The possible sources of scale-economies and their respective roles in reducing average cost were explained. But it is also true that there are limits to economies of scale. Any firm that exceeds a certain size realizes that too big a size leads to increase in certain costs.
These costs, arising out of very big size of firm is known as diseconomies of scale. There are several reasons behind diseconomies of scale. Some of the important causes are described below:
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1. Labour Cost:
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Generally in large organisations the labourers are likely to be unionised and the unions, through the process of bargaining, raise wages of the workers. This wage dfferential is certainly a cost for the large firms.
2. Administrative Cost:
When the size of a firm grows beyond a limit, it becomes extremely difficult for the supervisors and managers to coordinate among themselves and to monitor and communicate with the workers. As a result, proper utilisation of labour force and synchronisation of jobs may not be possible, which may invite inefficiency in the production process.
3. Crowding out Effect:
Professional service providers like advertising agencies, consulting firms etc. may experience disadvantags by increasing scale of operation, provided their expertise remains limited to a particular industry which is oligopolistic remains nature.
In oligopoly, success of one firm’s strategy is highly dependent on the counter moves of its rival(s). So, no firm belonging to oligopoly relies on a consultant or an advertising agency, which also helps their rivals.
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Suppose, a consultant gathers experience while working with a soft drink company operating in India. Now, if he plans expansion of business in anticipation of working for the other leading soft drink manufacturer, then it will be a mistake for him, since neither a new soft drink manufacturing company nor his present client (of the same industry) will agree to work with him because both of them will fear leakage of their sensitive information and data.