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:
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.
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.
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.
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.
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.
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.
- 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.
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