Economies of scale refers to the cost reduction due to the increase in production volume. A firm experiences economies of scale when it increases the volume of output without increasing the fixed costs. It decreases the cost of production and increase the profit margin.
Advantages Of Economies Of Scale
The main advantages of economies of scale can be pointed out as follows:
1. Reduced Cost Of Production
Economies of scale helps the business to lower the cost of production because of large volume of output. Firms produce more items without increasing the fixed costs that lead to decrease in the per unit cost.
2. Increased Profit Margin
Another advantage of economies of scale is that it increases the profit of the firm. Because of reduced per unit cost of production, companies can generate more profit.
3. Lower Selling Price
Because of reduced cost of production company can lower the selling price of its products or services that helps to attract more buyers. It helps the company ti expand market share. It also increases the brand image and goodwill of the firm.
4. Entry Barrier
Economies of scale may create entry barrier for new entrants. New firms may hesitate to compete with well-established company in the market.
5. More Return On Investment
As we know that economies of scale increases the earnings of the firm, it means company can pay higher return to its investors.
6. Benefit Of Bulk Buying
A firm buys large quantity of raw materials and other items to produce large volume of products. So, a firm can get cash discount or quantity discount from the supplier.
Disadvantages Of Economies Of Scale
The main disadvantages of economies of scale can be highlighted as follows:
1. Huge Capital Required
It requires huge initial investment to achieve economies of scale. It requires modern production technology, huge infrastructure and specialization to produce large volume of products. So, it is difficult for the smaller firms to achieve the benefit of economies of scale.
2. Poor Monitoring And Control
It will be difficult for the management to monitor and control the production activities because of large number of employees and continuous flow of operation. It may reduce the quality of output.
3. Lack Of Flexibility
Another disadvantage of economies of scale is that it is less flexible. It is very difficult for the firms to adopt or adjust as per the change in internal or external business environment. So, it is more complex, rigid and inflexible.
4. Possibility Of Surplus Inventory
Firms try to produce more items in order to achieve economies of scale. It may lead to overproduction and may cause surplus of inventory.
5. Lower Employee Morale
It may lower the morale and motivation of employees because of lack of proper guidance, monitoring and direction in the workplace. It may reduce their efficiency and decrease the quality of output.
Also Read
Factors causing economies of scale
Pros And Cons Of Economies Of Scale In Brief
Pros
* It minimizes the production cost and increases the profit
* It increases the market share
* It minimizes the selling price
* It provides more return to the investors
* It promotes specialization and modernization
* It discourages the competitors
Cons
* It requires huge investment
* It gives focus on quantity of output rather than the quality of the product
* It may demotivate the employees
* It is difficult to maintain proper monitoring and discipline
* It lacks flexibility
