One of the ways for a business to grow faster is to sell more and spend less. In other words, it should know how to identify economies of scale.
What You Should Know about Economies of Scale?
Definition of economies of scale
According to Merriam-Webster’s Dictionary, economies of scale mean “a reduction in the cost of producing something brought about especially by the increased size of production facilities”. It can be more simply explained that the more you make of something, the less it will cost.
Some people might assume economies of scale only appear in producing manufactured goods. However, if your business range in the areas from purchasing, specialization, and administration, then it can still benefit from economies of scale.
Additionally, it can depend on industry and location that you might experience external economies of scale. This concept could take place outside your business, yet still brings a positive impact on costs.
Economies of scale in production
You might witness the most obvious examples of economies of scale when it comes to production. But before going to details of how this work, you should know the difference between fixed costs and variable costs. Fixed costs would include expenses such as rent, equipment, and business licenses, which must be paid regardless of the number of units that a company can sell. By contrast, variable costs are the expenses that occur when the company is producing additional products.
One example of these concepts can be taken from a food truck. Equipment such as a deep fryer to make French fries is a fixed cost, which means that if you sell one or thousands of orders, the cost of a deep fryer remains the same. However, the potatoes to make those fries are variable costs, which implies that the more orders you sell, the more potatoes you have to buy, and thus the more costs it would be.
This effect can be best observed in traditional production, which has a lot of machinery or fixed costs. Additionally, to reduce this overall fixed cost over time, you can begin by improving the production equipment and efficiency. Thus, no matter how much your business expands, economies of scale will help reduce the costs.
What are the types of economies of scale?
The good news is economies of scale not only affect the manufacturing sectors but also other areas such as administration, specialization, services. Also, small businesses can take advantage of the external economies of scale without experiencing growth themselves.
Let us take an example from that food truck again. If there are plenty of food trucks in an area, then the extra supporting industry will appear around them. They can be a vehicle service or specialized restaurant supply. Moreover, since the more food trucks in the area, more workers would apply to work in these trucks. As a result, finding workers with experience for lesser salaries will be easier for the business owners.
Besides, location also plays a crucial role in external economies of scale. For instance, an area that is filled with parks, construction sites with limited food options will be more in need of food trucks. Better infrastructure is also a factor of the external economy of scale. It is true since better roads will result in better access to customers and less wear on the tire of those food trucks.
What are the benefits of economies of scale?
There are so many benefits that a business can reap from when it starts growing. In terms of specialization, when the small business first starts, often one person will oversee most roles of the company. By hiring a dedicated worker to cope with specific jobs, you will receive better work thanks to their greater expertise in each role.
About the administration, some might think it is essential to hire new workers if the business is expanding to multiple locations. But there is no need for each location to hire a management team when that can be handled centrally.
Moreover, if you are having a technical business, you might need to understand more about economies of scale that manufacturing costs will generally fall when production increases. Besides, to reduce the fixed costs, you also need to invest in equipment so that it can work for a long time with better efficiency.
Finally, your business might be still small, yet it is still better to try different ways for growing. Growing will generate some benefits including economies of scale, thus you need to ensure that your team is understanding well about the concept to take full advantage of it.
How to Improve Your Current Business Relationships
Relationships often come to one’s mind as romance and family. And building strong bonds play a critical role in a business’s success as well. It is believed that engaged employees are more productive, innovative, and healthier. While 70 percent of workers in the U.S. are disengaged.
Research from MSW Research and Dale Carnegie shows that the key determinant of employee engagement is a good relationship with his or her direct supervisor.
Some leaders might be talented in dealing with people, some might have no aptitude at all. Entrepreneurs who are in phase two of adding more staff may find that employee relationship more challenging. It is because they must work not only with their former employees but also with other new people, who could create an entirely new social system. And most entrepreneurs witness themselves falling at this point, often badly.
There are several ways involved in building strong relationships, but in this part, I will mention two important ways that can help transform the current status of relationships with your employees.
#1: Ask, do not tell
Edgar Schein, an emeritus professor at MIT’s Sloan School of Management believes that we are living a world of “tell”, which weakens the relationships instead of strengthening them. Rather than telling someone what to do or to think which could make them presume that they know nothing. You can start to improve your relationships by being inquisitive.
Inquiry can be applied in any form ranging from problem-solving, strategic thinking to get to know your employees better. Inquiry gives more opportunity for learning and understanding. There is even an old saying which contains 7 powerful words for a business leader to use: “I don’t know. What do you think?”
Asking questions is not an easy task for several leaders. When you are at the top, it is believed that you have all the answers. And admitting that you lack knowledge might raise the feeling of incompetency. But it is so important to know that when you are expanding your business into new territory, there should be no way that you can be always omniscient.
Even when you do know the correct answer, still asking inquiry can help you a lot. If an employee comes to you with a problem, you can ask instead of just proposing them a readymade solution. You might want to ask “What triggered the problem? What solutions have they used so far? Why don’t those solutions work according to you? What other solutions do you have in mind and still haven’t tried?”
Asking questions offer you so many benefits. It allows you to learn more about your employees like what is their motivation, how they see the world, and how their thinking processes work. As a result, you can predict how they will react to certain situations and better grasp their strengths and weaknesses.
Some quick tips:
Avoid any rhetorical questions that you already have the answers to. Remember that you are not trying to lead them to your solutions.
Interrogating matter will ruin your asking purpose. If employees feel like their answers could spark retaliation, they will not be going to give honest answers.
Try to ask “why” questions instead of “yes/no” ones.
It is so important to be truly interested in what you are asking. Because curiosity cannot be faked.
#2: From inquiry to empowerment
As said, inquiry can help you to improve the current relationships with your employees. However, you cannot just ask them for feedback and then ignore it. Instead, it will be better to let their input shape your decisions and let them know the reason why and how decisions are made.
