Sources of diseconomies of scale
Diseconomies of scale are the opposite of economies of scale. They are associated with costs increasing as the volumes increases – increasing costs per unit. Some common causes of diseconomies of scale include:
- Coordination difficulties: Different departments pulling in different directions, and misalignment due to different areas prioritizing different things.
- Extra layers of management: The cost associated with additional supervisors and management needed in larger firms.
- Lack of focus on small improvements: For large firms, small improvements may be de-prioritized given the large size of the firm.
Recognizing that economies of scale are not inevitable
It is possible to fall into the trap of thinking that economies of scale are inevitable – as the number of employees (or volume of production) increases, inevitably inefficiencies will start to impact production. A good counter-example to this though is FoxCom facilities (that assembly many electronic products, such as the iPhone) – often employing hundreds of thousands of employees.
While there will inevitably be challenges with managing such a large workforce, recognizing that some companies have succeeded with a very large workforce illustrates that it is not inevitable that you will run into problems – there are approaches that can help manage a large facility size. The key thing is adapting your processes to allow efficient operations despite a large scale.
Approaches for overcoming diseconomies of scale
Operating multiple manufacturing sites
One of the easiest, and commonly implemented approaches for managing a very large workforce is to split the operations into separate facilities. Managing two sites, each with 1,000 employees may be easier than managing one site with 2,000.
While splitting the operation into multiple separate facilities comes with its own cost – how there is some degree of duplication in management between the facilities – the cost associated with this may be less than inefficiencies of running a large production facility – particularly if there are easy ways of splitting the facilities up.
Re-emphasizing small scale improvements
Another approach to overcoming diseconomies of scale, specifically associated with not caring about small impact improvements is to re-emphasize the cumulative effect of small scale improvements. Small changes can mount up, and have a substantial overall impact. While it is easier to ignore such impacts in a large firm, there is no reason this should necessarily be the case – monitoring performance over time, and continually looking for incremental improvements can go a long way of avoiding becoming complacent.
Improving coordination channels
A final approach to reduce diseconomies of scale is to improve coordination channels. Diseconomies of scale can arise from problems associated with poor coordination – potentially causing mistakes or misalignment in priorities between divisions. Smoothing these communication channels can help avoid situations where poor communication results in inefficiencies in company operations.
Final thoughts: Spin off divisions
While avoiding diseconomies of scale is important to consider, it is also useful to reflect whether it genuinely makes sense to have different divisions within the same firm. While there can be benefits associated with related diversification – allowing you to share resources across different parts of the firm – having very different areas can be a distraction. If the company would be more effectively run as two separate businesses, it is important to consider this as an approach to removing diseconomies that may be associated with your scale.
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