Economies of Scale

The benefits that come from having large or very large operations. In economics, the term means the reduction in a producer's average cost per unit that results from having large output compared with that of competitors. Examples of the benefits which arise from economies of scale in production include the ability to price lower in the market than competitors, the ability to negotiate improved supplier pricing in return for greater volumes, the ability to allow managers to specialise, the ability to gain access to loans at lower interest rates etc. Procurement strategies that focus on volume aggregation and leverage rely on the principles of economies of scale. The corollary of the concept is that there is a point where diseconomies of scale begin. In procurement, an example might be that improving the percentage of spend with a preferred supplier arrangement from 80% to 90% of the total category spend might yield savings, but the organisational cost of securing the next 10 per cent of compliance might outweigh the incremental benefits. See also Leverage.

In short

Buying or producing more lowers the cost of each unit, up to a point.

How procurement uses it

• Combining demand across business units or agencies into one contract, so suppliers price for the larger volume.
• Consolidating the supplier base, so each remaining supplier gets more of the spend.
• Joining collective arrangements, such as whole-of-government contracts, instead of buying alone.

Where it stops working

Past a point, more volume with one supplier brings dependency, less competition at renewal and service problems the supplier cannot fix quickly. These are diseconomies of scale. A spend analysis shows where combining spend still pays and where it has stopped.