The Myth that Large Corporations are more Efficient.

[johnaries]

Anyone who argues that a Large Corporation is more efficient than smaller businesses or Government has obviously either never worked for a large corporation or they are currently working for a large corporation and it’s their job to say that.

Since there are two arguments here: a) that large corporations are more efficient than small businesses and b) that any business is more efficient than government, I will answer each argument separately.

A) Large corporations are more efficient than small businesses.

The argument here is based on the concept of “economy of scale”. However, there are hidden costs to a larger scale operation that offset any advantages, often disproportionately. For instance, consider a central service site vs. many different regional sites. While it is true that a larger group of service employees in a central service site would be less than the total of employees in many smaller sites, there are many disadvantages to a single larger group. For instance, you must implement much stricter policies for a larger group. Therefore, you instantly lose flexibility. Further, a single larger groups requires more supervision and administration, often driving administration costs disproportionately higher. Can you say “golden parachute”?

Some may argue that a single site means lower costs for office buildings , maintenance, or office space rental. However, depreciation, maintenance, and rental are typically tax-deductible.

So, why then are large corporations generally so successful? Because of their ability to manipulate the market. Large corporations are in a better position to negotiate with their vendors and suppliers for lower costs, discounts, and even rebates (legal kick-backs). This is what gives them an advantage over smaller businesses. Further, in order to recoup the lost revenue from these various discounts, the vendors and suppliers must raise their prices for their other customers. This puts the smaller businesses at an even greater disadvantage.

In a truly “Free Market”, business does not control the market, the market controls business.

B) Any business is more efficient than government.

Although I am an advocate for a true “Free Market” in most areas, I do support socialization in public services such as Health Care.

It is true that many agencies currently run by the government are rather inefficient. Particularly in the areas of bureaucratic waste and budget management. However, these inefficiencies can be easily fixed if our government would just take the initiative to do so. Further, government-run agencies have two major advantages over private business:

1. Lower administrative costs.
2. No profit motive.

Number 2 is pretty self-explanatory. If you do not include a profit margin in your prices, your prices will be lower. Some argue that it is the desire to increase the profit margin by lowering costs that gives businesses the incentive to be more efficient. However, although businesses do make an (often feeble) attempt to decrease costs and increase productivity, by far the favored methods of increasing profit margin is by either increasing sales or increasing price. In many public services, such as health care, the desirable goal is to lower costs by decreasing the need (sales).

If anyone wants to argue Number 1, I refer you to the administrative costs of Medicare vs. the administrative costs of private health insurance. Try page 138 of this document prepared for the House Ways and Means Committee:

http://www.gpo.gov/congress/house/ways-and-means/sec3.pdf
“Medicare’s administrative costs are substantially lower than those for private
insurance. In 1993, Medicare’s administrative costs represented about 2% of total
program costs, while such costs represented 9.5% of private insurers costs and 11.9%
of program costs for health maintenance organizations (HMOs). Private insurance
and HMO administrative costs include marketing, profits, and other costs which are
not part of Medicare’s expenses. Administrative costs for HMOs are higher than for
private insurance because HMOs invest more resources into managing the care
provided to enrollees.

Administrative Costs: Medicare Compared
to Private Insurance and HMOs, 1993
Percent of Costs
Medicare 2.0
Private insurance 9.5
HMOs 11.9
NOTE: Table prepared by CRS.”

edited to add link.

[antigop]

1. Do you have a link for this document? n/t

[johnaries]

3. Oops! I forgot to add it. Thanks for reminding me!

I've added it now.
:hi:

[The Velveteen Ocelot]

2. I've had this argument with Republicans more times than I can count.

They say government should be run like a business, and that would make it more efficient. And I say, bullshit. Dilbert says it all. I've worked for the government and I've worked for a large corporation -- and both are inefficient. I didn't find the corporation to be any less bogged down in bureaucracy, unnecessary paperwork or layers of administration than the government agency I worked for. They are inherently inefficient mainly because they are large, and size begets bureaucracy.

The other important thing is that government has an entirely different purpose than a corporation. A private corporation exists to make money for its shareholders; that is, make a profit. Government exists to do that which it is constitutionally obligated to do; that is, provide for the defense and the common good of its citizens. While obviously it should not waste the taxpayers' money, there is no profit motive, either. Sometimes, as where health and safety are concerned, it may have to operate at what might be a loss if a private corporation handled that function.

