What Are Economies Of Scale? What Factors Affect Economies Of Scale?
by Shahnawaz Alam Business 07 September 2023
A company achieves economies of scale through a rapid rise of production, thereby reducing the cost of per unit production.
Usually, the managerial or technical improvement of production is the common reason behind achieving economies of scale. However, businesses can also get diseconomies of scale by chasing it without a proper plan and understanding.
Go through this article to understand economies of scale and how to achieve them.
What Are Economies Of Scale?
Economies of scale are the cost advantage companies gain due to high output or production. Because of a large number of product outputs, the company has many products to spread their production cost over.
When the company has a massive level of production that surpasses the fixed costs (administration costs), the production cost is easily spread over more production units. This reduces the per-unit cost.
The larger-sized companies can take most of the benefits of economies of scale. The higher the number of employees, the higher the amount the company can generate in production. It gives them heavy cost advantages, and they can save more savings on production.
Different detrimental factors govern the economies of scale and cost savings on production. Here are the various factors that you need to keep in mind –
How Does A Company Gain Economies Of Scale?
There are two different ways for a company to achieve economies of scale.
The first scenario is when the company rearranges its production equipment, resources, and other necessary factors. Thus, they can increase the production of the company through efficient and productive arrangements. This helps them lower the cost of production, helping them achieve economies of scale.
The other way is for a company to grow in size. Therefore, they have the advantage of producing more than their competitors. They can hold negotiations for bulk purchases of raw products, giving them an advantage over production costs.
Detrimental Factors Behind Economies Of Scale
Large companies have higher advantages when it comes to economies of scale. There are different detrimental factors for economies of scale. Go through the section below to learn about that –
One of many detrimental factors for production for economies of scale is the company’s internal factors. The internal factors are the different factors associated with production. These factors could include –
- Changes in production decisions.
- Management changes.
- Or increasing the size of the company.
Large manufacturing companies will have a competitive advantage here. The reason is that they can negotiate while purchasing raw materials for production. They can avail themselves of the discount for the raw materials they purchase. They also can fund the capital needed for advanced and specialized tech equipment.
The external factors can influence and affect any particular industry. This way, not just one company but a line of different companies in the industry can benefit. Some of the common detrimental external factors include –
- Highly skilled labor pool.
- Partnerships or joint ventures.
- Reductions in tax/subsidies.
No matter the cause of economies of scale, it involves spreading the production cost over more units.
What Effect Do Economies Of Scale Has On The Market?
When the production cost is because of the high amount of production, it has some effects on the market. Here are some of the effects that you must remember –
- Due to economies of scale, the per-unit cost for products is reduced. This happens due to increased production, which allows the opportunity to spread the cost across more production units.
- The per unit variable costs also get reduced due to economies of scale. This result occurs because the expanded production has increased the production process efficiency.
What Is Technical Economies Of Scale?
Technical economies of scale happen when the business can increase the efficiency of its production. Such economies of scale can reduce the production cost by 70% to 90%. Larger companies can have the advantage of acquiring more technologically efficient equipment.
One of the examples can be data mining. It allows businesses to target more profitable market niches.
Shipping companies can cut their shipping cost by using supertankers. Large companies have the advantage of learning, trying, and doing something new.
What Are Economies Of Scope?
Economies of scope are also similar to economies of scale. But it does not happen until the company branches out to create different and new product offerings. But new product lines alone cannot make it happen. A business has to combine its new product lines with an efficient production process that results in economies of scope.
But what is the difference between economies of scale and economies of scope? Economies of scale and economies differ based on their approach to production. Economies of scale mean boosting the production of one specific product. On the other hand, economies of scope deal with the boosted production of multiple types of products.
What Is Diseconomies Of Scale?
Sometimes, companies make the mistake of chasing economies of scale too much. This makes them grow too large while not being able to achieve economies of scale. Such overgrowth is termed as diseconomies of scale.
Sometimes, it is not possible for an organization to produce more because they have already reached the maximum level of efficiency. Any more production of new units can now increase production costs for each unit.
Also, the diseconomies may not always be related to physical efficiency in production. Sometimes, the company might take longer for decision-making, which in turn can make the company less flexible. There are other common reasons behind diseconomies of scale. Some of them might be miscommunication or acquiring other companies. Some of these reasons can cause a clash within the corporate culture.
A positive effect of economies of scale can result from a good managerial approach or technical improvements in the production process. Financial ability, access to a large network, or monopsony power can also result in economies of scale. However, chasing economies of scale can also give the opposite result. However, if a company is able to work on its managerial or technical aspects of production, it will have a better chance of achieving economies of scale.
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