Economics

Business Economics
Session 9: Cost Analysis II : Tata-Daewoo

“The Road to Gunsan”
Faculty: Prof. Sunitha Raju Session Date: 17.08.2019

MBA (IB) 2019-22(Weekend)
Long Run Cost Decisions
Business Economics
 how costs influence plant size and location decisions of

business firms
 what factors contribute to Economies and Diseconomies

of scale
 to relate Minimum Efficient Scale (MES) to market size

Cost Analysis for Optimum Plant Size

Business Economics
AC1L
AC
AC1L
.
B
ACS
ACM
AC1M
AC1S
.C ACL
E
.D
Q1 Q2 Q3 Q
BCDE : Range of output where AC is lower for the three scale options
given the market demand of Q1, Q2 & Q3.
Cost Analysis for Optimum Plant Size

Business Economics
AC
.
B
.C
.
D
Q
Long Run Average Cost Curve

(Planning Curve)
Business Economics
AC
Minimum Efficient
Scale (MES)
.
Q
• Scale economies: As scale of operation increases, average costs fall
Scale diseconomies : As scale of operation rises, average costs rise
MES : Optimum scale of operation where full economies are exploited
LRAC : Envelope of SRAC curves
SRAC and LRAC Curves .

Business Economics
AC
A .
.
F
.
B
. .
E
C .
D
Q* Q
 When economies of scale exist (A,B,C) and market demand is expanding, in the short run, it
is better for firms to have bigger plants and operate under excess capacity conditions.
 When diseconomies of scale exist and market demand is expanding, in the short run, it is
better for firms to have smaller plants and operate in the rising part of SRAC curve.
Competitive Implications of LRAC

Business Economics
AC AC
MES MES
A B
Q Q
A : Low economies of scale and smaller MES (optimum size) relative to market size
A number of small firms can operate in this market, i.e., competitive
B: Higher economies of scale and large MES (optimum size) relative to market size.
One or few large firms can operate in this market, i.e., non competitive
Minimum Efficient Scale (MES):

Competitive Implications
Business Economics
(i) Competitive Market

 When MES is low relative to the total industry demand
Large number of small sized firms can operate in the

industry
(ii) Non-Competitive Market
 When MES is high relative to total industry demand
One or few large sized firms can operate efficiently in

the industry
Transport Cost and Optimal Plant

Size
Business Economics
AC
.
.
Q*2 Q*1 Q
Trade off between Transport Costs & Scale economies

Transportation Costs: Competitive

Implications
Business Economics
(i) High Transportation Costs

 Small plants closer to the market
(ii) Low Transportation Costs

 Bigger plants far away from the market
Multiplant Economies
Business Economics
 Business firm can have plants operating multiple facilities in the

same line of business or industry
 Cost advantages can arise from expanding production facilities and
intra plant economies
AC AC
Q* Q Q* QF*
(a) Constant costs in (b) Decreasing costs in

multiplant facility multi plant facility
Economies of Scope
Business Economics
 Economies of scope exist when cost of jointly producing

two (or more) products is less than producing each
separately.
eg : * Reliance : Polyster to Petroleum products
 Economies of scope important for developing new product

lines.
Learning Curve
Business Economics
(i) Definition
 Experience improves production efficiency
thereby reducing average costs
 If learning curve effects induces efficiency for
every output level then LRAC shifts parallelly
(ii) Strategic Implications

 Large firms can reap learning curve effects
 Facilitates a firm to maintain a dominant position
in the market
Cost Analysis for Optimal Scale

Business Economics
Tata Motors: The Road to Gunsan
1. Why did Tata Motors acquire Daewoo’s plant at

