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The Benefits of Economies of Scale

Vestas, one of the largest wind turbine manufacturing companies in the world, sold one of its most important internal operations to an outside partner. VTC Partners, a German industrial group, bought the operations of the company that were in charge of producing the giant steel poles that hold the wind turbine in the air.. Why would a company sell such important operations? The answer is efficiency.

Vestas has realized that it is inefficient for them to make the large steel poles “in house”. VTC has relationships with many other companies that have much higher economies of scale that can produce the poles at a much lower cost than Vestas can. The higher economies of scale that other companies possess lead to lower costs of production, which are then transferred to lower costs of purchase for Vestas. Another benefit that Vestas gains from this new relationship with VTC is a more flexible supply chain. In times of low demand for wind turbines, the in house production of the steel poles would come to a standstill costing the company a great deal of money. With the production now being outsourced, Vestas only orders as many steel poles that the demand for wind turbine calls for. This process also works because the steel poles are not specialized and can be produced by almost anyone. By removing this unspecialized production from the company, it can now focus on more specialized aspects of wind turbines such as blades and generators.

Some may see this move from Vestas being a novel idea. However, it was adopted by the automotive industry decades ago. Companies like Ford and General Motors used to produce many parts, such as windshields and brakes, in house. They soon realized that other companies could make these parts more efficiently and that they were not a differentiating feature. Therefore they would save money and increase their flexibility by buying these parts from other companies.

This is a classic case of the benefits of economies of scale. At first glance one might think it is more cost effective to have all aspects of production in house. If the operations have not reached minimum efficient scale, however, the company is wasting resources. Buying basic parts from another company that is more efficient can save firms resources and increase profits. Firms must be careful about which parts they buy from other companies. Parts that differentiate a firm’s product from others, like the engine for a Ford versus that of a Honda, should be produced by the firm. These parts are more scrutinized by the consumer much more than say the seatbelts or windows so their quality needs to be more closely measured.

One Comment

  1. In the background must be production by firms that are able to use the same facilities either (i) to make products other that poles for wind turbines, so that they don’t have such fixed costs or (ii) that because they are independent of Vestas are able to sell to others in the industry. The latter is not necessarily trivial: GM and Ford both spun off most of their parts-making operations, Delphi and Visteon respectively, which had had their “parent” companies as overwhelming customers. That’s no longer true, Delphi and Visteon now have global customer lists. [Toyota spun off its internal parts operations ca. 1950, consequent to a bankruptcy-like restructuring.]

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