Competition can be worn down over time as a firm grows bigger and bigger. For instance, Amazon has grown at a rapid pace and now has a strong position in the eCommerce market. Although it does not have a monopoly, it has little in the way of competition. In turn, such large companies may suffer from inefficiencies if management do not keep on top of the numerous issues that may result.
When there is little competition, there is less pressure on management to do so. In addition, high profits with large costs, acts as a signal to potential competitors. Higher Costs : Companies that have significant market share usually have thousands of employees. As a result of its strong positioning, it may find management does not have the same incentives to implement universal efficiencies within the firm. As a firm grows bigger, it may look to buy new factories or real estate.
In turn, it will require new sources of funding. If these are no organically raised, they will come from external sources such as banks or other financial instruments. As a result, the firm will have to repay interest. This creates an additional cost that smaller firms do not always have. As costs of financing increases, so too do the costs of managing financial records. More accountants and legal teams may be required.
In turn, the final cost of production can increase if productivity does not grow over and above these costs. Expanded Workforce : Borrowing more assets requires more employees to oversee the finances, as well as to manage those resources. As the firm needs to hire more workers, it may also need to borrow more. High Levels of Interest : When a firm uses external finance to grow inorganically, it can become increasingly expensive to continue.
The more a firm borrows, the riskier it becomes for investors. In turn, lenders account for the risk with higher interest rates. External diseconomies refer to costs that increase due to factors outside of the company but impact the whole industry. In other words, as the industry grows, diseconomies impact the firm as well as the wider industry. As an industry grows larger, it can create additional costs to the local or national population.
For example, several factories may open in close proximity to each other in order to benefit from efficiencies. This may come from knowledge efficiencies, supplier efficiencies, or other such efficiencies. As a result, such factories may create additional costs in the form of pollution to its local surroundings. Often this can lead to severe respiratory illnesses to local residents. Pollution is not a cost that is necessarily borne by the company, but it can have a heavy cost to both employees and local residents.
This could come in the form of air and noise pollution. For instance, a new airport built may create a cost onto a third party in the form of noise pollution. As a result, house prices may be negatively affected. Poor Health: Air pollution is known for its potential effects on respiratory health. Furthermore, there are other long-term side effects such as heart disease, lung cancer, and damage to peoples nerves, brain, kidneys, and other organs.
Lower House Prices : Areas that are more prone to air and noise pollution may lose value over time. For example, a new airport may cause significant noise pollution to local residents, thereby creating a dis-incentive for the next buyer of the property. All industries require a number of natural resources. These could range from labour, to land, to physical resources, such as coal. As an industry grows larger, it uses more and more resources. In turn, the existing resources become rarer and more expensive.
Skilled labour in the STEM subjects are notably in short supply. For companies hiring such workers, it is difficult to attract them from a limited supply, so they offer higher salaries.
As a result, the cost of production increases. Another example can include the extraction of natural resources such as coal, oil, or gold. There is only a set supply, so when this becomes rarer, it also becomes more costly to find and extract. Purchasing economies of scale:. Large firms are able to negotiate more favourable terms when buying raw materials etc. Bulk buying - remember it is the cost per unit of buying in bulk not the total cost Great example is supermarkets and local shop.
Financial - similar in principle to buying in bulk but this time interest rates a more favorable. Reasons for diseconomies of scale. Communication - becomes more complex. The diagram below illustrates a diseconomy of scale. If the firm produces more or less output, then the average cost per unit will be higher. Diseconomies of scale specifically come about due to several reasons, but all can be broadly categorized as internal or external.
Internal diseconomies of scale can arise from technical issues of production or organizational issues within the structure of a firm or industry. External diseconomies of scale can arise due to constraints imposed by the environment within which a firm or industry operates.
Essentially, diseconomies of scale are the result of the growing pains of a company after it's already realized the cost-reducing benefits of economies of scale. The first is a situation of overcrowding, where employees and machines get in each other's way, lowering operational efficiencies. The second situation arises when there is a higher level of operational waste, due to a lack of proper coordination. The third reason for diseconomies of scale happens when there is a mismatch in the optimum level of outputs within different operations.
Internal diseconomies of scale involve either technical constraints on the production process that the firm uses or organizational issues that increase costs or waste resources without any change to the physical production process. Technical diseconomies of scale involve physical limits on handling and combining inputs and goods in process. These can include overcrowding and mismatches between the feasible scale or speed of different inputs and processes.
Diseconomies of scale can occur for a variety of reasons, but the cause often comes from the difficulty of managing an increasingly large workforce.
An overcrowding effect within an organization is often the leading cause of diseconomies of scale. This happens when a company grows too quickly, thinking that it can achieve economies of scale in perpetuity. If, for example, a company can reduce the per-unit cost of its product each time it adds a machine to its warehouse, it might think that maxing out the number of machines is a great way to reduce costs.
However, if it takes one person to operate a machine, and 50 machines are added to the warehouse, there is a good chance that these 50 additional employees will get in each other's way and make it harder to produce the same level of output per hour.
This increases costs and decreases output. Sometimes, diseconomies of scale happen within an organization when a company's plant cannot produce the same quantity of output as another related plant. For example, if a product is made up of two components, gadget A and gadget B, diseconomies of scale might occur if gadget B is produced at a slower rate than gadget A. This forces the company to slow the production rate of gadget A, increasing its per-unit cost.
Organizational diseconomies of scale can happen for many reasons, but overall, they arise because of the difficulties of managing a larger workforce. The two concepts are essential to the study of economics, and are very useful to corporations to monitor the point at which increases in production can result in higher per unit costs. The following article provides a good explanation of what each term means, shows how they are related to one another and highlights their differences.
Economies of scale is a concept that is widely used in the study of economics and explains the reductions in cost that a firm experiences as the scale of operations increase.
Cost of production entails two types of costs; fixed costs and variable costs. Fixed costs remain the same, regardless of the number of units produced such as the cost of property or equipment. Variable costs are costs that change with the number of units produced, such as the cost of raw material and labor cost, given that salaries are paid at a per hour or per unit basis.
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