In business, economy of scale is the cost advantage that arises with increased output of a product. The concept applies to a variety of areas, such as production, logistics, and even management. For instance, it is cheaper to build one large factory than two smaller ones; and it is cheaper to ship large volumes of goods in one go than in several smaller consignments.
There are two main types of economies of scale – internal and external. Internal economies of scale arise from within the firm, for example from the introduction of new technology or better management techniques. External economies of scale arise from factors outside the firm, such as a cluster of suppliers in one location.
There are many ways in which firms can take advantage of economies of scale. One is by expanding output. This could involve building a new factory, or extending an existing one. Another is by increasing the scale of production, for example by investing in new machinery.
Firms can also take advantage of economies of scale by specialising in one particular product or service. This could involve investing in research and development to create a unique selling point. Once a firm has a competitive advantage, it can use this to drive down costs and prices, and increase market share.
There are some disadvantages to economies of scale. One is that firms can become too big and unwieldy, making them difficult to manage. Another is that they can become reliant on a small number of suppliers, which could make them vulnerable to supply shocks. Finally, economies of scale can make it difficult for new firms to enter the market.
Overall, economies of scale can be a powerful tool for firms to increase their efficiency and competitiveness. However, they need to be managed carefully to avoid some of the potential pitfalls.