As we enter the new millennium, headlines trumpet record levels of mergers and the
global consolidation in different industries. The primary driving force behind this
consolidation is one of the most fundamental concepts in economics-economies of scale.
Defined as the decline in long-run average cost as operation size increases, economies of
scale today incorporate much more than just the old style “Henry Ford” production
process.
Long ago, Adam Smith formally recognized the value of capitalizing on
economies of scale in his classic analysis of pin manufacturing. Later, the first Secretary
of the U.S. Treasury Alexander Hamilton argued that it would be almost impossible for
the U.S. economy to develop in a system of free and open trade because of the economies
of scale already in place in Great Britain. Unfortunately, the analytic tools available to
economists frequently lacked the precision necessary to clearly identify most economies
of scale. Even today, statistical realities make it very difficult for a 1-2 percent economy
of scale effect to be identified as statistically significant even though this change
represents a large competitive advantage over the long run.
