In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies 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 its costs will help the organization scale further.
Economies of scale types
Economies of scale can usually 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 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 coordinate the resources of the scaled company better.
Improved financial structure
As the company scales, it might also be able to improve its financial structure (see Amazon inventory turnover).
More bargaining power
Companies that scale also have more negotiating leverage with their supplier, making it easy for them to gain better deals and pass them to final customers through lower prices and more convenience (see Amazon cash conversion cycle).
External
A company with external economies of scale can use a scale to get better treatment (perhaps from the government or regulators).
For instance, as a company creates jobs in an area, it might get advantages like tax credits, public funds, or else.
Beware of diseconomies of scale

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.
Economies of scale and network effects
In the digital business world, moats are built on network effects.

In general Network Effects can be direct or indirect. Direct is also called the same side.
As an example of the direct network effect, take the case of a platform like Instagram, where the more users join, the more the platform becomes valuable to the additional user who joins the platform.
As an example of indirect network effects, take the case of LinkedIn, where the more qualified professionals join the platform, the more it becomes valuable for recruiters and vice-versa.
Network effects are typical of platform business models, which can grow non-linearly.
However, building platform business models is extremely hard, as they face two core issues:
- Initial network effects are hard to kick off (so-called chicken and egg or cold start problems).
- Network effects are hard to scale.
- Network effects are hard to maintain.
That is why very few companies can build successful platform business models, and those who can do so become extremely valuable companies.
In addition to that, when a company reaches a certain level of scale, there is a sweet spot where these network effects seem almost self-reinforcing, and it doesn’t matter what; the platform can keep its momentum.
After a certain scale, though, also negative network effects might be kicked off!

Network effects enable platform business models to achieve economies of scale.

Read Also: Network effects for digital platforms.
What are economies of scale?
Economies of Scale is an economic theory for which, as companies grow, they gain cost advantages thanks to increased efficiency in production, manufacturing, and organizational structure. Thus, as companies scale and increase production, a subsequent cost decrease will help the organization scale further.
What are the main types of economies of scale?
Economies of scale can primarily be internal and external:
Connected Economic Concepts

Positive and Normative Economics


































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