Economies of scale

Identify the source of the lower unit cost

One possible mechanism is spreading the same fixed production bill over more identical units. ACCA’s cost-behavior discussion also explains why fixed costs can step up when extra capacity is required.

Hypothetical annual production: variable cost is US$6 per unit and fixed production cost is US$60,000. At 10,000 units, total cost is US$120,000, or US$12 per unit.

At 20,000 units, the same fixed bill plus US$120,000 variable cost totals US$180,000, or US$9 per unit. Assume equal product quality, no waste change and enough existing capacity for both volumes.

This set of assumptions produces the decline shown above.

If doubling output instead requires another US$60,000 of annual fixed cost, the 20,000-unit cost becomes US$12 again. Request capacity, staffing, purchasing and scrap data before assigning the observed saving to scale.

A supplier discount or a change in product mix would require a different explanation.

Verify that the acquired volume can use the existing capacity

In a buy-and-build case, the calculation above supports savings only if the acquired orders can actually run through the existing equipment and staffing. Different specifications, geography or service commitments may prevent that combination.

Ask for the supplier quote at combined volume, the production schedule and the cost of moving the work. A lower assumed unit cost in the acquisition model should correspond to a feasible operating change with an implementation date.