The ability to achieve economies of scale underlies much of the world’s modern wealth. At the original Ford Motor plant in Detroit, the company was able to gradually reduce the time it took to assemble a Model T from 12 hours to 93 minutes. The process of endless methodical improvements included everything from speeding up production to offering few or no options (“any color you want, as long as it’s black”) to finding a version of black paint that dries faster than others.
I believe we are at the beginning of a new cycle of disruption, fueled by public blockchains and tokenization of industrial processes, but also by several other digital processes that are changing the economics of business.
Blockchains use standardization through tokenization and the flexibility enabled by smart contracts to increase efficiency without companies needing traditional economies of scale to keep costs down. The results will be hugely disruptive to industries, regions and supply chains.
Scale isn’t the only game in town. Diseconomies of scale also exist. Government legislation routinely imposes stricter rules and targets on larger companies. Larger companies develop bureaucracy. The same systems that allow companies to operate consistently globally also eliminate local discretion.
The CIA published a (now declassified) top secret manual on how to do that in 1944 sabotage the enemy. It contained useful guidelines, such as ‘do things only through the right channels’ and ‘haggle over the precise wording of communications’. Unfortunately, it’s timeless advice on how to achieve success in many large firms.
Very simple: Bigger is not endlessly better. There is a range of scales that are ‘optimal’ – big enough to benefit the economies, but not so big that you get caught up in red tape. The lower end of this range is known as the “minimum economic scale” and is important because the smaller it is, the more companies and more competition you can support in a market.
Traditionally, these numbers are large, and the greater the scale of investment required, the more difficult it is for companies to maintain and remain competitive. Some industries are still moving toward the ever-increasing investments and capacity required to achieve scale. Today, building a new state-of-the-art semiconductor factory is so expensive – estimated at around $30 billion – that there are only a few companies left in the industry where there were once dozens.
Directly related to the shortage of state-of-the-art semiconductor manufacturing capacity is the shortage of chips used to train advanced AI models. Many of these orders are on the order of $1 billion and larger; the cost per AI model is estimated at more than $50 million for the most advanced models.
Even as technological changes drive some industries to consolidate, as entities require increasingly large scale to remain competitive; others are sent in the other direction. 3D printing is slowly transforming manufacturing by significantly reducing scale. Traditionally, metal stamping presses can produce a large number of parts quickly and cheaply, but fixed costs are high and they can only make one part at a time.
3D printers, on the other hand, can make a huge range of parts. Each printer itself can be slow, but you can simply add more printers. Research I led at IBM has shown that 3D printers can reduce scaling requirements in some industries by as much as 90%.
A similar story is playing out in IT. Internet e-commerce has allowed even the smallest businesses to sell globally. With API-enabled services, it’s possible to plug in everything from credit card payments to shipping and tracking services.
So far, API-based web services have done an excellent job of simplifying relatively standardized systems and services. The next big shift will come from blockchains that enable much more complex and customizable integrations between companies using tokenization and smart contracts.
Systems integration – connecting companies so they can work together – is quickly becoming the key to maturing and growing companies. No company makes or produces everything itself. Instead, almost every business is a coordination game in which companies add their most unique and useful value to a long chain of partners.
Coordinating all those partners is quite a challenge. For example, if you have a supply restriction on an essential part, there is no point in ordering more other parts because they will remain unused in the warehouse. Unfortunately, few supply chains manage this complex process. Companies routinely try to advertise and sell products that they cannot deliver due to internal coordination problems.
The more closely companies are digitally connected, the better this coordination process works. Representing all products as digital tokens, allowing visibility across multiple stops in a supply chain, would be transformative for most companies. The world’s largest companies are already doing some version of this kind of deep coordination, with a mix of customized systems and human management. As every large company tries to set up its own collaboration hubs, smaller companies find it expensive and challenging to maintain.
Blockchains will transform this dynamic because, instead of having to integrate with many different proprietary systems, companies can create standardized models of their products as digital tokens and then integrate them into a single location: a public blockchain, such as Ethereum. With the addition of privacy technology on top of Ethereum, companies can manage which partners see their information and prevent competitors or intermediaries from exploiting their data.
In any sector, where the minimum scale shrinks, markets can support more competitors. In research I led at IBM, we found that as 3D printing matures, it could enable reductions in scale of up to 90% in some manufacturing sectors. This means until Ten times more companies can be competitive in the same space.
Imagine increasing the number of companies that can be viable across a range of industries using blockchain software by a factor of 10. This would turn these markets upside down.
When the minimum economic scale is high, you end up in a market with few products and very standardized products. When that same minimal scale becomes much smaller, you see enormous variation. In those cases, local products tailored to local needs begin to win out over global options. Small companies also perform better in these environments than larger ones, given their flexibility and proximity to customers.
The most optimistic outcome is a return to an era when small businesses provided local services. That era feels like the distant past today, and the replacement of small businesses of the past with large corporations of today was not malicious. It was part of what led to a huge gain in living standards for all due to the resulting efficiencies.
As blockchain and other technologies push back on minimum economic scale, we can get the best of both worlds: locally enriched economies, hugely competitive markets, and all with high operational efficiency.