Increasing Returns to Scale in Components and in Systems:

An Essay

by

Jeffrey L. Funk
Associate Professor
National University of Singapore
7 Engineering Drive 1
Block E3A, 4th Floor
Singapore 129793
etmfjl@nus.edu.sg

Increasing Returns to Scale in Components and in Systems:

An Essay

Abstract

This paper provides one of the first full-length overviews of increasing returns to scale
in technologies. Using the concept of nested hierarchy of subsystems, it shows how
increasing returns to scale in a higher level system depends on the performance and cost of
lower level components (along with advances in science) and increasing returns to scale in
a lower level component can drive large improvements in the performance and cost of a
higher level system even when increasing returns to scale does not exist in the system itself.
Following a presentation of examples from the existing literature, it applies the concept of
increasing returns to scale to wind and solar energy.

1. Introduction
An increasing demand for technologies that can help the world deal with energy,
environmental, health and other problems increases the need for a better understanding of
where long-term improvements in performance and cost come from. The conventional
wisdom is that these improvements come from advances in science (Balconia et al,
forthcoming), a change from product to process innovation (Utterback, 1994), and increases
in production volumes (Argote and Epple, 1990). The fact that there is a long time lag
between advances in science and the commercialization of them (Kline and Rosenberg, 1986;
Klevorick et al, 1995; Mansfield, 1991) and the fact that some technologies have experienced
much greater improvements or what some call exponential improvements in cost and
performance (Kurzweil, 2005: Kressel and Lento, 2007) suggests that these three factors are
by themselves inadequate explanations.
Another literature suggests that increasing returns to scale (IRtS) (Nelson and Winter,
1982; Rosenberg, 1982; Rosenberg, 1994; Freeman and Louca, 2001; Lipsey et al, 2005;
Winter, 2008) provides a better explanation for long-term improvements, including
exponential improvements (Kurzweil, 2005), in the cost and performance of technologies
than do the above-mentioned reasons. While economy of scale refers to a situation in which
increases in production volume at a single point in time leads to lower cost, IRtS refers to a
situation in which large increases in an input over long periods of time lead to larger
increases in an output than in the input and it can apply to both larger (e.g., production,
energy systems, transportation equipment) and smaller (e.g., semiconductors) scale. For
example, IRtS in some production equipment has led to dramatic increases in the scale of this
equipment and thus the emergence of large economies of scale in this equipment.
A key aspect of this IRtS is the notion of so-called geometrical scaling (Sahal, 2005) in
which the scale effects are permanently embedded in the geometry and the physical nature
of the world in which we live (Lipsey et al, 2005). In technologies that display geometrical
3

scaling, cost is roughly proportional to one dimension (e.g., length squared or area) less than
is the output (e.g., length cubed or volume) thus leading to IRtS. For example, the output
from a steam or jet engine roughly rises with its volume while the cost rises with its surface
area (Lipsey et al, 2005). Similarly, the carrying capacity of trains, ships, automobiles, and
aircraft roughly rises with the volume (i.e., cube of a dimension) while the cost of them rises
with the surface area (i.e., square of a dimension) (Sahal, 1985; Winter, 2008).
In spite of the many anecdotal examples of IRtS, however, our theoretical and practical
understanding is severely limited (Winter, 2008). Most papers merely provide examples of
IRtS and do not attempt to organize them in any way. Without such an organization, how can
we understand what technologies have or might benefit the most from IRtS and why?
Similarly, how do limits to scale emerge and how can we recognize and overcome them?
These questions are relevant to firms, universities, governments, and other organizations
when they search for and evaluate the potential of new systems. In fact, understanding these
questions is an essential part of any solution to the worlds energy and environmental
problems.
This paper focuses on these questions and makes three contributions. First, it shows how
IRtS of systems depends on improvements in components and how a lack of sufficient
improvements in components may prevent further increases in scale. In doing so it uses the
notion of a nested hierarchy of subsystems to examine the relationship between components
and systems and thus more finely examine the aspects of a technology (Lipsey et al, 2005)
that enable one to realize and benefit from IRtS. Second, building on the first point, it shows
how the existence of IRtS in components can contribute to IRtS in systems. Third, it argues
that IRtS in components can drive long-term improvements in system performance and cost
even when the system itself does not exhibit IRtS.
This paper is organized in the following way. First, it places the issue of IRtS within the
literature on technological change and in particular within Dosis (1982) notion of technology
4

paradigms. Second, it discusses the relationship between IRtS in systems and in

components and it organizes these historical examples of IRtS in terms of: 1) production;
2) energy; 3) transportation; and 4) electronics. Third, it applies the concept of IRtS to the
future of wind turbines and solar cells. Fourth, it uses these examples to discuss ideas for
future research.

2. Research Literature
IRtS refers to a situation where the output of a technology increases faster than does an
input(s) such as labor, capital, materials, and energy. It is different from economies of scale
(noted above), increasing returns to scale in demand (i.e., network effects), and learning.
Increasing returns to scale in demand refers to a situation when the value of a technology
depends on the number of users or complementary products (Katz and Shapiro, 1985; Arthur,
1994; Katz and Shapiro, 1994). The literature on learning focuses on the organizational
processes that are involved with reducing costs or improving performance (Arrow, 1962;
Huber, 1991; March, 1991) while IRtS focuses on the characteristics of a technology that
determine the potential for learning (Gold, 1981). Thus, while the literature on learning
suggests that solving energy and environmental problems is primarily an organizational issue,
the literature on IRtS suggests that IRtS can tell us where an organizations learning efforts
should be focused.
IRtS is an important aspect in Dosis (1982) concept of a technology paradigm. Such a
paradigm is associated with a specific technological discontinuity (Abernathy and Utterback,
1978; Tushman and Anderson, 1986; Anderson and Tushman, 1990; Utterback, 1994) where
such a discontinuity is typically defined and classified by the extent to which a new product,
when compared to previous ones, involves changes in the concepts or architectures that form
the basis of a product or key component (Henderson and Clark, 1990; Murmann and Frenken,
2006). New concepts, and to a lesser extent new architectures, are the result of advances in
5

