Diseconomies of scale

Diseconomies of scale
See also
Composite demand Operational performance Outsourcing and offshoring Research and development costs Capacity management Negative correlation Workforce productivity Sales price variance Job enlargement

Diseconomies of scale are costs associated with increased size that result in a decline in efficiency. They can include:

• Increased complexity of operations: As a business grows, it may become more difficult to manage, resulting in additional costs and decreased efficiency.
• Loss of personal contact: As a business grows, it can become more difficult for managers to interact with each employee and understand their concerns, which can lead to decreased efficiency and quality of work.
• Increased costs of capital: As a business increases in size, it may require more capital to finance its operations. This increased capital can reduce profitability by increasing the cost of capital.
• Increased bureaucracy: Large businesses can become more bureaucratic, resulting in increased costs of operations and decreased efficiency.
• Diminishing returns to scale: As a business grows, the returns to scale may decline, resulting in decreased efficiency.

In summary, diseconomies of scale are costs associated with increased size that can result in a decline in efficiency. These costs can include increased complexity of operations, loss of personal contact, increased costs of capital, increased bureaucracy, and diminishing returns to scale.

Example of Diseconomies of scale

The Baumol cost disease is an example of a diseconomy of scale. This is a phenomenon in which wages rise faster than productivity, resulting in increased costs that reduce efficiency. This is due to the fact that some sectors, such as healthcare, are labor-intensive and require a high degree of human interaction, making it difficult to increase productivity. As a result, wages tend to increase faster than productivity, resulting in increased costs and decreased efficiency.

Formula of Diseconomies of scale

The formula for diseconomies of scale is given by the following equation:

$Diseconomies\ of\ Scale={\frac {\Delta Total\ Cost}{\Delta Output}}$

This formula indicates that the diseconomies of scale are calculated by dividing the change in total costs by the change in output. This allows us to measure the cost associated with increasing the size of a business and the resulting decrease in efficiency.

Application of Diseconomies of scale

Diseconomies of scale are most useful when a business is considering expanding its operations. By understanding the potential costs associated with increased size, a business can make better informed decisions about expanding its operations. Additionally, a business can use diseconomies of scale to identify areas where costs can be reduced to increase efficiency. By understanding the costs associated with increased size, a business can better understand how to maximize efficiency and profitability.

Types of Diseconomies of scale

Diseconomies of scale can be divided into two main categories: internal diseconomies of scale and external diseconomies of scale.

Internal diseconomies of scale are those that arise within a business, such as increased complexity of operations, loss of personal contact, increased costs of capital, and increased bureaucracy.

External diseconomies of scale are those that arise outside of the business, such as increased competition, increased costs of inputs, and increased taxes.

Steps of Diseconomies of scale

The steps of diseconomies of scale involve recognizing and managing the costs associated with increased size. These steps can include:

• Identifying and analyzing costs: The first step is to identify and analyze the costs associated with increased size, such as increased complexity, loss of personal contact, increased costs of capital, and increased bureaucracy.
• Developing strategies to reduce costs: Once the costs are identified, strategies should be developed to reduce them, such as streamlining operations, improving communication, and reducing bureaucracy.
• Implementing strategies: The strategies should be implemented in order to reduce the costs associated with increased size.
• Monitoring performance: The performance of the strategies should be monitored to ensure that the costs are being reduced and that the efficiency of operations is increasing.

Advantages of Diseconomies of scale

Although diseconomies of scale are typically seen as a negative for businesses, there are some advantages. These can include:

• Improved flexibility: A business that is smaller in size can be more flexible and can respond to changing market conditions more quickly.
• Improved quality: A smaller business can focus on providing higher quality products or services, as there is less need to focus on cost-cutting measures.
• Improved customer service: A smaller business can provide more personalized customer service, as there is less need to focus on quantity.

Limitations of Diseconomies of scale

There are several limitations of diseconomies of scale. First, diseconomies of scale only occur when a firm has reached a certain size. This means that a business may not be able to identify and react to them until it has already been affected by them. Second, diseconomies of scale can be difficult to measure as they are not always directly correlated with increased size. Third, diseconomies of scale can be difficult to counteract as they require an understanding of how the business is operating and how it can be improved. Finally, diseconomies of scale can be expensive to counteract as they often require significant changes to how the business operates.

In summary, diseconomies of scale have several limitations, including that they can only occur when a firm has reached a certain size, can be difficult to measure, can be difficult to counteract, and can be expensive to counteract.

Other approaches related to Diseconomies of scale

• Expansion of managerial staff: To cope with the increased complexity of a larger business, additional managerial staff may be required, resulting in increased costs.
• Unfavorable economies of scope: The larger a business becomes, the more difficult it may be to achieve economies of scope, which can lead to decreased efficiency.
• Loss of flexibility: As a business grows, it may become less flexible, resulting in decreased efficiency.

In summary, other approaches related to diseconomies of scale can include expansion of managerial staff, unfavorable economies of scope, and loss of flexibility. Each of these can lead to increased costs and decreased efficiency.

Suggested literature

• McAfee, R. P., & McMillan, J. (1995). Organizational diseconomies of scale. Journal of Economics & Management Strategy, 4(3), 399-426.
• Canback, S., Samouel, P., & Price, D. (2006). Do diseconomies of scale impact firm size and performance? A theoretical and empirical overview. ICFAI Journal of Managerial Economics, 4(1), 27-70.