Economies of scale


Last time I published my post in “e-business” category, I talked about savings due to the increasing amount of products manufactured.

My friend Gabriele works as sales representative in a hi-tech shop and, after having read my post, he asked me: “why doesn’t my 80Gb hard disk cost as much as the double of a 40Gb one?”.

The answer can be found in economies of scale, because fixed costs are “absorbed”.

For example, if you had to manage a warehouse where little merchandise is stored, and you had to pay a fixed amount of money for renting, every product would absorb a portion of the fixed expenses. Differently, if you had to pay the same amount of money for renting but had to manage a lot of products in the warehouse, every product would be allocated a very little percentage of the total cost!

That’s all: every company would like to increase its production in order to make the costs less heavy, but a clever manager has to make sure his colleagues the demand will raise! Otherwise, the increasing  production would mean the opposite than savings ……

E-commerce businesses have generally to face similar problems because fixed expenses (server and data transmission, direct labour costs and salaries for administrative personnel, rent, design and development of the web site, depreciation, insurance premiums etc.) are very important, and we’ve already talked about the uniqueness of the product.

If an internet based firm produces only a product, or few copies of its product after having hired a number of technicians (perhaps the most important expense), there are two keys for profitability: fixed costs could be transformed in variable costs (look at, or management should add high mark-up on to each product’s price in order to get high incremental revenues.

Anyway, you’ll see the great importance related to structural costs: break-even-point is very far, and e-businesses must be managed with a strong strategic vision in the long run. A technician can create a start-up, but only a business administrator is able to run the shop successfully.

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