this success into an opportunity? Marshall’s world is characterized by planning, control, and hierarchy. Precisely because processing is low-margin, operations must struggle to stay afloat. Those’ll emerge as the game unfolds. But when the games themselves are not even fully defined, you cannot optimize. It is only on account of several external as well as internal economies in the form of innovations; marketing, publicity, management etc. Let’s go back to beginnings—to the diminishing-returns view of Alfred Marshall and his contemporaries. Copyright © 2020 Harvard Business School Publishing. They require training. "Cost of capital" may vary, that is, for funds raised with bank loans, the sale of bonds, or equity financing. To lock in, a product usually has been discounted, and this established low price is often hard to raise. Hence they typically have R&D costs that are large relative to their unit production costs. What is needed is active management of increasing returns. A firm that just has increasing returns to scale may not have economies of scale because even though output increased at a higher rate than the increases in input, scarcity of resources may have resulted in higher raw material cost and, therefore, higher per unit cost. In short, it needs to adapt. In fact, the style in the diminishing-returns Halls of Production is much like that of a sophisticated modern factory: the goal is to keep high-quality product flowing at low cost. The increase in labor productivity can bee attributed to technological progress, increase in the quantity of capital per worker, improvements in the education and training of workers, the exploitation of economies of scale, and improvements in the allocation of labor across different industries. We can’t say. Example: Company X is willing to introduce a new product. The law of increasing returns is based on the following assumptions: 1. Many managers have some intuitive grasp of this new increasing-returns world. Few understand it thoroughly. In such firms, it’s important to effectively manage liquidity to avoid problems. No moves need be made in this strategy of premarket facedown. The U.S. airline business, for example, processes passengers day to day. It takes place when economies of scale no longer function. So it seemed in 1981 that deregulation should enhance competition, as it normally does under diminishing returns. Hence, economies that are available in large scale production, i.e., internal and external economies are helpful for operation of the law of increasing returns. It means demand of each factor can be increased whenever required. It slopes downward. A locked-in product may obstruct technological advancement. Privacy Policy3. Stated another way, it's the growth that can be achieved given the company's current profitability, asset utilization, dividend payout, and debt ratios. Increasing returns mean lower costs per unit just as diminishing returns mean higher costs. Now the manager has to identify the sources of funds needed for producing the new product. The Marginal Cost of Capital (MCC), which is sometimes called the Opportunity Cost of Capital (OCC) or Weighted Average Cost of Capital (WACC), tells us how much we are paying for our financing. Unit costs fall as sales increase. It would be difficult to separate out each thread and to regulate it. Yet even smart discounting to seed the market is ineffective unless the resulting installed base is exploited later. So it set up incentives for software developers to write for NetWare rather than for its rivals. In order to define the sustainable growth rate for a particular business, shareholders must first identify the maximum growth rate their business can achieve without having to increase financial leverage or debt financing. Netscape handed out its Internet browser for free and won 70% of its market. They exist in mini-ecologies. In fact, a major part of the economy was subject to increasing returns—high technology. The increasing-returns world is characterized by observation, positioning, flattened organizations, missions, teams, and cunning. The great managers have a knack for consistently lowering their weighted average cost of capital by increasing productivity, seeking out higher-return products, and more. By contrast, the style of competition in the increasing-returns arena is more like gambling. Increases in LABOR PRODUCTIVITY. The law of returns to scale analysis the effects of scale on the level of output. Marshall’s world of the 1880s and 1890s was one of bulk production: of metal ores, aniline dyes, pig iron, coal, lumber, heavy chemicals, soybeans, coffee—commodities heavy on resources, light on know-how. In the processing world, strategy typically hinges upon capitalizing on core competencies, pricing competitively, getting costs down, bringing quality up. Finance companies and manufacturers might provide funds for the purchase of larger capital equipment or real estate. And because such products are normally substitutable for one another, something like a standard price emerges. Technologies exist not alone but in an interlinked web, or ecology. The Law of diminishing returns and increasing returns have similar as well dissimilar characteristics with each other. Competing therefore means keeping product flowing, trying to improve quality, getting costs down. It went on to profit hugely from upgrades, spin-offs, and applications of its own. There are plenty of independent sources of credit available to buyers – your role as a seller is to identify those sources and facilitate the introduction between your buyer and the lender. Better to exit with financial dignity. Similarly, the larger a bank’s or insurance company’s customer base, the more it can spread its fixed costs of headquarters staff, real estate, and computer operations. Due to this advantage production is more than the proportionate increase in factors. Success goes to those who have the vision to foresee, to imagine, what shapes these next games will take. Due to these economies total cost per unit falls while the total product increases at an increasing rate. These feedbacks are interwoven and operate at different levels in the market and over different time frames. Hanging on to a losing position that is being further eroded by positive feedbacks requires throwing reinforcements into a battle already lost. The Internet’s World Wide Web operates within a grouping of businesses that include browsers, online news, E-mail, network retailing, and financial services. Arrangement of fixed as well as variable factors can be made more effective. Over at that one, a game called Web services. The main points of difference between the law of diminishing returns and increasing returns. Dominance may consist not so much in cornering a single product as in successively taking over more and more threads of the web of technology, thereby preventing other players from getting access to new, breaking markets. But it should have been predicted—given increasing returns. If it locks in merely because user base was levered over from a neighboring lock-in, this is unfair. Active management of such a web can be an important magnifier of increasing returns. They begin to operate as the efforts are made by the organizer to expand the production. The existence of oligopoly requires that a few firms are able to gain significant market power, preventing other, smaller competitors from entering the market. For example, when