Diseconomies of Scale

Now most of us are familiar with the concept of economies of scale: the principle that as we scale our production our unit costs fall making us more efficient and more profitable. This may be true in manufacturing or stock ordering terms but that where it ends.

Rather than economies of scale early-stage businesses inevitably face DISECONOMIES OF SCALE. Think about it. This typically what happens for most start-ups:

  • We start from the kitchen table with no significant fixed costs
  • Once we employ our first staff we incur fixed salaries overheads
  • We then typically move into offices incurring further costs – rent, rates, insurances, telecoms, hardware, software and so on
  • As we grow our team we typically face another step cost as we hire more senior managers
  • And so on…

 

Couple this staggered increase in overheads with inflationary pressures and very often a tendency for business owners to not price up as we grow volume sales and we have a steady decrease in net margins.

In my experience it’s this fall in underlying margin that is the single biggest threat to business growth and survival. Business owners often push ahead with top line sales growth and as long as they see some growth in profits they lose sight of the fact that for every increase in sale they are making steadily less money. Hence the saying ‘sales is vanity, profit is sanity (and cash is reality)’.

Reduced margins increase the risk of business failure and may be the reason why only one in 20 businesses grows to more than 10 staff and why there are now only around 6,600 UK businesses with more than 250 staff!

As a business grows it is vital that we all try to maintain or even increase profit margins. It’s good margin that puts cash in the bank and it’s decent margins that allow any business to tackle the step costs of growth without falling over.

If cash is king, margin then is emperor!

This blog was kindly written for us by Duncan Cheatle, CEO and founder of the Prelude Group

Duncan has spent over 15 years championing UK enterprise and has worked with over 1000 entrepreneurs. The Prelude Group offers advanced learning for entrepreneurs through its Master Class, Growth Partner Programme and Speaker Boutique initiatives.

In 2003 Duncan set up The Supper Club, now home to around 300 of Britain’s most innovative, high growth entrepreneurs.  The Club has hosted over 1200 events and won the SFEDI UK Best Enterprise Support Awards in 2010.  He is co-founder of StartUp Britain backed by the Prime Minister and sits on the Advisory Boards of the government funded Start Up Loans Company and the Sheffield University Management School. Duncan also founded Rise To which improves employability in young people and ThanksTo.com bringing recognition to those who positively impact their communities.

As well as being FCA qualified (PWC), Duncan is also a Fellow at the RSA.

About the Author Company Shortcuts

Company Shortcuts works with a team of outstanding Sales Accelerators to deliver consultancy and training, who also guest blog for us on topics of interest to sales leaders.