Understanding Economies and Diseconomies of Scale

Economies and Diseconomies of Scale

Economies of scale: Reduction in the average unit costs as the business increases in size. When a business increases the scale of operations, it becomes more efficient.

Diseconomies of scale: Increase in average unit costs as the business increases in size. This occurs when the business experiences inefficiencies as it becomes larger.

Internal Economies of Scale

Efficiencies the business makes itself:

• Technical: Bigger units of production reduce costs since the increase in variable costs are spread over a set of fixed costs.

• Managerial: Managers specialize in one job and not in many.

• Financial: Bigger businesses are less risky than smaller ones since big businesses are considered safe by financial institutions, so they can charge less interest.

• Marketing: They have more money to spend, resulting in more effective marketing campaigns.

• Purchasing: Can obtain discounts through bulk buying.

• Risk Bearing: They can have a range of products/brands to decrease the risk of failure if one product fails.

External Economies of Scale

Efficiencies that the business achieves by the expansion of someone else:

• Consumers: In a shopping mall, people enter various stores, so the smaller businesses in the mall will benefit.

Employees: If a specific geographic area has a concentration of a certain industry, a business working in that area can benefit from the workers.

Internal Diseconomies of Scale

Inefficiencies the business creates itself:

• Technical: Airplane too big for airport.

• Managerial: Over-specialized workers that can only work in one area.

• Financial: Businesses with a large amount of excess production can make poor investments.

• Marketing: If they promise a deal to customers and they don't honor it, they may face legal problems.

• Purchasing: Large businesses that buy too much stock may lose money if it becomes unfashionable or spoiled.

• Risk Bearing: If a company buys another one from a different area and can't manage it correctly, they may have to resell it.

External Diseconomies of Scale

• Employees: If an area becomes concentrated in a certain job, there will be few skilled workers, and it would be expensive to attract or retain them.

Big Business Advantages

• Survival: Fewer chances of failing and being taken over by competitors.

• Economies of scale

• Higher status

• Market leader status: Leaders can shape market habits, creating a competitive advantage.

Increased market share: They can control marketing.