Value Investing – Economies of Scale (Lesson 24)
Of the basic business principles, economies of scale has the greatest impact on profitability over any other business principle. As an enterprise’s investment is spread over higher volume the cost per unit of production decreases. The differential between sales price and cost changes add to the overall profitability for the company.
Economies of scale exists in two distinct forms. One isn’t reported in the financial statements and is referred to as the ‘learning curve’. The second form is identified in the financial reports and is called ‘leverage‘. When both forms exist in a business and tweaked to perfection, efficiency is maximized and therefore profits reach optimum peaks. Once achieved, the business must exercise the same forms of scale as they grow from a start-up to a publicly traded company.
Children are the perfect examples of how learning works. After failing in their first attempt they’ll try a different tack until they achieve success. With each attempt the time decreases significantly at first, then marginally after achieving success; basically they get faster. It is human nature.
This same behavioral process exists in business.
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