In a now-famous talk given to a group of students at USC Business School in 1994, legendary investor, Charles Munger, described a number of mental models. One of those models concerned scaling effects:
"And once we get into microeconomics, we get into the concept of advantages of scale. Now we're getting closer to investment analysis—because in terms of which businesses succeed and which businesses fail, advantages of scale are ungodly important.
For example, one great advantage of scale taught in all of the business schools of the world is cost reductions along the so-called experience curve. Just doing something complicated in more and more volume enables human beings, who are trying to improve and are motivated by the incentives of capitalism, to do it more and more efficiently.
The very nature of things is that if you get a whole lot of volume through your joint, you get better at processing that volume. That's an enormous advantage. And it has a lot to do with which businesses succeed and fail....
Let's go through a list—albeit an incomplete one—of possible advantages of scale. Some come from simple geometry. If you're building a great spherical tank, obviously as you build it bigger, the amount of steel you use in the surface goes up with the square and the cubic volume goes up with the cube. So as you increase the dimensions, you can hold a lot more volume per unit area of steel.
And there are all kinds of things like that where the simple geometry—the simple reality—gives you an advantage of scale."
- Charlie Munger, A Lesson on Elementary, Worldly Wisdom As It Relates To Investment Management & Business. A talk given at USC Business School in 1994.
Comments
Post a Comment