Scale as a moat

Scale-effects are omnipresent: the large / venti / super-size drink is just 30 cents more than a regular cup; buying items in bulk is cheaper per item (I just bought 100 wall anchors and the price is about half); and even AWS Lambda gives you a discount when you consume a lot. Although some of these are the result of deliberate behavioral economics, large companies have long benefited from scale effects: because they buy more, they can negotiate better prices and operate more efficiently. Acquisitions are a natural move in scale economics because making one out of two costs less. An so are enterprise architecture standards: if we all use the same database, we can negotiate a better deal.

Economies of scale provide an economic moat for big organizations because it’s difficult for smaller companies to enter the market and compete. Marketplaces, or any business that is based on a network effect, such as social media, are prototypical examples of scale economics. Amazon even codified this effect in the “Amazon Flywheel” (actually originating from Jim Collin’s work): more sellers attract more buyers, which attract more sellers. This is also why ride sharing networks like Uber or Grab poured countless Billions into rapid growth, so they can fend off the GoJeks, Lyfts, or Bolts thanks to their scale.

Economies of Speed

Life inside the scale-defined moat has become less cozy for traditional organizations. Digital disruptors can challenge them by better understanding customer expectations, offering appealing products, releasing snazzy mobile apps, or predicting customer needs with the help of AI. These disruptors can challenge large, established organizations because the market dynamics have changed. The modern world is driven by ever-faster shifts in consumer expectations and technological advancement. Such an environment rewards speed over scale.

Economies of Speed reward companies that move fast.

Speed does not entirely replace scale, but being big often also means being slow. In an environment that is defined by Economies of Speed, that’s a problem, as positive scale effects run the risk of being undone by lack of speed.

Good scale vs. bad scale: Friction leads to bigger blocks

Some scale effects are inherent in the laws of physics, especially where moving physical goods are involved. You should pay less for multiple items to be packed into one box to be delivered to your house, instead of having five trucks drive five times to deliver five boxes. However, other scale effects are artificial or self-inflicted.

As observed in a prior post, friction leads to larger batch sizes. A classic example is the notion of an album. The main reason to bundle many songs onto one vinyl record or CD is that packaging, shipping, shelving, and selling a CD carries too much friction to sell songs one by one. Streaming eliminated this friction, making the notion of an album all but obsolete.

So, a scale effect that an organization appears to harvest may actually be a self-inflicted penalty for small batch sizes due to excessive friction. For example, infrequent, large software releases aren’t a scale effect. They are the inability to release more often due to lack of automation.

Lastly, some scale effects are entirely artificial. Large cloud providers give discounts for multi-year spend commitments. There are little scale effects in their services, so these “enterprise discount plans” are purely a pricing strategy.

The cost of coordination

Harvesting scale effects comes at a cost. Those 100 wall anchors I bought need to be stored, they may deteriorate over time, and I may never use all of them. So, what I saved on unit cost may be eaten up by the cost of keeping inventory or waste.

Platforms harvest economies of speed on economies of scale

Economies of scale are welcome, as long as they don’t distract us from economies of speed. So, one may wonder whether you can double-dip and harvest both. Indeed you can! The magic word is “platforms”: they harvest scale economics because they harmonize. They also harvest speed economics because they make teams more productive and don’t constrain.

The tension between economies of scale and speed plays out at most major organizations undergoing a transformation, which is one reason that most of them are looking into platforms.

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