Analysis 59: Economies of Scale by Type of Employee


HOW TO INTERPRET THE ANALYSIS: This analysis portrays the growth rates and Economies of Scale of the units of each type of Full Time Equivalent (FTE), "Think", "Supervise" and "Do". It measures these growth rates over a period of at least three years. The horizontal dotted line indicates that the units of Output in this company are growing at 25% per annum. The vertical bars represent the company's FTE growth rates by type of employee. Any growth rate of FTEs less than 25% but greater than zero creates sustainable Economies of Scale. Any growth rate in FTEs above 25% per annum creates Dis-economies of Scale, where the company becomes less cost effective as it increases its Output. Any shrinkage in head count while unit sales are growing creates Super Economies of Scale. Neither Dis-economies or Super Economies of Scale are sustainable over a long period of time.

In this exhibit, "Think", "Supervise" and "Do" FTE head counts are compared to the rates of growth for the overall FTE head count and for the customer transaction Output. The company is creating Economies of Scale as its overall head count grows at 16% while units of Output grow at 25%. However, the "Think" people are growing faster than the overall head count and as fast as "Do" people. This should cause the company to ask why "Think" people should be growing as fast as "Do" people. Normally, the company would expect that the "Think" people would grow at a rate slower than both "Supervise" and "Do" people.

PURPOSE: This analysis groups employees by three salary grade groupings and then measures the Economies of Scale (EOS) of each group. The company uses this analysis to ensure unit costs fall as volume grows by analyzing more detailed Economies of Scale measures by FTE types with different costs.

APPROACH: The finance and human resources functions assign each compensation grade level to one of these three types of FTE. As a rule, non-exempt people tend to be "Do" people. The exempt employees fall into the "Think" and "Supervise" categories and are placed in their respective categories using salary grades as the best indicator of their work type.

If the company cost structure grows more slowly than does its Output, it creates sustainable Economies of Scale. Sustainable Economies of Scale happen whenever the growth rate in head count is somewhere between zero and the rate of growth in units of sale. Creation of Economies of Scale enable the Company both to reduce its unit costs as it grows, and to improve its cost position compared to competitors, as long as the Company grows market share.

Dis-economies of Scale occur whenever head count rises at a faster rate than does the rate of unit sales growth. Dis-economies of Scale would imply that the company becomes less cost effective as it grows its business.

Super-economies of Scale occur when an organization's head count actually declines as the company adds volume. Super-economies of Scale are always temporary. They usually occur when the company has implemented a major change in technology, which produces a significant reduction in force for one or several departments. Super-economies can also occur when departments are de-centralized to other parts of the organization. This latter kind of Super-economies are merely accounting changes, rather than true Economies of Scale.

In broad terms, the company employees fall into three groups according to the type of work they do. First, there are the "Do" people. These members of the organization have no one reporting to them and are responsible for executing the tasks set for them by the other members of the organization. They are the less costly, lower compensation grade people in the organization. The "Supervise" people are middle managers and, often, technical employees. They have higher compensation grades and often have people reporting to them, but are not members of the management of the company. The "Think" people are members of the management of the company. They include department heads, deputy department heads, senior research and engineering staff and others responsible for plotting the development of the company.

Each type of employee should grow at a different rate as the company grows its sales units. That is, each should have its own unique rate of creation of Economies of Scale. The following are all hypothetical examples. "Do" people might grow at 80% of the rate of the growth in units, while "Supervise" people grow at 65% and "Think" people grow at 50% of the rate of unit Output growth.

Return to Diagnose Costs: Measuring Economies of Scale by People Type

Return to Basic Strategy Guide Step 29

Recommended Reading

For a greater overall perspective on this subject, we recommend the following related items:


Symptoms and Implications: Symptoms developing in the market that would suggest the need for this analysis.

Perspectives: Conclusions we have reached as a result of our long-term study and observations.

  • "Making Acquisitions Work in Hostile Markets"
    Strategic acquisitions can help a company through hostility, but the acquisition target must add the right customers to the buyer's base and reduce unit costs without sacrificing customer service. (1995)

  • "Costs: The Last Consideration"
    As margins fall and profitability slides, the obvious first response is to cut cost. Knowing why that may be the wrong choice requires an understanding of the difference between effective cost control in hostile and non-hostile markets. (1995)

  • "Cutting The Right Cost" When markets turn hostile, managers turn to cost cutting. Reducing cost seems like the most direct route to improving profitability. Often, though, efforts to control costs make the situation worse. (1991)

  • "Getting Bigger, Getting Smarter"
    During hostility, acquisition is a realistic path to achieving, quickly, significant share growth. The full value of the acquisition can be achieved, though, only if reductions in cost occur along with market share growth. (1996)