INFORMATION TECHNOLOGY & INNOVATION FOUNDATION | MAY 2024 PAGE 4
Policymakers thus need to promote greater consolidation in industries that benefit from large
scale economies and that have not yet achieved such scale. The best way to do that is to modify
or, if possible, remove government regulations—at the local, state, and federal levels—that
disincentivize consolidation or promote fragmentation. This is necessary because doing so would
allow efficient firms to stay in the market and grow while encouraging the less efficient ones to
either merge or exit the market, boosting an industry’s productivity. As a starting point, the Biden
administration should follow up on its prior executive order on competition with a new one, such
as an “Executive Order on Removing Barriers to Consolidation in the American Economy” that
would do at least two things. First, such an order would call for regulatory size neutrality to
minimize bias toward firms of a specific size. Second, it would examine industries and policies
with the goal of eliminating policies and regulations that keep industries too fragmented.
This report shows 1) that larger firms in the economy are generally more efficient due to scale
economies, 2) how consolidation can help smaller firms maximize economies of scale, and 3)
how 12 industries in 5 sectors (banking, doctor’s offices, construction, farming, and
telecommunications) face barriers to consolidation because of government regulations. For each
of the five sectors, it suggests what governments can do to enable market-based consolidation.
ECONOMIES OF SCALE AND PRODUCTIVITY
The vast majority of industries in the economy enjoy scale economies for two reasons. The first is
that most industries have not insignificant fixed costs that do not grow as output increases (a
fact that is particularly true in the high technology markets that drive innovation). Firms
producing a small output volume will face higher average costs because there are fewer units of
output to spread out fixed costs. However, as output increases, the average cost of a unit of
output goes down because fixed costs remain stable despite costs growing with revenues. For
instance, it can be cheaper per unit of output to produce 100,000 items than 100 because
specialized machines can be introduced. Second, every additional unit of production usually
declines in cost as workers gain experience. These cost declines continue until the firm reaches
an efficient scale wherein greater efficiencies are outweighed by rising inefficiencies from size
(such as greater coordination costs).
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The efficient scale varies by industry for a number of
reasons, so it is difficult for governments to determine the “proper’ limit.
However, larger firms are generally more efficient than smaller ones in the vast majority of
industries throughout the economy. In an analysis of large firms with over 500 employees from
938 six-digit NAICS industries, we found that the receipts per worker are higher than the
industry average for 710 industries.
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In comparison, the remaining 228 industries have receipts
per worker that are less than the industry average, although some of this could be a result of
their charging lower prices.
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These 228 industries with lower receipts per worker than the
average tend to be industries wherein massive scale is unnecessary to achieve the lowest costs.
For example, large nail salons (NAICS: 812113) have receipts per worker of $40,854 compared
with the industry average of $64,131.
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Nail salons have few fixed costs and little returns from
scale, meaning that their average costs will only decline by a minuscule amount after serving a
number of customers. In fact, the marginal cost of serving an additional customer may increase
if a nail salon becomes too large for idiosyncratic reasons, such as nail technicians getting in the
way of one another. In other words, some industries are efficient with small firms partly because
they do not need large outputs with many workers in order to maximize scale economies.
