In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
Difference between economies and diseconomies of scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further and more efficiently.
Diseconomies of Scale represent the opposite phenomenon instead. Where a company has grown too large, the cost per unit increases, thus making the firm no longer able to benefit from its achieved scale.
Diseconomies of scale can happen for a variety of reasons that might span from the inability of the organization to keep organizing its resource efficiently (due for instance, to a too large number of the workforce). When diseconomies of scale pick up, the firm will have higher marginal costs for each additional unit of output.
Thus a primary consequence for diseconomies of scale is a significant increase in coordination costs and a drastically reduced benefit in scaling.
Why do companies experience diseconomies of scale? Economists argue that several reasons might cause that to happen:
Coordination issues: as a company becomes too big, it needs more administrative departments, divisions, and management. When a large organization becomes too hierarchical, centralization might prevent it from being efficient. Therefore, it might slow down production and manufacturing.
Management inefficiencies: as the company needs more management as it grows, this might also slow-down decision-making processes.
Difficulties in keeping a smooth communication flow: communications costs might increase exponentially with the size of the organization. And when the organization becomes too large, those costs might also influence the output and the cost per unit of production.
It is essential to rethink the theory of Diseconomies of Scale as digital businesses manage to take advantage of new business models.
As a platform business model the main asset is its network, which makes it possible for thousands of consumers and producers to connect, interact, transact, and exchange, those platforms can scale quickly and efficiently.
Thus, they might manage to grab close to total market shares, compared to linear businesses, that instead are affected by the Diseconomies of Scale as they grow. In short, while Diseconomies of Scale might affect linear businesses, platform business models, might, in most cases, be immune to that.
While many attributes to platforms business models the ability to scale at an indefinite level, in reality, also platforms enjoy negative consequences of scale, which are called reverse or negative network effects.
Just like diseconomies of scale take hold of more traditional, physical businesses. Reverse network effects can create substantial damages to platforms.
Take the case, of a platform that scales so quickly with user-generated content, that as it scales the risk of generating bad content at scale grows exponentially. There is a threshold where this becomes a real problem and the platform itself might actually collapse!
Key takeaways
In economics, economies of scale are achieved when companies can enjoy a higher degree of efficiency, and lowest structural costs as they scale.
Reached a threshold of scale, diseconomies of scale might kick in, and perhaps size rather be an advantage it becomes a risk factor and inefficient. This is what happens when economies of scale kick in.
In the digital world, there is a similar effect thanks to network effects that enable platforms to scale in size.
While many think that platforms business models are immune to scale, and they can grow indefinitely. In reality, also for platform business models, negative network effects can kick in, thus causing a platform to lose value, if not collapse on its own reversed network effects.
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organizationscale further.
In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.
Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.
Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.
In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage. Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
Gennaro is the creator of FourWeekMBA, which reached about three million business students, executives, and aspiring entrepreneurs in 2021 alone | He is also Head of Enterprise Sales for a high-tech startup, which he helped grow at a double-digit rate since the onset | In 2012 Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
