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Why businesses grow: economies of scale, market power and profit

Edexcel IAL Business · WBS13 Business decisions and strategy

Many businesses set growth as a corporate objective. This lesson sets out why: lower unit costs, power in the market, a bigger share and brand, and higher profit. It also introduces the two routes to growth.

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Economies of scale

Economies of scale are the falls in average (unit) cost that come from increasing the scale of production.

Internal economies arise inside the firm as it grows:

Purchasing (bulk-buying): discounts for buying inputs in large quantities.
Technical: large firms can afford specialist, efficient machinery and spread its cost over more units.
Managerial (specialisation): specialist managers for each function.
Financial: large firms can borrow more cheaply because lenders see them as lower risk.
Marketing: the cost of an advertising campaign is spread over more sales.

External economies arise when the whole industry grows in an area, benefiting every firm: a pool of skilled labour, specialist suppliers and services nearby, shared infrastructure and research links with universities.

Market power, share and brand

Market power over customers: a large firm faces fewer close rivals, so it may raise prices without losing many customers.
Market power over suppliers: a big buyer can negotiate lower prices and better credit terms, because suppliers depend on its orders.
Market share and brand recognition: a larger share makes the brand more visible, which attracts customers and retailers, and may make the firm the market leader that others follow.
Profitability: lower costs plus pricing power can raise profit margins and total profit, rewarding owners and funding further investment.

Other reasons include spreading risk across products and markets, and managers' own goals (status and pay often rise with size).

Organic and inorganic growth

Organic (internal) growth: the business expands from within, using its own resources: more outlets, new products, new markets.
Inorganic (external) growth: the business grows by joining with other businesses through mergers and takeovers.

The next two lessons cover each route in detail.

Worked example

A bakery's average cost is calculated as total cost / output. At 2,000 loaves a week its total cost is $12,000; after expanding, at 10,000 loaves a week, total cost is $50,000. Find the average cost before and after, and explain the change.

Before: 12,000 / 2,000 = $6.00 per loaf.
After: 50,000 / 10,000 = $5.00 per loaf.
Average cost has fallen as output rose: economies of scale, for example bulk-buying flour and using a larger, more efficient oven.

Answer: $6.00 falling to $5.00 per loaf: economies of scale.

Key idea: Growth can bring internal economies (purchasing, technical, managerial, financial, marketing), external economies, market power over customers and suppliers, a bigger share and brand, and higher profit. It can be organic or inorganic.

Check yourself

A supermarket chain gets a lower price per unit from suppliers because it orders huge quantities. This is
- a purchasing economy of scale
- a technical economy of scale
- an external economy of scale
- a diseconomy of scale
Show answer
a purchasing economy of scale. Bulk-buying discounts.
Large firms can often borrow at lower interest rates than small firms. This is
- a marketing economy of scale
- an external economy of scale
- a financial economy of scale
- overtrading
Show answer
a financial economy of scale. Lenders see them as lower risk.
Which is an external economy of scale?
- Many specialist suppliers locating near a cluster of firms in the same industry
- A firm buying a more efficient machine
- A firm hiring specialist managers
- A firm spreading advertising costs over more sales
Show answer
Many specialist suppliers locating near a cluster of firms in the same industry. External economies come from the growth of the industry in an area.
A firm produces 4,000 units at a total cost of $36,000. After growing, it produces 9,000 units at a total cost of $72,000. By how much has average cost per unit fallen?
Show answer
$1.00. Before: 36,000 / 4,000 = $9.00. After: 72,000 / 9,000 = $8.00. Fall = $1.00.
How does growth give a business market power over its suppliers?
- It can charge customers higher prices
- Suppliers depend on its large orders, so it can negotiate lower prices
- It can borrow more cheaply
- It has more shareholders
Show answer
Suppliers depend on its large orders, so it can negotiate lower prices. A big customer has bargaining power.
Which is an example of inorganic growth?
- Opening ten new branches
- Launching a new product range
- Reinvesting profit in new machinery
- Taking over a rival business
Show answer
Taking over a rival business. Inorganic growth involves joining with another business.
Explain how technical economies of scale lower average costs for a large manufacturer.
Show answer
A large firm can afford specialist, efficient machinery and spread its high fixed cost over a large output, so the cost per unit falls.. Machinery, spread over more output, lower unit cost.

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Sources

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (XBS11/YBS11, 2018), Unit 3 Business decisions and strategy and Appendices 6, 7 and 9

Last updated 8 November 2026. Spotted a mistake? Tell us.