Diseconomies of Scale: Definition, Types, and Causes

Diseconomies of scale occur when production scales up past the point of efficiency and unit costs begin to rise instead of fall. In cases of diseconomies of scale, increases in production output generate a negative effect since marginal costs also increase. This economic phenomenon appears as an upward trend on the long-run average cost curve and results in a decrease in profit and efficiency.

There are two main categories of diseconomies of scale: internal and external. While internal diseconomies of scale result from factors within the company’s control, external diseconomies of scale occur due to factors outside of a company’s influence. Here are different types of internal and external diseconomies:

1. 1. Competitive diseconomies: A lack of a competitive market can create a diseconomy of scale, as companies have no incentive to address inefficiencies and improve processes. Ignoring process disorganization drives up the cost of production and results in a competitive diseconomy of scale.
2. 2. Infrastructure diseconomies: Business growth can also place constraints on local infrastructure. The production process might develop problems if a company grows to a point where natural geography cannot support it. For example, companies constructing buildings in regions that cannot handle the manufacturing level might experience an operational efficiency that results in a net loss.
3. 3. Organizational diseconomies: Both small and large firms experience organizational diseconomies of scale. When a business suddenly grows, the company needs to hire new employees and open additional departments to scale effectively. Training new employees drives up a company’s average costs. More departments also means more potential for communication mishaps and management inefficiencies, which can also create organizational diseconomies.
   
4. 4. Purchasing diseconomies: Companies can also trigger poor spending habits as businesses make more money. When a company experiences growth and an increase in sales, owners are more willing to pay higher costs for the same resource inputs. Known as a purchasing diseconomy, this spending phenomenon results in an increase in total costs.
5. 5. Technical diseconomies: This internal diseconomy occurs when companies grow at a rate that is not scalable. As businesses grow, existing systems often require updates to meet new demands; however, in the transitioning process, inefficiencies can create additional costs, resulting in technical diseconomies of scale.

Both internal and external factors result in diseconomies of scale. While causes vary according to a company’s circumstances, below are common sources of diseconomies of scale:

1. 1. Organizational disruptions: In large companies, overseeing multiple departments often results in organizational issues. Mismanagement and poor communication slow down productivity and prevent optimal coordination. These types of organizational disruptions are a common cause of the increased costs you can associate with diseconomies of scale.
2. 2. Rapid growth: When a company experiences sudden growth, the business becomes less nimble and less able to integrate new technology and sales methods. Diseconomies of scale often occur. As the demand for a product or service increases to a point the business is not prepared to handle, production difficulties create a diseconomy of scale. Such businesses might need to divest or downsize to reach optimal cost savings.
3. 3. Resource shortages: As the price of supplies increases due to limited availability or high demand, overall production costs also increase. When resource shortages occur, companies overpay for goods, reducing profitability and resulting in diseconomies of scale.
4. 4. Technical difficulties: Like organizational issues, technical disruptions can also slow down a production line. Some common types of technical difficulties include system overloads, process malfunctions, and security disturbances.

Solutions to diseconomies of scale vary on a case-by-case basis. Depending on the cause and type of diseconomy, businesses need to adopt a strategy that targets the initial problem. A common solution to diseconomies of scale is dividing a large company into smaller, more manageable sections. This division helps ease organizational and technical constraints on company growth.

Economies of scale are antithetical to diseconomies of scale. While diseconomies of scale describe a negative impact on businesses, economies of scale refer to increased production and profitability. Economies of scale occur when a company’s costs decrease as production increases. As a result, economies of scale generate an increase in profit and productivity for a company.

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