Munger on Scale

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Charlie Munger believes advantages of scale are "ungodly important" in determining which businesses succeed and which fail. In "Seeking Wisdom From Darwin to Munger" (2007, 3rd edition), Munger explains how scale creates competitive advantages, and perhaps more importantly, when it becomes a weakness.

His insights show why some companies grow stronger as they get bigger while others become slow and bureaucratic. As organizations expand, they often develop what Munger calls "big, fat, dumb, unmotivated bureaucracies" where nimbler competitors can run circles around them.

This post will discuss Munger's perspective on the advantages and disadvantages of scale, so that you can better evaluate which companies have lasting competitive advantages and which face disruption as they grow.

One great advantage of scale taught in business schools is the experience curve.

When companies do something complicated over and over again in increasing volumes, they naturally get better at it. The people involved, motivated by capitalism's incentives, find ways to work more efficiently.

As Munger explains:

This isn’t just theory. The more times you perform a task, the more opportunities you have to streamline processes, eliminate waste, and discover better methods.

Some scale advantages come from simple geometry and physics.

Munger uses the example of building a spherical tank. As you make the tank bigger, the amount of steel needed for the surface increases with the square of the dimensions, but the volume it can hold increases with the cube. This means larger tanks can hold proportionally more liquid per unit of steel used.

These kinds of physical realities create natural advantages for larger operations across many industries. For instance, larger ships carry more cargo per ton of steel. Bigger factories produce more output per square foot of floor space.

The math creates natural advantages for the largest players.

The arrival of television advertising created massive advantages for companies that were already large.

In the early days of TV, when three networks commanded 90% of the audience, only big companies like Proctor & Gamble ($PG ( ▼ 0.34% )) could afford the expensive cost of network television. Smaller competitors couldn't buy partial advertising slots, so they were completely shut out of this powerful new medium.

This created what Munger calls a "huge tail wind" for established brands. They could reach millions of customers through this incredibly effective new channel, while smaller competitors had no access at all.

As Munger says, the branded companies "prospered and prospered and prospered until some of them got fat and foolish, which happens with prosperity."

Scale creates informational advantages that influence consumer behavior.

Munger illustrates this with a simple scenario about choosing between known and unknown brands:

This advantage compounds over time. The more widely distributed and recognized a product becomes, the more it benefits from consumer familiarity and trust.

In other words, this information asymmetry allows established players to charge premium prices even when identical products exist.

Human psychology provides another clear advantage to scale.

People are influenced, both consciously and subconsciously, by what others do and approve of. As Munger explains:

Sometimes this happens at a conscious level, where people rationally think that others must know something they don't. Other times it's purely subconscious.

Either way, this social proof phenomenon gives significant advantages to products with wide distribution and high visibility.

Coca-Cola ($KO ( ▲ 0.6% )), for example, benefits greatly from being available almost everywhere in the world. Once a product achieves this level of presence, it becomes extremely difficult for competitors to dislodge it.

Some businesses naturally cascade toward the dominance of a single firm. If we look at daily newspapers (even now), almost no U.S. city, except for a few very large ones, supports more than one daily newspaper anymore.

Once one newspaper gets most of the circulation, it attracts most of the advertising. With more advertising revenue, it can afford more content and better coverage.

Readers then prefer the thicker paper with more information, which attracts even more circulation and advertising. This creates a self-reinforcing cycle that leads to a winner-take-all outcome.

Scale allows for greater specialization within companies, making each person better at their specific role. Chain stores demonstrate this advantage perfectly. Munger finds the concept of chain stores to be "a fascinating invention" for several reasons:

Munger elaborates further:

The reverse is demonstrated by the little store where one guy does all the buying. Munger shares a story about a small store with salt all over its walls. A stranger asks the owner, "You must sell a lot of salt." The owner replies, "No, I don't. But you should see the guy who sells me salt."

Bigger isn't always better. Munger shares how Berkshire's trade publications got "murdered" by narrower competitors.

Capital Cities/ABC had a general travel magazine for business travel. Competitors created magazines aimed solely at corporate travel departments. This narrow focus made them much more efficient. They could provide exactly what corporate travel managers needed without wasting ink and paper on irrelevant content.

The same fate befell The Saturday Evening Post and other broad publications. They're gone. What survived? Ultra-specialized magazines like Motorcross, which serves enthusiasts who "turn somersaults on their motorcycles." As Munger notes:

This demonstrates how scaling down and intensifying focus can create powerful advantages over larger, more general competitors.

The great defect of scale is bureaucracy. As companies grow larger, they develop layers of management that slow decision-making and create perverse incentives.

Munger uses AT&T ($T ( ▲ 3.06% )) as a prime example. In a massive bureaucracy, employees stop thinking about shareholders or delivering value. Instead, they focus on moving work from their in-basket to someone else's. As Munger explains:

This mindset creates "big, fat, dumb, unmotivated bureaucracies" where nimbler competitors can run circles around established giants.

Human nature makes these problems worse. Large organizations develop territoriality, where departments protect their turf rather than working together.

Corruption also creeps in through unwritten rules. When departments share power, managers often adopt a philosophy of mutual non-interference:

This creates unnecessary layers of management and associated costs. While people justify these layers, decision-making slows to a crawl. The organization becomes too sluggish to respond to market changes or competitive threats.

According to Munger, these problems reach their peak in government organizations, where incentives are "really awful." This doesn't mean we don't need governments, but it highlights how difficult it is to make large bureaucracies function effectively.

The constant curse of scale is this tendency toward bureaucratic dysfunction. Even successful companies that gain significant advantages from scale must constantly fight against these natural disadvantages.

Those that fail to maintain efficiency and focus often find themselves overtaken by smaller, more agile competitors who better serve specific customer needs.