Question

What are diseconomies of scale? What is the main reason that a firm eventually encounters diseconomies of scale as it keeps increasing the size of its store or factory?

Short answer

Diseconomies of scale occur when the cost per unit increases as a firm continues to grow, most often due to increased inefficiencies and complexities in managing and coordinating the firm's operations as its size increases.

Step-by-step solution

Understanding Diseconomies of Scale

Diseconomies of scale occur when a business grows so large that the costs per unit increase. It happens when a company's production increases to the point that the cost of producing each additional unit begins to rise. This can be due to several factors like managerial inefficiencies, increased difficulties in coordinating operations, or even problems with logistics and communication.

Identifying the Reason for Diseconomies of Scale

The main reason a firm eventually encounters diseconomies of scale is that as the firm grows larger, it becomes more difficult to manage and coordinate its operations. As the number of employees increases, communication becomes more difficult. Following the decision-making process becomes more complex with multiple layers of management. This leads to inefficient use of resources and higher per unit costs.

Real-life Application

For example, if a firm continues to increase the size of its store or factory, it may face issues with overstaffing, increased waste due to poor management, and difficulties in maintaining the same level of service or product quality. This shows how as a business keeps increasing its scale, diseconomies may kick in and the costs per unit begin to rise.

Key concepts

Managerial Inefficiencies

Managerial inefficiencies are a significant aspect of diseconomies of scale. As companies expand, they often require more managers and administrative staff to oversee operations. This can lead to several issues that increase costs rather than decrease them.
Managers have to deal with larger teams and more complex operations, which can lead to slower decision-making. Decision-making becomes burdened with bureaucratic processes, making it less responsive to changes and opportunities.
This can result in missed opportunities and a lack of agility in the marketplace. Consequently, the business operates less effectively and efficiently, which contributes to higher per-unit costs rather than the desired lower ones.

Communication Challenges

Communication challenges arise as firms grow, presenting another factor in diseconomies of scale. Larger organizations typically mean more layers of management between the top decision-makers and the workers.
Increasing the number of management layers can make communication pathways overly complicated, leading to miscommunication or loss of information.

• This can result in confusion about goals and objectives among employees.
• Misalignment can occur, causing delays in project completion.
• Errors might increase because information is not conveyed accurately.

In the long run, these communication difficulties can hinder overall productivity and increase operational expenses.

Coordination Difficulties

Coordination difficulties often occur when scaling up business operations. As a company grows, it needs to synchronize more activities across different departments and geographical locations.
The complexity of coordinating activities can be overwhelming, leading to inefficiencies. Some departments might work at different speeds or in conflicting directions, resulting in bottlenecks.

• Misalignment between departments can disrupt workflow.
• Tasks may have to be redone, wasting time and resources.
• Overall productivity could diminish as coordination becomes more cumbersome.

Effective coordination is crucial to maintain cost efficiency, and failure to do so can lead to diseconomies of scale.

Logistics Problems

Logistics problems can also contribute to diseconomies of scale, especially in larger companies with sprawling operations. As a firm grows, the complexity of shipping, warehousing, and inventory management increases significantly.
Managing a vast supply chain requires substantial planning, and any inefficiencies can lead to increased costs.

• Larger inventories increase the risk of overproduction or stockouts.
• Transportation issues could delay the distribution of goods.
• Storage costs can soar if inventory levels are mismanaged.

All these factors can escalate operational costs when not tightly controlled, highlighting that bigger isn't always better in logistics management.