science and they define new technology paradigms (Dosi, 1982). For example, electric
vehicles are based on a different concept for propulsion than are gasoline powered ones just
as solar cells (and wind turbines) and light-emitting diodes (LEDs) are based on different
concepts for creating electricity and light respectively than are existing technologies. Each of
these new concepts was based on advances in science (Balconia et al, forthcoming) and each
of them defines a new technology paradigm.
A technology paradigm determines the tradeoffs between various dimensions of
technological performance and cost and between various design choices, and the potential
directions of advance within these tradeoffs (Dosi, 1982). Thus, the progress of a technology
is both facilitated and entrapped by the paradigm(s) that guide it. For example, many engines
and methods of transportation (e.g., aircraft) exhibit a tradeoff between speed, weight, and
end energy usage where as noted below; performance rises faster than do costs as the size is
increased. However, there are limits to this IRtS since weight increases as the cube of a
dimension while strength only increases as the square of the dimension1. Although increasing
the strength-to weight ratio of materials can partially solve this problem and enable further
increases in the size of an aircraft, the extent of these increases in scale is limited by the
technology paradigm for the material. Similarly, the technology paradigm for semiconductors
involves a tradeoff between power consumption and speed, as defined by laws of electricity
where shrinking (i.e., smaller scale) the so-called gate length of a transistor has enabled
improvements in some combination of power consumption, speed, and other dimensions of
performance (Dosi, 1982; Winter, 2008). On the other hand, shrinking this gate length beyond
a certain point causes quantum mechanical forces to become stronger than electrical ones and
thus requires the creation of a new paradigm (Kurzweil, 2005).
These technology paradigms, including the extent of IRtS in them and the concepts and

1 Some argue that this limits the IRtS of buildings and bridges (Lipsey et al, 2005).

advances in science that they are based on, can be defined for any level in a so-called nested
hierarchy of subsystems (Tushman and Rosenkopf, 1992; Tushman and Murmann, 1998;
Malerba, et al, 1999). Systems are composed of sub-systems, sub-systems are composed of
components, and components may be composed of various inputs including equipment and
raw materials (Simon, 1962; Alexander, 1964; Tushman and Murmann, 1998). For example, a
system for producing ICs is composed of components such as raw materials and more
importantly semiconductor manufacturing equipment. This paper only uses the term
component to simplify the description as it addresses the relationship between IRtS in
components and IRtS in systems.
IRtS can exist at any level in a nested hierarchy of subsystems where there is an
interaction between different levels of such a hierarchy. On one hand, IRtS in a lower level
component can drive large improvements in the performance and cost of a higher level
system even when there is not IRtS in the system itself. On the other hand, IRtS in a higher
level system depends on the performance and cost of lower-level components.
The first instance can occur when a component performs the key function of a system and
is thus the core component (Murmann and Frenken, 2006) in the system. For example,
engines perform the key function in automobiles, trains, and aircraft and integrated circuits
(ICs) perform the key function in electronic systems (including computers). In such cases
long-term improvements in the performance or costs of a system (Kurzweil, 2005; Kressel
and Lento, 2007) may depend more on long-term improvements in the performance and costs
of components that exhibit IRtS than on novel combinations of components (Rosenberg,
1963, 1969; Basalla 1988) or technologies (Iansiti, 1995; Fleming, 2001) in a system.
The second instance extends Lipsey et als (2005) notion that the ability to exploit [IRtS]
is dependent on the existing state of technology. Using the concept of a nested hierarchy of
subsystems allows one to decompose the existing state of [a] technology into its relevant
components where improvements in specific components (including advances in science)
7

may be necessary before IRtS in a system can be realized. Similarly, insufficient

improvements in a component may cause diminishing returns at the system level to emerge
and a characterization of these diminishing returns to scale might look similar to the way that
Foster (1986) characterizes diminishing returns to technologies in his S-curves. The
difference between diminishing returns to scale and Fosters diminishing returns to a
technology is that scale is on the x-axis for the former while the amount of R&D expenditures
(or time) is on the x-axis for the latter. Thus the former focuses on the extent of the benefits
from increasing the scale of a technology (either larger or smaller) and the latter focuses on
the extent of the benefits from increasing R&D expenditures. Both approaches help us
understand the relative benefits from continuing to invest in an existing or new technological
discontinuity and its associated technology paradigm.

3. Research Methodology
The author first searched for examples of IRtS in some of the few papers that mention it
(Rosenberg, 1979; Dosi, 1982; Sahal, 1985; Freeman and Louca, 2001; Winter, 2008)2.
Second, whenever a relevant discussion of IRtS was found, the original reference was
searched for using Google and Google Books. Third, the specific technologies that were
found in these examples (such as electricity, energy, aircraft, furnaces, and engines) were also
Googled along with terms such as scale, increasing, and large. Fourth, for each
instance of IRtS, the author searched for both the improvements in components and the
advances in science that were needed to realize IRtS, which are summarized in Table 1. The
necessary advances in science were also investigated by reading many histories of technology
of which several were particularly useful (Crump, 2001; Cardwell, 2001; McCellan and Dorn,
2006). Nevertheless, it is likely that this papers interpretation of IRtS applies to a much
2 It also skips some of the more well-know examples such as agriculture (Diamond, 1999) that are ordinarily not considered in the
management literature.

broader number of industries than the ones noted in this paper and there is probably a longer
list of components and advances in science than are listed in Table 1. As discussed at the end
of the paper, more systematic analysis, including empirical analysis, is needed and hopefully
this paper will encourage other scholars to pursue this area of research.

