Why Does Efficiency drop off, after a certain size?

I’ve always wondered why human enterprises have an optimum size-after which marginal costs start to rise. take farming-the USDA estimated once, that the optimum size of a privately owned farm was about 700 acres. In the old soviet union, the central planners thought that HUGE collective farms ought to be the most efficient-but found that these very large operations were difficult to manage, and inefficient. Size is seductive-the reasoning that you can spread your fixed costs over larger production is always on every manager’s mind. yest, huge organizations seem to become VERY inefficient, once they pass a certain size. is there any simple explanation for this phenomenon?

Part of it is just the law of diminishing returns. As an organization gets bigger, at some point, your variable costs will increase more than you’ll gain in output.

I remember once watching some kind of training video where they had an interview with a guy who’d made loads of money running steel “mini-mills” (where instead of smelting from raw ore, they remelt scrap). Whenever he wanted to expand he started a new company.

When asked why, he said something to the effect that whenever you got more than 200 people in a company, everything turned to sh*t.

I’m going to suggest that there’s an optimum size to flexibility ratio in any enterprise.

Corruption was no doubt a large factor in why Soviet state-owned megafactories and sovkhozs, but there’s also the issue that such industries were not very adaptable to change. An assumption in a free market economy is “change or die”; if wheat is the cash crop of the year, you plow under your corn fields and grow wheat. Soviet collective planning, however, was monolithic, and you grew what they told you to grow, even if climate predictions or market demand dictated otherwise. Even without collective planning, it’s easier for a small manufacturer to retool and build something different than a large one. And of course, worker productivity is more noticable when there are fewer workers and nowhere to hide, and when there’s only a couple layers of management the managers are directly accountable for lack of productivity or planning, whereas large organizations inevitably have a vast group of totally nonproductive middlemen whose primary job it is to say, “Yes, sir!” and make pretty charts. The Russians actually had pretty good grain yields on a number of years, especially after the Khrushchev reforms and the elimination of Lysenkoism-based agricultural policies, but the distribution and use was not well planned, and the worldwide economic stagnation of the Seventies combined with Breznev’s weak leadership and poor economic development, and a couple of bad climate years hit the USSR particularly hard.

The “oligarchs” you mention were able to pick up formerly state-run industries for pennies on the dollar, strip them bare for assets and production, and sell to the isolated, cash-poor Russian and Eastern European nations at exhorbiant prices. That worked well for a few years, and then they banked their money (in Western banks) and declared bankruptcy or demanded government subsidy, which the Russian government was then obliged to hand over lest it be without fuel, oil, and manufactured goods.

Stranger

I vote for Dunbar’s number (aka, the Monkeysphere ).

It’s theorized that humans just don’t have brains large enough to maintain close social relations in groups of more than about 150 people. Larger than that, and you have to commit significant resources (and formalized, artificial strictures) to maintain order.

The following is a true anecdote. My daughter got a job with a small publisher, she was the 8th hire. They made a tidy, but not huge profit. She was chief scientific editor. When she needed one more copy editor, she spoke to the owner and the owner either said yes or no, but that was it. Then they got bought out by a large well-known publisher of scientific texts and journals. For another year or so, they remained in the rented brownstone in Brooklyn where they had been. When their lease expired, they were moved into the Manhattan office, a huge enterprise. Although no new space was rented for them, everybody was squeezed a bit and space was made. Nonetheless, a portion of the downtown rent, considerably larger than the Brookly rental was “attributed” to them and suddenly that (somewhat specialized) division was losing money, all on this attributed rent. But the worst thing (and the thing that was relevant to this thread) was that if she needed a new hire, there were no fewer than five levels of administration that had to clear. It took months and if she really needed them, it interfered with their schedule.

My take on all this is that the larger enterprise is, the more effort has to be devoted to management, which contributes nothing to the actual output.

Here is another story that was told me by a mathematician who was working for Hitachi in Japan. It was a large enterprise with lots of engineers and they had a library in part to avoid the necessity of everyone who wanted to look at a book to buy a copy. Then some bean counter decided that every division had to show a profit. Including that library. So they used to charge for taking books out. Naturally, few people did since then they needed authorization to make the expense, even though it was purely internal. In order to try to show a profit, the cost of borrowing became very large, maybe as much as 10-15% of the purchase. You can guess what happened next. Some divisions began to start their own library of frequently referenced books. The main library just sort of withered. Administration gone berserk. A small enterprise would not have gone down that road.

The upper levels of administration seem to get increasingly useless, but also with higher pay and more perks. Certainly that is the pattern at my university.

Of course it’s not all sunshine and roses for all the oligarchs.

http://en.wikipedia.org/wiki/Mikhail_Khodorkovsky

Possible explanations:

  1. Humans beings can feel emotionally attached to a small organization. When that happens, their willing to invest their time and energy fully towards the goals of that organization. For enterprises above a certain size, the attachment becomes impossible. There’s simply no way to derive meaning and purpose from a goal that’s shared by 100,000 others.

