What are Economies of Scope?

What are economies of scope?

Economies of scope are cost savings and efficiencies that are generated when different, distinct products are produced in tandem, as opposed to a high volume of the same product being produced.

Put another way, companies who are seeking to leverage economies of scope are using the production of complementary goods to reduce the costs of both products.

Economies of scope are distinct from economies of scale, which rely on leveraging the size of an organization to create cost savings and generate efficiencies.

How Do Economies of Scope Work?

Unlike economies of scale, which rely on volume and other size-related characteristics, economies of scope rely on variety to produce increased efficiency and cost savings.

When looking for examples of economies of scope in action, look to one or more of the following production circumstances:

  • Goods that are co-products or that complement one another in production
  • Goods that share production inputs

Economies of scale are most closely associated with physical production and firms that engage in manufacturing, but the same concepts can apply to a service business.

All businesses have a value chain that relies on inputs in some form; when viewed through the lens of value, all businesses can benefit from leveraging the concepts of economies of scope.

Co-Products and Production Complements

Co-products are products that are produced simultaneously. In many cases one product is a by-product or consequence of the production of the other.

For example, when a tree is cut down to produce boards or beams, there is a significant amount of surplus material.

Thin branches, bark, and other material is used as fuel in lumber processing plants to reduce fuel costs. More substantial boughs are often turned into pulpwood that can be used in the production of paper or lower-cost manufacturing and construction material.

Other examples include petroleum refining and dairy production.

Crude oil is made up of a wide range of different chemical compounds. The refining process releases and changes chemical bonds and creates new compounds and other products that can be captured and refined to be sold for profit.

Similarly, the production of processed milk results in the creation of other products, such as whey, which can be used in the production of cheese.

In each of these examples, processes that are designed to capture and utilize co-products benefit from economies of scope to produce revenue and reduce costs.

Shared Production Inputs

Product lines that share production inputs benefit from economies of scope. These are product lines that share enough inputs—raw materials, for example—that the production of one is marginally more costly than the production of another.

For example, a company that makes T-shirts for adults can very easily also make T-shirts for children.

T-shirts require the same inputs but produce distinct products. A company that produces men’s and women’s T-shirts already keeps raw cotton and materials for screen printing on hand. Producing similar products (shirts) of a different form is marginally more costly than producing an entire new product line that requires a new set of inputs and processes.

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