PERFORMANCE IN DUTCH NURSING HOMES
Merger fever in the Dutch elder care, how real are the perceived advantages?
A qualitative approach to economies of scale in the Dutch nursing home industryMaster Thesis
University of Groningen
Faculty of Economics and Business
MSc. Business Administration
Specialization: Organizational and Management Control
April 2013
Author:
Gideon den Hertog
Middenland 3
PERFORMANCE IN DUTCH NURSING HOMES
Merger fever in the Dutch elder care, how real are the perceived advantages?
A
qualitative approach to economies of scale in the Dutch nursing home industry
Master Thesis
University of Groningen
Faculty of Economics and Business
MSc. Business Administration
Specialization: Organizational and Management Control
April 2013
Author:
Gideon den Hertog
Middenland 3
Economies of Scale in Dutch Nursing Homes 2
Preface
The document lying in front of you is the result of a research performed to finalize my education at the Faculty of Economics and Business at the University of Groningen. Inspiration for the research was found during my work at an elder care organization preceding this thesis.
In 2010 I got the opportunity to work at an elder care organization. This particular organization was the result of a number of mergers over the years and consisted of several nursing homes, two home-care divisions and a few other operations. The organization achieves a small positive financial result each year. Currently the organization is again involved in a merger. The merging partner is a larger organization which is incurring significant financial losses over recent years.
A major part of my job was assisting in the reorganization of the facility division in reaction to a changed governmental funds allocation structure. During my time with the organization it appeared to me that the achievement of economies of scale was not very evident. In contrary in some cases. This intrigued me and as a result led to focusing my master thesis on this subject.
I would like to thank several people for their support in the process of conducting this thesis. First, I would like to thank my supervisor Prof. dr. D.M. Swagerman for our cooperation during the writing of this thesis and the useful feedback he provided me with. I would also like to thank all the people I have interviewed for their time, cooperation and critical thinking. Furthermore, I hereby seize the opportunity to express a word of gratitude to my family and friends. They gave me such great support in so many ways during the completion of my thesis.
This thesis marks the end of my student career. A time on which I look back with great pleasure. Writing this thesis was a very challenging, but also a valuable experience. Nevertheless, I am glad it is finished, and I am looking forward to starting my career with the benefit everything I have learned at the university as well as during the activities I have undertaken outside the university.
Hopefully you will enjoy reading this thesis.
Yours sincerely,
Economies of Scale in Dutch Nursing Homes 3
Abstract
This research investigates economies of scale in Dutch nursing homes by means of a qualitative analysis. Based on literature on economies of scale, literature and data on nursing homes and a case study, the likelihood of economies of scale was analyzed.
The literature on economies of scale led to a conceptual model that includes 4 sources of economies of scale and 5 sources of diseconomies of scale. Furthermore the literature distinguishes dimensions of scale and categories of scale.
Analysis of the nursing home industry found that 13 organizational parts could be distinguished in nursing homes, spread over three main categories; nursing, facilities and overhead. Analysis of the external environment found a low competitive market, where geographical position close to the (potential) clients is vital and where a very stable and slowly rising demand exceeds supply.
In the analysis the characteristics of the 13 organizational parts were compared to the characteristics of the 9 sources of scale. It found that economies of scale are present in nursing homes. The extend of the economies of scale is limited however, and most present in the range up to an output of approximately 120 clients. An average cost curve based upon the qualitative findings would show a decreasing decrease in costs. These findings are comparable to earlier findings in quantitative research and provide explanation for these findings.
The geographical dimension of scale showed a significant difference in economies of scale between the plant level and the organizational level. At the organizational level the economies of scale were lower and the diseconomies of scale were higher. The economies of scale on the organizational level seem to be very limited, and might be nonexistent or negative at very large scales. Due to the geographical and social demands of the demand however, an increase in scale at the plant level is only limitedly possible.
Key words
Economies of Scale in Dutch Nursing Homes 4
Table of contents
PREFACE ... 2 ABSTRACT ... 3 TABLE OF CONTENTS ... 4 INTRODUCTION ... 7 1 PREVIOUS RESEARCH ... 9 2 RESEARCH DESIGN ... 11 2.1 PROBLEM STATEMENT ... 11 2.1.1 Research objective ... 12 2.1.2 Research question ... 12 2.1.3 Sub-questions ... 122.2 DEFINITION OF KEY CONCEPTS ... 12
2.3 RESEARCH METHODOLOGY ... 13
2.4 CONCEPTUAL RESEARCH MODEL ... 16
2.5 STRUCTURE OF THE THESIS ... 17
3 ECONOMIES OF SCALE ... 18
3.1 INTRODUCTION ... 18
3.2 HISTORY OF ECONOMIES OF SCALE ... 18
3.3 DEFINITION OF ECONOMIES OF SCALE ... 20
3.4 EXPLANATION AND GRAPHICAL PRESENTATION OF THE PRINCIPLES OF ECONOMIES OF SCALE ... 22
3.4.1 The average cost curve ... 22
3.4.2 Long-run versus short-run... 23
3.4.3 Efficiency ... 23
3.4.4 Different shapes of scale curves ... 24
3.5 SOURCES OF ECONOMIES OF SCALE ... 25
3.5.1 Overview of literature ... 25
3.5.2 Analysis and explanation of the sources of economies of scale ... 31
3.5.3 Analysis and explanation of the sources of diseconomies of scale ... 35
3.5.4 Dimensions of scale ... 38
3.5.5 Categories of scale ... 39
3.6 EXPANDED CONCEPTUAL RESEARCH MODEL... 40
4 NURSING HOMES AND THEIR ENVIRONMENT ... 41
4.1 INTRODUCTION ... 41
4.2 INTRODUCTION TO THE NURSING HOME INDUSTRY AND THE CASE ... 41
Economies of Scale in Dutch Nursing Homes 5 5.2.3 Higher wages ... 62 5.2.4 Fixed factors ... 63 5.2.5 Conflicting out ... 63 5.2.6 Transportation costs ... 63 5.3 NURSING ... 64 5.3.1 Nursing care ... 64 5.3.2 Treatment ... 66 5.3.3 Social care ... 67 5.4 FACILITIES ... 68 5.4.1 Food ... 68 5.4.2 Reception ... 70 5.4.3 Technical support ... 71 5.4.4 Laundry ... 73 5.4.5 Cleaning ... 75 5.5 OVERHEAD ... 77 5.5.1 Management ... 77 5.5.2 Finance ... 78
5.5.3 Personnel & Organization ... 79
5.5.4 ICT ... 79
5.5.5 Communication ... 81
5.6 SUMMARY OF THE RESULTS ... 82
6 TRIANGULATION ... 84
7 CONCLUSION AND RECOMMENDATIONS FOR PRACTICE ... 86
7.1 INTRODUCTION ... 86
7.2 ANSWERS TO THE SUB-QUESTIONS ... 86
7.3 ANSWER TO THE RESEARCH QUESTION ... 91
7.4 DISCUSSION ... 92
7.5 RECOMMENDATIONS FOR PRACTICE ... 93
8 LIMITATIONS OF THE RESEARCH AND RECOMMENDATIONS FOR FURTHER RESEARCH 95 8.1 LIMITATIONS OF THE RESEARCH ... 95
8.2 RECOMMENDATIONS FOR FURTHER RESEARCH ... 96
FINAL NOTE ... 98
REFERENCES ... 99
FIGURES FIGURE 1–CONCEPTUAL RESEARCH MODEL ... 16
FIGURE 2–RESEARCH LAY-OUT ... 17
FIGURE 3–AU-SHAPED AVERAGE COST CURVE ... 22
FIGURE 4–LONG-RUN VERSUS SHORT-RUN COST CURVES ... 23
FIGURE 5–SEVERAL SHAPES OF SCALE CURVES ... 24
FIGURE 6–FRAMEWORK FOR THE ASSESSMENT OF THE NATURE OF LABOR AND TASKS ... 33
FIGURE 7–EXPANDED CONCEPTUAL RESEARCH MODEL ... 40
TABLES TABLE 1-OVERVIEW OF THE SOURCES OF ECONOMIES OF SCALE ... 31
TABLE 2-OVERVIEW OF THE SOURCES OF DISECONOMIES OF SCALE ... 35
TABLE 3–THE ZZP BUDGETS PER CLIENT PER DAY FOR NURSING HOMES FOR 2013 ... 44
TABLE 4–THE ZZP BUDGETS PER CLIENT PER DAY OF FACILITIES FOR NURSING HOMES FOR 2012... 47
TABLE 5–OVERVIEW OF THE FINDINGS OF ECONOMIES OF SCALE IN NURSING HOMES AT THE PLANT LEVEL ... 82
Economies of Scale in Dutch Nursing Homes 6 APPENDICES
APPENDIX 1–OVERVIEW INTERVIEWEES………... APPENDIX 2–CHECKLIST &QUESTIONS INTERVIEWS………... APPENDIX 3–ZZP BUDGET AND REALIZATION FACILITIES 2009AMSTELRING... APPENDIX 4–CALCULATION DETAILED ZZP BUDGETS NURSING HOMES...