4. IRtS in Production
IRtS in production exists when the output from production equipment increases faster
than does the cost of the equipment, as the size of the equipment is increased. The potential
benefits from IRtS in production were first noted by Adam Smith in his Wealth of Nations
where he described how a finer division of labor directly led to reductions in labor time and
indirectly enabled further reductions in labor time through the replacement of human labor
with machinery. Realizing the benefits from IRtS in this production equipment required the
concept of interchangeable parts, advances in the science of machining (Cardwell, 2001;
Crump, 2001; McCllellan and Dorn, 2006), new forms of management (Chandler, 1977,
1994) and two key components in any modern manufacturing system: special purpose
machine tools and electric motors.
Special purpose machine tools such as lathes and boring machines and ones that could
produce parts with a high degree of tolerances did not become available until the latter half of
the 19th century. This is partly since finer tolerances from these machine tools required that
the machine tools themselves be made from machine tools capable of producing parts with
fine tolerances 3 . Such machine tools became more available for some discrete part
manufacturing operations than others (Rosenberg, 1963, 1969) and thus for certain types of
products such as automobiles and bicycles (Hounshell, 1982) than for other products such as

The notion that improvements in manufacturing equipment depend on the use of this equipment to make parts for this equipment is also

evident in computers; improvements in computers are needed in order in for semiconductor manufacturing equipment to produce the ICs for
the computers.

shoes and apparel. Furthermore, it was easier to increase the size of some types of machine
tools such as lathes and boring machines than for others. Larger machines could cut and bore
metal faster than could smaller machines and they could do this on larger pieces of metal.
New materials for machine tool bits also contributed to increases in the speed of these
machine tools (Cardwell, 2001; Crump, 2001; McCllellan and Dorn, 2006).
Second, the development of electrical generating stations at the end of the 19th century
enabled machine tools to be driven by electric motors. The use of electric motors enabled the
implementation of new forms of factory organization in which the placement of machines in
a factory did not need to be dictated by the system of shafts and belts that drove the machine
tools. It is generally recognized that these new forms of factory organization were important
contributors towards improvements in factory performance (David, 1990) where the percent
of U.S. factories with electric drive had exceeded 90% by 1940 (Freeman and Louca, 2001).
Although electric motors did not exhibit IRtS (Lipsey et al, 2005), the production of them and
more importantly the generation of electricity did exhibit IRtS (see below) where this IRtS
caused the price of electricity to drop by about 90% in inflation-adjust terms in the U.S.
between the late 19th century and 1973 (Hirsh, 1989).
Many scholars argue that limits to scale in discrete parts production had been reached by
the mid-20th century (e.g., in Fords River Rouge Plant) for several reasons. First, machines
could only be made so big and so fast, particularly when one considers the limited demand
for standardized products such as Fords Model T. Second, big and fast machines required
longer setup times particularly as the demand for variety increased. These and other problems
led to the emergence of a new technology paradigm for manufacturing that focused on just-in
time manufacturing, programmable machine tools, and computer-controlled factories and that
enabled economies of scope. Instead of a factory making one kind of product and
benefiting from economies of scale for this single product, factories made a family of
products or a family of parts that could be economically made from the same type of
10

equipment and processes (Piore and Sabel, 1984; Freeman and Louca, 2001).
Greater IRtS probably exist in continuous flow than in discrete parts manufacturing.
Organic and inorganic chemicals, plastics, paints, and pharmaceuticals are made in factories
that largely consist of pipes and reaction vessels and the high degree of automation in these
kinds of factories suggest that there are more benefits from IRtS in them than in discrete parts
factories. This caused many scholars to note that the costs of pipes, i.e., surface area of
cylinders, vary as a function of radius whereas the output from a pipe, i.e., volume of flow,
varies as function of radius squared. Empirical analysis found that the costs of these pipes and
reaction vessels only rose about 2/3 for each doubling of output (Haldi and Whitcomb, 1967;
Levin, 1977; Freeman and Louca, 2001; Winter, 2008)4. For example, the cost of catalytic
cracking dropped by more than 50% for materials, 80% for capital and energy, and 98% for
labor between the first installation in 1939 and the year 1960 (Enos, 1962).
Like the IRtS in discrete parts manufacturing, the emergence of IRtS in continuous flow
manufacturing depended on advances in science, improvements in processing equipment, and
on the availability of the equivalent of electric motors for continuous flow manufacturing:
equipment for implementing such techniques as electrometallurgy, electrochemistry, and
electrolysis (Rosenberg, 1979; Morris et al, 1991; Freeman and Louca, 2001). Advances in
our understanding of electricity, the basic chemical elements, and the reactions between them
(Cardwell, 2001; Crump, 2001; McCllellan and Dorn, 2006) were needed before scaling of
these factories could even be considered. Process-related equipment for mixing, separating,
heating, cooling, filtering, settling, extracting, distilling, and drying of gases, liquids and
solids were needed to increase the scale of chemical plants and they became available at the
end of the 19th century partly because machine tools made their production possible.
Advances in electricity also made it possible to use an electric current to drive a variety of

4 Rosenberg (1994, p. 198) estimates the increases in capital costs with each doubling to be 60%.

11

chemical reactions involved with the techniques of electrometallurgy, electrochemistry, and

electrolysis (Cardwell, 2001; Crump, 2001; McCllellan and Dorn, 2006). Large-scale
equipment for these techniques also emerged in the late 19th century for some of the same
reasons that other process-related equipment emerged and supported IRtS in continuous flow
manufacturing (Morris et al, 1991; Freeman and Louca, 2001).
In summary, the papers characterization of IRtS in production equipment has a different
focus from the conventional wisdom. In the conventional wisdom, innovations in products
give way to innovations in processes as volumes increase, a so-called dominant design
emerges (Utterback, 1994), and firms reorganize their factories and introduce flow lines and
special purpose manufacturing equipment (Argote and Epple, 1990; Utterback, 1994;
Freeman and Louca, 2001). Some students of technology change also interpret Christensens
(1997) model of disruptive change in this way: the expansion of production that occurs once
a niche is found enables costs to drop and the low-end product to displace the mainstream
products.
However, this paper argues that combining the concept of a nested hierarchy of
subsystems with the notion of IRtS enables us to look much more closely at the sources of
cost reductions (and performance increases) than can be done with the conventional wisdom
about cost reductions. Not only has empirical analyses of Utterbacks model shown that the
number of product (or even process) innovations in specific industries (Klepper and Simon,
1997) do not conform to Utterbacks model, research on IRtS (as noted above) suggests that
the cost reductions from increases in the scale of equipment vary quite differently among
different products and technologies because different types of production equipment benefit
from scaling more than do other equipment5. Third, subsequent sections argue that the
benefits of IRtS often come from the operation (and not just production) of technological
5 It is probably no accident that many of the examples of disruptive technologies (Christensen, 1997) involve components such as ICs that
exhibit IRtS.

