This document discusses economies and diseconomies of scale. It explains that economies of scale are factors that cause average unit costs to fall as output increases, while diseconomies of scale cause average costs to rise with increased output. The document provides examples of economies of scale like bulk buying and technical efficiencies. It also discusses potential diseconomies like poor employee motivation, communication, and managerial coordination issues that can arise in large firms. Overall, it analyzes how both economies and diseconomies can impact costs as businesses grow.

1. ECONOMIES AND DISECONOMIES OF SCALE
Economies of scale are factors which cause average unit costs to fall as the scale of output
increases. Diseconomies of scale are factors causing average costs to rise as the scale of output
increases.
Internal growth occurs when a firm expands its own sales and output. Firms growing in this manner
must invest in new machinery and usually take on extra labour too. Firms that are successful in
achieving internal growth have to be competitive. Companies like Sony have grown rapidly by taking
market share from their less efficient competitors.
External growth is created by takeover and merger activity. Recently the German car manufacturer
BMW bought a controlling stake in Rover. By doing this BMW grew overnight. Rover’s output
produced in its own factories now belonged to Rover’s new owner, BMW.
The trend towards increased industrial concentration has been largely due to external growth. There
are many different reasons why firms may wish to grow by takeover or merger. One of the most
significant is that many managers believe growth will create cost savings for their firms. They
anticipate benefiting from economies of scale. Unfortunately, this is not always true. Many mergers
and takeovers actually reduce efficiency. Any economies of scale prove to be outweighed by
diseconomies. Research has shown consistently that, on average, takeovers and mergers fail to
improve efficiency.
When a firm grows there are some things it can do more efficiently. The group term given to these
factors is ‘economies of scale’. When firms experience economies of scale their unit
costs fall. For example, a pottery which could produce 100 vases at £5 each produces 1,000
vases at £4.50 per unit. The total cost rises (from £500 to £4,500) but the cost per unit
falls.
Assuming the firm sells the vases for £6 each, the profit margin rises from £1 per vase to
£1.50.
Economies of scale are, in effect, the benefits of being big. Therefore, for small firms, they represent
a threat. If a large-scale producer of televisions can sell them for £99 and still make a profit,
there may be no chance for the small guy.
There are five main economies of scale. These are discussed below.
BULK-BUYING ECONOMIES
As a firm grows larger it will have to order more raw materials and components. This is likely to
mean an increase in the average order size the firm places with its suppliers. Large orders are more
profitable to the supplier. Both the buyer and the potential suppliers are aware of this.
Consequently, firms who can place large orders have significant market power. The larger the order
the larger the opportunity cost of losing it. Therefore the supplier has a big incentive to offer a
discount. Big multinational manufacturers like Volkswagen have been relentless in demanding larger
discounts from their component suppliers. This has helped Volkswagen reduce its variable costs per
car.

2. TECHNICAL ECONOMIES
When supplying a product or service there is usually more than one production method that could be
used. As a firm grows it will usually have a greater desire and a greater ability to invest in new
technology. Using more machinery and less labour will usually generate cost savings. Second, the
new machinery may well be less wasteful. Reducing the quantity of raw materials being wasted will
cut the firm’s variable costs.
These cost savings may not be available to smaller firms. They may lack the financial resources
required to purchase the machinery. Even if the firm did have the money it may still not invest.
Technology only becomes viable to use if the firm has a long enough production run to spread out
the fixed costs of the equipment. For example, a small company may wish to buy a new computer. As
the firm is small it may end up using it for only two days a week. The total cost of the computer will
be the same whether the firm uses it one day or five days per week. So the average cost of each job
done will be high as the small firm is unable to make full use of its investment. Capital investment
becomes more viable as a firm grows because capital costs per unit fall as usage rises.
MANAGERIAL ECONOMIES
When firms grow there is greater potential for managers to specialise in particular tasks. For
instance, large firms will probably have enough specialised personnel work to warrant employing a
full-time personnel specialist. In many small firms the owner has to make numerous decisions, some
of which he or she may have little knowledge of, for example accounting. This means the quality of
decision making in large firms could be better than in small firms. If fewer mistakes are made, large
firms should gain a cost advantage.
FINANCIAL ECONOMIES
Many small firms find it difficult to obtain finance. Even if banks are willing to lend they will tend to
charge very high rates of interest. This is because logic and experience shows that lending to small
(especially new) firms is more risky. They are more likely to go into liquidation than large firms.
There are two main reasons for this:
Successful small firms grow into large firms. Consequently, large firms tend to have more
established products and have experienced teams of managers.
Small firms are often over-reliant on one product or one customer; larger firms’ risks are
more widely spread.
The result of all this is that large firms find it far easier to find potential lenders. Second, they also
pay lower rates of interest.
GLOBAL FINANCE
In the car component industry, supply is dominated by a small number of multi-billion dollar
turnover organisations. Firms like Bosch, Lear and Varity need the financial resources to operate
globally. They also have to have the massive sums of finance needed to pay for the design,
development and production of new components. In today’s global market, access to finance
can be the difference between success and failure.
MARKETING ECONOMIES

