Economies of Scale in the Production of Bottled Water

The economy of scale principle may be applied to the production of bottled water. Initial entry costs are significant, but once they are sunk, the per unit cost thereafter is not great. Therefore, the more water a bottler produces, the more profit will be generated because expenses will not increase significantly as sales increase. Another aspect that increases economies of scale is the proximity of the source to the bottling facility, as it correlates to cheaper raw production cost.

Here are some figures for the Danone Group, taken from their annual report. The individual numbers themselves are not as important, but the percentages and ratios derived are representative of the industry as a whole.

The operating margin, which is operating income divided by total sales, has remained fairly constant over time, as indicated in the above chart.

The ratio of the number of employees to sales has decreased over time, although minutely.

Sales have increased as well, though not resulting in a significant rise in cost.

All of these factors indicate an economy of scale principle in bottled water production. Initial entry costs are generally quite large and significant, but once these costs are sunk, the per unit cost thereafter is fairly minute. Therefore, the more water a bottler produces, the more profit will be generated because expenses will not increase more rapidly than revenues. This principle probably indicates as well why many bottlers are moving into vertically integrated production plants, sourcing the water, bottling the water, and distributing it from the same plant, minimizing the transportation of the water, which could become more expensive than the water itself. (For water that costs about one cent per gallon, it may cost five cents per gallon to transport it). For an example of this production capability, check out the Naya plant in Mirabel, Quebec, Canada.

The bottled water industry is not labor intensive. Production increases as plant size increases. Scientists are needed to certify and monitor the water source, and quality control people are needed as well, but the majority of production processes are automated. Many brands, including Evian and Naya, advertise that their water has never been touched by human hands, thus using their technological capabilities as marketing techniques.

Here's an example of large sunk costs and diminishing per unit costs:

Fixed costs for a small, regional company:

Source Certification, Pumping, Road Grading, Fencing, Holding Tanks, Disinfecting Equipment, Maintenance: $300,000.

Once this has been expended, however, the price per gallon could be as low as $.0125.