APPENDIX 5–ORGANIZATIONAL CHART ZORGCENTRUM AELSMEER………
Economies of Scale in Dutch Nursing Homes 7
Introduction
This research focuses on Dutch elder care. The Dutch elder care industry is an interesting subject for research due to a number of developments. Three major developments can be observed. These are: (1) a large number of mergers, (2) the introduction of a new governmental funds allocation structure and (3) aging of the population. These three developments and their implications are discussed and explained below.
To begin with, in recent years, within the industry a trend can be observed of an increasing number of mergers. The Dutch Healthcare Authority (NZA) has devoted several papers to this subject (Mosca, Pomp & Shestalova, 2007; Katona & Bogetoft, 2008). Nursing homes are merging with other nursing homes, home care organizations and/or other organizations. Apparently, larger organizations are preferred. However, occasionally these larger organizations turn up in the news in a negative way. These are stories about organizations which have lost managerial control over their finances and/or quality. Examples in the Netherlands are 'Meavita', 'Hestia stichting' 'Philadelphia' and 'Osira groep'. Also taking into account several research findings that concluded a low success rate of mergers in general, one might question to which extend these mergers are successful. Bruner (2002), for example, found that approximately 70-80% of mergers and acquisitions do not create significant value above the annual cost of capital. And even conservative estimates place M&A failure rates at approximately 50% or higher for nearly four decades (Coffey, Garrow, & Holbeche, 2003; Kitching, 1974). Furthermore, a branch report by PricewaterhouseCoopers (2010a) analyzed elder care organizations and found most of the positive outliers in solvency in the lower range of size.
Secondly, as of 2010 a new funds allocation structure for elder care industry was introduced in the Netherlands. This new funding system was announced in 2006 by the secretary of ‘Volksgezondheid, welzijn en sport’ (VWS) and further developed in the years leading up to 2010. This new funding system is called 'zorgzwaartepakketten' (further referred to as ZZP) and has replaced the old funding system. The Netherlands can be seen as a precursor in the development of (the organization) of the care industries considering several reports of the European Consumer Powerhouse (Björnberg & Uhlir, 2008; Björnberg, Garrofé & Lindblad, 2009). According to the reports, The Netherlands are in “uncontested leadership”. And this funding system appears to be the first of its kind.
Economies of Scale in Dutch Nursing Homes 8 one of ten categories (care need packages) based upon his or her care needs. The total budget a nursing home receives consists of the total of these budgets of all its clients. The idea behind this ZZP funding system is that every organization is awarded an amount of funds which is in accordance to the care needs of its clients (Katona & Bogetoft, 2008)
Nationwide this transition was supposed to be budget-neutral. Depending on the client-composition there will be different budget-effects per nursing home. However both in public as within the industry a general image appears to exist that the size of the budgets has declined and that the current size of the budgets is insufficient to adequately cover the expenses. Whether or not this image is correct to a degree, the new funding system certainly endorsed organizations to re-examine their finances. On top of that this new system enables an unprecedented comparison of nursing homes in financial terms.
The third development is the aging of the Dutch population. Currently about 15% of the population is above the retiring age. The prognosis is that this percentage will increase up to 25.9% in 2040 (Duin & Garssen, 2011). This puts a financial pressure upon the working part of the population, which calls for an efficient elder care industry.
Economies of Scale in Dutch Nursing Homes 9
1 Previous research
Looking at earlier research, a number of studies have been published in the last decades considering the relationship between scale and financial performance of nursing homes. Prime examples are Christensen (2004), Dor (1989), Gertler and Waldman (1992), McKay (1988) and Nyman (1988). All of these studies are quantitative of nature; they estimate scale and scope economies in nursing homes through statistical analysis. The findings differ between the different studies. These different findings can be the result of differences between the samples, but are likely also caused by differences in the type of statistical analysis and whether the analysis is controlled for quality. An overview of (some) previous research is given below by describing two of the studies mentioned above; McKay (1988) en Christensen (2004). Furthermore the findings of the other studies mentioned above are presented as well.
The research of McKay (1988) was based upon 82 for-profit Nursing homes, providing only intermediate nursing care (a care level comparable to the middle ZZP-classes), and located in Texas (USA). The size of the nursing homes varied in size from 22 to 185 beds, with a mean of 85 beds. Of the 82 homes, 46 were part of a chain, but this fact is discarded under the statement that every home within the sample made its own input decisions. The study was controlled for input prices of the nursing homes. The findings of the study are that there are significant economies of scale in nursing homes. When controlled for quality the economies are slightly lower, but significant none the less. The average costs decrease at a decreasing rate which is greatest up to 3000 client days (approximately 82 clients), and keep dropping after that, though at a much slower rate, up to the upper end of the sample; 185 beds. McKay states that these results are quite different from the findings of other studies, which found no evidence of significant economies of scale. He attributes this to the statistical method being used. As an example he uses a different method on his sample which results in a U-shaped average cost curve with the minimum average cost occurring at 133 beds.
