HSIR-13

Economics Project Report

Group members

1) Akshit Kumar Shandilya

2) Atif Rehman
3) Anshuman Dhar
4) Rishit Somayaji
5) Sanjit Ponnuswamy Krishnajegan
6) Siddharth Shrivastav
7) Tanmay Sahu
 Index

Sr no. Content Page

number

1. Abstract 01

2. Introduction 02

3. Large volume purchases

4. Cost reduction

5. Standardization

6. Efficient supply chain

7. Economies of scope

8. Store expansion

9. Low prices and bulk production

10. IKEA vs Walmart

11. References
Abstract

1
 Introduction
Economies of scale is a concept that refers to the cost advantages that a firm or industry can
achieve by producing goods or services on a large scale. Simply put, it indicates that the
average cost of production drops as production quantity rises. This idea is crucial to the
industry because it enables companies to boost profitability by lowering manufacturing costs.

As quantity of production increases from Q to Q2, the average cost of

each unit decreases from C to C1. LRAC is the long-run average cost.

The size of the business generally matters when it comes to economies of scale. The larger
the business, the more the cost savings. Businesses may be able to access more effective
production technologies as they expand, negotiate better prices with suppliers, and profit
from economies of scope by diversifying their product offerings. These factors have the
potential to result in even greater cost savings and competitive benefits.

In this project report, we will discuss the concept of economies of scale and its relevance in
the retail industry by taking the example of the biggest furniture retailer in the world, IKEA.

IKEA is a major player in the retail furniture industry, serving a wide variety of customers all
across the globe. As a multinational company, IKEA creates and markets ready-to-assemble
furniture, kitchen appliances, and home decor. It was established in Sweden in 1943 by

2
Ingvar Kamprad, who was 17 at the time. The name of the business is an acronym made up of
the first letters of Ingvar Kamprad (the founder's name), Elmtaryd (the estate where he was
raised), and Agunnaryd (his hometown in the southern Swedish province of Smland). It
operates over 460+ stores in more than 60+ countries, with an annual revenue of over 48
billion dollars.

IKEA's success has been largely attributed to its capacity to take advantage of economies of
scale. It is able to produce huge quantities of furniture at a cheaper cost per unit than many of
its rivals thanks to its approach to design and production. IKEA has been able to offer clients
affordable furniture while still upholding high standards because to this cost advantage.
IKEA also benefits from economies of scale thanks to its effective distribution system and
worldwide supply chain network.

According to IKEA's financial reports, the company's revenue in 2021 was $45.7 billion,
representing a year-on-year increase of 5.7%. Additionally, IKEA's net income in 2021 was
$3 billion, representing a year-on-year increase of 24.7%. These figures demonstrate the
effectiveness of IKEA's business model, which relies heavily on economies of scale to reduce
costs and improve profitability.

IKEA has recently made investments in sustainability projects such waste reduction, the
promotion of circular business methods, and the source of renewable energy. By 2030, the

3
corporation wants to be climate positive, which means it will release fewer greenhouse gases
than it does today.

Large volume purchases

One of the major expenses that furniture companies must deal with is the cost of production.
Labour and machinery involved in furniture production are costly. However, IKEA has been
able to maintain its low prices for customers by producing many components in bulk.
Additionally, using many common parts across different furniture designs has allowed IKEA
to manufacture more furniture units for a lower cost.

According to IKEA, it uses 1 percent of the planet’s lumber, which equates to about 530
million cubic feet of wood each year. To keep prices low, IKEA employs a vertically
integrated supply chain model. This model includes self-owned forestry operations, forestry
specialists, and direct sourcing from over 1,000 suppliers in more than 50 countries. This
supply chain model has allowed IKEA to adopt an asset-light business model without having
to make significant investments in property or inventories.

Composite wood has an average cost of approximately £75 per m²(INR 7694.87), which is
higher than the cost of solid wood. The cost of solid wood, ranges from £75 to £150 per
m²(INR 7694.87 to INR 13850.77), with hardwood being the pricier option. (Source:
Checkatrade.com).

