COLUMN-Economies of scale

keeping acctIt has long been accepted in economic and business theory that firms (private sector companies) have a profit objective that is enshrined in the creation of wealth and provision of satisfactory return on investments for its owners and shareholders. Economic theory and business practice therefore dictate that management should do all within its power to generate profits through the provision of its core goods and/or services.

For developing nations, especially those with small open economies such as Barbados, the challenge confronting these firms is often the relationship between the required investment and the threshold of both the market size and the price
that the said market can sustain.

The recent announcement of a planned buyout/merger between telecommunications giant Cable & Wireless (LIME) and new player in the market Columbus Communications, which recently bought out the assets of TeleBarbados and Karib Cable, has once again brought these and the greater issue of economies of scale and the inherent size of developing economies to the fore, all in the context of consumer choice and market pricing.

Economies of scale are defined in summary as doing things more efficiently with increasing size or speed of operation, and often originate with fixed capital, which is lowered per unit of output as capacity increases. Essentially, achieving this state of play requires expansion of business units to achieve the returns that such economies of scale present.

A firm’s efficiency is directly affected by its size, but can prove detrimental in the long run where productive efficiencies are adversely affected by the speed or scale of growth.

In the public relations surrounding the pending buyout, Cable & Wireless and Columbus indicated the following: “The proposed acquisition will enable the combined entity to accelerate their growth strategy, improve service delivery to customers in the region, offer customers a comprehensive portfolio of high-quality products and services, and strengthen their position against larger competitors. The increased scale and capabilities of the combined company will provide the technical platform and financial capacity to help enable CWC to drive greater innovation and expand our geographic footprint.”

In my opinion, the basis for the acquisition is sound, given an understanding of economic theory. So where then lies the concern for many, including their valued consumers? I vividly recall at the start of the century when I joined the Fair Trading Commission, that the Government was at the time fully engaged in the liberalization of the telecommunications market in Barbados that eventually led to the issuing of a range of licences, primarily in the mobile sector, and welcomed Digicel, AT&T/Cingular to compete with Cable & Wireless. Additionally, there were to be licences for fixed wireless and a range of other services.

The immediate benefit to consumers were:

1. Access to more innovative products and services (not necessarily new to the industry);

2. Improvement in access and quality of service;

3. Consumer choice.

And to date these may arguably have been the sole advantages, depending on your individual vantage point. Now, we seem poised to return to some measure of monopoly on certain services through yet another larger than life enterprise, and I suggest that it was eventually bound to occur. Why?

Regardless of industry or sector in our economy, all of our businesses are forced to contend with the inherent reality and resulting risk of the scale of our economy or more specifically our market. With a population of an estimated 290,000 where consumers are 150,000 or maybe even fewer, it is impossible to adequately recover investment and to place additional investment to facilitate expansion.

Consider this scenario (fictitious):

Population: 290,000.

Estimated consumers: 150,000.

Telecom providers: LIME, Flow, Digicel as main providers all providing same of similar services.

Split of consumers: assuming an even one –– 50,000 subscribers each.

Investment per company: $1 billion.

Investment per subscriber: $20,000.

Three full service providers are likely very unsustainable in our market and from the time of liberalization there have been acquisitions, mergers, buyouts and so on that support this theory. The way forward in my opinion is to have one major full service provider (mobile, landline, broadband, Internet, business communication services and so on) and one or two small mobile providers as appears set to occur. However, where I believe the emphasis needs to be placed is on regulation of the single or multiple players in a stricter manner as it relates to:

1. Quality of service;

2. Range of services;

3. Access to services;

4. Market pricing of services.

Such strict regulation or oversight for those who cherish the notion of a free market should ensure maximum benefit remains with the consumer while allowing the business enterprise to meet its shareholder and profit objectives. Where the market due to size cannot sustain multiple players, I believe this has to be replaced with strong oversight.

In the Barbados context, the free market has ultimately moved from monopoly to a competitive environment and now possibly back to a virtual monopoly.

I am sure that the jury will remain out on the merits and demerits of the proposed acquisition, but we cannot evade the harsh reality that there exists an inherent risk in the sheer size of our market, and reinforces the need for more of our local businesses to spread their wings regionally and internationally to achieve sustainability and earn foreign exchange for our country.

(David Simpson is immediate past president of ICAB and a director of the Barbados Entrepreneurship Foundation, and serves as co-champion of its finance pillar.)


One Response to COLUMN-Economies of scale

  1. James Austin Bynoe
    James Austin Bynoe December 9, 2014 at 10:23 am

    From the technology profession perspective this merger could have a stifling affect on innovation in barbados and across the region.

    As we seek to emerge from the so called global recession now is not the time to be stifling IT innovation via high prices and poor service which often are inherent to monopolies.


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