Scale Economies exist when unit costs decline as the business size increases. Again, this Power can’t exist in the infancy of a company but the prospect of them can. Media businesses, certain high tech manufacturing businesses, and industries with high fixed costs and declining variable costs with scale can have Scale Economies as a Power.

Benefits of Scale Economies

The benefits of scale economies are all on the cost side…

• Input Cost Reduction - ie. Netflix’s early massive lead in subscriber base allowed them to pay more for content while that cost per user was still lower than the competition.

• Scale of Production / Distribution:

  • Volume/area relationships such as a fruit/vegetable processing plant located in the salad bowl of America (Salinas, CA) is going to have a big advantage over one in the midwest.

  • Distribution network density such as Amazon’s continually increasing network of delivery methods in a given area leads to lower and lower costs and the ability to offer “free” shipping

  • Purchasing economies such as Costco’s bulk sales enabling them to purchase mass quantities at low costs

Barriers of Scale Economies to challengers

Challenges to a Scale Economies Power holder will evaluate the cost of gaining market share and will either be unwilling to challenge or if they do challenge the Power holder will quickly cut prices and drive out the challenger. TSMC is investing $40-44 BILLION in capex in 2022 to increase production capacity and drive down variable costs, a competitor looking to challenge them would have to make that level of investment or likely far more to have a shot and even then the prospects would be dim.

The cost is too high and the probability of a positive outcome too low to make that gamble.

Just like with Network Economies, early stage companies will never have Scale Economies at the outset. I haven’t invested in many companies or industries with the potential for Scale Economies, and I generally try to avoid prognosticating on that potential, given how hard it is to both predict and achieve. One company that does have that potential is Revolv, an EV fleet-as-a-service business. At scale, Revolv could have a low cost of capital and purchasing power for EVs and charging infrastructure, they can offer the best value to their customers. The question will be, even if they get to that scale, are those advantages defendable and differentiated or can they be arbitraged away? Time will tell.

Up next, Switching Costs…