March 30, 2024; most recent update March 28, 2025

 

Table of Contents

 

1. Starting Points

2. Introduction

3. SES Definition, Explanation, & Other General Truths

4. SES Fundamental Types

    a. Inventory-Based SES (Expanded Production & Buying)

    b. Selling-Based SES (Bulk Selling)

5. Common Markups: Increasing Profits with Sales

6. Seller Diseconomies of Scale (-SES)

    a. Cause 1: Added Inefficiencies

    b. Cause 2: Diminishing Returns

    c. Cause 3: Market Saturation

    d. Cause 4: Long-Term Input Shortages

    e. Cause 5: Necessary, Non-Production Investments

    f. Larger Sellers' Double-Edged Sword

7.  SES vs -SES, the Real Difference

 

 

For this article, "inventory" means the quantity of items that a producer or middleman has for sale.

 

A "unit" or "item" of inventory refers not just to individual items that are clearly physically separate from others but also raw, sellable quantities (pound, quart, ton, etc). So, for example, when a business has more raw quantity (e.g. more tonnage) to sell, it also has more units (tons) to sell. Sellable quantities can also be a money amount, such as the coverage of an insurance policy. Thus when someone buys a larger insurance policy, they buy more units from the insurer. In that case, each unit is a dollar, pound, peso, or whatever currency is being used in the transaction.

 

"Necessary revenue" means total business costs plus the business's minimum acceptable profit for a given time period.

 

"Economies of scale" seems like just a plural term, but it also refers to a principle, a concept, a collective phenomenon, and even a goal for some businesses. So it can be written in the singular and usually will be in this article.

 

For simplicity, let's assume a supply chain just of producers, middlemen, and consumers: those who produce goods, those who buy goods from producers  and other middlemen for selling, and those who buy goods from middlemen and producers for consumption.

 

 

Economies of scale is an important concept, in understanding the ways that businesses can lower prices for consumers and gain leverage over their competition.

 

The ability to lower prices is by far the biggest implication of economies of scale, for both businesses and consumers. While certainly not the only factor, price is the most important one for consumers generally. Since every buyer has limited money, it's not hard to understand why this is so.

 

In economies of scale, an increase in the number of units produced, bought, transported, or stored decreases the cost per unit of those actions respectively. This happens because of greater production efficiencies that tend to occur when production is increased, or because fixed costs are divided by more units, or both.

 

But there is an economies of scale-like phenomenon that exists independent of any per unit cost reduction. It happens when a business can offer a lower price per item simply by increasing its inventory through production or buying, or with an increase of items sold in a given transaction. Also, unlike true economies of scale, it doesn't start from the perspective of the firm actually reducing its per unit costs but of it simply being able to reduce the per unit price of its items.

 

Now, it can seem impossible that an inventory expansion-caused price reduction can occur without a per unit cost decrease. The key assumption in this wrong idea is a plausible one: absent routes such as cutting profits or increasing debt, prices can be lowered only by cutting some cost. So when a price decrease follows a volume increase and without more debt or less profit, it's natural to think that it's because the larger inventory cut the overall per unit cost. But, while this does usually happen, it needn't be a  factor.

 

Consider the example below in Table 1. For simplicity, let's assume that "production costs" are total business costs -- all costs the business must endure for the product to exist -- and that there are no fixed costs. Let's also assume that the business has no secondary money sources and must make a $100 monthly profit for the venture to be worthwhile for the business owner.

 

 

[Table 1]

 

                  A        B                C                D                    E

           

                                                                                      Lowest

                              Production  Production    "Acceptable      Possible   

                  Qty      Cost Per      Costs          Profit: $100"    Price

Time Period    Made    Unit          (A * B)        ("C + $100")      (D/A)

-----------    ----    ----          -------        ------------    -----

January.........10........$5.............$50..............$150................$15

February........20........$6.............$120............$220................$11

March...........40.........$7.............$280............$380................$9.50

April.............80.........$8.............$640............$740.................$9.25

May.............160........$9............$1440...........$1540...............$9.63

 

 

Even though the per unit cost keeps going up, the lowest possible price nevertheless continues to fall, at least for a while. This shows that what allows increased volume to lower the per unit price is not necessarily a lower per unit cost. Rather, a price reduction is also possible simply because there are more units with which to make the lowest acceptable profit: the lowest acceptable profit is divided by more units for sale, which means a lower price per unit in order to reach that minimum profit.

