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The Benefits of Being Small: Balancing Economies of Scale Against the Advantages of Intimacy Is a Delicate Task



In the 1970s the British economist E. F. Schumacher coined the phrase "small is beautiful." The expression focused on a design question. As companies become larger and more complex, can they restructure to retain the human benefits of smaller companies? Schumacher believed that they could not. They would have to reduce in size and change their command structure. His argument was simple. As a company adds more people in more locations the sheer task of holding this lot together becomes an end in itself. The economic advantages of scale will be eroded by the disadvantages of a loss of intimacy.

 

Schumacher was largely ignored outside Europe. At the time a prevailing view was that large companies could be very profitable if structures were crystal clear and rational. Through these means human error or deviance could be minimized. One company was always quoted as the supreme example of the triumph of structure over deviance: International Business Machines, arguably the greatest exponent of machine-like precision through command and control structures. However, in 1993 IBM lost $5bn (£ 5.6bn). Forthoseon the inside, the collapse of the world's most successful computing company was stunning. At the time I taught on IBM's senior management programme at La Hulpe in Belgium and I could track the growing unease. Yet the IBM staff still believed that creative, structural solutions would save the day.

 

Managers largely ignored the evidence of paralysis at the top. They were part of the paralysis. The rest is history. Lou Gerstner, with no background in computing, was brought in to rebuild IBM. Seemingly, overnight half of the far-flung 450,000 devoted, loyal, programmed IBM-ers were banished. The rational model had been shown to be flawed. Since the 1990s various studies have reinforced the idea that 1,000 employees in one location is about the maximum size for any company if it is to retain the advantages of the economies of scale and minimize the human diseconomies arising from adding more people. IBM did clean out 50 per cent of its workforce -- but controlling size was not the main way the company reinvented itself. Its most important decision was to offload its entire hardware and components manufacturing.

Outsourcing was its most spectacular strategy. In the latest McKinsey Quarterly, the logic and effect of outsourcing as a strategy and how it affected IBM are examined. The research question posed by the authors is: has outsourcing gone too far? The logic of outsourcing is that by shedding assets companies can concentrate on the interesting work. Employees are remotivated to develop product or services, discover solutions and be innovators or supply chain integrators. Liberation leads to an increased rate of return on invested capital The Journal provides sensible, practical insights into the sort of questions companies should ask before embarking on outsourcing. If internal suppliers can meet industry standards within a set time and present a competitive advantage, an internal solution may be preferable. If, as well, the internals are not readily substituted outside and are vital to the corporate culture and reputation, the company should resist outsourcing.

 

Conversely, if there are dramatic cost savings available from cheaper labour sources or the skills are hard to acquire or suppliers have greater productive capacity and higher levels of expertise and knowledge, the case for outsourcing is strong. Rarely is outsourcing an either/or decision. So the authors discuss a mixture of tactics in which the company gets the best from both sources, internal and external. They rightly question the general assumption that outsourcing is always best. One issue that the authors do not discuss is dependence. This is often critical.

 

How dependent does a company become once it has transferred all its information technology processing to a supplier? Transferring staff is fine if the explicit and tacit knowledge is readily available elsewhere. It may be dangerous if it is not. By the mid-1990s IBM had redefined its core business as e-business services and solutions, research and design and semiconductor architecture and manufacturing and spun off its hardware and components manufacturing business. By 2000 it reported revenues of $ 8.09 bn. What does all this tell us? First, by outsourcing manufacturing IBM made possible a massive strategic shift.

 

Lesson: outsourcing is not just a tactic for transferring costs, or people problems. Second, IBM's leaders could not have known in 1994 how the company's future would evolve. This was not change based on a clear vision and a rational plan. Lesson: To outperform the competitors, companies must take risks, follow a shared hunch and tolerate ambiguity about the outcomes. Third, this transformation was achieved by relentless segmentation into smaller units.

 

Lesson: Schumacher's argument on the human diseconomies of size was valid. For innovation and creativity, free forming self-governing teams are essential. Small in this sense is beautiful.

John W. Hunt, "Financial Times"

 

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