Types of Internal Economies of Scale with Industry Examples
Explanation of Economies of Scale
Economies of Scale are when a company grows bigger and better, the company will experience decreases in costs along with increases in output. As a result, the cost per unit of an individual item decreases when increasing the scale of production.
Explanation of Internal Economies of Scale
Internal economies of scale are unique within the company. It is purely based on the outcomes and the unique capabilities of the company. Those are typically the unit cost advantages for the company when expanding its scale of production.
Types of Internal Economies of Scale
Following are the different types of Internal Economies of Scale.
- Technical Economies of Scale
- Managerial Economies of Scale
- Marketing Economies of Scale
- Financial Economies of Scale
- Commercial Economies of Scale
- Network Economies of Scale
- Risk Bearing Economies of Scale
- Labor Economies of Scale
1. Technical Economies of Scale
Companies achieve technical economies of scale by lowering the unit cost using the improvements in their production process. These economies can be achieved by using efficient equipment, improving quality control, using improved processes, etc.
Companies can invest in these efficiency optimization methods based on their experience due to specialization. When a company scales its operation, it is much easier to improve the link of various different processes efficiently.
Industry Example for Technical Economies of Scale
Toyota invested heavily in their lean production system (Toyota Production System). This resulted in quality improvements, waste reductions, customer satisfaction improvements, which result in technical economies of scale by reducing the unit cost of production.
More information about Toyota Production System
2. Managerial Economies of Scale
Managerial economies of scale happen based on the improvements of the management team of the company. The company will have a greater opportunity to attract more expert talent when the company is scaling up. When the company is growing, the current management will gain experience more and more. The performance of management increases because of greater knowledge in managerial staff with their experience gained.
Industry Example for Managerial Economies of Scale
IT solutions development company has grown much in the reason past. Now they can headhunt industry experts because of their reputation, stability, and salary range to scale the company more and more.
3. Marketing Economies of Scale
When the company’s scale of production increases, the spread of the fixed marketing expenses will be distributed among a large number of units, which results in lower per-unit costs. Larger established companies have a strong brand reputation which increases their chance of having the same level of advertising impact at a lower cost than the small companies. Also, large companies are benefited from better-experienced sales staff resulting in increased sales volume.
Industry Example for Marketing Economies of Scale
Global and well-reputed FMCG Company wants to promote its new soap product. They can easily promote their new product using the brand reputation, which results in lower unit cost proportionate to advertising expenses. Comparatively, there is a higher unit cost proportionate to advertising expenses for small-scale companies.
4. Financial Economies of Scale
Larger and established companies are considered more creditworthy than relatively smaller companies. Bank provides loans to the corporate for an agreed interest rate. This interest rate can be vary based on the risk of the borrower that the bank foresee. Banks usually consider larger established companies as low risk, which results in obtaining debt (loans) with a much lower interest rate.
Also, larger companies have different ways to gain capital, rather than not depending on debt/bank loans. Listed companies can also raise capital from the stock market by issuing bonds.
How do Banks Profit from Loan Interest?
Industry Example for Financial Economies of Scale
A larger and well-reputed global apparel product manufacturing company in the united states wants to add another manufacturing plant in the Asian region. They wanted to obtain a loan for the capital investment of this project, which they planned to repay using the profits made by this new plant. They can demand a lower interest rate from the Banks in the United States. Banks see this large well-reputed firm as low risk (creditworthy), which they don’t reluctant to offer lower interest rates to keep their customer satisfied.
5. Commercial Economies of Scale
Larger companies usually buy larger quantities of raw materials from their suppliers. They will usually have the demand power over the suppliers due to the larger quantities of purchase. This will result in demanding discounts on the purchases having a lower cost of raw materials comparatively. Larger companies have the chance of reducing the sales price of the product because the per-unit cost of the product is reduced.
Commercial economies of scale also known as purchasing economies of scale.
Industry Example for Commercial Economies of Scale
A larger and well-reputed construction company frequently buys raw materials such as cement, bricks, sand, and metal from suppliers. This company has a centralized purchasing unit which results in bulk purchasing from the direct suppliers. They can bargain and negotiate higher discounts from the suppliers due to the larger quantity of frequent purchases. This results in a lower total cost of the construction projects with a higher profit margin.
6. Network Economies of Scale
Network economies of scale are achieved by large companies when the marginal cost of adding a new customer is comparatively lower than a smaller company. Larger companies usually have a higher active customer base. Onboarding a new customer will not usually increase the variable cost much because the ecosystem and infrastructure capabilities are strong. Larger companies have the advantage of increasing the profit margin furthermore by onboarding new customers at a lower marginal cost.
Industry Example for Network Economies of Scale
A larger eCommerce store has 1 million active monthly visitors to its website. Increase of another ten thousand (10,000) monthly visits is not a big hazel for this company since they have the infrastructure to support this. This is only increasing another 1% of monthly traffic.
Let’s say there is a smaller eCommerce store that has ten thousand (10,000) active monthly visitors to its website. An increase of another ten thousand (10,000) monthly visits will be a challenge for this company since it is double their monthly visitor base. Probably they have to upgrade their infrastructure to support this.
7. Risk Bearing Economies of Scale
Larger companies have different products spanning across different customer segments. Usually, they sell their products in different geographic locations as well. If there is a reduction in demand for one product, the total impact for the company will be less due to the differentiation of the product portfolio.
On other hand, smaller companies have few products. If there is a reduction in demand for one product, the total impact for the company will be higher compared to the larger companies.
Larger companies spread their risk by producing different products/services as a contingency plan if one/few products are failed. This will reduce the overall risk of the company and its investors.
Industry Example for Risk Bearing Economies of Scale
Unilever is a British multinational consumer goods company. Unilever produces various quality products in food, home care, beauty & personal care segments. If case demand in one product decreases, it will not impact the overall company because the product differentiation is higher.
On the other hand, Smaller companies have a higher risk because the lower number of different products are there.
8. Labor Economies of Scale
Large companies usually have a bigger number of employees. People tend to work in globally established, well-reputed large companies more. These large companies have the distinct advantage of attracting skillful talent to their company. Also, the employees have the chance to be employed in the job where they are most suited.
Industry Example for Labor Economies of Scale
Fortune 500 companies have the comparative advantage of attracting and retaining skillful talent in the United States due to their brand reputation. Smaller companies do not have this comparative advantage.
Recommended Articles:
1. Meaning of Economies of Scale?
2. Diagram illustrates Economies of Scale
3. Advantages and Disadvantages of Economies of Scale
4. Internal Economies of Scale vs External Economies of Scale
5. Diseconomies of Scale with Examples
