The MBA curriculum is full of case studies in which large or well-known companies perfectly illustrate important concepts in business and economics. We wrote our book, “Roadside MBA” to introduce small business owners operating in the unlikeliest of places, whose growth strategies are as grounded in such principles as those of the leaders of Google or Ford.
To understand economies of scale, you won’t find a better model than Clyde Lear.
On a very hot Tuesday, we met Lear for lunch at the local country club in Jefferson City, Missouri. He told us how, as a fresh graduate of the University of Missouri journalism school, he started Learfield Communications and over 40 years grew it into a business with more than 350 employees. “At the very start,” Lear recalled, “I visited the station manager of KMMO in little Marshall, Missouri. And I asked the station manager, `What are you doing in the way of farm programming?’”
"He said, 'Well, the disk jockey reads the news from the wire machines.'”
“Why do you let the larger stations---the KCMOs out of Kansas City---do all this farm programming and you’re not doing anything?” Lear asked.
“'We don’t have enough money to pay a full-time farm reporter, and....'”
Hook set, Lear interrupted the station manager with his pitch. He offered to provide a full-time farm broadcaster to little KMMO. This broadcaster would do live farm reports throughout the day and--with luck--would pull farmers away from the giant metro stations. Better yet, this service would be completely free to KMMO. All Lear asked in return was the right to sell advertising to run during the break in the farm report.
Lear explained that a big part of what makes local media---like small radio stations--attractive to consumers is the reporting on local stories, people, and events. That’s very expensive from a business perspective. The per-listener cost of content is high, and there is often no way to sell it to anyone else. Lear, however, recognized that much of the information farmers cared about was common across small communities in Missouri. Radio stations jumped at the chance to combine their expensive local coverage with quality live farm reports.
Lear's genius was in identifying an opportunity that had strong economies of scale. Three key concepts underlie critical idea. The first, “average cost,” is simply the total cost of a company, divided by the number of units that it produces. Economies of scale exist within a company if average costs go down when quantity goes up.
But total cost can be split into two categories. "Fixed costs" typically include such things as rent, equipment, and business licenses that must be paid no matter how many units a company sells. Fixed costs for the Brownfield Network would have included all the expenses associated with producing a farm report, like assembling the information about commodity pricing, hiring reporters to cover government hearings, purchasing the broadcasting equipment, and setting up the production studio.
"Variable costs," by contrast, are those expenses that a company incurs when it wants to produce additional quantity of whatever it is selling. In many businesses, inputs are important variable costs; an automaker, for example, has to purchase four more tires for every car it sells. However, in some companies, variable costs can be quite low. For Lear, the total costs of providing farm reports to two stations were not much more that the total costs of providing them to one, because reporters had already been hired and equipment purchased.
Putting these ideas together: Economies of scale are likely to be present anytime fixed costs are large in proportion to variable ones. In such cases, as the business sells more and more, its margins can actually increase as average cost falls.
Of course, Lear still needed to find the advertisers, and we listened as he described how he brazenly sold his first client. “I looked up Pfizer --- they had a large agricultural division,” he said. “Their account was handled by Bob Kunkel at Leo Burnett in Chicago. So, I called him.”
As it turned out, Kunkel was a pretty senior executive at Leo Burnett with not one--but two--secretaries, and an office with an incredible view of Lake Michigan. Kunkel did not typically meet with 20-something salesmen from unknown companies. Undaunted, Lear went off to the Windy City and managed to get 15 minutes.
"It was about three days later," Lear recalled, "that I got this call from the media department at Leo Burnett."
"Okey dokey,” Lear remembered thinking, with a laugh. “This is easy!”
The Lesson: Growth is never "easy." But a good start is to keep a sharp eye out for economies of scale--and then mix in some salesmanship when you find them.