Economies of scale are ways in which costs associated with producing a product decline with increasing volumes. It is one of the most fundamental components of cost leadership, with many low-cost goods produced in large volumes. This article explores examples of some of the primary cost savings that come from increased volumes.
Better bargaining power
One of the key sources of economies of scale is that can result in better bargaining power, and in turn, improved prices from purchasing inputs in large volumes. There may for example be volume discounts in the raw materials, savings on delivery, or other cost savings relative to small or one-off purchases.
Fixed costs spread over a larger number of products
There are likely fixed costs in operating, inured irrespective of the number of products produced. These may include the rent on a facility, the cost of machinery, or the cost of developing the product. When you manufacture a larger volume of products, these costs are spread over a much larger number of products, in turn pulling the fixed cost allocated to each product lower.
Labor costs per unit may decline
Beyond costs that are entirely fixed, there are certain variable costs that may decline the greater volume that you produce. Greater volumes may allow more efficient routines to be implemented, potentially reducing the labor component of each product produced.
Reduced change-over times
Large production runs also reduce costs associated with changing over the production process. The proportion of time associated with changing over equipment declines with larger production quantities.
Lower likelihood of mistakes
A final way that increased scale may reduced costs is by reducing the costs associated with mistakes and other defects. Small scale operations are prone to mistakes associated with making a product on a one-off basis. The greater the volume that is produced, the lower the better established the production procedures or training of employees to carry out the specific tasks, and in turn the lower likelihood, the reduced cost per product associated with mistakes and defects.