Economies of scale are the cost advantages derived by a company or an industry as its scale of operation increases. In business, the economies of scale can be internal or external. Let's explore the differences between these types of scalabilities:
Table of Contents
Difference between Internal vs. External Economies of Scale
The primary difference between internal and external economies of scale is that the former is specifically cost advantageous gained by an individual firm as it grows, while the latter is cost advantageous shared by an industry or group of firms in a particular geographic location due to its growth and development. However, internal and external economies of scale are the types of economies of scale that represent the enhanced production capabilities of a firm or industry and their impact on cost efficiency.
Key Takeaways
- Internal economies of scale are cost efficiencies a single firm achieves as it grows, expands, and becomes more competitive.
- External economies of scale are cost benefits shared by an entire industry or a group of firms in a particular location or market environment.
- The former results from the expertise and capabilities of a single business entity. However, the latter is driven by uncontrollable external factors that affect an industry or region.
- The different internal economies of scale are technical, managerial, purchasing, marketing, financial, and risk-bearing.
- Various external economies of scale are economies of concentration, information, disintegration, research and development, and taxation.
Comparative Table
| Basis | Internal Economies of Scale | External Economies of Scale |
|---|---|---|
| 1. Definition | Internal scale economies are attained by a particular company when it expands and reduces its production cost or operations to become more competent. | Internal scale economies are attained by a particular company when it expands and reduces its production cost or operations to become more competent. |
| 2. Long-Run Average Cost Curve | Forms a U-shaped curve indicating the fall and rise in long-run average cost. | The U-shaped long-run average cost curve shifts downward and upward. |
| 3. Occurs | Within an organization or company. | Within an industry or region. |
| 4. Within an industry or region. | Often, large-scale companies benefit from such scalability. | Companies of all sizes functional within an industry or a region benefit from external scalability. |
| 5. Reflected | Movement along the long average cost (LAC) curve. | Movement along the long average cost (LAC) curve. |
| 6. Causes or Factors Responsible | Capabilities, expertise, and efficiency of a firm. | External factors beyond direct control impact the overall industry or the region where the companies are situated. |
| 7. Advantages | A single firm enjoys cost advantages due to its growth and expansion; it becomes more competent globally. | The companies in an industry or region grow and benefit altogether. |
| 8. Types |
|
|
| 9. Diseconomies of Scale | However, effective control, coordination, better communication, demotivation, and bureaucracy within the company can lead to internal diseconomies of scale. | Also, limited land space, transportation issues, workforce problems, government restrictions, over-competitiveness, etc., can cause external diseconomies of scale. |
| 10. Examples | Suppose a panel manufacturing company can attain economies of scale by buying aluminum in bulk at great discounts. | Say, the construction of a new railway route reduced the transportation cost of the local companies in the region. |
What Is Internal Economies of Scale?
Internal-scale economies pertain to the cost efficiency and benefits that a business entity can attain by expanding its production scale. As a firm grows and produces more significant outputs, it can experience certain advantages that reduce average production costs.
Several key internal economies of scale include:
- Technical Economies: Larger firms can switch to more advanced and efficient technology, machinery, and production methods to lower their average production costs.
- Managerial Economies: As companies grow, they employ specialized managers to improve coordination and efficiency, increasing their overall productivity and curtailing the cost of operations.
- Financial Economies: Big corporations with high creditworthiness can borrow huge funds at lower interest rates, reducing their financing cost.
- Purchasing Economies: Buying raw materials or inputs in bulk can lead to lower unit costs for the firm.
- Marketing Economies: Companies can spread marketing expenses over a larger output, reducing the average cost per unit.
- Risk-bearing Economies: Larger business entities can diversify risk across a broader range of products or markets.
What Are External Economies of Scale?
External scale economies refer to the cost efficiency achieved by an industry or group of firms within a specific geographical area because of positive externalities (innovation, suppliers, specialized labor) and negative externalities (external diseconomies of scale).
The different kinds of external economies of scale are as follows:
- Economies of Specialization or Disintegration: The firms in the same industry select a niche or further divide the production process to select a specialization to attain scalability. By selling goods or services to each other and sharing resources, they can minimize wastage and production costs.
- Economies of Information: Companies in the same industry can benefit from the information and innovation of one another related to new techniques, markets, processes, suppliers, and sources of raw material.
- Economies of Concentration: When many companies from the same industry or location join hands to attain cost efficiency on factors of production (such as skilled labor, suppliers, and energy) and efficient support services (like training, research, insurance, repairs, and maintenance).
- Research and Development: Companies with R&D departments can develop cost-efficient methods, techniques, and technology that they can patent and sell to other companies after enjoying a monopoly over it for a certain period. Also, the infrastructure development in a specific region can bring down the transportation costs of the local companies
- Taxation: Sometimes, the government provides a tax advantage to companies in a particular industry or region.
Similarities
Internal and external economies of scale share similarities as they both pertain to the economic benefits or cost advantages a firm or industry can achieve by increasing its production scale. Both types of economies of scale play a crucial role in shaping the structure and competitiveness of industries. Since larger production volumes often lead to better resource utilization, access to specialized labor, and the adoption of more efficient production techniques. Hence, both economies of scale aim to decrease the average or marginal cost of production and foster greater efficiency in production processes.
Moreover, internal and external economies of scale are generally attained over the long run as the firm or industry expands its operations. These benefits are temporary but gradually develop over time as the scale of activities increases. In both cases, firms or industries can enhance their competitive standing in the market through competitive pricing strategies. Thus attracting more customers and leading to market dominance. Overall, both economies of scale present growth opportunities for firms and industries by expanding their market share and pursuing new business ventures as they capitalize on the cost advantages.
