Business - 1.5 Growth: Internal Economies & Diseconomies of Scale

Internal Economies of Scale: Types

• Purchasing = buying in bulk, gain discounts

• Technical = better technology, improve efficiency

• Financial = larger firm can get larger loan rates

• Marketing = selling in bulk, reducing time and transaction costs, spread costs over sales (same advertising or campaigns)

• Managerial = specialization leads to higher productivity, avoid duplication of effort

Risk-bearing = spread fixed costs across a range of operations

Purchasing Economies: Definition

Purchasing economies of scale occur when a business reduces its cost per unit by buying inputs (raw materials, components, or supplies) in bulk. Suppliers often offer discounts for large orders, allowing businesses to lower their average costs.

• When a business can achieve lower average costs per unit by purchasing in bulk (larger quantities of goods or materials)

Ex:

🔹 Walmart – Purchases massive quantities of goods from suppliers at discounted rates, allowing it to offer low prices.
🔹 Car Manufacturers (e.g., Toyota, Ford) – Buy raw materials like steel and tires in bulk to reduce production costs.
🔹 Fast Food Chains (e.g., McDonald’s) – Purchase large quantities of ingredients like potatoes for fries, reducing per-unit costs.

Purchasing Economies: Benefits

✅ Lower Costs per Unit – Bulk purchasing leads to supplier discounts, reducing the overall cost per item.
✅ Increased Profit Margins – Lower input costs can lead to higher profits if selling prices remain stable.
✅ Stronger Supplier Relationships – Large orders can improve a company’s bargaining power and lead to better contract terms.
✅ Competitive Advantage – Lower costs allow firms to price products more competitively or invest in other areas like R&D.

Purchasing Economies: Drawbacks

❌ High Initial Investment – Large orders require significant capital, which might strain cash flow.
❌ Storage Costs – Businesses need sufficient warehouse space, leading to higher inventory costs.
❌ Risk of Obsolescence – Excess stock may become outdated or obsolete, leading to potential losses.
❌ Supplier Dependence – Relying on a few key suppliers for bulk orders can be risky if they raise prices or fail to deliver.

Technical Economies: Definition

Firms achieve technical economies of scale by using more efficient production techniques, machinery, and automation to lower average costs.

• Invest in machinery to lower average costs per unit of output

• Making things cheaper and faster—reduce labor costs and improve efficiency

Ex:

🔹 Car manufacturers (Tesla, Ford) – Use robotic assembly lines to reduce labor costs and increase production speed.
🔹 Amazon warehouses – Use AI-powered sorting and robotic automation to improve order fulfillment.
🔹 Airlines – Use fuel-efficient aircraft.
🔹 Supermarkets – Use automated stock management and self-checkout, reducing labor costs and improving efficiency

Technical Economies: Benefits

✅ Increased Efficiency – Advanced machinery and automated systems improve productivity.
✅ Lower Costs per Unit – Higher output spreads fixed costs (e.g., factory setup costs) over more units.
✅ Better Product Quality – Modern technology ensures precision and consistency.

Technical Economies: Drawbacks

❌ High Initial Costs – Investing in advanced machinery is expensive.
❌ Risk of Redundancy – Workers may be replaced by machines, leading to potential layoffs.
❌ Inflexibility – Expensive machinery is hard to adapt if market demand changes.

Financial Economies of Scale: Definition

Larger firms can access better financing options, such as lower interest rates on loans, because banks see them as lower risk.

• Large companies can borrow at lower interest rates compared to smaller ones

Ex:

🔹 Apple & Microsoft – Raise billions in capital through stock markets rather than relying on bank loans.
🔹 Walmart – Negotiates low-interest loans for store expansions.

Financial Economies of Scale: Benefits

✅ Lower Interest Rates – Banks offer cheaper loans to large, stable businesses.
✅ Easier Access to Capital – Large firms can raise funds through stock markets.
✅ Better Credit Terms – Suppliers may offer longer payment periods to trusted big firms.

Financial Economies of Scale: Drawbacks

❌ Overborrowing Risk – Large firms may take excessive loans, leading to financial strain.
❌ Debt Obligations – Interest payments can become a burden if profits fall.
❌ Limited Access for Small Firms – Smaller businesses may struggle to compete due to higher borrowing costs.

