Diseconomies of Scale

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Definition of Diseconomies of Scale:

Diseconomies of scale refer to a cost disadvantage that occurs when increasing output leads to higher average costs for producing a good or service.

Detailed Explanation:

There are limits to how much a large company can grow and capitalize on its economies of scale. Initially, increasing output and sales can improve profit margins because economies of scale decrease the average cost of producing a good or service. However, at a certain point, the cost of producing each additional unit will start to rise. This phenomenon is known as diseconomies of scale.

For instance, consider a landscaping company that decides to expand rapidly. It invests in state-of-the-art mowers, chainsaws, and excavating equipment. Initially, much of this equipment is used only a few days each week because the company lacks the workers and jobs to operate it daily. Eventually, the company hires more workers and secures additional contracts, allowing for more frequent use of the equipment. This increase in equipment utilization boosts productivity and lowers the average cost per job. As a result, the company enjoys economies of scale, and profits continue to rise. 

However, as management hires even more workers, there comes a point when some workers may have little to do while others are busy completing their tasks. Additionally, the new hires require training, and absenteeism becomes a more significant issue. Consequently, the company’s average cost per lawn begins to rise, signaling that it has reached diseconomies of scale.

The graph below illustrates economies and diseconomies of scale. Up to output level Q, economies of scale are present as the company’s average unit cost decreases. Diseconomies of scale occur when output exceeds Q.

Diseconomies of scale occur when inefficiencies arise from excessive growth. Here are some examples of challenges that can lead to diseconomies of scale:

• Difficulty in coordination – For instance, coordinating all workers at a job site to complete a task simultaneously can be challenging. Once workers finish their part, they may wait for others to complete their tasks. Larger companies may also struggle to coordinate their supply chains, especially when dealing with hundreds of suppliers.
  
  
• Control – As a company’s output increases, monitoring the work of thousands of employees across several plants becomes more complicated.
  
  
• Bureaucracy – In a growing company, decisions might need to pass through more layers of management, leading to an increase in the time spent on decision-making.
  
  
• Communication – Language and cultural differences can complicate communication with employees. In larger organizations, managers may receive incorrect or conflicting messages, hindering effective communication.
  
  
• Employee morale – Getting all employees to “buy into” a policy or idea is an added challenge in large companies. Employees may feel unappreciated if they are one of thousands. If workers believe that their absence will go unnoticed, this can lead to increased absenteeism.

These challenges highlight how growth can inadvertently create inefficiencies within a company.

An external diseconomy of scale occurs when factors outside a business increase the average unit production cost as output rises. For example, if growth pushes an area’s infrastructure beyond its limits, it can have adverse effects. A crowded port, for instance, may cause costly delays in receiving supplies or transporting finished goods.

To address issues related to diseconomies of scale, many larger companies have fostered a more entrepreneurial environment that encourages innovative ideas. Human resource departments can enhance employee value and appreciation by organizing team-building exercises or implementing smaller production teams.

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