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Part 2: Measuring Current Economies of Scale

Measuring Current Economies of Scale
Capsule: The Company sets up its cost reduction efforts by measuring current trends in Economies of Scale. This work involves the creation of countable measures of costs and customer benefits and the use of those measures in each cost function in the Company.

The Company has the management cost accounting system to track its revenues and costs. This system works well in some companies and not so well in others. Many companies, though, could benefit by measuring the Productivity of the company’s Input costs in producing the Outputs for the customer. This system creates physical measures of both costs and benefits. A company’s measurement of these physical costs and benefits creates measures of Productivity, the ratio of the number of Inputs required to produce the Outputs for customers. In most cases, a company is able to create countable measures of cost Inputs and benefit Outputs for customers.

Once the Company has produced countable measures of Productivity, it can begin to measure the Economies of Scale that it is producing as it grows. As the Company increases in size, the fixed costs in the Company’s cost structure do not grow as fast as the Outputs for the customer. This creates more Productivity as the Company becomes larger. Over time, this better Productivity creates Economies of Scale, which is a superiority in cost structure that a larger company should enjoy over a smaller company because of the fixed costs in both companies’ cost structure. The Company can measure this Productivity improvement over time, to measure the Economies of Scale for the Company and for each cost function in the organization.

In the majority of companies, the most important cost is the cost of People. As a result, the Company would want to be particularly sensitive to the Economies of Scale the Company produces with its People. There are at least three different types, or levels, of People in each functional cost organization. The Company can improve its control over its growth of Productivity and Economies of Scale by measuring the creation of Economies of Scale among its People for each of the three different types of employee.

We discuss each of these concepts in more detail in the following sections:

Creating Countable Measures of Productivity
Capsule: Productivity measures the ratio of cost Inputs divided by Outputs for customers. Productivity is best measured in physical terms by tracking the basic costs of the Company through the cost functions in the organization and their Intermediate and Final Outputs for customers.

Measuring Economies of Scale in Each Functional Cost Organization
Capsule: Economies of Scale implies that a bigger company should have a lower cost than a smaller company due to the fixed costs in the cost structure. The Company can determine its rate of creation of Economies of Scale by measuring its Productivity as it grows. Still, size alone will not create low costs.

Measuring Economies of Scale by People Type
Capsule: The Company employs at least three different types of People: "Do", "Supervise" and "Think". Each of these types of people grows at different rates compared to the rate of growth in Output for the customer. So the Company should measure each separately in order to manage Economies of Scale.

We begin this effort by creating countable measures of Inputs, Outputs and Productivity.

Basic Strategy Guide Users Return To: Step 27

Summary Points

Next: Creating Countable Measures of Productivity