12

systems and from the existence of IRtS in different levels of these nested hierarchies of
subsystems.

5. IRtS in Energy Systems

Many examples of IRtS have been found in energy production and usage including
furnaces, smelters, engines, and electricity production. Furnaces are used in many
manufacturing processes for chemicals, metals, and ceramics and IRtS exists in their
construction and operation. Like the above examples, the cost of constructing a furnace is
largely a function of area while the output is a function of volume. For example, the cost of
welding together a heat furnace is proportional to the length of seams while the capacity is a
function of the containers volume. Similarly, the heat loss from blast furnaces and other
equipment is proportional to the area of its surface while the amount of metal that can be
smelted or the amount of power a steam engine generates is proportional to the cube of the
surface sides (Lipsey et al, 2005).
Also like the above examples, advances in science in the form of thermodynamics
(Cardwell, 2001; Crump, 2001) and improvements in components enabled this realization of
IRtS in furnaces. For example, the size of a furnace or smelter is limited by the need to
deliver a smooth flow of air to all of the molten metal where hand- and animal-driven bellows
could only deliver a limited flow of air. Water-driven bellows and steam-driven ones allowed
air to be injected with more force so that larger furnaces could be built (Lipsey et al, 2005)
and these larger furnaces caused dramatic reductions in the cost of metals. For example, the
cost of crude of steel dropped 80-90% between the early 1860s and the mid-1890s (Landes,
1969). On the other hand, limits to the size of furnaces have emerged as improvements in air
flow, stronger materials, and other components have not kept pace with what is needed to
further increase their scale (Lipsey et al, 2005).
Steam, jet, and internal combustion engines have experienced IRtS and advances in the
13

science of thermodynamics and combustion (Cardwell, 2001; Crump, 2001; McCllellan and
Dorn, 2006) and improvements in components have made these increases in scale possible
(von Tunzelman, 1978). Engines exhibit IRtS for the reasons cited above plus the fact that
larger engines often have higher temperatures and higher temperatures increase the efficiency
of heat engines. Stronger materials and better processing methods enabled the development
of these larger engines, which have been implemented to the greatest extent in the form of
steam turbines and jet engines (Lipsey et al, 2005). The IRtS for steam turbines is one of the
largest reasons for the large drop in the price of electricity cited above. Similar results have
emerged for jet engines as their scale was increased in response to the increases in scale of
aircraft (Sahal, 1985), which is discussed more below. But over time diminishing returns to
scale have emerged for steam turbines (Hirsh and Serchuk, 1996) and may emerge for jet
engines in the near future particularly if improvements in materials slow.
Although IRtS also exist in internal combustion engines, they are much less important for
them than for other types of engines. First, one reason that internal combustion engines
became the dominant form of propulsion in automobiles is that they can be made much
smaller than steam engines due to their use of cylinders and gasoline rather than boilers and
coal (Crump, 2001). Second, although there is demand for large buses and ships, the demand
for big and fast automobiles is not as large as that for small and fuel efficient automobiles.
Unfortunately, there are few IRtS for small automobile engines (unlike small ICs). Instead, it
is advances in science and improvements in components such as lighter materials and better
ICs (for engine control) that have enabled some improvements in the fuel efficiency of
engines.

6. IRtS in Transportation Equipment

IRtS exists in transportation equipment for many of the same reasons that it exists in
engines, furnaces, and continuous flow manufacturing plants. The carrying capacity of trains,
14

ships (including tankers) (Lipsey et al, 2005), buses, and aircraft (Miller and Sawyers, 1968;
OConner, 2001) rises with the volume (i.e., cube of a dimension) while the cost of them rises
with the surface area (i.e., square of a dimension) (Sahal, 1985; Winter, 2008). Furthermore,
the speed that they can travel also increases as a function of size, partly because the engines
display IRtS. The combination of lower costs and faster speeds is one reason why both global
trade and global travel have grown faster than have overall economic output since the end of
the Second World War.
Like the above examples, advances in thermodynamics, combustion, and fluid flow
(Cardwell, 2001; Crump, 2001; McCllellan and Dorn, 2006) and improvements in materials,
i.e., components, have supported IRtS in transportation. Improvements in steel and steam
engines in the 19th century were needed to make longer trains and larger ships and a change
to electric trains required the large-scale implementation of electricity. Larger buses required
improved steel, better internal combustion engines, and improvements in other materials such
as aluminum and plastics. Larger aircraft has required improvements in aluminum, jet
engines, and more recently composites; the weight of aircraft has dropped significantly over
the last 20 years as the strength to weight ratio of materials has been increased several times
(Freeman and Louca, 2001). On the other hand, limits to this IRtS appeared many years ago
in trains and buses, they are appearing in ships, and they are probably right around the corner
for aircraft.

7. Special Case of Increasing Returns to Smaller Scale for Electronic Components

The IRtS that exist in many electronic components might be considered a special case of
IRtS for several reasons. First, improvements in the performance of ICs, magnetic and optical
storage, semiconductor lasers and sensors, and similar components are sometimes called
exponential improvements (Kurzweil, 2005) since the rate of these improvements has been
in multiple orders of magnitude (See Table 2) and thus is much higher than anything seen
15

in the history of technology. Second, they have had a large impact on the performance of
electronic systems such as computers and the Internet (See Tables 3).
Third, the IRtS of ICs and magnetic and optical storage are primarily from
miniaturization. While the previous examples in this paper are for increasing returns to larger
scale, exponential improvements in the cost and performance of electronic components are
primarily from increasing returns to smaller scale, which was first noted by Nobel Laureate
Richard Feynman (1959) in a speech entitled There's Plenty of Room at the Bottom: An
Invitation to Enter a New Field of Physics. He could not have been more insightful about the
future. However, the issues that Feynman addressed, and the increasing returns to smaller
scale that have emerged in many electronic components also has implications for increasing
returns to larger scale in for example liquid crystal displays (LCDs) and solar cells. This
section summarizes the key aspects of miniaturization in electronic components and their
impact on electronic systems before addressing LCDs, solar cells, and also wind turbines.

