In the end, the seafood packager was able to save on bulk shipping costs by doing its labor-intensive loining “on-site,” in the middle of the fishing grounds. The 60 percent of the fish that didn’t end up in the can wasn’t shipped anywhere. Meanwhile, by consolidating canning and can making in a few centralized facilities, the company ultimately realized better economies of scale where they actually applied.
Today, all leading tuna manufacturers follow a similar operations strategy. Bumble Bee ships frozen loins to its canning facility in California; Star-Kist has increased the canning and can-making capacity of its plant in American Samoa and has converted part of the operation to process frozen loins. We estimate the tuna industry has saved more than $100 million since adopting this new structure and has substantially improved return on invested capital and return on assets as a direct result of optimizing loining and canning operations.
This — you’ll excuse the expression — sea change in the fortunes of a mature industry, seemingly burdened by fixed costs and inflexible operations, was made possible only by the reconception of a commonplace idea: economies of scale. For too long, a black-and-white myopia has applied scale either everywhere or nowhere in manufacturing industries. We would argue for a more nuanced view — a fundamental reinvention of scale. This reinvention can be accomplished in most industries by breaking the operation’s value chain into vertical functions and horizontal product flows, examining the real cost drivers, and finding those parts of the business where scale applies and those where it does not. By applying the concept of scale differently across different parts of a business, a firm can unleash real power and unlock hidden value.
Why Size Matters
Few tenets of economic thought are as timeworn as the concept of economies of scale — that is, the more units you produce, the lower the cost for each individual unit. So hoary is this concept that all too often it goes unscrutinized. There are certainly industries, products, and geographies where nobody thinks being really big can help much: prescription eyeglasses, Formula 1 cars, or fine art, for instance. However, by and large, manufacturing companies believe that scale can lower their cost of goods and raise margins.
The concept of scale originated during the Industrial Revolution, when the manufacturing sphere changed rapidly from a customized universe of artisans and craftsmen producing piecework goods into factories staffed by dozens of workers taking steps toward mass production. In the custom-made clothing business, there is no scale; every tailored shirt is as expensive to make as the one before, and making a lot more shirts does not lower the cost of any one of them. But move that business into a factory outfitted with broadlooms and taking mass delivery of raw materials, and you start to realize the benefits of scale. Producing more units almost always brings the cost of each individual unit down, as the fixed costs of the looms and other overhead are spread over more and more shirts.
The early literature in what was then called “political economy” was rife with excitement over the power of this emerging concept. Adam Smith opened The Wealth of Nations with a paean to “this great increase in the quantity of work which, in consequence of the division of labor, the same number of people are capable of performing….” As business historian Alfred D. Chandler Jr. points out in his classic Scale and Scope: The Dynamics of Industrial Capitalism: “The major innovations made in the processes of production during the last quarter of the nineteenth century created many new industries and transformed many old industries. These processes differed from earlier ones in their potential for exploiting the unprecedented cost advantages of the economies of scale….” (See “Professor Chandler’s Revolution,” by Art Kleiner, s+b, Second Quarter 2002.)