what exactly are economies of scale? how do they come about, and what do they do exactly?
In: Economics
Economies of scale is the idea that the per unit cost of creating a good or service goes down when you create more of it at a time.
There’s a few ways that this happens. One is through simply distributing the same fixed costs over a larger number of units. For example, imagine you design a new type of phone case. Regardless of how many units of the case you sell, your design costs are gonna be about the same. So if you sell more cases, then the design costs get spread over a larger number of units, and each unit is cheaper that way.
Another way is to invest in upfront efficiency upgrades that only make sense with large-scale initial investments. For example, you could purchase a $1 million phone case manufacturing robot that reduces the per unit cost by 10 cents each. Therefore, if you sell 10 million phone cases, you break even on your upgrade (assuming you keep the price the same). If you sell 100 million phone cases, you can make a giant profit while also lowering the cost of your case by 8 cents, benefitting both you and your customers.
Finally, you can use your larger size to convince the entire industry to move to newer, more efficient standards. Maybe there’s a component of your phone case that’s being made by an older process, and if you get your component supplier to switch to a newer process then you can drive down unit costs industry-wide. However, the supplier doesn’t want to switch processes because it might break compatibility with most of their customers. If you simply expand large enough to become ‘most of their customers’ then you can convince them that it’s worth switching to the newer, more efficient process.
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