Diseconomies of scale

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In microeconomics, diseconomies of scale are the cost disadvantages that economic actors accrue due to an increase in organizational size or in output, resulting in production of goods and services at increased per-unit costs. The concept of diseconomies of scale is the opposite of economies of scale. In business, diseconomies of scale [1] are the features that lead to an increase in average costs as a business grows beyond a certain size.


The rising part of the long-run average cost curve illustrates the effect of diseconomies of scale. The Long Run Average Cost (LRAC) curve plots the average cost of producing the lowest cost method. The Long Run Marginal Cost (LRMC) is the change in total cost attributable to a change in the output of one unit after the plant size has been adjusted to produce that rate of output at minimum LRAC. Economies-of-Scale.jpg
The rising part of the long-run average cost curve illustrates the effect of diseconomies of scale. The Long Run Average Cost (LRAC) curve plots the average cost of producing the lowest cost method. The Long Run Marginal Cost (LRMC) is the change in total cost attributable to a change in the output of one unit after the plant size has been adjusted to produce that rate of output at minimum LRAC.


Communication costs

Ideally, all employees of a firm would have one-on-one communication with each other so they know exactly what the other workers are doing. A firm with a single worker does not require any communication between employees. A firm with two workers requires one communication channel, directly between those two workers. A firm with three workers requires three communication channels between employees (between employees A & B, B & C, and A & C). Here is a chart of one-on-one communication channels required:

WorkersCommunication Channels

The graph of all one-on-one channels is a complete graph.

The number of one-on-one channels of communication grows more rapidly than the number of workers, thus increasing the time and costs of communication. At some point one-on-one communications between all workers becomes impractical; therefore only certain groups of employees will communicate with one another (e.g. within departments or within geographical locations). This reduces, but does not stop, the increase in unit costs; and also the organisation will incur some inefficiencies due to the reduced level of communication.

Duplication of effort

An organisation with just one person cannot have any duplication of effort between employees. If there are two employees, there could be some duplication of efforts, but this is likely to be minor, as each of the two will generally know what the other is working on. When organisations grow to thousands of workers, it is inevitable that someone, or even a team, will take on a function that is already being handled by another person or team. In colloquial terms, this is described as "one hand not knowing what the other hand is doing". General Motors, for example, developed two in-house CAD/CAM systems: CADANCE was designed by the GM Design Staff, while Fisher Graphics was created by the former Fisher Body division. These similar systems later needed to be combined into a single Corporate Graphics System, CGS, at great expense. A smaller firm would have had neither the money to allow such expensive parallel developments, nor the lack of communication and cooperation which precipitated this event. In addition to CGS, GM also used CADAM, UNIGRAPHICS, CATIA and other off-the-shelf CAD/CAM systems, thus increasing the cost of translating designs from one system to another. This endeavor eventually became so unmanageable that they acquired (and then eventually sold off) Electronic Data Systems (EDS) in an effort to control the situation. Smaller firms typically choose a single off-the-shelf CAD/CAM system, with no need to combine or translate between systems.[ citation needed ]

Office politics

"Office politics" is management behavior which a manager knows is counter to the best interest of the company, but is in their personal best interest. For example, a manager might intentionally promote an incompetent worker, knowing that the worker will never be able to compete for the manager's job. This type of behavior only makes sense in a company with multiple levels of management. The more levels there are, the more opportunity for this behavior. In a small company, such behavior could cause the company to go bankrupt, and thus cost the manager their job, so they would not make such a decision. In a large company, one manager would not have much effect on the overall health of the company, so such "office politics" are in the interest of individual managers.

