Alain Ruche argues: ‘Economy of scale is a myth’.
“When he was head of strategy planning at the UK Cabinet Office Geoff Mulgan commissioned a study into the evidence for economies of scale in public-sector reform. The study found none. It was not published. Economists say that if we keep moving to the right –seeking more output- from the lowest point of the Long-Run Average Cost (LAC) curve, we start to experience diseconomies of scale. The arguments are concerned with the management of costs. Cost savings will be made through common IT systems, less buildings and fewer managers. Specialization and standardization lead to lower costs and greater productivity. While it isn’t difficult to find anecdotal evidence to support the idea, there are no empirical studies showing that the LAC theory has predictive capability. Indivisibilities, fixed capital investment and specialization, the three reasons argued for economy of scale have no real evidence. The public sector has been ‘industrialized’ like mass production under the hypothesis that public services should be specialized, standardized and centralized.
Taiichi Ohno was the man who developed the Toyota Production System: a system designed to make vehicles not at the rate the machines demanded in order to achieve economies of scale, but at the rate of customer demand. While Ford was concerned with unit cost, Ohno concentrated on total cost. He took the view that cost was in flow – how smoothly and economically the parts were brought together in the final assembly – not just the aggregation of unit costs. How long the part is in the system is also part of its real cost. So Ohno’s factory had parts delivered to the manufacturing line at the rate the line required them.
While ‘scale’ manufacturing plants are usually replete with stock Ohno minimized stock throughout the process, his ideal batch size being one. Whereas most manufacturers still focus on unit costs, Ohno focused on the flow of the work, confident that better flow would lead to lower overall costs. And so it did. His system would tolerate higher unit costs; it was not dependent on low costs per unit. What was critical was the availability of the part, not the cost – an affront to convention. Ohno was the first to demonstrate that greater economy comes from flow rather than scale.
His second and more profound challenge to convention was to put variety into the line, making different models in the same production line. A corollary of economies of scale is that a system must be large and standardized to deliver high volume, and thus low cost; but by definition it can’t deliver variety at the same time. Variety = low volumes = high cost. The Toyota System disproved this axiom and broke new ground. It showed that it is possible to manufacture small volumes in high varieties at lower costs. And putting the workers in control of the line – they could stop it any time they saw a defect – would ensure flow was treated as paramount. It was Toyota’s ability to achieve high variety, high quality and low cost at the same time that caused Tom Johnson to propose that the concept of economies of scale had outlived it usefulness and should be abandoned.
Perhaps more has been written about Toyota than any other manufacturer in history, with the possible exception of Ford’s first assembly line. Yet despite its fame among manufacturers (and leaving aside the recent fall from grace, which by Toyota’s own admission was due to moving away from these principles), the Toyota System has had no influence on mainstream.”