The Long-Run Average Cost Puzzle

Abstract

It is common in business analyses to invoke different efficiencies generated by scale and assume that costs grow at a slower rate than sales as organizations grow. Factors cited include the relatively fixed nature of many costs and increased bargaining power. Growth should thus be associated with declining average costs/sales and higher profit margins. We investigate how average costs/sales for different cost items evolve for a sample of US firms after their IPO. To our surprise, we find that costs/sales remains relatively unchanged, even during the early years when growth is high. Similar results are observed for other samples of domestic and overseas firms, both public and private. We speculate about possible explanations for our results and discuss implications, especially for financial projections and cost allocations.

Keywords: scale economies; scale efficiencies; average cost; marginal cost; fixed cost

JEL Classification: M41, M13, G30, D24