While over 50 percent of IKEA's furniture is manufactured by third-party vendors in

countries like China, Romania, Poland, and Slovakia, the company's business performance is
susceptible to developments in these markets and its ability to negotiate prices with suppliers.

4
Nonetheless, the company's vertically integrated supply chain model allows it to maintain
low prices across its vast store network.

Cost Reduction

Due to its extensive global presence and dominant position in the furniture industry, Ikea
experiences high demand and supply compared to its competitors. The company's affordable
pricing strategy attracts many customers, enabling it to purchase raw materials in large
quantities, thereby reducing production costs per item. Ikea continually strives to lower prices
by leveraging technological innovation, and one of the strategies it has adopted to achieve
this is the circular business model.

5
A circular business model is an economical approach that involves creating a closed-loop
system where all inputs and outputs are reused and recycled as raw materials. This shift from
a linear to a circular model is essential for the planet's sustainability and is what Ikea is
striving for. To adopt this model, Ikea has implemented four loops - recycle, refurbish, reuse,
and remanufacturing.

(Reverse Logistics in the Transition Towards Circular Economy A Case Study of Customer Returns at IKEA by Karin
Malmgren & Karl Mötsch Larsson)

The refurbishing loop entails improving used, damaged, or non-compliant products so they
can be resold with little alterations as brand-new. Customers, IKEA, or outside service
providers may all make these improvements. Before the product is put back on the market,
this procedure entails inspecting, cleaning, repairing, updating, and recertifying it. Indirectly
assisting with product rotation, the remanufacturing and recycling loops concentrate on
repurposing components and resources from outdated items to build new ones. These loops
can, however, also reduce supply chain costs.

6
 (www.thehustle.co)

In the above image, the data on the cost of Ikea's Poang chair has been analyzed for about
three decades. Even with inflation, the prices seem to drop, which proves the point of the
circular business model.

This model typically comes with challenges, such as customer, company, supply, and
environmental challenges. Customers need to return the end-of-life products instead of
disposing of them, which will, in turn, be the raw materials for the next production. And
obviously, the customers would expect some returns like discounts or free installations for
giving away their old furniture. If the customers like this way of recycling and benefit from it,
they will continue to buy from Ikea and become permanent buyers. Circular business models
will only take off if customers and businesses continue to prefer linear consumption and
production. A shift to a circular business model necessitates significant expenditures and
adjustments across all organizations.

The business additionally faces difficulties on its own. If the clients are better suited to a
linear model, changing from a linear business model to a circular one takes significant effort,
adjustments, and starting capital. Designing for sustained use is one tactic to meet this
difficulty. Customers acquire durable items using this strategy and ones whose parts are
simple to replace. This is done to draw in more loyal clients.

Thus Ikea has demonstrated that it can effectively overcome these challenges and yet achieve
greater efficiency and profitability after reducing cost per unit production. By prioritizing
longevity and recyclability, Ikea has created a circular loop where the resources are kept in
use for as long as possible

7
 Standardization

“It is better to sell 600 chairs at a lower price than sell 60 chairs at a high price.”

— IKEA FOUNDER INGVAR KAMPRAD .

Standardisation is the process of establishing uniformity across manufacturing materials and

processes. Potential benefits of standardization include lower production and procurement
costs through economies of scale, easier and less expensive repair and replacement, and faster
and more efficient processes.

One standardization method that IKEA uses to achieve economies of scale is the
standardization of its product design, packaging, and assembly instructions. By designing
products with standardized parts and dimensions, IKEA can achieve efficiencies in
manufacturing and reduce its production costs.

Additionally, IKEA uses a standardized packaging and shipping system, which allows it to
maximize the use of shipping containers and reduce transportation costs. IKEA's “flat-pack”
furniture design, where products are packaged in a compact box and assembled by the
customer, also allows the company to save on storage, transportation, and labor costs. These
standardization methods help IKEA to produce and sell products at lower costs than its
competitors.

Moreover, IKEA's standardized store layout is also an essential part of its economies of scale
strategy. All IKEA stores have a similar layout, with well-defined sections for various
product categories, such as bedrooms, kitchens, and living rooms. This allows IKEA to
achieve efficiencies in store design, store operations, and inventory management. It also
allows customers to navigate the store easily, enhancing their shopping experience and
driving sales.