  2. Once past a certain size, management must be split up. Hence there’s no longer any person who understands everything that goes on in the organization, making it difficult to coordinate between the various departments.

  3. Click here.

Feedback.

You work alone, your work matters, and it shows immediately.

Work with a dozen people, and one or two slackers get carried by one or two real producers, and both ends suffer a lack of real understanding how to make things better.

Add any more and you need organizers, managers, and every new level of complexity has as its primary reason for existing a reduction in the immediacy of consequences for both good and bad performance. So, the larger a group gets, the more insulated each member is from the feedback that we all need to keep ourselves performing.

When it comes to management, you can’t plan for excellence. Well, you can, but if you get adequacy where you expected excellence, your plans fail. The more complex the plan, the more you end up planning for mediocrity. Low expectations are a self fulfilling prophecy. High expectations are not. If I have high expectations of you, you end up resenting me. If I have high expectations of myself, well, why are you here, again?

Tris

“We are what we repeatedly do. Excellence, then, is not an act, but a habit.” ~ Aristotle ~

In the early 1970’s/late 1960’s there was a book called “The Peter Principle” which originated the idea that “Everyone rises to their own level of incompetency”.

What the author meant was that in a large organization, people rise through promotion based on skill, til they run out of skills. Then they stay at that level, or at best move “Sideways”.

In a small organization (less than 200 people), the imcompetents soon show up, and are reassigned/eliminated. In Larger organisations, their incompetencies blur out and are absorbed by the larger group, taxing resources, and reducing efficency.

Its an old Idea, but I have seen it happen many times.

Look at the major big block home improvement store… HD… when it was in its growth stages, the corporation’s actual plan was to let each store operate almost independantly, and actively look for best practices, good solutions and innovation. Once the original founders retired and sold the company to GE, it became run by “spread sheet”, upper managment was parachuted in, and had little or no experience with the realities of home improvement sales. Plus they only had to twist their portfolios profit ratio up a notch, and then would leave for another position.

6 months later the long term effects of their tweaking would come to pass (skilled employee departure, reduction in cuatomer service, introductions of lines unrealted to customer demographis (lets sell cushions!).
Regards
FML

With in 6 month Home Depot went from high $70/share to low / mid $20s.

Cite that Home Depot was sold to GE? I don’t think so. Home Depot hired an EX-GE manager to run the business.

There are many forces at play here when it comes to efficiency. Large organizations can be MORE efficient, if they are run correctly, due to economies of scale, sharing of best practices among units, and other benefits of bigness. It’s no conspiracy that small farmers are losing out to big agri-business like ADM, or that small shops are losing out to Wal-Mart, or that the local stereo store is losing out to Best Buy. For that matter, your own example of Home Depot is an example of a very big company killing the smaller competition because it is much more efficient. So the entire premise that efficiency drops off with size has to be questioned.

It all comes down to management structure. Take GE. At one time, it was a very monolithic ‘old technology’ company with strong central control. There were zillions of divisions and business units, and they all had their own bureaucracies. The result is the same thing you see in centralized governments - information hiding, people at the top making decisions for people at the bottom without knowing the facts, lack of agility, etc.

When Jack Welch was hired on, he basically gutted the company structure and rebuilt it. He sold off most of the business units (if they weren’t #1 or #2 in their market segment, they were gone). He flattened the corporate hierarchy. He fired people who had built up little fiefdoms and mini-bureaucracies inside the company. Then he took that leaner, flatter organization and split it into main functional areas and gave each one of them broad autonomy to attack the business they knew best in the way they knew how. The result was that GE thrived and grew, while most of its peers among corporate giants of the early 20th century faded away and died.

So GE is an example of a big, complex company that is also very efficient. It does that by avoiding the pitfalls of bigness (complexity of centralized control), while retaining the advantages of bigness (economies of scale, cross-marketing, developing wide-ranging expertise that it can share among business units etc).

[nitpick]
ADM is not in the farming business, as far as I know. It supplies farmers with a variety of stuff including seed, but doesn’t actually grow stuff for sale as food. The big agri-businesses that are displacing the family farm usually started out as family farmers who incorporated and then bought out some of their neighbors or something like that.

Edit: Also note that the buying out often happens when those neighbors retire or die and their children don’t want to take over the farming.

While peope have mentioned economies of scale, individual performance, morale, etc., I’m surprised that people touched on Communication but didn’t realy go there. It’s the key factor - most everything else is just one small aspect of it.

Small organizations can communicate far more easily. If Upper management needs information, they most likely go directly to the source, or it only goes through one middleman; this gets done accurately and quickly. A large organization may require much more time for much less accurate information to move from bottom to top. Likewise, if management has a goal in mind, large organizations have more trouble communicating it to employees. Employees wind up working for goals they can only guess at, and hence don’t really care about. And if employees have to communicate something important up the chain of command, good luck. If it ever gets there, it may take months. Hope that information can wait!

Eventually, companies have to start installing layers which do little except prune the communcations branches and try to deal with it so other managers don’t get caught up in it.