Diseconomies of scale: How efficiencies can start to decline with scale

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What are diseconomies of scale?

Diseconomies of scale is the possibility that it becomes more expensive to produce a particular good as volume increase. While economies of scale result in the costs of producing a single good declining as production grows, diseconomies of scale result in increasing costs per unit as volumes go past a certain point.

Examples of diseconomies of scale

Coordination difficulties

A key cause of diseconomies of scale is associated with coordination difficulties as the firm grows. While it is easy to manage a small organization, a large organization has a lot of moving parts – each potentially pulling in different directions, with different perceptions of what the firm is, and what it should be doing.

Extra layers of management

Beyond the coordination difficulties that can occur in large organizations, the extra layers of management add in additional costs. There may be additional layers of management requires to supervise operations, each with associated overhead expenses. 

Lack of focus on small improvements

Another possible source of diseconomy of scale arises because particularly large firms may not be interested in making minor incremental improvements. In part because of coordination difficulties, and in part because of monitoring issues, there may not be the incentives in place to drive managers to pursue small efficiency improvements. Small changes may be thought not big enough to move the needle, with a danger that waste and inefficiencies gradually start to seep in. 

Overcoming diseconomies of scale

One approach to overcome diseconomies of scale is to split the firm up into separate divisions or facilities. Rather than having one factory with say 100,000 employees, a company could instead have two at 50,000, each of which may be easier to manage than one large firm.