3 things I learned when achieving Economies of Scale as an entrepreneur.
Economies of scale are fundamental for any product or business in any industry. The concept represents the cost and competitive advantages larger businesses have over smaller ones. In this article I will cover some of the things I learned as an entrepreneur, and give examples on how even startups and small businesses can leverage technology and product strategy to achieve Economies of scale.
So, Let’s be very clear about the explanation of Economies of scale; In short — Size does matter! However, the trick is to understand that size doesn’t have to be directly linked to your team’s or company’s headcount and that it can be leveraged in different ways just like in the financial world.
Examples for EoS:
Marketing: Can be achieved by spreading the cost of advertising and marketing budget over a greater range of media sources which can lead to better ROI per campaigns. I personally lead marketing campaigns for mobile apps, it takes time and money to optimize your campaign message and find the right marketing channel to reach your target audience. Big brands like Amazon and Booking.com have made their ability to acquire high intient users and optimize their ROI a competitive advantage in their respective industries and part of their growth strategy.
Technological: Can be achieved by taking advantage of technological advances. A nice example for that can be seen in the fast food industry with companies like Mcdonalds who not too long ago acquired Dynamic Yields to extend their drive thru business and deployed Self-service kiosks that allowed them to cut down on workers and increase the average value per order.
Managerial: Can be achieved when an organisation increases the specialization of their personnel by means of training or hiring which can result in a more effective management and development of specific parts of the business.
Monopsony power: Can be achieved when one buys big quantities of a product resulting in lower cost per unit. For example, Amazon has an advantage in the retail book market as a result of their size they get better prices which leads to a competitive advantage over other booksellers.
Financial: Can be achieved (for example) by obtaining lower-interest charges or gaining additional financial capital faster.
Network: Network EoS have become one of the key growth factors in today’s world and I’m going to write about it in detail in the future. The logic behind this EoS is based on Metcalfe’s law and suggests that the value added by a single user or customer to your product is greater than the cost of acquiring this user.
Economies of Scale as a strategy
There are different ways for achieving EoS, however, if there is one thing that I have learned during my career is that if you want to achieve something you have to:
Understand what you want to achieve and why.
Identify measurable indicators that can help you assess your progress / success.
Have a concrete action plan or strategy and define milestones for achieving your goal(s).
Achieving economies of scale can bring great value to brands that makes it part of their strategy, from lowering their production cost and all the way to a significant competitive advantage in their industries.
The diagram below presents one of the main outcomes of EoS — As the quantity of production increases, the average cost of each unit decreases — I’m going to use this outcome and demonstrate the importance of EoS and why it should be part of your strategy in early stages of your product or business:
Imagine that you are planning an event but you don’t take the time to create an invitees list, instead you go online and look for prices for invitation cards and find the following:
10 Cards — 1$ / card
50 Cards — 0.8$ / card
100 Cards — 0.5$ / card
You order 10 invitation cards for 1$ each and fill in the details of the first 10 people you have in mind, you continue with this approach until you cover all the people you wish to invite, ending up sending invitation cards to 100 people and spending 100$ for it.
When it comes to printing, prices will usually fall after the initial set-up costs of the printer resulting in more cheaper prices per unit as quantity increases. (which is a classic demonstration of EoS). In our story, if you would have taken the time to plan the invitees list and ordered 100 cards in one go instead of iteration of 10 each time you could have achieved Economies of Scale and spend 50% less on the invitation cards you ordered.
It’s important to realize that scale could only be valuable to your business once you understand what it is that you would like to achieve (i.e. How can I reduce the cost per invite card) and plan for this goal (i.e. create an invitees list in advance). Building an EoS strategy in early stages doesn’t mean that exciting products or companies cannot achieve it (on the contrary) instead it means that every change you want to incorporate in your business needs to be well considered and evaluated beforehand.
3 things I learned when achieving EoS as an entrepreneur
Economies of scale are generally associated with big organizations and often suggested that small businesses have less opportunities to achieve them. Like I already mentioned above, this statement and generalization is only true if EoS is viewed narrowly.
In today’s modern world where technology and services are common and the impact of the network can generate value even for the smallest companies it’s important to plan your moves and consider the benefits of achieving EoS.
Here are some of the things that helped me to achieve economies of scale as an entrepreneur:
Use existing services
As a small startup with big goals we had to focus on our main business, our target audience and main problems that we tried to solve. It was crucial that the objectives and outcomes will be clearly defined from a commercial perspective as well as from technological perspective. Although you might already assume what am I referring to by the title “use existing services” but you need to keep in mind that it’s not only about open source services and free tiers program it’s about understanding the following principles:
Keep features/products that are part of your core value proposition in-house (I would say even in the cost of slower time to market).
When choosing a third party service make sure it has a relatively big community that keeps it up-to-date.
Make sure to always understand the cost: (a) integration (b) flexibility © future migration.
Evaluate the cost against the added value (time to market, infrastructure, etc.)
Finding strategic partners
When building a product or a business it’s important to understand your strengths and weakness, by finding the right strategic partner(s) you can extend your resources in a way that will not only increase your velocity and capacity but can also bring competitive advantage when you launch your product.
Scaling through technology
For startups and new businesses scaling can be a great challenge! Right from the start I asked myself two questions:
How can we increase the development speed and the value proposition of our product?
How can we reduce marketing costs and still maintain a growing user base?
The answers for those two questions allowed me to build a product strategy that tied together technology and marketing. By designing a platform for rapid generation of componentes that are being used in all of our apps we were able to reduce production cost per app and used this new ability to produce more products when each product was cross promoting the usage of another.
Economies of scale can have a huge impact on the success of your business or product, understanding the basics of this principle and the way those could be adjusted to fit your needs can introduce you to a wide range of opportunities and end up increasing your value proposition to your customers or users.