This week’s podcast is about economies of scale – and why it is still the standard strategy. Especially in specialized areas and niche markets.
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- 3 Big Questions for GoTo (Gojek + Tokopedia) Going Forward (2 of 2)(Winning Tech Strategy – Daily Article)
From the Concept Library, concepts for this article are:
- Economies of Scale
- Economies of Scale – CA11 Fixed Operating and Capital Costs
From the Company Library, companies for this article are:
Welcome welcome everybody. My name is Jeff Towson and this is the tech strategy podcast where we dissect the strategies of the best digital companies of the US China and Asia and the topic for today Why economies of scale is still the default digital strategy? And this is I mean this is kind of going back to strategy 101 which is economies of scale which everybody talks about but I think very few people actually really understand it. There’s actually kind of a lot going on under that term. So I’m gonna go into just sort of the basics of how to think about economies of scale and then why it’s still basically is the key strategy for digital and most things. Now I’ll go into sort of the details of that. So it’s gonna be a bit of a theory day, sort of traditional econ theory meets newer digital thinking. Now for those of you who are subscribers, I sent you an email about this a couple days ago, economies of scale and fixed costs. I’ll touch on that a bit here, but I wanna sort of stay more general and I’ll give you some other categories, but I’ll probably be sending out a little bit more about this subject in the next week. For those of you who aren’t subscribers, feel free to go over to jefftausen.com. You can sign up there, free 30 day trials, see what you think, other stuff, Motes and Marathons, my… book series, which is gonna be six books. I’m in the home stretch basically. Books one through four in ebook and paperback are now all available on Amazon. I had to sort of fiddle with that a little bit. And then five and six will be done pretty quick because most of the thinking is done at this point. Anyways, that’s on the way. All right, and let’s see, standard disclaimer, nothing in this podcast or in my writing or website is investment advice. The numbers and information for me may be incorrect, the views and opinions expressed may no longer be relevant or accurate. Overall, investing is risky. Investing is risky. This is not investment advice. Do your own research. And with that, let me jump into the content. Now, as always, there’s some key concepts for today, which are located in the concept library on my web page. Really big surprise. The big idea for today is economies of scale. But I also wanted to talk specifically about economies of scale in fixed costs. And I usually break economies of scale down into five different types. Other people do this other ways. I use five. The most common one that people talk about, in fact, when most people are talking about economies of scale, they’re usually talking about economies of scale and fixed costs. But there are other types that are very important. And the other distinction here is I’m talking about economies of scale that is different than economies of scope, which is related but kind of different. So don’t worry about that one for right now. This is going to be the two concepts for today. Economies of scale and then economies of scale specific to fixed costs. Okay. So those are the two ideas. Now let me sort of start out with the idea that like, look, this is a really old idea. I mean… Economies of scale came right out of the Industrial Revolution, the idea of mass production. I mean Adam Smith used to talk about this stuff. So a lot of the language and the way this is viewed is very industrial. It’s very like manufacturing based. It’s a lot about tangible fixed assets and things like that. Well, I mean, the problem there obviously is once you go into digital, you start talking about intangible assets and things like that. So Accounting helps you when you’re thinking about economies of scale with physical things. The accounting really doesn’t help you when you start moving into software and digital this and intangible that. But generally the idea is when you get bigger, there’s a lot of advantages. It’s just true expertise, specialization, better management, less volatility, more stable revenue. A bigger company has a lot of advantages over a smaller company. It’s a long list. Smaller companies actually do have a couple of advantages. Probably the best one is speed and flexibility because it’s small. But generally speaking, bigger is almost always better. It just means it’s a little more difficult to manage. Okay. Now, within that list of why scale can be an advantage. economies of scale is usually the first one on the list. And the standard argument you’ll hear is, here’s factory A, which has three size, which is basically three times as big as factory B. Therefore the per unit costs of everything produced in factory A are lower. It’s a supply side and cost competitive advantage. Actually, people talk about it like volume. That’s actually not true. It’s actually a measurement of throughput You’re looking at the output produced from a factory per unit per time so it’s more like a new people would view it like One factories bigger than another so it’s like one vat of milk is bigger than a smaller carton of milk So it holds on it’s actually that’s