What are Economies of Scope
Economies of scope are economic factors that make the simultaneous manufacturing of different products more cost-effective than manufacturing them on their own. For example, McDonald's can produce both hamburgers and French fries at a lower average expense than what it would cost two separate firms to produce each of the goods separately. This is because McDonald's hamburgers and French fries can share the use of food storage, preparation facilities and so forth during production.
Economies of Scope
BREAKING DOWN Economies of Scope
Economies of scope describe situations in which the long-run average and marginal cost of a company, organization or economy decreases, due to the production of similar complementary goods and services. The output of item A, therefore, reduces the price of producing item B.
Proctor & Gamble is an excellent example of a company that efficiently realizes economies of scope since it produces hundreds of hygiene-related products from razors to toothpaste. The company can afford to hire expensive graphic designers and marketing experts who can use their skills across all of the company's product lines, adding value to each one. If these team members are salaried, each additional product they work on increases the company's economies of scope, because of the average cost per good decreases. Additionally, the company can consolidate and streamline its production process, making it easier to produce both a razor and a tube of toothpaste, further decreasing average unit costs.
Different Ways to Achieve Economies of Scope
Economies of scope are essential for any large business, and a firm can go about achieving such scope in a variety of ways. First, and most common, is the idea that this operational efficiency is gained through related diversification. This is a similar strategy to that of McDonald's and Proctor & Gamble. Kleenex — using another example — has achieved economies of scope through the diversification of its simple tissue paper. The company expanded its product line to service numerous, unrelated end users, such as consumers and hospitals, all of which required a unique type of paper product.
Merging with or acquiring another company is another a way to achieve economies of scope. Two regional retail chains, for example, may merge with each other to combine different product lines and reduce average warehouse costs.
Finally, a company that wants to achieve economies of scope can link its supply chain through vertical integration. The ownership of a supply chain, from raw materials to the point of sale, allows many companies to consolidate the logistical process by combining multiple products into one production process, thus reducing costs.
Advantages of Economies of Scope
There is some discrepancy between economists when it comes to the importance of economies of scale because some believe that the theory can only apply to specific industries. For those that apply it, there are some advantages, including:
- A flexible mix of products and product design
- Quick responses to market demand, production design, and output rates
- Less waste and lower training which lead to a reduction in costs
- A reduction in risk — a company that diversifies its product line in many different markets can reduce its risk
Economies of Scope vs. Economies of Scale
While economies of scope are characterized by efficiencies formed by variety, economies of scale are characterized by volume. The latter involves the reduction of the average cost, or the cost per unit, that stems from increasing production for one type of product. Economies of scale helped drive corporate growth in the 20th century and were essential to Ford’s assembly line.