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.
Aspect
Explanation
Definition
Economies of Scope is an economic concept that refers to the cost advantages a company can achieve when it produces a variety of products or services rather than specializing in a single product or service. It is the opposite of economies of scale, where cost savings are achieved by producing a larger quantity of a single product. Economies of scope result from sharing resources, knowledge, or processes across multiple products or services within the same organization.
Key Concepts
– Diversification: Economies of scope are often associated with diversification, where a company expands its product or service offerings to enter new markets or cater to a broader customer base. – Resource Sharing: Companies can benefit from economies of scope by sharing common resources, such as production facilities, distribution networks, research and development (R&D) teams, or marketing efforts across multiple product lines. – Cost Reduction: The primary goal of economies of scope is to reduce the average cost per unit of production by spreading fixed costs over a wider range of products or services.
Examples
– Conglomerates: Conglomerate companies, such as General Electric, benefit from economies of scope by operating in diverse industries like aviation, healthcare, and energy. Shared R&D, manufacturing capabilities, and distribution networks result in cost savings. – Fast-Food Chains: Fast-food chains like McDonald’s offer a broad menu with various items. They benefit from economies of scope by sharing cooking equipment, staff, and supply chain logistics across different menu items. – Media Companies: Media companies that produce both print and digital content can reduce costs by sharing editorial teams, content distribution platforms, and marketing efforts.
Advantages
– Cost Efficiency: Economies of scope allow companies to produce multiple products or services more efficiently, reducing the overall cost structure. – Risk Diversification: Diversifying product or service offerings can help spread business risk, making the company less vulnerable to market fluctuations in a specific industry. – Competitive Edge: Companies with a diverse portfolio can leverage their capabilities to enter new markets and compete more effectively.
Limitations
– Management Complexity: Managing a diverse portfolio of products or services can be complex and may require different skill sets, strategies, and market insights. – Resource Allocation: Allocating resources effectively across different business units or product lines can be challenging, leading to potential conflicts over resource allocation. – Market Fit: Not all products or services may fit well within a company’s portfolio, and the pursuit of economies of scope can dilute a company’s brand and focus.
Real-World Example
A major automobile manufacturer, such as Toyota, benefits from economies of scope by producing a wide range of vehicle models, from compact cars to SUVs and hybrids. Toyota can share manufacturing facilities, research and development efforts, and supply chain resources across its diverse product lines, leading to cost savings and a competitive edge in various market segments.
Table of Contents
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.
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.
The main premise of economies of scale is how to reduce the cost per unit as production gets scaled up.
This usually happens through internal and external factors:
On the contrary, economies of scope focus on creating an advantage in producing a variety of products.
Take the example of a car manufacturer.
Whereas economies of scale will focus on the decreased cost of production per car happening, for instance, because manufacturing has been robotized.
Economies of scope will happen as a result of the fact that two products might share the same production line and assembly.
So for instance on the same production line the company can make tow types of cars, which tackle different customer segments!
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.
Key Highlights
Definition and Origin: Economies of scope occur when a company produces multiple related products together, resulting in lower costs for each product. This concept is based on the idea that producing a variety of products together reduces unit costs and enhances efficiency.
Examples: Economies of scope are present in various industries and scenarios:
Warehouses: Renting space to multiple clients maximizes warehouse investment and resource utilization.
Breweries: Utilizing by-products like raw ethanol for additional purposes, like making hand sanitizer.
Airlines: Carrying both passengers and freight on commercial flights to optimize operational costs.
Gas Stations: Selling a variety of items alongside gas to increase profitability.
Bars: Expanding services, such as offering meals or hosting events, to make the most of the establishment’s premises.
Mechanisms for Economies of Scope:
Co-products: When the production of one good yields another as a by-product, finding a use or market for these by-products reduces waste and increases revenue.
Complementary Production Processes: Interaction between different production processes can lead to economies of scope. For instance, companion planting in agriculture.
Shared Inputs: When production inputs like labor, land, and capital have multiple uses, economies of scope can arise. Example: Kleenex Corporation’s range of paper-based products.
Distinguishing from Economies of Scale:
Economies of Scale: Focuses on decreasing costs per unit as production scales up. Factors contributing to this include cost efficiency, technology, organizational and financial structure improvements, and increased bargaining power.
Economies of Scope: Concentrates on producing a variety of products together, sharing resources and processes. This allows the business to reach more consumers per unit of expenditure.
Case Studies
Industry/Business Context
Description
Application of Economies of Scope
Examples and Impact
Conglomerate Companies
Diversified corporations with various business units.
Centralized support functions, such as HR, finance, and IT, serving multiple subsidiaries. Cost-sharing and efficiency gains across diverse business segments.
Companies like General Electric (GE) benefit from reduced administrative overhead by managing diverse business units under one umbrella.
Retail
Retailers offering a wide range of product categories.
Centralized distribution and logistics operations for various product lines. Shared resources, such as warehouses and transportation, reduce overall distribution costs.
Retail giants like Walmart and Amazon benefit from economies of scope by leveraging their extensive logistics networks for diverse product categories.
Airlines
Airlines providing various passenger and cargo services.
Using the same aircraft for both passenger and cargo operations. Shared fleet and maintenance facilities result in cost savings and utilization efficiencies.
Airlines like FedEx and UPS maximize economies of scope by combining passenger and cargo services on their planes.
Hospitality Industry
Hotel chains offering multiple hotel brands and services.
Shared reservation systems, marketing, and loyalty programs across different brands. Economies of scale in marketing and customer acquisition.
Marriott International operates a diverse portfolio of hotel brands and leverages economies of scope for centralized reservation and marketing strategies.
Technology Companies
Tech companies offering hardware, software, and services.
Bundling hardware and software products with complementary services. Cross-selling products and services, resulting in increased revenue and customer loyalty.
Companies like Apple bundle hardware (e.g., iPhone) with software (e.g., iOS) and services (e.g., Apple Music) to create a seamless customer experience.
Media and Entertainment
Media conglomerates with diverse content and distribution.
Cross-promotion of movies, TV shows, and merchandise across various platforms. Maximizing brand recognition and monetization opportunities.
Disney leverages its diverse portfolio of content (e.g., Marvel, Star Wars) across theme parks, merchandise, and streaming services for economies of scope.
Food and Beverage
Companies producing a variety of food and beverage products.
Shared manufacturing facilities, distribution, and marketing resources. Cost efficiencies and brand diversification across product lines.
Nestlé operates in multiple food and beverage categories (e.g., coffee, chocolate, pet food) and achieves economies of scope through shared resources.
Financial Services
Banks and financial institutions offering a range of services.
Cross-selling financial products, such as banking, insurance, and investment services. Maximizing customer relationships and revenue streams.
JP Morgan Chase, for instance, combines banking, investment, and insurance services to create comprehensive financial solutions for customers.
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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.
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.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
