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What are 'Diseconomies of Scale'

Diseconomies of scale happen when a company or business grows so large that the costs per unit increase. It takes place when economies of scale no longer function for a firm. With this principle, rather than experiencing continued decreasing costs and increasing output, a firm sees an increase in marginal costs when output is increased. Diseconomies of scale can occur for variety of reasons, but the cause usually comes from the difficulty of managing an increasingly large workforce.

BREAKING DOWN 'Diseconomies of Scale'

Diseconomies of scale specifically come about due to three reasons. The first is a situation of overcrowding, where employees and machines get in each other's way, lowering operational efficiencies. The second situation arises when there is a higher level of operational waste, due to a lack of proper coordination. The third and final reason for diseconomies of scale happens when there is a mismatch between the optimum level of outputs between different operations. Essentially, diseconomies of scale are the result of the growing pains of a company after it's already realized the cost-reducing benefits of economies of scale.

The diagram below graphically illustrates a diseconomy of scale:

Diseconomies Of Scale

Problems With Diseconomies of Scale

Diseconomies of scale can happen for many reasons, but overall, they arise because of the difficulties of managing a larger workforce. Several problems can be identified with diseconomies of scale. First, communication becomes less effective. As a business expands, communication between different departments becomes more difficult. Employees may not have explicit instructions or expectations from management. In some instances, written communication becomes more prevalent over face-to-face meetings, which can lead to less feedback. Another drawback to diseconomies of scale is motivation. Larger businesses can isolate employees and make them feel less appreciated, which can result in a drop in productivity

Examples of Diseconomies of Scale

An overcrowding effect within an organization is often the leading cause of diseconomies of scale. This happens when a company grows too quickly, thinking that it can achieve economies of scale in perpetuity. If, for example, a company can reduce the per unit cost of its product each time it adds a machine to its warehouse, it might think that maxing out the number of machines is a great way to reduce costs. However, if it takes one person to operate a machine, and 50 machines are added to the warehouse, there is a good chance that these 50 additional employees will get in each other's way and make it harder to produce the same level of output per hour. This increases costs and decreases output.

Sometimes, diseconomies of scale happen within an organization when a company's plant cannot produce the same quantity of output as another related plant. For example, if a product is made up of two components, gadget A and gadget B, diseconomies of scale might occur if gadget B is produced at a slower rate than gadget A. This forces the company to slow the production of gadget A, increasing its per unit cost.

Finally, as output increases, the logistical costs of transporting goods to distant markets can increase enough to offset any economies of scale. For example, when a firm has a plant capable of producing a large output in one location, the more the firm produces at that plant, the more it needs to ship the product to distant locations, increasing certain costs rather than decreasing them.

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