Problems arising from growth Flashcards
Diseconomies of scale
Occurs if a business expands the scale of its operations further than the minimum efficient scale. This means the long-run average costs rise as output rises.
Sources of diseconomies of scale
There are many reasons why long-run average costs might rise as output is pushed above the minimum efficient scale, they fall into two groups. Internal diseconomies of scale and external diseconomies of scale.
Internal diseconomies of scale
The rising costs caused by excessive growth in the business. Mainly caused by the problems of managing very large organisations such as:
Poor communication- the flow of information between individual employees and departments or between head office and subsidiaries become difficult. This is due to the long chain of command. Both internal and external communication can be affected and sometimes they could lose touch with customers.
Control and co-ordination- with thousands of employees, large amount of resources and many operational locations around the world they require added responsibility and supervision. This means they have to employ a large number of supervisors and managers to maintain adequate control which results in higher costs.
Poor work motivation- with the large amount of employees, individual employees may feel unimportant. Managers may lose touch with the needs of employees and this can lead to high turn over rates.
Technical diseconomies- plants, machinery and equipment will usually have an optimum (most efficient) capacity. If these resources are overused they are likely to become inefficient (break). This can lead to a fall in output and a rise in costs to repair the equipment.
Bureaucracy- if a business become too bureaucratic it means that too many resources are being used up in administration. Decisions made by executives may take too long to communicated due to long organisational structure.
External diseconomies of scale
Occurs when an industry grows too big instead of the individual firm
Rapid growth in an industry can lead in a sharp rise in price of production factors, which means higher costs of production. This is due to the growing demand.
Rising labour costs may increase as output falls due to higher wages.
External diseconomies of scale are more likely to increase when an industry grows in the same geographical region. The price of land, labour, services and materials might rise ad firms compete with each other for a limited amount of resources.
Traffic in the area might lead to inefficiency such as delayed deliveries, employees late to work.
Internal communication
As a result of the long organisational structures, channels of communication get longer and the scope for error in in sharing messages in increases.
These distortions to informations could lead to arguments and misunderstandings between workers and managers, and this can lead to a waste of resources and in turn higher costs. This also reduces productivity.
Miscommunication mean competition will have negative effects. Firms may adopt a ‘silo mentality’ where they are reluctant to share information with other organisations, which could lead to missed opportunities and higher costs.
Overtrading
When a business does not have enough cash to support its production and sales, usually because it is growing too fast.
Young, rapidly growing businesses are more vulnerable to this.
Most likely to occur if a business is:
Overcapitalised- means they do not have enough cash to buy the resourced needed to meet the growing orders
Offers too much trade credit to customers- they will have to wait a long or more to be paid. They will be short in cash to buy resources
Operating with small profit margins- a new business may start with lower prices to make an impact in the market, but with lower prices it may not produce enough profit to fund the growing volume of the business
