Economies of Scale are crucial for businesses seeking efficient growth. This week's episode explains how this concept applies across industries, especially in small businesses and the creative arts. When businesses grow, unit costs generally decrease, leading to more profit when managed well. Additionally, economies of scale provide businesses with the opportunity to optimise resources, which is vital for sustainable success.

The Core of Economies of Scale

Economies of Scale mean that when businesses expand, they can produce goods or services at lower costs. Fixed costs, e.g., rent and salaries, spread across more products, consequently reducing each unit's cost. For example, buying ingredients in bulk lowers the cost per cake, thus allowing for either higher profits or competitive pricing. Furthermore, the larger the scale of operations, the more opportunities arise for negotiating better deals with suppliers, leading to additional cost savings.

Comparatively, businesses operating on a smaller scale may struggle to achieve such savings, making it even more critical to understand the timing and scale of expansion. However, it's important to recognise that economies of scale are not just about cost reduction. Instead, they also offer a strategic advantage in improving market competitiveness by enabling businesses to lower prices while maintaining or even improving quality.

Why Economies of Scale Matter

Understanding economies of scale is essential for small businesses. It helps in planning growth and guides decisions on investments in staff, equipment, or premises. Lowering unit costs undoubtedly boosts profits, enables competitive pricing, and supports business reinvestment, driving continuous growth. Moreover, economies of scale can make the difference between mere survival and thriving in a competitive market. Specifically, businesses that leverage these efficiencies can reinvest savings into other areas, such as marketing or product development, creating a cycle of growth and innovation.

Practical Examples from the Arts

In creative arts, economies of scale have a significant impact. A full theatre audience spreads fixed costs over more tickets, thus lowering the average cost per ticket. Similarly, artists printing larger batches of their work reduce the cost per print, thereby increasing profits or alternatively allowing competitive pricing. Consequently, this attracts more buyers and enhances the artist’s market presence. Likewise, in a production company, producing content at scale can lead to better utilisation of resources, such as equipment and crew, making each project more cost-effective.

Challenges and Conclusion

Economies of scale present challenges, especially when growth occurs too quickly. This can lead to inefficiencies, known as diseconomies of scale. Albeit, careful planning is essential to maintain quality and ensure sustainable growth. Undeniably, understanding it is key to long-term business success, regardless of size. Finally, it’s worth noting that while economies of scale offer substantial benefits, they require strategic management to avoid potential pitfalls such as overexpansion or loss of quality. To learn more about how economies of scale can benefit your business, listen to the "I Hate Numbers" podcast.

In last week's I Hate Numbers podcast, the topic and the conversation was around operating profit. Economies of scale was mentioned in that podcast, and this is something I'm going to be expanding on in this week's episode. Economies of scale is something that's, at the same time of being simple, is a very powerful concept both in terms of its application and its impact.

It can be both positive and negative. And in this week's podcast, I'm going to draw from examples from the world of arts, the world of business. It's something that every business owner or creative professional should be aware of. Whether you're running something on a small business scale, a local cafe perhaps, an art gallery, an online shop, a production company, whether that big business is much bigger in scale, it matters not.

Understanding economies of scale helps you not only grow more efficiently but actually increase your profitability if done correctly. Let's crack on.

Now, firstly, what are economies of scale? Now, economies of scale is just a fancy way, perhaps, of saying that as your business grows, it can produce goods or provide services at a lower unit cost. The bigger you become, the cheaper it is to make or deliver each individual thing. This happens, in essence, because the costs that you incur, more so the fixed ones, will get spread over a larger number of products and services.

Let me throw in a couple of examples by way of illustration. Now let's go into the world of baking. If you're baking one single cake, you might buy yourself a small pack of flour, buy some eggs and sugar, and if you're making 50 cakes, you'd buy the same ingredients, but you'd probably buy them in larger quantities.

Now if you look at the cost of making a single cake, and you bought the ingredients accordingly, the cost of that cake will be whatever that cost is in relation to one cake that you've made. If you decide that you're going to make many more cakes and sell them on, let's say 50, then when you look at the cost in relation to them making those 50 cakes and spread them out on a unit basis, it's very likely you'll see a unit cost reduction.

This is effectively economies of scale. Another way of looking at it - imagine you have a sum of money, and that sum of money is 100 pounds. That sum of money in this example, by the way, folks, represents your costs. Let's assume you're in a room, you've got five people there. Those five people could represent the number of units you're manufacturing, could represent the customers you're delivering products and services to.

And you share your 100 pounds out equally amongst the five individuals. That's 20 pounds each. Please, by all means, folks, substitute your own unit of currency. Now, if the number of people in that room grew, let's say it doubled to 10, and you shared that out, then that's going to be 100 pounds divided by 10, and that's 10 pounds per person.

If we relate that to costs, those same costs that you have across a wider base i.e. more products that you're manufacturing, more units of service perhaps, more customers that are buying your goods, then the average unit cost diminishes. Now, perversely, by the way, folks, if the number of people drops, let's say to a single digit, then the unit cost goes up accordingly.