Economies of Scale in Dutch Nursing Homes 10 The findings of the study of Christensen (2004) were that scale economies were present for both the intermediate care facilities and the skilled care facilities in the lower deciles. In the higher deciles scale economies were present for intermediate care facilities, but for skilled care facilities no significant scale economies were found. The economies of scale were higher for the intermediate care facilities than for the skilled care facilities. As for combined facilities, the findings show economies of scale and scope in the lower deciles and diseconomies of scale or no significant economies of scale at higher deciles. Regarding the study there are two points of attention: (1) the deciles are based on total costs, where as chosing the deciles based upon average costs would seem more logical and valuable, (2) furthermore, in part because of the previous point, the results are not based upon the efficient frontier.
Furthermore Gertler and Waldman (1992) used a sample of 279 nursing homes in New York (USA), with a mean of 121 clients per home and found slight economies of scale when not controlled for quality. When controlled for quality they found no significant economies of scale. It is unclear what the level of care (intermediate versus skilled) of the homes in the sample is. A research by Nyman (1988) used a sample of 419 nursing homes from New York city (USA), with a mean of 174 clients per home. Nyman found significant economies of scale. The economies were larger for intermediate care than for skilled care. The findings were not controlled for quality however. Nyman (1990) did another study which used a sample of 296 nursing homes from Iowa (USA) that provided intermediate care and had an average of 71 clients per home. The study was controlled for quality. Nyman did two analyses, finding two different optimal scales of 170 and 104 clients respectively. Dor (1989) found significant diseconomies for skilled care facilities. The study did not control for quality.
Economies of Scale in Dutch Nursing Homes 11
2 Research Design
2.1 Problem statement
The subject of this research, the relationship between scale and financial performance in Dutch nursing homes, can be assessed from different angles. One approach is quantitative research in the form of a statistical analysis of extensive and detailed data of a large sample of nursing homes, focusing on the 'when', 'how often' and 'how many'. Such research could add value to previous research partly thanks to the new ZZP-classification, which enables a more refined comparison of organizations and locations. Possible data-sets exist such as the 'DIGIMV'. However, most of these data-sets, even such as extensive as the 'DIGIMV', lack one or multiple variables needed. These are also the findings of Kooreman (2008). He found that the availability of systematic data of nursing homes in the Netherlands has worsened since the abolishment of the yearly governmental survey, the information is too fragmented and incomplete. So due to practical limitations in terms of availability of data in combination with the limited scope of a master thesis, this is currently not feasible.
Another approach is a qualitative research in the form of an exploratory research focusing on the 'why' and 'how' of the relationship between size and financial performance. Such research can add value to earlier research in explaining the relationship between size and financial performance, since previous research has focused predominantly on quantitative results and not so much on explaining these results. This thesis will therefore use an qualitative approach.
The two main subjects/developments stated in the introduction are (what looks like) a merger fever within the Dutch elder care and a need for efficiency. These two combined, deal with the relationship between (1) 'size & composition' and (2) 'financial performance' of (3) 'elder care organizations'. These three elements are still rather broad and need to be more specified in order to come to a scope suitable for this research
Economies of Scale in Dutch Nursing Homes 12 (2) Financial performance: In terms of the subject of this thesis, financial performance, or in other words efficiency, is total costs in relation to total production.
(3) Elder care: Within the elder care, a number of different types of activities can be distinguished. These are: nursing homes, home care (domestic help & nursing, meal service, etc.), provision of 'aid appliances' (rental & sales) and daycare. Due to the scope of a master thesis it is not feasible to assess all forms of elder care. Of these different types of activities nursing homes are most interesting in relation to scale. Firstly nursing homes deal with the most diverse range of activities. Secondly nursing homes and their logistics are relatively geographically bound, which affects possible economies of scale.
2.1.1 Research objective
The above leads to the following research objective:
“To gain insight in the role of economies of scale within the industry of nursing homes.”
2.1.2 Research question
Based on the introduction and the research objective, the question on which this thesis will focus is: “What is the relationship between scale and financial performance in Dutch nursing homes?”
2.1.3 Sub-questions
In order to answer the research question, the following sub-questions are formulated:
1. What are the sources of (dis)economies of scale?
2. What are the characteristics of nursing homes and their environment?
3. How do the characteristics of nursing homes and their environment relate to economies of scale?
3a. Which (dis)economies of scale occur in which areas of the organization?
3b. In which scale-range(s) and to which degree do these (dis)economies of scale occur?
2.2 Definition of key concepts
Economies of Scale in Dutch Nursing Homes 13
Scale
Scale can be defined as planned capacity, planned output or realized output. Within this thesis scale is defined as the planned capacity. In the context of the subject of this thesis, capacity is defined as the number of client days per year, or in full time clients per year (FTC), which is the number of client days divided by the number of days per year.
Financial performance/efficiency
Financial performance in the context of this thesis is the total costs of the organization divided by the production, which is the realized number of client days per year. Which is the average costs per client (per year or per day).
Nursing homes
A nursing home is a long-term care facility licensed by the state that offers 24-hour room, board, personal care and nursing care. The clients or residents of nursing homes are predominantly the elderly, but include also younger people who need long-term care.
2.3
Research Methodology
This research methodology clarifies: (1) for what type of research is chosen, (2) how the data is collected, and (3) describing possible validity and reliability issues, to ensure that the content of the research corresponds with the aim and problem of this research.
Research type
Economies of Scale in Dutch Nursing Homes 14 The third and final part compares the properties of economies of scale to the properties of nursing homes and is exploratory and explanatory of nature.
Data collection
The research will be based upon literature. For specific information about the industry, its activities and its environment, literature will be supplemented where needed by policy documents, case documentation and archival records, interviews, observations and participant-observations.
Interviewees are chosen based upon their experience and competence. Regarding their experience, they should be experienced with varying sizes of nursing homes, and varying possible set-ups of their work. The latter could of course be very well partly gained in settings and organizations other than nursing homes. Regarding their competence, the interviewees should perform (above) par in terms of both quality and cost effectiveness. Furthermore the interviewees should be capable of looking beyond their own work, to see the broader perspective. A likely profile of the interviewees is persons which are 40+ years of age with 10+ years experience in nursing homes and their work, and performing well. Of course the required level of experience and competence varies per interview subject. However, as most of the interviews will likely be conducted to gather information about the transformation processes within nursing homes, the above should provide a good guideline.
Case documentation and archival records are used when needed or valuable. The documentation and archival records are chosen based upon relevance, reliability, representativeness and accessibility. Accessibility is mentioned as it is my personal experience is that (nursing home) organizations are reluctant to share data and documents. Furthermore data is not always available or of good quality.
This study is not specifically a case study research, but the interviews, case documentation and archival records can be seen as cases of case information. This information is collected in/from several organizations.
Economies of Scale in Dutch Nursing Homes 15
Validity and Reliability
This research has two objectives. The first one is to examine the theory on economies of scale to come to a framework. The second objective is to apply this framework to nursing homes to come insights for this industry. To realize these objectives, the research consists of three parts: a literature review of economies of scale, description of nursing homes and their environment and the analysis which relates the two. Validity and Reliability are most relevant for the second and third part.