Gunsan?
(a) Market/Demand Condition

(b) Production/cost Characteristics
(c) Indian Market Conditions
Business Economics
(a) Market/Demand Condition
 Tata Motor’s commercial vehicles (CV) focussed on

domestic market. Plans to expand global business from
5% to 20% by 2005-06. Also, plan to enter into big
markets with full product range.
 China is the world’s fastest growing market for CV (heavy
load). Therefore, advantages with respect to location and
entry conditions.
 Other growing markets are South Korea, Italy and Spain
for heavy load. For lighter CVs, the emerging markets are:
S. Korea, S. Africa, Middle East, Turkey and India.
Business Economics
(b) Production/cost Characteristics
 Daewoo’s (Gunsan) plant was operating at 25% capacity

and yet commanded a 22% market share. (This implies by
increasing the production and successful market expansion
will result in cost competitiveness).
 Gunsan plant had the technological capability to develop

new versions of heavy CVs.
 With the work on designs in the Technical centre at Gunsan

plant, Daewoo product-line complements the Tata product-
line.
Business Economics
(c) Indian Market Conditions
 The domestic market conditions for CV are also changing.

First, Euro III emission norms to be enforced for truck.
Second, truck overloading to be banned. Together, new
development in truck design and engines necessary.
Long Run Average Cost Curve
(Planning Curve)
Business Economics
AC
Minimum Efficient
Scale (MES)
.
Q
• Scale economies: As scale of operation increases, average costs fall
Scale diseconomies : As scale of operation rises, average costs rise
MES : Optimum scale of operation where full economies are exploited
LRAC : Envelope of SRAC curves
SRAC and LRAC Curves .

Business Economics
AC
A .
.
F
.
B
. .
E
C .
D
Q* Q
 When economies of scale exist (A,B,C) and market demand is expanding, in the short run, it
is better for firms to have bigger plants and operate under excess capacity conditions.
 When diseconomies of scale exist and market demand is expanding, in the short run, it is
better for firms to have smaller plants and operate in the rising part of SRAC curve.
Sources of Economies of Scale

Business Economics
Tata Motors: The Road to Gunsan
• In Manufacturing, Tata is upgrading to Euro III norms and

Daewoo is already complaint Tata trucks can integrate this
engine.
• In sourcing, Tata can get good prices from renders because of
bulk buying.
• In Marketing, Tata’s marketing and distribution network in South
Africa, Middle East have already sold Daewoo’s trucks.
• In design, Tatas make trucks of 1-tonne in India. With a bit of
atomization this product can find its may in S. Korean market,
currently the largest segment in Korean CV market.

Economics

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Business Economics

Session 9: Cost Analysis II : Tata-Daewoo

Faculty: Prof. Sunitha Raju Session Date: 17.08.2019

Long Run Cost Decisions

 how costs influence plant size and location decisions of

 what factors contribute to Economies and Diseconomies

 to relate Minimum Efficient Scale (MES) to market size

Cost Analysis for Optimum Plant Size

Cost Analysis for Optimum Plant Size

Long Run Average Cost Curve

SRAC and LRAC Curves .

Competitive Implications of LRAC

Minimum Efficient Scale (MES):

(i) Competitive Market

Large number of small sized firms can operate in the

(ii) Non-Competitive Market

 When MES is high relative to total industry demand

One or few large sized firms can operate efficiently in

Transport Cost and Optimal Plant

Trade off between Transport Costs & Scale economies

Transportation Costs: Competitive

(i) High Transportation Costs

(ii) Low Transportation Costs

 Business firm can have plants operating multiple facilities in the

(a) Constant costs in (b) Decreasing costs in

 Economies of scope exist when cost of jointly producing

 Economies of scope important for developing new product

(ii) Strategic Implications

Cost Analysis for Optimal Scale

Tata Motors: The Road to Gunsan

1. Why did Tata Motors acquire Daewoo’s plant at

(a) Market/Demand Condition

 Tata Motor’s commercial vehicles (CV) focussed on

(b) Production/cost Characteristics

 Daewoo’s (Gunsan) plant was operating at 25% capacity

 Gunsan plant had the technological capability to develop

 With the work on designs in the Technical centre at Gunsan

(c) Indian Market Conditions

 The domestic market conditions for CV are also changing.

SRAC and LRAC Curves .

Sources of Economies of Scale

Tata Motors: The Road to Gunsan

• In Manufacturing, Tata is upgrading to Euro III norms and

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