volume. You really want to think about it more like a pipeline A bigger pipeline can push more volume through than a smaller pipeline relative to the steel it takes to construct it. The volume over time increases faster than the amount of steel you need the surface area. So it’s sort of a geometric thing as well. Anyways, don’t think about it by volume, think about it by throughput, which is output per unit per time. That’s usually how it’s thought about. Now, why would a factory with a higher throughput be cheaper, because this is mostly a cost effect, all those other benefits, why would that be cheaper than a factory with a smaller throughput? Well, there’s actually kind of a lot of mechanisms. It’s not totally simple. There’s the division of labor, specialization of labor, equipment, and complicated processes tend to get more efficient as you go to larger volumes and throughput. When you start, and that could be the factory, but then when you start putting it into shipping, transportation, you have generally less friction loss. Things get more efficient when the trucks are moving out of the factory and into the factory faster. And then actually, as mentioned, there’s sort of the geometric properties of a lot of these things like pipelines, vats. production facilities. Generally the volume goes up faster than the surface area. I’ll talk about that a little bit more. That’s one of my five types. Now when you sort of plot this out, you’re going to see the standard decreasing cost curve. And I’ll put an example in the show notes. But I mean you basically plot per unit cost on the y-axis. You put throughput, volume, and such on the x-axis, and you get a downward sloping curve to the right, which means the higher volume your per unit costs drop. Pretty standard. The other way people talk about this is they call it sort of the long run average cost, the LARC. They drop in general, and you can see this at a lot of levels. You can see it at the company level. You know, this company is just cheaper overall. You’re the lowest cost producer, mostly because of your superior scale relative to a rival. But you can also see it at the asset level. This one factory, because it has a greater throughput, is cheaper than a smaller factory, usually with less throughput. So you can see it at the asset level, and you can actually see it at multiple assets tied together. five factories that work together with the coordinating, trucking, and logistics will also see this. So you can kind of see it at multiple levels. And it’s not always obvious why it’s happening. You have to kind of take it apart company by company by company. I’m gonna give you five different types, the first one being fixed costs. But let me just jump to the, so what. It’s still the default strategy for most digital companies, but they’ve tweaked it a little bit. The default strategy for most companies, let’s say, I don’t know, YouTube, Netflix, whatever, is to get demand side economies of scale, which we call network effects, on the revenue side, and to get supply side economies of scale, which is what I’m talking about. So you sort of get this cost advantage on the cost and supply side, and you get a demand advantage on the demand side. It’s basically two different types of economies of scale. I’m talking about the cost and supply side. Okay, now there’s a couple terms you gotta think about when you start looking at this. Now the first thing to remember, this is a relative advantage. This only works if you’re bigger than your rival. That means not everyone can have this. If you have switching costs, I like switching costs. Everyone can have switching costs. My company can have switching costs. The competitor, we can all have switching costs. Economies of scale only goes to the leader because you need to have a scale differential. That’s the important term. Between the leader and a smaller company when you have the differential the scale differential you’re cheaper. If that company manages to decrease that scale differential if they start getting bigger you lose your advantage. Now generally what happens in a market is we see three or four major leaders that have superior scale and then everyone else is smaller. So Coke and Pepsi both have economies of scale advantage versus all the tiny soda companies, but they don’t have an economies of scale advantage relative to each other. Airlines it’s the same thing. United, Delta, American, all have scale advantages versus small airlines. Now there’s some feeder networks and other things going on there, but they have a… Airlines are almost entirely a cost game. They have that advantage versus smaller airlines, but not versus each other. So we call that giants and dwarfs. We see that pattern with economies of scale all the time. But the term to think about is scale differential, and I’ll put that in the show notes. And you got to ask yourself, okay… Do you have a scale differential as a large soda company or a large factory versus a smaller one? How big is it? Some companies you can be bigger, but you’re not getting a big scale differential. The economic value that you can extract by being larger is just not that big. And that often tends to be the case if there’s a lot of variable costs. The smaller player and the bigger player have more or less the same cost advantages. So you’re looking for how big is that scale differential. The other question, the term you hear a lot is indivisibility. Within my cost