Crossroads

At the intersection of technology, finance and the Pacific Rim.

Saturday, May 31, 2008

Questions for the Week

What is the difference between scalability and economies of scale?

Economies of scale usually refers to the size that one must become in order to be profitable in a company’s operating environment. Technically speaking, it is the increment of profit that may be earned at the margin as you increase production. Scalability, on the other hand, refers to the ability of a company to grow—i.e., the resources or assets that a company must acquire in order to achieve rapid growth. Thus one can say that a company that has achieved economies of scale has addressed the issue (to date) of scalability. The two are very much related but not quite the same. Also, scalability is a relative term—what is scalable for a big company is not necessarily the same for a smaller firm with less resources.

Is direct more efficient or is distribution more efficient? How can we analyze the issue?

The answer revolves around the requirements and economics.of serving the end customer. The first criteria might be the cost of the sale itself relative to the value of the product. If you are Coca Cola, it is highly impractical for you to sell to every small convenience store out there. You would have to hire too many sales people and you could very well hit a point of “dis-economies of scale” as your organization would be flooded with salespeople whose job it was to sell a couple cases of coke each to literally dozens of convenience stores in their area. And then once you have sold it, you have the probably of fulfilling the order. An organizational nightmare. On the other hand, if the customer were Walmart, it could very well make sense for you to sell direct—and the rise of superstores has certainly disrupted the traditional distribution system in the US (in addition to the retail market as a whole).

Also whether you have a one tier system (direct) or four tier system (wholesale, to smaller wholesaler to retailer) you have to consider about how the end customer is served and what that end customer needs. Customer service is a key second criteria. It may very well pay for you to sell trucks that might cost $200,000 on a direct basis. After all, a salesman might go to one company and sell four to five trucks in one shot. But then the question are, “how do you service the trucks?” and “how do you get them spare parts for after sales service if they are doing their own truck service?”: This issue also contribute

I usually think of distribution as “outsourcing” of sales and service part of serving the end customer. Perhaps when put in this language the exercise of determining whether to go direct or through distribution becomes a little easier conceptually. The advent of the internet and supply chain management functions has also changed the economics of doing things on a direct basis. It is easier to reach the end customer and also the function of inventory management (an important role of distribution) becomes a lot easier through the internet and IT.

What is the difference between Winner Take All and High Scalability?

There are some cases of “Winner Takes All” but I would argue that in each case it had to do with the economics of serving the customer and yes, economies of scale. Microsoft was able to be in this very unique position, because imagine a world (in the 1980s and 1990s) where the operating system was not standardized and the work you did could not be used by others. So there was some natural inclination toward a monopoly. Similarly in telecom there might be a similar tendency if you lay expensive fiber optic lines to the home—it could very well be inefficient for two players to compete in the same place. Similarly electric utilities might be another example. These points raise interesting policy issues for government involve

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