In short, economies of scale refers to the benefits enjoyed by a company because of its production on a large scale.
Economies of scale can be separated into five categories:
- Purchasing Economies
When businesses buy in bulks, they are able to get discounts and special prices. This helps to cut down the costs of raw materials.
- Marketing Economies
The cost of advertising and distribution increases at a lower rate compared to the sales and incoming profits. This allows the company to advertise more cheaply and more effectively.
- Financial Economies
A large company often finds it easier to raise finance compared to small firms. Banks treat large companies more favourably and they are able to negotiate loans at preferable interest rates. Besides, large companies can also issue shares.
- Managerial Economies
Large companies are able to employ many highly specialised members on its management team, such as marketing managers, accountants, etc. This results in better decisions being made.
However, there is a downside to economies of scale.
And, it is called diseconomies of scale.
These are some of the factors that lead to an increase in average costs as a business grows in size.
- Human Relations
Companies may find it hard to organise a large number of employees. Chains of command may take too long to reach its destination, there may even be miscommunication in between. There will be less personal communication between decision makers and staff, which can result in lack of motivation and industrial relations problems.
- Decisions and Co-ordinations
In a larger company, the quality of information reaching from the management to the workers, or vice versa, can lead to poor decision making. There may be a lot of paperwork and many meetings.
- External Diseconomies
Recently, consumers have been more aware of activities carried out by big companies. So, these companies have to spend money to deal with environmental issues and social responsibility acts. This will lead to a higher average cost.
An example of diseconomies of scale would be the newly built world's largest cruise ship, Oasis of the Seas.
This cruise ship costs Royal Caribbean around $1 billion.
It has 20 restaurants, 17 bars, a walk through mock-up of New York's Central Park and two rock-climbing walls.
The possible problems which may happen in this cruise ship are such as, miscommunication between the captain and workers, the amount of water or fuel the company needs to prepare for the cruise ship, etc.
There are always two sides to a coin, the same goes to companies!
That's all for now, see you! :)