Chief executive officers of power companies are rushing to acquire and consolidate the competition. Extra mass, it is thought, will give them more clout in the marketplace and protect them against hostile acquisitions. While there might be some truth in this argument, greater size does not in itself guarantee higher returns for shareholders. The obvious benefits of size for any power company come from economies of scale, which are reaped at the business unit rather than the company level. Moreover, not all businesses in the power industry benefit from scale. Any CEO contemplating a merger or acquisition should be aware of both the extent to which economies of scale differ along the value chain and the disadvantages of size at the corporate level.

Variable benefits

Different parts of the power industry’s value chain benefit from scale to a very different extent—some a good deal, others hardly at all.

Power generation

Apart from the size of individual power stations, economies of scale in power generation derive mainly from the bargaining clout that size gives a company when it negotiates for fuel and other supplies. Yet even this benefit will be limited if the fuel market is liquid and suppliers are...