structure, is it indivisible, which means I can’t shrink my cost structure no matter what my volume is. So let’s say like a hospital. If I have hospital A, which has a high throughput, and I have hospital B, which has a lower throughput, Hospital B cannot decrease its cost structure relative to A because hospitals are kind of indivisible. You can’t lay off half of the staff because then you don’t have surgeons, right? Hospital cost structure is overwhelmingly fixed. Now, if you have coffee shops like a Starbucks versus a Costa, the cost structure is actually fairly divisible. If a smaller, let’s say Costa coffee chain, has lower volume, they can close outlets very, very easily. So you wanna look at the indivisibility, you wanna look at the scale differential, and the third one you wanna look at is what we call sort of the minimum efficient scale. To be a viable product or service in this business, can I have just one coffee shop or do I have to have 100 to play in this game? For most businesses that aren’t like coffee shops, there is a minimum efficient scale you need to be at to offer a competitive product. So those are the three terms, minimum efficient scale, indivisibility, and scale differential. And generally what you want in life, you wanna be the large player with economies of scale, you want a big scale differential, you want a high minimum efficient scale, and you want really high indivisibility. You want it to be not to be divisible. That means the smaller players are at a massive disadvantage to you and there’s not much they can do about it. So when you take these things apart you try and put numbers around those things. Okay and then the last question here. Does this advantage matter? If I’m a big firm and I can hire lawyers cheaper than a small firm, my administrative costs are lower than a small firm, does it really matter? Is it gonna give me strength in an activity that’s gonna help me compete? Having lower administrative costs, if I’m a big firm, I probably have lower administrative costs than a smaller firm. That doesn’t generally give you any competitive strength, but if I’m making a very cost, and price sensitive item like selling airline seats or selling a commodity that comes out of a factory, being significantly cheaper in those dimensions of production matters. So you gotta kind of ask yourself, does this play out? Who cares? Does it matter? And that’s kind of how I take it apart. There’s a lot more questions associated with that. I have… sent these out in detail to the subscribers. I’ll publish a book on this in the next couple of weeks and I’ll talk about this more. Okay. Three more general points to think about economies of scale that I think people miss often. My strength as a factory, as a product, as a hospital requires me to have superior scale. Usually we’re talking about throughput. versus a smaller competitor and to maintain my scale differential. Now, I almost always need a circumscribed market for that to be the case. I need a market with, look, there’s no more room to grow. I am a hospital in a small town up in the mountains. I have 50% of the market. If I have a competitor, the competitor has 20% of the market. there is simply no room for that competitor to grow and to decrease my scale differential because there’s no more market left. We’re a small town in the mountains, there’s only so many people, they only need so much healthcare. So if you’re gonna have a scale advantage, you really want a circumscribed market and that could be geographically circumscribed which is kind of what I said there. It could be product-based like candy bars. Candy bars is not growing dramatically at a business. They’re not innovating and opening up new dimensions of growth. If you’re selling candy bars in Texas, the market kinda is what it is, and the giant, the leaders, the Mars and the Snickers, it’s very hard for anyone. There’s no avenue or opportunity to grow as a smaller player and decrease the differential. you’re sort of stuck at a disadvantage. So you’re looking for a circumscribed market, which usually means it’s not very innovative or it’s geographic or it’s product limited, or maybe it’s a specialty product. Oftentimes niche specialty products, funky things like Etsy, you know, this weird e-commerce site, those sort of weird specialty markets. often have very hard sort of circumscribed markets. That can be an awesome place to have economies of scale advantage. Okay, so that’s point number one. Point number two, growth can kind of be a mixed blessing. If you’re dominating a market and the market is growing, that can be great for you. That’s Taobao. That’s Amazon. The mixed blessing is when it’s growing, your competitor has more opportunity to close the differential if they’re smaller than you. So that’s a bit of a mixed blessing. Alibaba talks about this a lot, that they dominate a very high growth up until recently and very innovative market so that they always have to be the best innovator. That’s how they maintain their scale differential. They don’t use those words, but they use some of them. So growth is a bit of a mixed blessing. I tend to like the mountain town better. I like supermarkets on islands. If you ever go to like Boracay in the Philippines, there’s one big supermarket. Absolute economies of scale advantage, good profits. There’s no room for growth and the market is so circumscribed, it’s literally an island. That one’s cool. Last point. It’s very