Now we come to another somewhat less reliable form of human wisdom—microeconomics. And here, I find it quite useful to think of a free market economy—or partly free market economy—as sort of the equivalent of an ecosystem….
This is a very unfashionable way of thinking because early in the days after Darwin came along, people like the robber barons assumed that the doctrine of the survival of the fittest authenticated them as deserving power—you know, “I’m the richest. Therefore, I’m the best. God’s in his heaven, etc.”
And that reaction of the robber barons was so irritating to people that it made it unfashionable to think of an economy as an ecosystem. But the truth is that it is a lot like an ecosystem. And you get many of the same results.
Just as in an ecosystem, people who narrowly specialize can get terribly good at occupying some little niche. Just as animals flourish in niches, similarly, people who specialize in the business world—and get very good because they specialize—frequently find good economics that they wouldn’t get any other way.
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.
For example, you can get advantages of scale from TV advertising. When TV advertising first arrived—when talking color pictures first came into our living rooms—it was an unbelievably powerful thing. And 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. Indeed, they prospered and prospered and prospered until some of them got fat and foolish, which happens with prosperity—at least to some people….
And your advantage of scale can be an informational advantage. If I go to some remote place, I may see Wrigley chewing gum alongside Glotz’s chewing gum. Well, I know that Wrigley is a satisfactory product, whereas I don’t know anything about Glotz’s.
So if one is 40 cents and the other is 30 cents, am I going to take something I don’t know and put it in my mouth—which is a pretty personal place, after all—for a lousy dime?
So, in effect, Wrigley , simply by being so well known, has advantages of scale—what you might call an informational advantage.
Another advantage of scale comes from psychology. The psychologists use the term social proof. We are all influenced—subconsciously and to some extent consciously—by what we see others do and approve. Therefore, if everybody’s buying something, we think it’s better. We don’t like to be the one guy who’s out of step.
Again, some of this is at a subconscious level and some of it isn’t. Sometimes, we consciously and rationally think, “Gee, I don’t know much about this. They know more than I do. Therefore, why shouldn’t I follow them?”
The social proof phenomenon which comes right out of psychology gives huge advantages to scale—for example, with very wide distribution, which of course is hard to get. One advantage of Coca-Cola is that it’s available almost everywhere in the world. Well, suppose you have a little soft drink. Exactly how do you make it available all over the Earth? The worldwide distribution setup—which is slowly won by a big enterprise—gets to be a huge advantage…. And if you think about it, once you get enough advantages of that type, it can become very hard for anybody to dislodge you.
There’s another kind of advantage to scale. In some businesses, the very nature of things is to sort of cascade toward the overwhelming dominance of one firm.
The most obvious one is daily newspapers. There’s practically no city left in the U.S., aside from a few very big ones, where there’s more than one daily newspaper.
And again, that’s a scale thing. Once I get most of the circulation, I get most of the advertising. And once I get most of the advertising and circulation, why would anyone want the thinner paper with less information in it? So it tends to cascade to a winner-take-allsituation. And that’s a separate form of the advantages of scale phenomenon.
Similarly, all these huge dvantages of scale allow greater specialization within the firm. Therefore, each person can be better at what he does.
And these advantages of scale are so great, for example, that when Jack Welch came into General Electric, he just said, “To hell with it. We’re either going to be # 1 or #2 in every field we’re in or we’re going to be out. I don’t care how many people I have to fire and what I have to sell. We’re going to be #1 or #2 or out.”
That was a very tough-minded thing to do, but I think it was a very correct decision if you’re thinking about maximizing shareholder wealth. And I don’t think it’s a bad thing to do for a civilization either, because I think that General Electric is stronger for having Jack Welch there.
And there are also disadvantages of scale. For example, we—by which I mean Berkshire Hathaway—are the largest shareholder in Capital Cities/ABC. And we had trade publications there that got murdered where our competitors beat us. And the way they beat us was by going to a narrower specialization.
We’d have a travel magazine for business travel. So somebody would create one which was addressed solely at corporate travel departments. Like an ecosystem, you’re getting a narrower and narrower specialization.
Well, they got much more efficient. They could tell more to the guys who ran corporate travel departments. Plus, they didn’t have to waste the ink and paper mailing out stuff that corporate travel departments weren’t interested in reading. It was a more efficient system. And they beat our brains out as we relied on our broader magazine.
That’s what happened to The Saturday Evening Post and all those things. They’re gone. What we have now is Motocross—which is read by a bunch of nuts who like to participate in tournaments where they turn somersaults on their motorcycles. But they care about it. For them, it’s the principal purpose of life. A magazine called Motocross is a total necessity to those people. And its profit margins would make you salivate.