Top-heavy companies

As an organisation increases in size, it becomes costly to keep control of a sprawling corporate empire, and this often results in bureaucracy as executives implement more and more levels of management. As firms increase in size, managers will initially provide a net benefit to the firm and increase productivity; however, as a firm grows and covers a larger geographical area and/or employs more people, a principal–agent problem arises, leading to lower productivity. To counter this, executives introduce standards and controls in order to maintain productivity, and this necessitates the hiring of more managers to apply these standards and controls, hence the proportion of managerial to working class begins to lean towards managerial and the company becomes "top-heavy". However, these additional managers are not providing additional output: they are spending their time implementing standards and carrying out supervision that is unnecessary in smaller firms, hence the cost-per-unit has increased.

Supply-chain disruption

Global emergencies, such as COVID-19 in 2020, can easily disrupt supply chains. This disruption has a higher chance of affecting large organizations[ citation needed ] - especially when there is only a few large suppliers. Smaller organizations with robust, local supply networks can manage supply chain shocks because any localized shock has a smaller effect on the overall ecosystem.

Other effects which reduce competitiveness of large firms

These do not always increase the cost-per-unit, but do reduce the ability of a large firm to compete.


A small firm only competes with other firms, but larger firms frequently find their own products are competing with each other. A Buick was just as likely to steal customers from another GM make, such as an Oldsmobile, as it was to steal customers from other companies. This may help to explain why Oldsmobiles were discontinued after 2004. This self-competition wastes resources that should be used to compete with other firms.

Isolation of decision-makers from the results of their decisions

If a single person makes and sells donuts and decides to try jalapeño flavoring, they would likely know on the same day whether their decision was good or not, based on the reaction of customers. A decision-maker at a huge company that makes donuts may not know for many months if such a decision is embraced by consumers or if it is rejected, especially if their research or marketing team fails to respond in a timely manner. By that time, the decision-makers may very well have moved on to another division or company and thus see no consequence from their decision. This lack of consequences can lead to poor decisions and cause an upward-sloping average cost curve.

Slow response time

In a reverse example, the smaller firm will know immediately if people begin to request other products, and be able to respond the next day. A large company would need to do research, create an assembly line, determine which distribution chains to use, plan an advertising campaign, etc., before any changes could be made. By this time, the smaller competitors may well have grabbed that market niche.

Inertia (Unwillingness to change)

This will be defined as the "we've always done it that way, so there's no need to ever change" attitude (see appeal to tradition). An old, successful company is far more likely to have this attitude than a new, struggling one. While "change for change's sake" is counter-productive, refusal to consider change, even when indicated, is likewise toxic to a company, as changes in the industry and market conditions will inevitably demand changes in the firm in order to remain successful. An example is Polaroid Corporation's delay in moving into digital imaging, which adversely affected the company, ultimately leading to bankruptcy.

Public and government opposition

Such opposition is largely a function of the size of the firm. Behavior from Microsoft, which would have been ignored from a smaller firm, was seen as an anti-competitive and monopolistic threat, due to Microsoft's size, thus bringing about government lawsuits.

Large market share

A small company with only a 1% market share could relatively easily double market share, and hence revenues, in a year. A large company with 50% market share will find it difficult to do so.

Large market portfolio

A small investment fund can potentially yield a higher return because it can concentrate its investments in a small number of good opportunities without driving up the purchase price as they buy in, and later sell them without driving down the sale price as they sell off. Conversely, a large investment fund must spread its investments among so many securities that its results tend to track those of the market as a whole. As the size of the market controlled grows, the results will be closer to market average.

Inelasticity of supply

A company which is heavily dependent on a resource supply of a fixed or relatively-fixed size will have trouble increasing production. For instance, a timber company cannot increase production above the sustainable harvest rate of its land (although it can still increase production by acquiring more land). Similarly, service companies are limited by available labor (and thus tend to concentrate in large, densely-populated metropolitan areas); STEM (science, technology, engineering, and mathematics) professions are often-cited examples.


Larger firms have a reputation to uphold and as a result may place more restrictions on employees, limiting their efficiency. This will be seen amplified in a regulated industry, where a company losing its license would be an extremely serious event.