 

However, since this doesn't involve a per unit cost decrease, it is a pseudo counterpart of true economies of scale.

 

Yet it's not clear what it's name is or if it even has a name, even though it's a familiar phenomenon. The second type is often called "bulk selling", among other terms. But there doesn't seem to be a word for the concept that unites both types, which are clearly connected. It's so much like actual economies of scale, it seems right to include that in whatever term it's eventually given. Since a key distinction is its focus on the per unit price rather than the per unit cost, we can start there. All businesses, whether producers or middlemen, have a seller aspect: they sell to buyers, have an inventory, and can offer lower per unit prices simply with a larger inventory or when a buyer purchases more in a single transaction. So, for now, it will be called seller economies of scale. That's not the most impressive name, but there's probably not a better choice.

 

 

 

This section will cover general truths that apply to both types of seller economies of scale, even if there's some redundancy.

 

First, the formal definition.

 

Seller economies of scale (SES) is a situation when a seller can lower a product's price if they increase the number of units sold in a given window, without any per unit cost decrease. That definition can seem to exclude inventory-based SES: increased inventory only increases the number of units for sale, not actually sold. But inventory expansion can lower the price only if it's assumed that the expanded inventory will be sold in the timeframe that the inventory increase is intended to cover (monthly, quarterly, etc). So, it's different from the second type only in that the increased number of units needn't be sold in a particular transaction to offer the price decrease.

 

The increase in the units for sale or actually sold can be of the product in question or other products, but this article will focus on the simpler situations, when inventory increases or larger purchases involve just the product in question.

 

The price reduction is possible because the business has more items with which to make the lowest acceptable profit (i.e. the profit it deems necessary for the business to be worthwhile) or more with which to stretch its profit in a single transaction. That gives it the leeway to sell each item at a lower price.

 

But an inventory increase or larger purchase doesn't guarantee that a price reduction can happen. It must also be possible that the price can be reduced by at least a penny and, in cases when inventory expands, that the inventory increases disproportionately to any increase in necessary revenue for the same time period.

 

Both types of SES are a priori truths, based on mathematics and reason.

 

 

 

Again, fundamentally there are two types of SES: inventory based and selling based. This section will cover these in more detail.

 

 

Table 1 demostrated SES. Here is a more thorough explanation. Suppose a one-product producer needs a $100-a-month profit for the venture to be worthwhile, can and does make 10 items a month, and it costs $5 each to make (i.e., total business costs divided by the number of units made, per month.) This means the business must charge enough per item to make $150 a month. So, assuming the business will sell all of its monthly production, the necessary minimum price is $15 ($150/10 items). But if production increases to 20 items a month and everything else stays the same, the business needs $200 a month. However, the price per item can then drop to $10 ($200/20 items).

 

Table 2 shows the entire process of price reductions that SES will allow, from start to finish.

 

 

[Table 2]

 

                  A        B                C                D                    E

           

                                                                                      Lowest

                              Production  Production    "Acceptable      Possible   

                  Qty      Cost Per      Costs          Profit: $100"    Price

Time Period    Made    Unit          (A * B)        ("C + $100")      (D/A)

-----------    ----    ----          -------        ------------    -----

January........10.........$5..............$50..............$150................$15

February.......20.........$5..............$100............$200................$10

March..........40..........$5..............$200............$300................$7.50

April.............80.........$5..............$400.............$500...............$6.25

May.............160........$5..............$800.............$900...............$5.63

June.............320........$5..............$1600...........$1700.............$5.31

July..............640........$5..............$3200...........$3300.............$5.16

August..........1280......$5..............$6400...........$6500.............$5.08

September.... 2560......$5..............$12800..........$12900...........$5.04

October........ 5120......$5..............$25600..........$25700...........$5.02

November......10240.....$5..............$51200..........$51300...........$5.01

December......20480.....$5..............$102400.........$102500.........$5.01

 

*For simplicity, let's assume production costs cover all of the business's costs and that inventory is its only source of money.