The best example I can think of is air traffic control, which is currently part of the FAA. The Bush administration wants to privatize it -- and this means that private operators, to reduce costs and make a profit, would inevitably cut corners, to the detriment of aviation safety. Some government functions simply should not be privatized or run as if they were businesses.

[johnaries]

7. More excellent points! thanks!

I'm afraid that the meme that "business is more efficient than government" and "the government should be run like a business" have become so ingrained in so many American's pysche that do one bothers to even about it critically.

In business terms, this is called "tribal knowledge". The concept that "everybody knows that" whether it is true or not.

[The Velveteen Ocelot]

10. It's also an example of "truthiness."

:rofl:

[johnaries]

17. I hadn't thought of that, but you're right!

A toast to the Word of the Year!
:toast:

[Kutjara]

4. Excellent analysis.

I remember from my college industrial economics class the 'bureaucratic theory of the firm.' It applies to any organization (public or private) that is of sufficient size that the profit-motive is either entirely absent (e.g. government departments) or sufficiently alienated from the control of ordinary employees that it may as well be absent (huge multinational corporations). To clarify the case of private companies, even though you may get a few shares if you work for AT&T, do you really think anything you do is going to cause the shares of a huge, diversified enterprise to increase significantly in value?

In such cases, "bureaucrats" (or, in a private company, managers) seek to maximize their own pay, power and perks, not their enterprise's profit. They realize that increasing their department's efficiency and profitability will not produce a return to them (except for a, usually capped, bonus based on their salary, not their contribution to the enterprise's success). The best way for managers to maximize salary and bonus, therefore, is to increase the resources under one's control, so this becomes the focus of managerial activities. The result is inefficiency and administrative bloat.

It's hard to see how a private sector manager in this scenario would differ in any material way from a public sector bureaucrat.

[Vidar]

5. Great post.

[Odin2005]

6. A bureaucracy is a bureaucracy, whether it is a government or private one doesn't matter.

The idea that corporations are more efficient then the government is just Free Market Fundimentalist dogma with no basis in fact.

[bunyip]

8. I agree

Large corporations tend to become miniature Soviet Unions, with abuse of power, poor coordination, wastage and fraud perpetrated from above, and resentment, pilfering and low productivity from below.

...

Governments do too little to prevent 'consolidation' of an industry into an oligopoly... Because the politicians receive 'donations' from crooked rich men seeking oligopolistic profits. :mad:

It is true that many agencies currently run by the government are rather inefficient. Particularly in the areas of bureaucratic waste and budget management.

True. Large agencies suffer the same problems as large companies, for the same reasons. And govt agencies lack even the blunt instrument of reform that is financial collapse, because they are fed by taxes.

But even with all that, because government monopolies can eliminate a lot of 'non-value-adding activity' (marketing, kickbacks, bonuses and share options for the CEO), they can still be more efficient in some things than private enterprise. Usually mature industries with low rates of innovation and very generic products. I guess the challenge is to devise better systems of oversight to detect and re-invent agencies that have become dysfunctional.

Good post, lots of different ideas

[Gman]

9. Large corporations by definition are inefficient

that's why large corps often spin off subsidiaries when the core competencies of the parent company are different or don't flow well with the core competencies of the subsidiary. This almost always increases shareholder wealth. Good examples of this are Halliburton spinning off KBR as well as Halliburton buying asbestos companies which they had no experience in and caused huge problems both in contingent liabilities and efficiencies. Also bureaucracies are inherently inefficient which is why any company that has survived the last 20 years or so has greatly flattened it's hierarchy.

In general the larger the volume, the greater the efficiencies of scale. This is universally accepted. The larger the quantities of raw materials you can buy, the lower your cost and that's just the beginning. In fact you can chart the decrease in marginal cost (the cost to produce one more unit) based on quantity produced. This is what the text books say.

However, it takes attention to detail (Total Quality Management type stuff, statistical analysis of error rates, defects, etc.) to obtain and maximize the economies of scale, but it most definitely can be done. About the best example around is the Japanese and their use of Edwards Deming's work.

So it all depends on how the company is run that determines if that company is achieving and maximizing economies of scale.

As for your points about government providing services cheaper than business, I agree. It completely ticks me off when I hear people complain that "the bus system here doesn't even make a profit!" First off government isn't meant to make a profit. Preferably it will break even, but if it makes a profit then tax cuts are in order. And, accounting for government is completely different from accounting in a for profit business. There is no owner's equity.

[johnaries]

18. Isn't it ironic that Deming's work was shunned by American

businesses, but when the Japanese embraced it they ended up kicking american business ass?

