Economies of Scale and Law of Diminishing Returns

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Running Arrow Bill

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Ok...guess I've created two book length topics here in one...lol.

Anyhoo...

Agree fully that the past several decades of the "corporate farms & ranches" and big government intervention into the American way of life has had a progressively negative impact on the grass roots family farming operation. The big chemical companies, seed companies, and others haven't helped much either. These mega businesses have choked out the "American Way of Life" with bits and pieces of "change" that have been subliminally inserted into agricultural's way of thinking. In the 1980's there were business theorists that suggested that even if it's not broke, we need to "break it" and (supposedly) fix it to make it bigger and better.

There is also the notion of "Economies of Scale" which suggest that a larger operation is more "efficient" whereas it reduces per unit input costs to allegedly reduce end product prices for the terminal user. "Enter the Corporate Farm"...

The other notion of the "Law of Diminishing Returns". This Law implies that as one's business operation increases past a certain point, that the capitalization, equipment, production, labor and other costs exceed the Economies of Scale and further "increases (in whatever)" will not be cost-effective and profitable.

One needs to understand and become cognizant of the "tipping point" of the scales when these two phenomena are about to grab one by the nookie and start a chain of events to either continued "break even" or worse...financial disaster.

In the past, I have owned and operated publishing, residential construction, landscaping and irrigation businesses. There was always the question of "should I expand?" In most cases my answer to myself was "No!" Why? Simply because expansion significantly increased problems of cash flow, more equipment purchases, one or more additional vehicles, more employees to supervise and deal with, and more inventory to buy and maintain. My practical and calculated analyses indicated that I could have gross income of X dollars using myself and one or two employees, while at the same time not having to work 24/7/365. If, however, I increased my operation past a certain point, then it would be significant increases in employee hours (as well as unproductive hours paid), insurance, advertising, etc., etc. Even a 50% increase in projected business would have nearly doubled my overhead and operating expenses, plus causing me to work more, with only minimal additional net profit.

True that all the realms of USA agriculture production have caused farmers and ranchers to buy or lease significantly more land, overpriced equipment, etc., in order to have a break-even or sustainable level of income...and, many with outside jobs to keep afloat. For a Wilda$$ Guess example: If a producer has a net spendable income from a venture of say $30,000 and then decides to double the size of his/her operation and then only realize a $40,000 net spendable income...well, what's the point? Will still probably have to have an outside job!

The point is, I suppose, is a "Way of Life" (no matter what the costs are or the time and effort involved). When I look at the Farmers in our West Texas regions (or in the Midwest crop belts) that are farming 1,000 or 2,000 acres and have $2 or 3 million dollars worth of equipment (sitting idle most of the year)...well it makes one wonder. [Low commodities prices and government regulations don't help any either]. When a producer has to borrow money to "put in next year's crop" (in hopes of paying the loan back with some left over spending money] once the harvest or livestock sales are made...as we all know it is the classic "Crap Shoot".

In sum, one must analyze and make decisions on the best approach to take, along with the degree of effort and risk one is willing to assume. Those that don't have to borrow money to "put in a crop", so to speak, are always ahead of the game...if there is a significant loss or economic downturn, the only thing they have lost is the money already spent (and not owed) and their time and effort...

Yes, those that are overextended and have exceeded the point of diminishing returns (and who feel there is no way out) may in fact commit suicide, murder significant others, or just have to walk away from it all. It applies to all forms of business from Stock Market players to Farmers, Ranchers, and over-extended home buyers, credit card junkies, etc.

There is no easy answer. Maybe the answer is "Survival of the Fittest"...
 

TheBullLady

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As far as wanting to expand or not.. I can tell you that in the past few years, we've decided that expansion is not necessarily a good thing. Primarily because of how hard it is to find decent employees! If you have to watch someone constantly.. or tell them over and over how to do something, you've really limited your growth, and added to your stress and frustration.

My husband has a dozer business, and he's decided that he's going to only take jobs he can do himself. It's saved a BUNCH of wear and tear on his machinery (which no one except himself seems to take care of) and saved a lot of aggravation.

I thought about hiring an assistant a few years ago, but decided against it. No one is going to take care of your business like you do yourself.!
 

Jogeephus

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1982vett":dlhvpogi said:
Well written piece Running Arrow Bill.

Ditto that. I've the same feelings and have come to the same conclusions and this is why I sometimes think about cashing in my chips and following the advice of the wise one - Jimmy Buffett.

There is one thing that I don't think you mentioned and that is one of the reasons the big boys can run their businesses the way they do. The reason I see is the stock market. For instance I used to work for the largest privately owned company in its field and our stock was worth a $1 per share. We went public and my stock was then worth $12 share. Now I am simpleton when it comes to big finance but to me this meant the dollar pen laying on my desk was now worth $12. Was it worth that much money? I don't think so. I doubt I could have sold it on the street corner for $0.50. But with the easy money we could throw around we did lots of things that may not be economically sound but the results of our actions either put other smaller ma and pop companies out of business or made it where we could buy them out. Everytime we bought one out, this acquisition was applauded on the stock market and our stock rallied more and "we made more money". This got me to thinking. Is it good business when your arctions weaken the country as a whole? I didn't think so. I hope I made sense.
 

grannysoo

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Excellent post!

One big thing that people need to remember is that you can not borrow your way out of debt... :mrgreen:
 

HerefordSire

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One must understand the nature and state of the milk and beef markets relative to the cycle, etc. For example, recently is has been a losing proposition to be in either of these two areas the last couple of years, no matter what your business philosopy is. About the only exception to the rule that I can think of is to be in a niche market. That is why I liquidated the commercial side before the market crashed completely.
 

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