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Key To Savings Is Economy Of Scale

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By Lowell L. Kalapa
(Released on 1/30/11)

Those in the business community understand one of the basics of a good and sound operation that allows any and every business to be profitable, the economies of scale.

This is the reason why the big box stores like Costco, Sam’s Club, and Target can deliver at a much lower price than one could with the same product that one buys in a mom and pop store. The simple reason is that the big box store sells a greater volume of the product and is able to spread the overhead costs of utilities, labor, and administration over a greater number of products. This is what economies of scale is all about.

This is the point that seems to be lost by public administrators. Because each department or office of state or county government doesn’t amortize its overhead costs over the number of services they deliver, they pay no attention to spreading the overhead costs of their department over the number of services or goods they provide.

Take for example the City & County of Honolulu. The City wants to dispose of its portfolio of affordable rental housing but it doesn’t want any one bidder to take advantage of the process by choosing to take only those projects that are attractive and ignore those that present challenges. That aside, what City officials do not recognize is that some of the smaller projects just won’t pencil out for someone looking to bid on the project. There are fixed costs regardless of the size of the project. For example, there will have to be a project manager who oversees the overall operation of the project, from the maintenance to the rental of the units, and more than likely there will be a resident manager who is on the property 24/7 to respond to tenants’ complaints and requests. If there is on-site maintenance staff, there probably will be someone who will have to handle payroll and benefits for those employees.

The point of the matter is that the more units over which these overhead costs can be spread, rental rates can be held at reasonable and affordable rates. The fewer units over which to spread these costs, the higher the rental rates will have to be in order to cover these costs. Thus, in order to attract potential purchasers of the City’s portfolio of rental housing, the projects should be grouped so that the minimum number of units would be enough to amortize these overhead costs.

The same can be said of road or street maintenance. As far back as 1974, observers have wondered why there is a state department transportation for highways and a city department of transportation, both of which have the responsibility of maintaining the public roads. While it is true that some roads are state owned and others are owned by the county, it makes little sense to have to two road crews doing the same type of work, filling potholes and re-paving streets. Both come with identical overhead costs and more than likely identical equipment and duplicate facilities to house the machinery and equipment to re-pave those roads. Combining the two made sense to the Commission on the Operation of Government (COG) back in 1974 and it still makes sense today.

Finally, there is that politically sensitive issue of schools with declining enrollment. As schools are targeted for closing, parents, students and teachers rebel saying that these school facilities are an integral part of their community or that the smaller classroom size helps improve learning for students, or sending students to another school would force them to cross a dangerous highway, or the distance is too far from their home. Those appeals may catch the ear of the elected official representing that district, but it ignores the impact on all students.

Although education administrators point out that there are cost savings to be had, the emotional cries from students, parents and teachers strike fear into the hearts of elected officials who turn out in droves to support the parents and students. After all, those folks are the people who vote to keep those elected officials in office. Meanwhile in other areas of the state where the population is growing faster than current school facilities can accommodate, students are literally sitting on top of one another because the classrooms are overcrowded and officials are awaiting funding for additional classrooms and more teachers.

While those students and their parents at schools with declining enrollments may enjoy the luxury of having those smaller classrooms, it comes a price to all students and all taxpayers.

As lawmakers are faced with the challenge of balancing the state budget which may require a tax increase, they might want to consider asking the parents in those schools where cost savings could be realized to pick up the tab for the subsidy and pay tuition equal to the amount of cost savings foregone.

Lowell L. Kalapa is the president of the Tax Foundation of Hawaii. Mr. Kalapa’s commentary is printed each week in the Maui News, West Hawaii Today, Garden Isle News, and the HawaiiReporter.com.


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