Economies of scale – As the production increases, efficiency of production also increases. . The advantages of large scale production that result in lower unit (average) costs (cost per unit) is the reason for the economies of scale is that the total costs are shared over the increased output.
There are two types of economies of scale:
1.Internal economies of scale
2.External economies of scale
Internal economies of scale refers to the advantages that arise as a result of the growth of the firm. hen a company reduces costs and increases production, internal economies of scale have been achieved.
Internal economies of scale relate to the lower unit costs a single firm can obtain by growing in size itself. There are five main types of internal economies of scale.
As businesses grow they need to order larger quantities of production inputs. For example, they will order more raw materials. As the order value increases, a business obtains more bargaining power with suppliers. It may be able to obtain discounts and lower prices for the raw materials.
Businesses with large-scale production can use more advanced machinery (or use existing machinery more efficiently). This may include using mass production techniques, which are a more efficient form of production. A larger firm can also afford to invest more in research and development.
Many small businesses find it hard to obtain finance and when they do obtain it, the cost of the finance is often quite high. This is because small businesses are perceived as being riskier than larger businesses that have developed a good track record. Larger firms therefore find it easier to find potential lenders and to raise money at lower interest rates.
Every part of marketing has a cost – particularly promotional methods such as advertising and running a sales force. Many of these marketing costs are fixed costs and so as a business gets larger, it is able to spread the cost of marketing over a wider range of products and sales – cutting the average marketing cost per unit.
As a firm grows, there is greater potential for managers to specialise in particular tasks (e.g. marketing, human resource management, finance). Specialist managers are likely to be more efficient as they possess a high level of expertise, experience and qualifications compared to one person in a smaller firm trying to perform all of these roles.
External economies of scale
External economies of scale refers to the advantages firms can gain as a result
of the growth of the industry. It is normally associated with a particular area. 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.
External economies of scale occur when a firm benefits from lower unit costs as a result of the whole industry growing in size. The main types are:
Transport and communication links improve
As an industry establishes itself and grows in a particular region, it is likely that the government will provide better transport and communication links to improve accessibility to the region. This will lower transport costs for firms in the area as journey times are reduced and also attract more potential customers.
Training and education becomes more focused on the industry
Universities and colleges will offer more courses suitable for a career in the industry which has become dominant in a region or nationally.
Other industries grow to support this industry
A network of suppliers or support industries may grow in size and/or locate close to the main industry. This means a firm has a greater chance of finding a high quality yet affordable supplier close to their site.
DISECONOMIES OF SCALE
These are the problems faced by businesses if they become too large
• Lose touch with the customers
• Managers lose touch with the workers
• Communication problems because the business is so large.