Validity is the degree to which the research measures what it should measure. The degree to which the findings represent the actual reality. There are three main forms of validity according to Yin (2009; p. 40): internal validity, external validity and construct validity.
Construct validity is the degree to which the operational measures cover the concepts being studied. This research pursues this goal by using a wide variety of data, as described above at the section about data collection. Secondly, the operational measures will be grounded in the literature on economies of scale. Furthermore, relevant parts of the draft (case study) report will be presented to key informants and/or experts for criticism.
Internal validity deals with the causality of the research, and is to a limited degree applicable to the third part of the research, the analysis. The tactics for achieving internal validity are difficult to identify according to Yin (2009). The tactics mentioned by Yin build on the tactics mentioned above, at construct validity. To pursue internal validity it is important to build a good line of reasoning and to have sufficiently comprehensive information in order to establish a causal relationship and not overlooking other relevant factors. This thesis will aim to achieve this by using a wide variety of data and presenting a clear path of reasoning.
External validity is the degree to which the findings can be generalized. This research aims to ensure external validity through a number of ways. To begin with, the research is grounded in the theory of economies of scale. Secondly, the activities and output of nursing homes are regulated by the government. This research takes into account these regulations in assessing the activities and output of nursing homes. Furthermore, the cases that are used for additional information and knowledge of the activities of nursing homes, contain a diversity of set-ups, and the chosen interviewees are long-time experienced employees who are familiar with a wide variety of set-ups of their work as well as nursing homes as a whole.
Economies of Scale in Dutch Nursing Homes 16 case this means that the research must be well referenced. Furthermore the literature, documentation and archival records need to be collected and well archived. Interviews will be recorded and kept in the archive as well. Points of attention are the observations and participant-observations. Most of these have found place before the start of the research and are not documented. The role of observations within this research however is likely limited. Moreover the observations will likely be supported by other data.
2.4
Conceptual research model
In this section a conceptual model is presented to illustrate the research. Figure 1 presents a basic conceptual research model of this thesis. This model follows from the research objective and questions. Resulting from the literature research, a more elaborate model will be presented at the end of chapter 3.
Figure 1 – Conceptual research model
Financial Performance (Degree of Economies
of Scale in this case)
+
(Increased) Scale
Product/Service Properties (Lead to the properties
of the process/labor)
Environmental Factors (Market & Macro)
-Economies of Scale in Dutch Nursing Homes 17
2.5 Structure of the thesis
The remainder of the thesis is structured as follows. In chapter 3 the theory on economies of scale is discussed in order to come to a framework upon which nursing homes can be analyzed. In chapter 4 nursing homes and their environment are described and analyzed. In chapter 5 the analysis will be made by relating nursing homes and their environment to the properties of economies of scale. This chapter results in a table in which the findings are summarized. Chapter 6 is a triangulation. Chapters 7 and 8 consist of the conclusions and discussion of the findings, and provide directions for future research. Figure 2 gives a visual representation of the structure of the thesis.
Figure 2 – Research lay-out
Chapter 1 Previous Research
Chapter 2 Methodology
Chapter 3 Literature Study
Chapter 4 Subject Description - Product & Process
- Environment Analysis Chapter 5 Analysis Chapter 6 Triangulation Chapter 7 Conclusion - Subquestions
- Main conclusion & discussion - Recommendations for practice
Chapter 8 Recommendations - Limitations
Economies of Scale in Dutch Nursing Homes 18
3 Economies of Scale
3.1 Introduction
In this chapter the history and theory on economies of scale and the underlying principles will be discussed. In order to analyze the possibilities for economies of scale in nursing homes, understanding of these principles and drivers of economies of scale is needed. Based upon the literature, a framework for (the analysis of) economies of scale will be presented. This framework is the basis for the analysis in chapter 5.
This chapter is structured as follows. In section 3.2 a short introduction to the history of economies of scale is given for better understanding. Section 3.3 presents a definition of economies of scale. In section 3.4 the principles of economies of scale are discussed and explained. Section 3.5 discusses the core of economies of scale; the sources of scale. Literature is discussed to find and analyze the sources of economies of scale. In section 3.6 an expanded conceptual model is presented for the analysis of nursing homes.
3.2
History of economies of scale
Economies of scale is a concept of all times & places. Anywhere people work together, likely tasks will be divided, and individuals or part of the group will focus on a specific part of the job. In other words, they specialize, which may be expected to increase productivity beyond the productivity of every individual doing all the different tasks.
Take for example families or communities in the Stone Age, where men would do the hunting and building, and women the cooking and making clothes. Or, later, during the Bronze and Iron Age, an agricultural community with farmers, but also a smith and a carpenter. Another example is the production of the clothing and equipment of the Roman army. The army was as large as up to nearly half a million men and their outfitting was highly uniform. This provided quite an economy of scale and most likely resulted in organizing the production in a very specialized and efficient way. However, the sizes of most of these economies of scale are relatively small and limited compared to the scale of quite a few organizations at present. This leads to the question what has changed to cause to this increase in economies of scale.
Economies of Scale in Dutch Nursing Homes 19 railroad and the telegraph provided the fast, regular, and dependable transportation and communication so essential to high-volume production and distribution – the hallmark of large modern manufacturing or marketing enterprises (Chandler, 1977). As a result of the regularity, increased volume, and greater speed of the flows of goods and materials made possible by the new transportation and communication systems, new and improved processes of production developed, that for the first time in history enjoyed substantial economies of scale and scope. Large manufacturing works applying the new technologies could produce at lower costs than could the smaller works (Chandler, 1994; p. 1, p. 8) (Gold, 1981; p. 7).
The vital change compared with the era before the early 1800's was technology. The technological changes in both transportation, communication and production. The innovation in transportation and communication increased the size of the markets for organizations significantly. The increase in the size of the market of demand enabled a larger production volume. At the same time the improved transportation and communication facilitated a greater provision of raw materials. Furthermore, the new technologies made the transportation, communication and production, among others, more efficient.
Economies of Scale in Dutch Nursing Homes 20
3.3 Definition of Economies of scale
Economies of Scale (EoS) is in principle a very simple concept. In essence economies of scale deal with the economic value of scale. Simply put: producing more provides a cost advantage. At the same time however the exact working of economies of scale can be complex, and there is not a uniform framework in literature. Gold (1981) for example states that analyses have repeatedly called attention to the fuzziness of the basic concept of scale and to uncertainties about the sources of expected benefits, as well as to the relatively modest gains apparently derived from additional increases in scale. (Modern) Research on economies of scale started with the well known 'Wealth of Nations' of Adam Smith (1778). In recent decades however, research has slowed (Stimpert & Laux, 2011; p.47). Especially qualitative research. Which is quite surprising since the lack of a broadly accepted framework of economies of scale and the developments in technology in recent decades. It appears that economies of scale are generally accepted as a given fact, despite, what appears to be, incomplete knowledge on the underlying principles of economies of scale. Which could explain (part of) the phenomenon of merger waves, despite the low success rate of mergers, as noted in the introduction of this thesis.
