Economies of scale and scalability - PowerPoint PPT Presentation

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Economies of scale and scalability

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  1. Economies of scale and scalability Business A has high level of fixed costs relative to variable costs and experiences a disproportionate change in profits for a given change in revenue compared to Business B which has a lower level of fixed cost relative to variable costs. Business A experiences excellent economies of scale, whereas B does not. For business A fixed costs (6,000) amount to 75% of total costs (2,000 + 6,000). For business B fixed costs (2,000) account for only 25% of total costs. Revenue for both business A and B increases by 20%. As a result the operating profit for A increases by 80% whereas it only increases by 40% for B. This is the effect of economies of scale. As business A grows in scale, it is becoming rapidly more profitable. For example, operating a shop with a fixed rent and staff costs becomes very profitable as sales increase. Of course the effect works in reverse if sales decline. A revenue increase of 20% delivers an increase in operating profit (EBITDA) of 80% A revenue increase of 20% delivers an increase in operating profit (EBITDA) of 40%