Understanding Economy of Scale Can Help Save You Money
Price.Price.Price. In the world of business, everything boils down to pricing. We often find ourselves in negotiations with customers centered on reducing costs. Well, what factors truly affect pricing in manufacturing? There are multiple answers to that question, but one sticks out. Volume. Reducing pricing can begin by understanding the idea of economy of scale in the market. Economy of scale is a proportionate saving in costs gained by an increased level of production. To simplify, the more you buy of a product, the less it’s going to cost you per unit. This idea is the same for people who shop at Sam’s Club or Costco; buying a case of candy bars is cheaper, per piece, than buying just one.
Being a high volume production shop, the concept of economy of scale is extremely relevant to our company. We set up our equipment to run large quantities of parts to eliminate costly and timely changeovers. Because of our expertise in producing high volumes of parts and being able to remove costly changeovers, the most economical price we can give to our customers, traditionally, are the quantities in the tens of thousands and up range. The reason for this is centered on the distribution of our fixed costs such as machine set-up costs and tooling costs. As volume increases, the fixed costs per unit is reduced.
In order to solidify the idea on how price affects volume, let’s look at simple a real life example. A gear manufacturer has $50,000 of fixed cost to make 50,000 gears annually. That means that each gear is $1. Through research and development, the gear manufacturer finds a new application for their product and sales jump to 100,000 pieces. The cost now reduces to $.50 each. Since sales doubled and the fixed costs remain the same, the cost per gear is cut in half. If sales were to triple to 150,000 gears, the fixed costs would be reduced by three times the original fixed price. As you can tell from this example, the more quantity you buy of something, the less the unit fixed costs, and thus a lower overall unit price.
Through these examples above, we can see how volume affects pricing. In a society that is extremely price sensitive, it is easy to discover that the most economical unit price you’re going to acquire is through large volume orders. This especially holds turn with our company, who specializes in high volume production. So next time you’re looking to cut costs and obtain a more economical unit price on your order, see if increasing volumes can help you achieve your cost cutting desires.