Source of Scale Economies

1. Commercial economies of scale

Commercial economies of scale mostly happen on the process of purchasing and marketing. Purchasing economies come from the bulk purchase discount from suppliers when a firm buys or sells these things in large volumes. The privilege may develop into strong negotiating power when the scale of company is large enough. The Companhia Vale do Rio Doce, as the second-largest mining company in the world, is so powerful on iron ore price negotiation that steel plants have to associate into unions like Cisa to bargain with it.

In the industry of airline, a larger scale means greater carrying capacity, bigger fleet of aircraft and better route structure. All these factors make airlines become the dominant carrier in each sector. The economies also help large airline companies to spread costs on airport operations and cargo, and share the limited terminal capacity in airports.

Marketing economies of scale benefit from the cost of marketing strategy. The advertisement costs used to build popularity need to be spread. Furthermore, the revenue enhancement technology "revenue management" also needs large scale of customers to achieve.

Additionally the major airlines are in a better position to utilize by-products of their industry. The by-products from prepackaged frozen foods to computer services all can be sold to smaller companies to increase profit [3].

2. Technical economies of scale

If the cost of machinery is not considered, the average cost of each unit will be reduced when large, modern facilities which automate production are used.

On the other hand, because of the huge investment on reconfiguring machines and optimizing capacity, it is necessary to produce large quantities of products to spread the cost of machinery (on the premise of all the products can be sold out). Toyota invested a new auto production line worth ￡300,000,000 in Guangzhou in 2008 and planned to produce 150,000 cars every year[4]. Suppose Toyota recovers the cost in one year time. If the output is cut down to 15,000 per year, it will take Toyota ten years to recover the investment.

As the biggest two costs cut into airline profits, the fleet of aircraft results in high lever sunk cost and rising fuel usually means 70% of the whole operating cost[5]. The airlines have to try and fill their seats and increase their capacity usage to reduce the costs.

3. Managerial economies of scale

As early as 1776, Adam Smith identified the division of labor and specialization as the two key means to achieve a larger return on production. These two techniques increase efficiency and improve the skills by doing the same work repeatedly. In a fast fashion company like H&M and Zara, thousands of dresses are designed, manufactured, and delivered around the world in two weeks' time [8].