Economic Nonsense: 32. Economies of scale mean that bigger is better


It can be true up to a point that bigger is better, and there can be economies of scale. It does vary, however, depending on the type of activity. In manufacturing, for example, larger orders for components or raw materials can yield bigger discounts. In service industries, however, bigger might mean less personal and therefore less attractive to customers. It is simply not true that bigger necessarily means better. Several different studies have put an upper limit of about 150 employees as the optimum size. Above that level relationships become more difficult and absenteeism can rise while productivity can fall. It is noticeable that some large organizations split themselves into smaller, semi-autonomous units in order to keep each one inside the threshold of manageability.

New firms are constantly entering the market and nearly always start small. Many succeed by taking business away from larger, more established firms that are slower to respond to changing tastes and needs and changing market conditions. Small firms create the overwhelming majority of new jobs in the UK. Small tends to be more adaptable, more nimble, and quicker to change. When firms grow large they can grow complacent, even sclerotic, with a bureaucracy that finds it difficult to change course. In larger units people often find it more difficult to relate to each other and to co-operate effectively.

If bigger necessarily meant better, firms would continue to grow. This does not tend to happen in practice. They expand to a size they feel comfortable with.

It has been claimed that large public industries and services, such as Britain's National Health Service, are literally too big to manage and would operate more efficiently if they were broken into smaller, more easily managed units. Experience suggests that schools have better results if their size is measured in hundreds rather than thousands.

While there can be economies of scale when a new firm is growing, there does seem to be a point after which diseconomies of scale outweigh the advantages of size.