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Home→The Westburn Dictionary of Marketing→E→economies of scale

economies of scale

Definition:
This basically means the benefits of reduction of average costs resulting from larger scale production. Gains in output and/or costs may be achieved from increasing the size of plant, the size of firm or the size of industry. For example, costs per unit output are likely to decrease if lower prices of inputs are possible through bulk buying. Also technological methods which may be impractical at lower levels of production may become economically beneficial at higher levels. Equally, if by-products are produced in larger quantities and more continuously, they may become saleable commodities for a ready market. Economies of scale may be internal or external. Internal economies of scale result from the imperfect divisibility of the factors of production. They will influence the size and number of firms in the market, the ease of entry into a market and the potential as well as the actual competition in it. If the most economic scale of production is large, firms will tend to be relatively few and large capital requirements for starting up will be high, protecting existing competition and any new entrants to the market are likely to be established firms wishing to use their resources to diversify. Such economies of scale can lead to OLIGOPOLY or MONOPOLY and are typical of such industries as electricity generating, needing large generating units, or steel-making, when large blast furnaces and rolling mills are integrated. External economies of scale result from expansion of the industry as a whole. Economies of scale, or scale effects, were identified in the PROFIT IMPACT OF MARKETING STRATEGY study as a major factor giving rise to the association between market share and profitability. The relationship between increased size and lower cost is well illustrated in process industries in which capital costs increase by 6/10ths power of capacity. Thus a 90-million-ton oil refinery costs 90/45 x 0.6 = 1.5 times as much as a 45 million-ton-refinery, or, put another way, doubling unit size reduced unit cost by 25 per cent reinforced by lower depreciation costs. Similarly, large plants require less labour proportionately and can make more effective use of control systems etc. Nowadays, the greatest economies of scale probably accrue to RESEARCH AND DEVELOPMENT and MARKETING, for example. Further, in the short run (of which the long run is made up) marketing efficiency/dominance is the best way to ensure full capacity utilization and justify the larger initial capital investment.

Cross-References:
[oligopoly] [monopoly] [Profit Impact of Marketing Strategies (PIMS)] [marketing] [experience curve] [research and development (R&D)]

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© Westburn Publishers Ltd 2002, The Westburn Dictionary of Marketing edited by Michael J Baker, ISBN 978-0-946433-01-8. www.themarketingdictionary.com. Entry: [Michael J. Baker and Joanna Kinsey], [1998].