Economy

Economies of scale – why the going is tough for small businesses

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Sometimes, when you’re running a small business, it can feel as if everything is set up against you. Big businesses find it much easier to get attention and support.

They’re more valued by government, they have better connections and they’re usually better able to withstand economic shocks. They also appear to benefit from economies of scale – but just what are these, how do they work and are there actions you can take towards levelling the playing field?

Running costs

When you’re in business there are certain costs you have to pay regardless of your size, such as the base cost of your accounting and your website. You’ll probably pay the same amount for manufacturing equipment whether it’s producing 50 items per day or 500. Because larger companies have a much bigger turnover in comparison to these costs, they have a built-in advantage. There’s not much that companies can do by themselves to make up for this, which is partly why small business discounts are available in some areas to help restore balance. It’s sometimes possible to reduce the burden by sharing things with other companies – for instance, it’s not uncommon for small businesses to share market stalls on which to sell their goods.

Purchasing and storage

Just like consumer goods, materials on sale to businesses tend to come with discounts attached to bulk purchase. The more you can buy at once, the lower the cost per item. This can significantly disadvantage small businesses which don’t have the capital up front for large purchases and have limited storage space. One option for dealing with the latter is to hire storage units as and when they’re needed, so that you can temporarily increase capacity without having to deal with larger overheads the rest of the time.

In order to secure better deals you should build up a financial float specifically for use when purchasing. Even though this means you won’t be able to spend it on other things, it will add to your company’s asset value and thereby increase your borrowing power.

Borrowing

Borrowing is another area where small companies are at a disadvantage because larger ones, operating on a larger scale, tend to have higher asset values. To put it simply, if they were to default on loans, lenders would have a better chance of fully recovering what they were owed through asset seizures. There’s not much you can do about this directly but you will find that your small business can access a wider range of low cost government loans targeted at specific areas of business development than larger companies.

Labour

As a rule, employment is also more cost efficient the larger the size of your business. There are two reasons for this. Firstly, larger companies are more likely to be operating across multiple sites, and it costs the same to pay a manager to look after one site as to look after two or three, so the fewer sites you have, the less you get for what you spend on senior staff wages. Secondly, as a small business there are certain things you won’t be able to do without, such as having somebody to take care of your finances, but you won’t necessarily have much work to give to those people to get a good deal in relation to the overheads involved with employing somebody full or even part time. One solution to this is outsourcing, bringing in contract workers, which is more expensive per hour worked but gives you flexibility and can work out cheaper overall.

Equipment

When a company has a higher volume of production, it can more easily invest in industrialising its processes and buying good quality equipment. When you’re not creating products on the same scale, this is more difficult to do, and saving up money over time isn’t always a practical strategy because it creates a greater risk of the equipment you’re using becoming obsolete. Smaller companies often resolve this by leasing rather than buying equipment – again, it costs a bit more overall, but it reduces the comparative disadvantage and also makes the process of scaling up your business easier.

It’s never possible to compete on a fully equal basis when you’re a small company sharing the market with big ones, but reducing the disadvantages created by economies of scale certainly helps. Always remember that you have some advantages big companies can only dream of – flexibility, adaptability, the speed with which you can innovate – and play to your strengths.

(Photos: Pixabay)

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