Tuesday, 20 September 2016

Benefits: economies of scale

Economies of scale is the cost advantage achieved when an increase in production leads to a fall in the unit costs of production, as fixed costs are spread over a larger amount of products. Thus, a larger company will have a lower unit cost when compared to smaller companies. This is because larger companies have the capability to make more products

An example of economies of scale; if a company will pay $500 to keep 2000 bottled water in a storage facility, however this same storage facility has the capability to store 4000 bottled water. This same company now decides to increase the amount of bottled water it produces to 4000 units and keeps them in the same storage facility. Economies of scale is said to arise when the unit costs of storing drops from $0.25 ($500/2000) to $0.125($500/4000). The company ends up saving $0.125($0.25-$0.125) on each product as result of increasing its production.

Economies of scale could be internal or external. Companies can enjoy it externally when there is a development in their industry or economy which gives them an opportunity to produce more which in turn leads to a fall in the unit costs of the product. Internal economies of scale on the other hand as to do with your company itself, development within your company can help you achieve economies of scale internally.

Internal economies of scale can be achieved technically, a situation whereby a company invest in larger machineries which can then be used to produce more goods which will in turn reduce the unit costs of production. Buying in bulk is another way internal economies of scale can be achieved, as purchasing discounts can be obtained when goods are bought in bulk (a supermarket can use this medium to achieve economies of scale), buying goods in bulk will reduce its unit cost.

In all, if you have the ability to increase your level of production then do it as it will help you reduce your costs. Cost reduction can help you compete better in the business market as you will able to drop prices, thus your goods will cost lower. It can also help you increase your profit, as dropping prices will help you gain more market share which will in turn increase your profit.

That is all for today, thanks for reading this article. Keep checking out my blog regularly, cheers!

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