Economies of Scale

Description of Economies of Scale. Explanation.

Definition Economies of Scale. Description.

Economies of Scale refers to the reduction in per unit costs which arises from the ability to perform activities differently and/or more efficiently at larger production volume. It is one of the Ten Cost Drivers of Porter that determine the cost position of a firm, as is Capacity Utilization.

The initial investment in capital is diffused through an increase in production. The marginal cost of producing a good or service decreases when additional units of production are added. Economies of scale may be achieved in a number of areas. A larger firm may be able to buy in bulk (Purchasing Economies of Scale), it may be able to organize production more efficiently (Production Economies of Scale), it may be able to raise capital cheaper and more efficiently (Financial Economies of Scale), it may be able to spread the costs of uncertainty more efficiently (Risk-bearing Economies of Scale), it may be able to spread the costs of advertising and promotion more efficiently (Marketing Economies of Scale). it may be able to spread transportation costs more efficiently (see Factory Gate Pricing).

Economies of scale can also be achieved by Outsourcing secondary (supporting) processes, see Facility Management.

Note that bigger is not always better. Larger firms can be more difficult to manage, due to their complexity. This may cause diseconomies of scale, especially when the external environment of firms is complex or changes quickly. But compare: Organizational Absorption.

Do not confuse economies of scale with Capacity Utilization, which spreads the fixed costs of existing facilities and workforce over a larger volume.

Economies of Scale Forum

Merits of Economies of Scale
"One more merit of economies of scale is in reduction in fuel cost due to inherent characteristic (not only due to organizing production more efficiently) of product or equipment as part of some of the operating cost listed above. However, the merit of economy of scale realized through the reduction in marginal variable cost is less in comparison of marginal increase in the product price. In the waterfall of pricing mechanism, the advantage or cushion realized due to economy of scale factoring some of the above economies of scale is a fraction of the increase in the unit price."

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