All of the above stated points are used to overall reduce the prices of the products of IKEA so
that people buy more of these. IKEA being a Swedish country had a pretty easy time getting
into markets similar to their own and maintain its standard of having cheap products, but

8
getting into Asian markets like India and China was a different thing. To maintain their lower
costs they had to go a step further for each of these markets

In China, IKEA was vulnerable to copying. Shops right outside the IKEA stores were
offering copies of IKEA’s products at much cheaper price. IKEA initially sourced products
from the same places for all stores. To win in the price war in China, IKEA started sourcing
more local made products. This change in the sourcing model allowed the company to reduce
price of most products by 30% and some products as much as by 90%. What’s more, it
emphased on its unique competences in interior design. Unique competences in interior
design gave the company ‘innovative’ and ‘non-traditional’ taglines. Chinese population aged
25–35, comprising 30 million people, is characterised as being well educated, easy to
influence and committed to foreign consumer brands. IKEA targeted this group.

Entering the Indian market was tough for IKEA. After a 12-year struggle it entered India in
2018 to perform in front of world’s most cost-conscious consumers. It opened a store in
Hyderabad’s Hitec City where Amazon, Google and Microsoft employ hundreds of people,
and where a good number of apartment buildings, meant for urban migrants, were under
construction. Policy approval, finalising large lands and selecting local sourcing took them
this time. Mostly policy approval.

While IKEA follows a standardisation ‘cutting price’ pricing method in all its markets, for
China and India, it went one step further of ‘cutting prices dramatically’ method.

Overall, IKEA's focus on standardization has allowed the company to achieve significant
economies of scale, reduce its costs, and offer affordable products to its customers.

9
 Efficient supply chain

Overview of Ikea’s supply chain strategy in 2023:

Ikea’s supply chain strategy plays a major role in its success in the retail market, the strategy
is focused on leveraging global sourcing, automation of process, lean manufacturing and e-
commerce to optimize the companies cost of production. Automation of processes helps Ikea
reduce the price of production and improve efficient meanwhile lean manufacturing is used to
reduce waste and improve production. E-commerce helps Ikea expand its market reach a
wider audience. 

• Global sourcing:

This is the process of sourcing goods from a wide range of countries including Europe, Asia,
and the US. This allows the firm to procure large amounts of products at lower costs, which
helps the firm to remain competitive in the market. This way Ikea has built a strong
reputation has high quality furniture retailer in the market.

IKEA has more than 1200 furniture suppliers around the world, as well as 100 food product
suppliers and 275 transport service providers. The five countries that supply most products
and services to IKEA are China, Poland, Italy, Germany and Sweden. 

10
 • Automation:

The firms make use of robots and other automated systems to reduce the cost of labor (that is,
reducing the Implicit cost) and improve efficiency. This helps the firm reduce cost and
increase efficiency while ensuring quality and customer satisfaction. Automation is a very
factor in Ikea’s success.

Ikea has teamed up with founders of amazon robotics and employed many robots into the
production line and slowly transform the supply chain.

 Benefits of automation as cited by Olof Orstadius employee at Ikea:

“Instead of manually checking the pallets using paper and pen, the solution is making the data
collection digital through a camera and other sensors. The whole process is done
autonomously during the night or between shifts, by the drones. This will increase the
inventory accuracy and help us show our customers what’s in stock at a certain IKEA store
today.” 

                                                                 

  • Lean Manufacturing:

This involves use of techniques to reduce waste and improve production. Techniques such as
Just-in-time (JIT) production, which ensures that materials and components are delivered jus
as in time to be used in production. This helps reduce costs of cleaning and other
maintenance improve efficiency and cuts the cost of storage.

11
Implementing lean manufacturing has immense financial benefits for your business, and these
benefits are sustainable if you ensure that lean is integrated into the culture of your business.
These benefits are often far more than can be achieved by offshoring (outsourcing overseas)
and allow you to retain control of the quality of your products and services.

The reduction in waste and defects immediately adds to your profit and so on.

