Economies of scale refer to economic efficiencies that result from carrying out a process on a larger scale. Scale effects are possible because in most production operations fixed and variable costs are involved; the fixed costs are not related to production volume; variable costs are. Large production runs therefore “absorb” more of the fixed costs. An example is a printing run.
Setting up the run requires burning a plate after a photographic process, mounting the plate on the printing press, adjusting ink flow, and running five or six pages to make sure everything is correctly set-up. The cost of setting up will be the same whether the printer produces one copy or 10,000. If the set-up cost is $55 and the printer produces 500 copies, each copy will carry 11 cents worth of set up cost. But if 10,000 pages are printed, each page carries only 0.55 cents of set-up cost. The reduction in cost per unit is an economy due to scale. Very much the same thing happens when an author writes a book and gets it published. Writing the book is the fixed cost. If the publisher pays the author a $10,000 advance and then only sells 25 copies, each book cost the publisher $400 in fixed cost alone—and the publisher will lose a lot of money. If the book sells 5,000 copies, each carries $2 dollars in fixed cost. An effective supervisor can supervise 10 to 12 people as effectively as three; after that the supervisor’s “span of control” will be affected. This example shows that economies of scale have limits. A forging press cannot be operated longer than 24 hours a day. A moderately sized accounting department cannot handle a growing volume of transactions indefinitely: it will have to add employees eventually.
Economies of scale are closely tied to systems of production where something standardized is replicated many times—or to fixed facilities that may be utilized for a few hours only or for 24 hours a day. Limitations are thus imposed by equipment capacity, time, and the nature of the product or service. Heart by-pass operations, although many thousands are performed every day, are always unique. A heart surgeon’s personal action is involved and cannot be mechanically multiplied. Economies of scale are thus not available in heart surgery. Neither are they available in barber shops. In general, therefore, businesses or activities that provide unique services delivered in person are less able to generate economies of scale. People who ultimately sell their time—rather than something that they have made (which can be multiplied)—tend therefore to charge more for their time; the higher the skill level, the more they charge.
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Small Business And Scale
It is frequently repeated that small businesses have less opportunity to apply economies of scale for the simple reason that they are small and unlikely to be engaged in mass production. The generalization is true enough if economies of scale are viewed narrowly. In effect economies of scale are also available to small businesses—and increasingly so as a consequence of modern developments in the services sectors and in electronics.
Buying Services Many small businesses achieve economies of scale by purchasing their payroll services from a large payroll company; they receive sophisticated services, including annual tax notifications, at a much lower cost than they could achieve by paying a payroll accountant in-house. Accounting services are purchased similarly, often in combination with using a modern software program for keying data in at the company’s location and having a professional accountant check and use the software for tax preparation purposes. The small business using the professional accountant only uses a small portion of his or her time—and pays only a small percentage of the accountant’s fixed costs. Small business are adept at using services rather than doing the job in-house. Any organization servicing a large number of small businesses (like a payroll service) is, from the small business perspective, an “economy of scale.”
Sharing Risks In many locations across the country chambers of commerce or other organizations offer health insurance services to small businesses. In these instances, the chamber becomes the effective “large scale” purchaser of insurance on behalf of its members. It thus creates a large pool of people much more attractive to the insurance carrier; the latter enjoys the scale effect by dealing with a single purchaser; the small business enjoys an attractively low premium unavailable except by this participation—an extension of the concept of economies of scale.
Scaling Through Technology Developments in computers and the spread of the Internet have created economies of scale at low cost to the small business which the small business is able to exploit. In the mid-2000s a small business with a handful of employees, a few computers, and an Internet connection can deliver services that, in the 1950s, would have required 200-some-odd employees. Aspects of this subject are covered under a variety of different contexts throughout this volume. The Internet has enabled small operations to be much more productive in purchasing, marketing, hiring, data collection, accounting, selling for credit, desktop publishing, and in other areas.
Providing an Economy of Scale Overlooked in the general discussion of economies of scale, narrowly construed, is the fact that small businesses are themselves providers of economies of scale. By their very nature they are physically closer to the consumer and therefore efficient outlets for the consumer who wishes to save time. Large retail discount houses attract by low pricing—but they are usually at a substantial distance. Small businesses are nimble, flexible, and creative precisely because they are small and, being small, they are not subject to the massive systems-responses of the giants whose recorded voices assure us that “Your call is important to us.” Our call is important but sometimes never answered by a living voice.