{"id":157,"date":"2015-05-23T01:53:31","date_gmt":"2015-05-23T01:53:31","guid":{"rendered":"http:\/\/commoncents.blogwyrm.com\/?p=157"},"modified":"2023-05-06T19:01:33","modified_gmt":"2023-05-06T23:01:33","slug":"economies-and-diseconomies-of-scale-part-2-david","status":"publish","type":"post","link":"https:\/\/commoncents.blogwyrm.com\/?p=157","title":{"rendered":"Economies and Diseconomies of Scale \u2013 Part 2 David"},"content":{"rendered":"

The week\u2019s exploration centers on how a small organization or firm can successfully compete with a larger corporation.\u00a0 Three substantial advantages associated with economies of scale naturally fall to a large and established firm.\u00a0 These are ability to amortize sunk costs over a large customer base, the possession of a larger and more specialized workforce, and leverage in buying goods and services.\u00a0 With all these advantages, how can smaller business ever hope to survive let alone compete?\u00a0 And, as a corollary question, how come large firms don\u2019t grow unboundedly?<\/p>\n

The simple answer is that firms also suffer from a host of disadvantages, called diseconomies of scale, that grow larger as the size of the firm goes.\u00a0 Initially, these disadvantages are not active in smaller firms.\u00a0 But at some point, above a critical size, they turn on and begin to offset the economy of scale advantages.<\/p>\n

There are two primary areas where diseconomies of scale present themselves: delegation of authority, span of control, and the principal agent problem; and poor communication, coordination, and standardization.<\/p>\n

Let\u2019s start with the first broad category which covers problems associated with delegation of authority, span of control, and the principal agent problem.\u00a0 Collectively, these problems describe the down side of the principle behind comparative advantage<\/a>.\u00a0 No matter how talented and dedicated the original founders and staff of a firm are, they are limited in the amount they can do based simply on the number of hours in a day.\u00a0 For the firm to grow, additional staff needs to be hired to not only perform the basic functions (manufacturing, delivery of services, etc.) but also manage the growth.<\/p>\n

In this process, a vast amount of control and authority has to be delegated to new staff and this is always accompanied by growing pains.\u00a0 Friction between the old guard and the young turks is natural even under the best of circumstances.\u00a0 When rapid growth occurs in a firm it is usually due to a highly motivated core group (e.g. the owners of the company).\u00a0 These individuals obviously have strong notions about what works and what doesn\u2019t.\u00a0 In addition, they want go-getters just like themselves and they tend to hire people who are just as opinionated and strong willed as they are themselves.\u00a0 I\u2019ve experienced the tremendous clash that happens next.\u00a0 The new blood yells about micromanagement and rigid and inflexible approaches of the existing management, who can\u2019t delegate and reduce their span of control.\u00a0 The original staff can\u2019t understand why there is a sudden rush to change the culture that has been so successful.\u00a0 Harsh words are exchanged, people quit or get fired and, meanwhile, the business of the firm is left fallow.<\/p>\n

As bad as this is, an even worse circumstance occurs when the new blood has designs on the existing corporate structure for their own purposes.\u00a0 They may see a niche area left undeveloped or may want to move the company in a direction more suited to their personal liking.\u00a0 In some cases, they may even be dishonorable people looking to exploit the existing cash cow with some scheme or another.\u00a0 This is the principal-agent problem<\/a>.\u00a0 Central to this situation is a difference in the amount of knowledge the two parties possess.\u00a0 The principal is the term used to describe the existing management\/ownership.\u00a0 In hiring the new staff, which are called the agents, the principal must trust the agent and delegate some ability for the agent to make decisions on behalf of the principal.\u00a0 Both the principal and the agent have their own self-interest, but while the principal has the advantage in authority, the agent has the advantage in terms of information.\u00a0 In all cases, the agent is required to report back to the principal (even if the reporting is a token report) and all agents filter the information at their disposal before sending it on to the principal.\u00a0 The larger the firm the more likely it is that at least one of its agents is using this asymmetry for this own ends at the expense of the firm.<\/p>\n

\"Principal<\/a><\/p>\n

The second broad category of diseconomies of scale includes problems with communication, coordination, and standardization.\u00a0\u00a0 Overall, I tend to refer to these problems collectively as the Dinosaur Problem.\u00a0 The organization in question has the same issues that the Jurassic behemoths had. \u00a0\u00a0Small organizations can comfortably handle peer-to-peer interactions since the number of people involved is relatively small.\u00a0 Once the size exceeds a critical threshold it is more efficient for interactions to happen through a central location, a manager who facilitates the activities of a whole.\u00a0 As the numbers continue to grow more managers come on board and the interaction between them may be handle by peer-to-peer even though the employee interactions are not.\u00a0 At some point, however, the number of managers becomes too large and a new layer of management is conceived and implemented.\u00a0 This layering continues until some point where the right-hand no longer knows what the left hand is doing.<\/p>\n

Along the way, such a firm begins to exhibit all the tell-tale signs of being too large.\u00a0 The implementation of a one-size-fits all strategy to avoid liabilities.\u00a0 Having meetings about how to have meetings or for the sake of having meetings. \u00a0An emphasis on fairness rather than performance and other idiocies to numerous to mention follow.<\/p>\n