Economies of Scale

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= the myth that bigger is better and more efficient


From the Wikipedia article on 'Returns to scale':

"In economics, returns to scale and economies of scale are related but different terms that describe what happens as the scale of production increases in the long run, when all input levels including physical capital usage are variable (chosen by the firm). The term returns to scale arises in the context of a firm's production function. It explains the behavior of the rate of increase in output (production) relative to the associated increase in the inputs (the factors of production) in the long run. In the long run all factors of production are variable and subject to change due to a given increase in size (scale). While economies of scale show the effect of an increased output level on unit costs, returns to scale focus only on the relation between input and output quantities.

The laws of returns to scale are a set of three interrelated and sequential laws: Law of Increasing Returns to Scale, Law of Constant Returns to Scale, and Law of Diminishing returns to Scale. If output increases by that same proportional change as all inputs change then there are constant returns to scale (CRS). If output increases by less than that proportional change in inputs, there are decreasing returns to scale (DRS). If output increases by more than the proportional change in inputs, there are increasing returns to scale (IRS). A firm's production function could exhibit different types of returns to scale in different ranges of output. Typically, there could be increasing returns at relatively low output levels, decreasing returns at relatively high output levels, and constant returns at one output level between those ranges.

In mainstream microeconomics, the returns to scale faced by a firm are purely technologically imposed and are not influenced by economic decisions or by market conditions (i.e., conclusions about returns to scale are derived from the specific mathematical structure of the production function in isolation)." (

Discussion 1

Dave Pollard on the Power of Scaling


"The corporations would have you believe that the combination promises "economies of scale" -- that redundant positions can be eliminated, duplicate processes eliminated, volume discounts obtained from suppliers, and efficiencies obtained by combining operations. Anyone who has ever been through a combination can tell you that this almost never occurs. In fact, costs rise after the combination because of diseconomies of scale -- the larger the organization, the greater the hierarchy, the more the bureaucracy, and the more infrastructure is needed to keep it all connected. Small is agile. Large is clumsy. There are no efficiencies of scale. So why do these transactions still occur?

In a word, power. Consolidation isn't about the consolidation of resources, it's about the consolidation of power.

Size gives you four types of power:

Power over regulators: Oligopolies of three or four companies controlling an industry (and this is the case in most industries now -- check out the wonderful blog Oligopoly Watch if you doubt me) have the power (and money) to lobby governments to deregulate their industries, provide them with massive subsidies, introduce 'free' trade agreements to expand the oligopoly's reach globally, and introduce and enforce intellectual property laws that inhibit innovation and block new competitors from entering the market. We used to have 'anti-combines' laws to prevent this market distortion but the oligopolies have effectively had all such regulations eliminated, neutered, or rendered unenforceable. So now governments are effectively in the back pockets of the corporatist oligopolies. That's power, and it brings with it enormous profit.

Power over consumers: Oligopolies can and do fix prices so that consumers have no choice but to pay these prices or do without. Those that try to find workarounds like file-sharing to circumvent oligopoly price-gouging are threatened with lawsuits and jail by the huge armies of lawyers that the oligopolies employ. These oligopolies also control the media and blanket the airwaves with their propaganda. The law of 'supply and demand' is hence subverted as the suppliers control the market.

Power over suppliers: Oligopolies can and do bully suppliers to sell to them at prices just high enough to keep them solvent and dependent on the oligopolies (this type of oligopoly, more correctly called an oligopsony, essentially dictates ever-decreasing prices they will pay to manufacturers or wholesalers, Ã la Wal-Mart, since there are no significant alternative ways for manufacturers or wholesalers to get their products to the consumer marketplace). If you're both a supplier and a customer of oligopolies (like small farmers for example) you get squeezed at both ends. They have all the power.

Power over employees: Oligopolies can and do bully employees to work for minimal wages and benefits or have their jobs offshored to struggling nations whose people are so desperate they'll work for almost nothing. And why are the people of struggling nations so desperate? Because these same oligopolies work in cahoots with despots and corrupt officials in those nations to steal the land and natural wealth of those nations and leave behind nothing but pollution, waste and destitution. Although the inequality between rich and poor has never been higher, the power of 'organized' labour has never been lower. The power rests with the oligopolies." (

Kevin Carson

See the entry on Diseconomies of Scale

Felix Stalder on Clay Shirky's arguments

Felix Stalder:

