Some companies produce a wide variety of products. Usually, these products differ from each other and cater to different market segments. In some cases, however, these products may act as a supplementary or complementary products to a company’s existing items. For most companies, producing these products may be crucial in providing customers with the best possible services.
When companies intentionally produce goods that complement their products, they may come with additional costs. However, these products may also generate from the same process that companies use for their primary items. For example, a company may produce a byproduct generated from the same process as its primary production. Therefore, the costs may be lower.
In economy and business, the term economies of scale relate to the production of goods and services. Usually, it suggests that companies can significantly lower their per-unit cost by increasing their volumes. For a variety of goods produced, the term economies of scope may also be relevant. It is similar to the economies of scale. However, it covers several products at the same time.
What are Economies of Scope?
Economies of scale is a term used to describe the reduction in the costs of producing a product through the production of another item. In other words, it is when manufacturing a wide range of products or services reduces costs. This concept suggests that doing so can be more cost-effective for companies than producing a single product.
In essence, economies of scale suggest that companies can reduce their costs by producing a wide variety of goods simultaneously. Instead, if companies use an independent process for each, they may increase their production costs significantly. Therefore, it suggests that a company’s average and marginal costs can decrease from producing complementary goods and services.
Economies of scope focus on efficiencies, similar to the economies of scale concept. However, it focuses on efficiencies formed through variety and not volume. The term “economies” within this term refers to the cost savings or economic benefits that companies receive. In contrast, “scope” represents the broadening of products and services through diversified products.
Economies of scope is an economic theory that covers the total costs that companies incur due to production. It states that the average total cost of production decreases from increasing the number of different goods produced. Similarly, it covers the economic factors that make the simultaneous production of different products more cost-effective than independent manufacturing.
Overall, it is a concept that covers the cost-saving in production through variety. It does not concern the production volume, which falls under the economies of scale. It is a crucial concept for large companies that produce or sell various products. Usually, companies can achieve economies of scope using several techniques or methods.
How to achieve Economies of Scope?
Companies can achieve it in several ways. Usually, these ways include increasing the variety of goods produced. There are various methods that companies can do so. However, these may come with additional costs. For companies, it is crucial to weigh those costs with the benefits this process helps provide. Overall, companies can achieve economies of scope using the following ways.
Mergers and acquisition
Mergers and acquisitions (M&A) is a process in which companies merge their business. Usually, this process must include horizontal integration with other companies. Through this method, companies can achieve economies of scale by expanding their product variety. These goods must share common inputs or processes for this process to be successful.
Sharing inputs or processes
Companies can also achieve it through sharing inputs or processes. Usually, they are both a part of a flexible manufacturing process that companies may use. Companies that share resources between goods can easily use them to produce others. This way, they can reduce costs using features such as bulk discounts. Similarly, the shared process already decreases production costs.
Diversification
As mentioned above, economies of scope relate to the variety of goods by companies. When companies expand their product variety through diversification, they can reduce their cost significantly. Usually, it involves using operational expertise, capabilities and resources to achieve economies of scope. However, these products must have similarities to reduce costs.
Co-products
Companies can also achieve economies of scope through co-products. These products include two or more items that companies can obtain from the same source. For example, the crude oil distillation process produces products, such as petrol, fuel oil, lubricating oil, gases, etc. In some cases, these may also include byproducts that come from the same process.
Complementary products
A complementary product is an item that customers buy with another product. Usually, companies sell a prime good that caters to their customers. However, they may also offer a complimentary product that enhances the features of its primary item. By manufacturing complimentary products, companies can also increase their product variety. Therefore, it can contribute to the economies of scope.
What are the four main benefits of Economies of Scope?
Economies of scope can have significant benefits to companies. Usually, these benefits relate to the reduction in costs that companies can achieve through this process. However, there may also be various other advantages of economies of scope. These advantages can impact the company and its products at the same time. Of these, the four main benefits include the following.
Reduced production costs
As mentioned above, the primary benefit of economies of scale is the reduction in production costs. This process primarily focuses on decreasing those costs through variety. This benefit comes from diversifying the product range that companies offer. These reduced costs may also relate to less wastage and lower changeover and training costs.
Increased efficiency
Economies of scope can also help companies increase their efficiency during the production process. By synchronizing various resources between products, it can result in more efficient production. This increased efficiency also results in the reduction of costs, as mentioned above. It also results in faster throughput from machine use, less in-process inventory or fewer stoppages.
Increased profits
Economies of scope can produce higher profits for companies. These profits may come for several reasons, including the lower costs. However, the increased earnings may also come from the diversified and more product variety. Through these, companies can cater to a wider potential customer base. Due to this improved base, companies can significantly increase their profits.
Reduced risks
Economies of scope can also result in reduced risks for companies. These reduced risks come from the variety of products that companies offer over several markets. If a product fails, companies will always have other options on which they can fall back. The diversification of products through economies of scope can significantly decrease the business risks that companies face.
What is the formula for Economies of Scope?
The formula for economies of scope considers the production quantity for two goods. It produces the economies of scope as a percentage, which represents the cost-saving from producing goods together. Usually, companies aim for this formula to produce a result above 0. When the economies of scope formula exceed 0, it means that companies can save costs by manufacturing two goods together.
Overall, the formula for economies of scope is as follows.
Economies of Scope (S) = (C(qa) + C(qb) – C(qa + qb)) / C(qa + qb)
In the above formula, “C(qa)” represents the cost of producing quantity qa of goods “a” separately. Similarly, “C(qb)” is the production cost of quantity qb of goods “b” separately. Lastly, “C(qa + qb)” denotes the costs of producing both together.
Example
A company, ABC Co., produces clothing items. The company incurs $100,000 to manufacture 1,000 shirts independently. Similarly, its production costs for 1,000 pairs of pants are $75,000. If ABC Co. produces both of these items together, the total expenditure would be $150,000. Therefore, the economies of scope for the process will be as follows.
Economies of Scope (S) = (C(qa) + C(qb) – C(qa + qb)) / C(qa + qb)
Economies of Scope (S) = ($100,000 + $75,000 – $150,000) / $150,000
Economies of Scope (S) = 16.67%
The above percentage implies that ABC Co. will incur 16.67% lower costs by producing both products together.
Conclusion
Economies of scope is a concept that relates to cost-saving through variety. It differs from economies of scale, which focuses on cost-saving through volume. Usually, companies can achieve economies of scope through diversifying their products. This process can lead to several other options, such as mergers and acquisitions, shared inputs and processes, etc.
