Understanding the Dynamics of Economy of Scale in Business
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Chapter 1: Introduction to Economy of Scale
While browsing through various videos on YouTube, I stumbled upon a fascinating term: "Economy of Scale."
At first, we might think of breaking it down into its components: "Economy" and "Scale." But how do these two concepts merge to create a vital strategy employed by many businesses today?
Simple Illustration of Economy of Scale
Consider the difference between taking a solo trip and traveling with a group of friends. For those who have planned solo excursions, you may realize that going alone often incurs higher costs. This occurs because expenses like accommodation and transport fall entirely on you, rather than being shared with others.
A similar situation arises with Netflix subscriptions; family plans tend to be more economical compared to individual plans when the costs are averaged out.
How It Operates
To understand this concept better, let’s break it down further. The economy of scale hinges on two primary elements: Internal Economy and External Economy.
Why does Netflix offer lower rates for family plans?
Internal Economy
Internal economies arise from factors within the company itself, such as operational costs, marketing expenses, and distribution overheads. For example, a family plan with five members on a single account often leads to reduced administrative costs, as billing and technical issues can be managed collectively.
Moreover, having multiple members on one account increases the likelihood that they will continue their subscriptions, benefiting the company.
External Economy
Conversely, external economies are influenced by broader market or industry conditions, including wage changes, competition, and fluctuations in supply or demand. For instance, Netflix may adjust its prices based on rising demand for its services or lower them in response to competitive promotions from rivals like Disney+.
The Mechanisms Behind the Economy of Scale
While the concept appears simple, several factors contribute to its effectiveness. Modern businesses benefit from advancements such as the internet, technology, and leveraging financial resources.
For example, automation technology enables round-the-clock production, significantly lowering operational costs and increasing efficiency. With higher output and reduced expenses, businesses can achieve economies of scale.
The internet further enhances this by allowing companies to reach a wider audience at a lower cost, eliminating the need for traditional marketing methods like door-to-door sales or flyer distribution. This shift saves time and resources, making economies of scale more attainable than ever.
Leverage, through loans, allows businesses to take calculated risks with lower capital costs.
Diseconomy of Scale
Now, let’s discuss the opposite concept: Diseconomy of Scale.
At first glance, this idea might seem perplexing. While economies of scale maximize profits and minimize costs, excessive expansion can lead to increased expenses even if production levels rise.
Imagine a noodle shop that has managed to keep prices stable for a decade due to a steady stream of customers. The owner has been able to reduce ingredient costs by purchasing in bulk.
However, one day, you notice two changes: the price of your noodles has risen, and a large machine has been installed to assist with ingredient sorting. Although the new machine helps serve more customers, the added operational costs from this purchase have driven up prices.
Contemporary Relevance
In summary, whether we encounter a favorable economy of scale with our Netflix subscriptions or experience diseconomy of scale at our favorite noodle shop, both scenarios illustrate the principles at play in the economy.
Davidson, an undergraduate at the National University of Singapore majoring in Business Analytics, expresses a keen interest in Finance and Technology. The views presented in this article reflect his opinions and may not be entirely accurate.
The first video title is Economies of Scale in One Minute: Definition/Theory, Explanation and Examples - YouTube. This video offers a concise overview of the definition and implications of economies of scale, making complex concepts accessible.
The second video titled The Economy Of Scale Explained - YouTube delves deeper into the mechanisms behind economies of scale, providing valuable insights for both businesses and consumers.