Definition: Economies of scale refers to the cost savings a company can earn by increasing the size of their operation or number of units produced. In other words, the production process becomes more efficient as more goods are produced.
What Does Economies of Scale Mean?
What is the definition of economies of scale? This is evident in all areas of production because as more units are produced, the fixed costs get spread among more units making each unit less expensive to produce. There are also number synergies and efficiencies realized as the production level increases. Bulk orders and shipments save time and money while batch production saves labor hours and machine time. Thus, as more units are produced, the cost per unit decreases. Other operational efficiencies can also lower the variable costs per unit as production increases as well.
This is one reason why large companies are able to sell their products for significantly less than their smaller competitors. They take advantage of their scale and produce each unit much cheaper than their smaller competitors are capable of producing their products.
Let’s look at an example.
Example
Alex is the CEO of a fast growing startup, one that has found a new, more efficient way to manufacture computer hardware. However, since this company is creating a product with a variety of components and sources, the per-unit costs can be as high as 90% of the final price.
The company has not been able to make a profit for the past few years. However, once the company starts producing over 2,000 units per day, it suddenly finds itself with per-unit costs at only 40% of total cost.
This is due to an ordering contract that takes affect once the company starts producing over 2,000 units per day. Bulk order discounts are one of the many ways EOS can help lower the per-unit cost of producing a product.
Economies of Scale, in the case of Alex’s company, helped his company become profitable once it achieved a certain production figure. This is the advantage that many large companies enjoy with their suppliers. Although overall costs may be increasing, per-unit costs decrease, which leaves more room for profit and the success of the company.
Summary Definition
Define Economies of Scale: Economy of scale means a company’s ability to make products more efficiently and less expensive as production increases and like operations are combined.