It's still the same amount of money that might go out of the bank account, but the unit cost changes accordingly. And that's the flip side to economies of scale. Now it's the same principle in business. As you grow and you produce more, you can take advantage of buying in larger quantities, using much more efficient technology, and spreading your fixed costs, like your salary costs, your rent, your marketing, over a greater number of products or services.

Now why should you care about economies of scale? Why is it so important? Economies of scale can be the difference between a business just surviving and a business that will be thriving. When a company can reduce its unit costs, it can either make more profits as a result or you can reduce your prices.

Or you could do a combo. And this could be a huge advantage over your competitors. Now, lower prices could attract more customers. A very simplistic approach we might be taking, but let's keep the language simple just so we understand the framework. More customers results in higher sales.

And when your business has got more sales, and it generates greater levels of revenue, and it generates greater levels of profit, then you've got more to invest in rewarding your staff team, invest in future growth, and this creates a good virtuous cycle. It's not just reductions of cost for making things cheaper, but it's also about utilising those resources more efficiently.

Now, for small businesses, understanding economies of scale can help plan for future growth. It can help you guide decisions like when to invest in more staff, upgrade your equipment, expand your premises perhaps. Knowing when and how you can reduce your costs as you grow can be the key to scaling your business successfully.

Now, if we want to look for more examples, let's move into the creative space, in the world of the arts, the world of say a theatre. Now, if you're a theatre putting on a performance, you want as many people to come into the auditorium, into the performance space, to experience and to watch the show you're putting on.

Now the cost of running that auditorium, the cost of running the theatre, is going to be your normal suspects, like your salary costs, any leasing or rental costs that you might have. There's going to be all the marketing resources that you've expensed on. Now if we just take those three, if we have a full auditorium, then the average cost per each individual is going to be a lower figure than if it was if the theatre was half full.

Obviously, that's going to have an impact on the experience as well, but if we purely look from a cost perspective, the more we can utilise that capacity, the more bums on seats, so to speak, we can have in, it makes the average cost of the production turn out to be much cheaper. And that's going to impact

on and have an input into our pricing policy. Now, if you're an artist selling prints of your work, you might initially use your local printer to get those one-off prints produced. As more and more people like what you do, demand grows, more people want your work, it makes sense to order a larger batch of prints at the same time.

Printing in bulk, the cost per print goes down, because the printer can offer you a discount on those higher quantities. The choice is then yours. You can sell them at the same price, make more money, make more profits. Or, you can consider, perhaps, a strategy where you might want to reduce the price of the print, to attract more people into your circle, so that you can actually sell them and showcase other things that you might be selling.

If we look at the world of small businesses, and again, economies of scale, which is not just for massive corporations, they're highly relevant for any sized organisation. If we take a local cafe, perhaps in the beginning the cafe might purchase smaller quantities of ingredients like the coffee beans, the milk, they might even buy in the pastries from local suppliers.

As the cafe grows in popularity and more customers come in, then the owner will be looking to negotiate with suppliers to buy those ingredients in larger quantities and get a bulk discount. The cost of running the operation of the cafe, the cost of the wages, is going to remain relatively static, and therefore you're going to get an economy of scale advantage.

Consider this folks, in organisations you've worked for or with, if sales lines increase, does your pay go up accordingly? The answer is not. Conversely, if sales drop, your salaries don't drop as a result. So, economies of scale can go the other way if your demand, your production levels drop, that cost burden is still there.

Average unit costs are going to go up as a result. Now, economies of scale do have their challenges. Growing too quickly or scaling up before you're ready, will lead to issues potentially with quality control, customer service, infrastructure strain, financial strain, cash flow being gobbled up quickly. So it's important that you plan your growth carefully, ensuring that the infrastructure, the resources, the working capital are all in place to handle those larger volumes without sacrificing quality.

We can sometimes end up with what's called diseconomies of scale, when a business becomes so large and big, efficiencies drop. Management will struggle to keep pace with what's going on, comms can break down, and it becomes very difficult to maintain the quality the customers expect. What can we say in conclusion?

To sum up, economies of scale are a crucial concept for any business whatever your size, whether you're private, whether you're not-for-profit, whether you’re creative enterprise, whether you’re a small business. Growing wisely, businesses can reduce costs, improve efficiency, and create opportunities for further growth. Understanding how to scale efficiently can be the key to your long-term success. Now, folks, I hope you found this useful, I'd love it if you could share it with those who you feel will get some benefit from that. Let me know what your thoughts are. In your business, what are your costs, and where do you perceive your economy to scale to kick in?

Please do check out the show notes, by the way, folks, for the link to the Numbers Knowhow community and also to the other services that we offer from Budgetwhizz and your online cash flow planning tool. And until next week, keep things simple and keep growing smartly. We hope you enjoyed this episode and appreciate you taking the time to listen to the show.

We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.