3. Every aspect of marketing is expensive. Probably the most expensive, though, is the salesforce.
These are the people who visit wholesale and retail outlets to try to persuade them to stock the
firm’s goods. To cover the country, nothing less than six sales staff would be realistic. Yet
that would cost a firm around £200,000 per year. For a small firm with sales of under £1
million a year, this would be a crippling cost. Larger firms can spread the costs over multi-million
sales, cutting the costs per unit.
BUSINESS CONCENTRATION
In May 1988 the world’s largest industrial merger was announced between Mercedes and
Chrysler.
But how important is scale? Does the biggest firm have such an advantage that others can never
catch up? By no means. J&P Coats was once Britain’s largest manufacturing company. Today
it forms one small part of a medium-sized business. Looking at it the other way, today’s
monster companies include many that were small or did not even exist 30 years ago. These include
Microsoft, Intel, Philip Morris (Marlboro) and Toyota.
It is not even true to say that large firms are taking a larger share of national output. The heyday of
large firms was in the 1970s, as the table shows:
PERCENTAGE SHARE OF MANUFACTURING OUTPUT BY THE LARGEST 100 MANUFACTURERS
1918 1970 1990
US 2% 33% 33%
Japan 23% 22% 21%
Germany 17% 30% 23%
UK 17% 40% 36%
The point is, therefore, that despite the apparent benefits from economies of scale, very large firms
have no guarantee of permanent success. They often became the biggest due to mergers or
takeovers, and can shrink again when managerial problems become overwhelming.
Size matters, but size is no guarantee of success.
Apart from achieving cost-reducing economies of scale there are some other benefits attached to
size.
REDUCED RISK
If a firm grows by diversifying into new markets the firm will now be less dependent on one product.
A recession might cause sales in one area of a business to fall. However, if the firm also
manufactures products which sell strongly in recessions, the overall turnover of the organisation
may change little. In recent years a high percentage of takeovers and mergers have involved firms
operating in totally different industries. When Volvo bought out Procordia, a firm in the processed
food business, Volvo was seeking a wider product base. This helps the company avoid the risk
inherent in ‘having all your eggs in one basket’.

