Finance

Economies of Scale and Its Importance for Companies

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When a company produces more goods or services on a larger scale but with fewer costs, that company has achieved economies of scale. As it grows and the production units increase, a business will have a better chance to decrease its costs. When economies of scale are achieved, economic growth is also achieved.

Internal and External Economies of Scale

According to economist Alfred Marshall, it’s important to distinguish between internal and external economies of scale.

Basically, internal economies of scale happen within the company. Its external counterpart, as you may have guessed, takes place outside the firm but within the industry. Usually, all companies within the same industry benefit from external economies of scale.

Inputs to Achieve Economies of scale

Lower input costs

When a company buys raw materials or goods in bulk, it can benefit from volume discounts.

Costly inputs

There are expensive inputs, such as research and development, advertising, managerial expertise, and skilled labors. However, since they carry with them higher quality and efficiency, there’s a chance that the overall cost of production and selling will be lower.

Specialized inputs

As the production scale in a company grows, a company can utilize specialized labor and machinery. And when that happens, there’s greater efficiency.

Workers would be better qualified for the job and wouldn’t spend too much time learning the ropes of duties not within their area of specialization.

Techniques and organizational inputs

Larger scale of production also means the company may apply better organizational skills to its resources, such as a clear-cut command, while also enhancing its techniques for production and distribution.

Learning inputs

Related to above, the learning processes related to production, selling, and distribution can lead to better efficiency.

Diseconomies

The opposite of economies of scale, the diseconomies, can also happen, stemming from inefficient managerial or worker policies, over-hiring, or weakening transportation networks.

Moreover, as the company’s scale grows, it may also have to distribute its products and services in more dispersed areas. This can lead to an increased average costs, which in turn leads to diseconomies of scale.

Arguments against Economies of Scale

Globally, there’s a hot argument criticizing economies of scale, and consequently international trade and the globalization of the economy.

For those who don’t like economies of scale and globalization, transnational corporations pave the way for the extinction of small businesses. Additionally, the environment will also be affected, developing countries will have stunted growth, and the workforce will be less viable.

Further, as the business gets bigger, the balance between demand and supply could become weaker, meaning the company will be out of touch with its customers’ real needs.

It is also feared that competition could eventually disappear as huge companies start to integrate. Monopolies could also create a focus on simply gaining profits instead of considering customers when determining the price.

Conclusion

To better understand economies and diseconomies of scale, one must consider their sources. Instead of focusing on just one source, a company needs to know how its decisions affect its business’s efficiency.

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