Large firms also tend to be old and in mature markets. Both of these have negative implications for future growth. Old firms tend to have a large retiree base, with high associated pension and health costs, and also tend to be unionized, with associated higher salaries and labor rights (lower productivity)[ citation needed ]. Mature markets tend to only offer the potential for small, incremental growth. (Everybody might go out and buy a new invention next year, but it is unlikely they will all buy cars next year, since most people already have them.)

Impact on smaller firms

While diseconomies of scale are typically associated with large mature firms, similar problems have been observed in the growth phase of small and medium-sized manufacturing companies. Mclean [2] has observed that this can occur once the workforce exceeds around 20 employees. At this point business complexity grows more rapidly than revenue. The business experiences falling productivity, leading to rising variable costs along with rapidly rising overheads. [3]


Solutions to the diseconomies of scale for large firms may involve splitting the company into smaller organisations. This can either happen by default when the company is in financial difficulties, sells off its profitable divisions and shuts down the rest; or can happen proactively, if the management is willing.

To avoid the negative effects of diseconomies of scale, a firm must stick to the lowest average output cost and try to recognise any external diseconomies of scale. Moreover, on reaching the lowest average cost, a firm must either expand to other countries to increase demand for its products, or seek new markets or produce new products that do not compete with its original products. However, neither of these actions will necessarily eliminate communications and management problems often associated with large organisations.

A systematic analysis and redesign of business processes, in order to reduce complexity, can counter diseconomies of scale. (Of course, this phase of analysis and revamping in itself can be, and usually is, a diseconomy leading to hiring of new personnel and investment in new, competing systems.) This leads to increased productivity. Improved management systems and more effective control of labor and operations can lower overhead.


Returning to the example of the large donut firm, each retail location could be allowed to operate relatively autonomously from the company headquarters.

For instance, the local management may decide on the following factors instead of relying on the central management:

  1. Employee decisions such as hiring, firing, promotions and wage scales, where the local management is directly involved and likely to have better understanding of each employee. For instance, employers may choose to offer higher wages and charge higher prices if they are in an affluent area.
  2. Purchasing decisions, with each location allowed to choose its own suppliers, which may or may not be owned by the corporation (wherever they find the best quality and prices).
  3. Research and marketing decisions. Each firm may decide to develop their own recipes or utilise different signature flavour unique to their locale. For instance, when fresh apple cider is available at bargain prices from local farmers in October, they may choose to market a cinnamon donut and hot apple cider combo.

While a single, large, centrally-controlled firm may have higher ability to innovate and develop or market new products more effectively than when its resources are divided, it may lack the flexibility to offer individual customizations. Allowing the different retail locations to make decisions independent of the central management may allow them to meet local consumers' demands more efficiently.

In addition, if the employees own a portion of the local business, employees will also have a more vested interest in its success.

Note that all these changes will likely result in a substantial reduction in corporate headquarters staff and other support staff. For this reason, many businesses delay such a reorganization until it is too late to be effective. However, the whole company incurs reputation and legal risks arising from each unit.


The empirical validity of diseconomies of scale as a rule of thumb has been criticised in recent years, following the increasing concentration of transnational corporations on the global level. The Cambridge economist Peter Nolan calculated that in almost all global production sectors, transnational corporations had merged and concentrated since the 1980s instead of succumbing to diseconomies of scale, leading to significant market power concentration and oligopolistic competition on the global level [4] This criticism suggests that earlier concerns on diseconomies of scale, e.g. voiced by Alfred Marshall, are increasingly invalid, as improvements to global supply chains, communication technology and reduction of transport costs allow benefits of scale (e.g. concentration of spending on R&D and market power) to trump diseconomies of scale.

See also

Related Research Articles

Economies of scale Cost advantages obtained via scale of operation

In microeconomics, economies of scale are the cost advantages that enterprises obtain due to their scale of operation, and are typically measured by the amount of output produced. A decrease in cost per unit of output enables an increase in scale. At the basis of economies of scale there may be technical, statistical, organizational or related factors to the degree of market control.