Marketing Economies of Scale: Definitions

Large firms spread marketing and advertising costs over a larger output, reducing the cost per unit.

• selling in bulk, reducing time and transaction costs, spreading costs over sales (same advertising or campaigns)

Ex:

🔹 Coca-Cola & Pepsi – Spend billions on global advertising, benefiting from mass exposure.
🔹 Nike – Sponsors multiple athletes and teams to reinforce brand visibility worldwide.

Marketing Economies of Scale: Benefits

✅ Lower Cost per Advertisement – The cost of a TV ad remains the same whether it reaches 1,000 or 1 million people.
✅ Stronger Brand Recognition – Large firms can invest heavily in branding, increasing consumer trust.
✅ Bulk Discounts for Advertising – Firms get discounts for large-scale ad campaigns.

Marketing Economies of Scale: Drawbacks

❌ High Upfront Costs – Large-scale advertising (e.g., Super Bowl ads) is expensive.
❌ Diminishing Returns – Spending too much on marketing may not always lead to higher sales.
❌ Risk of Brand Dilution – If marketing messages are inconsistent, it may confuse consumers.

Managerial Economies of Scale: Definitions

As businesses grow, they can hire specialized managers for different departments, leading to improved efficiency and decision-making.

• specialization leads to higher productivity, divide managerial roles by employing specialist managers

• (avoid duplication of effort in planning, communication, marketing, distribution and production processes)

Ex:

🔹 Google & Amazon – Employ specialists in AI, logistics, and marketing to optimize operations.
🔹 Banks & Multinational Corporations – Have CFOs, CMOs, and HR directors to manage specific business functions.

Managerial Economies of Scale: Benefits

✅ Expert Decision-Making – Specialized managers increase efficiency and productivity.
✅ Increased Innovation – R&D teams in large firms focus on developing new products.
✅ Better Coordination – Delegation of responsibilities prevents overburdening top executives.

Managerial Economies of Scale: Drawbacks

❌ Higher Salaries – Skilled managers demand high wages.
❌ Bureaucracy Issues – Too many managers can slow down decision-making.
❌ Lack of Personal Touch – Employees may feel disconnected in a large, hierarchical organization.

Risk-Bearing Economies of Scale: Definition

Large firms can spread risk by operating in multiple markets, launching different product lines, or diversifying their investments.

• spread fixed costs across a range of operations

• conglomerates (firms with diverse portfolios of products in different markets)

• loss in one area doesn’t jeopardise the business overall

Ex:

🔹 Amazon – Operates in e-commerce, cloud computing (AWS), and entertainment (Prime Video).
🔹 Samsung – Produces smartphones, home appliances, and semiconductor chips, reducing reliance on a single market.

Risk-Bearing Economies of Scale: Benefits

✅ Reduced Business Risk – If one product or market underperforms, other areas can compensate.
✅ More Financial Stability – Diversification reduces the impact of economic downturns.
✅ Increased Investor Confidence – Shareholders feel safer investing in diversified companies.

Risk-Bearing Economies of Scale: Drawbacks

❌ High Management Complexity – Managing multiple products or markets requires more resources.
❌ Risk of Overexpansion – Expanding too much can lead to inefficiencies and losses.
❌ Loss of Focus – A company may struggle to maintain quality across multiple business areas.

Internal Diseconomies of Scale: Definition

• when a firm's growth leads to increased unit costs due to inefficiencies within the company, such as poor management, communication breakdowns, or organizational problems, rather than external factors

• Increase output = price falls UNTIL the equilibrium, then the inverse happens

Internal Diseconomies of Scale: Problems

• Lack control and coordination due to increase in span of control → communication problems, slow down decision-making

• Worker alienation & poorer working relationships in large organizations → harm staff moral & reduce productivity

  • senior managers are likely to become detached from those lower down in the hierarchy, making them feel distanced or out of touch

• Disadvantages of specialization and division of labor: workers become bored with performing repetitive tasks → workers slack (inefficiency and procrastination)

• Bureaucracy (administration, paperwork and company policies) is likely to increase as a business grows → increased time for decision-making and difficult communication

• Complacency: large and dominant player can reduce productivity

(Franchising can be a strategy to expand their business and raise awareness without having to face higher unit costs of being large)