Economies or Diseconomies of Scale

The costs of a value activity are often subject to economies or diseconomies of scale. Economies of scale occur from the capability to perform activities differently and more proficiently at larger volume, or from the capability to amortize the cost of intangibles like advertising and R&D over a greater sales volume. Economies of scale can result from efficiencies in the actual operation of an activity at higher scale as well as from less than proportional increases in the infrastructure or overhead needed to support an activity as it grows. In a bauxite mine, for illustration, real mining costs go downward less with scale than do infrastructure costs.

Economies of scale should be clearly distinguished from capacity utilization. Rising capacity utilization spreads the fixed costs of existing facilities and personnel over big volume, whereas economies of scale imply that an activity operating at full capacity is more proficient at larger scale. Mistaking capacity utilization for economies of scale can lead a firm to the false conclusion that its costs will continue to fall if it expands capacity once its existing capacity is full.

Rising complexity and costs of coordination can lead to diseconomies of scale in a value activity as scale rises. Whenever the number of lines in a metal can plant exceeds around 15, for illustration, the complexity of the plant becomes awkward. Increasing scale also sometimes dampens employee motivation and may increase wage or purchased input costs. For illustration, a large plant might have a greater likelihood of unionization or lead to high expectations and larger stridency of union negotiators. Diseconomies of scale in procurement can also take place if large needs meet an inelastic supply, forcing up input prices. Diseconomies of scale emerge to be present in most of the fashion-sensitive industries and professional services that rely heavily on fast response times and creative individuals who do not function fine in large organizations.

The scale sensitivity of activities differs broadly. Value activities like product development, national advertising, and firm infrastructure are usually more scale-sensitive than activities like procurement and sales force operations since their costs are heavily fixed no matter what the firm's scale is. Though, economies (and diseconomies) of scale can be found to some extent in virtually every value activity of a firm.