• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

Penpoin.

Better Knowledge. Your Insight Is Sharper

  • Business
    • Business and Strategy
    • Marketing
    • Operation
    • Human Resources
  • Finance
    • Financial Analysis
    • Investment
  • Economics
    • Introduction to Economics
    • Microeconomics
    • Macroeconomics
  • Online Learning
    • Coursera
    • Udacity
    • Udemy
    • Skillshare
    • Magoosh
  • Reading List
    • Self-Help
    • Business and Money
You are here: Home / Business and Strategy / Diseconomies of Scale: Types, and Causes

Diseconomies of Scale: Types, and Causes

Updated on April 9, 2022 by Ahmad Nasrudin

Diseconomies of Scale Types and Causes

What’s it: Diseconomies of scale are the economic disadvantages when a firm increases its production. Instead of lowering average costs, increasing output results in higher average costs.

It usually occurs when the company has reached the minimum efficient scale, which is the lowest point of average cost. Before that point, the company achieved economies of scale. When increasing production, it realizes a decrease in average costs. After that point, however, average costs increase as production increases.

Diseconomies of scale have an impact on increasing operating costs. Assuming the selling price unchanged, it leads to decreased profitability.

Meanwhile, if the company passes the increased cost per unit on the selling price, it will reduce its competitiveness. Market share decreases as consumers switch to cheaper competing products.

Diseconomies of scale graph

Well, to explain the diseconomies of scale concept, let’s take an average cost (or unit cost or cost per unit) curve. In the curve, the X-axis represents total output (quantity), while the Y-axis represents costs.

Economies of scale and diseconomies of scale - Long-run average cost curve
Economies of scale and diseconomies of scale – Long-run average cost curve

The average cost curve is U-shaped. Look at the graph above. Until the output is Q1, the firm achieves economies of scale as the average cost decreases. However, any increase in output beyond Q1 leads to an increase in the average cost.

In areas of economies of scale, the average cost decreases for several reasons. First, the company spreads the total fixed costs to more output. Thus, although total costs remain unchanged, the average fixed cost decreases as production volume increases.

Remember, the average cost is the sum of average variable costs with average fixed costs.

Thus, unit cost also decreases as the average variable cost decreases. For example, when purchasing raw materials in a larger volume, the company usually receives a discount. Thus, the company bears lower total raw material costs. Therefore, the cost of raw materials per unit of output will also decrease.

After reaching the point of minimum efficient scale, the unit cost behavior changes. An increase in output does not result in a decrease in costs, but an increase in costs. There are several factors why it happened. I will discuss them below.

The difference between internal diseconomies of scale and external diseconomies of scale

Like economies of scale, diseconomies of scale fall into two categories:

  • Internal diseconomies of scale
  • External diseconomies of scale

Under internal diseconomies of scale, the average cost increase is due to internal factors of the company. So, it only applies to that company, not to other companies.

On the other hand, for the external diseconomies of scale, the increase in cost per unit comes from external factors. The company has no control over those factors. Also, cost increases occurred for all firms in the industry.

Causes of internal diseconomies of scale

Four reasons why diseconomies of scale emerge. Here are the details:

  • Bureaucratic inefficiency. As companies become more extensive, operations become more complex and lead to less effective communication. Companies cannot rely on old methods to operate on a larger scale. They need transformation.
  • Decreased motivation from management and employees. The complexity of work reduces focus and consumes a lot of energy. Without adequate compensation (e.g., more extended leave and higher pay), it can lead to demotivation.
  • Duplication of work and business functions. As operations become more extensive, the company may form several new divisions. However, without a clear mapping, it will only lead to duplication.
  • Increased costs of special arrangements. For example, when the amount of output is large, the company needs special waste disposal arrangements. These arrangements are often expensive.

Bureaucratic inefficiency

Larger companies require the development of a broad managerial hierarchy. Such transitions do not always end in success.

When the scale of operations is small, the company adopts a more flexible organizational structure. And when the scale of operations becomes larger, companies adopt a tall organizational structure with several command chain layers.

However, such transitions often fail because employees and management cannot adapt. They are accustomed to flat structures without multiple chains of command.

A more complex chain of command produces a distortion of information. I mean, top decision-makers don’t receive the exact same message as bottom-level operational information. That’s because information flows through several managerial layers. In the end, it results in poor decision making.

Also, larger operations increase administrative and bureaucratic procedures. It often hinders quick decision making. Companies rely more on written forms of communication, such as notice boards and memos. And, such communication has the disadvantage of not allowing feedback.