7.1 Miniaturization and Increasing Returns to Smaller Scale

As noted in the summary of the research literature, the technology paradigm of ICs has
meant that their performance can benefit from placing more of them on a single chip. Smaller
features enable more information to be stored on ICs and also on magnetic disks, drums, and
tape and optical disks. However, it was advances in science and the existence of and
improvements to the relevant equipment that has made miniaturization possible. Advances in
science were needed in the solid state physics of semiconductor transistors, insulators,
conducting materials (Tilton, 1971; Braun and MacDonald, 1982; Riordan and Hoddeson,
1997). Equipment for making and etching patterns and depositing, diffusing, and implanting
materials was borrowed from a diverse set of industries including the printing, aerospace, and
nuclear energy industries in the 1950s before the semiconductor industry began driving
improvements in this equipment (Moore, 1963). Improvements to this equipment reduced
16

defect densities (IC Knowledge, 2005) and feature sizes where the reduction in defect
densities has enabled a 30-fold increase in die size over the last 25 years (ICEC) and both
larger die sizes and reduced feature sizes have increased the number of transistors that can be
placed on a single IC chip, which is often called Moores Law (Flamm, 2004).
Part of Moores Law is driven by the IRtS of semiconductor manufacturing equipment
itself. First, just like the two-thirds scaling law for many chemical processes and furnaces
(discussed above), output probably rises faster than do equipment costs as equipment is made
larger. The reason is that the processing time (inverse of output) falls as the volume of gases,
liquids, and reaction chambers gets larger while the costs rise as a function of the equipments
relevant surface area. Second, the ability to process multiple ICs on a single wafer, whose
size has been increased many times over the last 50 years, supports the first reason. Third, the
techniques for miniaturizing patterns on wafers have required firms to also reduce the
thickness of materials that are deposited (and later patterned) on these wafers. This reduces
the cost of materials and the equipments processing time. The result is that the costs per
transistor, capital costs per transistor, and even to some extent costs per area of a silicon
wafer (See Table 4) have fallen over the last 50 years even as the cost of fabrication facilities
has increased (ICKnowledge, 2009)6.
On the other hand, the rising cost of fabrication facilities cannot go on forever7 and many
observers (IRTS, 2007) argue that diminishing returns to scale are emerging in ICs and thus
there is a need for a new technology paradigm for them. For example, if one were to plot
increases in the number of transistors per chip versus R&D effort as done by Foster (1986)
and not versus time as is almost always done (IRTS, various years), one would see the
diminishing returns of Fosters S-curve. Not only has the rate of improvement in the number
of transistors per chip slowed in the last ten years, the R&D effort has certainly increased,
6 It is likely that similar arguments can be made for ultra-filtration equipment that is used in desalination plants (Winter, 2008).
7 The newest fabrication facilities cost more than $3Billion and it is estimated that only six producers can afford these facilities (FT, 2009).

17

where the rising cost of equipment is just one example. The need for a new technology
paradigm can be seen in firms searching for new concepts that form the basis for
photolithographic equipment (Henderson, 1995), for interconnect (Lim, forthcoming), and for
information processing and storage devices themselves (Kurzweil, 2005).
Similar stories can be told for optical and magnetic storage. In the case of optical storage
(and also fiber optics), semiconductor lasers and sensors are the key components in them and
like ICs, they benefit from increasing returns to smaller scale and rely heavily on
manufacturing equipment from the semiconductor industry. Although magnetic storage is
based on a different concept than are semiconductor ICs, they also benefits from increasing
returns to smaller scale and from equipment that has been borrowed the semiconductor
industry (e.g., sputtering equipment). Furthermore, like ICs, improvements in them have had
a dramatic impact on the performance of systems (See Table 2) and the emergence of
discontinuities in them (See Table 3) and diminishing returns to scale will eventually emerge
in them.

7.2 Impact on Electronic Systems

IRtS in electronic components such as ICs and magnetic and optical storage have had a
dramatic impact on the performance of electronic systems (See Table 2) and probably on the
emergence of discontinuities in them (Kurzweil, 2005; Kressel and Lento, 2007; Malerba et
al, 1999) where these electronic systems benefit from IRtS much less than do electronic
components (Smith, 1988; . In fact, many electronic systems exhibit decreasing returns to
scale with respect to ICs since the number of ICs (even more so transistors) used in electronic
systems (because of their falling prices) has increased much faster than has the performance
of electronic systems. For example, the change from analog to digital-based products required
several order of magnitude increases in the number of transistors in microprocessor and
memory ICs in order to handle the increased data processing requirements of digital products
18

(Kressel and Lento, 2007). Similar things have occurred in the changes from so-called first
generation to second, third, and fourth generation mobile phones (Subramanian, 1999), from
circuit- to packet-based telecommunication systems (MacKie-Mason and Varian, 1994), and
in computers. It was once thought that computers displayed some IRtS. For example, Herb
Grosch concluded in 1965 that the cost of computing power only increased as the square root
of processing power and thus cost per instruction per second declined as computers were
made bigger. However, more recent analyses (Ein-dor, 1985; Smith, 1988; Strassman, 1997)
and the replacement of large (e.g., mainframe) with small (personal) computers suggests that
increasing returns only exist over a very limited range of scale.
The best example of decreasing returns to scale in computers and other electronic systems
can be found in software. The cost of both developing software and implementing this
software in corporate settings increases faster than does increases in the size of the software.
Furthermore, the much touted economies of scale in software comes from the ability to
cheaply and quickly replicate software and this ability is the result of the falling cost of
memory and microprocessor ICs, which is due to the IRtS in electronic components, and not
from the software itself. The decreasing returns to scale associated with the high cost of
implementing conventional software is one reason why many expect software-as a service
(SaaS) and utility computing to replace conventional software and computing. SaaS and
utility computing dramatically reduce implementation costs and and improvements in the
speed of the Internet, which are primarily from the IRtS of electronic components, are
reducing the disadvantages of SaaS and utility computing (Carr, 2008).

