Economies of scale occur when a firm’s costs decrease due to large masses of production or improved manufacturing efficiencies. They can result from a variety of changes, such as a reduction in the cost of goods used, new capital infrastructure investments or improvements on a business-specific level. Macroeconomic variables are typically outside of a company’s control and can cause improvements in economies of scale or adversely diseconomies of scale. These types of variables are often managed through corporate hedging strategies to reduce the risk of higher costs.
External Economies of Scale
Nineteenth-century economist Alfred Marshall was the first to distinguish between internal variables for economies of scale, which are controlled by the firm, and external economies of scale, which impact the industry as a whole. Marshall argued that significant external variable developments can substantially impact economies of scale leading to extreme changes in cost structures and for the economy at large. The invention of the internet is one example, as it dynamically changed economies of scale cost structures for businesses through an external variable influence. The internet helps companies of all types by reducing the cost and time required to gather information, communicate with consumers and partners, and expedite operations.
Internal Economies of Scale
Internal economies of scale can arise from many different sources. Economic theory suggests economies of scale arise as firms begin to specialize in their operations. This is often a focus area for companies as they age and become more entrenched in an industry. This specialization can happen in the production process, the administrative process, or the distribution process. It may also be the result of organic growth initiatives rather than new market introductions. For one example, an original equipment manufacturer that builds a large plant in a relatively lower cost location can potentially benefit from better economies of scale by manufacturing more equipment in mass quantities at a lower price. Approval of patented technologies for manufacturing is also another internal variable that can dramatically improve economies of scale.
Internal Technology Improvements
Broadly, technical economies of scale improvements are often achieved by upgrading the capital equipment and production processes that a firm uses. When Henry Ford introduced the assembly line to his automobile manufacturing plant, he significantly improved his company's economy of scale. By the time other businesses began adopting his more efficient production process, the assembly line had moved from being an internal economy of scale to an external one.
Globalization is also a key variable in economies of scale. Globalization allows large businesses to realize greater economies of scale by giving them the opportunity to pursue cheaper resources around the world. It may be cheaper, for instance, to employ labor in a workforce-rich developing country than in the United States. These opportunities do not just extend to labor since any input resource obtained at a lower cost can help reduce production expenses, assuming the cost of finding, transporting, or incorporating does not wash out any gains. Theoretically, globalization allows the productivity of the world to be maximized for better economies of scale with more efficient cost structures and divisions of labor through utilization of the combined resources of the entire globe.