What it means
As a business grows, unit costs often fall. Fixed costs such as equipment, buildings and management are spread over more units, and larger operations can specialise and buy materials in bulk.
These savings are known as economies of scale. Eventually the savings run out.
At some point the cost per unit stops falling, and the minimum efficiency scale is the output at which this happens. Beyond it, average costs may stay flat for a range of output before eventually rising if the business becomes too complex to manage well.
The measure matters because it sets a benchmark for competitiveness. A firm operating well below the minimum efficiency scale has higher costs than rivals that have reached it, and may struggle to match their prices.
Industries with a large minimum efficiency scale relative to total demand, such as car manufacturing or aircraft production, tend to be dominated by a small number of big firms. The concept is also used in competition analysis.
If the minimum efficiency scale is a small fraction of the market, many firms can survive at the efficient size. If it is a large fraction, only a few can, which helps explain why some markets are concentrated.
In practice, finding the exact number is difficult because costs are estimated rather than observed directly. Technology also shifts the figure over time, as new methods can lower the output needed to be efficient.
Managers use it as a guide for decisions on plant size, mergers and market entry rather than a precise target.
In practice
Real-world examples.
Example
A craft brewer producing 1,000 barrels a year finds its costs per barrel are well above those of a regional brewer making 10,000 barrels. The analysis suggests a minimum efficiency scale near 8,000 barrels. The owner considers contract brewing to reach the efficient size without building a new plant.
Example
A new entrant in the car industry studies the output needed to build vehicles at competitive cost. The figure is very large relative to the market, which tells the founders that they need major funding or partners. They decide to focus on a specialist niche instead.
Example
Two regional supermarket chains consider a merger. Analysis shows that each operates below the efficient scale for distribution, and that combining their warehouses would reduce unit costs. The merger case rests on reaching that scale.
Formula
Calculation
Minimum efficiency scale = the lowest output at which long-run average cost reaches its minimum
Suppose a firm studies the average cost per unit at different plant sizes: at 1,000 units the cost is $50, at 2,000 units $40, at 3,000 units $34, at 4,000 units $32, at 5,000 units $32, at 6,000 units $32 and at 8,000 units $36. The lowest average cost is $32, first reached at 4,000 units, so the minimum efficiency scale is 4,000 units. If the whole market buys 20,000 units a year, the minimum efficiency scale is 4,000 / 20,000 = 20% of the market, meaning about five firms of efficient size could fit.Case study
Seen in the real world.
Kestrel Plastics is an illustrative, fictional manufacturer of moulded containers. Its single factory produces 2,000,000 units a year at an average cost of $0.85 per unit. A consultant estimates that the minimum efficiency scale is 5,000,000 units, where the cost falls to $0.65.
The finance director calculates the benefit. At 5,000,000 units, the saving of $0.20 per unit would be worth $1,000,000 a year, if the extra units can be sold. The additional equipment would cost $6,000,000, so the payback is six years if everything goes to plan.
In this illustrative case, the board decides to pursue a smaller step: winning a contract for 1,500,000 extra units from a supermarket supplier, taking output to 3,500,000 and cutting the unit cost to about $0.72. They agree to revisit expansion when demand has been proven.
Watch out
Common mistakes.
- Assuming that bigger always means cheaper, when unit costs flatten and can rise beyond a certain size.
- Using short-run cost data to judge the efficient scale, when the concept is about long-run costs where all inputs can change.
- Treating the estimate as precise, when it depends on assumptions that change with technology and input prices.
Questions
People also ask.
What does minimum efficiency scale mean in simple terms?
It is the smallest size at which a business can produce at the lowest cost per unit.
How does it relate to economies of scale?
Economies of scale describe falling unit costs as output grows, and the minimum efficiency scale is the point where those savings are exhausted.
Why is it important for competition?
If the efficient size is large compared with the market, only a few firms can be efficient, which shapes pricing and barriers to entry.
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