7.3 Miniaturization and Increasing Returns to Larger Scale

Improvements in semiconductor manufacturing equipment, which enabled increasing
returns to smaller scale for ICs and other semiconductors, have also played in role in the
emergence of increasing returns to larger scale in LCDs and solar cells. Since so-called
19

active-matrix LCDs use transistors to control the output of individual pixels in an LCD, there
are similarities between the technology paradigms for LCDs and semiconductors and many of
the same processing techniques and equipment can be used, albeit some of the materials are
different. The largest difference between their technology paradigms is that reductions in
feature size are far less important in LCDs than in semiconductors and increases in panel
size are far more important in LCDs than in semiconductors. For LCDs, it is the deposition
of thin-film materials on a scale of multi-meter substrates whereas for semiconductors it is
the forming of sub-micron patterns on a 0.30 meter diameter wafer that is important and that
drives large reductions in cost.
Nevertheless, the reduction in the thickness of materials that has accompanied
miniaturization in the semiconductor industry and the application of this semiconductor
manufacturing equipment to LCDs has led to dramatic reductions in the cost of LCD panels
(Gay, 2008). As shown in Table 4, the recent reductions in cost per area of semiconductors
and of LCDs (as are solar cells) are of a similar magnitude where the greater reductions in
cost per area for LCDs than for semiconductors is expected given that suppliers of LCDs
place more emphasis on cost per area than do suppliers of semiconductors (who emphasize
cost per transistor). One result of the similarities in the processes and the IRtS in them for
semiconductors and LCDs (and for solar cells) is that leading providers of semiconductor and
LCD (and solar) manufacturing equipment are the same firms where Applied Materials is the
leader in all three areas.

8. IRtS for Clean Energy

It is widely recognized that the world needs to replace fossil fuels with cleaner energy
sources such as wind, solar, and perhaps even nuclear power. The technology paradigm for
fossil fuels involves the release of carbon dioxide into the atmosphere and the increasing
concentration of carbon dioxide in the atmosphere is probably the main cause of global
20

warming. Finding new energy sources that involve a new technology paradigm is a major
challenge for the world and given the currently higher prices of many forms of clean energy
such as wind and solar, the technology paradigm for these forms of clean electricity must
involve IRtS in order for their costs to experience large reductions in the near future and thus
eventually fall below those of fossil fuel-based electricity.
Theoretical and empirical analyses suggest that wind energy does exhibit some benefits
from IRtS. The output of a wind turbine is a function of diameter squared and wind speed
cubed, while the cost of making turbine blades probably increases at a rate less than diameter
squared, particularly since materials (various forms of composites) with higher strength to
weight ratios are being borrowed from other industries such as initially pleasure boats (i.e.,
yachts) and now aircraft. A higher strength to weight ratio also enables the use of large wind
turbines in areas with strong wind speeds. Empirical analyses have found that the cost per
kWh of producing electricity from wind turbines has dropped about 50% in the last 25 years
while the blade diameter has been increased by more than 10 times in the last 20 years
(Zervos, 2008). As an aside, there have been no major changes in the design of the
three-blade, vertical axis, upwind mounted design during this time frame and thus advances
in wind turbine-science have probably played a much smaller role in these cost reductions
(Nemet, 2009) than have increases in blade diameter. If there are still benefits from further
increases in blade diameter, we can expect further reductions in the cost of wind energy and
wind energy probably deserves further attention. Furthermore, improvements in materials,
either through the modification of materials being used in other industries such as the
airframe one, or the development of new ones from advances in science may contribute more
towards reductions in the cost of wind energy than research on wind turbine design itself.
For solar cells, although the costs of electricity generated from them is currently higher
than from wind turbines, they have experienced a 500 times drop in the cost per peak kilowatt
over the last 50 years, the concept that forms the basis for the cheapest systems is unchanged
21

over that time period (Nemet, 2006), and there have been few recent increases in the
laboratory efficiency of solar cells (Wikipedia, 2009). Instead it has been the existence of
IRtS in their production equipment (and some perhaps in operation8) and the increases in
efficiency that accompany improvements in production equipment that have probably had the
largest impact on falling costs. Like many of the other examples cited in this paper, the cost
of equipment probably does not rise as fast as does output (on a per area basis) and like LCDs
and to some extent semiconductors, the use of thinner materials also leads to lower material
and equipment (through faster processing) costs (Nemet, 2006).
Furthermore, most of the equipment being used to make solar cells has been borrowed
and continues to be borrowed from the LCD and to a lesser extent semiconductor, hard disk,
and printed circuit board industries. In particular, the falling cost per area of LCD panels (Gay,
2008), which can also be seen in the falling price of large screen televisions, suggests that the
cost per area of solar cells will also continue to drop as larger production equipment is
installed. This suggests that solar energy warrants further investments and it also suggests
that research on this equipment and how the equipment from these other industries can be
modified for the production of solar cells may contribute more towards further reductions in
the cost of solar cells than research on the solar cells themselves.

9. Discussion
The purpose of this paper was to explore how IRtS can lead to long-term improvements
and some cases exponential improvements in cost and performance of some technologies.
While the conventional wisdom is that these improvements come from advances in science
(Balconia et al, forthcoming), a change from product to process innovation (Utterback, 1994),
and increases in production volumes (Argote and Epple, 1990), these theories do not explain
8 The operation of electricity production from solar cells may involve some IRtS since some of the operating costs are lower on a per unit
basis for large than small operations (Nemet, 2006).

