Economies Of Scale

What Are Economies Of Scale?

Economies of scale are the merits that a larger company has access to relative to its smaller counterparts as a result of its size.

They are usually a result of the increased efficiency in the larger company due to a significant reduction in per-unit fixed cost as the quantity produced increases.

Deeper Definition

As businesses attain increased production capacity, it costs less to produce as well. Usually, the first set of products is hugely capital-intensive. Still, as the cycle goes on, each batch of products correspondingly has their costs reduced due to each one benefiting from the investments on the preceding one. Companies with a high turnover tend to make lots of profits. Suppose they choose to reinvest the revenue into the business for enhanced production. In that case, they can cut costs by making bulk purchases of raw materials, increased allocation for research and development, quality control, monitoring, innovation, equipment purchase, recruitment, improved technology, and so on.

Economies of scale are hugely important due to the competitive advantage they guarantee the larger firms over the smaller ones. It also increases the likelihood of landing investments as investors tend to look out for these when making the decisions. Economies of scale can be achieved either externally or internally. In the case of internal economies of scale, companies usually pay attention to how their equipment and personnel are used within the organization to increase efficiency. Similarly, external economies of scale are possible when the firm outgrows the rest of the competition in the industry and can then leverage that to engage in such things as bonuses and discounts, as the case may be.

It is common in mass production plants like an assembly plant or a factory for the concept of economies of scale to be put to use.

Typically, the first item or batch of items is costly considering setting up the factory and overhead costs. Still, as more of the said items pass through the line, the costs are spread, and the seemingly heavy initial investment evens out in the long run and becomes even more profitable than it could have been otherwise.

Economies Of Scale Example

John decides to set up a protein powder company. To make his first batch of protein powder he has to buy all the equipment to do so. This sets him back $10,000. For each subsequent batch after that, John does not have to purchase the equipment again, so the cost is lower. As John makes more, larger batches, the cost of the raw materials also reduces, he can further take advantage of economies of scale.