Diseconomies of scale
Economic theory predicts that a firm may become less efficient
if it becomes too large. The additional costs of becoming too large
are called diseconomies of scale.
Examples of diseconomies include:
- Larger firms often suffer poor communication because
they find it difficult to maintain an effective flow of information
between departments, divisions or between head office and
subsidiaries. Time lags in the flow of information can also create
problems in terms of the speed of response to changing market
conditions. For example, a large supermarket chain may be less
responsive to changing tastes and fashions than a much smaller,
‘local’ retailer.
- Co-ordination problems also affect large firms with
many departments and divisions, and may find it much harder to
co-ordinate its operations than a smaller firm. For example, a
small manufacturer can more easily co-ordinate the activities of
its small number of staff than a large manufacturer employing tens
of thousands.
- ‘X’ inefficiency is the loss of management efficiency
that occurs when firms become large and operate in uncompetitive
markets. Such loses of efficiency include over paying for
resources, such as paying managers salaries higher than needed to
secure their services, and excessive waste of resources. ‘X’
inefficiency means that average costs are higher than would be
experienced by firms in more competitive markets.
- Low motivation of workers in large firms is a
potential diseconomy of scale that results in lower productivity,
as measured by output per worker.
- Large firms may experience inefficiencies related to the
principal-agent problem. This problem is caused because
the size and complexity of most large firms means that their owners
often have to delegate decision making to appointed managers, which
can lead to inefficiencies. For example, the owners of a large
chain of clothes retailers will have to employ managers for each
store, and delegate some of the jobs to managers but they may not
necessarily make decisions in the best interest of the owners. For
example, a store manager may employ the most attractive sales
assistant rather than the most productive one.
Generally large firms in service sector experience
inefficiencies that small firms do not experience. Example In Hotel
industry, Barbers, Tailors, Doctors, Lawers, Chartered accountants,
etc., the so called professionals and self employed category, small
firms cater to the needs of individual customers considering
personal taste of their clients or customers with a personal touch.
This advantage is not there for large firms.