Strategies for Efficiency in Business Operations: Economies of Scale

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Table of Contents

Introduction
Diversification
Bulk purchasing
Mergers
Easier Access to Capital
Technological Innovation
Managerial Efficiency
Conclusion
Reference List

Introduction

Every business established for profit generation pays keen attention to the efficiency of their production process to develop a balance between costs of production and revenue generated. Lipsey (2018) defines economies of scale as firm’s savings or cost advantages due to efficient production and marketing processes. While some costs are fixed in the short –run, analyzing the corporations’ finances, in the long run, offers an accurate picture of the economies of scale since all costs are assumed to vary in the long run (Lipsey, 2018). Diversification, bulk purchasing, mergers, easier access to capital, technological innovation, and managerial efficiency are some of the ways through which large companies enjoy economies of scale in the long run.

Diversification

Economic resilience is one of the critical concepts worth understanding in economies of scale. Business risks play an essential role in determining the profitability of any given company. According to De Roest, Ferrari and Knickel (2018), diversification enables a company to spread the business risks over a wider range, reducing the overall risk associated with any given line of operations. This concept is closely linked to economic sustainability, which results from reduced vulnerability due to economies of scope.

Large firms are sometimes challenged to choose specialization or economies of scale to minimize production costs. Mydland et al. (2020) assert that although specialization may reduce production costs, it leads to a firm’s dependence on one line of operation, increasing costs in the long run. As companies grow, their abilities to produce different products concurrently increase. Jayne, Chamberlin and Benfica (2018) argue that diversification is a potential solution to the economic challenges facing Africa, implying that if large companies in Africa diversify their operations, considerable economies of scale can be realized. Essentially, large corporations can gain economies of scale if they venture into additional production processes to spread the risks and develop economic resilience.

Bulk purchasing

Raw materials form a significant portion of a firm’s calling for efficient resource acquisition methods to minimize production costs while maximizing output. Research by Dillon, De Weerdt and O’Donoghue (2020) on purchasing behaviour reveals that if individuals and companies buy in bulk, they may benefit from up to 8.7% discounts without altering their purchasing quantities. Large firms are financially capable of purchasing on a large scale to enjoy economies of scale resulting from low input costs. Bigger firms have more bargaining power due to bulk buying, significantly reducing operating costs and enjoying economies of scale (Kim, 2019). In addition, large-volume purchasing is associated with better delivery rates and inventory management enabling long-run economies of scale.

Mergers

Mergers entail firms coming together to benefit from large-scale operations and reduce the costs associated with individual production lines. As large companies join, whether in research or production, they generate preferential treatment and benefit from external economies of scale (Lipsey, 2018). For instance, governments develop incentives such as tax deductions to companies offering more employment opportunities, significantly reducing their operating costs. Quwe (2021) mentions that large firms in South Africa have embraced mergers and acquisitions as one of the key techniques to enhance financial performance. In the beginning, a merger may experience challenges with management, but in the long run, it gains economies of scale attributed to large-scale production and improvement.

Easier Access to Capital

Capital is undoubtedly a vital factor of production necessary for business operation and growth. As companies increase in size, they gain financial economies of scale. Higher credit ratings mean that large companies can easily access loans at more affordable rates than smaller companies. In the long run, the market power increases companies’ creditworthiness, providing them with easier means of accessing financial resources (Born, Hughen and Sirmans, 2020). Initial public offerings (IPOs) are additional ways companies generate financial resources from the stock market.

Notably, companies are only listed on the stock exchange once they have attained a minimum level of performance, implying that only large companies enjoy these financial economies of scale. The low-interest rates charged in bonds issued to large companies are attributed to the fact that they have more resources and corporate assets that can be used as collateral. Essentially, these economies of scale mean that over the long-run large firms are in a better position to borrow more money than smaller companies. These loans are used for further investments leading to more economies of scale.