The theory on the underlying principles of economies of scale may be diverse, the definitions of economies of scale however are quite uniform. Economies of scale are generally defined as equivalent to a falling long-run average cost function (Smith, 1955, p. 215). A definition given by Besanko, Dranove and Shanley (2000, p. 72) is as follows:
“The production process for a specific good or service exhibits economies of scale over a range of output when average cost (i.e., cost per unit of output) declines over that range. If average cost (AC) declines as output increases, then the marginal cost of the last unit produced (MC) must be less than the average cost. If average cost is increasing, then marginal cost must exceed average cost, and we say that production exhibits diseconomies of scale.”.
Silberston (1972) gives a more elaborate definition which is more specific and includes a few other elements, making it the definition that will be used for this thesis:
“Classic economies of scale relate to the effect on average costs of production of different rates of output, per unit of time, of a given commodity, when all possible adaptations have been carried out to make production at each scale as efficient as possible. This is the long run average cost curve of the firm, or the "scale curve" as it is more usefully called” (p. 369)
Economies of Scale in Dutch Nursing Homes 21 decline, (2) over a certain range of output, (3) per unit of time, (4) of a given commodity, (5) on the long run. Furthermore, a number of conditions and assumptions underlie the principle of EoS, such as: (1) production at each scale as efficient as possible, (2) sufficient demand, (3) given factor prices of supply. These elements and underlying principles of economies of scale are further explained in section 3.4.
Economies of scale versus economies of scope
It is important to note the distinction between economies of scale and economies of scope. Economies of scope is a concept that is closely related to economies of scale. Economies of scope are essentially the same as economies of scale, with one significant difference; the increased output is not the result of one commodity, but of multiple commodities (Panzar and Willig, 1981). So economies of scope aim to achieve economies of scale by expanding the output by adding other product types or services.
An interesting case is an increase in scale of a multi-product firm. Benefits of scale are in these cases not called economies of scope. When the scale of the firm increases but the output mix remains the same, the resulting benefits are called ‘ray economies of scale’. When the increase in the scale of the firm involves changes in the output mix, then the behavior of the costs depends on product specific factors, which is called ‘product specific economies of scale’ (Panzar and Willig, 1977).
Economies of Scale in Dutch Nursing Homes 22
3.4 Explanation and graphical presentation of the principles of economies of scale
3.4.1 The average cost curve
Graphically, economies of scale as defined above can be illustrated as in figure 3 (Besanko et al., figure 2.1, p. 72). This figure shows the relation between output volume and average cost for a given economy of scale; the 'long-run average cost curve', or 'scale curve'. This U-shaped scale curve is the shape that is often used in literature to describe economies of scale. The first part of the graph is an economy of scale, since over this range of output the average costs decline as output rises. The second part of the graph is the lowest point. At this level of output, the average costs per unit of output are minimal. This is the optimal scale. The first level of volume to reach this point is called the “minimum efficient scale”, which is often shortened to “MES”. After this point, the third and last part of the graph shows diseconomies of scale; rising average costs in relation to increases in output. This means that in this range of output the marginal costs are higher than the average cost. This is in fact the opposite of 'economies of scale', called 'diseconomies of scale'.
If the competition is effective, all companies will have a size that is very close to MES. Gold (1981, p.20) states it as following: “Logic alone suggests that the greater the economies and subsequent diseconomies of successive increases in scale, the narrower the range of plant sizes that can survive under conditions of effective competition.” The effectiveness of the market however might not be that great, thus enabling organizations to survive that have a sub-optimal size. Especially in the areas of the scale curve where the slopes (the cost gradient) are not very steep, e.g. where the economies of scale are not very large.
Figure 3 – A U-shaped average cost curve
Economies of Scale in Dutch Nursing Homes 23
3.4.2 Long-run versus short-run
The smooth (long-run) curve as presented in figure 3 does not actually exists as such, but is actually the result of a number of different curves, the 'short-run average cost curves' (SRAC). This graphically presented in figure 4. A company or plant is designed for a certain capacity. It has an optimal level or range of output. On the short-run a company can vary its output only to a limited amount. Larger changes in output will likely deviate to far from the optimal level of output, resulting in inefficiencies. In case of an output far smaller than designed, a machine may be severely under-utilized, or in the case of an output far larger than the designed capacity, a machine at (near) maximum capacity may start to error or simply function as the bottleneck. On the long-run companies or plants can expand or shrink and adjust their capacity, thus adjusting their optimal size. The 'smaller' 'short-run average cost curves' represent the different sizes in designed capacity. The optimal level or range of output of each of the short-run curves combined form the 'long-run average cost curve'. It represents the lowest average costs for a given amount of output if the plant or company has the optimal design.
Figure 4 – Long-run versus short-run cost curves
Source: based on Gold (1981; p. 19) and Shepherd (1979; p. 232), and modified for this thesis
3.4.3 Efficiency
Economies of Scale in Dutch Nursing Homes 24
3.4.4 Different shapes of scale curves
As mentioned above, the U-shaped scale curve is the shape that is often used in literature to describe economies of scale. However, the actual shape of the scale curve varies very much, depending on the situation. Figure 5 shows three different curve shapes. The variety of possible shapes is far greater than these three, but these curves help illustrate the different ways in which economies of scale can develop, depending on the subject and the circumstances.
The first curve resembles the curve in figure 3. It is U-shaped and has steep cost gradients. The lowest point is different however, as it has a single optimal size instead of an optimal range. In this market all firms would be close to the optimal size if competition is effective. If the same curve has slopes that are less steep (has a lower cost gradient), or the market is less effective, there will be still only one optimal scale, but the spread of the firm sizes in the market will likely be wider.
The second curve shows a market with very little economies and diseconomies of scale. The MES is reached at a low output volume and continues until a high output volume. Within this range there are essentially no economies or diseconomies of scale, but the returns to scale are constant. In this market firms could be viable at nearly any size.
The third and last curve shows an ever decreasing scale curve. In the case of this L-shaped curve, the economies of scale are large and might expand beyond the size of the market. An excellent example of this is the production of software, for example Microsoft Windows. The production and distribution costs are negligible compared to the development costs. These low marginal costs result in decreasing average costs as scale increases. The average cost will continue to decrease until the marginal costs approach the average cost. This L-shaped scale curve is suggested as very common by Silberston (1972) and Besanko et al. (2009).
Figure 5 – Several shapes of scale curves
Economies of Scale in Dutch Nursing Homes 25
3.5 Sources of economies of Scale
The previous sections have discussed the general principles of economies of scale (EoS). However, it has not explained the essence of EoS: ‘what causes the decline in average costs over a range of output?’. In other words: what are the drivers of EoS? On this point, existing literature seems to be quite diverse. There does not seem to be a commonly used framework. Different authors provide different sets of drivers, but there is some overlap. In explaining economies of scale most researchers use the concept ‘sources of scale’. However, which sources are distinguished differs between authors. Furthermore some researchers take a more elaborate view of economies of scale in adding ‘dimensions of scale’, e.g. Silberston (1972) or ‘categories of scale’, e.g. Besanko et al. (2000). The following part will analyze different frameworks of economies of scale to come to one framework for the analysis of nursing homes.
