Understanding Economies of Scale

by Craig Anthony

2 min read

If you’re trying to keep your new small business afloat and potentially expand, having economies of scale can help you with both profitability and growth. Economies of scale means lowering the cost per product or service to make your business a larger operation; you spread the production or service costs over larger volumes of output. Economies of scale can only happen if you invest more money in your business to cover the initial surge in costs necessary to boost production or expand services.

Defining Economies of Scale

Your business incurs both fixed and variable cost. Before you can produce any products or deliver any services, you must have the facilities and a supporting system in place by making necessary business investments. The amount of business investments you make – a fixed cost – determines the level of your production or service capacity. Within a given output capacity, if you can churn out more products or services, you have better economies of scale, which lets you allocate the fixed cost over larger volumes of output. In other words, you can lower the unit fixed cost by producing more products or delivering more services. Variable cost relates to direct inputs such as materials and labour used to make a product or deliver a service. Variable cost varies in the sense that total variable cost changes in accordance with the increase or decrease of productions or services, while unit variable cost for each product produced or service delivered doesn’t change. Therefore, the total unit cost, after accounting for both fixed and variable cost, is a function of the total volume of productions or services. As your business makes more products or delivers more services, it decreases the lower the total unit cost for each product or service delivered – the definition of economies of scale.

Applying Economies of Scale

Economies of scale means mass production of products or delivery of services. Achieving economies of scale can be challenging for a new small business with limited resources. You may have to look for unique ways to apply economies of scale. For example, a small business should consider to make more quality investments to help increase productions or services, instead of making more investments that only big businesses can easily do. Instead of building large, costly production or service facilities, your small business is better off focusing on investing in technologies or relevant expertise to help increase production or service efficiency to drive up the volume of production or services to achieve economies of scale. A small business should use the least inputs to achieve maximum outputs. Another example of applying economies of scale to small business has to do with organizational skills. A small business could organize its existing resources more effectively, such as creating highly specialized working positions to prevent any waste of manpower on the job. With increased efficiency and effectiveness, your small business can reach a level of economies of scale, even with limited business investments. As you apply economies of scale to help improve profitability and growth, your small business can flourish in the long run.

References & Resources

Related Articles

4 Tips for Scaling up Your Small Service-Based Business

You can scale up your small service-based business; you just need to…

Read more

Understanding the Difference Between Growth and Scaling

Many business owners would consider their business a success if they managed…

Read more

Thinking Big: A Step-by-Step Guide to Winning Shelf Space at Big Box Retailers

If your business manufactures consumer goods, you might think that winning a…

Read more