" There are limits to the scale particular forms of organisation can handle efficiently. Ever since the publication of Roland Coase's seminal article ‘The Nature of the Firm’ in 1937, economists and organisational theorists have been analysing the ‘Coasian ceiling’. It indicates the maximum size an organisation can grow to before the costs of managing its internal complexity rise beyond the gains the increased size can offer. At that point, it becomes more efficient to acquire a resource externally (e.g. to buy it) than to produce it internally. This has to do with the relative transaction costs generated by each way of securing that resource. If these costs decline in general (e.g. due to new communication technologies and management techniques) two things can take place. On the one hand, the ceiling rises, meaning large firms can grow even larger without becoming inefficient. On the other hand, small firms are becoming more competitive because they can handle the complexities of larger markets. This decline in transaction costs is a key element in the organisational transformations of the last three decades, creating today's environment where very large global players and relatively small companies can compete in global markets. Yet, a moderate decline does not affect the basic structure of production as being organised through firms and markets.

In 2002, Yochai Benkler was the first to argue that production was no longer bound to the old dichotomy between firms and markets. Rather, a third mode of production had emerged which he called ‘commons-based peer production’.1 Here, the central mode of coordination was neither command (as it is inside the firm) nor price (as it is in the market) but self-assigned volunteer contributions to a common pool of resources. This new mode of production, Benkler points out, relies on the dramatic decline in transaction costs made possible by the internet. Shirky develops this idea into a different direction, by introducing the concept of the ‘Coasian floor’.

Organised efforts underneath this floor are, as Shirky writes,

‘valuable to someone but too expensive to be taken on in any institutional way, because the basic and unsheddable costs of being an institution in the first place make those activities not worth pursuing’.

Until recently, life underneath that floor was necessarily small scale because scaling up required building up an organisation and this was prohibitively expensive. Now, and this is Shirky's central claim, even large group efforts are no longer dependent on the existence of a formal organisation with its overheads. Or, as he memorably puts it, ‘we are used to a world where little things happen for love, and big things happen for money. ... Now, though, we can do big things for love’. (

Alain Ruche: Economies of Scale are a Myth

Alain Ruche:

'Economy of scale is a myth.

When he was head of strategy planning at the UK Cabinet Office Geoff Mulgan commissioned a study into the evidence for economies of scale in public-sector reform. The study found none. It was not published. Economists say that if we keep moving to the right –seeking more output- from the lowest point of the Long-Run Average Cost (LAC) curve, we start to experience diseconomies of scale. The arguments are concerned with the management of costs. Cost savings will be made through common IT systems, less buildings and fewer managers. Specialization and standardization lead to lower costs and greater productivity. While it isn’t difficult to find anecdotal evidence to support the idea, there are no empirical studies showing that the LAC theory has predictive capability. Indivisibilities, fixed capital investment and specialization, the three reasons argued for economy of scale have no real evidence. The public sector has been ‘industrialized’ like mass production under the hypothesis that public services should be specialized, standardized and centralized.

Taiichi Ohno was the man who developed the Toyota Production System: a system designed to make vehicles not at the rate the machines demanded in order to achieve economies of scale, but at the rate of customer demand. While Ford was concerned with unit cost, Ohno concentrated on total cost. He took the view that cost was in flow – how smoothly and economically the parts were brought together in the final assembly – not just the aggregation of unit costs. How long the part is in the system is also part of its real cost. So Ohno’s factory had parts delivered to the manufacturing line at the rate the line required them.

While ‘scale’ manufacturing plants are usually replete with stock Ohno minimized stock throughout the process, his ideal batch size being one. Whereas most manufacturers still focus on unit costs, Ohno focused on the flow of the work, confident that better flow would lead to lower overall costs. And so it did. His system would tolerate higher unit costs; it was not dependent on low costs per unit. What was critical was the availability of the part, not the cost – an affront to convention. Ohno was the first to demonstrate that greater economy comes from flow rather than scale.

His second and more profound challenge to convention was to put variety into the line, making different models in the same production line. A corollary of economies of scale is that a system must be large and standardized to deliver high volume, and thus low cost; but by definition it can’t deliver variety at the same time. Variety = low volumes = high cost. The Toyota System disproved this axiom and broke new ground. It showed that it is possible to manufacture small volumes in high varieties at lower costs. And putting the workers in control of the line – they could stop it any time they saw a defect – would ensure flow was treated as paramount. It was Toyota’s ability to achieve high variety, high quality and low cost at the same time that caused Tom Johnson to propose that the concept of economies of scale had outlived it usefulness and should be abandoned.

Perhaps more has been written about Toyota than any other manufacturer in history, with the possible exception of Ford’s first assembly line. Yet despite its fame among manufacturers (and leaving aside the recent fall from grace, which by Toyota’s own admission was due to moving away from these principles), the Toyota System has had no influence on mainstream economic thinking. The secret of Ohno’s method was studying the work, as a system. His favourite word was ‘understanding’.

