Economies of Scope

What is Economies of Scope?

Economies of scope is an economic principle in which a business's unit cost to produce a product will decline as the variety of its products increases. In other words, the more different-but-similar goods you produce, the lower the total cost to produce each one will be.

Economies of Scope vs. Economies of Scale

Economies of scope and economies of scale are two concepts that explain why costs are often lower for larger companies. Economies of scope focus on the average total cost of production of a variety of goods. In contrast, economies of scale focus on the cost advantage that arises when there is a higher level of production for one good.

A company that benefits from economies of scope has lower average costs because costs are spread over a variety of products. For example, it is much easier for a restaurant chain to offer new dishes than to start a new restaurant chain offering the same new foods. Advertising can promote multiple dishes at the same time, and the new foods can be prepared and served using the same equipment and personnel. Economies of scope work best when production or consumption is complementary.

On the other hand, a company that benefits from economies of scale has a lower average cost because costs decrease as the amount produced increases. For example, a company may be able to make 100 million computer chips at a much lower cost per unit than 1 million chips. The company has to spend a certain amount of money on research and development (R&D) for each chip, as well as money on setting up each factory. Once that is done, less money is required to produce additional chips. Economies of scale work best when fixed costs are high.

Examples of Economies of Scope

The business world is filled with examples of economies of scope.

1. Airlines: Passenger airlines frequently transport freight cargo underneath the plane. This optimizes the use of the plane, the fuel, and the flight crew already needed to run a passenger flight.
2. Warehouses: Many warehouses store goods belonging to multiple companies, with each renting out sections based on square footage. This maximizes the physical investment in building, buying, or leasing the warehouse itself.
3. Breweries and distilleries: Breweries and distilleries produce raw ethanol as a byproduct of their beer and liquor manufacturing. Some have turned this ethanol into hand sanitizer, resulting in a new profit stream.

Advantages of Economies of scope

Economies of scope have the following advantages for businesses:

• Extreme flexibility in product design and product mix
• Rapid responses to changes in market demand, product design and mix, output rates, and equipment scheduling
• Greater control, accuracy, and repeatability of processes
• Reduced costs from less waste and lower training and changeover costs
• More predictability (e.g., maintenance costs)
• Faster throughput thanks to better machine use, less in-process inventory, or fewer stoppages for missing or broken parts. (Higher speeds are now made possible and economically feasible by the sensory and control capabilities of the “smart” machines and the information management abilities of computer-aided manufacturing (CAM) software.)
• Distributed processing capability made possible and economical by the encoding of process information in easily replicable software
• Less risk: A company that sells many product lines, sells in many countries, or both will benefit from reduced risk (e.g., if a product line falls out of fashion or if one country has an economic slowdown, the company will likely be able to continue trading)

See Also

Economic Value Added (EVA)