Internal Economies of Scale - Overview

Overview

An example of a firm utilizing internal economies of scale is when a company is cut in size but the remaining firms still hold the same amount of final output. Therefore the company has become more efficient in production and has experienced internal economies of scale.

Six main types of internal economies of scale can be defined.

1. Technical economies. They are found mostly in plants and arise mostly because neither the capital cost nor the running cost of plants increase in proportion to their size. The main idea is to spread the fixed costs over as large output as possible, so Average Fixed Cost decreases.
2. Managerial or administrative economies arise because the same people can usually manage with bigger output, so average administrative cost decreases when production increases. Large firms can employ specialists, which leads to the increase in efficiency.
3. Financial economies arise because e.g. the interest rate for getting a loan is higher for smaller firm than for larger one. This is because large firms have large assets and banks trust them more. It is also relatively easier for large firms to raise their share-capital by issuing shares.
4. Marketing economies. They are available both in purchases of raw material and in selling of the product. A large firm may have a bulk discount when purchasing raw materials. In terms of promotion, to large firms the average cost is smaller, because the prices of advertisements are the same for all firms, hence the large firms can afford costs of sales promotion without causing much difference in their profit shares.
5. Social economies. They may be developed into two groups: those that build up the goodwill of the community and so attract customer (sponsorship), and those that develop the loyalty of the firm's employers (Christmas bonuses)
6. Risk-bearing economies. They are the firm's ability to bear losses. If one part of the company has a loss, other parts of the company can support it. If the company sustains a loss, it has enough capital to overcome it.