Diseconomies of Distribution

Generally, the bigger a processing facility, the larger the geographic area it has to service. Moreover, if the density of its customers decreases rapidly as their distance from the facility increases the distribution costs required to supply an expanding region will probably increase much faster than the sales volume. Even in cases where the company does not incur the transportation costs directly, it may have to pay freight equalization or customer transport charges to prevent competitors nearer the customer from gaining a cost advantage.

The same type of distribution diseconomies may affect the demand for a firm’s products in situations where the response time to customer requests for service or assistance is critical to success. If customers are located with constant density in a given geographic area, it can be shown that the average distance between a facility and a customer is inversely proportional to the square root of the number of facilities in the area. This relationship has been used to estimate, for example, the optimum number of fire houses or schools in an urban environment. Therefore, fewer large plants may both increase the transport costs associated with servicing distant customers and reduce a firm’s total sales because its customers prefer the faster service provided by a nearby competitor.

If a product’s transportation cost is very high in comparison with its sales price, however, (examples include bricks, cement, and manufactured housing), companies may be constrained to a rather small geographic market area. Although this prevents them from fully exploiting scale economies, they may be almost invulnerable to the attacks of competitors who are located outside their home market. Should a competitor choose to locate a new plant in that market, and there are pronounced economies of scale in facility construction or operation, the costs of the two competitors may actually be higher than those of the original producer when it alone served that market. This is because each of them would now operate at a lower and less efficient volume than did the former company by itself.

Different economies and diseconomies of scale can operate within the same company, and their effects must be considered separately.

As the scale of a facility increases, generally so does the workplace required to operate it. The larger the workforce, the more supervisors, coordinates, and managers are required. Since managers usually feel that the number of people reporting to them (often referred to as their span of control) ought to be less than some maximum number (generally ten to twenty) organizations tend to grow like pyramids: as the base of pyramid representing the number of operators) grows, so does the number of layers of management – each of which usually requires its own retinue of secretaries and assistants. Whereas a 200 person workforce would normally have at most three organizational levels above the operating level (supervisors, department heads, and the facility manager), a 2,000 person workforce typically has four or five levels.  As the number of layers in the management hierarchy grows, communication and coordination become more difficult, so additional support personnel are required

The results are predicable: management costs increase; the organization’s response time (to both external forces and internal crises) deteriorates; and people on the plant floor – the base upon which the pyramid rests – lose their sense of identity  and personal loyalty both to each other and to the firm as a whole. It becomes increasingly likely that the information filtering up or down   through the organization gets lost or distorted. Worse, first level supervisors (on whom the operators depend for direction and support) tend to lose some of their credibility and authority if they are constrained by incorrect or incomplete information.

Another danger arises when the number of people working in a facility becomes large relative to the population in its immediate region. As a community becomes more and more dependent on a single facility or company, it tends to become more concerned about that facility’s activities. Often this growing sense of dependence can lead to attempts to become more involved in decisions involving the facility. Eventually this process can lead to open hostility.

The end result is that large facilities tend to attract successful unionization efforts (which have the effect of adding another bureaucracy to the organization) as well as increased public scrutiny. There is some evidence that the frequency of labour disputes also goes up. As a result, many companies cap the number of people that can be employed at each of their facilities – limiting it, say to 3 to 4 per cent of the working population within a twenty mile commuting distance.