Long Term Cost and Curve Analysis: Application of Conventional Firms to Hybrid Organizations

3569 words (14 pages) Business Assignment

17th Nov 2020 Business Assignment Reference this

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Economics section:

This section includes three parts. At the first part I will try to define long-term average cost and explain its curve. Next in the second part I will explain how we can apply this economics concept of conventional firms to hybrid organizations. I will apply these economic concepts to my own social enterprise. At the last part, I will answer to the question that ‘does economies of scale explain why social enterprises seek to scale-up?’

1-Long-term Average Cost Curve

1-1 Assumption

Long-term average cost has two main assumption. Firstly, all factors of production are variable. The main difference between short-run and long-run is not about time, but it is about the inputs. There are no fixed inputs in the long run. There is, therefore, no fixed cost. Indeed, all costs are variable, so total variable cost is equal to total cost. Secondly, the Long-term average cost shows the minimum average total cost at which a firm can produce any level of output in the long run. In other words, the firm has chosen the optimal factor mix. As a result, LAC shows the firm’s lowest cost per unit at each level of output.

1-2 Economies of scale

If we look at the curve it mainly consists of two modes; a decreasing section and an increasing section. The main reason behind the decreasing section is the economies of scale; as a firm expands, its productive efficiency increases. Economies of scale can be described as the result of:

  • Specialization of the workforce
  • Invisible capital input
  • Cube-square rule
  • Learning by doing
  • Monopsony Power

Thus, there are the cost advantages from expanding the scale of production in the long run and the average total cost curve (LAC) is declining due to the economies of scale.

1-2 Diseconomies of scale

The second section of the curve is increasing due to the diseconomies of scale. Diseconomies of scale stems from different reasons, but we can broadly categorize them as organizational and technical constraints such as:

  • Overcrowding
  • Lack of co-ordination
  • Lack of motivation

Some firms are too big to make profit. In other words, after a certain point, producing more output does not decrease the average cost, but it decreases the average cost.

2-Long-term Average Cost Curve for Hybrid Organization

2-1 How mechanisms work for hybrid organizations

As it has described beforehand, there are two reasons behind the U-shape of LAC for conventional commercial firms; economies of scale and diseconomies of scale. When we go deeper and look at the drivers of each mechanism, we realize that most of them follow the same logic in hybrid organization too. I made a table of important factors driving economies of scale and diseconomies of scale to understand whether these factors performing the same at hybrid organization or not.

Table 1:

Main reason behind economies of scale in firms

Conventional commercial organizations

Hybrid Organization

1-Specialization of the workforce

As they become larger labor and workforce become more specialized, therefore the cost decrease

Similar

2- Invisible capital input

As they produce more, they have more access to capital and investment.

Very very very stronger. As social enterprises grew up, their credit and social capital increase and many more people want to help them by donating and investing. 

3- Cube-square rule

The cost goes up in second order but the profit goes up in the third order.

Similar

4- Learning by doing

They would reduce their waste of their operations by growing bigger

Similar

5- Monopsony Power

As they produce more, they need more inputs and can buy them in bulk and thus cheaper.

Similar

Table 2:

Main reason behind diseconomies of scale in firms

Conventional commercial organizations

Hybrid Organization

1-       Overcrowding

 

As organizations become bigger it becomes overcrowded and the efficiency of labor and workforce reduces and the cost goes up

Similar

2-       Lack of co-ordination

As organizations grows it become more complex and require more cost to be operated.

Similar

3-       Lack of motivation

As organization becomes larger and makes more money and they think they reach their goal and sometimes their motivation decreases!

Opposite

I think as a social enterprise grows up and becomes larger it would have more impacts on society and making impact incentivize and motivate hybrid organization to scale up- more!

2-2 Long-term Average Cost Curve for my own social enterprise

All in all, I think the mechanisms and logics are broadly similar in hybrid organization and commercial organization, so the long-term average cost is U-shaped in hybrid organization. However, due to the first table I think that the effect of economies of scale is stronger in social enterprise because the invisible capital input, particularly social capital, is more significant in hybrid organization. They have social mission and as they are growing up and serving more people, more people trust them and support them.

On the other hand, the diseconomies of scale is weaker in hybrid organization. One of the main reasons behind the diseconomies of scale is lack of motivation for further growth in commercial firm. My hypothesis is that as social enterprises scaling up, the social entrepreneur become more motivated to have more impact. So, motivation is not a deterrent but it is an incentiviser for hybrid organization.

As I have mentioned earlier, I own a social enterprise in Iran. Roshana Social Innovation is a hybrid organization. At first, I asked myself that if Roshana was for-profit (instead of being a social enterprise) how the curve would be look like, figure 1. The logics behind the figure 1 are the same as above described logics.

