Economies and Diseconomies of Scale

17/04/2020 3 By indiafreenotes

Economies of scale are defined as the cost advantages that an organization can achieve by expanding its production in the long run.

In other words, these are the advantages of large scale production of the organization. The cost advantages are achieved in the form of lower average costs per unit.

It is a long term concept. Economies of scale are achieved when there is an increase in the sales of an organization. As a result, the savings of the organization increases, which further enables the organization to obtain raw materials in bulk. This helps the organization to enjoy discounts. These benefits are called as economies of scale.

The economies of scale are divided in to internal economies and external economies discussed as follows:

  1. Internal Economies

Refer to real economies which arise from the expansion of the plant size of the organization. These economies arise from the growth of the organization itself.

The examples of internal economies of scale are as follows:

(i) Technical economies of scale

Occur when organizations invest in the expensive and advanced technology. This helps in lowering and controlling the costs of production of organizations. These economies are enjoyed because of the technical efficiency gained by the organizations. The advanced technology enables an organization to produce a large number of goods in short time. Thus, production costs per unit falls leading to economies of scale.

(ii) Marketing economies of scale

Occur when large organizations spread their marketing budget over the large output. The marketing economies of scale are achieved in case of bulk buying, branding, and advertising. For instance, large organizations enjoy benefits on advertising costs as they cover larger audience. On the other hand, small organizations pay equal advertising expenses as large organizations, but do not enjoy such benefits on advertising costs.

(iii) Financial economies of scale

Take place when large organizations borrow money at lower rate of interest. These organizations have good credibility in the market. Generally, banks prefer to grant loans to those organizations that have strong foothold in the market and have good repaying capacity.

(iv) Managerial economies of scale

Occur when large organizations employ specialized workers for performing different tasks. These workers are experts in their fields and use their knowledge and experience to maximize the profits of the organization. For instance, in an organization, accounts and research department are created and managed by experienced individuals, SO that all costs and profits of the organization can be estimated properly.

(v) Commercial economies

Refer to economies in which organizations enjoy benefits of buying raw materials and selling of finished goods at lower cost. Large organizations buy raw materials in bulk; therefore, enjoy benefits in transportation charges, easy credit from banks, and prompt delivery of products to customers.

  1. External economies

Occur outside the organization. These economies occur within the industries which benefit organizations. When an industry expands, organizations may benefit from better transportation network, infrastructure, and other facilities. This helps in decreasing the cost of an organization.

Some of the examples of external economies of scale are discussed as follows:

(i) Economies of Concentration

Refer to economies that arise from the availability of skilled labor, better credit, and transportation facilities.

(ii) Economies of Information

Imply advantages that are derived from publication related to trade and business. The central research institutions are the source of information for organizations.

(iii) Economies of Disintegration

Refer to the economies that arise when organizations split their processes into different processes.

Diseconomies of Scale

Diseconomies of scale occur when the long run average costs of the organization increases. It may happen when an organization grows excessively large. In other words, the diseconomies of scale cause larger organizations to produce goods and services at increased costs.

  1. Internal diseconomies of scale

Refer to diseconomies that raise the cost of production of an organization. The main factors that influence the cost of production of an organization include the lack of decision, supervision, and technical difficulties.

  1. External diseconomies of scale

Refer to diseconomies that limit the expansion of an organization or industry. The factors that act as restraint to expansion include increased cost of production, scarcity of raw materials, and low supply of skilled laborer.

There are a number of causes for diseconomies of scale

Some of the causes which lead to diseconomies of scale are as follows:

(i) Poor Communication

Act as a major reason for diseconomies of scale. If production goals and objectives of an organization are not properly communicated to employees within the organization, it may lead to overproduction or production. This may lead to diseconomies of scale.

Apart from this, if the communication process of the organization is not strong then the employees would not get adequate feedback. As a result, there would be less face-to-face interaction among employees- thus the production process would be affected.

(ii) Lack of Motivation

Leads to fall in productivity levels. In case of a large organization, workers may feel isolated and are less appreciated for their work, thus their motivation diminishes. Due to poor communication network, it is harder for employers to interact with the employees and build a sense of belongingness. This leads to fall in the productivity levels of output owing to lack of motivation. This further leads to increase in costs of the organization.

(iii) Loss of Control

Acts as the main problem of large organizations. Monitoring and controlling the work of every employee in a large organization becomes impossible and costly. It is harder to make out that all the employees of an organization are working towards the same goal. It becomes difficult for managers to supervise the sub-ordinates in large organizations.

(iv) Cannibalization

Implies a situation when an organization faces competition from its own product. A small organization faces competition from products of other organizations, whereas sometimes large organizations find that their own products are competing with each other.