Economic Growth

Why scale might be the most important factor in the development of new technology

A neon Google logo is seen at the new Google office in Toronto, November 13, 2012.    REUTERS/Mark Blinch (CANADA - Tags: SCIENCE TECHNOLOGY BUSINESS LOGO) - RTR3ACWW

Scale enables big companies to have extraordinary advantage over rivals, especially smaller companies. Image: REUTERS/Mark Blinch

Mauro F. Guillén
Anthony L. Davis Director of The Lauder Institute, Dr. Felix Zandman Professor of International Management, The Wharton School, University of Pennsylvania
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Scale has been a central aspect of the development of industry and the economy over the last 300 years. Innovation in terms of sources of energy, manufacturing techniques, and services has been driven by the prospect of high volumes and large markets. After all, Adam Smith wrote that “the division of labor is limited by the extent of the market.”

Scale has become a major topic of conversation among entrepreneurs and technologists in connection to the rise of companies such as Google, Facebook, Amazon, Baidu, and Alibaba, which have come to dominate the competitive landscape. Scale enables these companies to have more data, attract more capital, enjoy stronger network effects, and reach tipping points, giving them an extraordinary advantage over rivals, especially those that are smaller in size.

From an economic point of view, scale only matters when there are large fixed costs associated with doing business. Fixed costs are those that do not change with the volume of production. When large fixed investments are needed, companies seek to grow quickly and become big so that they can spread the fixed costs over a large number of products sold or customer served.

One area of specific interest nowadays is how big data might affect the impact of economies of scale. This new technology opens up a large array of possibilities for exploring problems related to basic research, diagnosis, forecasting, product design, advertising, marketing, and many other fields. Here’s the catch: big data means big data, that is, the potential of the technology and its accuracy depend on having access to massive amounts of data collected in real time about as many units of observation (i.e. consumers, products, systems, etc.) as possible. Large companies have an intrinsic advantage when it comes to collecting big data. To the extent that they are proprietary, they represent a major competitive advantage.

A similar argument may be made regarding national markets. The intuition is that companies with a large domestic market enjoy an advantage in global competition. Even in the absence of protectionism, they know the market better and they may benefit from first-mover advantages, from having an established presence in the market. It is true that firms from small markets have no choice but to innovate and to expand internationally, and might well become more competitive out of necessity. In the age of big data, companies from large markets will also enjoy an advantage in that they will have access to larger amounts of big data. This effect gets multiplied by the fact that the largest national markets of the future—especially China and India—are markets in which the rate of adoption of technologies such as mobile payments or the Internet of Things are among the highest in the world. Thus, not only more people but also more people using interconnected devices means more big data. In the future, companies that have a strong presence in the larger markets will enjoy a huge advantage when it comes to using big data. Whether those companies are local or foreign remains to be determined. Suffice it to say for now that in the Chinese and Indian markets local firms are nowadays better positioned than foreign firms. The cases of Baidu and Alibaba make this abundantly clear in the Chinese case.

The advantages of scale also manifest themselves financially. It took Hewlett Packard 36 years to qualify to join the Standard and Poor’s 500. Microsoft brought the figure down to 19 years, and Amazon to 11 years. The record has been set by Google and Uber, both at 6 years, while AirBNB took 7, and Facebook had to wait 9. Access to capital represents an enormous advantage. For startups, it can make the difference between remaining embryonic and being born as a company. For established players in the technology area, it marks the difference between life and death. The technologies of the future require not only large amounts of money to discover and refine, but also to deploy.

Perhaps the single most important factor in the future development of technology will not be the process of innovation itself but how effectively companies align themselves with large transformations in the marketplace so that they can gain scale quickly. The rise of the global middle class of consumers means that every year there are 105 additional million people with sufficient purchasing power to participate in the markets of the future. Falling prices are also making technology accessible to the so-called bottom of the pyramid markets, which are the fastest growing nowadays. Thus, the future of technology belongs to the companies that ride these waves of market growth while exploring new frontiers and innovating.

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Related topics:
Economic GrowthManufacturing and Value ChainsBusiness
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