Economies / Diseconomies of Scale

Economies of scale mean that as output increases, the cost of producing each item goes down. Internal economies of scale increase efficiency within an individual firm. There are different types of internal economies of scale:

• Technical
• Specialisation
• Purchasing
• Financial
• Marketing
• Risk-bearing

• Relate to production.
• Production methods for large volumes are often more efficient.
• Large business can afford to buy better, more advanced machinery, which might mean they need fewer staff, and wage costs will fall.

• Linked to employees.
• Large business can employ managers with specialist skills and separate them out into specialised departments, which means the work is usually done more quickly and is of a higher quality than in non-specialised companies.

• Are to do with discounts.
• Large businesses can negotiate discounts when buying supplies.
• They can get bigger discounts and longer credit periods than their smaller competitors.

• Financial economies of scale happen when companies borrow money.
• Large firms can borrow at lower rates of interest than smaller firms.
• Lenders feel more comfortable lending money to a big firm than a small firm.

• Are related to promotional costs.
• The cost of an ad campaign is a fixed cost.
• A business with a large output can share out the cost over more products than a business with a low output.

• Involve diversification into several different markets or catering to several different market segments.
• Large firms have a greater ability to bear risk than their smaller competitors.

External economies of scale happen when industries are concentrated in small geographical areas.

• Having a large number of suppliers to choose from gives economies of scale. Locating near to suppliers means firms can easily negotiate with a range of suppliers, which tends to increase quality and reduce prices.
• A good skilled local labour supply makes an industry more efficient. This is most important in industries where training is expensive or takes a long time. For example, software development firms in California's "Silicon Valley" know that plenty of people who are qualified to fill their vacancies already live within driving distance.
• Firms located in certain areas can benefit from good infrastructure - e.g. an airport, a motorway or good rail links. E.g. Dublin's tourist industry had a massive boost in profits after Ryanair started cheap flights to Dublin.

Diseconomies of scale make unit costs of production rise as output rises. They happen because large firms are harder to manage than small ones. They're caused by poor motivation, poor communication and poor coordination.

• It's important to keep all departments working towards the same objectives. Poor coordination makes a business less efficient. In a big firm, it's hard to coordinate activities between different departments.
• Communication is harder in a big business. It can be slow and difficult to get messages to the right people, especially when there are long chains of command. The amount of information circulating in a business can increase at a faster rate than the business is actually growing.
• It can be hard to motivate people in a large company. In a small firm, managers are in close contact with staff, and it's easier for people to feel like they belong and that they're working towards the same aims. When people don't feel they belong, and there's no point to what they're doing, they get demotivated.
• Diseconomies of scale are caused by problems with management. Strong leadership, delegation and decentralisation can all help prevent diesconomies of scale and keep costs down.