Economies of scale are factors that lead to a reduction in average costs that are obtained by growth of a business. There are five economies of scale:
- Purchasing economies: When businesses buy in bulk, they reduce the unit cost of each item, because when a business buys in bulk it is able to gain discounts. This gives the firm advantage over smaller businesses which buy in small quantities.
- Marketing economies: More money for advertising and own transportation, cutting costs.
- Financial economies: Large businesses are often able to raise capital more cheaply than smaller ones. Bank mangers often consider that lending to large organisations is less risky than lending to small ones. A lower rate of interest is therefore often charged.
- Technical economies: They can now buy specialised and latest equipment to cut overall production costs.
- Managerial economies: Larger businesses can now afford specialist managers in all departments, increasing efficiency.
However, there are diseconomies of scale which increases average costs when a business grows:
- Poor communication: It is more difficult to communicate in larger firms since there are so many people a message has to pass through. The managers might loose contact to customers and make wrong decisions.
- Low morale: People who work in large businesses with thousands of workers do not get much attention. They feel they are not needed so this decreases morale and in turn efficiency.
- Slower decision making: More people have to agree with a decision and communication difficulties also make decision-making slower as well.