Congestion 

Large manufacturing requires a variety of different stages. When individual manufacturing processes have reached their optimum capacity, they cannot produce anymore. This creates problems such as congestion due to more people using the same machine.

Demotivation

As the operation grows, the number of employees increases. Companies adopt specializations and divide complex processes into smaller tasks. Employees perform the same tasks from time to time.

When operations increase as output increases, each employee must complete more tasks. Although they are still doing the same task, they are likely to be more stressed because of their higher targets.

Increasing the target reduces the likelihood of employee interaction. They feel isolated and easily lose focus. That, in turn, leads to decreased productivity because they lose motivation.

Lack of coordination

The growing size of the business makes coordination and empowerment of employees more difficult. Managers find it more challenging to relate day-to-day with workers and build a conducive work environment, such as listening to their aspirations. As a result, managers have difficulty coordinating operations and ensuring that everyone plays their role effectively.

Such situations require companies to hire or promote more supervisors to oversee operations and monitor employee performance. As a result, they bear more costs.

Causes of external diseconomies scale

When the size of all companies’ output increases, it creates several problems, which causes an increase in unit costs for all firms in the industry.

Increase in input prices

Some inputs are available on a more limited basis. Increased production creates more demand for these inputs.

When the demand is so great while the amount of resources is relatively limited, it will lead to a market shortage. As a result, input prices will slowly move up. The impact may not be on just one company but all companies in the industry.

For example, the eCommerce industry’s rapid growth rate increases the demand for programmers to handle big data. Supply becomes an obstacle due to the low quality of local labor and does not meet the qualifications.

Then, companies in the industry recruit foreign programmers to make ends meet. Finally, they have to pay higher salaries to recruit foreign workers.

On the other hand, foreign programmers also have a stronger bargaining position. When they realize the labor market is insufficient, they are likely to negotiate a higher salary.

Negative externalities

The rapid development of industry creates more negative externalities. Without government control, it contributes to an increase in long-term average costs, not only for firms in a specific industry but also in almost all industries.

An example is the increased risk of global warming and climate change due to pollution. This not only increases the risk of doing business in one industry but also has other consequences such as carbon taxes, which are additional costs for other industries.

Negative externalities also arise in the case of agglomeration. When industrial growth in an area increases, it can cause traffic jams, thus increasing logistics costs.

Topic: Business Growth, Diseconomies of Scale Category: Business and Strategy

AFFILIATE

If you click on this link, thank you for contributing to us. We may earn a commission when you buy through our links. Learn more ›

5 NEW ARTICLES

How to Handle and Resolve Stakeholder Conflicts

How to Handle and Resolve Stakeholder Conflicts

Stakeholders have different interests and goals, which are often contradictory. Stakeholder

What are the Benefits of International Trade

What are the Benefits of International Trade?

Increased access to cheaper and more varied goods and services is key benefits of international

Where Do Comparative Advantages Come From

Where Do Comparative Advantages Come From?

The comparative advantage stems from the ability to produce goods and services at low opportunity

What is the Capital Budgeting Process

What is the Capital Budgeting Process?

In simple terms, the capital budgeting process involves generating ideas, making proposals about

Autarky Examples, Pros, and Cons

Autarky: Examples, Pros, and Cons

What's it: Autarky is a system or philosophy in which an economy seeks to

Primary Sidebar

  • "Becoming Supernatural" by Joe Dispenza
    "Becoming Supernatural" by Joe Dispenza
  • "Thinking, Fast and Slow" by Daniel Kahneman
    "Thinking, Fast and Slow" by Daniel Kahneman
  • "All About Love" by Bell Hooks
    "All About Love" by Bell Hooks

Footer

5 TRENDING ARTICLES

  • Business Size: Definition, Measurement, Classification
  • Socio-cultural Factors: Examples and How They Impact Business
  • The Role of Business in Society and the Economy
  • Trade Restriction: Reasons, Types, and Impacts
  • List of Examples of Social Enterprises You May Be Familiar

EXPLORE MORE

CATEGORIES

Accounting and Finance Books Business and Strategy Financial Analysis Human Resources Investment Macroeconomics Marketing Microeconomics Operation

TOPICS

Aggregate Demand Business Management Demand Financial Analysis Financial Ratio Government Budget International Trade Leadership Macroeconomic Equilibrium Marketing Marketing Management Organizational Structure Profitability Ratio

Copyright © 2023 · About Us  · Privacy Policy and Disclaimer  ·  Affiliate Disclaimer  ·  Terms of Use  ·  Comment Policy  ·  Contact Us