The increasingly competitive business setting motivates most businesses to seek economies of scale. Economies of scale are realized when organizations expand in a way that allows them to lower the cost of production thereby maximizing profitability (Boyes 211). However, ambitious expansion of the organization is often accompanied by diseconomies of scale, which pose real challenges to the management of the organization. While economies of scale allow organizations to manufacture products at a low per-unit cost, diseconomies of scale complicate the management process and can hinder an organization’s growth process. Managerial diseconomies of scale are the challenges and complications in the administration of resources (especially the human resource) that are faced by large organizations.
The Managerial Diseconomies of Scale
According to John Sloman, the percentage of the number of line employees is inversely proportionate to the company size (92). A big company with many employees is likely to have more managers whose salaries are higher than other line employees. Increased cost of management is often transferred to the company products and is likely to cause an increase in the price of goods and services offered by the company. If not, then the cost of management is likely to affect company profitability and deter the company from gaining a competitive advantage.
Bureaucracy is another diseconomy of scale associated with excessive expansion of the organization (Kaplan and Henderson 512). Bigger organizations are often vastly bureaucratized by way of formalization. This bureaucratization often inhibits the overall growth and profitability of the organization. The additional costs associated with bureaucracy often impede the company growth and business success. Png categorizes diseconomies associated with bureaucracy into unnecessary rigidity, conservatism or opposition to the proposed change and the adoption of differentiation of employees by their apparent social classes (302).
A view of the company as a processor of information identifies diseconomies of scale associated with rigidity and information loss. Big companies often adopt specialization of their workforce with specific employees performing certain tasks. This kind of specialization demands effective communication and information flow throughout all the segments of the organization, which can be very costly in a large organization.
To reduce the cost associated with the flow of information, most large companies opt for information coding. However, in as much as coding helps in the economization of the available resources, it also contributes to rigidity. In addition, much information is lost during the process of coding. This implies that an organization that has many hierarchical levels is more likely to face the loss of information during coding as well as the distortion of results. Since such big companies are often existent in the market for a considerably long time, their employees are also likely to be relatively rigid.
Excessive expansion of a company also complicates its communication process. A company with one employee does not require elaborate communication channels. However, as the company expands and the number of its employees grows, it is required to adopt intricate communication channels to ensure the effective transmission of information. The need for improved communication channels is instigated by increased difficulty in communication between and within the organization’s departments. A large organization with many employees means that there is a wide span of employees to manage. Moreover, a wide hierarchical structure often causes information distortion. Consequently, low level employees often receive distorted misinterpreted information. This often results in the employees performing incorrect or unfinished tasks.
Large companies usually use written modes of communication in the management of their employees, which is often characterized by little or no direct contact. This lack of direct contact inhibits communication effectiveness as the employees cannot offer their feedback. Feedback is always important in channeling employee opinions and concerns.
Large organizations also make it difficult for managers to stay in contact with their employees on a daily basis and ensure that the employees are committed to achieving the company objectives. The absence of direct contact with their managers can also cause a feeling of being isolated and unacknowledged among employees. Low employee morale and lack of focus and direction can be detrimental to the company productivity.
Large organizations also require an intricate and multilayered infrastructure so as to maintain a competitive advantage. Such complicated infrastructure in large companies cause delays in the decision making process and can cut off decision makers from the products of their decisions. This can increase the operational costs incurred by the organization.
Moreover, small companies can easily identify shifts in the demands and tastes of their customers. Large companies, on the other hand, face complications and stringent procedures in their quest to implement change in order to adapt to market changes. Change in any part of a large organization is likely to impact the rest of the organization. Big, successful companies often face inertia or unwillingness of managers to embrace change. Market dynamics require companies to embrace change according to environmental trends and customer demands so as to obtain and maintain a competitive advantage.
Multifaceted organizations are also faced with office politics that are rarely in the interest of the company. Managers pursuing private goals often compromise the development of the company. Such managers use office politics to acquire advantage outside their legitimate mandate. For instance, a manager may use office politics to promote an underperforming or unqualified employee. While managers often get away with such conduct in large organizations, negative politics in small organizations are easily detectable and punishable.