rare, if you have a scale differential, economies of scale. Your competitors are always coming at you trying to decrease your advantage. It’s generally hard to do that without another type of competitive advantage on the demand side. You really want switching costs on the demand side and economies of scale on the supply side. So if they’re going to try and decrease your scale advantage, it’s very hard for them to steal a CPG products have this. They have share of the consumer mind on the demand side and economies of scale on the supply side. You almost always want some form of customer capture on the demand side. Otherwise it’s too easy for someone to steal your customers and therefore slowly catch up to you in scale. That’s the other point. Okay so those are kind of my basic points for economies of scale. Other thing to sort of keep in mind is there are diseconomies of scale traditionally. As you get bigger as a company, you do start to have more and more problems. You start to get bureaucracy. You start to get internal politics. You start to get internal coordination costs. I’ve talked a lot about coordination costs, transaction costs in the marketplace. Coasean coordination costs and… companies like Taobao and Shopee decrease these coordination costs in the marketplace. Well, you can have coordination costs inside a company, internal coordination costs. And as companies get bigger, the costs of doing things, of communicating, of coordinating activities, of duplication of effort, all become problematic within a company. That becomes a problem. becomes more and more of a problem as you become a bigger company. Inertia, an unwillingness to change becomes a problem. So basically what you see is this chart I’ve sent out many times as, as you get bigger and bigger in scale, you get decreasing per unit costs and lots of other advantages. But beyond a certain point, you get diseconomies of scale that start to eventually outweigh the advantages of size. So most companies based on traditional economics, not digital, end up at sort of medium to large, but they don’t go beyond that. Digital companies like Netflix and YouTube seem to have most of the advantages of scale and none of the disadvantages. Why? We see companies like Netflix and Disney Plus and TikTok going from nothing to nothing. to global dominance in a couple years. They don’t appear to have many of the diseconomies of scale, which is why digital is really cool. Okay, which is why economies of scale is still sort of your default strategy for digital. All right, that’s most of what I wanted to talk about in terms of just general thinking about economies of scale. And I’m gonna give you basically five types which are gonna be in the show notes. They’re in my level two competitive advantages. The first one, CA-11 is fixed costs, I’m sorry, fixed operating and capital costs. I’m gonna talk about that one shortly. CA-12, purchasing economies and bargaining power. CA-13, geographic and distribution density. CA-14, geometry effect. CA-15 learning scales. Those are the five types of economies of scale I look for. I’m not going to go through all of those because it’s kind of a lot, but that’s all covered in motes and marathons in pretty ridiculous detail. So I’ll go through those. Now let’s say you have economies of scale, which is a cost side, supply side, competitive advantage. which means you are basically cheaper than your competitors in some dimension and you want a dimension that matters. Like you can do marketing cheaper than them, you can do production cheaper than them, you can do R&D cheaper than them. Now, if you look on my symbol for level two competitive advantage, you’ll notice that I have a little graphic. I put a graphic for each of them, which is a sword and a shield. This competitive advantage you can use as a weapon or you can use it for defense. Simplest thing, if I am a factory and I am cheaper than my competitor in making, I don’t know, lamps, I can pass all of that advantage onto the customer as lower prices. So that’s playing defense. My customer’s lamps cost $1.20, well, let’s say $10, my lamps cost $8. And I’m just maintaining that all the time. And in many cases what happens, you use that either to defend your current business or to expand it because you’re cheaper so more customers come to you, which expands your market share at the expense of your competitor. You are therefore even larger than them. Your scale differential goes up and you should be cheaper. So that’s just sort of going for market share and being purely defensive. This is what Costco does. They are all about being cheap and they pass all of those advantages, savings onto their customers as lower prices and nobody can get near their cost structure. Walmart pretty much does the same thing. That’s pure defense. Now the other thing you can do, let’s say I’m making lamps, instead of charging $8, which I could do with my cost structure, I charge $9. $9.50. My competitor charges $10. So I’m pricing a little bit underneath them, but I’m basically doing is taking profits. I have a larger than normal operating profit and I can be just sort of handing that back to the shareholders. So let’s just do profit taking activity. That’s an option with my advantage. The more common one, what you see in a lot of aggressive companies is they take their advantage and they turn it into a weapon. where they say, I can sell these lamps at eight, but I’m gonna basically, instead