Ever wonder how leading direct-to-consumer brands like Allbirds and Solo Brands can invest so much in research and development, marketing, and retail while offering free shipping and still turn a profit? These companies use economies of scale to reap profits by organizing their resources better and capturing a larger market share than competitors.
Achieving economies of scale allows ecommerce companies to lower their per-unit costs while growing revenue to increase profit margins.
In ecommerce fulfillment, economies of scale refer to the per-unit cost advantages that come with an increase in order volume. Generally, as a company produces and sells more product, its costs are spread out over a larger volume of goods, which can lead to lower average costs. The more the company can produce, ship, and sell, the more the costs of materials and labor decrease per unit. So as economies of scale drive down the costs of each item individually, the company can sell at a lower price and gather a greater share of the market.
Ecommerce is an exceptional market space for innovation in economies of scale. But as more businesses enter the market, consumers have a wider range of options for comparable products. When faced with several options for the same product, most consumers will opt for the cheapest, so competing on price is critical. Larger, established companies have a strong competitive advantage because they can achieve economies of scale and reduce their landed cost.
Amazon is perhaps the best example of economies of scale in ecommerce. Because of its size, Amazon can bring shipping in-house or obtain exceptional contracts from providers. On the other hand, smaller ecommerce startups will face higher shipping rates per package without the added leverage or negotiating strength.
The irony of economies of scale is that companies need to spend money to save money. When brands are just starting out, they’ll have limited funds and will want to order materials and products in smaller quantities until their order volume grows. But the nature of manufacturers, suppliers, and third-party logistics (3PL) companies is to charge higher rates for lower volume to achieve their own economic order quantity (EOQ).
As with anything else, buying in bulk in the world of distribution and fulfillment comes with cost savings. As ecommerce companies scale, they have to strike a delicate balance between providing the quality products and services that will delight customers and grow their market share while also keeping costs low enough to achieve profitability. The path to achieving economies of scale is a race to the bottom in terms of cost, but companies must be careful not to sacrifice quality.
Our research found that DTC brands that went public attributed their healthy margins in large part to achieving economies of scale through a reliable distribution network. Learn more in The New Direct-to-Consumer Playbook.
You can apply economies of scale to many operations within a company, as well as the overall ecommerce industry. The most common applications of economies of scale include technological innovations, buying in bulk, and specialization of tasks or functions. While large companies are better positioned to increase production, economies of scale can also help small- and medium-sized businesses grow.
Growth leads to more growth and opens the door for new opportunities. When a company's costs are lower, it can keep more of its revenue as profit. This can be used to reinvest in the business, expand into new markets, or increase shareholder returns. Also, when a business produces products or services at a lower cost than its competitors, it can increase market share. And when a company has more resources, it can invest in research and development, which can lead to new products and services.
Cost reductions in production and raw materials are obvious benefits of achieving an economy of scale, but the advantages don’t end there for direct-to-consumer brands.
Order fulfillment—one of the biggest operating expenses for DTC brands—is also heavily influenced by economies of scale. Just about every fulfillment expense falls on a per-order basis as a company’s order volume grows. Packaging can be purchased in larger quantities; the company can benefit from using full truckload (FTL) freight as opposed to less-than-truckload (LTL); and from negotiating lower fulfillment costs from their 3PL. Many fulfillment providers charge different rates based on a company’s expected volume, offering more attractive rates to businesses that project more orders.
Economies of scale will also streamline operations, which can help DTC brands as they develop new and improved product lines. A larger scale allows for a more efficient division of labor, making management more specialized and effective.
Growth allows businesses to expand and streamline inventory management to increase stock levels. Scaling up will reduce the need for restocking while avoiding stockouts and backorders, keeping customers happy and sales strong. When a DTC brand can place larger orders, it can often benefit from bulk pricing or negotiate better shipping rates by offering a significant volume of business.
Growing also expands advertising campaigns to spread out over larger areas and reach more people. Economies of scale apply to bulk purchases of advertising space for a reduced rate. A good marketing strategy will yield more usable data on the markets and customers, which in turn can be used to target specific areas in your business that can grow next.
Even if your ecommerce business is just getting started, you can employ these strategies to increase production and reduce costs:
By optimizing supply chain management, you'll improve economies of scale. This strategy involves consolidating the sources of materials for production and reducing the number of suppliers and vendors used, while also benefiting from the cost savings that come with buying in bulk.
Streamlining operations by implementing automation technology can help businesses to reduce their per-unit production costs. Business managers can incorporate automation into nearly every area of ecommerce, including order fulfillment, inventory management, and customer service.
Develop a strong marketing strategy based on data and proven channels, as opposed to pouring money into costly advertising campaigns. User-generated content (UGC), organic website content that is optimized for search engines (SEO), and soliciting feedback from existing customers are all ways you can supplement a paid ad strategy to grow your brand recognition.
Focus on what your business does best while outsourcing non-core functions. For example, outsourcing fulfillment to a 3PL allows smaller ecommerce companies to access the economies of scale of a much larger business through negotiated carrier rates and variable costs that would otherwise be fixed (like warehouse and staffing overhead).
Shipping costs are determined by several factors, including weight, package dimensions (or dimensional weight), fuel costs, shipping method, and distance. To achieve economies of scale, you’ll need a strategy that fits your business — whether that’s handling shipping in-house or partnering with another company.
Larger companies that ship in greater volume can often benefit from discounted services. However, even smaller companies can benefit from economies of scale in shipping. For example, using a multi-warehousing strategy can reduce the distance traveled for each individual package, cutting down on the per-item cost of shipping.
Another option is to offer customers free shipping. By offering this option after customers hit a certain threshold of spend, businesses incentivize customers to spend more, thus reducing the cost per unit. Note that this strategy will likely increase the size and weight of your average order, so the offer has to make sense in your overall strategy.
Keep in mind that packaging significantly impacts your shipping costs. Since larger and heavier packages are more expensive, your packaging strategy should make the most of the available space while using light, durable materials and dunnage that ensure the goods inside reach their destination intact.
Companies can enjoy a cost benefit from larger orders of packaging components; the price per box or mailer is likely to decrease when ordering more. This is especially true for ecommerce businesses that use branded, printed packaging as part of their unboxing experience. Some types of packaging can also cost less to ship; for example, poly bubble mailers can cost less to ship and add less volume to an order than cardboard boxes.
For ecommerce businesses, technology can be especially crucial in achieving economies of scale. Access to data analytics, automation of key procedures, AI services, and large-scale cloud computing can allow businesses to become more efficient and strategically target expansion goals.
To make the most of data analytics, you’ll need a robust set of data. Be sure to consider the fulfillment pricing model you 3PL uses. While all-in-one models are attractive for their simplicity, a la carte models provide much more insight into your per-order costs, which is necessary to fully optimize your operations and expenses.
If your ecommerce business can benefit from access to a vast shipping and warehouse network accompanied by advanced technology and tools, Airhouse can help make it a reality. Contact our fulfillment experts to try Airhouse's offerings for yourself.
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