Economies of Scale External: Meaning and Causes
In the dynamic world of business, the concept of economies of scale plays a significant role in shaping the competitive landscape. Among these economies, external economies of scale are a crucial factor that contributes to the success of industries and individual companies.
External economies of scale occur when the average cost for each company decreases as the industry's output increases. This phenomenon is distinct from internal economies of scale, which apply only to specific companies. The origin of external economies lies outside the company, making them different from their internal counterparts.
One of the primary drivers of external economies of scale is agglomeration economics. When various identical companies are in the same location, such as Silicon Valley and Hollywood, they attract skilled workers, reducing recruitment costs, and increasing productivity. Agglomeration economies also make suppliers more efficient to meet a more extensive buyer base, and companies can often receive discounts when buying inputs in large quantities, thereby reducing input costs.
Beyond government infrastructure and agglomeration economics, specific examples and factors contributing to external economies of scale include economic growth in the industry leading to stronger buyer demand and higher revenues. This reduction in average costs as firms scale production collectively within the sector is a powerful force driving industry expansion.
Tax incentives or favourable policies provided by governments also contribute to external economies of scale. These incentives reduce the cost of doing business, even though they are outside the firms’ direct control.
Access to a specialized, skilled labor pool is another factor. This is often due to the presence of universities or research hubs that benefit multiple companies, such as tech firms near major universities. The development of specialized suppliers and service providers clustered near an industry also reduces input costs and improves supply chain efficiency for all firms in that area.
Improvements in transportation and logistics infrastructure, beyond direct government spending on roads, also play a role. Better public transit reducing commuting costs or more efficient shipping networks, lowering distribution expenses across the industry, are examples of such improvements.
Industry-wide technological spillovers and knowledge sharing are another significant contributor to external economies of scale. Innovations or specialized equipment developed by some firms become accessible or diffuse to others nearby, thus lowering costs sector-wide.
In essence, external economies of scale arise because the growth, concentration, or collective activity of an industry creates a shared environment of lower input costs, specialized resources, improved services, and enhanced labor markets, benefiting all firms regardless of individual actions. They differ from internal economies as they are external to any one company and often tied to the industry's geographic or sectoral expansion.
While external economies of scale can have numerous positive aspects, they can also have negative aspects. For instance, all companies get the same benefits, not making a company superior and not allowing exclusion of competitors from benefiting. Moreover, management does not have control over the determining factors and impacts of external economies of scale.
In conclusion, understanding external economies of scale is essential for businesses and policymakers alike. By recognising and leveraging these economies, industries and companies can thrive, leading to economic growth and development.
Businesses operating within the same industry can reap benefits from external economies of scale, which decreases average costs as the industry's output increases. Tax incentives, specialized labor pools, and improvements in transportation and logistics infrastructure are examples of factors contributing to these economies.
Understanding and leveraging external economies of scale is vital for industry thriving, resulting in economic growth and development, as recognized by both businesses and policymakers.