---------------------------------------------------

 

Likewise, when a middlemen purchases more from producers or other middlemen than before, they have more inventory to sell to customers, thereby allowing a lower per unit price.

 

Moreover, even in situations where the production cost of a product increases and the producer must sell the product at a higher per unit price, a middleman can still sell it at the same price they had before or even lower if they buy enough from the producer to compensate or overcompensate for the now-higher price. All that's required is that the producer's new price is still lower than the middleman's original price.

 

Let's say a middleman needs to make a $100 a month profit and they purchase 50 units at $2 each, every month. Therefore they actually need to make $200 a month. So they would need to sell each of the 50 units at a minimum of $4. Now suppose the producer's price rises to $2.50 each due to production cost increases. If the middleman were to again purchase 50 units a month, it would cost them $125 and so they would now have to make $225 with 50 units. Therefore, the necessary price per unit would increase to $4.50 from $4. However, if in those inflationary conditions the middleman were to purchase 100 units a month instead, the purchase would cost $250 and therefore the required monthly revenue would go to $350. But with 100 units to work with, the middleman could achieve $350 at just $3.50 per item.

 

 

Bulk selling also involves SES but, unlike the other type, not because of an inventory increase. Instead, a lower price per unit can be offered when the buyer purchases more units in a single transaction.

 

Inventory-based SES simply establishes the best per unit price possible for the seller to make the minimum profit needed for a given timeframe. They don't mean that the seller will offer their lowest price with any purchase. Usually one of the reasons for offering a lower per unit price is to entice buyers to purchase more of the product so that the seller makes more profit per transaction. The buyer has extra incentive to purchase more if the best per unit price is offered only with a larger purchase.

 

Bulk selling happens when the number of purchased units required for the lower price results in more profit than with higher price offers. Suppose a product costs a seller $5 per unit. The seller might offer an $8 price if customers buy 2 or more units rather than the normal $10 price, since they will be guaranteed to receive at least $1 more in profit with a larger purchase than a single-item purchase.

 

How is selling-based SES an a priori truth, like the other type? Why can a lower price be offered if inventory isn't being increased? We start with the assumption that it's rational for the seller to profit more on a given sale than less since, at minimum, this makes it more likely that their necessary revenue will be reached. As already indicated, that's achieveable by selling more units, each at a lower price, than selling fewer at a higher price. But why is that a better way to the goal than just selling each unit at a higher, universal price and (seemingly) profit more that way? A second assumption is that it's rational for buyers to choose a bulk price if they need or want that greater amount of product; buyers have greater incentive to purchase more if the per unit price drops than if not.

 

Sometimes increasingly better prices are offered over a graduating scale, to entice buyers who can't afford or don't want to make a particularly large purchase.

 

However, it might not always be rational for a seller to bulk sell. Many factors can determine whether or not a seller sets bulk-selling prices or just a single, constant per unit price for all purchases. If the product is one that the vast majority of buyers will not likely buy more than one of, then the seller might set a constant, low price in order to attract more buyers. If middlemen would have a reason to purchase very large amounts, the seller might give them one extra reason with a bulk-selling price.

 

 

 

The examples of SES given have included just the minimum requirements for setting a lower price, not how the price is often or usually set. One of those bare minimums is that the calculation must include the periodic, lowest acceptable profit for the business owner to see the business as worthwhile.

 

A business might be content with the lowest acceptable profit, perhaps for maximum appeal to customers via the lowest possible price.

 

But with the possibility of increased customer purchases due to more inventory and lower prices, businesses have an incentive to capitalize on that and increase their periodic profits along with their sales. So, rather than reduce the per unit price to what is required under the lowest acceptable profit, businesses are likely to decrease the price less than that and pocket the difference. By doing that with each inventory expansion, the "lowest acceptable profit" increasingly goes beyond what is truly the lowest acceptable profit.

