ECONOMIES OF SCALE

E

conomies of scale are the cost advantages that enterprises obtain due to size, output, or scale of operation, with cost per unit of output generally decreasing with increasing scale as fixed costs are diversified over more units of output.

Economies of scale apply to a variety of organizational and business situations and at various levels, such as a business or manufacturing unit, plant or an entire enterprise. For example, a large manufacturing facility would be expected to have a lower cost per unit of output than a smaller facility, all other factors being equal, while a company with many facilities should have a cost advantage over a competitor with fewer.

Often operational efficiency is also greater with increasing scale, leading to lower variable cost as well.

As far as I have concern, I think to achieve highest economies of scale, you need to produce beyond the breakeven point & up to the point where cost of production of each unit of goods increases.

At breakeven point, you’re at balance no gain no loss, But achieving highest economy of scale means a point after which the each unit of production cost you more.

It may be due to the highest capacity utilization of the  production plant.

In other context, to get highest economy of scale from the same production plant, you need to get it in well working condition.

The simple meaning of Economies of scale means to increase the efficiency of operation by cost wise and volume wise, area wise, service wise.

The area of economies of scales are

a.       Lower Input Cost:-  When an entrepreneur buys input in bulk, but maximum limit. In case, if you don’t have the facility to store the excess input, it will get wasted and you have to do a lots of calculation to achieve ES.

b.      Costly Inputs:- Some inputs such as R & D, skilled labor, managerial expertise are expensive but because of the possibility of increase in efficiency with such inputs, they can lead to decreased the  cost of production of each goods sold apart from that R & D work and advertisement may discover new market for the outputs.

c.       Specialized Inputs:- As the production scale increases, company can afford for specialized inputs to increase the efficiency.

d.      Techniques and organizational inputs:- Clear cut chain of command, better logistics tracking techniques, improving techniques for production and distribution on the other hand organizing the input collection center, improved availability of outputs.

e.       Learning Inputs:- As above, the learning process should never be stopped. Learning process in related to production, selling & distribution, promotion, market research increases the efficiency as well as valuation of the enterprise.

Internal and External Economies of Scale

Alfred Marshall made a distinction between internal and external economies of scale. When a company reduces costs and increases production, internal economies of scale have been achieved. External economies of scale occur outside of a firm, within an industry. Thus, when an industry's scope of operations expands due to, for example, the creation of a better transportation network, resulting in a subsequent decrease in cost for a company working within that industry, external economies of scale are said to have been achieved. With external ES, all firms within the industry will benefit.

From the above, we come to point that, when we examine or research for the economies of scale, ultimately we have scale both the external and internal economy.

BUT Diseconomies also occur…..

It is just a  reverse scenario. They stem from inefficient managerial skill, inefficient labor and input management, over hiring or deteriorating transporation network. In simple word, jeopardizing the whole chain, whole network. Let us elaborate this, expanding the business will ultimately expands the complexity of business. You have to be at everybody’s reach. But in the process of expanding, small enterprises are not able to handle the big dogs in the race, and their own function are not handled properly.

Conclusion

The key to understanding Economies of scale (ES) and Diseconomies of Scale (DS) is that the sources vary. A company needs to determine the net effect of its decisions affecting its efficiency, and not just focus on one particular source. Thus, while a decision to increase its scale of operations may result in decreasing the average cost of inputs (volume discounts), it could also give rise to diseconomies of scale if its subsequently widened distribution network is inefficient because not enough transport trucks were invested in as well. Thus, when making a strategic decision to expand, companies need to balance the effects of different sources of ES and DS so that the average cost of all decisions made is lower, resulting in greater efficiency all around.

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