Fixed costs are expenses that do not change with the level of output. Large firms have lower unit costs than small firms because these fixed costs are spread more thinly over higher sales volumes. For instance, take a £1 million advertising campaign. If just two items are sold the unit cost of promotion is half a million pounds. If a million items are sold the unit cost falls to just one pound. Many economies of scale are about spreading fixed costs more thinly.
Economies of scale means large organisations can often produce items at a lower unit cost than their smaller rivals - a source of competitive advantage.
It is important not to confuse total cost with average cost. As a firm grows in size its total costs rise because it is necessary to use more resources. However, the benefits of becoming bigger can mean a fall in the average cost of making one item.
Small firms compete in two ways. They either operate in service industries such as hairdressing where there are few opportunities for economies of scale, or they offer high priced, premium, niche products. Customers are prepared to pay more for exclusive goods made by small businesses.