Part 2: Measuring Current Economies of Scale

Measuring Economies of Scale by People Type

Capsule: The Company employs at least three different types of People: Do Employees, Supervise Employees and Think Employees. 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.

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Symptoms and Implications:

The costs every company incurs for its People Inputs are so important in the overall cost structure of virtually every company that we recommend spending extra time understanding the costs of People and their contribution to Economies of Scale. Different salary grades of people have different rates of Productivity and creation of Economies of Scale as the business grows. The Company should evaluate the Economies of Scale by type of Full Time Equivalent (FTE) the Company employs.

Types of FTEs

The Company employs at least three different types of FTE: Do Employees, Supervise Employees, and Think Employees. Do Employees are highly variable in cost. These are the line employees of the Company. They produce the products. These employees vary most directly with the unit volume of final Output. Do Employees report to Supervise Employees. Supervise FTEs manage a few Do people. They include several levels of lower and middle management of the Company. Supervise FTEs will vary directly with the growth in the units of final Output as well. However, they are less directly variable with Output than are Do Employee FTEs because there is more of a fixed nature to their work. Supervise Employees report to the Think Employees of the Company. The Think Employees in the Company are the more senior managers of the organization. Their chief responsibility is to ensure the profitability of the organization and to chart its future course. The Think Employees vary the least with the growth of final Output of the Company. As the most extreme example, the Company needs only one CEO and one CFO, no matter how large the organization’s Output becomes.

In most cases, the Company may use salary grades to assign people to its Do, Supervise, and Think categories. When the Company uses this approach, it will easily fit specialized employees, such as engineers and researchers, into one of these three categories. The Company may use more than three categories of FTE should it wish. In order to maintain confidentiality and to ease the burden of calculation, we suggest using the midpoints of the salary ranges as the cost of each type of FTE. Using these midpoints, the Company easily creates a weighted average cost of each of the three types of employees and can calculate easily a weighted average cost for all FTEs in the functional cost organization and in the Company as a whole. The Company uses these weighted average costs in its brainstorming work where it seeks to reduce the rate of costs for the FTE in order to improve the Efficiency of the Input.

The calculation that the Company makes of its weighted average cost per FTE in the Company, and in each functional cost department, enables the Company to consider the potential savings of replacing a high cost employee with a lower cost employee. For example, using arbitrarily made up mid-points for each type of FTE, assume that a Do Employee costs about $50M per year, that a Supervise Employee costs $150M a year and that a Think Employee costs $300M a year. The Company might evaluate opportunities to reduce its costs by substituting less expensive Do FTEs for more expensive Supervise FTEs as follows. For each Do Employee the Company is able to substitute for a Supervise Employee, the Company saves two-thirds of a Supervise Employee in the functional cost department. The Do Employee, at an average rate of $50M per year, costs one-third of the average Supervise FTE, at $150M a year. Since we prefer to use physical measures in calculating Economies of Scale, this savings is the equivalent of adding one Do Employee and saving two-thirds of a Supervise FTE. Similar analyses may be employed to evaluate trade-offs between Supervise and Think FTEs.

Economies by People Type Questions

  • How many types of FTEs does the Company wish to measure for Economies of Scale?

  • What criteria, or salary grade levels, will the Company use to assign FTEs to each type?

  • What functional cost units and sub-units of the organization will the Company measure for Do Employee, Supervise Employee and Think Employees' FTE Economies of Scale?

  • Using the mid-point of each major salary grade, what is the weighted average cost per FTE in each organizational unit?

Focus on Think and Supervise

The objectives of these diagnoses are to help the Company measure its current Productivity and to create greater Economies of Scale in the future. Accordingly, the Company would measure the change in Productivity in its types of FTEs over the last several years, much as it did in the previous section. The Company should conduct an in-depth analysis of the Think and Supervise FTEs since they make up such a high proportion of the cost in the Company’s total cost structure.

The Company uses the same beginning and end-points in time for its Productivity measurements as it is used in Managing Costs: Measuring Current Economies of Scale/Productivity and Time . These points in time should be periods of three years or more. The Company also uses the same measures of Output in order to measure Economies of Scale by type of employee.

Each of these three types of employee should have a different rate of cost variability with the growth of Output. Supervise people are more fixed in cost than Do people and Think people are the most fixed in cost. The rate that each of these types of FTEs vary with the growth in Output is a characteristic of the industry. As an illustration, Do people might grow at eighty percent of the rate of growth in units of product Output. If Output increases by ten percent, the number of Do people would increase by eight percent. Supervise people might increase at sixty-five percent of the rate of increase in Output and Think people might increase at fifty percent of the rate of growth in units of product Output.

Since the Think and Supervise people are so costly, the Company would devote more analytical effort to understanding the Productivity and Economies of Scale of these two types of employees.

More Economies by People Type Questions

Analysis 59:
Employee Economies of Scale by Type of Work

Analysis 60:
"Think" and "Supervise" Employees Economies of Scale by Department

  • What are the Economies of Scale (i.e., FTE/Output) by type of employee across the Company as a whole?(Analysis 59)

  • What are the Economies of Scale by type of employee in each functional cost organizational unit? (Analysis 60)

  • Is any functional cost unit producing Diseconomies of Scale in any people type? Super-economies of Scale? What are the causes?

  • Why do Economies of Scale by type of employee vary across organizational units?

  • What would each functional cost organization unit's FTEs by type employee be if the Company grows its final Output by 10%?

Once you have completed these analyses, you have a superb picture of your current cost structure. Turn next to the Improve Costs section. There, you will develop new ideas to increase the Productivity, and Economies of Scale, of your Company.

Basic Strategy Guide Users Return To: Step 29

Summary Points Next:Improve Costs