The basics of production

We should never forget the basic components of competitive advantage. Each time I present on the basics, someone always reminds me that tried and proven methods of capturing a competitive advantage need to be periodically revisited and re-evaluated.

Our businesses are changing all the time and our product/market environment is forever altering with new products and new competition. Taking another look at what we are doing thus makes commonsense. This is certainly the case with the advantages of economies of scale.

At a simplistic level, economies of scale simply mean that the cost per item or per transaction is reduced as volumes increase. The lowering of costs comes from the fact that fixed costs are spread over larger volumes, thus decreasing the fixed cost component of each item or transaction. You can see this easily in quantity price discounts, but don’t forget the overhead of running the purchasing department which is then spread over a larger number of procurements. At the same time, some service costs and advisory costs will be relatively fixed over a wide range of output volumes.

So, for example, a quality inspector might be able to cover a range of output volumes up to 10,000 units, but the next 1,000 units will require a second inspector. A marketing program might cost $1 million but be the same cost for all the companies in the sector irrespective of their size. Clearly the larger ones are getting the benefits at much lower cost per unit of output.

Don’t just think of this as large company benefits, the principal can apply to any fixed or semi-fixed cost activity which you engage in. As you examine each of your costs, ask yourself whether you could create higher volumes of the underlying transactions through extending your distribution channel or account penetration. Perhaps by offering some quantity price discounts to your own customers, you could generate higher volumes. Maybe you could find some agents or distributors to take some part of your output so that you could reach higher volumes.

Maybe you don’t have to go it alone. Are there cost elements which you could buy in partnership with other businesses in your sector or region? There is no reason why you could not have different partnership groupings for different parts of your purchases. A local chamber of commerce might assist by bringing local firms together to negotiate utilities or telecommunications. You might link up with competitors to buy in basic ingredients or components. Or you might arrange a buying group to place advertising in selected trade magazines.

The underlying driver of negotiating power in the size of the order, it doesn’t matter whether you do it alone or in combination with other firms. What you do need, however, is competition at the supply end so that you can get the competing suppliers bidding for the business. What you gain are the procurement benefits of the large companies without being large yourself. Simply, another way of harnessing the basic components of competitive advantage.

Tom McKaskill is a successful global serial entrepreneur, educator and author who is a world acknowledged authority on exit strategies and the former Richard Pratt Professor of Entrepreneurship, Australian Graduate School of Entrepreneurship, Swinburne University of Technology, Melbourne, Australia.