#FUNdfact: Economies of Scale

Having a crack at explaining some ideas about the economy works

You may have heard people talk about ‘Economies of scale’ (or maybe you haven’t). Either way, we’re going to explain what it is, and the impact this can have on the economy.

Basically, it’s the fact that larger operations spend less money on each thing they create… They spend more in total, but the cost of each thing they produce is lower than someone with a smaller operation.

I feel a metaphor coming on

You’re probably living all kinds of examples… Here’s a good one: your power bill.

If you got a flatmate, would your power bill double? Probably not. Things like your fridge are going to use the same amount of power for two people as they do for one. Your power bill would increase overall, but the amount you’d have to each pay for power would go down.

Of course, this isn’t endless. There comes a point where you need to spend more, before you can lower the cost. For example, if you wanted to add even more flatmates (so you can have an even cheaper power bill), you might need to get a bigger flat – which would be more expensive.

There is also the chance you might double up on costs. Say you’re at the shop to buy bananas, and you end up getting a bunch so you can share them with your flatmate 💗. But when you get home your flatmate has done the same thing. You’ve now each bought twice as many bananas as you otherwise would have (if you guys weren’t such a great, sharing flatmates) — but unfort, now half your bananas are going to rot away.

This is the same in business. Lots of businesses have run into trouble where they scale up, hoping to save money, but end up spending more because they may end up doubling up on work and poor communication.

How about a real life business example

There has been some pretty big news about tech giant, Amazon over the last few weeks. They’re included in the US 500 fund we offer on Sharesies. So we thought we’d share what’s going on.

Source: REUTERS/Phil Noble

Source: REUTERS/Phil Noble

Is Amazon taking over?

Earlier this month, Amazon announced they’re planning to open a fulfillment centre in Melbourne. This will mean Australians will be able to get pretty much anything you could imagine in just a couple days.

Australian retail and grocery store executives are probably freaking out about this. But what impact could this have in general? Here are some thoughts.

In the short term

Since the announcement, some big retailers in Australia and NZ have already had their share prices fall. Fair enough. This is a pretty major threat to business — especially as more and more people are choosing to shop online.

Further out

But retail is just one part of the market. Other industries can thrive when they have access to the lower-cost goods and services that Amazon provides.

One good example is Amazon Web Services (AWS). Lots of technology companies use AWS for their hosting. It’s much easier than dealing with servers themselves and outsourcing this means they can focus on their core business.

Since we don’t have a crystal ball, we can’t say which industries (if any) would benefit from Amazon opening up in Australia. But it’s hard to imagine a scenario where it negatively impacts the entire market — people still need to buy things. If they buy those things from Amazon instead of JB Hi Fi, and get a better deal from Amazon, that frees up more money to spend on other stuff.

A lot of this focuses on how they’re able to deliver economies of scale. And now hopefully you have a bit more of an idea what that is.

What about the little guy/gal?

Does this mean smaller retailers should pack it in today? Not necessarily. It’s true that when people know exactly what they want, they can get it from Amazon. But this isn’t always the case.

Often, people just know they have a problem to solve, and they need to talk to an expert about how to make it happen. That’s a niche smaller retailers can fill — like this dog food salesman in the USA. This guy can’t possibly beat Amazon’s prices, but when dogs develop itchy skin or bad hips, their owners talk to him, not Amazon, about what their furry mate should be eating.

To wrap up

If you hear people talking about economies of scale think of your power bill and getting flatmates — and ask yourself whether this is a power bill situation, or a banana situation.

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