 

 

Seller diseconomies of scale (-SES) is contrasted with SES. It is when a seller must raise a product's price because of increasing its inventory.

 

There's a clear reason -SES doesn't include selling-based SES. No real problems can occur with increasing the units of product sold in a single transaction, as long as the seller gets the math right in order to profit more than with fewer items sold or at least avoid a loss. Even if the seller makes a math mistake in one or more transactions and now must raise prices to meet their necessary revenue, increasing the number of units sold has nothing to do with that. But inventory expansion is much more dynamic and many things can go wrong, with unintended consequences on price.

 

In -SES, the actual or potential revenue from sales cannot cover the necessary revenue, following an inventory expansion. Since "necessary revenue" includes the lowest acceptable profit for a given time period, we can see that -SES doesn't necessarily mean that the business suffers a loss for that period; it can even make a profit. It just means that, at minimum, the lowest acceptable profit cannot be met at the current price.

 

-SES is due to costs from inventory expansion increasing faster than (disproportionate to) the actual or potential revenue from the expansion.

These costs are not necessarily restricted to just the units purchased or produced, but can include other costs associated with making the expansion possible.

 

It's important to emphasize that -SES focuses on inventory expansion costs and not unrelated costs or factors (natural disasters, lawsuits, inflation, a desire for more profit, etc) that might force a business to raise a product's price following increased inventory.

 

The causes of -SES are added inefficiencies; diminishing returns; market saturation; long-term input shortages; and necessary, non-production investments. Added inefficiencies and long-term input shortages are not inevitable, whereas the other three are unavoidable. That's not to say that -SES itself is unavoidable. Rather, certain things that make it more likely to happen necessarily occur or would eventually occur, as a business expands its inventory. In contrast (excluding malicious acts), added inefficiencies result from a failure to foresee the negative effects of some change in business production. These are events that may or may not occur and therefore are not inevitable. Likewise, long-term input shortages are arbitrary events that are not destined to happen as a business continues to increase inventory.

 

 

Added inefficiencies apply to both producers and middlemen. When an added inefficiency occurs, a certain task in producing, moving, or locating units becomes physically or mentally harder.

 

Therefore more physical or mental resources are required to accomplish one or more tasks, whether from humans, animals, machines and robots, or inanimate tools. Economically, this means each unit produced or bought costs more than before the inventory expansion, because of increased physical resources or time to make, move, or locate it.

 

Hiring more workers might increase overall output but cramp factory space, slowing the production per worker. A larger factory, intended to produce more units, might also be more complicated when it comes to repair or identifying problems, adding costs relative to increased output. Or the inefficiency might be with the new tools. New machinery might produce units faster than the old, but consume more fuel or have parts that wear down quicker or break more often, significantly increasing energy, maintenance, or replacement costs relative to the increased units. And perhaps the new machinery is not as intuitive as the old, again reducing the long-term productivity per worker.

 

As for non-production tasks, transporting products to different business locations can become more inefficient when inventory is expanded since it might require more trips, increasing labor and material inputs. Also, with inventory increases, new or old buildings often increase in size to store the larger inventory. That can make units relatively harder to stock, retrieve, or find.

 

These are just some examples.

 

 

But taking measures to avoid added inefficiencies won't prevent a fundamental problem that exists for both producers and middlemen when inventory is expanded: diminishing returns. Despite the name, this is a singular phenomenon that occurs over time; several individual returns, the plural.

 

This isn't the same as economics' diminishing returns involving input and output. This is the diminishing returns of sellers pursuing SES. Mathematically, it becomes increasingly harder to reduce a product's price simply by increasing how much of it can be, or is, sold; the seller gets increasingly less of a price decrease (less of a reward) for the same proportion of inventory increase.

