Economies of Scale

Economies of scale refers to reduction in unit costs associated with producing large volumes of a product. Reductions in cost in this manner arise in a number of ways. First, by producing in volume, more of the fixed costs involved can be distributed over a larger number of final products. Then, too, large-scale producers can take advantage of specialized equipment and manpower that are highly productive due to increasing returns of specialization. Economies of scale play a critical role in global business today, with respect to government policy, regional integration, and business strategy. It is a central component of strategic trade policy (otherwise known as the new trade theory) and in the strategic profiles of multinational firms. A growing concern for multinationals is the increasing difficulties implementing economies of scale strategies in the 21st century.

The origins of economies-of-scale production can be traced to the early phases of the industrial revolution in the United States, and particularly in the second half of the 19th century. The ability to efficiently turn out products in large volumes was in part due to the growing pool of labor-saving machines designed and built by American inventors and machinists. A turning point in this progression was the shift from batch and semi-continuous production to fully continuous operations. The moving assembly line and the division of labor into specialized tasks carried out at specific workstations along that line to produce standardized products was a culmination point in this effort to place production on an economies-of-scale basis. The automotive industry—and Ford Motor Co. in particular—spearheaded this mass production revolution. Other industries soon adopted the technology in its various incarnations suitable to the particularities of their production processes.

Achieving economies of scale in production depended also on seamlessly integrating these machines and systems into the organizational fabric of the factory and ultimately the corporate structure as a whole. The close structural interlinkages formed between corporate divisions through managerial and organizational innovations by the third decade of the 20th century assured a smooth and timely flow of materials and components upstream into the plant and the readiness of the distribution network and market demand at the appropriate time downstream. All this contributed to a steady high-volume output of final product and the essential economies that attended large-scale production.

Since the 1980s, economies-of-scale production has diffused into many industries, including electronics and information technology. Economies of scale are also an important force in the evolution of the European Union and the rise of the “Single Market.” The fact that much of Western Europe is a monetary union, for example, leads to economies of scale in financial markets and, in turn, greater availability of cheaper capital for multinationals.

Global Strategies

Economies of scale play an important role in global business strategy. Supporters of neomercantilist policies stress that governments that support certain industries, especially those burdened by high capital costs—which can include high research and development (R&D) costs—to achieve first-mover advantage in global markets actually produce a net positive impact for all countries. Such strategic [Page 568]trade policy is relevant in high-fixed cost industries, such as aircraft production, in which total market demand globally is limited and can support only one or two multinational companies (MNCs) efficiently. Government subsidies to these companies, including tax incentives, R&D support, and so forth, allow them to take early control of global markets. This assures them that they serve sufficiently large demand to produce in volume and, through economies of scale, at reduced costs. In turn, the market receives a greater variety of products at low prices. But government support is by no means a sine qua non of achieving such first-mover advantage.

...