Debitoor's accounting dictionary
Economies of scale

Economies of Scale - what are economies of scale?

Economies of scale are where a company is able to reduce their cost of a product due to how many of the product they can produce on a larger scale.

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There are two main types when talking about economies of scale - internal, and external. These types work on different levels - across individual companies, or across an industry as a whole.

Internal economies of scale

Internal economies of scale are unique to a particular company, or companies. This could be via patents on certain technologies to automate the production process, or being able to source the best components from a certain supplier at the best price.

A great example of this would be Apple who insist on the best quality screens for their phones. They can negotiate with Samsung (or LG, depending on which one they've chosen), and order enough to meet demand. In some cases, this demand has been so big that LG and Samsung have struggled to meet the demand for their own displays, causing a shortage of parts.

External economies of scale

External economies are wider in nature- something that affects and entire industry. An example would be if a government wanted to boost its companies automotive industry. They could do this by deciding that any automotive company with over 30,000 employees would receive a 15% tax break.

This means that all companies with below 30,000 employees would be incentivised to hire more staff as the tax break would reduce their overall cost.

What advantages do economies of scale have, and where do they occur in a business?

Normally, economies of scale occurs in a few distinct cases (often a mixture). Either:

  • Manufacturing the product has become efficient enough that cost savings occur throughout the entire process. This could be due to robotics and machines assembling part of a product (saving on staff and down-time), or highly skilled workers
  • The company has negotiated a good price for the materials they use to make their product because they are buying such large quantities. (known as purchasing)

What disadvantages do economies of scale have?

Distinct disadvantages are most notable if a small company is trying to compete with a much larger one. If the initial start up capital is lacking, then it will not be possible to purchase the necessary materials and technology for production in large enough quantities - in turn meaning that it becomes more expensive.

However, generally speaking, over the last decade or so, the idea of economies of scale has declined thanks to technological advancements. Now that the technology to automate parts (or all) of production are available at a much more affordable cost, it is easier than ever to buy just enough to meet demand.

Rather than having to produce such a large output to get the cost per unit down, it is now achievable to figure most of it out in advance so that there is no wasted money on overheads and production costs remain as low as they can possibly be. This is especially true for industries such as craft beer and other niches.

Economies of scale and Debitoor

You can keep track of your expenses and material costs within Debitoor to get an overview at a glance to see how you're doing. The expenses tab will show you your costs for the month or quarter, as well as the value of your assets such as necessary equipment.

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