9.2 - Internal Economies & Diseconomies of Scale
The meaning of scale of operations and factors influencing it
Scale of operations describes the size and scope of a business, distinguishing between small enterprises with limited resources and large organisations with extensive production capabilities and assets.
Factors that influence scale of operations
- Owners' objectives - Some owners prefer to maintain a small business for easier management and control.
- Capital available - Limited funds restrict growth and expansion opportunities.
- Size of the market - A narrow market limits the need for large-scale production.
- Number of competitors - High competition can result in smaller market shares for individual firms.
- Scope for scale economies - Industries with significant cost advantages from large operations, such as utilities, encourage bigger scales.
Increasing the scale of operations
Expanding a business's scale involves long-term growth by increasing all inputs, such as labour, capital, and materials. This process boosts production capacity to meet rising customer demand and take advantage of cost efficiencies associated with larger operations.
Reasons for increasing the scale of operations
- Meeting demand - Growth allows businesses to produce more to satisfy increasing customer needs.
- Gaining competitive advantages - Larger scale can lead to lower costs per unit, improving market position.
- Long-term planning - Expansion requires investing in additional resources over time, rather than short-term adjustments.
Internal economies of scale
Internal economies of scale are cost advantages that arise within a business as it grows, reducing the average cost per unit and potentially making smaller competitors less viable in certain sectors.
Types of internal economies of scale
- Purchasing economies - Large firms secure discounts on bulk orders from suppliers. They often use specialist buyers to negotiate global deals.
- Technical economies - Bigger operations can afford automated production lines and advanced machinery, which lower unit costs due to high output levels. Such equipment is often indivisible, meaning it cannot be scaled down for smaller firms without losing efficiency.
- Financial economies - Larger businesses access loans at lower interest rates from banks, which view them as lower-risk due to established records and diverse products. Issuing shares publicly also spreads fixed costs more effectively over a bigger operation.
- Marketing economies - While marketing expenses increase with size, they do not rise proportionally to sales. Costs of advertising campaigns are distributed across a larger volume of output, reducing the expense per unit.
- Managerial economies - Expanding firms hire specialised managers for specific functions, leading to greater efficiency and fewer errors compared to small businesses relying on generalist staff.
Internal diseconomies of scale
Internal diseconomies of scale occur when a business grows too large, causing average costs per unit to rise due to inefficiencies.
Causes of internal diseconomies of scale
- Communication problems - Feedback between workers and management becomes ineffective. Over-reliance on impersonal methods like emails leads to misunderstandings. Too many messages cause overload and delays. Long chains of command distort information, resulting in poor decisions and higher costs.
- Alienation of the workforce - Employees in large organisations may feel disconnected and unimportant. This demotivation reduces productivity, especially in repetitive production environments. Techniques such as team-based working or job rotation can help address this issue.
- Poor coordination - Complex structures with multiple departments make oversight difficult. Maintaining uniform standards across divisions becomes challenging. Duplication of efforts, such as repeated research, wastes resources and increases overall costs.
Avoiding internal diseconomies of scale
Businesses can implement strategies to prevent or mitigate the rising costs associated with excessive growth, ensuring efficient operations even at a large scale.
Strategies for avoiding internal diseconomies of scale
- Management by objectives - Assigns specific goals to divisions that align with the overall company strategy, helping to maintain coordination and focus.
- Decentralisation - Grants individual units more independence, allowing them to function like smaller entities. Local managers with relevant expertise handle day-to-day control. Central oversight is limited to key strategic matters, though care is needed to prevent conflicting goals between units.
- Reducing diversification - Focuses on core activities to simplify management and avoid coordination issues. This can involve demerging, where parts of the business are split into independent entities, lowering the risk of inefficiencies.
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