Economies of Scale

Economies of scale describe the fall in unit costs that occurs as the quantity produced or sold increases. One cause is the spreading of fixed costs across more units. Others are purchasing advantages from larger order volumes, better utilisation of plant, specialisation of staff and lower administrative costs per unit. In practice they do not continue indefinitely: above a certain size coordination effort, complexity and management overhead rise again, so unit costs increase once more. Economies of scale should be distinguished from fixed cost degression, which has its own entry in this glossary and describes only the first of these mechanisms, namely the arithmetic spreading of unchanged fixed costs.

Economies of scale additionally cover advantages that only arise with size and do not follow from a division alone. They should further be distinguished from economies of scope, which arise from sharing resources across several products. In a transaction context, economies of scale are the main argument for combinations between competitors and for buy-and-build strategies bringing several small businesses under one roof. The assumption only becomes credible once it can be stated which cost line changes by what amount and which measure is required, for example consolidating sites, bundling procurement or standardising systems.

Without that specificity, a reference to size advantages remains an assertion that regularly fails to survive diligence and is therefore only partly reflected in the price. An example makes the effect tangible: fixed costs of 4 million euros spread over 100,000 units come to 40 euros per unit. If volume rises to 160,000 units the figure falls to 25 euros, which at an unchanged price directly raises the margin. It should also be noted that scale advantages are often weaker in labour-intensive services than in manufacturing, because staffing grows more closely with volume.