What are Economies of Scale?

Economies of scale


What Are Economies Of Scale?

The theory of economies of scale was proposed by Adam Smith. The theory posits that if economies of scale can be obtained, a country can attain economic growth.

Economies of scale are when a company enjoys a reduction in its average cost of production because of an increase in production or output. This simply means that an inverse relationship exists between cost and output. The higher the units of production, the lesser the average cost incurred in production. 

Economies of scale demonstrate the cost-cutting and competitive advantages that larger companies have over smaller organisations. The greater the company’s size, the greater the cost savings. This is because profits are re-invested in the manufacturing process by companies having a lot of revenue. They can also afford to acquire raw materials in bulk, saving money in the process. Some companies also put aside funding for R&D, which allows them to innovate and improve their product offerings.

Key Takeaways 

  • Economies of scale refer to the cost savings that organisations enjoy as a result of efficient production processes that enable them to produce more for less. It helps businesses become more price competitive and generate more revenue.
  • Internal economies of scale happen within the organisation and includes technical, marketing, managerial, financial, and network economies of scale. External economies of scale are when a company gains an advantage because of events and developments in its own industry or the larger external environment.
  • Diseconomies of scale occur when a corporation or business has reached its maximum point of efficiency. Instead of continuing to reduce costs while increasing output, a company will see an increase in costs as output rises.

There are two types of economies of scale. Internal and external. Internal economies of scale are within the control of an organisation’s management. While external economies are influenced by external factors such as government policies, geographical limitations and industry-related factors. 

Internal Economies of Scale

There are five types of internal economies of scale that typically exist as an organisations expands.


Technical economies of scale is the cost reductions that a company achieves as a result of increased usage of large-scale mechanical processes and technology.

It gives larger companies more advantages than smaller businesses because they have the capacity to improve and optimise the manufacturing process.

As output grows, they invest in more efficient equipment and optimise processes based on past performance. 


When you recruit professional managers or people with competence, you can obtain managerial economies of scale. As a company expands in size, it becomes possible to afford to acquire highly trained people. As a result, various functional units are created that are overseen by these experts, resulting in increased efficiency. In comparison to a small business owner who performs everything in the business without specialist skills, an experienced sales executive or manager recruited in a large organisation will be able to help an organisation generate greater revenues.


When a company can spread its advertising and marketing budget across a larger output, it achieves marketing economies of scale. The unit per cost of advertising and marketing is reduced since these costs are spread over output. Furthermore, larger companies can get better advertising deals and reach a wider audience than small enterprises, resulting in increased brand awareness and influence over brand perception.


In contrast to a small business, a large organisation has easy access to low-cost capital. This is due to the fact that large organisations are thought to be more creditworthy. They have assets that can be used as collateral to get a loan. To put it another way, they have better credit ratings than smaller businesses. It is believed that their risk of default is low because of the amount of money they generate in sales and revenue. Again, larger organisations can raise capital by launching an initial public offering (IPO) or issuing bonds on the stock market. They tend to have larger economies of scale since they have better access to more capital.


Online and eCommerce businesses are examples of businesses that have network economies of scale. This is because a digital business can increase its customer base with little or no additional cost incurred in infrastructure. As a result, businesses in this domain enjoy increasing profitability as they add new customers. 

External Economies of Scale

As previously stated, they are the benefits that an organisation receives as a result of events or variables that occur outside of its control. Industry developments, as well as national economic trends, could be among the contributors.  

External Economies of Scale

  • A rising GDP can lead to increased consumer demand, resulting in economies of scale.
  • When there is an overall growth in the industry that helps organisations gain access to suppliers at a cheaper rate. 
  • Lower cost of doing business instigated by reduced taxes or tax incentives.

Diseconomies of scale

Advantages accrue to an organisation when it expands or grows in size. However, too much growth gives rise to what is called diseconomies of scale.

For example, one of the problems of very large organisations is decreased efficiency. There will be too many people doing the same thing as a result of specialisation of jobs.