• Commerce:

The use of e-commerce allows the firm to be in a bigger market, its extensive online
presence, social media presence increases firms’ visibility and reach a large customer base.
Ikea has a sophisticated logistics system to ensure all online orders are fulfilled quickly and
accurately.

12
 Economies Of Scope
Economies of scope are "efficiencies formed by variety, not volume" (the latter concept is
"economies of scale"). Economies of scope is an economic theory stating that average total
cost of production decrease as a result of increasing the number of different goods produced.
In other words, it is the ability of a company to use its resources and capabilities to produce a
range of different products or services at a lower cost than producing them separately.

For example, a company that produces both bread and cakes can use its existing equipment,
facilities, and employees to make both products. This way, it can benefit from economies of
scope by spreading the fixed costs (e.g., rent, utilities, and equipment) over both products,
leading to lower per-unit costs for each.

Another example is a media company that owns several TV channels and a website. By
sharing content across all its platforms, it can achieve economies of scope by reducing the
cost of producing content and increasing its audience reach. This can result in a higher return
on investment for the company than if it were to produce content separately for each
platform.

Ikea leverages economies of scope by producing a variety of products that share common
design, production, and distribution processes, which allows the company to benefit from
lower costs and improve efficiency. By designing furniture that can be packed flat and
offering a wide range of products in a single store, Ikea can reduce costs and maintain its
position as a leader in affordable and stylish furniture and home goods.

The company creates standardized designs for furniture pieces that can be manufactured in
large quantities at a lower cost. This allows IKEA to produce a wide range of products that
are both cost-effective and of high quality.

By selling a vast range of home furniture in large stores that are located in suburban areas
where land and labor costs are lower, it enables IKEA to offer its products at lower prices
than its competitors who may be located in more expensive areas. It also creates economies
of scope as a customer is willing to pay more for a bundle of items than for the items
separately. The vast product range also reduces IKEA’s cost as the knowledge gained from
building one type of furniture improves another type of furniture.

In addition, IKEA’s marketing strategy is focused on creating a strong brand image that
resonates with consumers around the world. This allows the company to create economies of

13
scope by using the same marketing message in different markets and over a vast range of
products, which reduces costs and increases efficiency.

Furthermore, IKEA offers a range of services that complement its product offerings, such as
installation, delivery, and financing. By offering these services, IKEA is able to create a one-
stop-shop experience for customers, which increases customer loyalty and helps the company
to cross-sell and upsell its products. This allows IKEA to take advantage of economies of
scope by offering a range of products and services that meet the needs of customers in
different markets.

in a single location and offering matching furniture, IKEA creates economies of scope:.
These economies of scope also enable IKEA to spread marketing costs (like catalog costs)
over 9,500 products. IKEA has also incurred large sunk costs in long-term supplier contracts,
production capacity and branding/advertising. This means that competitors and potential
entrants know that IKEA has incurred fixed costs for remaining in business, and would be
incentivised to retaliate if competitors competed with IKEA directly. IKEA’s accumulated
investments mean that it has spent many years accumulating and reaping the benefits of lower
costs and a higher customer willingness to pay. Any new entrant would not have these
experiences and the resulting cost and WTP gains, and thus, would be deterred from entering
the industry.

14
 Store expansion

As of now, IKEA is known to have stores in around 61 countries (including the store that
opened in India recently) around the world, with over 300 stores in total.

From this, we can see how they have distributed their stores worldwide. This expansion is
possible because of the company’s ability to take advantage of its economies of scale and
distribution network. But how does it relate to economies of scale?

By operating many stores, IKEA can significantly save its distribution costs. The company
can use its existing infrastructure to transport products to new stores rather than building new
distribution centers from scratch. Additionally, the company can negotiate better rates with
shipping providers due to its high volume of shipments. Thus, they have more cost
advantages as the scale of production and distribution increases.

15
 Low prices and bulk production

As we all know, the best way to maximize profits is by increasing production and decreasing
costs; IKEA uses the same formula as they produce in bulk to achieve economies of scale,

which in return reduces cost. We can tell that they produce in bulk due to their heavy usage
of wood, as they consume 1% of the total commercial wood worldwide. Their largest wood
supplier is Swedwood which even produces wooden parts as a subsidiary of IKEA, and they
have around 22 facilities around Europe and Asia alone.

