Blockchains Will Upend Economies of Scale

The ability to achieve economies of scale is the foundation of much of the world’s modern wealth. In the original Ford Motor factory in Detroit, the company managed to gradually take the time required to assemble a model T from 12 hours to 93 minutes. The process of endless methodical improvement included everything from just speeding up the production to offering few or no options (“any color you want, as long as it’s black”) to finding a version of black paint that would dry faster than others.

I believe we’re at the beginning of a new cycle of disruption, this one fueled by public blockchains and tokenization of industrial processes, as well as several other digital processes that change the economics of doing business.

Blockchains use standardization from tokenization, and the flexibility which is enabled by smart contracts, to drive efficiency without firms needing traditional economies of scale to keep costs down. The results will be immensely disruptive to industries, geographies, and supply chains.

Now, scale isn’t the only game in town. Diseconomies of scale also exist. Government legislation routinely imposes tougher rules and targets on larger companies. Larger companies develop bureaucracy. The same systems that keep companies operating with consistency globally also eliminate local discretion.

The CIA published a (since declassified) top-secret manual in 1944 on how to sabotage the enemy. It contained useful guidance like “only do things through proper channels,” and “haggle over precise wording of communications.” It is, sadly, timeless advice on how to succeed in many large offices.

Very simply: Bigger is not endlessly better. There is a range of scales as what is “optimal” – large enough to take advantage of economies, but not so large as to be strangled in red tape. The bottom end of this range is known as “minimum economic scale” and it’s important because the smaller it is, the more firms and more competition you can support in a market.

Traditionally, those numbers have been big, and the bigger the required scale of investment, the harder it is for firms to enter and stay competitive. Some industries are still headed in the direction of ever bigger investments and capacity required to achieve scale. Today, building a new state-of-the-art semiconductor facility is so expensive – estimated at up to $30 billion – that only a few companies are left in the business where there were once dozens.

We could be getting locally enriched economies, hugely competitive markets, all running at high efficiency

Directly related to the shortage of state-of-the-art semiconductor fabrication capacity is the shortage of chips used to train advanced AI models. Many of these orders are in the $1 billion and greater range; the cost per AI model is estimated at more than $50 million for the most advanced ones.

Even as technology changes are driving some industries to consolidate because entities must have ever bigger scale to stay competitive; others are being upended in the other direction. 3-D printing is slowly transforming manufacturing by driving down scale significantly. Traditionally, metal-stamping presses can churn out a large number of parts quickly and cheaply, but the fixed cost is high, and they can only do one part at a time.

3-D printers, on the other hand, can make a huge range of parts. Each printer may itself be slow, but you can just add more printers. Research I led at IBM showed that 3-D printers can reduce scale requirements in some industries by as much as 90%.

A similar story is happening in IT. eCommerce on the Web enabled even the smallest companies to sell worldwide. API-enabled services make it possible to plug in everything from credit card payments to shipping and tracking services.

So far, API-based web-services have done a great job of simplifying relatively standardized systems and services. The next big shift will come from blockchains enabling much more complex and customizable integrations between firms using tokenization and smart contracts.

Systems integration – linking up firms so they can work in tandem – is quickly becoming the key to maturing businesses and growing them. No company makes or produces everything itself. Instead, nearly every business is a game of coordination where firms add their most unique and useful value to a long chain of partners.

Coordinating all those partners is very challenging. For example, if you have a restriction on supply for a critical component, there’s no point in ordering more of other components as they will just sit in the warehouse unused. Unfortunately, there are few supply chains that are able to master this complex process. Companies routinely try to advertise and sell products they cannot deliver because of internal coordination challenges.

The more tightly firms are bound together digitally, the better this coordination process works. Representing all products as digital tokens, enabling visibility across multiple stops in a supply chain would be transformational for most companies. The world’s biggest companies already do a version of this kind of deep coordination with a blend of customized systems and human management. With each big firm trying to set up their own collaboration hubs, smaller companies find it costly and challenging to keep.

Blockchains will transform this dynamic because, instead of having to integrate to many different proprietary systems, businesses can create standardized models of their products as digital tokens and then integrate into a single location – a public blockchain, like Ethereum. With the addition of privacy technology on top of Ethereum, firms can manage which partners see their information and prevent competitors or intermediaries from exploiting their data.

In each industry, where the minimum scale goes down, markets can support more competitors. In research I led at IBM, we found that as 3D printing matures, it can enable scale reductions of up to 90% in some manufacturing sectors. This means up to 10 times more companies can be competitive in the same space.

Imagine increasing the number of firms that can be viable in a range of industries using blockchain software by a factor of 10. It would up-end these markets.

When the minimum economic scale is high, you end up in a market with few products and very standardized products. When that same minimum scale gets much smaller, you start to see enormous variety. In those cases, local products that are tailored to local needs start to win out over global options. Small businesses perform better than larger ones in these environments as well, given their flexibility and proximity to the customer.

The most optimistic outcome is a return to an era where small companies provided local services. That era feels like the distant past today, and the replacement of small firms in the past with big firms today wasn’t malicious. It was part of what has driven a huge gain in living standards for everyone from the resulting efficiencies.

With blockchain and other technologies driving minimum economic scale back down, we could be getting the best of both worlds: locally enriched economies, hugely competitive markets, and all running at high operational efficiency.