October 14, 2003
Economies of scale just ain’t what they used to be
Our eighth topic in the series “Nine trends that are going to rock your world” deals with a sea-change in the way business will operate in the coming decades. Many of us, at some time in our sordid histories, took a class called “Economics 101”. When I took Econ 101 the professor explained to us how “scale economies” work, namely that capital investment in fixed assets combined with increasing unit volume would result in reduced unit costs, and lower prices, leading to increased demand, and a perfect growth-spiral. Well at least it sounded good in class.
About a decade later I learned that scale economies are a dangerous double-edged sword. To compete in a growing product category we must invest in capacity to compete. If we “play it safe” and do not invest in more capacity, a competitor with lower unit costs could price us out of the market. If we “get aggressive” and add capacity and realize lower unit costs, we might grow market share versus a slow (or undercapitalized) competitor. But if everyone invests in more capacity, and cuts prices to grow share based on lower unit costs, we get a classic “price war” in which everybody loses. The customer benefits in the short term from increased product availability at lower prices only until one or both suppliers inevitably go out of business.
The traditional model was ideally suited to the post World War II economy as American industry had one imperative, to serve the insatiable appetite of the baby boom generation for ever more stuff. The name of the game in that expansive environment was to make one simple product, in massive quantities, to drive down unit costs and gain market share. In that high growth environment manufacturers made money automatically as volumes dependably rose above the break-even point quarter after quarter. Engineers loved making a single product over and over because they could work the bugs out of the process until defect levels were close to zero, and assembly line speeds reached Ferrari-like velocities.
Then three factors converged to blow that model out of the water in the 1990’s.
The first factor was the maturing of the baby boomers. With extraordinary levels of discretionary income available the idea of getting a “one size fits all” product was just not going to work. Boomers began demanding variety, luxury, and rapid innovation in virtually every product category.
The second factor was the explosion of information-driven computer aided manufacturing technology. In the traditional manufacturing model, changing the line over from one product to another meant shutting everything down, calling in a crew to do a “job change”, and then starting everything up again and recalibrating the operation until economic speeds and defect levels were restored. Each job change meant “upsetting” the “set points” of the manufacturing process, leading to defects and lost productivity.
As software controlled automation came into its own, companies such as Allen Bradley pioneered the concept of “mass-customization” on the assembly line. Put another way, a computer could make instantaneous “job changes” combining a palette of interchangeable parts or modular sub-assemblies into a wide assortment of end products.
The third factor was the internet revolution, enabling retail consumers and industrial customers to communicate unique wants in real-time to eager suppliers. The new standard of service was permanently reset to “I want access to everything available, instantly, in a better, updated version, at a lower cost, with zero defects (by the way).”
The impact of these three changes on scale economies was extreme. Manufacturers with large fixed cost investments not readily adaptable to quick response or mass customization found themselves caught flat footed. Today adaptability is the real economic advantage. Scale now means flexible access to manufacturing capacity in the form you need at the moment you need it. The only “survivable” strategies, whether in-house or outsourced, are modular, scalable solutions that can change on a dime, and ramp up or down to meet changing demand.
Syndicated columnist Gene C. Mage is author of the book Managing for High Performance. Visit www.makingitwork.com
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