Economies of Scale

Reviewed by Annapoorna | Updated on Aug 27, 2020

What is Meant by Economies of Scale?

Economies of Scale refer to cost advantages that businesses reap when production turns efficient and effective. Through increasing production and cutting costs, companies can achieve economies of scale due to prices getting spread over a significant number of goods. The costs may be fixed as well as variable.

Regarding the economies of scale, the size of the company usually matters. The bigger the business, the higher the savings on costs. Economies of scale can be internal, as well as global. Internal economies of scale are based on decisions of management, while external ones are based on external factors.

Economies of Scale Explained

Economies of scale are an essential concept in any sector for any company and reflect the cost-savings and competitive advantages that larger businesses have over smaller ones.

Larger enterprises can produce more by spreading production costs over a larger quantity of goods. The company may also be able to dictate the cost of a service if several different companies within that sector produce similar goods.

There are various reasons for economies of scale to produce lower costs per unit. Labour specialisation and more advanced technology improve the amount of production. A lower cost per unit may come from manufacturers ' bulk orders, more significant advertising sales, or lower capital costs. Spreading the internal cost of operation across more produced and sold units helps to reduce costs.

Internal functions include accounting, marketing, and information technology. Operational efficiencies and synergies are also regarded on the first two grounds. The reasons for mergers and acquisitions are cited as advantages.

Internal and External Economies of Scale

There are two different types of scale markets—internal markets and external markets. The enterprise carries within itself the internal markets, whereas the external ones are built on external factors.

Internal economies of scale arise when a company cuts costs, so they're unique to that particular company. It could be the result of a company's sheer scale or the company's management decisions. Larger firms can gain internal economies of scale by lowering their costs and increasing their production levels. This is done because they can purchase bulk materials, have a patent or special technology, or access more money.

On the other hand, the external economies of scale are achieved due to external factors or factors that affect an entire industry. It ensures that no one organisation alone manages the amount. Those arise when there is a highly-skilled pool of workers, incentives and/or tax cuts, and alliances and joint ventures—anything that can cut costs for many companies in a particular industry.