Economies of scale refers to the economic advantage for an organization owing to its increased level of output. The advantage comes from the inverse relationship quantity of units produced and fixed cost per unit. It often acts as a key source of competitive advantage for large-scale organizations over small ones. For a management student, it is extremely important to learn about economies of scale and understand how it is leveraged by firms for their own benefits, so that you can implement the same in your business plan. Economies of scale can be defined in simple words as:
“the proportionate saving of cost achieved by increasing the production level”
The concept of economies of scale is based on the idea of overcoming the fixed cost of the company. Almost every organization has to bear certain degree of fixed costs which comes from the cost of administration and setting up the production infrastructure and logistics costs, among several others. A company with high economies of scale can spread out its fixed cost over a large number of units produced. In certain situations, the higher volume of production can also allow an organization to lower their variable costs as well, such as the cost of raw materials procured from the suppliers. Before we get into the details of economies of scale, first thing you need to know for your college essay is that an organization becomes more cost efficient when it produces in more quantities. This is the central construct of economies of scale.
As we have discussed earlier, based on the concept of economies of scale, the higher production volume can lead to lower average cost. However, this is only partially true. Increasing the production volume can reduce average cost but only to a certain extent. This where the concept of diseconomies of scale comes to play.
As shown in the diagram above, the average cost per unit reduces as the production volume increases. However, the cost only decreases to a certain point, denoted by ‘Q’, before going up again. Thus, the company can enjoy economies of scale at any point before reaching Q. Any more production that crosses Q, will increase the average cost, leading to diseconomies of scale.
Economies of scale has a significant effect on the cost of production of an organization, thereby affecting its profitability.
The above diagram is an LRAC curve, or a Long Run Average Cost curve. The LRAC curve of an organization plots the lowest average cost for producing a certain output in the long run. It is shown that as the quantity produced moves from Q1 to Q2, the average cost falls from P1 to P2. Therefore, in order to achieve highest possible efficiency, the organizational maintains a certain level of production (Q2), which leads to the lowest level of average cost (P2).
In the above diagram, the intersection of the LRAC (Long Run Average Cost) and LRMC (Long Run Marginal Cost) has been showcased. The LRMC is the lowest increase in total cost of production attributable to the increase in production volume by one unit. The interaction point of the LRMC and the LRAC gives the lowest long run cost for any company. It is always advisable to maintain this rate of production to achieve the highest possible economic benefits.
By this point, you should have a clear understanding about what is economies of scale and how it can be advantageous for an organization. But before you start writing papers on this topic let us look into all different ways an organization can achieve economies of scale.
The internal economies of scale originate from the internal factors of the organization, which the company has full control over.
Technical: Technical economies of scale refers to the ability of the company to adopt advanced technologies to make its production process highly efficient. By adopting the right technologies and equipment, a firm can reduce its cost of production while increasing the production volume to a certain degree.
Managerial: Managerial economies of scale arise from the managerial skills of the organization to run certain functions at higher efficiencies.
Financial: Financial economies of scale refers to the company having cheaper access to capital and resources required for running its business ventures.
The external economies of scale originate from the external factors such as political and industrial factors. The large-scale business operations of a company and its positive impact on the local economy may lead to special treatment and support by the government. Moreover, the extremely high buying capacity of the company may convince suppliers to offer special discounts to the company, thereby further reducing their cost of production.
Achieving economies of scale can be quite beneficial for an organization, as it can help in improving its profitability by reducing the average cost of operation. However, it should be noted that economies of scale, is usually leveraged by well-established firms with strong financial capacity. Since, it relies on the ability of the company to yield high production volume, therefore economies of scale may only be utilized by big companies. It can also be a significant source of competitive advantage for a company, allowing you to implement this concept in your marketing essay as well. While applying the concept of economies of scale in your own formal essay, you need to think of all the different ways a company can spread out its fixed costs over a higher number of units produced. You also need to ensure that the company maintains its position at the intersection point of its LRAC and LRMC curve, to achieve the maximum long-term benefits.
Both economies of scale and economies of scope are aimed at improving the competitive advantage of an organization by reducing its operating cost as much as possible. As we have learnt from this article that economies of scale involve reduction of average fixed cost of production by increasing the production volume. On the other hand, the economies of scope aim at reducing the overall cost of the company, through diversification of goods produced. A company which produces a range of product categories which are complementary to one another, then it is able to have a cost advantage. It relies on the idea that it is cheaper to produce two items that share same resources and processes that each of them having separate inputs.
Economies of scale can be a very complicated concept when implementing in an organization. You will require an in-depth knowledge of its principles and practices to properly apply theories into any case scenario. So, if you need to write a research paper, simply place your assignment order with us, while our professionals work on your paper to get you the grade you always wanted.
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