Yes, I agree that using TQM, statistical analysis, and other tools business can become highly efficient. In fact, I am a certified Six Sigma Black Belt. If you're familiar with Deming's work and TQM you probably know what that means. However, in my own experience it all depends on whether or not the Executive Committee adopts your recommendations and how it is implemented, as well as follow-up. I know that in my own company the emphasis was on "booking" the theoretical savings so it could help drive up stock prices, rather than actual improvement. Once a project had been implemented, there was virtually no follow-up. Which effectively meant that the long-term sigma was practically nil.

[johnaries]

19. You also bring up another good point:

Out-sourcing and the use of sub-contractors. Since both that contracting business and the subcontractors must make profits, it adds another layer of margin to the final price.

[Gman]

31. It depends on the outcome of a "make or buy" analysis

It can be that it is in fact cheaper to sub-contract out a function rather than do it in house. Of course if the outcome to the above mentioned analysis is to buy then it is cheaper overall to subcontract. The sub's profit margin is included in the total cost of the project that contributes to the buy decision. Sub-contracting something doesn't automatically imply that the sub's profit increases the total cost of the project and decreases EofS. If it did, the answer to the analysis would be to make.

My main point is that. There is such a thing as "economies of scale" and it does exist and is demonstrable. The problem is business does inefficient things because of greed of upper level management, company politics, etc., that negate the gains from EofS.

Changing corporate culture is one of the hardest things to do because of human nature.

[johnaries]

32. Yes, I agree with you. .

In many cases it is more efficient to sub-contract out to established experts rather than try to become experts in-house. However, many times these decisions are not based on such an analysis as you mention, but often for other reasons than long-term efficiency. Often these decisions are made for reasons of expediency, market positioning, name-recognition, tax-evasion, even nepotism.

And I fully agree with you that "There is such a thing as "economies of scale" and it does exist and is demonstrable. The problem is business does inefficient things because of greed of upper level management, company politics, etc., that negate the gains from EofS." The "greed of ...management, company politics, etc." more or less is what I was talking about. But the point is that in the real world there are factors in most large companies that, as you said, "negate the gains from EofS."

Of course, there are some large companies that are quite well run.

Let me clarify that I am not against Large Corporations in general. I am ust trying to dispel the Republican myths that Large Conglomerates automatically serve the country better (such as in Media or Communications Consolidation) or that privatization is automatically better than a government-run agency.

A Regulated Free Market that promotes competition is the best way to ensure increased efficiency, IMHO. Huge Conglomerates and consolidation decreases competition. Therefore, I support anti-trust legislation.

Further, I support government control of most social services over privatization of these services. I would perfer that social services are provided by agencies whose priority is to see these services provided, not to businesses whose priority is to make a profit.

[Nikia]

11. Sometimes health insurance at a small business is more expensive

If there have been a couple of chronically ill people and/or major medical bills associated with a one time event.
I have worked at relatively small businesses that have problems of their own. I, and several others at our business, are overworked in a way that probably wouldn't happen at a large company. Some departments are the same size in ppeople as they were when they company was a quarter of the size. I suppose this more efficient, but it is hard to compete with some companies that have multiple people handling the projects that one person handles as part of several other duties.

[johnaries]

20. This is another example of how larger companies can manipulate

their costs. Health Insurance is offered at a lower rate to large companies because of the volume involved. And smaller companies have to pay the difference. Especially if the claims have been large for any reason.

Also, as far as health care is concerned, let's not forget that Insurance companies depend on their revenues from premiums to give them investment capital for the stock market, which is where they make their most profits. If the stock market goes down, the premiums go up. However, they never lower their premiums if the stock market goes up.

[baldguy]

12. One company's profit is another's inefficiency.

[johnaries]

21. Nope, Not true.

You would think it would be true, but it doesn't work that way in the real world. the most efficient company in the world cannot compete against companies who get the discounts, rebates, etc. I mentioned.

[seasat]

13. One big difference is transparency.

Government run enterprises are constantly under scrutiny but a a corporation can shield inefficiencies and fraud. Corporations feel they are better off if their mistakes are not made public because it can affect shareholder value in the larger scale and can affect an individual manager's salary in the smaller scale. Therefore, large corporations appear more efficient than government agencies because they hide their mistakes until they reach Enron size proportions.

When markets consolidate, there is less competition. This leads to less innovation and efficiency. Larger corporations once they reach oligopoly or monopoly status are not more efficient. R&D is expensive and it is much more profitable to maintain the status quo while using predatory methods to eliminate the smaller competition.