An even better way is to delegate and let the employees make the decisions. You might want to take full advantage of your people’s brainpower rather than micromanaging them which might take a lot of effort and time.
To second-stage entrepreneurs, delegation is not easy since you are used to doing all by yourself. And lending the authority to someone else can be quite risky as, after all, this business is your spirit and some certain mistakes can lead to more troubles.
However, if delegating tasks makes your blood pressure skyrocketing, then you can start with trying something low risk, especially for new employees. If they do it well, delegate them bigger tasks. If things do not go like you expected, discuss the problems since you might have given them the wrong task.
Even when everything is going well, it is still crucial to keep a feedback loop going. You should always discuss the assignment about its process, results, additionally ask them and listen hard.
Delegation is not about giving up your authority, but it is temporarily lending your authority to others. And this takes time which might be unsuitable for those impatient entrepreneurs. However, it is the combination of inquiry and empowerment that could enhance trust. By delegation, the employees will feel they are working for something more than a paycheck, and they are given the active roles which could help them have a chance to perform at the highest level.
And this delegation pays off for your business when it can engage your employees, which increases not only quality, productivity, profitability but also liberates you. Instead of being a boss who cares for everything, you can become a visionary leader and coach for your employees.
How to Scale Your Company without Messing It Up
Scaling requires not only good relationships with employees but also the ability not to ruin this period.
In 2007, Starbucks CEO Howard Schultz used to complain about his chain of coffee shops that scaled from 1,000 to 13,000 stores. He believed that the expansion led to that Starbucks experience watering down and the best part of Starbucks like the aroma of roasting coffee being removed.
Another famous example of scaling clusterfugs is Home Depot’s expansion to China. The launching failed since the company did not change its “do it yourself” to “do it for me” culture, where the labor costs are much lower compared to the U.S.
These two examples show the common mistakes that the leaders have made during their scaling phase. They only paid attention to anatomy which includes the physical size and corporate culture and probably ignored the other two important parts of their businesses: first, the psychology or the culture and second, the physiology, or the processes that make it run.
And to successfully scale, the leaders should not disregard but think very intentionally about those three concepts: anatomy, psychology, physiology, and about enhancing the ability to grow in all these three in the long run.
The anatomy of a scaling organization: Achieve the right level of flatness
Hierarchies might be loved or hated by different people. On the one hand, they can prevent innovation and reduce productivity. On the other hand, power and status differences can further increase the effectiveness in many ways.
Consider a failed experiment by Google’s Larry Page, who removed all the company’s middle managers, which led to one hundred frustrated engineers reporting to one overwhelmed senior executive. Later, he had to restore the old system.
However, if the leaders know how to weave complexity into a system in a way that could do as much good and as little harm as possible, then hierarchies can propose the best benefits. A lesson can be taken from Salesforce that could strike a balance in placing the accountability evenly. Each of Salesforce’s software team was required to complete a new software demo every 30 days, yet every engineer had the right to move to a new team without getting permission, which encouraged leaders to treat people right.
The psychology of a scaling organization: Build accountability.
Accountability plays such an important role in a scaling organization. With accountability, you can lead people to the same goal and use that pressure to do the right thing. Michael Bloomberg, the mayor of New York City, used to jam himself and his 51 most crucial employees into a bullpen, which made them live and breathe his vision.
In an extreme situation, accountability is heroic. One example is at the Taj Mahal Palace hotel, where its employees were targeted by a terrorist attack in 2008. Malika Jagad, the banquet manager, after knowing that his wife and children had died somewhere in the hotel, he still tried his best to complete his task which was to lead 35 employees to protect guests.
The secret of Taj to establish such extreme accountability lies in the company’s very specific practices. It hires the people with a prewired mindset for the company, often the people from small villages who could be inspired by compensation. The company has a reward system to strengthen the mindset. Moreover, the Taj also tries to firmly establish its value through an 18-month training program while normally the typical training in the industry only lasts for 12 months or less.
Undoubtedly, the Taj is only an example and your specific solutions will rely on the type of company and challenges you might face when your business scales. But it is important to remember that scaling is a process that takes time and requires consistently taking many small actions that could add up and improve the qualities you want to scale.
The physiology of a scaling organization: Build processes to transmit excellence
Apart from the hiring and training process, which are among the most critical, a scaling business needs to bear in mind other types of processes as well. The leaders of Pulse, a company that sold itself to LinkedIn for $90 million, emphasized one process that could enhance the trust within their organization. That process started every Friday when they asked their employees to submit anonymous answers to the question: “What are you wondering about?”. While some asked for tools that make their jobs easier, others showed their confusion, like, “Is Google going to buy us?”. And by 3 p.m., these problems and issues would be responded by the founders.
The processes used by the nonprofit Institute for Healthcare Improvement are also worth mentioning. The organization did a great job of spreading pockets of excellence among hospitals. To spread that knowledge, the team did everything from maintaining the website to conducted call-ins each week for hundreds of people. Besides, its process includes identifying the mentor hospitals which are good at certain practices and made their staffs available to train others. As a result, thanks to its campaign, 120,000 fewer preventable deaths occurred.
In the end, every business will reach a period of scaling. And when it comes, the entrepreneurs should recall the definition of economies of scale to maximize the outcomes and reduce the costs as much as possible. They also need to remember that having good relationships with the employees is a critical factor to their business’s success and to achieve that, asking questions is the key. Finally, to scale without messing it up, it is essential to keep in mind all three concepts of anatomy, psychology, and physiology in order to continue moving ahead for the long term. Scaling will never end basically. If we keep on trying, investing the effort, and sticking together, then good things will keep happening.