My second query about the steel industry is: why does steel- making seem to be stuck in a batch mode? Some of the literature I have read seems to say that there are technical reasons for this. Perhaps. I would think that there are also some market demand reasons for this, i.e. some purely economic reasons. Let me just recapitulate the problem: the crucible was a batch sys- tem; the Bessemer is a batch process; Thomas is a batch process;
the open hearth is a larger patch process; the basic oxygen pro- cess is still a batch process. With some electrolytic vacuum processes, there may be possibilities of a continuous line pro- cess. Continuous casting of ingots and lamination trains are a line process which is exerting up-stream pressure towards a more continuous production process. But all the main steel-making processes are batch.
There are batches of various sizes in terms of tonnage and length in terms of time, in terms of minutes or hours for each of them. What is surprising is that there is not any set pre-deter- mined trajectory of evolution. With the open hearth, we get larger quantities, but longer batch time, than in Thomas proces- ses. In terms of economics of speed and economics of scale, it does not make that much intuitive economic sense. The importance of economics of scope is perhaps what explains it. Firms try to remain flexible and retain a capacity to produce a variety of different products. If economics of scale were the sole preoc- cupation, one would expect a transition from large batches to line production, but this does not happen.
The precondition for scale is standardized homogeneous goods.
Where is there a sufficient demand for standardized goods in steel? The demand for rails, nails, armor plate, roofing sheet, barbed wire, ingots, casts will lead toward line processes because these standardized goods would have fairly large demand. Mass
standardized demand is where you might expect line processes. We have seen some of that in end-products. But is there a stable homogeneous, standardized demand in the first stage of steel- making which actually justifies locking oneself into a line pro- cess, even if it is a technical possibility to do it?
My hunch is that scope economies are more important in the first segment of steel-making, where firms are supplying a semi- finished material to changing specifications. That would explain why one keeps a batch organization which is relatively more fle- xible. Economies of scope are realized by sharing input cost, the know-how, and the competence across a variety of products.
Being able to mix different qualities of inputs in different ways depending on the client's requirements for different qualities of steel is essential for firms. You do not need always the same characteristics of the steel output. The user might need some- times higher quality, sometimes less, depending on its end use.
Firms want to reduce the constraints and have some flexibility to address various market segments as demand shifts.
There is a trade-off between economics of scope and economics of scale. Beyond a certain scale, you are going to have to reduce the scope of your products. Vice-versa, if you stretch the scope and variety of your products, you are going to have to keep your scale down. My graphics are still in a suitcase which is some- where between Madrid, Rome and Sofia, so I have had to reconsti- tute them very quickly. It is a bit complicated, but I think you will understand (Figure 6). Baumol, Panzar, and Willig have a graphic device to compare joint and separate costs: trans ray convexity. Let us suppose two products: Product 1 and Product 2. Each have geometrical scale for the amount produced by unit of time. We are comparing individual costs, unit costs, on the vertical axis of each product individually to the joint unit costs of producing them jointly. It does not matter really what
individual cost curves are for the purpose of this comparison as long as they are the same for the two products. We are only comparing individual costs with joint costs. Here we chose ar- bitrarily monotonically increasing returns to scale.
My proposition is the following: there is a limit (which is different according to each industry) where you go from positive economics of scope to negative dis-economies of scope. Economies of scope would be expressed by the equation (1) that the joint cost c p l , c p p , and dis-economies by the reverse (equation 2).
Economies of Scope (1)
Dis-economies of Scope
There is a scale limit where you lose your economies of scope (Figure 6) if you stretch the technical distance between your products (the angle). If you are further away from your technical field, then you risk
--
there is an indeterminancy and uncertain- ty, which may yield punishment--
to find yourself into dis- economies of scope (Figure 7). If one plots the technical dis- tance of a firm from its established technical experience, thereis a limit beyond which you do not know what you are going to get: positive economics of scope or negative diseconomies of scope. If you are close, you have a greater probability of eco- nomics of scope. For instance, producing two very close types of steel may yield scope economies in the same furnace. But if the firm goes further from its technical field of competence, there will eventually come a point where it will not know whether it still is going to have economics of scope by joint production.
Then the probability of having economies of scope is non-zero, but it is indeterminate.
Renk Thom called this a catastrophe in the sense that it is a functional discontinuity: you do not know which way it is going to go. Here functional analysis breaks down.
So to sum it up, economics of scope at technical proximity and diseconomies of scope at technical distance induces firms to acquire flexibility in order to share their input cost. The
batch process is the ideal flexible organization to reap economies of scope.
In as much as the demand for steel grade is not homogenous, staying in business requires to design a furnace to adapt flexibly to future unknown shifts in demand. Perhaps
--
just an hypothesis for the steel specialists--
this explains the economic induce- ments to produce steel in batch mode.REFERENCES
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