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Jim's avatar

The reason for this situation seems pretty straightforward.

Manufacturers achieve economies of scale by investing in expensive capital equipment that increases the productivity of labor. It was expensive to build the early Ford factories, but the completed factories contained sophisticated equipment that made the marginal cost of building one Ford auto cheaper than the cost of an auto built by a boutique manufacturer. So Ford captured market share from the boutique auto manufacturers, and the new equilibrium became a small number of well-capitalized, high-volume car manufacturers dominating the market.

Complex factories are expensive, so firms can only afford to build a few of them and need high output from them to be profitable. This means that the products need to be shipped relatively far from the few factories to their many final destinations.

The obvious issue is that the physical dimensions of a factory’s product have to be small enough to fit within the dimensional constraints of our transportation infrastructure. Roughly speaking, this means that the product needs to be small enough to fit within a shipping container. Any product that’s substantially larger than a shipping container can’t be transported cheaply, so it’s pointless to invest in expensive equipment to build it in a centralized factory.

If you zoom out and look at manufacturing as a whole, defined broadly to include the production of any physical object, you see a sharp disparity in efficiency between the manufacturing of small and large objects. Small things, like cars and widgets, are built in a few expensive, centrally-located factories and shipped. Big things, like houses, skyscrapers, roads, and sewage-treatment plants, are too big to be shipped, so they’re built on-site. But only one of the big items is built in each location, so it’s not cost-effective to install expensive volume-production equipment there. It’s cheaper to use simple, labor-intensive methods.

Based on the above, it makes sense that a 300-unit apartment building isn’t much cheaper on a PSF basis than a single-family house. Although the apartment building is a lot bigger than the house, the relevant factor is not the size disparity between the two but rather the fact that both of them are, unlike a car or widget, too big to fit in a highway lane. So they’re both built at their final locations with similar labor-intensive construction methods, at similar PSF costs.

Based on the above, we’d also predict that discrete building components that *do* fit within shipping containers will be built like cars and widgets, not like buildings. And that’s exactly what we see. The window industry, unlike the home building industry, is highly centralized. Andersen and Pella have huge, expensive factories, ship their windows thousands of miles, and capture large shares of the window market. Likewise for boilers, appliances, etc.

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James's avatar

A few years back, I did some analysis of economies of scale while working at a major national homebuilder. We found some evidence of economies of scale *within* local markets: in general, the national homebuilders with larger relative scale in local markets tended to be more profitable. This didn't generalize to national scale. I expect that was mainly due to the many unique aspects of each metro area around land development and entitlement, building codes, relative market power of the building trades, etc.

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