The Advantages of Economies of Scale and Its Flaws

This article is an excerpt from the Shortform book guide to "Poor Charlie's Almanack" by Charles T. Munger. Shortform has the world's best summaries and analyses of books you should be reading.

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What are the advantages of economies of scale? Does scale come with its own disadvantages?

The advantages of economies of scale include greater cost efficiency from increased product volume, competitive advantages due to size, and more sales because of brand ubiquity. Scale can also be disadvantageous because it can lead to bureaucracy and corruption.

Read on to learn more about the advantages of economies of scale and its possible drawbacks.

On the Advantages of Economies of Scale

Businesses often seek to grow larger because of the many advantages of economies of scale. These include:

  • Efficiency: The more volume you process, the more efficiently you process the volume, and your costs per unit decrease.
  • Complex systems, when running well, become a large moat.
  • Winner-takes-all aspects: In certain industries with flywheel effects, the largest player continues to grow fastest and ends up dominating the industry. For example, in publishing, the largest newspapers got most of the circulation, which drives most of the advertising dollars, which then drives even more circulation.
  • Social proof: When everyone is using your product, then the marginal customer becomes more likely to use your product.

Munger points to chain stores as an example of a dominating business model. Larger stores get large purchasing power, which lowers merchandise costs. A larger headquarters means smart staff members who can specialize in buying in certain niches and thus make smarter decisions. And more stores means more experiments that can be run simultaneously to learn more about the market.

Contrast this with a single store operated by a single proprietor, which is in the inverse situation. This person lacks buying power, so merchandise costs a lot; she has to make lots of purchasing decisions across many categories, which likely means worse decisions. It’s difficult for this store operator to compete.

A fan of growth, Munger is skeptical of antitrust, noting that every business tries to take their success to achieve even greater success. “It’s hard for me to see why Microsoft is sinful to do this. If it’s a sin, then I hope all of Berkshire Hathaway’s subsidiaries are sinners.”

However, scale can also come with its own disadvantages:

  • Inability to specialize and explore niches
  • Bureaucracy: Large organizations can become slow to make decisions
  • Corruption: Oversight becomes more difficult, and people within an organization may condone each other’s corruption—”I won’t bother you if you won’t bother me.”
Economies of Scale: Advantages and Flaws

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Joseph Adebisi

Joseph has had a lifelong obsession with reading and acquiring new knowledge. He reads and writes for a living, and reads some more when he is supposedly taking a break from work. The first literature he read as a kid were Shakespeare's plays. Not surprisingly, he barely understood any of it. His favorite fiction authors are Tom Clancy, Ted Bell, and John Grisham. His preferred non-fiction genres are history, philosophy, business & economics, and instructional guides.

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