Why Economies of Scale Matter in Marketing

Why Economies of Scale Matter in Marketing:

from Wide Angle by Karl Schmidt


We all have grown up with the idea that bigger is better.  Whether it was more ice cream as a kid or sales volume as a marketer, we want more.  But what if going big is no longer valuable?
My last post  explored the disruptions that have impacted external economies of scale for marketing and highlighted how one traditional source of scale advantage (consumer consumption of media) has eroded as a result of changes in technology and consumer viewing habits.  In response to that post, some have asked why it is important that this particular scale advantage is under attack.  They argue that there are lots of other sources of scale, and have even asked if this source of advantage is shrinking, isn’t it still good to be big?
Unfortunately for Marketers, the focus of the first post – fragmentation of consumer media consumption – was chosen because it is the primary external source of scale economies for marketers.  However, it sounds like a more thorough analysis is requested, which requires a review of the standard framework for sources of economies of scale.
For those interested in the early research on scale economies in marketing, I strongly recommend Arndt and Simon’s seminal 1983 paper in the Journal of Industrial Economics.  In that work, the authors established a framework for thinking about scale that I will borrow to highlight the problems faced by Marketers today.
Framework for Economies of Scale
Sources of economies of scale can either be real (advantages in some portion of the value chain that result from scale) or pecuniary (advantages in pricing power).  In my last post, I focused on the real advantages and subdivided those real advantages between internal and external.  Let’s review Arndt and Simon’s four real sources of economies of scale and analyze the opportunities for marketing to realize external advantages:
1)      Specialization/Division of labor – Adam Smith’s pin making or Henry Ford’s assembly line
2)      Indivisibility of inputs/Value chain components – reduces excess capacity/waste
3)      Better/cheaper administration – management is relatively more cost effective if cost is spread over broader base
4)      Less uncertainty – risk is reduced through diversification
#1 Specialization/Division of labor and #3 Better/cheaper administration do not have customer components and are exclusively internal.  #4 Less uncertainty may be the source of some scale advantages for larger brands to survive short term market disruptions, but I have not heard Marketers point to this as a primary scale advantage and is a secondary source of advantage at best.
This leaves #2, Indivisibility of inputs/value chain components as the primary source of external real economies of scale.  For customers, this is largely an advantage in traditional mass communication channels, which had been largely indivisible. Running a 30 second spot was more cost effective if a greater percentage of the audience were potential customers. Unfortunately, with the fragmentation of consumer attention across media today, this advantage has eroded.  But before we explore the internal sources of scale economies, we should also review the other external source of advantage – pecuniary scale – that marketers can still leverage.
Purchasing Power
With the tremendous increase in customer access to price information, it is hard to make the case that big brands have substantial advantages in customer pricing.  However, there may still be pricing power with other suppliers.  Among marketing spend, this would be most beneficial if the spend on marketing communications was significantly impacted by scale advantages.  In traditional ad buys, volume discounting gave large brands scale advantage, but agencies and media buyers have long reduced the purchasing advantages of large brands by providing for the ability to obtain externally scale advantages.  Compounding the problem is the shift of marketing spend to digital channels (and latest reports are that over 20% of total marketing ad budgets are now spent on digital).  In digital, the benefit of volume discounting is lessened as in areas like adword auctions for SEO, bulk purchasing does not provide the same pricing advantage.
This means that if there are still advantages to being big, they are going to need to be internal.  Our next post on this topic will explore what is happening to internal advantages driving economies of scale.  Without giving away too much, I have to warn you that the picture is not pretty.