Economies of Scale, Vertical Integration, and the Brand I Love Most | Ep 989

**Alex Hormozi** (0:00)
Economies of scale. And so there's two different ways that you can attack this. One is cost advantages. And so basically, you achieve a lower cost basis per unit sold through larger scale production. And so that allows you to undercut prices and deter smaller competitors. It means other people who are smaller can't find the volume that you can. And so as a result, can't price as low as you can. And so this is a price based strategy, as in you can still make a profit at a lower price than all of your competition. And so this is a low cost leader strategy, which typically is paired with economies of scale. Where you don't want to get into this, I want to make this a clear cautionary tale, is that if you're getting into one of these markets, there's no advantage, this is Dan Kennedy quote, there's no advantage to being the second cheapest player in a marketplace.
The cool thing with this strategy is that it gets better with time. And so that's what you'll notice is a common theme which each of these points is that as you have a greater network or as you have a more robust ecosystem of products or you have larger economies of scale, most businesses, like I said, degrade with scale. They get worse and harder with scale. Whereas if you have one of these strategic advantages woven into the fabric of your business, as you get bigger and the business becomes more complex, you have another force that's driving your competitors away. So you have something that's very strong and working in your favor as you scale, which is one of the key traits of becoming a very large business, is having one of these thoughts into your DNA woven day one. So for example, my software company, Allen, we started scheduling appointments, 100 appointments a day, 1,000 appointments a day. We got up to 4,000 or 5,000 appointments a day, and we still continue to do that in that company. And so as we acquire more data and we send more messages, we get economies of scale on literally messaging itself. And so if somebody else wants to come in and we're sending millions of messages a day, they're going to have to pay more permissions than we do. And so with that, we know that we actually have increasing margins as we have more messages that go out in addition to the data that we have that no one else has. And so that is a compounding advantage that makes it harder to compete if someone starts two years later than us. And again, any one of these competitive motes will be enough to build you a massive, multi-billion dollar company. And so you don't need more than one of these. You just need to do one right all the way. The fifth way to destroy competition is vertical integration. Now this is one of the sweethearts of private equity because it's something that usually capital can come in to do. And this is something that we've done in multiple of our portfolio companies, which we'll talk about in a second. So there's two kind of common ones that people have. One is control over supply and the other is distribution networks. So control over supply means that you own everything that is required from kind of click to close. And so in the De Beers example I gave earlier, they own the mines all the way to owning the front store, right? Or Tesla, right? When Elon is building the cars, he wants to get as close to the supply chain of like, where do I get steel from all the way to the actual retailers, which are just Tesla retailers that sell online to the customer. So he vertically integrated the entire chain end to end, and he was able to capture margin at every step. And by doing that, you can have a more profitable business and or sell products that are better than other people at lower prices because you can eat into your own margin and then put everyone else out of business. And so there are multiple advantages to controlling your supply. One is that you can control quality all the way through, and everyone is aligned with the end user and the ultimate business at large. The other piece is that you control disruption because if you have vendors that you rely on for key components of your products, if those vendors go out of business, then it threatens your business. And so by controlling all of these things, like control is kind of the opposite of risk in a lot of businesses, if you control those elements, then they are things that you can manipulate and adjust more proactively than being reliant on third parties.