 

In Table 2, we saw that when volume doubled from 10 units to 20, the price dropped $5, from $15 to $10. When volume doubled the second time, to 40 units, the price fell by $2.50, from $10 to $7.50. When 80 units were reached, a $1.25 price reduction to $6.25 occurred. And so on. The inevitable pattern is this: as inventory doubles, the per unit price reduction shrinks by half. The reason is that, as you divide the minimum profit by an increasingly larger number of units, each unit continues to represent a smaller portion of that minimum profit. But because it represents an increasingly smaller share, that means its price drops by an increasingly smaller amount of the minimum profit as inventory expands.

 

As the number of units increase, eventually they would divide the lowest acceptable profit by increasingly smaller fractions of a penny (or the lowest unit of whatever currency applies) -- economically meaningless results. So, for all intents and purposes, SES price reductions inevitably flatten, assuming all relevant factors stay the same.

 

Nevertheless, diminishing returns does not alone cause -SES; it never increases the price. However, along with any of the other causes, it can help set the stage for -SES. For example, in the early period of inventory increases, price decreases can be significant enough that they mask the real effect of any added inefficiencies that might have occurred during the increase. These added inefficiencies might continue to grow with each inventory expansion. But as diminishing returns continue, the effect of added inefficiencies becomes less insulated and -SES is more likely to happen. Thus diminishing returns would help explain why -SES happened this time and not during previous inventory increases.

 

Such a scenerio is given in (again) Table 1 below. Even though the per unit production cost continues to rise for several months -- due to added inefficiencies, let's assume -- the lowest possible price nevertheless keeps dropping until the fifth month, when -SES occurs. The reason is that diminishing returns finally prevents the inventory increase from blocking the negative effect of added inefficiencies.

 

[Table 1]

 

                  A        B                C                D                    E

           

                                                                                      Lowest

                              Production  Production    "Acceptable      Possible   

                  Qty      Cost Per      Costs          Profit: $100"    Price

Time Period    Made    Unit          (A * B)        ("C + $100")      (D/A)

-----------    ----    ----          -------        ------------    -----

January.........10........$5.............$50..............$150................$15

February........20........$6.............$120............$220................$11

March...........40.........$7.............$280............$380................$9.50

April.............80.........$8.............$640............$740.................$9.25

May.............160........$9............$1440...........$1540...............$9.63

 

*For simplicity, let's assume production costs cover all of the business's costs and that inventory is its only source of money.

 

 

The previous examples of inventory-based SES made sense only if we assumed that the business would sell all of the extra inventory made or bought. While businesses can't know exactly how many units or quantity they will sell, in many cases they can justifiably make a rough prediction and  thus adjust their lowest price or prices accordingly. But what if the estimate is off and a portion of their extra inventory doesn't sell?

 

A business can miss its revenue target for various reasons. But one that always looms in the background with increased business expansion is market saturation. Market saturation is a situation when demand for a product or kind of product has been, or is being, fully satisfied. Therefore, depending on the kind of product, sales of it have been exhausted for the foreseeable future or their average for a given time period (e.g. monthly) is at or past its peak. It can refer to cases when demand has been met in the market as a whole or just for the market in a certain geographical area. For instance, if a business has just local aspirations and demand has been fully met in that area, then for that business the market is saturated.

 

Different things can cause market saturation. For one, certain demographics  might be shrinking or at least not expanding. Also, many products are essentially fads, and only reflect current trends in fashion, taste, and technology. People's wants or needs for them eventually fade. But even for products with a more timeless and universal quality, sales can't increase forever. We enter some very basic, unavoidable facts of the world: there are finite customers and each has finite money.

 

By preventing increased revenue, or preventing it from increasing equally to the costs of increased inventory, market saturation can cause -SES. But, like added inefficiencies, it may or may not happen when a business increases its inventory. Still, it's unavoidable in the sense that it would eventually happen if inventory were to continually increase and the chance of it happening necessarily increases as inventory expands.

 

 

In some cases, input shortages can cause -SES.

 

Input shortages are shortages of labor, equipment, material, or anything else required for making a certain desired amount of a product or kind of product.