4. INCREASED CAPACITY UTILISATION
Some firms may wish to grow in order to increase their capacity utilisation. Capacity utilisation
measures the firm’s current output as a percentage of the maximum the firm can produce.
Increasing capacity utilisation will spread the fixed costs over more units of output. This lowers the
total cost per unit.
When firms grow, costs rise. But why should costs per unit rise? This is because growth can also
create diseconomies of scale. Diseconomies of scale are factors that tend to push unit costs up.
Large organisations face three main types of diseconomy of scale.
POOR EMPLOYEE MOTIVATION
When firms grow, staff may have less personal contact with management. In large organisations
there is often a sense of alienation. If staff believe that their efforts are going unnoticed a sense of
despondency may spread. According to the motivation theorist Elton Mayo, employees enjoy working
for managers who pay an interest in them as individuals. This is the so-called ‘Hawthorne
effect’. In large firms some managers may feel they do not have sufficient time for frequent
informal chats with their staff. Professor Herzberg also believes that recognition for achievement is
vital for employee motivation. If managers do not take this into account the likelihood is that staff
motivation will fall. A falling level of work effort will increase the firm’s costs. Poor
motivation will make staff work less hard when they are actually at work. Absenteeism is also a
consequence of poor motivation. This means that the firm may have to employ more staff to cover for
the staff they expect to be absent on any given day. In both cases output per worker will fall. As a
result, labour costs per unit will rise.
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Northants centred Search engine ranking optimization enterprise Tonyp.co.uk commenced an
investigation on leaflet marketing and advertising.
The fundamental components of creating a successful and worthwhile leaflet and/or flyer marketing
campaign.
Laying the foundation: All things considered, an effective leaflet or brochure does a number of tasks:
compel the householder's curiosity, and ask the receiver of the promotional media to visit your
repair shop or phone you and so on.
Photos, colours and content: Concerning design, it’s much better to use a more conservative
tactic regarding printed media. Countless colors and written messages can dilute the major brand
information. If you require something bold, think of a inciteful motto but keep the other content
easy-to-read, uncomplicated, and most of all to the point.
Overal size: When considering the actual size of the leaflet or brochure, give thought to your
distribution approach. When it comes to pamphlets which are given out individually by promo staff,
for instance, A6 paper size is typically a popular choice as it is sufficiently small for the individual to
place in their handbag or wallet. They also tend to be thicker, and printed on high shine paper.
Pamphlets or flyers that are sent in the post obtain the maximum engagement rate if distributed
within newspapers. This can be an ideal strategy to check out client base feedback for your
marketing. A lot of flyers and leaflets are printed using lighter in weight less expensive paper
weight, using a silky finish giving a top notch look.

5. The tone: Keep the wording in clear language and response driven.
The distribution: When being familiar with the current market well, it's possible to figure out the
best possible logistics strategy for your printed material. There are a lot of options to consider: you
may choose to distribute them on their own, inserted in a newspaper, to passer’s-by on the
street, on cars or door-to-door.
Overseeing feedback: Promo offers that are leaflet focused should be efficient in keeping track of the
reaction to and subsequent outcomes of your marketing strategy and are a great option to bring
forth engagement. A small firm will not lose money and may get results as a result of extra business
when your recipients act on it. Obviously if you are aiming to reduce expenses yet ensure you get
your information out to all your market, leaflets are the ideal business strategy. If full colour leaflets
are to be a vital element of your promotions project, then you should also take into consideration
dispersal on a regular basis.
POOR COMMUNICATION
Communication can be a significant problem when a firm grows. First, effective communication is
dependent on high levels of motivation. Communication is only effective if the person being
communicated with is willing to listen. If growth has left the workforce with a feeling of alienation,
communication can deteriorate alongside productivity. A second reason for poor communication in
large organisations is that the methods chosen to communicate may be less effective. As a firm
grows it may become necessary to use written forms of communication more frequently. Unlike
verbal communication, written communication is less personal and therefore less motivating.
Written messages are easier to ignore and provide less feedback. Relying too much on written forms
of communication could result in an increase in the number of expensive mistakes being made.
POOR MANAGERIAL COORDINATION
In a small firm coordination is easy. The boss decides what the goals are, and who is doing what. As
firms grow, it becomes harder for the person at the top to control and coordinate effectively. The
leader who refuses to delegate ‘drowns’ under the weight of work. The leader who
delegates finds (later) that manager A is heading in a slightly different direction from manager B.
Regular meetings are arranged to try to keep everyone focused on the same goals through the same
strategy. But not only are such meetings expensive, they are also rather ineffective. Coordination is
effective and free in a small firm, expensive and hugely ineffective in large corporations.
It is important to realise that growth normally creates both economies and diseconomies of scale. If
growth creates more economies than diseconomies then unit costs will fall. On the other hand, if the
growth creates more diseconomies, the opposite will happen.
Normally, when a firm is small, initial bouts of growth will create more economies of scale than
diseconomies. So growth pushes average costs down.
WHAT CAN MANAGERS DO ABOUT DISECONOMIES OF SCALE?
Diseconomies of scale are to a certain extent inevitable. However, this does not mean that managers
should just accept them. With careful planning, many diseconomies may be minimised or avoided
completely. They key point is that diseconomies are more likely to arise either when growth is
unplanned or when it is too rapid. When a firm embarks on a programme of growth it is vital that
managers recognise the need to change and adapt.

