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Diseconomies of Scale

Definition - What does Diseconomies of Scale mean?

Diseconomies of scale are the factors that result in increasing per unit cost for larger organizations. Economies of scale have the advantages that an organization obtains due to expansion leading to lower unit cost of production or an increase in capacity of the firm due to purchasing of new machinery, mergers and acquisitions, etc. However, the same factors that create economies of scale can lead to a cost disadvantage resulting in diseconomies of scale.

Divestopedia explains Diseconomies of Scale

Diseconomies of scale occur when a firm experiences an increase in marginal costs with a concomitant increase in output. This phenomenon occurs as raising production beyond a certain level results in a fall in the output and increases long run average cost. This is a consequence of an administration becoming more and more complicated as higher levels of production are targeted; there is a greater division of labor. With an increase in levels of hierarchy, effectiveness of communication breaks down, coordination becomes difficult, and an increase in employment cost may occur. There may even be a breakdown of personalized relationships between both suppliers and buyers.

The same factors that favor creating economies of scale lead to diseconomies as the scale grows too big. It is difficult to determine when diseconomies of scale set in, or at which point they become strong enough to outweigh the economies of scale. For industries where economies of scale are negligible, diseconomies tend to set in at relatively smaller volumes of output. In addition, economies of scale are more likely to occur in industries with high capital cost.

Finally, diseconomies of scale can be a factor that drives divestment of a business unit or subsidiary within a larger organization.

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