Does "economies of scale" really make a business efficient?

July 27, 2006 11:44 AM

Economies of Scale

One thing that fascinates me about the business world is the way so many businesses around the world go for the holy grail of "economies of scale"...but how big can a company
grow before it becomes inefficient ?

Everyone I know who works for a big company always
talks about the level of waste that goes on compared
to a small company.

So do "economies of scale" really work / not work for a business ?

posted by jacobean to work & money (10 comments total)

Here's some starter information.
posted by SeizeTheDay at 11:48 AM on July 27, 2006

a lot of information here and here, via the wikipedia articles on diseconomies of scale and ideal firm size.
posted by sergeant sandwich at 11:59 AM on July 27, 2006

A major challenge (some business theorist hold that the major challenge) of managing the larger firm is the principal/agent problem.

There (theoretically should be) minimal waste in a sole proprietorship because every penny that's being wasted is coming out of his pocket.

A firm with 100,000 employees has a much harder time creating proper incentives for each employee to manage the shareholders' money as if it were his own. Indeed, large firms create perverse incentives, making actually in an individual best interest to be wasteful. Travel and entertainment policies are classic examples of this -- a big company will glady reimburse an employee's $500 hotel room and a $40 room-service breakfast, but won't give an employee a nickel's better pay if instead he spends $69.99 staying at the Motel 6 and $6.99 on a Grand Slam Breakfast at the Denny's next door.

The incredible increase in stock option compensation was designed to overcome the principal / agent problem, at least at the level of senior executives, but the evidence is no better than mixed that the way managers respond to the short-term share price incentive of stock options as ordinarily structured actually aligns with the interests of passive shareholders better than other compensation schemes might.
posted by MattD at 12:26 PM on July 27, 2006

Economies of scale apply to manufacturing plants.

For example, if you can refine a pound of ore into iron, it probably costs a lot more per pound than if you figured out how to refine a ton at a time.

Information, unfortunately, works differently. Thus, the diseconomy of scale your friends discuss.
posted by GuyZero at 12:33 PM on July 27, 2006

Economies of scale apply to manufacturing more then management.

A perfect current example of economy of scale in action is the Negroponte(sp?) "100$ laptop" . Only when produced in massive quantites does the price decrese ( 140$/unit is the current pricing )
posted by petethered at 12:53 PM on July 27, 2006

Economies of scale apply to everything.

Wal-Mart is perhaps the classic example -- they are able to price everything rock-bottom because they're buying everything in ginormous quantities. They're able to manage this through ruthless efficiencies in their logistics pipeline.
posted by frogan at 1:16 PM on July 27, 2006

Yes, they work.

Manufacturing is highly dependant on volume, so they appear there more than in other places.

Certain processes also lend themselves to economies of scale. For instance, you can make a pound of paper from pulp you make at home. To scale that process up to several million pounds of material makes no economic sense, but once your demand for the substance exceeds a certain point, you can consider industrial scale processes.

EOS also apply to service situations in which acquisition can be aggregated and a secondary economy of scale due to higher raw material input can be had. For instance, Holiday Inns can arrange for large scale contracts for toilet tissue based on annual volumes in the several million range, whereas Bob's Hotel only needs a few cases.

The models of EOS are reasonably simple, and in most, there is a point of diminishing returns where further economies do not warrant increased investment.
posted by FauxScot at 1:38 PM on July 27, 2006

When big companies talk about "economies of scale" it's often because they've merged with another company.

Now they only need one payroll department, one accounting department and so on. It's often just shorthand for

"Company A had twenty people doing the accounts; Company B had twenty people doing the accounts; but the newly-formed A-B Corp will have thirty accountants doing the work of those forty"
posted by AmbroseChapel at 2:45 PM on July 27, 2006

I've always seen economies of scale as a bathtub curve. Initially costs are reduced per unit (for whatever they do, manufacturing/service/retail whatever) then flatten out until they reach diseconomies of scale.
posted by geoff. at 5:30 PM on July 27, 2006

I suspect that government regulations create a lot of false economies of scale. Well.. More specifically, regulations are a barrier to entry into a market, unless the costs of overcoming that barrier are spread over a large scale, the business will not be profitable.
posted by Chuckles at 7:57 PM on July 27, 2006