Economies of Scope

The term economies of scope refers to the economies, or benefits, that firms derive by producing particular combinations of output. These exist if one firm can produce two separate products more efficiently than two firms can independently produce them separately. Economies of scope resemble economies of scale but operate in a different manner. Whereas economies of scale refer to the lower costs involved in producing larger quantities of a single type of good, economies of scope refer to the benefits generated from producing a mix of goods and thus are common in multiproduct firms. These arise essentially because a firm can use a given stock of factor inputs to generate a variety of related or complementary outputs. Average costs decline due to the mix of output between two or more products. Thus, economies of scope refer to the potential cost savings that result from the joint production of products not directly related to one another. If a firm can produce multiple goods and services more efficiently than several firms could produce them independently, it enjoys economies of scope. Otherwise, it suffers from diseconomies of scope (increases in price that accompany the production of different goods).

For example, a fast-food franchise may produce two types of foods more quickly than it could produce both in isolation, largely by using the same storage and preparation facilities. As another example, a firm's administration and management may carry out services necessary to the production of a variety of different goods, including research, marketing, and financing. Economies of scope are common in the learning process when the knowledge and experience gained in the production or sale of one good are useful in the production and sale of other goods. One warehouse may be used to store a range of products. The salaries and transportation costs of a sales force may be used effectively to sell a variety of different goods or services. A publishing firm may realize cost savings by using staff members to produce more than one magazine. These benefits are frequently found in marketing and distribution, where they underscore strategies such as product bundling.

Economies of scope also occur when there are cost savings generated by the production of by-products, that is, when the production of one good automatically triggers the production of another. For example, a beef producer may also generate leather, or a lumber company may also create sawdust.

Potential economies of scope underlie the mergers, acquisitions, and takeovers of firms seeking to diversify into new product lines and markets. In this case, the attraction is the ability to reduce costs by operating two or more businesses under the same corporate umbrella.

Economies of scope and economies of scale are often inversely related, particularly as firms face a “make” or “buy” decision regarding their inputs. For example, firms may subcontract (buy) inputs rather than make them “in-house” when they face rising uncertainty or rapid change in products or technology, when the labor process resists easy automation, or[Page 126] when the optimal scales of operation of production processes are markedly different. Thus, from the transaction costs perspective, externalization allows external economies of scale to replace internal economies of scope. By externalizing, firms substitute variable costs for fixed ones and spread the risks of production over their subcontractors, a particularly vital role during peak periods of demand.

...