Explain how the dimensions of Economies of Scale contribute towards reduction of unit cost for the company

Question: Most of the CEOs' cannot understand as to how the Economies of Scale (EoS) reduce the unit cost in mass scale operations. Take a company of your choice involved in mass scale production and explain how the dimensions of EoS contribute towards reduction of unit cost for the company. You may use appropriate examples to emphasize the facts.

Answer:

Economies of scale is a phenomenon which states that big business can outshine small economies based on cost cutting and savings. It is generally based on the idea that a big business operation is able to produce each unit of product at a comparatively lower cost unit due to financial economies, network economies, purchasing, division of labour and technical economies. In simple words, it can be said that big scale companies can produce a greater number of products with same cost as incurred by small scale companies. Lets us take an example of Amazon to discuss how big scale companies can outshine small scale companies. Amazon is able to deliver different products at comparatively lower price comparatively to small delivery companies. This is due to the following reasons:

• Financial economies: Large scale companies can take credit facility at comparatively lower rate of interest and thus able to save a large portion of cost that might be incurred had the rate of interest of such credit facility would be higher. This is because the banking institutions have greater faith on top MNCs rather than small domestic companies as large-scale companies has higher credit rating and secure payment system. In this way, financial economies help the large-scale companies to save a lot of costs that have been incurred by small-scale companies due to better arrangement with banking institutions.

• Network economies: Network economies work on the principle that companies will get benefits due to its networking among public i.e., people know about the company and its products. In this way, the company will receive more order and to fulfil the order, the company will have to expand the capacity of production. With the expansion of capacity, the fixed costs of company become stagnant and thereby company will be able to produce at comparatively lower price. In this way, network economies help the large-scale companies to save a lot of costs that have been incurred by small-scale companies due to aggressive marketing among public.

• Purchasing: The large-scale companies purchase raw materials or inputs from vendors in bulk quantity and thus get huge trade discount from the said vendor. This benefit is not available with the small-scale companies as they can purchase relatively lower quantity of raw materials and thus don't get any huge trade discounts. In this way, purchasing power economies help the large-scale companies to save a lot of costs that have been incurred by small-scale companies due to better arrangement with vendors.

• Division of labour: The large- scale companies allocate the employees to different divisions based on specialization and thus greatly benefit from the utilization of their skills and efficiency which is totally missing in the small-scale companies. In this way, network economies help the large-scale companies to save a lot of costs that have been incurred by small-scale companies due to better allocation of labour across the entity.

• Technical economies: The large-scale companies have access to new and modern technology through which manual intervention can be reduced to the maximum extent possible and thereby increasing the efficiency of business operations dramatically. In this way, network economies help the large-scale companies to save a lot of costs that have been incurred by small-scale companies due to greater access of new and modern technology.

In this way, it can be said that dimensions of economies of scale contribute towards reduction of unit cost for the company.

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