From the above graph, we can see how the sales increase with the wood consumption and
mass production of furniture. Due to this, popular products experience a further price decline,
despite the increasing demand. They increase production and can reduce the profit margins
on these products. It helps in increasing revenue and reduce material costs at the same time.
So they can earn higher profits even at lower margins. Due to this, their income has been
increasing at a CAGR(Compound Annual Growth Rate) of 5%. In contrast, its competitors,
like Walmart, witnessed 1.5% growth over the past years.

16
 How does IKEA compare to its competitors, namely Walmart?

Although Walmart offers a wider range of products, Ikea remains one of its biggest
competitors and holds a larger market share. In order to stay competitive, Ikea focuses on
delivering a superior customer experience and offering high-quality products that meet its
customers' needs. One of its biggest strengths is its loyal consumer base and how it advertises
itself to all age groups. IKEA has a big and very dedicated customer base, which shows its
high brand loyalty. Ikea offers an extensive range of furniture for different room types, in
addition to home accessories like kitchen appliances, home textiles, and tabletop products, at
affordable prices.. Ikea has a very personalised shopping experience that is very unique and
stands out when compared to competitors, making customers happy and building loyalty.

This means that they don’t need to spend a lot on advertisement as compared to other
competitors.

Walmart spends more on marketing and advertising than Ikea, in part because it sells a wider
range of products. In 2020, Walmart spent over $3 billion on advertising, while Ikea spent
around $1.5 billion.

  

Area of Ikea Walmart

Comparison

Purchasing Significant due to large size and
Power volume of sales. In 2020, Ikea had
revenue of $44.6 billion and operates
in 52 countries.
Significant due to large size and
volume of sales. In 2020, Walmart
had revenue of $559 billion and
operates in 24 countries. However,
Walmart's broader range of products
means that it has more diverse supply
chain needs and may not have the
same level of specialization as Ikea
in certain areas.

17
Standardization Strong emphasis on standardization
and simplification of products. Ikea's
product range is designed to be
produced in large quantities with
minimal customization. In 2021, Ikea
sold over 9,500 products worldwide,
with the most popular items being its
Billy bookcase, Klippan sofa, and
Lack table.
Store Size and Stores are typically larger, allowing
Layout for greater efficiency in logistics and
operations. Ikea's largest store is in
South Korea, measuring 640,000
square feet.
Supply Chain Highly efficient supply chain with use Highly efficient supply chain, but
Efficiency of flat-packaging and specialized
logistics infrastructure. Ikea's supply
chain is vertically integrated, and it
owns forests, sawmills, and factories.
Overall Achieved significant economies of
scale. In 2020, Ikea's cost of sales was scale, with benefits from
64.3% of its revenue, and its gross
profit margin was 35.7%. In
comparison, Walmart's cost of sales
was 76.6% of its revenue, and its
gross profit margin was 23.4%. Ikea's
focus on standardization, efficient
supply chain, and larger store format
may give it an advantage in terms of
cost structure and efficiency.
18
Benefits from economies of scale
through standardization of products,
but may require more variation in
production and logistics due to
broader range of products. Walmart's
private label brand, Great Value,
accounts for 21% of its sales. In
2020, Walmart sold over 120,000
items in its stores, including
groceries, electronics, and clothing.
Smaller stores and more
straightforward layout may require
less staff and lower operating costs.
Walmart's average store size is
around 180,000 square feet.
may not have the same level of
specialization as Ikea in certain areas.
Walmart uses cross-docking, which
reduces inventory holding costs and
increases efficiency.
Achieved significant economies of
standardization and efficient supply
chain, but may face more complex
logistics due to broader range of
products. In 2020, Walmart's
operating expenses were 20.3% of its
revenue, while Ikea's operating
expenses were 30.3% of its revenue.
Walmart's larger size and broader
range of products may allow for
 greater bargaining power with
suppliers, while Ikea's focus on
standardization and vertical
integration may provide greater cost
savings.

19
References

20