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The Law of Scale (the benefits are “Ungodly Important”)

In his epic commencement speech to the USC law school grads in 1994, Charlie Munger mentions “scale” 24 times.

The advantages of scale are “ungodly important”, he points out.

Benefits of Scale = Lower Costs, Higher Prices & Bets on New Markets

Benefits of scale include  reducing costs, raising prices and testing new markets.

In a beer business, for example, Anheuser-Busch operates at such a higher volume than Anchor Steam beer (based in San Francisco), that Anheuser-Busch can buy bottles and cans for much cheaper than Anchor Steam (and thus charge less for their beer). Anheuser-Busch’s scale allows them to lower their costs significantly.

The Law of Scale can also allow for charging higher prices.

One of Charlie’s favorite examples of higher prices is this Wrigley gum example in which I paraphrase Charlie:

If you’re given a choice of paying $.30 for a pack of Wrigley Chewing Gum versus $.20 for “Schlotz’s Gum,” you’re likely going to choose to pay $.10 more for Wrigley because you’ve heard of it before.

The law of scale also allows a business to test new customer acquisition.

Charlie, in his USC speech, gives the example of how scale allowed Proctor and Gamble to enter the TV advertising market in the 1950′s and ’60s:

“…in the early days, we had three networks that had whatever it was—say 90% of the audience.

Well, if you were Procter & Gamble, you could afford to use this new method of advertising. You could afford the very expensive cost of network television because you were selling so many cans and bottles. Some little guy couldn’t. And there was no way of buying it in part. Therefore, he couldn’t use it. In effect, if you didn’t have a big volume, you couldn’t use network TV advertising which was the most effective technique.

So when TV came in, the branded companies that were already big got a huge tail wind.”

The law of scale can also have a “network effect” (see Google and other examples here: The Network Effect), providing the  business who who wields it with an ever-growing advantage to other parts of its business.

The law of scale is also related to social proof. As a product becomes dominant (think Google, Coca Cola, Visa, Apple, etc.), then most humans will feel at a sub-conscious level that those products are superior.

The Drawbacks to Scale

A major drawback to scale — and this is also the downside of another mental model, The Law Of Large Numbers, — is that the larger you get the harder it is for you to grow at the same levels as smaller businesses.

And with bureaucracy comes territoriality which then leads to you ignoring opportunities outside your territory.

This article on the Law of Scale continues my quest to list out The Top 100 Mental Models Needed to Succeed in Business.

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