22

why some technologies experience greater improvements in cost and performance than other
technologies. Although more empirical research is needed (see below), IRtS seems to provide
a more fine-grained explanation for these differences between technologies than does the
conventional wisdom.
IRtS is different from economies of scale. While economy of scale refers to a situation in
which increases in production volume at a single point in time leads to lower cost, IRtS refers
to a situation in which large increases in an input over long periods of time lead to larger
increases in an output than in the input. For example, IRtS in some production equipment has
led to dramatic increases in the scale of this equipment and thus the emergence of large
economies of scale in this equipment. This means that even when the limits of further scaling
to equipment have been reached, economies of scale still exist in the production equipment.
Furthermore, IRtS also applies to the operation of many technologies and it can apply to
both larger and smaller scale. Dramatic increases in the scale of energy-related systems (e.g.,
furnaces, steam engines, internal combustion engines) and transportation equipment (trains,
ships, buses, aircraft) have led to dramatic improvements in their cost and performance where
many of the increases in scale and the resulting improvements can be called exponential.
Similarly, dramatic reductions in the size of features on ICs, in the storage elements on
magnetic platters or tape or on optical disks have also led to dramatic improvements in cost
and performance where many of the decreases in scale and the resulting improvements can be
called exponential.
This papers analysis suggests that the emergence of IRtS and the limits to it depend on
the system of the technology and the sub-systems and components that are embedded in the
technologys nested hierarchy of subsystems. Such a hierarchy defines the different
sub-systems and the components that are used or could be used in the system where this
paper has just used the terms systems and components to simplify the discussion and where
these components include equipment and raw materials. As shown in Table 1 and discussed in
23

the above sections, every example of IRtS described in this paper was supported by and
depended on advances in science and improvements in components. For example, advances
in the science of high-speed machining, electricity, and chemistry and improvements in
special purpose manufacturing equipment and electric motors supported the realization of
IRtS in discrete parts and continuous flow manufacturing. Improved bellows for increasing
the flow of air to furnaces facilitated the realization of IRtS in furnaces. Advances in
thermodynamics and combustion and the higher tolerance parts and better materials
supported the realization of IRtS in engines. Advances in thermodynamics and fluid flow and
improvements in steel, aluminum, plastics, and composites have supported the realization of
IRtS in most modes of transportation equipment. In all of these examples, the limits to IRtS
have probably been or will soon be reached.
Similar conclusions can be stated for increasing returns to smaller scale. Advances in
solid state physics and improvements in many types of manufacturing supported the
realization of IRtS in ICs, LCDs, and magnetic storage. Furthermore, much of this equipment
has exhibited increasing returns to larger scale for the same reasons that much of the
equipment for continuous flow industries exhibit IRtS. IRtS in optical storage and fiber optic
also depended on advances in solid state physics but the relevant components were
semiconductor lasers, sensors, and amplifiers.
Second, this papers analysis suggests that IRtS in a component can lead to dramatic
improvements in the performance and cost of a system. For example, IRtS in ICs have had a
dramatic impact on the performance and cost of many electronic systems including
computers, mobile phones, and the Internet where many of these electronic systems do not
exhibit IRtS. Third, in some cases IRtS existed in both a component and a system and
they reinforced each other. Examples include IRtS in engines and transportation equipment
and IRtS in equipment and production systems; the most prominent example is IRtS in
semiconductor manufacturing equipment and ICs.
24

This paper also analyzed two types of clean energy: wind and solar. A typical analysis of
wind, solar, and other new energy technologies focuses on existing costs or some generic
aspect of improvement such as learning. A focus on existing costs would suggest that wind
energy is much cheaper than solar energy and thus has a much greater chance of diffusion
than do solar cells. However, a focus on IRtS in the nested hierarchy of subsystems for these
two technologies suggests that solar cells may experience greater reductions in cost than will
wind turbines. Wind turbines directly benefits from the IRtS of the turbine blade while solar
cells benefit from the IRtS of producing solar cells and the IRtS that have already emerged
for the equipment that is being borrowed from the LCD and other industries for them. IRtS
for the equipment can already be found in the dramatic reductions that have occurred in the
production of LCD panels. If solar cells were to experience in the next ten years the kinds of
cost reductions (20 times) that LCD panels experienced between 1995 and 2005, solar cells
would become the cheapest form of energy.
Furthermore, one could also apply the concept of IRtS, or more accurately the recent
lack of them to our environment. Every example of IRtS in this paper has impacted, often
strongly, on the environment and some say that the environment has reached its limit in
terms of its ability to handle further economic growth. Can this metaphor improve our overall
understanding of IRtS?
This papers review of IRtS suggests many avenues of research. First, and foremost, better
empirical data is needed. Not only is there little historical data available on the performance
and price of most technologies or the systems that comprise these technologies, there is even
less data available on the sizes of the systems and in particular data for the relevant
dimensions of the systems. Without such data, it is difficult to understand the phenomenon of
IRtS and certainly to construct production functions as some economists (Winter, 2008)
suggest are needed. Even in ICs, for which large amounts of data are available, this papers
analysis suggests that it would be useful to better understand the degree to which IRtS exists
25

in ICs and the equipment itself. For example, what is the relationship between increases in
equipment size, price, and output for ICs (both area and number of transistors), LCDs (just
area), and solar cells (just area)?
Second, better empirical analysis of the relationship between advances in science,
improvements in components, and IRtS is needed. Is there a way to better examine this
relationship through for example surveys of experts or coding-based analyses of books on the
history of technology books? Combined with better empirical data on cost, performance, and
size, this could probably tell us much more about the benefits from IRtS and the factors that
support IRtS. Such an analysis could also improve policies towards alternative forms of
energy.
Third, models of technological change should include the concept of IRtS. The most
commonly used models in management and economics such as the product life cycle
(Abernathy and Utterback, 1978; Utterback, 1994; Klepper, 1997), cyclical (Anderson and
Tushman, 1990), and disruptive (Christenson and Bower, 1996; Christensen, 1997) models of
technological change do not consider IRtS for technologies nor their impact on the sources of
discontinuities, the displacement of an existing technology by a discontinuity, or the
evolution of competition in the new discontinuity9. For example, some academic analyses of
Christensens (1997) theory of disruptive technologies focus on preference overlap (Adner,
2002; Adner and Zemsky, 2005) while this papers analysis suggests that the existence of
IRtS can drive large improvements in the performance and/or cost of a system either directly
or indirectly (through a key component). Thus IRtS may have a larger impact on whether a
new technology, independent of whether it is a disruptive or sustaining one, displaces an
existing one than does the degree of preference overlap. In fact, every disruptive technology
described by Christensen in his 1997 book, which includes computers, hard disk drives,
9 For example, does IRtS in technology impact on Kleppers (1997) notion of IRtS in R&D?