Internet-based retail banking arrives, regional demand limitations will vanish. Increasing returns are the tendency for that which is ahead to get further ahead, for that which loses advantage to lose further advantage. Why? Share Your Word File But over the long term, increasing returns will dominate—even though their destabilizing effects are not as pronounced as in high tech. Economies have bifurcated into two worlds—intertwined, overlapping, and different. It believed that with its superior technology, it could hold its increasing-returns market to itself. Hierarchies flatten not because democracy is suddenly bestowed on the workforce or because computers can cut out much of middle management. But because of the Internet’s dominance, it is not yet clear whether it can transform this huge base into later profits. Exit may not mean quitting the business entirely. An aircraft’s safe arrival depends on the captain, not on the flight attendants. Some factors of production should be divisible or variable. Pharmaceuticals exist within a network of physicians, testing labs, hospitals, and HMOs. A new economics—one very different from that in the textbooks—now applies, and nowhere is this more true than in high technology. Let’s expand on the idea that the Marginal Cost of Capital repre… So if coffee plantations competed, each one would expand until it ran into limitations in the form of rising costs or diminishing profits. So the more prevalent they are, the more prevalent they can become. But they will likely continue in a side game with its own competition for dominance within the Net’s ecology. Novell managed these cross-product positive feedbacks actively to lock in its market. However, when production is carried on large scale basis, it is possible for a firm to have more complex and better machinery, i.e., it is possible to have complex division of labour and advantageous combination of factors of production ; which brings down the cost of production. The various sources of liquidity for a firm can be classified as primary and secondary sources. A. Prodigy was first into the on-line services market but was passive in building its subscriber base to take advantage of increasing returns. So operations that were once handled by people—designing fancy financial instruments or automobiles or fashion goods, processing insurance claims, supplying and inventorying in retail, conducting paralegal searches for case precedents—are increasingly being handled by software. The truth is that network or user-base effects often operate in services. In that world it was reasonable to suppose, for example, that if a coffee plantation expanded production it would ultimately be driven to use land less suitable for coffee. The term " returns to scale " refers to how well a business or company is producing its products. Content Guidelines 2. Returns to scale, in economics, the quantitative change in output of a firm or industry resulting from a proportionate increase in all inputs.If the quantity of output rises by a greater proportion—e.g., if output increases by 2.5 times in response to a doubling of all inputs—the production process is said to exhibit increasing returns to scale. The producer increases factors of production by 20 per cent and as a result the production of shoes increases by 35 per cent. Two maxims are widely accepted in knowledge-based markets: it pays to hit the market first, and it pays to have superb technology. With a few changes, Marshall’s world lives on a century later within that part of the modern economy still devoted to bulk processing: of grains, livestock, heavy chemicals, metals and ores, foodstuffs, retail goods—the part where operations are largely repetitive day to day or week to week. So they—and the commando teams that report to them in turn—will be treated not as employees but as equals in the business of the company’s success. However, the effect is temporary unless other resources increase as well. Law of Increasing Returns: Definitions, Assumptions, Explanation, Causes and Similarities and Dissimilarities! It favors an environment free of surprises or glitches—an environment characterized by control and planning. There are several reasons: High-tech products—pharmaceuticals, computer hardware and software, aircraft and missiles, telecommunications equipment, bioengineered drugs, and suchlike—are by definition complicated to design and to deliver to the marketplace. Above all, it is a world of optimization. One of the marks of our time is that in services everything is going software—everything that is information based. You can be cunning. Much of this “re-everything” predilection—in the bulk-processing world—is a fancy label for streamlining, computerizing, downsizing. It is a mistake to think that what works in one world is appropriate for the other. One active strategy is to discount heavily initially to build up an installed base. But the company itself wound up with a small share of the spoils. Generally, in the manufacturing industry, factors of production have elastic supply. But forever there will be a distinction—a hierarchy—between cockpit and cabin crews. At least one factor of production is divisible. We can also fathom the mystery of what I’ve alluded to as re-everything. Hicks felt repugnance not just because of unsavory properties but also because in his day no mathematical apparatus existed to analyze increasing-returns markets. These internal and external economies are helpful in reducing the cost of production and increasing the amount of production. A locked-in product may provide a single standard of convenience. Increasing returns in financial services. The alternatives are then slow death or graceful exit—relinquishing the field to concentrate on positioning for the next technology wave. According to this law, “Production of a commodity increases in a larger proportion as compared to the increase in the units of factors of production.” For instance, we want to increase the production of shoes. And so, Marshall’s world tends to be one that favors hierarchy, planning, and controls. The final case, in financial services, illustrates the power of HCM to drive stock performance. If a product locks in because it is superior, this is fair, and it would be foolish to penalize such success. But usually under heavy lock-in, these tactics do not work. Over at this table, a game is starting called multimedia. This interdependence has deep implications for strategy. However, in the increasing-returns world, especially in high tech, re-everything has become necessary because every time the quest changes, the company needs to change. It will become an increasing-returns business. The two worlds are not neatly split. The theory of increasing returns is new, but it already is well established. But it recognizes that positive feedbacks apply across markets as well as within markets. Increasing returns reign in the newer part—the knowledge-based industries. This approach is wise and proper. The profit for a business owner is the difference between the return on capital and the cost of capital. It is an understanding based squarely upon the assumption of diminishing returns: products or companies that get ahead in a market eventually run into limitations, so that a predictable equilibrium of prices and market shares is reached. Hierarchy dissipates and dissolves. Now it can profit from spin-off software and applications. 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