6. Analysis
Economies of scale is a concept used frequently by students in examinations. When using it to
analyse a business situation, the following points should be considered:
In most business circumstances, a rise in demand cuts average costs because of improved capacity
utilisation. In other words, if a half-used factory gets a big order, unit costs fall because the fixed
overheads are spread over more output. This is great, but should not be referred to as an economy
of scale. It is simply an increase in capacity utilisation. The term ‘economies of scale’
refers to increases in the scale of operation, e.g. when a firm moves to new, bigger premises.
The cost advantages from bulk buying can be considerable, but are often exaggerated. A medium
sized builder can buy bricks at much the same cost per brick as a multinational construction
company. It should also be remembered that materials and components form quite a low proportion
of the total costs for many products. For cosmetics or pharmaceuticals, bought-in materials would
usually cost less than one-tenth of the selling price of the product. So lively minds dreaming up new
products will count for far more than minor savings from bulk buying.
Traditionally, managers of growing or merging companies have tended to predict economies of scale
with confidence, but to turn a blind eye to diseconomies. In the medium to long term, though,
managerial problems of coping with huge organisations have tended to create more diseconomies
than economies of scale.
CAPACITY – the maximum output possible from a business over a specified period of time.
CAPACITY UTILISATION – actual output as a proportion of maximum capacity.
CAPITAL INVESTMENT – expenditure on fixed assets such as machinery.
DELEGATE – hand power down the hierarchy to junior managers or workers.
THEORY X – Douglas McGregor’s category for managers who think of workers as lazy
and money-focused.
Three important issues should be considered:
If diseconomies are all people problems, why can’t they be better managed? Most
diseconomies of scale are caused by an inability to manage people effectively. When firms grow
managers must be willing to delegate power in an attempt to avoid the problems caused by
alienation. Some types of manager might find it hard to accept the need for delegation. If the
manager has strong status needs and has Theory X attitudes, he or she may find it difficult to cope.
Enriching jobs and running training courses are expensive in the short term. These costs are also
easy to quantify financially. The benefits of job enrichment and training are more long term. Second,
they are harder to quantify financially. This means that it can be quite hard for the managers of a
company to push through the changes required to minimise the damage created by diseconomies of
scale. Public limited companies may find this a particular problem. Their shares can be bought freely
and sold on the stock market. This means that con- siderable pressure is put on the managers to
achieve consistently good financial results. The penalty for investing too much in any one year could
be a falling share price and an increased risk of takeover. Do economies of scale make it impossible
for small firms to survive?

7. In highly competitive markets it is difficult for small firms to compete with large established
businesses. Especially if they try to compete with them in the mass market. In this situation the
small firm will lose out nine times out of ten. The small firm will not be able to achieve the same
economies of scale. As a result, its prices will have to be higher to compensate for its higher costs.
To a degree this view is correct. However, the fact that the majority of firms within the economy
have less than 200 employees proves that small firms do find ways of surviving, despite the
existence of economies of scale.
The importance of being unimportant.
Many small firms do not need economies of scale to survive. They rely upon the fact that they do not
compete head on with their larger competitors. Small firms often produce a highly specialised
product. These products are well differentiated. This means the small firm can charge higher prices.
So even though they have higher costs their profit margins can be healthy. The larger firms in the
industry are frequently not interested in launching their own specialist products. They believe there
is more money to be made from the much larger mass market. By operating in these smaller so-called
niche markets, many small firms not only survive but often prosper. By being small and by
operating in tiny market segments they are not seen as a threat to the larger firms. As a
consequence they are ignored because large firms see them as unimportant.