Economies of Scope - Learn How to Achieve Economic ...

Economies of scope is an economic concept that refers to the decrease in the total cost of production when a range of products are produced ... Home›Resources›Knowledge›Economics›EconomiesofScope EconomiesofScope Costbenefitsfromproducingagreatervarietyofgoods Writtenby CFITeam UpdatedFebruary23,2021 WhatareEconomiesofScope? Economiesofscopeisaneconomicconceptthatreferstothedecreaseinthetotalcostofproductionwhenarangeofproductsareproducedtogetherratherthanseparately. FormulaforEconomiesofScope Where: C(qa)isthecostofproducingquantityqaofgoodaseparately C(qb)isthecostofproducingquantityqbofgoodbseparately C(qa+qb)isthecostofproducingquantitiesqaandqbtogether EconomiesofScope(S)isthepercentagecostsavingwhenthegoodsareproducedtogether.Therefore,Swouldbegreaterthan0wheneconomiesofscopeexist. Exampleof EconomiesofScope Forexample,arestaurantproducesbothhamburgersandsandwiches.Thecostofseparatelyproducing1,000,000hamburgersis$0.50each.Likewise,if4,000,000sandwichesareproducedseparately,thecostis$0.30each.If1,000,000hamburgersand4,000,000sandwichesareproducedtogether(byusingthesamepreparationandstoragefacility),thetotalcostis$1,500,000. Todeterminetheeconomiesofscope: DetermineC(qa)=1,000,000*0.50=$500,000 DetermineC(qb)=4,000,000*0.30=$1,200,000 DetermineC(qa+qb)=$1,500,000 PlugthenumbersintotheEconomiesofScopeformula ($500,000+$1,200,000–$1,500,000)/$1,500,000=13.33%.Therefore,thecostofproducinghamburgersandsandwichestogetheris13.33%lessthanthecostofproducingthemseparately. HowtoAchieveEconomiesofScope? 1.FlexibleManufacturing Flexiblemanufacturingexistsifmultipleproductscanbeproducedusingthesamemanufacturingsystemsandinputs–forexample,usingthesamepreparationandstoragefacilitieswhenmakinghamburgersandfries,asopposedtousingtwoseparatefacilities. 2.RelatedDiversification Ifacompanyisabletouseitsoperationalexpertise,resources,andcapabilitiesacrossitsorganization,thenitcantakeadvantageofrelateddiversification.Forexample,hiringdesignersandmarketerswhocanusetheirskillsacrossdifferentproductlinesallowsfortheproductionofawiderangeofproducts. 3.Mergers Mergersoftenenableacompanytoshareresearchanddevelopmentexpensestoreducecostsanddiversifyitsproductportfolioorknowledge.Forexample,twopharmaceuticalcompaniesmightmergetocombinetheirresearchanddevelopmentexpensestocreatenewproducts. EconomiesofScopevs.EconomiesofScale Economiesofscopeareoftenconfusedwitheconomiesofscale.Theformerreferstothedecreaseintheaveragetotalcostofproductionwhenthereisanincreasingvarietyofgoodsproduced.Ontheotherhand,economiesofscalerefertothecostsavingsachievedfromincreasingthescaleofproductionofasinglegood. Economiesofscope:Savingsincostduetotheincreasedproductionofdistinctproductsusingthesameoperations.Economiesofscopereducetheaveragecostofproducingmultipleproducts. Economiesofscale:Savingsincostduetotheincreasedproductionofthesameproduct.Economiesofscalereducetheaveragecostofproducingoneproduct. TheImportanceofEconomiesofScope Economiesofscopeallowacompanytogainefficiencyfromproducingalargervarietyofproducts.Acompanyisabletosellagreaterrangeofproductsandalsorespondtochangesinconsumerpreferences.Itreducesrisksforacompanybyallowingforrelateddiversification.IfamajorcarproduceronlyproducedSUVs,thecompanywouldbevulnerabletomarketchanges(if,forexample,oilpricespikesandconsumersswitchtobuyingmoreeco-friendlycars). RelatedReadings Tolearnmoreandadvanceyourcareer,seethefollowingfreeCFIresources: MarketEconomy CostStructure LawofSupply InelasticDemand FinancialAnalystCertification BecomeacertifiedFinancialModelingandValuationAnalyst (FMVA)®bycompletingCFI’sonlinefinancialmodelingclasses! 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