One aspect where governments are inefficient is payment of reasonable wages to employees. Just anecdotal, but here in Florida, the Department of Environmental protection only hires new people as OPS. They hire folks with bachelor degrees in science and pay them a low hourly salary with no benefits or overtime. They usually aren't eligible for promotion for couple of years and have to survive on this compensation. Many of the good employees eventually get scooped up by private environmental consulting firms while slackers stick around for years. You end up with a few dedicated long term employees carrying a lot of dead weight. That is absolutely a stupid short sighted policy that actually costs more to tax payers.

[eallen]

14. I don't know anyone who claims large corporations are ALWAYS more efficient than small....

There are reams of papers in business and economics written on when size helps a business, and on when it hurts. I've never seen anyone argue that bigger is always better. There are many cases where a large business was acquired solely for the purpose of selling off parts of it, which had more value separately than together, and then closing the rest. It seems to me that you're largely arguing against a strawman.

I also question your claim that "large corporations generally (are) successful." A large business generally has been successful in the past. That is how it got to be big. But that's history. And as the saying goes, past performance is no guarantee of anything. Over time, small cap stocks outperform large cap stocks, which says that large businesses really aren't all that successful. Many theories have been put forward to explain this, but it doesn't seem such a puzzle to me. It is the nature of a business's lifecycle to start small, grow as it does well, and then get acquired, split, or liquidated when it fails to adapt to market shifts. Large cap stocks are just later in their lifecycle.

:hippie:

[johnaries]

22. I'm arguing primarily against the FCC rule changes and other

relaxations against monopolistic practices since Repubs have been in control of Congress, as well as the argument for Privatized Health Insurance and the Repub arguments ot privatize many current government services.

Hardly a strawman, don't you think?

edit to add: I actually do know some conservatives at work who do claim that business is ALWAYS more efficient than government. I point out how many times they themselves have complained about our own company, but their mindset is that no matter how bad private business may be government is always worse. Especially since government "wastes" their taxes on programs like Welfare.

[ComerPerro]

15. I think you are mixing definitions of "efficient" here.

[johnaries]

23. Perhaps, but don't blame me, I'm addressing the Conservative

arguments that privatization provides the best service at the lowest cost.

[ComerPerro]

29. not blaming. Just reminding you that corporations can be efficient in one sense

but not in others.

for example, when you look at costs, its efficient for Wal Mart to purchase large quantities of items and ship them from their own regional distribution centers.

[johnaries]

30. Sorry, but I think it was pretty clear that I was talking about overall,

"bottom-line" efficiency. As I later said, "the best service at the lowest cost".

And BTW, your example may not necessarily be efficient since you are not taking into account the shipping costs to get the products to the regional distribution centers. The cost of the goods may be lower since they are buying in bulk and (as I previously said) and can better negotiate prices, but the costs of shipping and handling must be accounted for as well.

[Morgana LaFey]

16. Most excellent -- and amazingly enough, I was just thinking about

this very subject this afternoon. So glad somebody else sketched it all out. Thanks.

[johnaries]

24. Thanks! After I posted it I noticed a few other threads on CEO's

such as "having a CEO for President". Actually, I was inspired by an email I got from Americans United for the Separation of Church and State regarding an upcoming forum on media consolidation. But as Dems prepare to take over Both Houses for the first time in over a decade it seems that this and many other Repub memes on a lot of people's minds.

[dailykoff]

25. K&R! But why do you think socialist economies keep tanking?

For example why do Cubans still drive 1950s cars if they can get them, or why did East Germany rot while West Germany flourished?

[johnaries]

26. Well, the Free Market and competition is good for some things!

Innovation, for one. Personally, I would like to see Health Care remain private but socialize Health Insurance.

[Mythsaje]

27. Herbert said it...

The problem with corporate bureaucrats is that they adopt a CYA mentality that tends to stamp out innovation because taking risks is dangerous...you can be destroyed if they fail, and made to look incompetent if they succeed. "Why didn't YOU think of this?"

And all too often it's not the cream that rises to the top, but the people that kiss ass the best. The idea of corporate America as a meritocracy is nonsense. There are plenty of very competent people stuck in middle management, if not lower, because they don't do corporate politics worth a damn. It's not about how good they are at their jobs, or how good they'd be in even higher positions, but whether they can get there without 'rocking the boat.'

Real boats rock.

[johnaries]

28. Ah, yes. And we cannot forget the Peter Principle.

“In a hierarchy, every employee tends to rise to his level of incompetence.”