Economies Of Scale

Almost everyone knows enough about economics to understand the concept of economies of scale. That concept, of course, makes the point that a larger organization
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Economies Of Scale

Jul 1, 2003 12:00 PM, Michael MacDonald

Almost everyone knows enough about economics to understand the concept of economies of scale. That concept, of course, makes the point that a larger organization is inherently more efficient than a smaller one because of factors like buying power, access to capital, standardizing repetitive projects, and specializing staffing. It seems plausible that a larger contractor would have a built-in advantage, right? It also makes sense that if a company becomes large enough in a geographical area, it will potentially have a large enough market share to control pricing, something that business people like to dream about and the government frowns upon.

If we take a look at the current state and recent past of the contracting world, it would appear that the venerable concept of economies of scale does not apply. Without naming names, I can think of at least three large contracting entities that raised large amounts of capital and went nationwide, only to fold within a few years.

SO MUCH FOR THAT THEORY

So what went wrong? What lessons can we learn from this series of failures?

The first lesson is that size alone is not going to make you profitable. Large companies make several assumptions that just don't pan out. Many large companies in the systems contracting business imagine that they can bid projects more efficiently than smaller companies. They surmise that by taking a cookie cutter approach to estimating and designing system projects, they can crank out more designs and bids faster and therefore garner more revenue at higher profit margins than the little guys do.

While great in theory, this has not worked in practice. The contracting business defies the cookie cutter approach. Audio and video systems installed are virtually unique for each application. It is the rare case where a system design can be taken from one project to another without modification. Of course, using old project files as templates for new jobs is a time-honored tradition, only made easier by CAD software. Almost everyone has learned that it's not that easy to port one design from one project to another. It is all too easy to overlook some element of the design and get bitten in the end.

The second lesson is based on the false assumption that large companies are more efficient because they have lower overhead ratio. Let's take a look at this one. The theory says that if you buy ten small contracting companies to make one larger one, you can lay off the management that ran each of the small companies and replace it with one management team in a central location. Additionally, you may be able to consolidate some of the company locations, reducing space and related fixed expenses like insurance and utilities. While that is possible, the corporate overhead structure frequently gets out of control and costs as much, if not more, than the pre-existing smaller company management.

One real advantage that large companies frequently have is access to capital. Having a lot of cash on hand can be a real advantage at times, but it can turn on a company fast. That happens when managers make quick decisions with the financial resources at their disposal and then don't manage the results carefully. This can result in a lot of slow moving or obsolete inventory. Dead inventory ties up working capital, and that can paralyze a business fast.

SMALL AND FAST

So how can smaller businesses keep on the roll? How can the small competitor take advantage of the large company's inherent weaknesses and maximize the opportunity? Consider the following advantages small companies have in today's competitive market.

Agility

Small companies have the inherent advantage of agility. They make decisions faster, move faster, and just get the job done more quickly. Smaller companies also have less trouble attracting qualified talent. Working for the big brand company on the manufacturing side can frequently have a positive effect on an employee's career decision, but on the contracting side, brand has less influence. Often the best employees want to work for a smaller company where they can have a relationship with managers that they trust and influence the company's direction. Everyone likes to feel that he or she can affect the future.

Smaller companies can manage fixed overhead better than larger companies

Small companies can scale overhead faster and easier. This is the most critical element in the planning and construction of any installation business. The more dynamic the industry, the more important scalable overhead becomes. What does that mean? In this business, companies sometimes experience a period of high volume followed by a period of low activity. That makes managing cash flow difficult. The best way to compensate for these dynamic peaks and troughs is to be able to quickly scale up resources needed to respond to the peaks while avoiding a fixed structure that you always have to pay for, even when the income drops off during one of the troughs. In today's economy, no one can afford to project a loss in any calendar period.

Smaller companies can manage quality and customer relationships better

This is the big one! The key to this wacky little industry is taking care of the people that are our customers. When ten small contracting companies go away and become one large contracting company, the customers that used to deal with the president of a small company now deal with a manager of a larger company. They feel demoted; customers want to deal with the top person. They want to know that if they have a problem, they are talking to person with final authority.

As a smaller company, managing this relationship dynamic can make a major difference in a customer's choice of a contractor. The best companies have learned how to make customers feel good about their relationship with the senior management of the company. In the end, if the price is close, the relationships will make the difference. Small contractors find it all too easy to get psyched out by the big guys. They start thinking that the larger companies will always win. Remember if you are the little guy, there are a lot of factors in your favor right now. Go for it!

Michael MacDonaldhas been involved in the professional audio industry for more than 20 years. He has provided sound for touring acts, special events broadcast and permanent installations, and has been employed, developed products for, and consulted with major companies such as Yamaha and JBL Professional. He can be reached atmchlmacdonald@aol.com.

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