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Diseconomies of Scale

Diseconomies of Scale

Diseconomies of scale is a rare condition in large business when the average cost of producing one unit of material increases. It is contrary to the theory of economies of scale, which lays emphasis on having large organizations.
Rahul Pandita
Economists have thoroughly researched the benefits of having a large organization. According to economies of scale, the average cost of producing one unit of a material decreases as the size and scale of an organization increases. Diseconomies of scale are just the opposite. These are the factors that tend to increase the per unit cost in a large economy. They represent a system in which the economic theory that large organizations are better in managing average cost per unit no longer holds true, and in fact, an increase in average cost per unit is observed. They are rarer in organizations and are more a result of internal factors than external ones.
Causes
  • Control: Monitoring each and every employee closely is practically impossible in a large organization. Apart from this, individuals in a large firm come with different agendas. Knowing their aspirations and motivations becomes a bit difficult. This increases the chances of individual and the firm working for different objectives.
  • Miscommunication: Miscommunication in the workplace is becoming a common phenomena. There are a large number of people working in a big firm, so effectively communicating the business plan or some valuable information to everyone becomes a bit difficult. Also, the cost of communication is higher in a big organization as compared to a small business.
  • Coordination: Getting employees together for a common objective is challenging in a big organization. There are times when the business wants it employees to focus on one business plan to deal with the competition, but in large organizations, people are so used to working in teams that internal competition is of paramount importance to them. This decreases the productivity of the organization as a whole.
Example
Motorola was one of the fastest growing companies in the world in the mid 1980s. In 1995, it was ranked 24th on the Fortune 500 list. Until 1996, it was considered as the best-managed companies of the world with its sales doubling in size every five years. It had a revenue of $27 billion dollars in 1995 and it was looked upon as a pioneer in the field of electronics. It made cellular phones, pagers, two-way radios, semi-conductors, etc. Motorola had unique self-directed teams and they were often pitted against each other. It was clearly an economy of scale while reaping enormous profits year after year, further propelling its economic growth. Then came the dark phase when it lost out its market share to a Finland-based company called Nokia and a slump followed. Motorola had huge expectations from Iridium, its satellite world-wide telephone service, but it failed to take off and filed for bankruptcy. It also lost on its revenues and in 2000 Fortune 500 list, it was ranked 109th.
Many economists felt that Motorola failed to manage its huge success and did not correctly read the changing scenarios caused due to globalization. The production had become sluggish and as mentioned before, teams were often competing against each other. Since then, Motorola is on a revival path and in 2005, the results were heartening for Motorola again. It has gained a lot of ground and is trying to close in on its biggest rival Nokia.
Most diseconomies of scale are the result of the organization not able to manage itself on a large-scale. So, the best way to avoid being a diseconomy of scale is to monitor your business closely and be innovative before it is too late.