Diseconomies of Scale

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From the Wikipedia:

"Diseconomies of scale are the forces that cause larger firms to produce goods and services at increased per-unit costs. They are less well known than what economists have long understood as "economies of scale", the forces which enable larger firms to produce goods and services at reduced per-unit costs." (http://en.wikipedia.org/wiki/Diseconomies_of_scale)


Hierarchies don't bring economies of scale

Dave Pollard:

"It is because business and government systems are wedded to the orthodoxy of hierarchy that as they become larger and larger (which such systems tend to do) they become more and more dysfunctional. Simply put, complicated hierarchical systems don’t scale. That is why we have runaway bureaucracy, governments that everyone hates, and the massive, bloated and inept Department of Homeland Security.

But, you say, what about “economies of scale”? Why are we constantly merging municipalities and countries and corporations together into larger and ever-more-efficient megaliths? Why is the mantra of business “bigger is better”?

The simple answer is that there are no economies of scale. In fact, there are inherent diseconomies of scale in complicated systems. When you double the number of nodes (people, departments, companies, locations or whatever) in a complicated system you quadruple the number of connections between them that have to be managed. And each “connection” between people in an organization has a number of ‘costly’ attributes: information exchange (“know-what”), training (“know-how”), relationships (“know-who”), collaboration/coordination, and decision-making. That is why large corporations have to establish command-and-control structures that discourage or prohibit connection between people working at the same level of the hierarchy, and between people working in different departments.

Why do we continue to believe such economies of scale exist? The illustration above shows what appears to happen when an organization becomes a hierarchy. In the top drawing, two 5-person organizations with 10 people between them have a total of 20 connections between them. But if they go hierarchical, the total number of connections to be ‘managed’ drops from 20 to 8. Similarly, a 10-person co-op has a total of 45 connections to ‘manage’, but if it goes hierarchical, this number drops to just 9.

This is clearly ‘efficient’, but it is highly ineffective. The drop in connections means less exchange of useful information peer-to-peer and cross-department, less peer and cross-functional learning, less knowledge of who does what well, less trust, less collaboration, less informed decision-making, less creative improvisation, and, as the number of layers in the hierarchy increases, more chance of communication errors and gaps.

Nevertheless, this is considered a fair and necessary trade-off. The 10-person co-op organization in this illustration is already starting to look unwieldy, so imagine what it would look like with 100 people (thousands of connections) or 10,000 people (millions of connections). By contrast, the hierarchical organization that combines 2 five-person companies only increases its number of connections from 8 to 9 (and perhaps even fewer if some ‘redundant’ employees are let go after consolidation). With similar control spans a hierarchical organization of 100 or 10,000 people only needs an average of one or two connections per employee, a fraction of what the non-hierarchical organization would seem to need. Isn’t this apparent efficiency advantage a worthwhile ‘economy of scale’?

It isn’t, and for the same reasons noted above: as the hierarchy gets larger, the loss in exchange of useful information peer-to-peer and cross-department, the loss in peer and cross-functional learning, the loss of knowledge of who does what well, the loss of trust, the loss of capacity for collaboration, improvisation and innovation, the inability to make informed decisions, and the volume of communication errors and gaps increases exponentially. Beyond about 50 people, the hierarchy begins to get dysfunctional, and much above that (as in most large corporations, government departments, agencies and other organizations) it becomes totally dysfunctional and sclerotic — incapable of change or innovation.

Why do these large organizations seem to be so effective then, at least in the private sector and when measured by market dominance and profitability? There are a number of reasons:

  • As they get larger, their political power rises proportionally, so they can effectively lobby governments worldwide for subsidies, legal protections, preferential treatment, and tax and regulatory changes that give them a huge competitive advantage.
  • As they get larger, they qualify for large volume discounts from suppliers.
  • As they get larger, their power in negotiating with unions and employees grows — they can always threaten to hire new, cheaper employees, contract out, outsource or offshore work (and usually do so)
  • As they get larger, their market presence gets larger, so they don’t have to work so hard to attract new customers or experienced employees
  • As they get larger, they can afford to buy up, intimidate and crush smaller innovative competitors, and by eliminating competition easily increase market share and reduce downward pressure on product prices.

So these so-called “economies of scale” have absolutely nothing to do with efficiency or effectiveness and everything to do with abuse of power. These abuses of power are all “win-lose” — and the losers are taxpayers, ripped-off customers, domestic and third-world citizens and workers, innovation, so-called ‘free’ markets, and our massively-degraded natural environment (which they shrug off as “externalized costs”)." (http://www.resilience.org/stories/2013-05-31/what-if-everything-ran-like-the-internet)

More Information

  1. Study at http://canback.com//archive/jmanec.pdf
  2. Kevin Carson's extensive study on decentralized production focuses on the diseconomies of scale or large corporations.