Figure1
the hypothetical for-profit Roshana
Hypothesis behind the below figure: Roshana performs in a commercial form

Now, I think to the real Roshana which is a social enterprise. How the curve could be for this hybrid organization? From table 1, all the mechanisms remain fixed unless factor number 2, invisible capital input. I believe that Roshana as a social enterprise has more access to invisible capital as it scales up rather for-profit Roshana. The main reason behind my argument is legitimacy and social capital. As you have more impact, more people trust you and invest financially and socially in your social enterprise. Other factor that would be different between unreal for-profit Roshana and real socially-focused Roshana is factor number 3 in table 2, lack of motivation. If I managed Roshana for money, after reaching a particular profit my motivation would decrease and I do not have enough energy and passion to grew up. On the other hand, in real Roshana as I saw that we were making positive impact my motivation for growth increased. Thus, this motivating mechanism perform differently in social enterprise and commercial enterprise, at last for me and my enterprise. All in all, these two differences between the Roshana as a social enterprise and Roshana as a commercial enterprise, move the tipping point of the curve left and downward. The red line is the curve for real Roshana that is a hybrid organization, and the black line is the curve for the hypothetical and commercial Roshana.

Figure 2
Red line: LAC curve for the real Roshana(a social enterprise)
Black line: LAC curve for the hypothetical Roshana(a for-profit enterprise)

3- Does economies of scale explain why social enterprise want to scale up?

Social enterprises face a dilemma. There is duality and paradox in managing a hybrid organization. You as the owner of the social enterprise are seeking for more impact. You want to help and serve more people. This is your mission. But you cannot scale-up your enterprise to what extent that you like. While your organization stands at the first half of the graph, the economic and social factors are aligned. As you grew, the economic situation become better because of the economies of scale and due to the increased output, you have more impact. Thus, there is no conflict in the first half zone. You as a social entrepreneur eager to scale-up your organization because it is financially and socially reasonable.

But the story in the second half is totally different. The cost of producing more output and having more impact is decrease in profit. The economics factors and social factors contradict each other. Your heart tells you to scale-up to serve more people and have more impact. However, your pocket disagrees and tells you that if you become larger, your profit would decrease. There is the conflict zone, the second half of the graph is bloody. The economics and social motivation in a hybrid organization acts in a contradict way. Economist tell you to stand at the tipping point of the graph, while altruistic charities ask you to produce more output to have more impact.

Personally, I think hybrid organization should go beyond the tipping point, but to a particular extent. Their first mission is helping more people, so they can sacrifice part of their profit. But they should be very careful if they became too big, they would lose money. If I want to locate the best operating point for commercial and hybrid organization my answer is like the below figure.

The best operating point for for-profit organization

The best operating point for social enterprise

Accounting section:

In this section at first, I will describe how SROI measurement extend our understanding of organizations’ performance and then I will define four related terms including attribution, deadweight, displacement, and drop-off.

1-how SROI measures contribute to our understanding of an organization’s performance

Firstly, I will introduce three aspects that SROI helping us to understand more about the performance of our organization. Then I will describe the logic of ratio and why SROI is a beneficial ratio. Finally, I will explain two challenges I have faced when I decided to calculate this ratio for my social enterprise.

When I look through the SROI’s lens to my social enterprise, Roshana Social Innovation, I would understand somethings new about its performance. I can categorize new insights that SROI provide for me in three groups as below. Indeed, traditional financial approaches do not provide this information about performance.

  • Who: I named the first category “who”. SROI measures are not restricted to shareholders or customers. In fact, it considers a broader influenced people. It is so interesting to be aware of the scope of your impact. SROI bring many people in to your consideration who are hidden from traditional approach.
  • To what extent: Second group, which I name it “to what extent”, presents one of the main ideas of SROI. This measurement method tries to quantify and monotonize impact to make a comparison between investment(input) and impact(output). It is helpful to understand the extent of social impact of your organization. Thus, as the social entrepreneur you can make better decision to have more impact and you can select between different activities. You also can manage your investment for more impact.
  • How: Final group, “how”, is another advantage of SROI. This method is based on the theory of change. Hence, you can understand how inputs are connected to outputs, outcome and impacts. The whole process of having impact is transparent in this model. We are not interested just about the effects of organizations; we want to know how they make these effects. In a nutshell, I think these three groups describe how the SROI approach contribute to our understanding of the performance of an organization.

