Cost structure of firms
Some production techniques will be labour intensive and some will be capital intensive. So what do these terms mean?
A labour-intensive industry is one where the cost structure is largely made up of variable cost, with labour being the main resource required for production. Job production is a highly labour intensive production method with the cost of labour being significantly higher than the cost of the capital structure, such as machinery. The service sector includes many examples of labour-intensive activities, including schools, banks and legal firms.
A capital-intensive industry is one with a high quantity of capital per worker and, therefore, a relatively high proportion of capital costs compared to the cost of labour. Capital-intensive firms require large amounts of fixed assets and/or cash to operate and need a high volume of production and a high margin to provide adequate returns on investment. Capital-intensity is typical of mass and flow production. Steel, automobile manufacturing and mining are examples of capital-intensive industries.
The difference between an activity which is labour-intensive and one that is capital-intensive has significant implications for a firm and there is often a link to the size of the business. Small firms tend to be more labour-intensive than larger ones. Large capital-intensive firms tend to be more profitable than small ones, when conditions are good. However, when times are hard, small labour-intensive firms may find survival easier than large ones as they will find cost reduction easier.
Capital-intensive firms tend to produce standardised products, with low profit margins whereas labour-intensive firms are normally more customer focused, resulting in the opportunity to charge higher prices and obtain larger profit margins.
The bigger the market for a product, the more likely it is that it will be produced by capital-intensive methods. This has significant implications for the international market. Firms based in large markets, such as the USA, have a significant advantage over those that have developed in smaller national markets, such as Belgium or Luxembourg.