Natural monopoly Concept in economics

A natural monopoly is a monopoly in an industry in which high infrastructural costs and other barriers to entry relative to the size of the market give the largest supplier in an industry, often the first supplier in a market, an overwhelming advantage over potential competitors. Specifically, an industry is a natural monopoly if the total cost of one firm, producing the total output, is lower than the total cost of two or more firms producing the entire production. This frequently occurs in industries where capital costs predominate, creating large economies of scale about the size of the market; examples include public utilities such as water services, electricity, telecommunications, mail, etc. Due to resource scarcity, economies of scale, and scope of economic benefits. Therefore, the probability that a company that provides a single product and service or a company that jointly provides most products and services will form a company (monopoly) or a minimal number of companies (oligopoly) is very probable. Natural monopolies were recognized as potential sources of market failure as early as the 19th century; John Stuart Mill advocated government regulation to make them serve the public good.

Cost accounting Procedures to optimize practices in cost efficient ways

Cost accounting is defined as "a systematic set of procedures for recording and reporting measurements of the cost of manufacturing goods and performing services in the aggregate and in detail. It includes methods for recognizing, classifying, allocating, aggregating and reporting such costs and comparing them with standard costs." (IMA) Often considered a subset of managerial accounting, its end goal is to advise the management on how to optimize business practices and processes based on cost efficiency and capability. Cost accounting provides the detailed cost information that management needs to control current operations and plan for the future.

Economies of scope are "efficiencies formed by variety, not volume". In economics, "economies" is synonymous with cost savings and "scope" is synonymous with broadening production/services through diversified products. Economies of scope is an economic theory stating that average total cost of production decrease as a result of increasing the number of different goods produced. For example, a gas station that sells gasoline can sell soda, milk, baked goods, etc. through their customer service representatives and thus gasoline companies achieve economies of scope.

Economies of agglomeration or agglomeration effects are cost savings arising from urban agglomeration, a major topic of urban economics. One aspect of agglomeration is that firms are often located near to each other. This concept relates to the idea of economies of scale and network effects.

Small business Business with fewer employees or revenue

Small businesses are corporations, partnerships, or sole proprietorships which have fewer employees and/or less annual revenue than a regular-sized business or corporation. Businesses are defined as "small" in terms of being able to apply for government support and qualify for preferential tax policy varies depending on the country and industry. Small businesses range from fifteen employees under the Australian Fair Work Act 2009, fifty employees according to the definition used by the European Union, and fewer than five hundred employees to qualify for many U.S. Small Business Administration programs. While small businesses can also be classified according to other methods, such as annual revenues, shipments, sales, assets, or by annual gross or net revenue or net profits, the number of employees is one of the most widely used measures.

Marginal cost Cost added by producing one additional unit of a product or service

In economics, the marginal cost is the change in the total cost that arises when the quantity produced is incremented, the cost of producing additional quantity. In some contexts, it refers to an increment of one unit of output, and in others it refers to the rate of change of total cost as output is increased by an infinitesimal amount. As Figure 1 shows, the marginal cost is measured in dollars per unit, whereas total cost is in dollars, and the marginal cost is the slope of the total cost, the rate at which it increases with output. Marginal cost is different from average cost, which is the total cost divided by the number of units produced.

Managerial economics is a branch of economics involving the application of economic methods in the managerial decision-making process.And, Managerial Economics is the integration of economic theory with business practice for the purpose of facilitating Decision making and forward planning by the Management. Managerial economics aims to provide a framework for decision making which are directed to maximise the profits and outcomes of a company. Managerial economics focuses on increasing the efficiency of organizations by employing all possible business resources to increase output while decreasing unproductive activities. The two main purposes of managerial economics are:

  1. To optimize decision making when the firm is faced with problems or obstacles, with the consideration of macro and microeconomic theories and principles.
  2. To analyse the possible effects and implications of both short and long-term planning decisions on the revenue and profitability of the Business.