If economy of scale is a myth and flow is what matters, what are the implications for our strategies and policies?" (

Discussion 2

There is no civilisation without scaling


"you can’t have civilisation without division of labour. The two are inseparable. Indeed, it is only when we specialise in certain sectors or develop expertise that we can achieve the sort of efficiencies that allow civilised existence to manifest.

Trust and centralised distribution are essential ingredients in that set up because without them there is no point in being a specialist. The benefits of specialisation would not be able to flow further because nobody would be able to trust you had done your job properly, thus eliminating the scaling advantage. Hence civilisation would not follow.

Look around. Structural specialisation based on trust in centralised process is everywhere around us. From the food we consume — mostly produced, slaughtered or prepared by other specialists — to the energy we depend on, or the entertainment we enjoy. Even when we cook our own meals, the ingredients, hardware or recipes we use are all the product of many other people’s specialised activities. And what makes all that specialised delegation possible is trust in the units that entitle specialists to the product of other specialists.

The way capitalism organises itself, those who specialise in sectors that are most demanded by society or which are most difficult to dislodge competitively — because of years and years of necessary investment and specialisation — gain the greatest social rewards, which are mostly distributed to them in varied claims on the product of other people’s specialisation.

This can cause resentment, tiering and inequality — especially if the specialism is inherited rather than earned. That’s not good for society because it prevents new generations acquiring the skills or knowledge necessary to deploy in useful specialisations of their own and develops a dependency on the primary specialist at the cost of other specialisations and diversity." (

Scaling in the digital economy


"The digital economy, like the financial industry, has been profoundly useful in encouraging smarter distribution and matching of other people’s specialisations vis-a-vis their wants and needs. When done well, this becomes a service that allows society to organise itself more efficiently, growing the pie for everyone. It — the service — even becomes a specialist activity in its own right.

This works great for as long as these specialists, whose core product is trust in themselves to better distribute product, don’t demand excessive returns, don’t abuse the trust and society as a whole doesn’t grow too dependent at the cost of its own knowledge, capacity or expertise.

Sadly, in both the digital and financial industry the temptation to abuse this trust can be significant. In some cases, just as per the real economy, powerful monopolies can emerge squeezing the fruits of other people’s specialisation beyond their entitlement. It’s arguably more malicious in finance and information technology, because their returns are based on allocating other people’s goods and services not even their own. Consequently, if and when there’s a major breach of trust, the implications for the real economy can be significant.

Critically, trade related scaling is impacted because vendors/producers have to once again supervise distribution directly, almost on a back to barter basis. But that’s not sustainable for a world economy which has structured itself to take advantage of scaled up services.

It is these circumstances that understandably lead us to the search for a new type of digital or financial organisation, one that doesn’t need to be trusted at all. The thinking is that if you can turn finance or information technology into a mechanism by which people’s wants and needs can be matched with those of other specialists at their own prerogative, there is no scope for abuse. You will remain in control whilst drawing benefits from information-based distribution mechanisms provided and developed by someone else.

But as I pointed out in this post, this may be a dangerous fallacy.

For a so-called P2P system to effectively reduce our dependency on a central agent or institution it must instead increase our dependency on bilateral trust relationships at the cost of our own labour and expertise. This is why these systems can’t scale!

And because unscaling or zero-scale structures simply can’t support our modern system, P2P systems don’t tend to stay P2P systems very long. They quietly evolve instead into centralised or pejorative structures.

That they have to do this is no sin of course. It’s inevitable. What is a sin is their insistence to the common man that they are somehow different to the trust/centralised systems that have come before them.

In fact, that’s the most dangerous thing about the current P2P platform fad. By presenting itself as “trustless”, it encourages the common man to take his eye off the trust abuse ball. That’s not good for society because it’s far easier to abuse someone’s trust if they didn’t even know they’re having to trust you.

In any case, what you need to know is that as time moves on, the rules that govern scaling in the real world end up governing these “P2P” systems as well. Small eBay vendors are pushed out by professionals. Amateur property landlords or hospitality agents lose business to professional landlords or hospitality agents on AirBnb. And in companies like Uber, the lowest cost service providers survive at the expense of the higher cost agents — mostly those who are prepared to go into debt to the same extent or diminish their quality of life.

Amateurs using these platform either get taken advantage of by more adept professional parties or end up trusting third parties to make decisions on their part without even knowing it.

Before you know it these platforms moat up, the winning agents become entrenched vested interests, and we arrive back at exactly the same model we had before." (

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