 

In the context of -SES, an input shortage is not necessarily a shortage in the market generally. It is a shortage just for any producer wanting to increase inventory beyond what is possible with the inputs available in the market.

 

However, a few conditions must be present for -SES to happen.

 

First, by definition, there must be an increase in inventory despite the shortage.

 

Second, the producer must have made production-related investments that,  periodically, cannot be fully paid by the stunted inventory increase. 

 

Third, the investments must have long-term costs -- costs that can't be quickly shed. (This also gets back to the definition.) For instance, the business might have built one or more factories.

 

Fourth, the input shortage or shortages must be long-term as well.

 

Fifth, the business cannot quickly find alternative inputs or at least not cost-effective ones.

 

 

So far, the examples of SES have been simplistic in order to clearly show the principle. They would apply in cases where the business, and its increase in inventory or selling, were very small. Let's say you owned a small bakery that made very large, generic cakes that could apply to any occasion: weddings, birthdays, graduations, business celebrations, and so on. If you increased the supply from 10 to 20 cakes a month, you would have to worry about little else but the increased costs for the ingredients, energy, and labor required for making the extra cakes -- at only 20 cakes, the labor might involve you alone. In other words, the increase in total business costs would simply be the increased costs for making more of your product.

 

That would change if your business continued to grow and gather a larger customer base. At first, when sales are low, perhaps you could do it all yourself: make the cakes, answer phone calls, check out customers at the front desk, and so on. But as more people show interest in your product with the lower prices, and you continue to produce more, the increase in answering calls and cashiering would hamper your ability to make the cakes. To continue to increase sales, or even keep them at current levels, would require hiring at least one person to run the register and answer the phone.

 

In other words, eventually non-production workers are needed so that production workers can maximize output and achieve SES. That reflects a more general truth: increasingly there is a need for greater specialization as producers' and middlemen's businesses mature. More kinds of workers will be necessary. More kinds of non-production workers will be required for both; and more kinds of production workers for producers, especially if the producer provides finished goods.

 

That stems from an even more general truth, a simple but profound idea at the heart of the Industrial Revolution and modern economies: usually a person can accomplish more in the same time period by doing one kind of task rather than several (or at least fewer kinds of tasks rather than more). This is because they aren't wasting time (or as much time) going back and forth between different tasks.

 

When your cake shop is in its infancy, you would probably save money by being a DIY generalist or at least hiring a generalist rather than multiple specialists. Demand is low enough that there isn't a great price for occasionally being drawn away from making cakes in order to answer the phone or check out customers. But as business picks up, the cost in lost productivity outweighs the cost of hiring specifically a cashier or a baker so that cake productivity can keep up with demand and revenue can reach its potential. After all, nothing is being accomplished in the periods that a generalist worker runs between the register and the kitchen. So if the number of times workers collectively have to move between different tasks is great, the lost productivity is relatively expensive for the business versus hiring specialists. Both the business and consumers lose: the average wait for customers on the phone or at the register line is longer, cakes are much fewer and prices higher, and profits are likely lower. As the saying goes, "Time is money."

 

If your business continued to grow, it would eventually make sense to further specialize the labor. For example, at some point increased demand would justify separating the bakers into, say, those who deal with the dough and the inside of the cakes and those who work on the cakes' exterior.

 

Satisfying a growing customer base also eventually demands more locations and/or larger facilities. More space is necessary both to store the increased inventory and to house more workers and equipment needed to either make those goods or get them to the customer. In turn, those usually require more layers of bureaucracy for effective management and oversight. Larger facilities are typically more complex and need managers within certain sections of it, not just general managers. And as a business increases its locations, at some point district management is required in addition to regional management, and so on.

 

So, with inventory expansion, necessary, non-production investments (NNIs) ultimately increase. NNIs are investments needed for business operations but not involved in making more products, unlike production workers, production equipment and machinery, energy, and product materials.

 

However, there are two main problems with NNIs that eventually make -SES  more likely.