In economics, average cost or unit cost is equal to total cost (TC) divided by the number of units of a good produced :

An organizational structure defines how activities such as task allocation, coordination, and supervision are directed toward the achievement of organizational aims.

The term efficiency wages was introduced by Alfred Marshall to denote the wage per efficiency unit of labor. Marshallian efficiency wages would make employers pay different wages to workers who are of different efficiencies such that the employer would be indifferent between more-efficient workers and less-efficient workers. The modern use of the term is quite different and refers to the idea that higher wages may increase the efficiency of the workers by various channels, making it worthwhile for the employers to offer wages that exceed a market-clearing level. Optimal efficiency wage is achieved when the marginal cost of an increase in wages is equal to the marginal benefit of improved productivity to an employer.

In economics, returns to scale describe what happens to long-run returns as the scale of production increases, when all input levels including physical capital usage are variable. The concept of returns to scale arises in the context of a firm's production function. It explains the long-run linkage of the rate of increase in output (production) relative to associated increases in the inputs. In the long run, all factors of production are variable and subject to change in response to a given increase in production scale. While economies of scale show the effect of an increased output level on unit costs, returns to scale focus only on the relation between input and output quantities.

The theory of the firm consists of a number of economic theories that explain and predict the nature of the firm, company, or corporation, including its existence, behaviour, structure, and relationship to the market.

In economics, a cost curve is a graph of the costs of production as a function of total quantity produced. In a free market economy, productively efficient firms optimize their production process by minimizing cost consistent with each possible level of production, and the result is a cost curve. Profit-maximizing firms use cost curves to decide output quantities. There are various types of cost curves, all related to each other, including total and average cost curves; marginal cost curves, which are equal to the differential of the total cost curves; and variable cost curves. Some are applicable to the short run, others to the long run.

Field service management (FSM) refers to the management of a company's resources employed at or en route to the property of clients, rather than on company property. Examples include locating vehicles, managing worker activity, scheduling and dispatching work, ensuring driver safety, and integrating the management of such activities with inventory, billing, accounting and other back-office systems. FSM most commonly refers to companies who need to manage installation, service, or repairs of systems or equipment. It can also refer to software and cloud-based platforms that aid in field service management.

Minimum efficient scale

In industrial organization, the minimum efficient scale (MES) or efficient scale of production is the lowest point where the plant can produce such that its long run average costs are minimized. It is also the point at which the firm can achieve necessary economies of scale for it to compete effectively within the market.

Quick response manufacturing (QRM) is an approach to manufacturing which emphasizes the beneficial effect of reducing internal and external lead times.

Multi-divisional form refers to an organizational structure by which the firm is separated into several semi autonomous units which are guided and controlled by (financial) targets from the center.

Socially optimal firm size

The socially optimal firm size is the size for a company in a given industry at a given time which results in the lowest production costs per unit of output.

Workplace democracy is the application of democracy in various forms to the workplace. It can be implemented in a variety of ways, depending on the size, culture, and other variables of an organization.


  1. Chappelow, Jim. "Understanding Diseconomies of Scale". Investopedia. Retrieved 2020-05-16.
  2. McLean, Timothy A. (December 2014). Grow Your Factory, Grow Your Profits: Lean for Small and Medium Sized Manufacturing Enterprises. New York: Productivity Press. ISBN   978-1-4822-5585-0.
  3. McLean, Timothy A. "Lean for Small and Medium Sized Manufacturing Enterprises". TXM Lean Solutions.
  4. Peter Nolan, Jin Zhang, Chunhang Liu, "The global business revolution, the cascade effect, and the challenge for firms from developing countries", Cambridge Journal of Economics, Volume 32, Issue 1, January 2008, Pages 29–47, https://doi.org/10.1093/cje/bem016