Scale, or “economy of scale,” is something that every investor will eventually come across. The economy of scale is virtually the cost advantage that comes up along with the increased output of a certain product.
The economy of scale will come forward as a result of the inverse relationship between per-unit fixed cost and the quantity produced. The advantages of scale may cause reduced variable costs – therefore increasing operational efficiency.
Types of Scale
When it comes to the economy of scale, investors generally narrow them down to two types:
- Internal Economy of Scale
This happens when the efforts of a company manage to bring profit on their own – therefore increasing their benefits. In these cases, the scale can change thanks to technical or managerial changes – the economy changing from within.
- External Economy of Scale
This occurs usually when external factors such as other companies end up benefiting from the profit of another one. For example, when a new highway is built, the city government may inadvertently increase a company’s profit by decreasing the costs of transportation.
The advantage of scale is at its finest when it’s put together with other advantages. Since not every economy of scale is created to be the same, you will need an analyst to dig into the structure and create a proper framework. In return, the balance will bring profit to the company.
Advantages of Scale
With time, you will see several advantages of scale:
- Lower Fixed Costs
Salaries, rent, taxes – these will all cost you a lot of money in the long run. For example, a reactor that makes more products per hour will see minimal differences in costs – while still bringing bigger profit.
It’s not necessarily that you will pay less for those costs; they will virtually stay the same. However, if the scale goes higher, it will be much easier for you to cover the costs.
- Higher Variable Cost Efficiency
A higher efficiency of scale is more likely to have an increased return on variable costs than the lower ones. Once more, this will mean that it will be much easier for you to deal with feedstock purchase, bills, and others variable costs needed to keep the company going.
- Increased Order
A high economy of scale will usually lead to a less flexible business. Once demands rise, you will no longer have the option of putting things off until the right time. While in the past you may have been able to place a stock order upon reaching 10 clients, now you have to make that order every day, at the same time. Product transitions will also become costlier, but the costs will be covered by the higher scale.
Go big or go home – this is generally the mantra of every company. The bigger the scale, the easier it will be to cover the costs. Indeed, the scale may be overwhelming to organize at some point – but with the right staff and tactics, you will eventually reap the advantages of scale.