This section is structured as follows. First, an overview of the literature is given. This is done by presenting the relevant items per article or book. The relevant items include (1) the sources of economies of scale, (2) the sources of diseconomies of scale, (3) dimensions of scale and (4) categories of scale. Following the overview of the literature, the different sources of economies of scale presented by the different authors will be analyzed and merged to come to one set of sources of EoS to be used in this thesis. Subsequently the same will be done with sources of diseconomies of scale, dimensions of scale and categories of scale.
The articles will be discussed in chronicle order of publication date, with the exception of the article of Silberston (1972). The content and structure of this article differs somewhat from the other articles. Therefore it will be the last one to be discussed instead of second, in order to enable a better understanding of the content and how it is related to the content of the other articles.
3.5.1 Overview of literature
Smith (1778), Wealth of Nations
In his famous book 'An inquiry into the nature and causes of the wealth of nations', Smith does not present a framework for economies of scale. He does not even use the term 'economies of scale' nor does he use the term 'sources of scale'. However, his book is a standard work in (classical) economics, as well as one of the first to describe the industrialization and the role of the division of labor within it. As such it is included in this literature review.
Economies of Scale in Dutch Nursing Homes 26 increases productivity per capita, and that productivity per capita is the real wealth of nations. This division of labor is one of the main sources of economies of scale. The essence of it is that labor is divided into several smaller elements, with people and machines specializing in each of the elements.
Shepherd (1979)
The second item of literature being reviewed is the book 'The Economics of Industrial Organization' by William G. Shepherd (1979). Before presenting the sources of scale Shepherd distinguishes technical economies of scale from pecuniary gains to scale. Where technical economies of scale arise from the actual physical organization of production activities, pecuniary gains to scale mainly stem from lower input prices paid by the firm. The pecuniary gains may in return reflect technical economies of scale realized by the supplier. These lower prices are however not a technical economy of scale in itself. They are a result, not a source of economic efficiency.
Shepherd distinguishes five economies of scale: (1) Specialization, (2) Physical laws, (3) the law of multiples, (4) Overhead costs and (5) Cheaper inputs. The first source of scale, specialization, is equal to what Smith (1778) calls 'division of labor'. In fact, Shepherd refers to Smith.
Shepherd names three diseconomies of scale: (1) fixed factors, (2) bureaucracy, (3) transport costs and market density. Furthermore Shepherd notes that economies of scale can become a diseconomies of scale if they are pushed too far. Specialization for example can become excessive, resulting in alienation, careless work, or frequent breakdowns. Thus resulting in reduced efficiency and quality. The same holds for the other economies of scale. In the case of physical laws, too-large pipes will burst, and supercritical temperatures can become unstable and dangerous.
Shepherd presents two dimensions of scale: (1) time and (2) multi-plant conditions. Interestingly, regarding multi-plant conditions another economy of scale is presented: the pooling of risks.
Shepherd presents a wide range of different categories of scale, explaining that the types, size and shape economies and diseconomies of scale found may differ per category. Categories mentioned are: Management, advertising, research and development, purchasing, market research, maintenance, personnel and marketing.
Gold (1981)
Economies of Scale in Dutch Nursing Homes 27 different elements, whether they are sources, elements of sources or examples of sources. Based upon the other literature regarding economies of scale it looks like Gold presents three sources of scale: (1) division of labor, (2) indivisibilities and (3) risk bearing capabilities.
Further on in the article, 'division of labor' is used in combination with the term 'specialization', and later on the term 'division of labor' is replaced completely with the term 'specialization and technology'. Gold divides the source 'specialization and technology' into several elements. The main elements described by Gold are: re-organization of tasks, change in cost-structure (shifts in the proportions of labor and capital inputs), change in skill composition, change in the technology of production, and finally research and other forms of improved knowledge. The second economy of scale, 'indivisibilities', matches the earlier mentioned source called 'the law of multiples' of Shepherd (1979). The third economy of scale, 'risk bearing capabilities' corresponds to Shepherd's 'pooling of risks', but is more extensively discussed by Gold.
Gold names two diseconomies of scale. The first one is a disproportionate increase in salaried personnel and costs in order to cope with the increasing complexities of integrating an increasing array of more specialized tasks and equipment. Alternatively this could be called an increase in overhead or bureaucracy. The second diseconomy of scale is the higher wage rate often found in large scale plants relative to comparable skills in small plants.
The article does not discuss dimensions or categories of scale.
Besanko, Dranove and Shanley (2000)
In their book 'Economics of Strategy', Besanko et al. (2000) focus on diverse economic approaches of strategy as may be expected. As part of that, economies of scale and scope are discussed. Apart from sources of (dis-)economies of scale Besanko et al. present four categories of economies of scale: (1) production, (2) purchasing, (3) advertising and (4) research and development. Per category of scale the sources of scale are discussed. This suggests that the sources of scale differ between the different categories. An approach not found in other literature discussed in this thesis. Interestingly only under the category 'production' sources are actually being named by Besanko et al.
Besanko et al. state that there are four major sources of scale: (1) Indivisibilities and spread of fixed costs (Capital Intensity), (2) Increased productivity of variable inputs (mainly Specialization), (3) Inventories, (4) Engineering principles associated with the “cube-square rule”.
Economies of Scale in Dutch Nursing Homes 28 The first diseconomy, labor costs and firm size, corresponds to the higher wage rate mentioned above by Gold (1981). The second diseconomy, incentive and bureaucracy effects, is also mentioned above, by both Shepherd (1979) and Gold (1981). The third diseconomy, conflicting out, is not mentioned in
the other articles.The fourth diseconomy, spreading specialized resources to thin, corresponds to the
earlier mentioned diseconomy 'fixed factors' from Shepherd (1979).
No dimensions of scale are mentioned in the book.
Stimpert & Laux (2011)
The fourth item of literature is the article of Stimpert and Laux (2011), called 'Does size matter? Economies of scale in the banking industry'. The article used 2007 data from more than 1200 banking institutions to examine the relationships between size, costs and profitability in the banking industry. Prior to the quantitative analysis, the article examines the theory on economies of scale.
The article presents four sources of economies of scale: (1) specialized and more efficient equipment, machinery and technology, (2) spread of fixed costs over increased output, (3) specialization of employees. These three sources resemble the sources mentioned above at the other reviews. Interestingly Stimpert and Laux discuss the specialization of employees and the specialization of machinery separately. It could be that they see the two as different forms of the same source, however this does not become clear from the article. Furthermore, experience and learning effects are presented as part of, or the result of, the specialization of employees. A view they share with Gold (1981).
The diseconomies of scale presented in the article are: (1) Fixed factors, (2) Bureaucracy and (3) Transportation costs. All three of these are also mentioned by one or more of the articles reviewed above. Regarding fixed factors, Stimpert and Laux take a rather narrow view. The article only discusses managers and managerial ability as a fixed factor.
