Economies and Diseconomies of Scale
The concept of economies of scale is well known: As product volumes increase, the average cost per unit decreases. This concept can be related to a best operating level for a given plant size. As shown in Exhibit 7.6, economies of scale' (as well as diseconomies of scale) are found not just between the cost curves for each plant, but within each one as well Exhibit 7.6 also shows the best operating levels, VA, VB, Vc, and VD, for-plant sizes
A, B. C. and D. respectively. Economies of scale occur for several reasons. As volumes increase fixed costs are spread out over a greater number of units, thereby reducing the
amount of overhead that is allocated to each product. With large volumes, a firm also can
take advantage of quantity discounts, thereby reducing material costs. Scale factors, which are associated with larger facilities, are a third source of economies of scale. For example, with processing operations such as breweries and refineries, doubling the capacity of facility increases its costs by about 40 percent, which reflects the ratio of change in the volume in a cylinder or pipe to its outside area (in other words in to double the volume through a pipe requires about 141 percent more material for the larger pipe) diseconomies of scale also can occur for several reasons. When the best operating level in a plant is exceeded, additional costs are incurred. These added costs can take the form of overtime, inefficient scheduling, and machine breakdowns resulting from a lack of time to perform preventive maintenance. Diseconomies of scale also can occur with larger plants. as indicated by Plant D in Exhibit 7.6. This could be due to an inability to efficiently coordinate material flows and schedule workers. Organizational factors also can contribute to diseconomies of scale. With larger facilities, the contribution of each individual is diminished. Management and workers become more segregated and communicate less with each other. In operations that have a labor union, for example, grievances per 100 employees tend to increase in relation to the size of the plant. Although finding the best size and operating level is illusive, managers often set policies regarding the maximum size for anyone facility. As a result, the real challenge is
predicting how costs will change for different output rates and facility sizes This assessment requires careful attention to the different causes of economies of scale for each situation.
In the past several years, we have begun to see that diseconomies of scale come much sooner than we previously anticipated This recognition along with technological capability to do more in a plant, has resulted in a shift toward mall facilities The steel industry, with its declining number of large, integrated plants and its corresponding shift toward minimills is a well-known case in point.