Not only that, bureaucracy becomes the order of the day when there are many levels of management. It’s possible that a lack of communication will occur, particularly if the organisation expands internationally. The acquisition of new businesses or mergers may lead to a conflict of corporate cultures. If such organisations don’t learn to deal with cultural differences or if not addressed in time, progress will be slowed. Other sources of diseconomies of scale include a lack of control, having numerous branches, and too many products. Rather than reduced average costs, inefficiencies will lead to increased production costs. At this point, it is said a company’s maximum point of efficiency has been reached. 

In conclusion, companies should aim for a balance between the effects of economies and diseconomies of scale whenever developing strategic plans to expand, so that the average cost of all decisions taken is lower, resulting in improved overall efficiency.


Recommended Resources:

Uncover your strengths and weaknesses with our complimentary assessment. Boost your effectiveness at work and with your team.

Free Resource Library: Access our extensive collection of valuable resources for instant support in your personal and professional growth.

Explore Our Course Library:

Enhance your leadership skills with our diverse selection of courses. Take your abilities to the next level and become a more effective leader and team player.


Our Clients Love the Professional Leadership Institute

Your team will, too! Check out some reviews from our students.
The PLI program was invaluable to our network.
The range of topics delivered, the open dialogue, experience, and examples that PLI brought to each session were outstanding and provided a path for our Franchisees and Managers to look at leadership, coaching, and connecting with their teams in a new light. Many have implemented these strategies in their bakeries and have seen immediate results.
Michelle C.
COBS Bread
Highly recommend to help your team move forward
We have locations around BC and Alberta, so getting people on the same page can be very difficult... Until now. Our entire management team and location managers take the same great courses and then meet monthly online with our coach to apply it to our situation. People are engaged, the courses are excellent, we love our coach, and we are all learning together!
Jason Fawcett
President, Kelson Group
The result has been a transformation of our culture. 
We decided to implement PLI's strategies across the country in over 150 locations and over 3500 employees.  The result has been a transformation of our culture.  People's lives have been positively impacted - professionally and personally.  Morale is high and sales and profits are up as a result.
Daryl Verbeek
Daryl Verbeek
We’ve learned how to fix ongoing personnel issues once and for all
The roadmap laid out set our business up to quintuple in sales.  We've learned how to fix ongoing personnel issues once and for all, attract top talent, and spend our time focused on results, not internal staffing problems.  I highly recommend PLI to you - it's worked for us!
John DeJong
Satisfied Client
I had no idea that running a business could be this fun!
In less than 18 months of working with Trevor, he has transformed my business from being average to exceptional, where mediocrity is not acceptable, where being great is standard.  Working with PLI has allowed me to realize my dream of not simply owning a job, but owning a business.
Justin Bontkes
Principal, Caliber Projects
Our culture has taken major steps forward this year
Our culture has taken major steps forward this year with Trevor’s help.  He is funny, relatable, and his tools are very very practical and have helped us focus and upgrade our teams throughout our retail network. Trevor recently spoke to an employee group, and one person remarked, “I could listen to Trevor all day.”   We would highly recommend Trevor.
Stan Pridham
Founder, KMS Tools
The results have been remarkable
At first, we resisted, “This just won’t work with a law firm.” But we persisted and the results have been remarkable: our client base and profits have steadily improved, and staff engagement and morale is the healthiest its ever been.
Doug Lester
Partner, RDM Lawyers
Helped our fast-growing business become what it is today
I've experienced PLI's approach first hand and it's been crucial to sustaining our growth.  I can't imagine a business that wouldn't benefit greatly from his help.
Brian Antenbring
Founder, TEEMA
Provided practical ways to make positive changes
Trevor was incredibly well-received by the entire organization. He was able to articulate people issues that many of our franchisees were experiencing and provided them with practical ways to make positive changes. We have implemented the Star Chart tool across the organization and see it as vital to building happy, effective teams.
Aaron Gillespie
President, COBS Bread
Scroll to Top

Start Learning Today

For Individuals

Unlock your potential and accelerate your career with sought-after management and leadership skills.


Transform Your Organization

For Teams

Book a consultation to discuss your challenges and discover how we can help you build a winning team.


Sign Up For Weekly Tips!

Get Weekly Coaching Tips Straight To Your Inbox Every Monday.