Technological Innovation

The choice of a technological solution significantly impacts the production process, determining the extent to which corporations enjoy technical economies of scale. Larger firms take advantage of advanced production equipment and techniques to make their manufacturing faster and more efficient. Demir and Dincer (2020) argue that large firms have tapped into data mining for efficient market analysis to gain more profitable niches. Logistics companies use large tankers for transport, reducing costs and enjoying more profit, thereby increasing their economies of scale. Learning is linked to better performance and economies of scale. The learning curve mentioned by Lipsey (2018) indicates that larger companies learn by actual implementation, which keeps them ahead of smaller companies. The knowledge gained over the years enables corporations to adapt their production techniques and incorporate new methods that further increase their economies of scale.

Managerial Efficiency

Internal economies of scale largely depend on the quality of internal staff and external stakeholders involved in the production, marketing, auditing, and performance valuation. According to Gilinsky, Newton and Eyler (2018), large firms are capable of hiring specialists in all their departments, significantly improving their performance. The more skilled a company’s staff members are, the better they manage inventory, produce high-quality goods, market products, and drive the firm’s mission and vision. In addition to employee skills, large firms can employ many workers, and reduce the workload on each employee, thereby enhancing their performance. In the long run, firms can enjoy economies of scale since the benefits resulting from improved performance outweigh the managerial costs incurred.

Conclusion

In conclusion, economies of scale are the cost benefits corporations enjoy as a result of large-scale production. In the short run, companies incur significant costs, including resource acquisition, production, transport, and marketing. As firms increase in size, they benefit from minimal costs per unit. Diversification enables companies to spread their risks over a wide range of operations, minimizing the overall costs of individual product lines. As corporations purchase inputs in bulk, they enjoy significant discounts and use the savings to expand their operations and gain financial economies of scale. Mergers increase firms’ market power placing them in a better position for external economies of scale, including tax deductions. Technical and managerial economies of scale are linked to the firm’s internal operations enabling it to produce high-quality goods, cut transport and manufacturing costs, and acquire highly skilled professionals for efficient production.

Reference List

Born, P.H., Hughen, L. and Sirmans, E.T. (2020). ‘The impact of market power and economies of scale on large group health insurer profitability’, Journal of Insurance Issues, 43(2), pp.43-63.

De Roest, K., Ferrari, P. and Knickel, K. (2018). ‘Specialisation and economies of scale or diversification and economies of scope? Assessing different agricultural development pathways’, Journal of Rural Studies, 59, pp.222-231.

Demir, E. and Dincer, S.E. (2020). ‘Place and solution proposals of data mining in production planning and control processes: A business application’, PressAcademia Procedia, 11(1), pp.189-193.

Dillon, B., De Weerdt, J. and O’Donoghue, T. (2020). ‘Paying more for less: Why don’t households in Tanzania take advantage of bulk discounts?’, The World Bank Economic Review, 35(1), pp.148-179.

Gilinsky, A., Newton, S. and Eyler, R. (2018). ‘Are strategic orientations and managerial characteristics drivers of performance in the US wine industry?’, International Journal of Wine Business Research, 30(1), pp.42-57.

Jayne, T., Chamberlin, J. and Benfica, R. (2018). ‘Africa’s unfolding economic transformation’, The Journal of Development Studies, 54(5), pp.777-787.

Kim, J.J. (2019). ‘The empirical study on purchasing behavior between Costco wholesale members and non-members’, Journal of Distribution Science, 17(9), pp.25-33.

Lipsey, R.G. (2018). A Reconsideration of the theory of non-linear scale effects: The sources of varying returns to, and economies of, scale. Cambridge University Press.

Mydland, Ø., Kumbhakar, S., Lien, G., Amundsveen, R. and Kvile, H. (2020). ‘Economies of scope and scale in the Norwegian electricity industry’, Economic Modelling, 88, pp.39-46.

Quwe, B. (2021). ‘Mergers and acquisitions performance within South African chemical industry: Pursuit of improved financial performance and economies of scale’, International Journal of Business and Management Sciences, 2(2), 33-46.

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