of passing on all the savings to customers and selling at eight, I’m gonna sell them at nine, and I’m gonna take that extra dollar I make, and I’m gonna put it into marketing. And I’m gonna be cheaper than my competitor on production, and I’m gonna outspend them on marketing. So a company like 3G Capital, they talk about this all the time. They are ruthlessly efficient on production costs, the necessary costs to run their business. But every dollar they save there, they flood into their strategic costs, which they beat their competitors with. So we’ll take that extra dollar, we’ll flood it into R&D, we’ll flood it into IT, we’ll flood it into marketing. So not only am I cheaper than my competitor, but I’m outspending them on a key strategic. cost, which is usually marketing or R&D. That’s a pretty common thing. Amazon has been doing this for like 20 years. They’re cheaper than everyone because they’re Amazon. They have an e-commerce site. They were beating traditional retailers, but they haven’t been giving profits to their shareholders forever. They’re just flooding that money into IT, R&D, new initiatives. And JD in China is basically doing the same thing. That’s pretty common with digital companies. So that’s a good question though. Do you want to save money and use it, you know, to take profits or be defensive or using it as an offensive weapon in various strategic costs? Okay. So, let me talk about CA-11, which is fixed operating and capital costs. Now, most people, when they talk about economies of scale. They are sort of almost, not always, most of the time talking about fixed costs. They’ll say something like this. I have a cool company like Coca-Cola. I will go and look at their income statement and I will look for what the major fixed costs are on their income statement and lo and behold, what is the major fixed cost for Coca-Cola? It’s marketing. I don’t remember what it is, like eight, nine, 10% of their spending. And because their revenue is so much bigger than their smaller competitors, they just outspend their competitors on marketing year after year. So they’re using it as a strategic weapon. Apple does the same thing, but they flood money into marketing and R&D. They outspend everyone on the planet on research and development every year on smartphones. Now a company like Huawei is basically playing the same game. They rose to global prominence by being the lowest cost manufacturer of telecommunications equipment. They were, you know, when they were a Chinese company fighting against Ericsson and Nokia, which were based out of Europe. And Chinese manufacturing is very good at being cheap. So they drove down their production costs year after year after year, and they were just cheaper. You know, if you wanted to put up a 3G tower in the Congo. or in Saudi Arabia in 2008, 2009, Huawei was dramatically cheaper than Ericsson and Nokia. So they passed that on to their customers and they used it as a way to go outside of China and pretty much go global. About 50% of Huawei’s revenue was international starting in about 2001. They were a big low-cost manufacturer. It was all a game of scale. However, Along the way, they have also been outspending pretty much everybody in R&D. So they’re doing both. We’re the cheapest in production and we’re outspending everyone in R&D. Even now, they’ve been hit pretty hard by the entity list and the US sanctions. They’re still probably spending about $18 billion per year on R&D, on telecommunications equipment. Nobody is spending anything like that. Their big competitors, Ericsson and Nokia, I think the last time I looked they were spending $2 billion. So they are just flooding money into telco R&D with the idea that look we took a pretty good hit with the US sanctions but over the next five to ten years we will spend $80 billion on telco R&D. Nobody on the planet will spend anything like that. We think we’re going to figure this out and at the same time we will be the lowest cost producer. They’re basically a game of economies of scale. Okay, so if you look at the income statement of Huawei, Apple, Coca-Cola, you’ll see these big fixed costs. People take that as a percentage. That’s how they come up with economies of scale. That’s really not accurate. It’s really not how it works. So my explanation of this is you have to look at fixed operating and fixed capital costs. You can’t just look at the spending this month on a factory or on marketing or on R&D or this year. You’ve got to look at the operating costs, fine. You probably want a rolling average of at least one to two years. You want to look at the average volume and throughput and then figure out how much they’re doing that for. What is their operating costs for an average sort of rolling throughput? Fine, that’s what most people do. you’ve got to look at the capital costs. How much did it cost to build this factory and how much does it cost to maintain this factory? Again, at the average throughput, at the average rolling volume. And that means looking forward and backwards in time several years. Okay, you’ve got a factory and I can look at your operating costs for that factory, your equipment, your staffing, but I’ve also got to look at the maintenance capex that is required to keep that factory at its current fixed asset level. And I may have to make some significant upgrades. Maybe I’m not even increasing the volume, the throughput, but maybe I am having to do continual upgrades to the