Economies of scale

Economies of scale are the increasing returns that are accomplished when the average costs decrease as output rises. This assumes that production becomes more effective when output rises.

Economies of scale are achieved when the scale of a company’s operations are increased. Reasons for this are

  • Fixed costs – if you have fixed costs, such as rent, these remain the same while you are located in the same building, regardless of whether you are producing 10 of your product or 10,000
  • Bulk buying – better deals can often be secured on goods when they are bought in bulk
  • Better equipment – larger companies often have access to better equipment, which can result in faster production
  • Specialisations – over time, processes become improved and efficiencies made, reducing costs.

Economies of scale occur when long-term average costs decline and costs of production per unit fall as output rises.

Economies of scale can also be realised through changing organisational structures. Flat organisational structures usually result in economies of scale because there are fewer managerial staff, who are more expensive than production staff. This only works if managers can continue to work efficiently in the new structure and are not overstretched.

What is it used for?

The economies of scale model is used to identify where improvements to production, processes or costs can be made to raise profits. Economies of scale can be optimised by careful calculation of levels of output. This model can be used to increase efficiency and reduce costs by better job design and cost controls, greater workforce efficiency and improving managerial techniques.

How do I use it?

This model is used by assessing how production, staffing and costs can be improved. Every manager with some level of autonomy can help to create economies of scale. To create or improve economies of scale, you might want to ask questions such as

  • Does an increase in output really require more staff, or could the staff that we have be used more efficiently to raise output?
  • Do we really need this number of staff/managers to maintain this level of output, or could we keep the current level of output by simply organising our staff better?
  • Do certain tasks have synergies and could they be performed together to increase efficiency?
  • If we increase output, can we buy our raw materials more cheaply because we are buying them in greater bulk? Will our suppliers give us a better deal if we increase the volume that we buy from them?
  • If we move into a bigger building with slightly higher fixed costs, could there be a rise in output? Will the rise in output produce revenues that are significantly greater than the increased fixed costs associated with a bigger building?
  • Can we cut down levels of bureaucracy and still deliver the product safely and at a reduced cost?

What are its limitations?

Limitations, or diseconomies of scale, can occur sometimes. A diseconomy of scale is when costs rise as output rises. Sometimes big companies can become very bureaucratic, increasing the paperwork required to get things done. This is often inefficient and increases costs. This can also happen if there is no local market or workforce. When organisations are over-staffed, the effects of economies of scale are reduced.

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