This note is a part of my Zettelkasten. What is below might not be complete or accurate. It is also likely to change often.
20th July, 2020

Management costs limit the size of organizations

There are two main limitations to the size of organizations - its cost curve and its ability to manage operations effectively.

Marginal cost vs Marginal revenue curve

Under perfect competition or if a market has limited demand, increasing production will lead to an increase in supply and a drop in pricing. The organization will beforced to limit its production or take losses since marginal cost will become greater than marginal revenue.

Under real world conditions, if the market has excess demand (or demand is manufactured), as production increases, the costs will likely go down and the prices will remain more or less constant. The organization can scale as long as there is excess demand in the market.

Cost of Management

Of course, the Marginal cost limitation only applies for one product and one market. The organization can grow if it gains access to multiple markets or fields multiple products - however, then too there are limits.

In any organization, especially Corporations, the manager directs the production. As the organization grows in size, two factors start limiting the size:

  • Cost of communication
    • As an organization becomes more spatially spread out, it costs more to communicate and coordinate between the parts.
    • This has been highly reduced by effective management techniques, telecommunications and the Internet
  • Cost of variety
    • As an organization spreads into different markets and product ranges, the variety of transactions becomes much bigger.
    • The entrepreneur/manager is more likely to make a mistake in allocating resources since they are probably more clueless about what is going on in the organization. Flaws of Central Planning as more details about this problem.