Diseconomies of scale can be defined as the increase in the production cost of each unit increases with the increase in either production of the company or the organizational size.
Diseconomies of scales take place when the average cost of production of a company increases with the increase in the production units or the size of the organization.
However, you must have heard quite the opposite of it which the production cost is less for large scale production, which is a concept of Economics known as economies of scale. Therefore, we can say that diseconomies of scale are the opposite of economies of scale.
A company expands with the intentions to reduce the average production cost of products and to increase the efficiency of the company. It is simple to deduce that the increase in the efficiency maximizes the profit generated by the organization by minimizing the expenses.
This is the concept that works behind mass production. However, when diseconomies of scale hit the production process, the marginal cost of products rises. There could be several reasons behind this, such as the expensive land expansion, inefficient management, poor market performance of the product, etc.
A company plans its expansion in such a way so that it can avoid reaching the point where diseconomies of scale hit the production.
However, whenever, diseconomies of scale hit the production process and the marginal cost of products increases then restricting business operations, closing down inefficient operations, and studying the market trend might help to get over the diseconomies of scale.
Types of Diseconomies of Scale
There are two types of diseconomies. Let us learn about them and the factors which cause them one by one.
A) Internal Diseconomies
The cost of production of a company increases when there is an increase in production due to the internal factors.
The internal factors could be technical issues, inefficient management, financial diseconomies, and marketing diseconomies, etc. in this section, you will learn how these factors cause diseconomies of scale.
#1 Production Diseconomies:
The production cost of the company increases with the increase in the production level to a certain limit. There could be various reasons behind it. For example, the unavailability of efficient material because of its shortage.
#2 Financial Diseconomies:
With the increase in the production to a larger scale the burden on finances also increases and company have to rely on external sources such as bank loan or financial institutions, and because of the strict policies for the large borrowers, it becomes expensive to produce in large production.
#3 Technical Diseconomies:
Technical diseconomies are related to the machinery used for production. Technical diseconomies rise with the increase in the production beyond a certain level. The cost of maintenance increases and the chances of breakdown and accidents add additional cost in the production cost.
Besides this, sometimes, superior machinery is required to take a load of overproduction further the training of staff or hiring experts to deal with the superior machinery adds to the diseconomies of scale.
#4 Inefficient Management:
Another cause of internal diseconomies is inefficient management. It becomes difficult for managers to manage the work when production increases beyond a certain level. The operational efficiency gets affected because of the lack of management.
#5 Limited natural resources:
There are certain production processes where natural resources are required. Natural resources are limited and can be used up to a certain limit to make the flow of goods natural and in equilibrium with nature. With the increase in the production the natural resources also being overused and sometimes run out fast.
B) External Diseconomies
External diseconomies consist of factors which a company can’t control, and it might not only affect the company, but it will affect the whole industry.
This type of diseconomies rises with the increase in the production of a company beyond a certain level. The following can be the factors causing external diseconomies of scale.
#1 Increased prices of raw material:
When the production of a company rises beyond a certain level. The requirement for the raw material also increases, and the increase in the demand increases the prices.
#3 The strain on infrastructure:
Increase in the production cause put an impact on the transportation services in the area. Increased demand for raw material for production relies on transportation services in the area.
The transportation services become overcrowd, which can cause a delay in the delivery of raw material and hence impact the production capability of the company. In addition to this, tax on the services may also rise, which can become another reason for inefficient production.
Examples of Diseconomies of scale
- When the production of a company increases, the main impact is seen on the machinery involved in the production process and labor performing the work. The overproduction might wear machinery which can cause accidents and damage to machinery. The insurance cost and installation of new machinery increase the cost of production and results in diseconomies of scale.
- The increased production process in the industry requires employees to work more and put some additional working hours, or more employees are required to be hired to match production requirement. The increased wages and the additional cost of recruitment of new employees and their training adds to the cost of production and become the reason of diseconomies of scale.
- The large organization suffers from the problem of coordination. The lack of coordination results in the inefficient performance of employees and also the wastage of resources and similarly in large organization departments tend not to communicate with one another efficiently which causes the miscommunication and results in diseconomies of scale.
Causes of Diseconomies of Scale
Followings are the cause of diseconomies of scale:
#1 Administrative costs:
Larger organizations require a good and efficient administration to manage various departments. When an organization grows or its production increases, the administrative cost also increases, which directly affect the average cost of production.
#2 Cost of human resources:
Large organization requires a large number of employees to be able to make the production work smoothly. Various employees are not directly related to the production process but are necessary to manage or to provide assistance to employees doing important work for the production.
For examples, take an example of Human Resource (HR) manager. The role of an HR manager is to manage the human resource of the company.
In smaller organizations this work is usually handled by the owner of the organization, and there is no need to pay huge salaries to the HR manager, but in larger organizations because of the large number of employees the lack of an HR manager rises to manage the employees of the organization, which increases the total cost of production.
#3 Failure coordination and communication:
The larger organization suffers from the problem of coordination and communication between the employees and different departments. The lack of coordination results in the wastage of various resources such as time, efforts, and material, and the lack of communication may also result in the lack of coordination and effective information flow.
There are gaps between the communication of a higher level of management and employees working at a lower level.