When a company can spread out its costs for factories, equipment and labor over more units of output, the average cost of producing each additional unit goes down -- and profits may go up. The theory behind economies of scale is sound. However, if the opposite starts to occur, it means the company has negated any advantage it gained by increasing the scale of its operations. A number of things can lead to such diseconomies of scale.
Too Big to Succeed
Companies can easily get caught up in trying to take advantage of economies of scale, but doing so can result in the creation of corporate bureaucracies that slowly, often insidiously, become cost ineffective. As financier T. Boone Pickens famously noted, "Most corporate bureaucracies have more people than they have work." Diseconomies of scale will eventually show up in a company's financial analysis, so it's not hard to detect. But once it's discovered, changing course is often daunting. Corporate monoliths, not unlike the Queen Mary, can't turn on a dime.
Complexity Killed the Cat
Projections of continued growth based on the assumption that a company will continue to benefit from economies of scale are often faulty. It's more satisfying to grow rather than shrink, to hire rather than fire, and to make capital investments rather than make better use of the capital a company already has. But greater scale brings with it the costs of increased complexity.
Lack of Coordination
As a company grows, decision making tends to become less centralized. The risk here is the emergence of fiefdoms with leaders often more concerned about protecting their own turf than supporting the company's broader strategic vision. To keep all the decision makers on the same page, many companies develop matrix reporting structures, which in theory can improve coordination, but which also can lead to increased complexity and its associated costs.
Perhaps the biggest problem that results when a company grows too big is poor communication. Communicating effectively is not easy, even face to face. Even in an era of instantaneous mass communication, employees, suppliers and customers often fail to speak clearly and concisely.
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