What is Economies of Scale & Examples of Economies of Scale
It is a crucial topic in helping us understand the benefits for businesses of growth and expansion.
What is Economies Of Scale
Economies of scale is a notion that as a business grows in size and increases its output level. However, its overall costs, total costs will increase, the cost per unit the cost of manufacturing or producing one unit of output actually falls on.
There are several reasons for this, and we can split those reasons into two different categories.
Types for Economies of Scale
It is categorized as internal economies of scale, while others are external economies of scale.
Internal Economies of Scale
Purchasing Economies of Scale
Number one internal economies of scale is what is known as purchasing economies. This is the notion that it becomes cheaper for larger businesses to produce a unit of output as they are grown to expand because they can purchase their stock on their raw materials in larger quantities.
And because they are placing larger orders with their supplies, they can demand discounts per unit for being a more valued customer, reducing the business unit cost.
Marketing Economies of Scale
This is the idea that as a business grows and expands, it can split its marketing costs over more units of production, and it can do things like purchase advertising space in magazines, on TV channels in larger quantities. And they can demand discounts for being a more extensive, more profitable customer for its supplier.
Technical Economies of Scale
The next life economy is known as technical economies of scale. This is the notion that larger businesses can afford to invest in greater mechanization, more up to date productive machinery that compacts produce more products in a given amount of time.
And that again drives down the cost of producing each unit. because the latest technology, the most up to date efficient machinery, can help a business lower its unit cost
Managerial Economies of Scale
This is the idea that, when a business is smaller, it may not be able to invest in as much for specialization, particularly at a managerial level. But as a business increases its scale of operations as it produces in larger quantities, it becomes more viable for the business to recruit specialist managers.
Maybe Specialist manages to work in areas of finance or areas of operations, or marketing.
And because these employees that have to join the organization arm was specialist, they should be able to perform their functions more productively, and it drives down the cost of producing a unit of output,
Financial Economies of Scale.
That’s because as businesses grow and expand as they become larger, they have access to sources of finance that smaller businesses much struggle to access. And they can obtain bank loans, that’s a more competitive rate of interest because they’re borrowing in more considerable sums.
They become a more valuable client for financial institutions like banks to negotiate with those banks lower interest rates because they are very lucrative customers to that bank because of that borrowing much larger sums of money.
External Economies of Scale
Rather than these issues taking place within the organization that is driving down the average cost of producing a unit of output.
These are issues that are taking place across the entire industry and it is not just one firm benefits from reduction unit costs but all organizations in that industry may experience the same reduction in costs as the first reason for that might be because of infrastructure changes.
Perhaps local authorities or national governments investing in new infrastructure projects all organizations in an industry might benefit from, such as building new transport links that benefit firms and drive down their costs.
Or perhaps, and investments in superfast broadband networks that all organizations in an industry might enjoy together on all experience a shared reduction in unit costs.
The next reason that’s external to a business that might prompt a fall in unit costs is external economies of scale associated with technological advancements.
Because of scientific breakthroughs because of advancements in research and development and new inventions and innovations, it may be possible that all firms in an industry can take advantage of those advances. All firms are industry together, share a reduction in unit costs.
The final external economy of scale could be to do with knowledge because a group or an industry might all be clustered in a specific geographic location; they may benefit from the knowledge that such a cluster of expertise fosters.
If you look at the car industry in the West Midlands in the United Kingdom, many firms all in the same industry are geographically located in that same area.
And so, expertise is developed; Local universities focus on providing graduates for those industries. Firms can benefit from poaching employees from each other, they bring great, and knowledge and skills to that organization which helps drive down the unit costs of the entire industry.
When there is a body of knowledge and expertise in the local area that can help make firms in the industry more productive and more efficient.