economies-of-scale

What Are Economies Of Scale And Why They Matter

In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Economies’ of scale types

Economies of scale can ususlly be of two types:

  • Internal: or if they come from factors within the company.
  • Or external: from factors that are outside the company.

Internal

Internal factors that determine economies of scale are:

  • Cost efficiency coming from scale: as companies scale up, in theory, they can also offer products at a lower cost, and still profit from them. This is at the core of cost leadership, one of Porter’s generic strategies for competitive advantage.
  • Technological development: as companies scale they also start to develop proprietary technologies to tackle key aspects of the business, thus improving efficiency, optimizing processes, and productivity.
  • Better organizational structure: up to a certain size, the scaled company will gain from better organizational efficiency, as management might be able to better coordinate the resources of the scaled company.
  • Improved financial structure: as the company scales it might also be able to improve its financial structure to (see Amazon inventory turnover).
  • More bargaining power: companies that scale also have more negotiating leverage with their supplier, which makes it easy for them to gain better deals, and pass them to final customers in the form of lower prices, and more convenience (see Amazon cash conversion cycle).
  • Network effects for digital platforms.

External

A company with external economies of scale is able to use scale to get a better treatment (perhaps from government or regulators).

For instance, as a company creates jobs in an area, as effect it might get advantages like tax credits, public funds or else.

Beware of diseconomies of scale

diseconomies-of-scale
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Diseconomies of Scale represent the opposite phenomenon instead. Where a company has grown too large, the cost per unit increases, thus making the firm no longer able to benefit from its achieved scale.

Read more: Diseconomies Of Scale

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Gennaro Cuofano

Gennaro is the creator of FourWeekMBA which target is to reach over two million business students, executives, and aspiring entrepreneurs in 2020 alone | He is also Head of Business Development for a high-tech startup, which he helped grow at double-digit rate | Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy | Visit The FourWeekMBA BizSchool | Or Get in touch with Gennaro here