technology. So if you look at the fixed operating and fixed capital costs of a mobile network, whichever one you want to look at. orange, whatever, you’ve got to look at the cost of operating their mobile network, but you’ve got to look at the capital costs of maintaining the current network and upgrading it because upgrades are a regular part of the business. You know, 3G to 4G, you know, they have to continually upgrade their network. You’ve got to factor that into the average cost, the average fixed cost. And then within there. Pretty much everything I’ve just told you is a tangible fixed asset. You’ve got to think about the intangibles. What does it cost to maintain all the customer support for an e-commerce site? Everyone always talks about e-commerce. Oh my God, that’s a cheaper model than running traditional retail, which it is in terms of some operations. But when you look at their customer service costs, they’re actually quite high. and actually their marketing costs are really big too. So you’ve got to start looking at the intangible operating assets required, and that gets really complicated. What are the standard fixed operating costs and upper and capital costs for Adobe? They have to maintain all that software. They have to do continual upgrades. They’ve got to amortize their software expenditures. I mean, when you start to take apart sort of the operating and capital costs of a software company, it’s actually pretty hard to figure out what is a fixed cost and what is a variable cost. It’s much easier to figure out the fixed operating and fixed capital costs of a factory than a software company. But, Generally speaking software has a larger fixed component, but it actually gets pretty complicated to tease all that apart Okay, so let me give you two examples because I’ve been kind of coming at you with a lot of theory. The easy one to think about is airlines. Airlines are a cost business from top to bottom. It’s a commodity service. If you can make your airline ticket $10 cheaper than someone else, everyone switches. And then that’s the primary dimension on which you have to compete as an airline. Second to that. There’s things like frequency of flights and whatever, but those are generally reflective of your cost structure anyways. If you’re cheaper, you have more routes like Southwest Airlines. So it’s mostly a game of scale on the cost side. And you can sort of see the economies of scale, the major players, American, Delta, United, and you could put Southwest. This is for the US obviously in there. I mean, All these people do, as far as I can tell, is study their cost structure over and over and over. But, you know, and they’re also looking for a throughput metric, which is generally cost per seat flown per mile. Like, how much does it cost me to take one seat and fly at this distance, and then I try and occupy that seat, but you’re kind of looking for the seat miles and things like that. So that’s kind of the same as a throughput metric, but it’s kind of funny to think about. Because when you look at a company like Southwest Airlines, they start to look at things like what percentage of time are our aircraft on the ground versus in the air. Because every moment an aircraft is on the ground, your throughput is zero. So they’ve got to keep all of their planes physically off the earth at all times. to maximize their throughput and therefore to lower their per unit cost economies of scale. So that’s sort of the business metric, but you can also take it apart at the asset level. You could look at a route, the flight from Burbank to San Jose, very common Southwest Airlines in California, but we could also just look at the plane. Do I get economies of scale based on the geometry? And it turns out you do. As you get a bigger plane, the number of seats you can put in the plane goes up faster than the amount of steel it takes to make the fuselage. Basically, the size of the plane goes up slower than the number of seats. The volume increases faster than the surface area of the steel or whatever they make it out of. So that’s one type. And you could look at other things. All right. Does the equipment go up slower than the volume? And it turns out that’s true. As you get a bigger plane, you don’t need to increase the number of engines on the wings proportionally to the volume. So you get a bonus, fewer engines are required for more volume. It’s not a linear relationship. Okay, and then we can look at something like staffing. In staffing you actually do quite well. I can have two pilots, which are a major cost. They can fly a small plane, just like they can fly a big plane. So I can load up the bigger plane with seats, but my pilot cost doesn’t change. That’s a fixed operating cost. So it’s like the pilots are a fixed operating cost, but the engines on the wings are more like a fixed capital cost. So you can take all this stuff apart with tangible. assets and it’s Yeah, you kind of got to do it company by company So let me give you a digital example Coupon the South Korean People call it the Amazon of South Korea. It’s the JD of South Korea It’s far more like JD in China than it is like Amazon But I mean those of you who’s listened to me for a while, you know, I like digital physical hybrids I like businesses that have a lot of software but also have sort of tangible physical assets. And it’s partly because you can get economies of scale. One they’re hard to replicate. Takes a long time