Economies of scale overridden by diseconomies of coordination

Posted on December 20, 2010  /  1 Comments

When Bill Melody was appearing as an expert witness in the AT&T case back in the 1980s, he used to be assailed about economies of scale that AT&T supposedly enjoyed, which made them per se more efficient than any of the challengers. His answer was not that they did not exist, but that they were overridden by diseconomies of coordination. His conclusion is being supported by two scientists from Santa Fe Institute. The discussion of corporations comes at the end of a fascinating article on the laws governing cities in the NYT.

This raises the obvious question: Why are corporations so fleeting? After buying data on more than 23,000 publicly traded companies, Bettencourt and West discovered that corporate productivity, unlike urban productivity, was entirely sublinear. As the number of employees grows, the amount of profit per employee shrinks. West gets giddy when he shows me the linear regression charts. “Look at this bloody plot,” he says. “It’s ridiculous how well the points line up.” The graph reflects the bleak reality of corporate growth, in which efficiencies of scale are almost always outweighed by the burdens of bureaucracy. “When a company starts out, it’s all about the new idea,” West says. “And then, if the company gets lucky, the idea takes off. Everybody is happy and rich. But then management starts worrying about the bottom line, and so all these people are hired to keep track of the paper clips. This is the beginning of the end.”

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