26

mini-mills (new form of steel plant), and mechanical excavators, exhibits IRtS either in the
system (mini-mill) or in a key component of the system. IRtS exist in ICs for computers,
magnetic platter for hard disk drives, and pumps and actuators (similar to IRtS in engines) for
mechanical excavators.
It is also likely that the concept of IRtS can help us better understand the sources of
technological discontinuities, an issue that is largely ignored by the literature (Kaplan and
Trispas, 2008), and also the reasons for the long time lag between scientific advances and the
commercialization of them (Kline and Rosenberg, 1986; Mansfield, 1991; Klevorick et al.,
1995; Balconia et al. forthcoming). Rapid improvements in components that exhibit IRtS can
impact on the design and performance of systems and thus an understanding of how IRtS
impacts on components and how improvements in components impact on the design of
systems (Funk, 2009) will probably help us better understand the sources and perhaps the
timing of discontinuities. Wind, solar, and other forms of clean energy are just some of the
examples that would benefit from a better understanding of the sources of discontinuities.

10. Conclusions
This paper presents one of the first full-length overviews of IRtS in technologies and it
does so by combining the concept of nested hierarchies of subsystems with IRtS. It shows
how IRtS can emerge at any level in a nested hierarchy of subsystems. IRtS in a higher level
system depends on the performance and cost of components in a lower level of the hierarchy
and IRtS in a lower level component can drive large improvements in the performance and
cost of a higher level system even when there is not IRtS in the system itself.

27

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Table 1. Summary of Necessary Advances in Science and Components to Realize Increasing

Returns to Scale in Selected Technologies
Technology

SubTechnology

Increasing Necessary
Necessary
returns to Advances in Components
scale
Science

Production

Discrete Parts

Larger

Machining

Continuous
Flow

Larger

Electricity,
chemical
elements and processing equipment
reactions

Furnaces

Larger

Steam Engine

Larger

Internal
combustion
engine

Larger

Improved bellows
Thermo
dynamics and Higher
tolerance
combustion
parts
and
better Not
materials
demanded

Trains

Larger

Steel and electricity

Buses

Larger

Steel, aluminum and

plastics

Ships

Larger

Aircraft

Larger

Energy
Systems

Transportation
Equipment

Electronics

ICs
LCDs

Smaller
and larger

Thermo
dynamics,
combustion,
fluid flow
Solid
physics

Reached
limits to
scaling?

Special purpose and Probably

accurate
machine
tools and other

Steel
Aluminum

and

composites

state Manufacturing
equipment

Optical Stor., Smaller

Semiconductor lasers,

Fiber Optics

sensors, amplifiers

Solar Cells

Energy
Wind

May
close

be
to

limits

Mag. Storage

Clean

Probably

Smaller

Manufacturing

Probably

and larger

equipment

not yet

Larger

Fluid flow

Better materials

Turbines

35

Table 2. Components that Exhibit Increasing Returns to Scale and Exponential Rates of
Improvement
Component

Measure of Performance

Rate

of

Improvement

(OOM:

orders of magnitude)
Integrated circuits

Feature size
Defect density
Die size
Number of transistors/chip

>2 OOM in 40 years

>3 OOM in 40 years
>30 times in 25 years
9 OOM in 50 years

Light-emitting
diodes (LEDs)

Luminescence per Watt

3 OOM in 50 years

Semiconductor/LCD Minimum feature size in 500 times reductions in 40 years

Manufacturing
semiconductors
Equipment

Cost per area of LCDs

20 times cost reduction between 1995

and 2005

Hard disk platters

Areal storage density

5 OOM in 40 years

Magnetic Tape

Areal storage density

5 OOM in 45 years

Glass fiber

Spectral loss

2 OOM in 10 years

Optical fiber

Information

Optical discs

capacity Five OOM in 20 years

(bits/sec)
Cost per bit

Six times reduction in 25 years

Capacity
Transfer rates

10 times in 10 years
3 OOM in 10 years

Source: (Kurzweil, 2005) and authors analysis

36

Table 3. Examples of Systems Whose Performance has been Strongly Impacted on by

Exponential Improvements in a Component
Selected Components
from Table 1
Semiconductors
circuits

and

Systems whose Performance is Impacted on by

Improvements in the Component
Integrated Many electronic products such as computers (9
OoM improvement in cost per speed in 60 years)
and digital cameras (300 times improvement in
pixels per dollar between 1996 and 2007)

Hard Disk Drives

Computers and other electronic products

Hard Disk Drive Platters

Hard Disk Drives

Magnetic tape

Computers, music and video recorders/ players

Light-emitting diodes (LEDs)

Instruments, electronic products and potentially

lighting systems

Liquid crystal displays (LCDs)

Many electronic products including computers and

phones

Glass fiber
lasers

and

semiconductor Telecommunication systems

Optical discs and lasers

Music and video recording and playback

Sources: (Kurzweil, 2005; Kressel and Lento, 2007; Daniel et al, 1999; Turley, 2003)

37

Table 4. Cost Reductions for Semiconductors, LCDs, and Solar Cells

Technology

Dimension

Time Frame

Ratio of New to Old Cost

Semiconductors

Price/Transistor

1970-2005

1/15,000,000

Price/Area

1970-2005

1/20

Price/Area

1995-2005

1/5.7

LCDs

Price/Area

1995-2005

1/20

Solar cells

Price/kwH

1957-2003

1/500

Price/kwH

1993-2003

1/5

Price/area

1993-2003

1/4.1

Sources: (Gay, 2008; ICKnowledge, 2009; Kurzweil, 2005; Nemet, 2006) and authors
analysis

38