From my engineering background I know that if you want to make comparison the subjects should be in the same units. For example, you can compare the weight of one person to another person. But making a comparison between the weight of an individual with the height of another individual does not make sense. In organization we invest in dollar(money). So, the output for our calculation should be in money if we want to have a reasonable and sense-making measuring tools. SROI translate the impact to money to produce a ratio. The input, investment, is in dollar and now we have our output in dollar too. Thus, we can judge and make decision about our investment and performance of different organizations.

The challenges that I faced when I was trying to implement this approach to evaluate the performance of my social enterprise were its ambiguity and subjectivity. By ambiguity, I mean that it was really difficult to define boundary to find the key stakeholders. I could be very broad and argue that I have effects on thousands of people’s lives or I could be strict and argue that we have just impact on hundreds of people. In engineering field, defining the system by finding the boundary was easy, but here in social sector it is really hard to include someone and exclude the others. The next challenge, I faced was the subjectivity of this method. When I wanted to assign money and quantify some impacts, I was dubious. Therefore, I concluded that this approach is open to subjectivity. I am working on SROI for my social enterprise and I would provide it for my summative essay.

In conclusion, based on my experience from my own social enterprise, this evaluation method provides precious insight about three aspect of the performance of my organization. Firstly, the scope of created impacts. Secondly, the amount of impact in dollar. Thirdly, the mechanism of having impact. It is also a very beneficial tool to decide whether invest money in an organization or not, when your goal is social impact. Indeed, this method would tell you that if you invest one dollar in an activity the impact equal to how many dollars. For example, if you put one dollar in an organization 3:1 SROI ratio, then your money would create social impacts equal to 3 dollars. And finally, it has two challenges in my point of view; firstly, defining a boundary to select the stakeholders is not a clear and straightforward action, secondly quantifying the impacts is open to different interpretation and is subjective.

2-Definitions

SROI consider four factors to make the calculation more reliable. Each of these terms and factors will be described below. I also try to connect my experience in managing my own social enterprise to these definitions.

Attribution: social enterprises create value to solve problem of target groups. The point is that the targeted group is influenced by some other activities as well. For example, in my own social enterprise (Roshana Social Innovation School) the participants are trained directly by our interventions while they are learning new things from universities too. Therefore, their skills will be fostered by Roshana and their universities. By arguing that the factor x in target group has raised we can not specify the impact of our activity. Indeed, we should identify what portion of the impact is created by us. By considering attribution we share the outcome among different interventions.

Deadweight: As I have described, there are many mechanisms affecting the target groups. Deadweight considers what happened if we would stop our activities. In my own social enterprise, the participants willing to learn and if Roshana did not exist, they would have learned something from different sources and improved their skills anyway. I think this term extend our understanding of the significance our activities. Low deadweight means that the interventions make no difference in the life of people, so it is not effective. High deadweight represents that the enterprise has impact.

Displacement: I personally this term makes a comparison in two different level: the impact at micro level, and the impact on the macro level. Roshan equips young people with required skills to find job. So far, it makes positive impact on the life of many youths. On the other hand, when these young people occupy a position someone misses the opportunity or lose the job. In other word, while Roshan making positive impact on some people, it has some negative impacts and consequences. At micro level it is impactful because it creates job for its attendances, but at macro level the story is different. Making benefits for someone imposes costs on someone. This term helps that SROI offers a more comprehensive measurement. For me, this concept is close to the concept of externalities from the economics part.

Drop-off: This term is concerning the durability of impacts and effects. To address a wicked problem, we need activities with sustainable effects. For example, in Roshana we support someone to find a job. This is a very positive output. What happened if after a few months he/she loses the job? I personally think that this term adds a new dimension to SROI which is quality! There is a tacit paradox in social activities; quality/quantity. Most of the impact measurement methods are focused on quantity, and answer how many questions. But drop-off concept leads us to reflect on the quality of the intervention, and answers how sustainable are these impacts which is more about the quality. I understood the importance of this term in my social enterprise when we faced the duality of scale-up. We scaled up and the number of people we supported increased, but the durability and quality of our support decreased.

In a nutshell, in the first section I described SROI method and how it extends our understanding of the performance of organization. I also pointed out that it has two challenges for me. In the second section I explained four terms relating to SROI and their functions. I personally think each of them stems from a concept from commercial domain. For example, the idea of attribution comes from the idea of the market share; displacement is kind of the economic concept of externalities. All in all, I found this approach very interesting and beneficial to evaluate the performance of organizations.

References:

I wrote these essays based on my learning and gained insights from the lectures and tried to make connection between them and my own experiences. Thus, I did not used many articles. However, for my summative essay I will provide more theoretical backgrounds for my arguments.

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