Another problem associated with diseconomies of scale is the loss of effective control of company functions. Opportunistic employees and company managers can exploit information asymmetries in large organizations to fulfil self-interests. This conflict of interest inhibits the achievement of company targets. Employee effectiveness drops as the company hierarchy becomes elongated. Employee input also becomes minimal as employees do not offer their best. This low employee input can be attributed to limited information flow as well as low employee morale since the employees are not sufficiently motivated.
Another managerial problem faced by large organizations is the duplication of effort. A large organization that has thousands of employees may end up having many employees that perform similar functions. General Motors, for instance, created identical graphic systems separately which it later synchronized into a unified graphic system, but at a very high budget that could have been avoided in the first place. It is common for large organizations to develop similar parallel programs due to lack of collaboration between departments.
Another problem faced by large organizations is cannibalization where a company may have to compete with its own products. Cannibalization is often caused by a company introducing multiple identical products that create unnecessary competition in the market. Similar competition can be observed between different brands produced under the same organization. This may lead to discontinuation of some of the company products.
Solutions to Diseconomies of Scale
There are several solutions that can be implemented to counter or minimize diseconomies of scale that many large companies face. Diseconomies of scale can be overcome without necessarily applying radical changes to the management practices of the organization. For instance, a company can use its human resource department to enhance the recruitment and retention of the most productive personnel. The human resource function of an organization can assist in the promotion of the company goals, which can in turn reduce the managerial diseconomies of scale.
A company can also execute a performance reward scheme that recognizes employee contributions towards achieving company goals and rewards the employees accordingly. This helps reduce managerial diseconomies by boosting employee morale and commitment to the organization’s objectives. Monetary motivations provided to employees can motivate productivity and lead to better work relations.
In addition, firms can outsource some of their functions. For instance, outsourcing the human resource function allows the organization to acquire the most competent employees in the field. This allows the company to reduce costs and enhance efficiency.
An alternative approach to overcoming diseconomies of scale involves the application of radical alterations to company functions. For example, the company can fragment itself into autonomous decentralized units. These units can operate independently of the mother company with their own management who are directly responsible for the units’ decision-making processes. The local management can be made responsible for certain functions like hiring, promotions, salaries, and termination of employee contracts. Other decisions such as setting of prices and marketing of different products can also be delegated to the autonomous units.
However, this disintegration of the company into units can lead to company reorganization and dismissal of employees at the company headquarters. Therefore, the company needs to weigh between the eminent costs of reorganization and the managerial benefits of decentralization.
The company can also adopt franchising as a way of eliminating diseconomies of scale (Wilkinson 231). Franchising enables big companies to realize the managerial benefits associated with small companies while still enjoying the advantages associated with economies of scale. A company that adopts franchising can promote its local presence in the market by branding itself as a local company and considering local customer demands in its operations.
An alternative strategy to franchising is working in collaboration with company employees, which enables the organization’s managers to adopt self-determination and become more success oriented. When an organization’s employees feel like they are in partnership with the company, they are likely to be motivated and committed to the organization’s success and purpose. Employee partnership can be achieved by encouraging employees to purchase shares in the company.
It is evident that aggressive growth campaigns can cause economies and diseconomies of scale. Though economic expansion exposes the company to a broad market base, such expansion poses many managerial challenges. The diseconomies of scale impede company profitability and employee efficiency. These challenges are company-specific and should be dealt with in line with organizational goals. The good news is that these diseconomies of scale can be resolved. Solutions to diseconomies of scale should involve company employees so as to boost employee morale and output. Such solutions include franchising, employee partnership, application of radical changes, and employee reward schemes.
Boyes, William. Managerial Economics: Markets and the Firm, USA: Cengage Learning, 2011. Print.
Kaplan, Sarah and Rebecca Henderson. “Inertia and Incentives: Bridging Organizational Economics and Organizational Theory.” Organization Science 16.5 (2005): 509-521. Print.
Png, Ivan. Managerial Economics, USA: Routledge, 2013. Print.
Sloman, John. Economics, UK: Pearson Education, 2006. Print.
Wilkinson, Nick. Managerial Economics: A Problem-solving Approach, UK: Cambridge University Press, 2005. Print.