to build warehouses and planes. So it’s more protected than a purely digital business. But also you can get economies of scale on the physical assets. So a company like Coupang, like JD, like Amazon, you get tremendous economies of scale. what they often refer to as infrastructure. If you ever read their notes, they’ll always talk about infrastructure. But what they’re really talking about is logistics and IT. Basically, they’re talking about a lot of warehouses and a lot of trucks and then a lot of servers. Well, that’s really interesting because that’s all about economies of scale. As you open more and more warehouses, as you… buy more and more trucks. As you get more packages moving through your warehouses, you basically get economies of scale in largely a fixed operating and fixed capital cost. Now you can also get geographic density, but that’s kind of, we won’t talk about that today. So we can see it in the physical tangible assets, we can see economies of scale. But we can also see it on the digital side, because what do they have? They’re buying lots and lots of servers. Now this is economies of scale in a digital capability. This is how you get Amazon Web Services. That is a economies of scale game. They built all these servers, all these servers, and they can start to offer web services dramatically cheaper than anyone else. So when I look at a company like Amazon, Coupang, JD, on the cost side, one of the things I like so much is that we can see economies of scale in tangible assets, which are kind of easier to measure. And we can also see them in intangible digital assets, the servers, the IT, the web services. And really the one to watch is these cloud businesses. They’ve got network effects on the demand side. Network effects are demand side economies of scale. And they’ve got tremendous economies of scale on the cost side in all these servers that they’re building out. So we can see that picture there. It’s still kind of a big deal. If you ever read Coupang’s SCC filings, I mean, they will talk about where their big areas of spending are, and here’s what they’ll say, quote, nationwide fulfillment and last mile delivery infrastructure. Let me say that again. Nationwide fulfillment and last mile delivery infrastructure. That’s a big fixed operating and fixed capital cost economies of scale. They also say their big area of spending is scalable, proprietary, and integrated technology. That’s kind of a combination of economies of scale on a big fixed cost, which is building servers, and they’re teeing up the idea that they have some other advantages based on proprietary tech and things, but it’s basically a scalable infrastructure on the tech side and a scalable infrastructure on the logistics side. I think that’s most of what I wanted to say. One last quick point. Economies of scale and really barriers to entry, it’s the favorite target of a digital disrupter. Digital disruptors love to take big fixed costs, big fixed assets that give an economies of scale advantage and just disrupt them. That’s blockbuster stores. at economies of scale based on fixed operating and capital costs. But streaming and DVD sending, mailing disrupted that and turned it from a tremendous strength to a tremendous liability. Now in supermarkets, it’s still a tremendous strength, but in video stores, record stores, yeah, it’s a liability. So we often see digital disruptors targeting supply side economies of scale. It’s super common. You could argue that Amazon Web Services has done this because companies used to sell big servers and that’s how you started a company. You bought a bunch of servers and now you don’t have to buy the whole server. You can just buy the service as you need it. That’s kind of attacking what used to be an indivisible cost structure in a tech company. You had to buy a bunch of servers. It was an indivisible cost structure. Well… Amazon Web Services made it divisible. That really did hit the economies of scale of a lot of these companies. Anyways, and I think that’s it for the content for today. Kind of a bit of theory. Obviously I’m writing this book, that’s kind of why I’m focused on all this. And yeah, but two concepts for today. Economies of scale, which is a broader concept. There’s a lot of types of economies of scale. and then economies of scale based on fixed operating and fixed capital cost which is CA11, which is one of my five types of economies of scale that I look for. And that is it for the content. As for me, I am on the road. It’s six weeks on the road, which is sort of like my old life. Probably another six weeks on the road till I’m finally back home, which is great. I do enjoy it, but I’m sort of traveling around on my way from Turkey to Brazil. which is going to be great and I’ll be in Brazil, São Paulo and Rio for at least a month, which is fantastic. Then back to Bangkok and then it looks like I’m going to Germany, Stuttgart and a couple other places in October. So yeah, I think I’m on the road perpetually, which is, I like to complain about it, but the truth is I really enjoy it. So anyways, there we are. Okay, that’s it for me. I hope everyone is doing well and I will talk to you next week. Bye bye.
I write, speak and consult about how to win (and not lose) in digital strategy and transformation.
I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.
My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.
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