What Are Economies of Scope?

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What Are Economies of Scope?

Let me explain economies of scope directly: it's the cost savings you get when a company produces multiple goods at the same time instead of making each one on its own. You see this when broadening the range of products or services becomes more cost-effective than sticking to a narrow lineup or producing items independently. In these scenarios, both the long-run average and marginal costs drop because of the complementary nature of the goods and services involved.

Key Takeaways

Economies of scope happen when making two or more goods together cuts the marginal cost below what it would be if produced separately.
They differ from economies of scale, which cut marginal costs by ramping up production of additional units.
These economies can come from co-products in production, complementary processes, or shared inputs.
A frequent method to gain economies of scope is through mergers and acquisitions.

Understanding Economies of Scope

I'm telling you, economies of scope are those economic factors that make manufacturing different products simultaneously more cost-effective than doing them individually. Think of it like this: a single train carrying both passengers and freight is cheaper than running separate trains for each. That setup not only saves on costs but might even lower prices for users. These savings come about because products are co-produced in the same process, the processes complement each other, or they share inputs.

Co-Products

You can find economies of scope in co-production, where making one good automatically creates another as a byproduct. Sometimes that byproduct has value, either for the producer's use or for sale, which cuts waste, reduces costs, and boosts revenue. For instance, dairy farmers separate milk into whey and curds for cheese, then use the whey as livestock feed to lower costs or sell it as a protein supplement. Another case is black liquor from paper pulp processing; instead of disposal costs, it gets burned for energy or turned into biofuels, saving on fuel expenses.

Complementary Production Processes

Economies of scope also emerge from interactions between production processes. Take companion planting, like the Native American 'Three Sisters' method with corn, beans, and squash. The corn supports the beans, beans add nitrogen to the soil for the corn and squash, and squash suppresses weeds. All crops yield more at lower cost when grown together. In a modern sense, consider an aerospace company partnering with an engineering school for training; the company gets cheap skilled labor, and the school cuts instructional costs by using the company's managers, reducing overall expenses for both airplanes and degrees.

Shared Inputs

Since inputs like land, labor, and capital often serve multiple purposes, economies of scope frequently stem from sharing them across different goods. A restaurant, for example, can make chicken fingers and French fries cheaper together than if separate firms handled each, thanks to shared cold storage, fryers, and cooks. Proctor & Gamble does this on a large scale with hygiene products from razors to toothpaste, employing graphic designers and marketers across lines to lower per-unit costs as they add more products.

How to Achieve Economies of Scope

You achieve economies of scope through methods like using the same resources for more goods or finding uses for byproducts. Real examples include mergers and acquisitions, new applications for byproducts like crude petroleum, or producers sharing production factors. For large businesses, this is crucial, often starting with related diversification where products share inputs or processes. Horizontal mergers, like two retail chains combining to cut warehouse costs, also work well for goods with common inputs.

Economies of Scope vs. Economies of Scale

Remember, economies of scope focus on efficiencies from variety, while economies of scale come from volume, reducing marginal costs by producing more units of the same thing. The key difference is that scope spreads costs over multiple goods, whereas scale saves on producing one good in larger quantities. Economies of scale drove 20th-century growth via assembly lines, but scope is about diversifying efficiently.

Example of Economies of Scope

Suppose company ABC leads in desktop computers and wants to expand. They remodel their building to produce laptops, tablets, and phones too. Spreading the building's operating costs across these products lowers the average total cost. Producing each in separate buildings would cost more than using one facility for multiple items.

How Do You Know If There Are Economies of Scope?

You know economies of scope exist if producing two or more goods together results in a lower marginal cost than producing them separately.

What Are the Benefits of Economies of Scope?

The main benefit is efficiency, saving money and time by using resources for multiple products, which boosts profitability and increases revenue through more items to sell.

What Is the Difference Between Economies of Scope and Scale?

Both help companies grow efficiently, but scope emphasizes variety for cost advantages, while scale reduces marginal costs via higher production volumes.

The Bottom Line

In summary, economies of scope are the cost advantages from producing a range of products together instead of apart. This happens through automatic byproducts, complementary processes, or shared inputs. Examples include using manufacturing byproducts valuably or leveraging the same facilities and staff for additional revenue streams.