What are the Economies of Scale?

When you produce a product or a service, you need to know what your costs are. Economies of scale can be described as the phenomenon where the more you produce (scale), the lower the average cost per product.

Economies of scale: As production of a firm goes up then cost per unit production deceases.Thus firm will gets benefited.This is an economy derived to the firm because of expansion of its scale of production.

Take an analogy. You are a single person living in an apartment. You then get a partner. It takes nearly the same amount of resources for the both of you to live together as it did for you alone. Hence the saying “two can live as cheaply as one”.

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The same applies to business. In simple terms, the more a company produces the cheaper the production becomes because businesses always have fixed costs which are static and production costs that are proportional.

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At the top end there is vehicle production. Pakistan have had car manufacturers like Suzuki and Honda since ages. More recently, induction of new brands like Renault, Porche and Fa has been in the market which could grow to be a lot for a country of 200 million alone. Those car manfacturers could only compete with some pricing help in the form of import tariffs. Those tariffs have been removed and thus those manufacturers have ceased production because they cannot produce cars cheaply enough domestically or fit into global plans. For car manufacturing to be successful, a car must sold on the global market at a competitive price and quality.

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What are the advantages of economies of scale?

Economies of scale are important, because it creates a competitive advantage for the firms who can produce at low cost. This does not always mean that bigger is better, since diseconomies of scale may kick in at a certain volume. Examples for economies of scales are everywhere. If you observe the financial industries, you will notice that smaller banks disappear and are taken over by larger banks. The reason for this is, to some extent, the extremely high fixed cost to run a bank in a very regulated environment.

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Disruptive Innovation

The same can be said for pharmaceutical firms. It is very expensive to produce pharmaceutical products. So, that’s why a few players dominate the industry. However, those giants are often not that agile when it comes to innovation in life science and biotech. Because they are aware of the diseconomies of scale in research, they often buy smaller companies for their research and do not integrate them in their organization.

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There is nothing automatic to economies of scale

Economies of scale are also important for small business owner and entrepreneurs. Small business owners, for example, desktop publishers, designers, photographers, or marketing consultants may decide to share their office to use economies of scale of some common services. It just makes a lot of sense to share the IT infrastructure, the receptionist, the office kitchen, and accounting. For entrepreneurs, economies of scale are often crucial in their strategy.

Competition drives economies of scale

It forces them to grow faster than the competition, which is the reason why so many start-ups remain unprofitable for many years. They know that economies of scale will finally pay out and need investors to finance their growth. So, as I’m sure you can see, the takeaway of this video is that you need to understand how your cost structure changes depending on the volume you produce. And you need to consider economies of scale in your strategic decisions.

Related: Types of Product Costs to Consider for Your Startup