Economies of Scale

Definition

Economies of Scale: Reduction in average unit costs as output increases and the business size grows.

Concept: As a business's output grows, it purchases more raw materials or components from suppliers.
Negotiation: Increased purchasing allows businesses to negotiate better deals because they become more important to suppliers.
Example: ChocSesh Chocolate Company
- Starts as a small business buying 3 tons of cocoa
- Cocoa costs
- Average unit cost:
- As it grows, buys 9 tons of cocoa
- Total cost:
- Average unit cost:
- Achieves reduction in average unit cost
Efficiency: Leads to increased efficiency as less input is needed for the same output; reduces waste (cash).
Additional Benefits:
- More negotiating power for favorable delivery times and longer trade credit terms
- Results in higher cash flow due to delayed payments

Concept: As a business grows, it has more access to finances (debt or equity)
Investments: Allows purchase of higher quality or more quantity of capital (machines, robots, vehicles)
Productivity Increase:
- Improved capital leads to higher productivity
- Higher productivity means a higher ratio of output from the same input
- Reduction in average unit costs
Example: ChocSesh and Chocolate Moulding Machine
- Before machine: 3,000 chocolates molded in 10 hours
- After machine: 9,000 chocolates molded in 10 hours
- Costs per chocolate molded falls, leading to lower average unit costs
Association: Often linked with the transition from job production to flow production