Economies of Scale

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Description of Economies of Scale. Explanation.




Definition Economies of Scale. Description.

Economies of Scale (EoS) refers to the reduction in per unit costs which arises from the ability to perform activities differently and/or more efficiently at larger production volume.

EoS is one of the Ten Cost Drivers of Porter that determine the cost position of a firm. Another one is Capacity Utilization.

Additional investments in capital can be diffused through an increase in production. After all, the marginal cost of producing a good or service decreases when additional units of production are added. Economies of scale may be achieved in a number of areas. A larger firm may be able to

  • Buy in bulk (Purchasing Economies of Scale)
  • Organize production more efficiently (Production Economies of Scale)
  • Raise capital cheaper and more efficiently (Financial Economies of Scale)
  • Spread the costs of uncertainty more efficiently (Risk-bearing Economies of Scale)
  • Spread the costs of advertising and promotion more efficiently (Marketing Economies of Scale)
  • Spread transportation costs more efficiently (Logistical Economies of Scale) (see alsoFactory Gate Pricing).

Economies of scale can also be achieved by Outsourcing secondary (supporting) processes, see Facility Management.

Note that bigger is not always better. Larger firms can be more difficult to manage, due to their complexity. This may cause diseconomies of scale, especially when the external environment of firms is complex or changes quickly. But compare: Organizational Absorption.

Do not confuse economies of scale with Capacity Utilization, which spreads the fixed costs of existing facilities and workforce over a larger volume.

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