Economies of Scale in Car Manufacturing

The essay discusses the factors that led to Toyota's decision to stop car manufacturing in Australia by the end of 2017, including high wages, exchange rates, and economic factors. The concept of economies of scale (EOS) is also analyzed, showing that producing a minimum of 250,000 vehicles per year is necessary for EOS to be achieved in the Australian automotive industry. However, all automakers in Australia are producing below this level, making it difficult for them to achieve EOS and compete with global competitors.

After half a century of operation, the leading vehicles maker Toyota decided to stop car
manufacturing in Australia by the end of 2017. In like manner, General Motor and Ford made
the same decision previously, which put an end for to the car manufacturing industry in
Australia. This seems to be a steep step for companies that large, but there are certainly some
reasonable motives behind this withdrawal. Including the exchange rate, high wages, and
economic factors of Australia, economies of scale also seems to be one of the most influential
factors in the companies’ decision (Griffiths, 2014). This essay will critically analyze the
application of economies of scale in car manufacturing industry, besides analyzing the factors
that influence companies in Australia and Toyota particularly in achieving economies of scale.
The concept of EOS is when the average cost –cost per unit of output- of a company’s
production starts to reduce with increased production (Baye, 2010). Economists around the
world consider this as a necessary condition to be able to run a successful business in any
sector (Blanchard, 2012). Focusing on producing the optimal level of output to reduce the cost
by car production companies is substantial to be competitive enough to sustain in the market.
Producing in low volumes can be viable only in case the company decided to focus on niche
vehicles, which its unit costs can observed by the high profit margins.
In Australia, carmakers should produce a minimum of 250,000 vehicles in per year in order to
gain sufficient EOS. This was the best practice identified for car manufacturers in Australia
(Dowling, 2014). However, all automakers in Australia are producing below that level, even
their combined production are significantly lower than 250,000. The graph bellow can show
how far total production of cars in Australia is from this target level. It also shows a reduction of

the production volume over the period, which signals that there are some obstacles, faced car
producers in Australia.
Source: Data from Federal Chamber of Automotive
Industry
Production costs, causes a major issue in achieving EOS. Relative with other countries in the
world, the costs of vehicle production in Australia are significantly higher. Another factor that
added to the problem is the high wage rate in Australia that raised the operating cost for the
company and made the production even more unfavorable. Holden mentioned that it cost near
$2000 more in input to produce a car in Australia comparing with other plants owned by
2 0 1 0 2 0 1 1 2 0 1 2 2 0 1 3 2 0 1 4 2 0 1 5
0
50,000
100,000
150,000
200,000
250,000
300,000
P r o d u c tio n Vo l u me o f A u st r a l i a n A u t o m o tiv e
In d u st r y
Cars per Year
Production Volume of Australian
Automotive Industry
2010 239,443
2011 219,376
2012 221,224
2013 210,538
2014 174,986
2015 167,538

Gereral Motors, which 80% derived by wages (Griffiths, 2014). Today vehicle manufacturers are
shifting their operations to regions with low wages and growing demand such as India and
China, so it will be unviable for the three car producers in Australia to continue their costly
production while other competitors can benefit from low costs.
Apart from this, the global competition in the automobile industry is certainly fierce, and the
economic conditions in Australia have not been supportive enough for car producers to afford
the competition. The unaffordable exchange rate of Australia makes exports of goods and
services certainly unviable (Maggo, 2015). The appreciation in its exchange rate causes a
reduction in aggregate demand for cars. When dollar increases, exports become expensive to
purchase by foreigners. Therefore, local car manufacturers were unable to make profits from
exports, especially that they have to compete against their global parents’ affiliates. In addition
to that, they have also loosed their local sales due to the fragmentation of the Australian
market. It is one of the most open markets with low barriers for imports resulted from free
trade agreements. This market structure alongside with the strong exchange rate limited the
sales of the three car producers in Australia, although they have the highest selling cars (Amiti,
2016). Many local customers in Australia are now buying from the low priced imported cars,
which are subject low or zero tariff by the government. This shift in the market limited the sales
of Australian- based cars, and that can be note from the following graph.

2007 2008 2009 2010 2011 2012 2013 2014 2015
0
50,000
100,000
150,000
200,000
250,000
300,000
Car Sales in Australia
Toyota Mazda Holden Hyundai Mitsubishi
Ford Nissan Volkswagen Subaru Honda
units sold per year
Source: Data from Performance Drive
Since 2008, the biggest profit that Toyota has made in Australian automobile industry after tax
is $194 million, and in the last six years, the company has only been able to make a profit twice
and faced a loss in all other years (Dowling, 2015). This really shows that after trying its best,
Toyota could only make profit twice and mainly had to bear the high manufacturing costs and
losses associated with these costs. Although the production level of Toyota has been impressive
and the company made 90,000 cars in 2015 that was five times more than Ford, the cost of
production was high that did not allow it to achieve EOS (Kewk, 2014).

There are a variety of reasons caused the regression of Toyota and other automotive producers
to in Australia and lead them to decide shutting down their production. These reasons included
increased wages in the country, high exchange rate, an unfavourable rate of the Australian
dollar and other economic factors. The most dominant reason behind this decision is the
inability of the companies to achieve the EOS. EOS enable a company to reduce its average cost
with increased production. However, this did not happen in the case of Australian- based
producers who faced excessive pressure from their competitors in the global market. As a
result, they were unable to gain a competitive advantage. In conclusion, it expected that car
producers would move after Australia to low-cost countries that have a favourable exchange
rate and cheap labour costs as well (Griffiths, 2014). This will allow a better condition for Toyota
and other companies to adjust their production in order to attain EOS and be able to sustain in
the competition.
Word Count:

References: To be edited
Amiti, M. (2016) What impact do exchange rates have on domestic prices? [online]. Available
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domestic-prices
Baye, M. (2010) Managerial Economics and Business Strategy 7th ed. Singapore: McGraw-Hill
Dowling, J. (2015) Toyota Australia posts $195 million profit after announcing factory shutdown
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