 

First, they add a cost that doesn't also add to production. In that way, any SES advantage that occurred during production is reduced a bit -- or negated in some cases -- when an NNI is added either by a producer or middleman. It's similar to, say, a business taking a costlier SES production route than a cheaper route they could have chosen: they would have still obtained a lower per unit price than before, but not to the same extent they could have had. Along with diminishing returns, over time NNIs create a bigger risk of -SES.

 

Second is the issue of complexity. NNIs usually get more complex over time and their growing numbers also increase complexity. (So do production-related investments). Both of those lead to additional costs not present at a simpler level. As mentioned above, more or larger business locations or facilities eventually require additional layers of management. But it hardly ends there. Eventually a business needs an accountant, and if it reaches a certain size, an accounting department with different types of accountants. For instance, if the business expands far enough, tax accountants will be needed to ensure tax compliance in different states, counties, cities, and other jurisdictions that might apply. The accounting department will also require management. Much of the blue collar work gets more complicated too. Cleaning, maintenance, and stocking are some examples. In general, they increasingly require greater skills and more sophisticated and expensive equipment as you go from, say, a convenience store or small shop, to a supermarket or medium factory, to a warehouse or large factory. More skilled and specialized labor also tends to be more expensive since it's harder to find.

 

That's far from a complete picture, but at least gives a basic idea of how increased complexity and its associated costs multiply.

 

Clearly, all of these extra costs can unexpectedly creep up on a business, raising it's long-term necessary revenue relative to increased revenue and thus cause -SES. These costs are often long-term because, again, they can't be easily cut. Once a large factory or warehouse is built, for example, the right NNI equipment and workforce must remain as well in order to utilize the investment.

 

 

There are advantages and disadvantages to larger producers' and middlemen's greater ability to expand inventory. Not only does it allow them to achieve SES to a greater degree than their smaller competition, and therefore enjoy price advantages over them. They're also initially more able to weather diminishing returns: because it takes ever-larger amounts of inventory increase to get the same amount of price reduction, they are less likely to suffer the same decreases in price reduction. But that greater capacity to expand also means that they are more likely to reach a greater level of diminishing returns, to reach market saturation, to get the greater complexity and added costs that come with NNIs, and therefore to experience -SES.

 

 

 

As mentioned before, -SES occurs when the actual or potential revenue from sales cannot cover necessary revenue, following an inventory expansion. SES would therefore mean that potential and actual sales are sufficient.

 

Those descriptions are adequate to give readers a general idea of the difference. But there's a little bit more that's going on under the surface. For instance, we can ask whether or not an -SES inventory expansion would have been successful had the seller increased the units even more than they actually did. And, as you'll see, in some instances that is the case.

 

So, what specifically (i.e., at the micro level) is happening that distinguishes -SES from SES? It's that [the profit margin per unit] times [the amount of units sold or for sale] either doesn't cover the necessary revenue for the given time period (-SES) or more than covers it (SES). And with SES, one more condition -- already discussed -- is required: that the price can be reduced by the lowest unit of currency.

 

In -SES, the business either takes a loss or revenue doesn't cover the lowest acceptable profit. The second situation is what eventually happened in Table 1.

 

Let's revisit Table 1 with the previous points in mind. Production costs were the business's only costs and the lowest acceptable monthly profit was $100. In May, -SES occurred when the cost per unit produced rose to $9 and 160 units were made. That's because, with April's per unit price of $9.25, the $0.25 profit margin per unit was too small to meet the $100 profit with 160 units: 160 * $0.25 = $40. Thus the lowest possible price per unit rose from $9.25 to $9.63. But the $9 production cost was below the $9.25 price, so there was still room to lower the price. If, say, 500 units had been produced in May rather than 160 -- and achieving that didn't increase per unit production costs -- then the potential profit would have surpassed the required $100 profit: 500 * $0.25 = $125. Therefore the price could have dropped to $9.20: 500 * $9 = $4500 in production costs, $4500 + $100 = $4600 to get the lowest acceptable profit, and $4600/500 = $9.20 for the lowest possible price.