Internal vs. External Economies of Scale: Key Differences Explained
Internal economies of scale are cost savings a single firm enjoys as it grows larger. External economies of scale are cost savings all firms in an industry gain when that industry clusters or expands.
People confuse the two because both drop average costs, but the first depends on your company’s size alone, while the second depends on the entire sector’s footprint. Mixing them leads to flawed expansion plans and misguided location choices.
Key Differences
Internal savings arise from bigger plant automation, bulk buying, or specialized management. External savings come from shared infrastructure like Silicon Valley’s talent pool or Hollywood’s supplier networks—benefits even tiny firms can tap once the cluster exists.
Which One Should You Choose?
Chasing internal gains? Scale your own operations. Seeking external gains? Move your startup to an established hub. Often, the smartest play is layering both: grow internally while locating where the ecosystem already delivers external savings.
Examples and Daily Life
A local bakery buys a high-volume oven (internal). All nearby bakeries share cheaper flour because a regional mill opened (external). Both lower the cost per loaf, but one is inside the business, the other outside yet nearby.
Can a small firm benefit from external economies?
Yes. A two-person game studio in Montreal pays less for motion-capture studios because the city hosts many studios sharing the facility.
Do internal economies ever disappear?
They can. Bureaucracy and communication drag can push costs back up after a certain size—think of giant airlines struggling with union complexity.