What are 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 some complementary goods and services. An economy of scope means that the production of one good reduces the cost of producing another related good.

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 single type of product. Economies of scale helped drive corporate growth in the 20th century, for example through assembly line production.

Key Takeaways

  • Economies of scope describe situations when producing two or more goods or services together results in a lower cost than producing them separately.
  • Economies of scope differ from economies of scale, in that the former means producing a variety of different products together to reduce costs while the latter means producing more of the same good in order to reduce costs by increasing efficiency.
  • Economies of scope can result from goods that are co-products or complements in production, goods that have complementary production processes, or goods that share inputs to production.
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Economies of Scope

Understanding 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. Economies of scope can occur because the products are co-produced by the same process, the production processes are complementary, or the inputs to production are shared by the products.

Co-Products

Economies of scope can arise from co-production relationships between the final products. In economic terms these goods are complements in production. This is when the production of one good automatically produces another good as a byproduct or a kind of side-effect of the production process. Sometimes one product might be a byproduct of another, but have value for use by the producer or for sale. Finding a productive use or market for the co-products can reduce costs or increase revenue.

For example, dairy farmers separate milk into whey and curds, with the curds going on to become cheese. In the process they also end up with a lot of whey, which they can use as a high protein feed for livestock to reduce their feed costs or sell as a nutritional product to fitness enthusiasts and weightlifters for additional revenue. Another example of this is the black liquor produced by the processing of wood into paper pulp. Instead of being just a waste product that might be costly to dispose of, black liquor is burned as an energy source to fuel and heat the plant, saving money on other fuels, or can even be processed into more advanced biofuels for use on-site or for sale. Producing and using the black liquor saves costs on producing the paper.

Complementary Production Processes

Economies of scope can result from direct interaction of the production processes. Companion planting in agriculture is a classic example here, such as the Three Sisters historically farmed by Native Americans. By planting corn, pole beans, and ground trailing squash together, the Three Sisters method can increase the yield of each crop, while also improving the soil. The tall corn stalks provide a structure for the bean vines to climb up; the beans fertilize the corn and the squash by fixing nitrogen in the soil; and the squash shades out weeds among the crops with its broad leaves. All three plants benefit from being produced together, so the farmer can grow more crops at lower cost.

A more modern example might be a co-operative training program between an aerospace manufacturer and an engineering school, where students at the school also work part time at the business. The manufacturer can reduce its overall costs by obtaining low cost access to skilled labor, and the engineering school can reduce its instructional costs by effectively outsourcing some instructional time to the manufacturer's training managers. The final goods being produced (airplanes and engineering degrees) might not seem to be direct complements or share many inputs, but producing them together reduces the cost of both.

Shared Inputs

Because productive inputs (land, labor, and capital) usually have more than one use, economies of scope can often come from common inputs to the production of two or more different goods. For example, a restaurant can produce both chicken fingers 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 chicken fingers and French fries can share the use of the same cold storage, fryers, and cooks during production.

Proctor & Gamble is an excellent example of a company that efficiently realizes economies of scope from common inputs 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 unit decreases.

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 efficiency is gained through related diversification. Products that share the same inputs or that have complementary productive processes offer great opportunities for economies of scope through diversification.

Horizontally 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. Goods that can share common inputs like this are very suitable for generating economies of scope through horizontal acquisitions.