Many CEOs like to claim that powerful scale economies exist in their industries. Why? Well, if large economies of scale exist, then they can make a persuasive argument for growing the size of their firms. Larger firms means more power and more pay in many cases. However, the question is whether such enormous scale economies exist in every industry. The answer is simple: Of course not! In some industries, such as airplane manufacturing, the scale economies are huge and obvious. In others, such as fitness centers, the economies of scale are rather modest. As investors and analysts of companies, we need to become much more critical and skeptical of scale economy arguments. We can't just accept the assertion that bigger is better.
In some industries, it is especially important for executives, investors, and analysts to understand precisely WHERE the scale economies exist in the value chain. For instance, many people presume that large scale effects exist in the cola business, given that there are two large, dominant players. However, a closer look reveals that the scale effects exist in bottling, distribution, and marketing - much more so than in concentrate production. Similarly, if we look at the personal computer industry, we find that the scale effects are much more pronounced in the operating system business than in the personal computer assembly business.