Diseconomies of Scale

In the 1940s, Anur-an Be-ven took the stand against Winston Churchill. 

The two political heavyweights were about to lock horns over the UK’s healthcare system.

Beven argued for the government provision of healthcare, a National Health Service – funded by the taxpayers and free for all to use. Healthcare, he argued, was a basic human right – everyone should have access, regardless of wealth or status.

Churchill frowned. It was a nice idea, he said, but utterly insane: free healthcare for everyone in the UK would cost billions! How on earth would we ever find the money?

The audience reluctantly agreed – a national health service was an elegant idea, but an expensive impossibility.

Beven, of course, had anticipated Churchill’s response. 

And fortunately, economics was on his side!

He explained how by exploiting internal economies of scale, a vast national health service could operate at incredibly low average costs.

The NHS could use purchasing economies to bulk-buy medical supplies at cheaper rates. It could use managerial economies to hire specialist accountancy and operations managers, boosting productivity and reducing costs further. And it could use technical economies to install high-tech equipment, to increase efficiency and make the NHS affordable.

Beven’s economic arguments were compelling, even Churchill agreed – and so the NHS was born.

2000 hospitals were constructed across the UK, each employing dozens of nurses and doctors. Beven’s plan to use internal economies of scale was working: as the NHS expanded, its long run average costs fell, free healthcare was now available to everyone and at little cost to the taxpayer.

But recently, the NHS has come under attack. As it’s continued to expand, long-run average costs have slowly crept upwards.

The NHS is now experiencing internal diseconomies of scale, when an organisation expands too much and its long-run average costs start to increase.

And there are three main reasons for internal diseconomies of scale, A B and C: 

• Alienation
• Bureaucracy 
• And Communication 

ABC, the internal diseconomies of scale!

Let’s start with A for alienation! 

At large call centres, employees are trapped in a small isolated cubicle, lost in a vast grey office space – they’re alienated from their co-workers, which decreases their motivation. 

Alienation reduces employee motivation, ruining their productivity and increasing firms’ long run average costs. 

Our next internal diseconomy is B for Bureaucracy:  

As firms expand, they have to hire more managers to supervise staff, fill out more forms to keep track of people’s work, and then employ more secretaries to help with all the filing! 

It’s estimated that over £21bn of the NHS budget is currently spent on this sort of bureaucracy, increasing the NHS’s long run average costs! 

So bureaucracy is our second internal diseconomy. 

And finally, we have C for communication! 

When firms get really big, communication can really slow down.

In big firms, like Tesco, communication is very slow: if a Tesco employee wants to send a message to his executive manager, he’ll have to go through assistants, secretaries, junior managers, senior managers…and only then will the executive manager hear his message! 

This sort of slow communication wastes precious time in a business, reducing productivity and again increasing long run average costs.

Which makes slow communication our final internal diseconomy.

When a firm expands too much and its LRAC start to rise, the firm is experiencing internal diseconomies of scale.

Remember your internal diseconomies as A, B, C. 

A for Alienation is when workers feel lost and disconnected at work. Like an employee at a massive call centre. The result is demotivation, which reduces productivity and increases LRAC. 

B for Bureaucracy is all the paperwork, managers, filing and secretaries that a firm has to pay for when it gets really big – which will of course drive up LRAC.

And finally there’s C for communication. Communication is really slow in big firms because it takes so long to send messages through a giant company. 

Slow communication will reduce productivity, and once again increase LRAC.

So those are three main reasons for diseconomies of scale! Easy as A B C.