Economies Of Scale
What do you understand by ‘economies of scale?’ This is the basic cost advantage that a manufacturer gets out of increasing the output of a particular product. While the cost of producing remains unaltered, the number of products manufactured increases thereby reducing the overall cost of production. Economies of scale are essentially incorporated to gain synergy and business efficiency.
Types Of Economies Of Scale
There are two main kinds of economies of scale:
- Internal economies of scale: This is when the efficiency and synergy are realized from within the organization.
- External economies of scale: This is the cost or manufacturing efficiency attained by virtue of external factors like overall size of the industry.
This distinction was identified by the renowned Alfred Marshall. According to him internal economies of scale is achieved when a specific company lessens the cost of production and increases the overall production without a significant rise in the related factors.
On the other hand when we discuss external economies of scale it essentially happens due to factors operational from outside a firm. For example if your firm’s operational efficiency improves as a result of a new train service introduced by the government or better road links incorporated by the state, it is termed external economies of scale. In this, the firm’s contribution is improving the efficiency of the particular factor is minimal whereas the benefit achieved is quite significant.
Examples of Economies Of Scale
It is possible to realize economies of scale in many areas within an enterprise. For example, let us consider two financial firms, a large company and a relatively smaller one. It will be seen that the larger of the two would be able to provide capital at a lower cost as they would be able to borrow money at a significantly lower rate of interest given the bulk of money that is being borrowed.
Here is another interesting example to further elucidate the point. Let’s say you have a modest business, and you are thinking of increasing awareness among people by printing a brochure. Now supposing the printer gives you a cost of $1000 for 100 brochures but $3000 for 500 brochures, you will realize that while you are paying $10 a piece for printing 100 brochures, just increasing the number of brochures to 500 reduces your cost by $4 to $6 a brochure while printing 500 pieces. This cost advantage is essentially there because the initial cost of setting up the basic print is same for the printer but with every additional copy the marginal efficiencies improve thereby passing on the cost advantage to you.
However, economies of scale is not an infinite opportunity. There is an upper limit to which a firm can expand or grow on the basis of this theory. It is noticed that beyond a point, managing a huge firm becomes a relatively expensive proposition and results in several operating inefficiencies. As the complexity increases and efficiencies to begin to go downhill resulting in overall losses.