Internal Diseconomies of Scale occur when a firm expands beyond its optimal scale of production. This can lead to rising average costs as variable costs outweigh falling fixed costs. There are also management diseconomies that can occur in large firms, including communication difficulties, slow decision-making, bureaucracy, and information overload for managers. Small firms are able to survive despite potential economies of scale for large firms by focusing on niche markets, providing personalized service, flexibility to changing markets, and through collective marketing and buying arrangements that provide scale advantages. Franchising also allows small operators to benefit from size advantages through support from larger franchisers.

1. Internal Diseconomies of Scale
By
Naeem Akram
Noor College of Business & Sciences

2. Diseconomies of Scale
The word diseconomies refers to all those losses
which accrue to the firm in the industry due to the
expansion of their output beyond a certain limit.
Economic theory predicts that a firm may become
less efficient if it becomes too large. The additional
costs of becoming too large are called
diseconomies of scale.

3. Diseconomies of Scale
Diseconomies of scale result in rising long run average
costs which are experienced when a firm expands
beyond its optimum scale, at Q.

4. Examples of Diseconomies of scale

5. Why it happens?
We have seen that increasing output will, at some
point, cause the firm's average cost to start to rise.
 This is because variable costs will outweigh the
effect of falling fixed costs.
Note that the firm can go on producing well
beyond its optimal scale so long as price covers
cost.
Even if the price remains fixed, it pays the firm to
go on adding capacity –all that happens is that
profit per unit decreases.

6. Reasons of diseconomies of scale
However, this is not the only factor causing costs to
rise after the firm has grown beyond its optimum size.
There are a number of disadvantages to large
organisations, principally in terms of management
diseconomies.
These include:
1. Communication difficulties caused by longer chains
of command
2. Delays in responding to market changes because of
slow decision-making processes and the need to
consult

7. Reasons of diseconomies of scale
3. Bureaucracy, which results in excessive
administration costs
4. Poor morale and motivation as people feel that they
do not have a stake in the firm
5. Information overload for managers, who cannot
absorb enough detail to make informed decisions.
Large firms can become such heavy users of labour
and raw material supplies that they create shortages
and drive up wages and prices against themselves.
With a large workforce, trade unions may be able to
exert strong influence to achieve wage increases.

8. Reasons of diseconomies of scale
Managers in market dominating firms grant higher
wages easily and accept overmanning because the
costs can be passed on to consumers.
Specialisation means that a small number of workers
become key personnel who are able to disrupt
production –
for example,
a bank’s mainframe
computer operators.

9. Survival of Small Firms
Most firms in industrialised economies are small,
employing fewer than a hundred people, and the
great majority fewer than ten.
Large enterprises exist in those industries where
there are significant economies of scale to be had.
These may be technical, as in electricity generation
which requires large plants, or it may be that there
are significant marketing or buying economies, as
in the case of supermarket chains, where the
individual plant (the shop itself) is relatively small.

10. Survival of Small Firms
The risk-bearing economies may be vital, as in
banking, where a network of small branches operates
to gather up a large-quantity of money in small
amounts to put it to use in diversified loans.
But even where there are significant technical
economies and advantages of size, there are invariably
small firms in the same industry.

11. Small firms do survive
There are various possible reasons why small firms can
and do survive.
1. Many industries do not require the use of much
equipment, so the technical economies are limited
and large firms do not have any significant advantage
–for example, there are few economies of scale in
window cleaning or hairdressing, so the average size
of firms in these sectors is low.
2. The size of the market is limited–for example, it may
be localised as in the case of house repairs and
alterations, so jobbing builders are small firms.

12. Small firms do survive
3. Personal service is important, and this limits the size of
the enterprise so that there are no significant advantages
of large scale production and large chains do not appear –
for example, hairdressers (again) and solicitors.
4. There are frequent changes in the market so the
flexibility and speed of response of small firms makes
them more successful than large ones –for example, in
the fashion industry where small firms are the norm in
the boutique clothing industry.
5. Small firms often fill niches left by large ones which do
not want to take on small scale specialist work –for
example, car makers like Morgan and Reliant serve
markets of no interest to companies like Ford and Fiat.

13. Small firms do survive
6. Individual skills may be of prime importance –for
example in the craft industries. The sole proprietor
in this kind of industry often benefits from collective
marketing at craft fairs and through craft
associations.
7. People simply want to be their own bosses and set up
enterprises where this is possible. Often little capital
is required, as in writing computer software, yet very
large incomes can sometimes be earned, and there is
no great value put on expansion and growth.

14. Growth of Small firms
There are many instances where small firms can flourish
because they get access to facilities and services which
give them the advantages of economies of scale.
Small printing firms can send completed books to
specialist binders which have large capacity machinery.
Industry associations, universities and government
laboratories offer research and development
opportunities to small firms.
Collective marketing and buying provide advantages, for
example in farmers' co-operatives and craft industries.

15. Franchise operator
The individual who wants to set up in business with as
many advantages of size as possible can turn to a
franchise operator.
The franchiser will provide a business plan, specialist
equipment and marketing support, and financial help
and assistance in finding premises are also usually
available.
The franchisee is guaranteed a local market.
There are many franchises on every high street
including McDonalds, The Body Shop, photo
processing and dry cleaning firms.
There are also industrial franchises.

16. Change in technology
As production technology changes towards more and
more assembly of components and as people want
more individual products, small firms are likely to
flourish just as much in manufacturing as they do in
services and retailing.