Economies of Scope Definition - Investopedia

Economies of scope are economic factors that make the simultaneous manufacturing of different products more cost-effective than manufacturing them on their own. Business BusinessEssentials WhatAreEconomiesofScope? Aneconomyofscopemeansthattheproductionofonegoodreducesthecostofproducinganotherrelatedgood.Economiesofscopeoccurwhenproducingawidervarietyofgoodsorservicesintandemismorecosteffectiveforafirmthanproducinglessofavariety,orproducingeachgoodindependently.Insuchacase,thelong-runaverageandmarginalcostofacompany,organization,oreconomydecreasesduetotheproductionofcomplementarygoodsandservices. Whileeconomiesofscopearecharacterizedbyefficienciesformedbyvariety,economiesofscaleareinsteadcharacterizedbyvolume.Thelatterreferstoareductioninmarginalcostbyproducingadditionalunits.Economiesofscale,forinstance,helpeddrivecorporategrowthinthe20thcenturythroughassemblylineproduction. KeyTakeaways Economiesofscopedescribesituationswhereproducingtwoormoregoodstogetherresultsinalowermarginalcostthanproducingthemseparately.Economiesofscopedifferfromeconomiesofscale,inthattheformermeansproducingavarietyofdifferentproductstogethertoreducecostswhilethelattermeansproducingmoreofthesamegoodinordertoreducecostsbyincreasingefficiency.Economiesofscopecanresultfromgoodsthatareco-productsorcomplementsinproduction,goodsthathavecomplementaryproductionprocesses,orgoodsthatshareinputstoproduction. 1:17 EconomiesofScope UnderstandingEconomiesofScope Economiesofscopeareeconomicfactorsthatmakethesimultaneousmanufacturingofdifferentproductsmorecost-effectivethanmanufacturingthemontheirown.Asimplewaytoillustrate thecontrastistousetheexampleofatrain:Asingletraincancarrybothpassengersandfreightmorecheaplythanhavingtwoseparatetrains,oneonlyforpassengersandanotherforfreight.Inthiscase,asingletrainthathascarsdedicatedtobothcategoriesisfarmorecosteffective,andmayalsoresultinlowerticketortonnagecostsforthetrain'susersaswell. Economiesofscopecanoccurbecausetheproductsareco-producedbythesameprocess,theproductionprocessesarecomplementary,ortheinputstoproductionaresharedbytheproducts. Co-Products Economiesofscopecanarisefromco-productionrelationshipsbetweenfinalproducts.Ineconomictermsthesegoodsarecalledcomplementsinproduction.Thisoccurswhentheproductionofonegoodautomaticallyproducesanothergoodasabyproductorakindofside-effectoftheproductionprocess.Sometimesoneproductmightbeabyproductofanother,buthavevalueforusebytheproducerorforsale.Findingaproductiveuseormarketfortheco-productscanreducebothwasteandcostsandincreaserevenues. Forexample,dairyfarmersseparaterawmilkfromcowsintowheyandcurds,withthecurdsgoingontobecomecheese.Intheprocesstheyalsoendupwithalotofwhey,whichtheycanthenuseasahigh-proteinfeedforlivestocktoreducetheiroverallfeedcostsorsellasanutritionalproducttofitnessenthusiastsandweightliftersforadditionalrevenue.Anotherexampleofthisistheso-calledblackliquorproducedwhenprocessingwoodintopaperpulp.Insteadofbeingmerelyawasteproductthatmightbecostlytodisposeof,blackliquorcanbeburnedasanenergysourcetofuelandheattheplant,savingmoneyonotherfuels,orcanevenbeprocessedintomoreadvancedbiofuelsforuseon-siteorforsale.Producingandusingtheblackliquorthussavescostsonproducingthepaper. ComplementaryProductionProcesses Economiesofscopecanalsoresultfromthedirectinteractionoftwoormoreproductionprocesses.Companionplantinginagricultureisaclassicexamplehere,suchasthe"ThreeSisters"cropshistoricallycultivatedbyNativeAmericans.Byplantingcorn,polebeans,andgroundtrailingsquashtogether,theThreeSistersmethodactuallyincreasestheyieldofeachcrop,whilealsoimprovingthesoil.Thetallcornstalksprovideastructureforthebeanvinestoclimbup;thebeansfertilizethecornandthesquashbyfixingnitrogeninthesoil;andthesquashshadesoutweedsamongthecropswithitsbroadleaves.Allthreeplantsbenefitfrombeingproducedtogether,sothefarmercangrowmorecropsatlowercost. Amodernexamplewouldbeaco-operativetrainingprogrambetweenanaerospacemanufacturerandanengineeringschool,wherestudentsattheschoolalsoworkparttimeorinternatthebusiness.Themanufacturercanreduceitsoverallcostsbyobtaininglowcostaccesstoskilledlabor,andtheengineeringschoolcanreduceitsinstructionalcostsbyeffectivelyoutsourcingsomeinstructionaltimetothemanufacturer'strainingmanagers.Thefinalgoodsbeingproduced(airplanesandengineeringdegrees)mightnotseemtobedirectcomplementsorsharemanyinputs,butproducingthemtogetherreducesthecostofboth. SharedInputs