Is Bigger Still Better?

SCIENTIFIC AMERICAN March 1994 109

THE ANALYTICAL ECONOMIST

Buried somewhere in every basiceconomics text lies a sleepy sec-tion on economies of scale. The

titans of economic theoryÑfrom Marxto Smith to SchumpeterÑgravitated to-ward one conclusion: capitalism inex-orably leads to mass production by bigenterprises. More than a century of anal-ysis has served only to contrast MarxÕsmaxim ÒThe larger capitals beat thesmallerÓ to textbook mogul Paul Samuel-sonÕs adage ÒLarge size breeds success.Ó

Discussions of economies of scale of-ten focus on the role of technology andhow it makes vast production runs pos-sible. On a graph the cost per widgetdrops as the quantity produced rises.Economists, in fact, borrow an exampleof scale economies from engineers whodesign gas pipelines. The cost of a pipe-line is roughly proportional to its circum-ference, which determines the amountsof steel needed to build it, but its gas-carrying capacity is equivalent to itsarea. Wider pipelines have dispropor-tionately increased capacity and thuslower unit costs.

The invention of the microchip sug-gests to some modern pundits the pos-sibility that the classic relationship canbe inverted. As the circuitry shrinks,smaller computers can handle the sameamount of work that had been assignedto a hulking cybernetic ancestor. Unlikethe gas pipeline, the eÛciencies comefrom dramatic reductions in the size ofthe means of production. ÒTechnologiesare less lumpy than they used to be,Ósays Harvard University economist DaleJorgenson. ÒThe economies associatedwith a mainframe are mimicked by a lo-cal-area network [LAN]. But the LAN isless indivisible. You can add or subtractunits.Ó

Such a concept becomes particularlypotent when markets demand increas-ing customization. The management andcontrol eÛciencies that computers makepossible mean that capitalists can de-ploy many assembly lines, each turningout a different variant of the same good,instead of one huge line stamping outidentical products. Henry Ford has beenpreempted: you can now get a widgetof any color you want, including black.

In burgeoning service industries,meanwhile, the new technology mini-mizes Òtransaction costs.Ó A computer

network, for example, makes it possibleto enter a piece of information such asan airplane reservation just once. Thegoal is not to pump an ever increasingamount of bits through an electronicpipeline but rather to make the mostuse of each bit.

A more speculative notion is whetherthe smaller means of production alterthe scale of the organizations that usethem. In other words, do companiesscale down along with the size of thewire widths in their computers? If theydo, then relatively small Þrms mightsometimes compete with larger ones onequal terms (or at least until the moresubstantial rival responds by institut-ing its own eÛciencies).

Is production of fewer numbers ofmore specialized products better car-ried out by a small company? Erik Bryn-jolfsson and Thomas W. Malone of theMassachusetts Institute of Technolo-gy have found evidence that suggestssmaller companies may be better atproducing short runs of specialized

products than are their oversized cous-ins. The two led a study that correlateda 20 percent decline in the number ofemployees in industrial Þrms with atripling in the investment in informa-tion technology over the decade of the1980s.

This trend, Brynjolfsson says, cannotfor the most part be explained by theprevailing idea that machines replacepeople. Instead the investment in com-puters and networks often makes itcheaper to farm out work to low-costspecialists rather than to retain the rigidorganizational structure needed to man-age the entire process under one roof.Small automotive-parts companies grow,and General Motors lays oÝ workers.ÒThere is a silent majority of very smallenterprises hiring as fast as big Þrmsare laying oÝ,Ó Brynjolfsson says.

Other economists look at the statis-tics and draw a nearly opposite conclu-sion. ÒThe small-Þrm myth is not true.ItÕs a myth thatÕs partly ideology andpartly wishful thinking,Ó says Bennett

Harrison, a professor of political econ-omy at Carnegie Mellon University. ÒAfter adjusting for ups and downs ofthe business cycle, the share of jobs attributed to small and medium-sizeÞrms has stayed almost exactly ßatsince 1960.Ó

True, large companies have slimmeddown, but they still account for a dis-proportionate share of economic activ-ity, Harrison argues. The notion that di-minishing costs lower the break-evenpoint for investing in a new technologyis often valid at the level of the individ-ual computer-controlled machine butnot at the scale of a business. A bigcompany will have the resources andcapital to invest in using the equip-ment most eÝectively. And as for ßexi-bility, Òthe technology can produce cus-tomized small lots, but that can be donein the corner of a Ford Motor Companyplant as easily as in a small business,Óhe contends.

Attempts to settle the argument infavor of either big or small Þrms mayultimately be futile. Instead of trying todetermine an optimal Þrm size in avacuum, some academics are looking atthe relationships among small Þrms,large Þrms and the political and eco-nomic environment around them.

These studies are often as much thediscipline of the geographer as they are of the economist. At the University of California at Los AngelesÕs LewisCenter for Regional Policy Studies, re-searchers are studying the means bywhich industrial districts such as Sil-icon Valley, the southern California aero-space industry or the agglomeration oftextile Þrms near Florence (known asthe Third Italy) achieve ÒexternalÓ econ-omies of scale. Once a regional indus-try has begun to grow, it attracts askilled labor force and a supporting in-frastructure of city streets, expresswaysand airports. Small specialty Þrms thenmay coexist with giant production hous-es. The scale factors can involve hun-dreds of thousands of workers spreadover a few square miles rather than sin-gle plants or pipelines.

The simple cost-curve portrayal oftraditional economies of scale may grad-ually fade from future texts. Perhapsthe only certainty in the big versussmall debate is that to capture the sub-tleties of these arguments the text-books themselves are bound to grow insize. ÑGary Stix and Paul Wallich

Is Bigger Still Better?

Economists ponder the notion that a firmÕs sizemay shrink along with thecircuits in its computers.

Copyright 1994 Scientific American, Inc.