Economies of Scale

CONTENTS

What are economies of scale?
Economies of scale for software as a service
Why is it useful to calculate economies of scale?

What are economies of scale?

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Definition of economies of scale

Economies of scale are the cost savings that can be achieved when working with larger amounts of product. When product volumes are greater, the percentage of fixed costs per output is smaller, as they are spread out across more products.

Buying materials in bulk tends to result in a cheaper per-unit price, which, in turn, also helps maximize economies of scale.

Economies of scale for software as a service

It is still important to analyze economies of scale for SaaS, despite the lack of tangible product.

You can work out an average cost of service — i.e. the costs associated with each customer and each piece of work — and then analyze how scaling up customer numbers will impact on this average cost of service.

As with tangible product volumes, the fixed costs of a company will be spread out across a larger number of clients and services, usually resulting in a lower cost per service.

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Why is it useful to calculate economies of scale?

Accurately calculating economies of scale is important, as it can give you a firm idea of how, and when it is wise to scale up your organization.

This metric will also give you an idea of how far you need to go to see a cost-saving impact, and how far you can keep going before you stop saving money, or even start to have a detrimental effect.

These calculations are vital for any company to have before attempting to scale a business, and can, in truth, mark the difference between success and failure.

General FAQ

What do economies of scale, the ownership of essential raw materials, and patents have in common?

Economies of scale, the ownership of essential raw materials, and patents all help businesses to gain a monopoly. They are considered barriers to entry, preventing new, smaller brands from securing a foothold in an industry, due to the presence of larger, more powerful organizations. The term ‘economies of scale’ relates to the financial advantages companies can achieve based on their scale, with the cost of each unit dropping as scale increases. Ownership of essential raw materials means a company either controls or owns the whole supply of the material used to create a product or deliver a service, shutting competitors out. Finally, having a patent provides businesses with legal protection against competing firms from producing identical goods.

What is the difference between economies of scale and economies of scope?

With economies of scope, a business’s total production costs decrease as it produces an increasingly-varied range of items. Essentially, companies can create two products using the same resources more cost-effectively than implementing different processes with different materials. Economies of scale relate to the cost advantage companies can attain if they manufacture products on a large scale, with production costs decreasing over time.

How do economies of scale give rise to international trade?

Economies of scale allow manufacturers to mass-produce goods at competitive costs with industry-leading efficiency in one location so that companies and suppliers in other countries around the world depend on them for their own operations. China is a great example here. As a result, businesses can avoid the expense of paying for their own labor, resources, etc., and import goods at lower costs instead.

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