economies-of-scope

What Are Economies of Scope? Economies of Scope In A Nutshell

An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.

Understanding economies of scope

Economies of scope occur when a company can produce two or more products simultaneously at a lower cost than producing them individually.

Consider the example of a vehicle manufacturer with a single assembly line producing one basic sedan. The manufacturer could increase its economies of scope by adding a sports and a luxury version since all three products use the same equipment, skilled labour, raw materials, and distribution channels

With three sedan models instead of one, the cost of producing each sedan decreases because the company’s resources stretch further. In other words, it would cost more to operate a separate factory and assembly line for each sedan variant. 

The theory is particularly useful whenever a business has fixed factors of production such as space, labor, raw materials, and taxes. In simple terms, increasing economies of scope allows the business to reach more consumers per unit of money spent.

Five more examples of economies of scope

Here are five more examples of economies of scope:

Warehouses

Many warehouses store goods owned by multiple clients. Each client rents a section of physical floor space, which maximizes the investment made by the business to build, lease, or operate the warehouse.

Breweries

Raw ethanol, which is produced during the beer fermentation process, has been used by some breweries to make hand sanitizer during the COVID-19 pandemic.

Airlines

Commercial flights also transport freight cargo in addition to passengers and their luggage. This maximizes the return on investment associated with the high operating costs operating each flight.

Gas stations

Profit margins on the sale of gas are typically low, so gas stations sell soda, milk, baked goods, ice, car products, and many other items to achieve economies of scope.

Bars

Once associated with happy hour and the sale of beer, many bars have diversified to offer breakfast, lunch, and dinner with perks such as free wi-fi. Other bars utilize live music or host sports-themed events to maximize the use of the premises.

How do economies of scope occur?

There are three main mechanisms for the facilitation of economies of scope. 

1 – Co-products 

Economies of scope occur this way when the production of one good produces another product as a natural by-product. For the business, finding a productive use or market for these secondary products reduces waste and increases revenue

During the production of cheese, for example, milk is separated into whey and curds. Once thought to be a waste product, the whey is now sold to farmers as a high protein feed for dairy cows.

2 – Complementary production processes

Economies of scope can also result from the direct interaction of two or more production processes. 

Companion planting in agriculture is the most obvious example, with nitrogen-fixing legumes often sown with other fruit and vegetable crops to increase yields. These legumes also outcompete weeds which has the flow-on effect of reducing herbicide costs.

3 – Shared inputs

When production inputs such as land, labor, and capital have more than one use, economies of scope can also result. 

Kleenex Corporation manufactures many paper-based products including sanitary napkins, paper towels, facial tissues, and toilet paper. These product lines utilize similar raw material inputs, manufacturing processes, and distribution channels.

Key takeaways:

  • Economies of scope occur when a company can produce two or more products simultaneously at a lower cost than producing them individually. Increasing economies of scope allow the business to reach more consumers per unit of money spent.
  • Economies of scope are frequently used in business. Examples include warehouse storage, gas stations, bars, commercial airlines, and breweries.
  • Economies of scope arise in three common scenarios: co-products, co-products, complementary production processes and shared resources.

Main Free Guides:

Connected Business Concepts

Economies of Scale

economies-of-scale
In Economics, Economies of Scale is a theory for which, as companies grow, they gain cost advantages. More precisely, companies manage to benefit from these cost advantages as they grow, due to increased efficiency in production. Thus, as companies scale and increase production, a subsequent decrease in the costs associated with it will help the organization scale further.

Diseconomies of Scale

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In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.

Network Effects

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A network effect is a phenomenon in which as more people or users join a platform, the more the value of the service offered by the platform improves for those joining afterward.

Negative Network Effects

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In a negative network effect as the network grows in usage or scale, the value of the platform might shrink. In platform business models network effects help the platform become more valuable for the next user joining. In negative network effects (congestion or pollution) reduce the value of the platform for the next user joining. 

Creative Destruction

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Creative destruction was first described by Austrian economist Joseph Schumpeter in 1942, who suggested that capital was never stationary and constantly evolving. To describe this process, Schumpeter defined creative destruction as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” Therefore, creative destruction is the replacing of long-standing practices or procedures with more innovative, disruptive practices in capitalist markets.

Happiness Economics

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Happiness economics seeks to relate economic decisions to wider measures of individual welfare than traditional measures which focus on income and wealth. Happiness economics, therefore, is the formal study of the relationship between individual satisfaction, employment, and wealth.

Command Economy

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In a command economy, the government controls the economy through various commands, laws, and national goals which are used to coordinate complex social and economic systems. In other words, a social or political hierarchy determines what is produced, how it is produced, and how it is distributed. Therefore, the command economy is one in which the government controls all major aspects of the economy and economic production.

Animal Spirits

animal-spirits
The term “animal spirits” is derived from the Latin spiritus animalis, loosely translated as “the breath that awakens the human mind”. As far back as 300 B.C., animal spirits were used to explain psychological phenomena such as hysterias and manias. Animal spirits also appeared in literature where they exemplified qualities such as exuberance, gaiety, and courage.  Thus, the term “animal spirits” is used to describe how people arrive at financial decisions during periods of economic stress or uncertainty.

State Capitalism

state-capitalism
State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.

Boom And Bust Cycle

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The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
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