The Economies of scale is the reduction in Average Cost as a result of producing on bulk. Firstly, we break them down in 2 parts, Internal Economies of Scale and External Economies of Scale. As the name itself suggests, Internal EOS is a reducing in Average Cost as a result of actions taken by the business, with in the business. External EOS, is where we achieve the same results but yielded from external factors, like the Government, Society.
Generally, there are many kinds of Economies of Scale, but since their types is not our main focus, I will only do a briefing about them. They range from Purchasing Economies of Scale, that is purchasing on bulk and as a result getting discount from the supplier, which eventually leads to reduced average cost. Another category is Managerial Economies of scale, which is when we have a very skilled manager who is able to manage the business, or the department so well that the overall cost is reduced. Technical economies of scale is another kind, where you are able to enjoy reduced average cost due to improvement in technology, e.g. High tech machinery that can produce much faster and with higher accuracy than humans. Financial economies of scale is another kind to talk about. Bigger businesses can get huge loans on relatively very low interest rates. Not just that, but they can also easily raise funds by issuing shares in the Stock Market. This means that as a result of large scale production and dealing in huge amount of finances, business can enjoy the ease of raising funds at low price.
This was all to give you a basic idea about Economies of Scale. One thing to consider is that almost all big businesses are doing this, almost unconsciously. But, how good a strategy is it for small businesses or medium sized businesses to try to pursue this? To be practical, it is understandable that even small businesses sometimes try to buy bigger quantities (for their size) in order to try to achieve discounts, which is one kind of economies of scale. One way or other, reduction in Average cost is a goal almost every business would try to pursue.
However, this pursue can often lead to serious damages. Let us begin with a simple example. Sometimes, big businesses who have once achieved the economies of scale keep on pushing themselves. As a result, after a time they start facing increase in Average cost as a result of large scale production. Is this not the opposite of Economies of Scale? Yes! Indeed, it is called Diseconomies of Scale.
This is the point where firms have expanded their level of production so much that the effects are now adverse. E.g. The business has now opened so many branches that instead of achieving risk bearing economies of scale (Which is spread of risk of loss due to more diversification) it will achieve diseconomies because the branches are just too many to always be in communication with each other. Let us now put Medium or Small sized business in a similar situation. It is very possible in case of a medium sized business, that in their objective of achieving purchasing economies of scale they have now ended up with an overflow of stock. Now they are neither able to sell it all, nor manage it well enough and keeping it in the warehouse is increasing their costs every minute.
There is now idea that trying to achieve economies of scale is a very good ambition and countless businesses stand as living examples in a state of success, all of whom have achieved economies of scale. However, being rational is the first priority. Carefully analyzing the situation and understanding that not everything works for every business, no matter how good it may seem. Nevertheless, with careful analysis and implementation of required strategic tools, success is possible.