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Diseconomies of Scale - Meaning and Definition

Updated on August 25, 2014

Introduction

When you manufacture a commodity, you try to utilize all factors of production optimally. Because, optimization provides you with maximum profit with less cost of production. However, there is a limit to this optimization. If you try to optimize beyond this limit, diseconomies of scale arises. Suppose you are truck driver. When you carry few parcels in your truck, you may incur loss or minimum profit. At the same time, if you utilize the space available in your truck optimally to carry many parcels, it will give you good profit. If you continue to add parcels thinking of huge profit, your truck will be damaged because of overload. This is what diseconomies of scale.

A firm cannot optimize its production continuously because diseconomies arise at some point. Diseconomies of scale tend to decrease profit by increasing cost of production. Diseconomies do not arise just because of optimization. In a production environment, there are certain internal and external forces, which act as diseconomies.

Possible Diseconomies in a Large-Scale Production

The following diseconomies may emerge in a large-scale production:

Diseconomies in management

When you try to optimize the production process beyond certain stage, you will have to face complex problems. These complex problems, which increase cost of production, are known as diseconomies. The basic problem of diseconomies is that they result in increased costs. When cost of production increases, profit reduces eventually. Hence, we can claim that diseconomies limit the production of a firm.

Diseconomies in management range from labor issues to financial problems. The indifferent attitude of workers, inefficient supervision, continuous demand for wage raise, increased wastage and unapproachable management are some of the examples of diseconomies in management. All these problems certainly hinder the production environment.

In a large-scale production, always there is a room for unethical practices and dishonesty. Both management and workers equally try to carry out unethical practices for various reasons. The reason for dishonesty is that it is difficult to keep everything or everybody under close watch.

As stated above, financial problem is one of major diseconomies in a large-scale production. If an organization is a human body, finance is the heart. Finance is necessary for everything from day-to-day business administration to future business expansion. Another important point is that adequate capital should be available at the right time to complete the ongoing projects. Hence, time element matters a lot in financial management. Furthermore, officials who handle financial affairs of an organization must be honest.

As the size of a firm increases, risk of uncertainty also increases. This is very similar to trading stocks or currency instruments. When you trade small quantities, the risk is also small. If you trade big quantities, the risk is also big.

Diseconomies in marketing

The success or sustainment of a firm depends upon its ability to capture market. Market capture is not an easy task now-a-days because of huge competition. If appropriate strategy is not in place to attract customers, the firm will not be able to sustain in the long-run.

Furthermore, projecting market demand accurately is a key point to success. If an organization fails to estimate market demand accurately, it may face the problem of over-production. What is the use of producing more commodities when there is no demand for them? Obviously, the firm incurs heavy losses because of over-production.

Competition from the rivals is another important diseconomy. Today, perfect competition prevails all over the world. Therefore, companies have to make huge efforts to tackle the rival products. The only way to tackle the stiff competition is to advertise the products extensively. Advertising, sales promotion and campaigning requires huge financial resources. Studies on expenditures of various companies show that they spend substantial portion of financial resources for advertisements. What happens when the competition increases further is that companies start spending more on advertising and sales promotion. These activities of a company lead to higher cost. When cost increases, profit starts declining naturally.

Most of the time, companies miscalculate customers’ expectations. Production managers must be knowledgeable to identify customers’ needs, tastes and preferences. There is no use of producing a commodity that is not preferred by anybody. In this case, the company is in the danger of losing its customers to other competitors.

Large-scale producers are often not flexible to customers’ complaints. They frame policies in the beginning or adapt existing policies of the industry and strictly follow them. The policies may be out-dated. When an out-dated policy is followed, the company causes itself an irreparable damage, which eventually collapses the very foundation of the company.

Political upheavals and abnormal situations are the most important diseconomies for a large-scale producer because they directly affect the sales of produced goods and availability of raw materials. Note that diseconomies like these are not under the control of a producer.

Diseconomies in technology

Technological improvement is undoubtedly helpful to improve the production process and maximize the output. However, the manufacturer cannot keep on utilizing all innovative technologies. The reason is that the sale of produced goods depends upon various external factors. Given this situation, adapting advanced technology continuously may result in over-production and the overly produced goods may not get sold as expected.

Diseconomies in labor management

One of the biggest problems faced by almost all firms is labor disputes. As the size of a firm increases, the management has to employ more laborers as well. The very first problem any organization faces is shortage of qualified laborers. A country with low fertility rate often faces this type of labor crisis. When there is a shortage of skilled laborers, management has to offer more wage. It increases the cost of production, which is not so desirable.

Secondly, as the number of laborers increases, more possibility of labor disputes, strikes and lockouts emerges. No matter how efficiently the manager handles the laborers – hostile and indifferent attitude always prevails among employees. All these can affect the production process directly or passively and hence result in huge loses.

Diseconomies in flexibility

For a large-scale firm, switching over from one business to another is not easy because of huge investments and intensive concentration. If the business does not perform well for any reason, the firm has to suffer a lot for its survival.

External diseconomies

Large-scale production is the primary reason for unequal distribution of wealth. The entire system is framed in such a way that it works for certain sect of people. Therefore, it causes a significant gap between the rich and poor. When this gap widens uncontrollably, many social problems such as civil war and political upheavals start emerging.

Possible Diseconomies in Small-Scale Production

Many of the small-scale firms are not able to compete with large-scale firms because of financial constraints, or lack of skilled laborers, market and technology. Therefore, small-scale firms eventually vanish over a period.

Small-scale firms cannot allot adequate financial resources to research and development. Therefore, these firms have to depend upon big industries for advanced technology to incorporate in the production process.

In general, wastage in a small-scale firm are huge because it lacks the ability to utilize the by-products in a useful manner.

Generally, small-scale firms possess labor-intensive technology. When a firm uses labor-intensive technology extensively, the cost of production increases drastically.

© 2013 Sundaram Ponnusamy

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