- A worked example: three factories, three unit costs
- The six internal types, with Shopify's examples
- Internal vs external economies of scale
- How a small business gets economies of scale
- The catch: past a point, growing makes each unit dearer
- How to check whether growing will lower your costs
- Where I come in
- My verdict
- Frequently asked questions
Economies of scale are the cost advantage a business gets as it produces more. Your fixed costs are spread over more units, so the cost of each unit falls, and Corporate Finance Institute (CFI) says average variable cost can drop too as operations get more efficient.
CFI describes it as an inverse relationship: the more you produce, the lower the fixed cost per unit. Shopify's definition is a little wider, covering the cost reductions and efficiency gains that come when operations and output increase. And it makes a point I like: although the idea usually refers to big companies, ecommerce merchants and small business owners can get them too.
A worked example: three factories, three unit costs
OpenStax, the free economics textbook, uses alarm clocks to show the effect. These are its US dollar figures, as of October 2026.
| Factory size (OpenStax example) | Output (alarm clocks) | Average cost each |
|---|---|---|
| Small (S) | 1,000 | $12 |
| Medium (M) | 2,000 | $8 |
| Large (L) | 5,000 | $4 |
Five times the output brings the average cost down to a third. OpenStax says this is the idea behind warehouse stores like Costco and Walmart. It also calls this a long-run average cost curve, because in the long run every factor of production, including the size of the factory, can change.
OpenStax has a neat physical example too. A pipe that uses twice as much material can carry four times the volume, because the cross-section area rises by a factor of four. Chemical engineers have a rule of thumb built on that, the six-tenths rule: raise a plant's output by a given percentage and total cost rises by only six-tenths as much.
The six internal types, with Shopify's examples
| Type | How it lowers cost | Shopify's example |
|---|---|---|
| Purchasing | Bigger orders earn discounts | A dropshipper switching to bulk buying at a discount |
| Technical | Automation and better equipment | Smart shelves that speed up picking |
| Financial | Cheaper borrowing | Growing, more creditworthy firms get capital at lower interest rates |
| Managerial | Fixed salaries spread over more output | The same management team running a bigger operation |
| Marketing | Bulk buying of advertising | Ad space bought in bulk at a discount |
| Risk-bearing | Risk spread across more bets | Running several projects or markets at once |
CFI's shorter list names purchasing, managerial and technological as the main sources, and notes the technological one often favours big firms, because only they can afford expensive new equipment. CFI also says scale can be found at any stage of production, from hiring a large marketing team to moving input sourcing from human to machine labour.
Internal vs external economies of scale
Internal economies are unique to one firm. CFI's example is a company holding a patent on a mass production machine. External economies are shared by a whole industry. CFI's example is a government offering a 20% tax break to steel producers that employ more than 10,000 workers. Shopify points to Silicon Valley as the result of external economies: tech businesses clustered together, shared a big pool of skilled labour and swapped ideas.
How a small business gets economies of scale
You don't need a factory. Shopify's small business example is a clothing brand that buys a direct-to-garment printing machine, so it can print more t-shirts at a lower cost per unit. Its dropshipper moving to bulk buying is another. And for marketing, buying ads in bulk can bring the cost per ad down.
Supply chain choices matter here as well. If you're looking at bulk buying, these tips for managing a small business supply chain are a good place to start.
The catch: past a point, growing makes each unit dearer
This is the part most explainers skip. OpenStax shows the long-run average cost curve in three zones. While it slopes down, you've got economies of scale. In the flat middle, you've got constant returns to scale: the scale benefits are used up. When it slopes up again, you've hit diseconomies of scale, and each extra unit costs more than the last.
CFI explains why. As firms grow they get more complex, and they can gain scale economies in one area, such as marketing, while suffering diseconomies in another, such as management. CFI also quotes management professor Frederick Herzberg, who warned that "numbers numb our feelings for what is being counted" and lead firms to chase scale blindly.
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Scale also shapes who can compete. Where big incumbents have already used up the cost advantages, newcomers struggle to match their prices, which is part of the threat of new entrants in Porter's five forces.
How to check whether growing will lower your costs
- Work out your fixed costs per month.
- Divide them by the units you produce to see your fixed cost per unit.
- Look for bulk-purchase discounts and cheaper borrowing as you grow.
- Track average cost per unit, not just revenue, as output rises.
- Stop expanding when average cost starts to climb again.
Where I come in
Marketing has its own version of this curve. More output can bring your cost per lead down, until the extra content, campaigns and channels start to need more people and more management than they're worth. I've spent 23 years in marketing, and I help small businesses and SaaS marketing teams grow what they produce without that cost per lead creeping back up. You can see how I work on my work with me page.
My verdict
Bigger is cheaper per unit, but only up to a point, and you won't see that point if you only watch revenue. Track your cost per unit every month. If you're small, start with the easy wins Shopify describes: buy in bulk where it makes sense, invest in the one piece of kit that cuts your unit cost, and buy ads in larger blocks. Then keep watching, because the curve turns back up quietly.
One way firms lower unit costs is to own more of their supply chain, as vertical integration describes.
Frequently asked questions
What are economies of scale in simple terms?
They're the cost savings a business gets as it produces more, because fixed costs are spread over more units and the cost of each unit falls.
What's an example of economies of scale?
In OpenStax's example, the average cost of an alarm clock falls from $12 at 1,000 units to $8 at 2,000 and $4 at 5,000.
What are diseconomies of scale?
The point where growing raises your average cost per unit, often because the business gets more complex to manage.
Can small businesses benefit from economies of scale?
Yes. Shopify says small business owners can achieve them, for example by buying in bulk or investing in equipment that lowers the cost per unit.
What is the difference between internal and external economies of scale?
Internal economies are unique to one firm, such as a patent. External economies benefit a whole industry, such as a tax break or a big local pool of skilled labour.