Regarding dimensions, the article casually mentions three 'levels' of scale, but does not discuss them. The three levels are: (1) the product/service level, (2) the plant level, (3) the firm level.
Silberston (1972)
Economies of Scale in Dutch Nursing Homes 29 A. Which affect capital costs (per unit)
A.1 Initial fixed costs A.2 Working capital
B. Which affect operating costs (per unit) B.1 Specialization of labor B.2 Vertical linking economies
C. Which affect both capital and operating costs (per unit) C.1 Increased size
C.2 Specialization of plant
A.1 – This source of scale is related to 'the spread of fixed costs' and 'Indivisibilities' as mentioned by the other authors discussed above. Silberston however takes a narrative view by limiting it to initial fixed costs, such as design costs and research and development costs. Thereby excluding other fixed costs, such as production equipment.
A.2 – This source can be compared to the 'inventories' mentioned by Besanko et al. (2000) and the 'risk bearing capabilities' presented by Gold (1981).
B.1 – Specialization of labor speaks for itself. Silberston distinguishes labor from technology regarding specialization.
B.2 – This isn't actually an economy of scale since economies of scale deal with homogenous products. By extending the stages of production vertically, you're in fact creating economies of scope, not scale.
C.1 – Silberston formulates this as “capital costs may not go up proportionately with scale”. Which is the essence of economies of scale, but not a driver or source. When attentively reading the description given by Silberston, he hints towards two other sources of scale mentioned in other literature: the spread of fixed costs and physical laws.
C.2 – This source is the specialization of technology. It has the same fundamentals as B.1 . Silberston names elements such as more specialized machines, but also the change in cost structure, which is the ratio between personnel and machines.
Silberston presents the following dimensions of scale:
D.1 Time Periods
(a) Life of plant and equipment (b) Life of (each) product D.2 Products
Economies of Scale in Dutch Nursing Homes 30 (c) Standardization between products
D.3 Units
(a) Plants (b) Firms (c) Industries
D.1a – Although the life of plant and equipment obviously has an influence on the possibilities of economies of scale, it does not seem to be part of (dimensions) of scale. In my opinion it is more a property of technology, than a dimension of scale.
D.1b – This is an interesting point and very close related if not the same as D.2a. Since economies of scale deal with long run average cost curves, it seems to implicate that the product is produced for a longer period of time. If total output over time isn't great and if the after that no comparable products can be produced, the depreciation period is limited, resulting in a limitation of the spread of fixed costs over time. Secondly, when dealing with a highly fluctuating output profile, depending on the product, a more flexible production capacity might be needed, limiting the possibilities for specialization of technology for example, due to the costs of unused capacity.
D.2a – See D.1b
D.2b – This is actually describing scale, not a dimension of scale D.2c – This actually has more to do with economies of scope
Economies of Scale in Dutch Nursing Homes 31
3.5.2 Analysis and explanation of the sources of economies of scale
Table 1 gives an overview of the different sources of economies of scale presented by the different authors, and how these relate to each other. As can be seen this table results in four core sources of scale. Each of these sources is explained and argued below.
Table 1 - Overview of the sources of economies of scale
Specialization
Specialization is the division of labor into several smaller parts, with people and machines specializing in each of these parts. This enables workers to do their specific tasks more rapidly and precisely, since they can focus all their attention on a limited part of labor therefore increasing their knowledge and skill of the transformation process. A possible increase in repetition can also aid in increasing their skill. Furthermore it avoids a loss of time and effort from shifting among tasks. Furthermore, certain parts of the job might be done more efficiently by other inputs, which are cheaper and/or more productive. Certain people can be cheaper or more productive for certain parts of the job. Lastly,
machines can be used/developed for certain parts of the labor.
As can be seen in table 1, the different authors use different terms for this source. From the explanation above, it easily follows that the meaning is the same. More interesting is the distinction made by a few authors between the specialization of employees and the specialization of technology. Since economies of scale are greatly related to technology, as explained in section 2.1, this seems logic. It is however debatable whether this means that specialization should be treated as a single source, or be divided into two sources. Since the essence of specialization is the narrower focus of an input in the transformation process regardless of whether this input is man or machine, specialization will be regarded as a single source within this thesis.
Economies of Scale in Dutch Nursing Homes 32 Stimpert en Laux (2011). They name learning as a separate source of scale. I want to argue however, that learning is not a separate source of scale, but in this sense the result of specialization. As mentioned above, specialization results in a narrower focus and possibly an increase in repetition, which in return helps to increase the knowledge and skill of the employee (which in return helps to increase efficiency). So specialization is at the base of these learning effects. The same holds for another form of increased knowledge: research and development (R&D). R&D can improve products, but can also improve production. In the case of production, the increase in efficiency is at the core the result of the specialization of employees in R&D.
The conditions that are required to realize this economy of scale is that the labor can be efficiently divided, so that people or machinery can specialize on these parts, resulting in less switching time/costs, learning, the use of cheaper inputs and/or the use of more productive inputs. Assessing whether labor can be efficiently divided is difficult to (pre)determine, more difficult than for example assessing the possibilities for the spread of fixed costs, which is rather straight forward. Whether labor can be efficiently divided depends on the properties of the labor and which knowledge and technology is available. The properties of the labor can be assessed and categorized in several ways. Relevant are the assessment of the number of different tasks the labor consists of, or can consist of, and the nature of these tasks.
Economies of Scale in Dutch Nursing Homes 33
Figure 6 – Framework for the assessment of the nature of labor and tasks
Source: Perrow (1967; p. 196)
Spread of fixed costs
The second major source of economies of scale is the spread of fixed costs. As scale increases, these fixed costs may rise relatively less, or may not rise at all. The result is spreading the fixed costs over a larger output. Take for example accounting software or a marketing campaign. Another example is research and development: you need to develop a product only once, regardless of the number of products produced. Fixed costs could also rise in fixed intervals as the result of indivisibilities. Take for example a machine, a software program, or a chef. In the case of nursing homes, having half the number of clients a chef could cook for, would result in twice the 'chef-costs' per client.
As can be seen in table 1, the different authors use a variety of terms, hardly giving the impression that they all regard the same source of scale. Shepherd (1979) names the spreading of 'overhead costs' as a source of scale. Shepherd does not argue why overhead costs would be significantly different from other fixed costs. Therefore this source is grouped under the source 'the spread of fixed costs'. Stimpert & laux's (2011) source 'experience and learning effects' have also been placed at this source. This is because these experience and learning effects can be the result of the spread of fixed costs. The spread of fixed costs could free funds for more research and development in R&D, resulting in 'experience and learning effects'. This however is the result of the spread of fixed costs, and not a source of scale itself. Silberston (1972) separately names 'initial costs' while also including it in 'increased size'. A distinction that seems to be the result of the classification Silberston uses. None the less, for analysis purposes, it is good to be aware of the two different forms of fixed costs: initial costs (such as development) and capital costs (such as machinery).
