Loading the player...

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.

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. 

RELATED TERMS
  1. Scope

    Scope is a project management term for the objectives and requirements ...
  2. Advanced Economies

    Advanced economies, as described by the International Monetary ...
  3. Minimum Efficient Scale

    The minimum efficient scale is the least amount of production ...
  4. Engagement Letter

    An engagement letter is an agreement defining the legal relationship ...
  5. Horizontal Integration

    Horizontal integration is the acquisition of a business operating ...
  6. Production Rate

    Production rate is the pace at which units of a product are manufactured ...
Related Articles
  1. Insights

    Explaining Minimum Efficient Scale

    Minimum efficient scale is the smallest amount of production a firm can achieve while still taking full advantage of economies of scale.
  2. Investing

    Understanding Marginal Cost of Production

    Marginal cost of production is an economics term that refers to the change in production costs resulting from producing one more unit.
  3. Insights

    Bank of England Cuts Interest Rates, Increases QE Program

    The Bank of England cut the base rate by 25bp to a record low and increased its QE program.
  4. Investing

    What's a Centrally Planned Economy?

    A centrally planned economy is one where the government controls the country’s supply and demand of goods and services.
  5. Insights

    What Consumers Want From McDonalds

    McDonald's is struggling to win back customers who have run off to premium hamburger restaurants. What can the fast food giant do to regain its popularity?
  6. Investing

    Why China Imports Matter to Global Economy

    The Chinese economy is a very important cog in the wheel of the global economy. If Chinese imports slow, the global economic threat is contagion.
  7. Insights

    How Productivity And Globalization Affect The Economy

    The systems designed to track the national economy is flawed. Discover the impacts of globalization.
  8. Personal Finance

    Market Economy

    In a market economy, economic decisions and prices are determined by market forces rather than by central planning.
  9. Insights

    What is jobless growth?

    What are the effects that a jobless growth economy has on workers and investors alike. Learn about these effects here.
  10. Insights

    What is Fiscal Policy?

    Fiscal Policy how governments adjust taxes and spending to moderate the economy. Fiscal Policy is the sister strategy to monetary policy, through which a central bank influences a nation's money ...
RELATED FAQS
  1. How does specialization help companies achieve economies of scale?

    Learn the definition of economies of scale, why it is important and how specialization during production can lead to economies ... Read Answer >>
  2. How are period costs and product costs different?

    Product costs are the direct costs involved in producing a product. Period costs are all costs not included in product costs ... Read Answer >>
  3. What is the difference between cost and price?

    Cost is typically the expense incurred for a product or service being sold by a company. Price is the amount a customer is ... Read Answer >>
  4. Can a government intervene in a market economy?

    Find out at what point a market economy receives so much government intervention that it can no longer be considered a market ... Read Answer >>
  5. What are the advantages and disadvantages of a command economy?

    Learn about the basic tenets of a command economy and what its inherent advantages and disadvantages are versus a free market ... Read Answer >>
  6. What is cost accounting?

    Learn about the main benefits of cost accounting systems, how they are different from financial accounting and why they are ... Read Answer >>
Trading Center