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  • Writer's pictureShreyan Shrimali

Strategies for Startups: Leveraging Economies of Scale to Propel Growth and Competitiveness

Updated: Jan 28

In simple words, we can say through economy of scale, a company can reduce cost per unit and achieve higher profits. But that's not about it, so let's explore economies of scale further in this blog.


The idea of Economies of scale dates back to Adam Smith; the idea was to get higher returns by division of labour. The primary purpose was to increase the efficiency of production changes as the size of production varies. There are also diseconomies of scale, which is the opposite of it.

There are 4 Economies of scale,

  • Purchasing power – Big companies like Starbucks and McDonald's purchase bulk materials with long-term contracts from which they save plenty of costs.

  • Managerial Specialisation – Companies hire specialised managers for separate tasks, which increases the overall efficiency of the output.

  • Financial advantages – We all know banks operate differently for familiar people & HNWI, and the same for companies as well. The opportunity to borrow money at significantly low-interest rates adds up to millions of dollars in actual value for companies like Reliance, even though the percentage change may not seem substantial.

  • Marketing Efficiency: these companies spread the cost of advertisement over a larger output, which ultimately reduces per-unit marketing costs. For instance, average companies spend around 20-30% of their revenue on marketing.


There are internal and external economies of scale as well,

Internal economies of scale include factors like Technical, purchasing, managerial & financial, whereas External economies of scale include tax reduction and partnership factors.


There is no fixed line when economies of scale will start existing in a company, but when more units of goods can be produced on a larger scale with fewer inputs, economies of scale are said to be achieved.


The best example is Amazon in today's world; they have crushed the local market by providing huge discounts, which a small business owner cannot give. They directly buy in bulk from the manufacturer, and they get a very high rate of discount. Economies of scale also exist in service platforms as well, like Netflix distributing its fixed cost with a growing number of subscribers, which cannot be achieved in the case of DVD distribution companies like Blockbuster, where the shipping cost for each subscriber would be the same.

Here is how a start-up can take benefit of Economies of scale.

Start-ups can benefit from economies of scale to increase production and efficiency, lower expenses, and boost competitiveness by utilising technology, building partnerships and alliances, diversifying products and services, and concentrating on cost reduction.

  • Startups can also pool their purchasing power with joint purchasing alliances.

  • Small companies don’t have enough resources to perform all functions in-house; hence, they can outsource specific tasks like manufacturing, from which they will get better products at cheap prices as well.

  • Regional collaboration is also a suitable method where small businesses can collaborate on logistics distribution, which will help them to be cost-efficient.

These companies do not do anything extraordinary, but the size of their operations sets them apart from the competition. Companies like Adani diversify and expand in such a way that they manage to become manufacturers and distributors, which helps them cut costs and operate efficiently. This is called backward integration, which is the topic of another blog.

As every coin has two sides, there are some limitations and challenges as well with economies of scale.

One of the biggest challenges with economies of scale is managerial issues; many new startup founders need help managing a massive number of employees and scale. We can see what happened with WeWork and how they went bankrupt because of economies of scale. With this enormous scale of operation, companies start to lose innovation, and they also decrease flexibility of operation.


Conclusion,

In conclusion, economies of scale are an ancient tradition that has changed the way of doing business in the modern world. They are essential to achieve higher profit margins for companies from which consumers get discounts. Companies should slowly adopt change rather than rushing to achieve it due to the pressure of investors. If rightly adopted, it can help to achieve massive success like Amazon, and if not, companies like WeWork can go bankrupt.


Comment down below Amazon and Netflix spread their costs over a large customer base. Is this model sustainable for other companies, or are there specific industries where it works best?


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1 komentarz


Kushika Chhabra
Kushika Chhabra
01 gru 2023

Cost-spreading works well for scalable digital services like streaming or e-commerce, but sustainability depends on factors like competition and scalability, making it challenging for some industries with high fixed costs.

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