Economies of Scale in Dutch Nursing Homes 34 on their minimum size (indivisibilities) and their growth curve in relation to increases in scale. Fixed costs and as a subsequently the spread of fixed costs can arise in various parts in the organization, such as inventories, personnel, finance, marketing, R&D and machinery.
Risk bearing capabilities
The third source of economies of scale is ‘risk bearing capabilities’. As can be seen in table 1 this source of scale is mentioned by three authors, with each of the authors using a different term. Risk bearing capabilities deals with uncertainties and the resulting variability. Depending on the nature of these uncertainties, the organization needs to prepare to deal with them. This can be done by using buffers of stock, staff or capital. Having buffers entails costs. However, as size increases, the size of the buffers can relatively decrease due to leveling effects. And as a result, the related costs relatively decrease as well. This statistical effect of decreased variance as a result of increased output is the nature of risk bearing capabilities.
An example of this is given by Lynk (1995). He considers the stock of blood bags in a hospital. In order to have only a 5% chance of running out, a certain sized hospital needs to keep a stock of 50 liters. However, a hospital twice the size does not need 100 liters of blood, but only 80 liters to keep the same chance of only 5% of running out. Lynk estimates that the potential savings can be as large as 10%. Another example, of a different nature, is a buffer of grocery clerks at a supermarket, to which the same principle holds.
Conditions required for realizing this economy of scale is the presence of uncertainties which the organization needs to prepare for.
Physical laws
The fourth and final source of economies of scale is physical laws. As can be seen in table 1 this source of scale is mentioned by three authors, with each of the authors using a different term. Each of these terms apply to the same principle; the physical laws of nature. This economy of scale will be explained through the prime example of physical laws; the cube-square rule. The cube-square rule states that as the volume of a vessel increases (e.g. a tank or a pipeline) by given proportion (e.g. it doubles), the surface of the vessel increases by a lesser amount (e.g. it less than doubles). The production capacity of a vessel is closely related to the volume of that vessel. The production and operating costs however are more closely related to the surface area of a vessel. This implies that as capacity increases, the costs increase relatively less.
Economies of Scale in Dutch Nursing Homes 35
3.5.3 Analysis and explanation of the sources of diseconomies of scale
In this section the sources of diseconomies of scale are analyzed and explained. Table 2 gives an overview of the different sources of diseconomies of scale presented by the different authors, and how these, relate to each other. As can be seen this table results in five core sources of scale. Each of these sources are explained and argued below.
Table 2 - Overview of the sources of diseconomies of scale
Bureaucracy
As can be seen in table 2 this diseconomy of scale is mentioned by four of the six authors. There are different meanings to the word bureaucracy. One is that of the organizational structure put forward by Max Weber, the other is the negative meaning of inflexibility, excessive rules and procedures, excessive number of organizational layers, etcetera. The latter is the sense of the word as it is intended in this case. Bureaucracy is a very abstract and hard to measure phenomenon of (disproportional) increases in the number of rules and procedures, the number of organizational layers and overhead and amount of communication needed. Regarding the amount of communication needed: the number of possible communication lines increases exponentially in relation to the number of employees. Bureaucracy is more likely in the case of service related work, and in the case of a complex and uncertain environment.
Higher wages
Economies of Scale in Dutch Nursing Homes 36 showed that the average annual earnings per employee for the top four firms was lower in only 41 industries, equal in 52 industries and higher in 355 industries. In those 355 industries, the average earning per employee were 15.4% higher on average. Miller did the same, using only the wages of the production workers. The results were that in 353 industries the workers of the top four firms earned 17.2% more on average. The study of Miller focused on manufacturing, but according to Besanko et al. (2000), a wage gap of 10% or more cuts across all manufacturing and service industries.
To assess whether a certain industry follows this pattern of higher wages in larger firms, requires analysis of detailed data from firms across the industry.
Fixed factors
Fixed factors are inputs that are vital for the organization and the transformation process, but which are limited available (variable inputs) or are unique and can be spread only to a limit (fixed inputs). This regards predominantly human inputs. An example of this is the chef of star restaurant. If the input of this chef is vital and unique to the concept of the restaurant, the scale can be increased only to the extent of the capacity of the chef. If the scale would increase further, by adding another restaurant for example, the chef cannot attend to this extra output, and the quality at the new restaurant, or perhaps even across all restaurants will drop. Other fixed factors can be inputs such as raw materials which are limited available or specialized tools. But also a unique business location can be a very important fixed factor.
Transportation costs
Transportation costs are mentioned in two articles, Shepherd (1979) and Stimpert & Laux (2011). Shepherd (1979) considers products whose transport costs are a large share of the total costs. Usually heavy, bulky products whose ratio of value to weight or size is low. The examples given include bricks, ready-mix cement and home-delivered milk. Depending on the market density and spread, an increase in scale will result in an increase in the average distance to suppliers or customers. Which in turn means that in these cases transportation costs rise as scale rises, making it a diseconomy of scale. Furthermore increases in scale could increase the transportation costs within the organization between the different locations/plants.
Conflicting out
Economies of Scale in Dutch Nursing Homes 37
Any economy can become a diseconomy
Economies of Scale in Dutch Nursing Homes 38
3.5.4 Dimensions of scale
Two of the authors reviewed above mention dimensions of scale. The article of Silberston (1972) is the most elaborate, distinguishing three dimensions of scale: time periods, products and units. Furthermore Shepherd (1979) also mentions time periods and units, albeit not calling them dimensions, but elements of scale. Neither Silberston, nor Shepherd, gives a definition of dimensions of scale. Based upon most of the examples and explanations given by Silberston, the following definition could be formulated: dimensions of scale are the shape that scale has in time, place and product-composition. The third one, product composition, is not mentioned by Shepherd, and is in my opinion not a dimension of scale, since economies of scale deal with one commodity, not a variety of commodities. This leaves us with the other two dimensions of scale: time and place (units).
The dimension time stands predominantly for the variation in output over time (due to for example seasonal influences or demand fluctuations). The dimension place stands for the geographical and organizational spread of the output (single-plant or multi-plant firms). Scale at the plant (location) level is the (average) size per plant. Scale at the multi-plant (organizational) level influences the total size of the organization without influencing the average size per plant. Regarding the dimension place, Silberston (1972) also mentions the industry-level. If scale increases at the industry-level, this can enable economies of scale by sharing (the costs of) infrastructure or research and development.
These two dimensions of scale (time and place) are relevant to be aware of. The possibilities and likelihood of the sources of scale are influenced by these dimensions. If for example the output varies throughout the year, certain specialized machines might not be economical, since they would be underutilized or remain idle large parts of the year. An example that illustrates the dimension place is that of a supermarket chain. The needs of the customers dictate that the chain needs to place their supermarkets close to the customers. They cannot be centralized to one big supermarket for the whole of The Netherlands. However, the back office functions such as the distribution centers and overhead can be centralized. The optimal scale of this supermarket chain is not just the total scale of the organization, but it is the combination of the scale per location (plant) and the scale of the entire organization. At both levels the scale needs to be optimal.
The dimensions of scale, time and place, are the result ofthe scale and the product characteristics and
