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Ideas for Leaders #107

Why Scaling Up Is No Longer the Only Strategy

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Key Concept

Traditionally, industrial production has moved in only one direction: from small to large. ‘Scaling up’ was the best way to maximize productivity and lower per-unit costs. A fleet of 100 ten-ton dump trucks requires more drivers than a fleet of 10 hundred-ton dump trucks. But automation and communication technology has evolved to the point where a large number of small units may be cheaper, better and more efficient than a small number of large units.

Idea Summary

Sooner or later, any engineer working on new technology or infrastructure will hear a familiar question from investors: Does it scale up? There are few axioms in business as simple and historically accepted as the idea that ‘big is better.’ Large-scale industrial agriculture is better — more efficient, more effective, cheaper — than the family farm.  A 150,000-ton capacity container ship is better than 2,000-ton capacity schooners.

Perhaps, however, scaling up is becoming an obsolete strategy. New research from Garrett van Ryzin, the Paul M. Montrone Professor of Decision, Risk and Operations at the Columbia University Graduate School of Business, and Klaus Lackner of Columbia University’s School of Engineering and Applied Science reveals that the advantages created from a large number of small units is in the end more efficient than the economies of scale offered by large-sized units. Thanks to advances in technology and automation, small modular infrastructure is becoming for many industries more cost-efficient and offers greater flexibility than traditional large infrastructure.

The manufacture of chlorine, a chemical that is widely used but dangerous to transport, is one example. Traditionally, economies of scale would have dictated that manufacturers build large chlorine plants, thus saving money on labour and other costs; however, these manufacturers would also be incurring the risk of large-scale industrial accidents and the additional risk of transporting the chlorine over long distances.

As advances in technology eliminate the economies-of-scale advantages of the large chlorine plants — automation lowers labour costs, for example — bigger mostly means riskier. The negatives of scaling up are not as counterbalanced by the positives as in the past. As a result, write van Ryzin and his co-authors in a working paper based on the research, “some companies have developed small modular chlorine plants that use relatively innocuous ingredients to make chlorine on site. They are automated and remotely monitored.”

This is just one specific example. The research by van Ryzin and Lackner reveals that as technology continues to change the old rules of engagement, a wide range of industries will benefit from the flexibility, cost-savings, and risk reduction that smaller production units make possible. Thinking small is becoming viable and even preferable to thinking big.

Not so long ago, the desktop computer revolution sank the once-indomitable supercomputers; this high-tech exception to the “scale, scale, scale” mantra could potentially be replicated in many industries throughout the world.

Business Application

Rejecting the big-is-better ground rule of industrial production, which arguably dates to the beginnings of the industrial revolution, has profound implications for future logistical and production strategy decisions. Leaders must now take into account some of the benefits of smaller-scale production as they plan the future infrastructure of their companies. Some of these benefits include:

  • Risk reduction. Industrial accidents occur on the smallest of sites, but a large-scale industrial disaster is less likely with smaller units of production. Another risk, less tragic but very costly, is the potential for a major system failure. This risk is mitigated by the operation of several smaller plants.
  • Financial flexibility. Why build large plants that will operate at less-than-full capacity when you can start with a cheaper, smaller plant? Capital can be invested over time and as needed, creating significant economic benefits to the company.
  • Operating flexibility. Even if several smaller plants are online, they do n’ot all have to be in operation. Thus, building several small plants vs. one large plant gives leaders the opportunity to operate as needed.
  • Geographic flexibility. Instead of concentrating production in one location, production can be dispersed among different locations close to supply or demand sources.

Perhaps the greatest barrier to this shift, according to van Ryzin, is in the mindset of leaders and investors who will, he says, have to start “using different frameworks for evaluating return on investment — traditional net present value measures might capture the cost of capital but they won’t capture the flexibility benefits that small units offer.”

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Idea conceived

  • 2012

Idea posted

  • March 2013

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