Scale

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Risk Anatomy
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The point where the scale opportunities are large enough to require active management.

“Passive” economies of scale flow from the simple fact of size (e.g., adding another user to an existing software licence automatically reduces the per-user cost of the licence, without anyone having to do anything). But these passive economies run off at the point where one needs to divert the firm’s resources and personnel towards managing these efficiencies. One must spend to save, manufacturing scale efficiencies that won’t arise by themselves. For example, negotiating law firm panel arrangements, outsourcing and offshoring).

A firm may engage management consultants, middle managers and eventually a chief operating officer whose only job is to extract efficiencies. As long as the efficiencies wrought are greater than the marginal cost of that person, team, or fiefdom, then the fiefdom can be justified on hard economic data.

But O, Paradox: the COO unit itself can become so complex that it presents its own scale opportunities. Beyond a point, it becomes so complex, so inefficient, that one should appoint a chief operating officer for the chief operating officer’s office, tasked with consolidating all the diaspora of COO functions groups, initiatives and change managers into a single function.

As you know, the JC is principally concerned with the management of in-house legal. Once upon a time, the legal department was itself a kind of operating office, there not to dispense its own legal advice so much as manage the outsourcing of legal advice from law firms... and, of course, check the firm’s name was spelled and punctuated correctly on the football team. That’s “Wickliffe Hampton S.A., acting through its London Branch”, everybody!

So it is some irony that its scale has become such — bigger operations may have the thick end of a thousand lawyers in-house — that firms are forming operations teams to manage the legal teams.

Scale and rent

It could be argued, and the JC does argue, that the yen for scale in modern commerce is driven not by an aspiration for economy, much less too save a customer money, but for the opportunities it affords to extract rent. However many thousands of organisations make you the financial services sector; however many hundreds of thousands are employed, directly or indirectly servicing those organisations, there are orders of magnitude more putting their hard-earned dollars into that system in the hope of some kind of return.

The point where scale becomes really exciting is where the cost of rent extraction, per dollar, is so minimal that the hosts — beg your pardon, customers — don't even notice it. Scale then becomes free money; you don't need to reduce your rate because the customers will pay it anyway.

This is why hedge fund managers with 5 billion AUM are happier than manners with 500m.

See also