Becauseproductiveinputs(i.e.land,labor,andcapital)usuallyhavemorethanoneuse,economiesofscopecanoftencomefromcommoninputstotheproductionoftwoormoredifferentgoods.Forexample,arestaurantcanproducebothchickenfingersandFrenchfriesataloweraverageexpensethanwhatitwouldcosttwoseparatefirmstoproduceeachofthegoodsseparately.Thisisbecausechickenfingersandfrenchfriescanshareuseofthesamecoldstorage,fryers,andcooksduringproduction. Proctor&Gambleisanexcellentexampleofacompanythatefficientlyrealizeseconomiesofscopefromcommoninputssinceitproduceshundredsofhygiene-relatedproductsfromrazorstotoothpaste.Thecompanycanaffordtohireexpensivegraphicdesignersandmarketingexpertswhocanusetheirskillsacrossallofthecompany'sproductlines,addingvaluetoeachone.Iftheseteammembersaresalaried,eachadditionalproducttheyworkonincreasesthecompany'seconomiesofscope,becauseoftheaveragecostperunitdecreases. DifferentWaystoAchieveEconomiesofScope Real-worldexamplesoftheeconomy ofscope canbeseenin mergersandacquisitions(M&A),newlydiscoveredusesofresourcebyproducts(suchascrudepetroleum),andwhentwoproducersagreetosharethesamefactorsofproduction.  Economiesofscopeareessentialforanylargebusiness,andafirmcangoaboutachievingsuchscopeinavarietyofways.First,andmostcommon,istheideathatefficiencyisgainedthroughrelateddiversification.Productsthatsharethesameinputsorthathavecomplementaryproductiveprocessesoffergreatopportunitiesforeconomiesofscopethroughdiversification. Horizontallymergingwithoracquiringanothercompanyisanotherawaytoachieveeconomiesofscope.Tworegionalretailchains,forexample,maymergewitheachothertocombinedifferentproductlinesandreduceaveragewarehousecosts.Goodsthatcansharecommoninputslikethisareverysuitableforgeneratingeconomiesofscopethroughhorizontalacquisitions. ExampleofEconomiesofScope Asonelastexample,assumethatcompanyABCistheleadingdesktopcomputerproducerintheindustry.CompanyABCwantstoincreaseits productline andremodelsitsmanufacturingbuildingtoproduceavarietyofelectronicdevices,suchaslaptops,tablets,andphones.Sincethecostofoperatingthemanufacturingbuildingisspreadoutacrossavarietyofproducts,theaveragetotalcostofproductiondecreases.Thecostsofproducingeachelectronicdeviceinanotherbuildingwouldbegreaterthanjustusingasinglemanufacturingbuildingtoproducemultipleproducts. ArticleSources Investopediarequireswriterstouseprimarysourcestosupporttheirwork.Theseincludewhitepapers,governmentdata,originalreporting,andinterviewswithindustryexperts.Wealsoreferenceoriginalresearchfromotherreputablepublisherswhereappropriate.Youcanlearnmoreaboutthestandardswefollowinproducingaccurate,unbiasedcontentinour editorialpolicy. NationalEnergyTechnologyLaboratory."BlackLiquorGasification." RelatedTerms Scope Scopeisaprojectmanagementtermfortheobjectivesnecessarytocompleteaproject,allowingmanagerstoestimatecostsandtimerequired. more UnderstandingEfficiency Efficiencyisalevelofperformancethatusesthelowestamountofinputstocreatethegreatestamountofoutputs.Learnhowtocalculateefficiency. more WhatAreEconomiesofScale? Economiesofscalearecostadvantagesreapedbycompanieswhenproductionbecomesefficient. more WhatIsJust-in-Time(JIT)? Ajust-in-time(JIT)inventorysystemisamanagementstrategythatalignsraw-materialordersfromsuppliersdirectlywithproductionschedules. more FactorsofProductionDefinition Factorsofproductionaretheinputsneededforthecreationofagoodorservice,theseincludelabor,entrepreneurship,andcapital. more HowaSupplyChainWorks Asupplychainisanetworkofpeopleandentitieswhoareinvolvedincreatingaproductanddeliveringittoitsconsumer. more PartnerLinks RelatedArticles GuidetoMicroeconomics UnderstandingEconomiesofScopevs.EconomiesofScale Macroeconomics WhyFactorsofProductionAreImportanttoEconomicActivity Macroeconomics 4CountriesThatProducetheMostFood Stocks&BondNews TopAgricultureDividendStocksforQ32022 Commodities The5CountriesThatProducetheMostSugar Commodities Commodities:ThePortfolioHedge