Selection Is Slow

If you imagine that a 25% cost advantage would let your firm quickly displace all rivals, think again. Yes more efficient firms and plants eventually displace less efficient ones, but it is easy to overestimate the strength and speed of this effect. For example, in a US manufacturing industry with five plants in use, the best plant will typically produce about twice as much with the same inputs (including materials, land, labor, etc.) as the worst plant. In India and China, it will make five times as much:

[The median] four digit SIC industr[y] in the U.S. manufacturing sector [has] a TFP ratio of … 1.92. … This … says … the plant at the 90th percentile of the productivity distribution makes almost twice as much output with the same measured inputs as the 10th percentile plant. Note that this is the average 90–10 range; … several industries see much larger productivity differences among their producers. U.S. manufacturing is … if anything … small relative to the productivity variation observed elsewhere. … [Researchers] find even larger productivity differences in China and India, with average 90–10 TFP ratios over 5:1.

These figures are for revenue-based productivity measures; i.e., where output is measured using plant revenues (deflated across years using industry-specific price indexes). TFP measures that use physical quantities as output measures rather than revenues actually exhibit even more variation than do revenue-based measures as documented. …

Another robust finding in the literature—virtually invariant to country, time period, or industry—is that higher productivity producers are more likely to survive than their less efficient industry competitors. …

Aggregate productivity growth in the U.S. retail sector is almost exclusively through the exit of less efficient single-store firms and by their replacement with more efficient national chain store affiliates. … Why is within-store productivity growth so small on average in retail, but not manufacturing? (more)

Yes, some of these large differences may be due to unmeasured quality differences.

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  • paulfchristiano

    How much would you value an institution which significantly accelerated selection (just using strong empirical evidence effectively, never mind doing much better)? How likely is such an institution to arise in the near future?

    My current feeling is that such an institution would be very valuable and will plausibly exist in the relatively near term (probably in the form of some large financial institution). Current non-existence demonstrates some obstruction, but while a few decades isn’t much time compared to human history, at the current rate it looks like it will represent a large fraction of historical innovation in finance.

    • Faster selection would be of great social value.

    • cytokinestorm

      Err… the takeover market?

    • Michael Wengler

      This is indeed what efficient capital markets accomplish. However, I suspect that production in factories suffers some of the same difficulty as the real estate market. No two houses are really the same, and the value of a particular house is not the same to any two people looking at it. Thus we don’t find effective ‘commodity’ markets in real estate, their is all sorts of room for extremely local expertiese to produce profits for extremely local traders, and there is little substitute when shopping for a house to spending lots of time looking at lots of houses.

      I wonder if it is somehow similar with factories, that the ‘trade secrecy’ of good and bad factories alike, plus the vagaries and variations of 100s of inputs to the factory across the land- and mind- scapes leave it an intrinsically inefficient market, a market where the information needed to make it more efficient is vast and expensive to acquire?

  • Thanatos Savehn

    Not sure, but I can say that I make a good living suing over trade secrets (engineered improvements to production, typically). Engineers combat commoditization, after all, and I work to be sure that their tiny improvements in productivity go to those who employ them.

  • Dan Weber

    Why would I want to drive out my competitors? I could do what Toyota did for a long time — slightly undercharge the competition, and take home the rest as profit.

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