Economies of Scope

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Economies of Scope

Economies of scope are cost advantages that result when firms provide a variety of products rather than specializing in the production or delivery of a single product or service. Economies of scope also exist if a firm can produce a given level of output of each product line more cheaply than a combination of separate firms, each producing a single product at the given output level. Economies of scope can arise from the sharing or joint utilization of inputs and lead to reductions in unit costs. Scope economies are frequently documented in the business literature and have been found to exist in countries, electronic-based B2B (business-to-business) providers, home healthcare, banking, publishing, distribution, and telecommunications.

METHODS OF ACHIEVING ECONOMIES OF SCOPE

Flexible Manufacturing

The use of flexible processes and flexible manufacturing systems has resulted in economies of scope because these systems allow quick, low-cost switching of one product line to another. If a producer can manufacture multiple products with the same equipment and if the equipment allows the flexibility to change as market demands change, the manufacturer can add a variety of new products to their current line. The scope of products increases, offering a barrier to entry for new firms and a competitive synergy for the firm itself.

Related Diversification

Economies of scope often result from a related diversification strategy and may even be termed "economies of diversification." This strategy is made operational when a firm builds upon or extends existing capabilities, resources, or areas of expertise for greater competitiveness. According to Hill, Ireland, and Hoskisson in their best selling strategic management textbook, Strategic Management: Competitiveness and Globalization, firms select related diversification as their corporate-level strategy in an attempt to exploit economies of scope between their various business units. Cost-savings result when a business transfers expertise in one business to a new business. The businesses can share operational skills and know-how in manufacturing or even share plant facilities, equipment, or other existing assets. They may also share intangible assets like expertise or a corporate core competence. Such sharing of activities is common and is a way to maximize limited constraints.

As an example, Kleenex Corporation manufactures a number of paper products for a variety of end users, including products targeted specifically for hospitals and health care providers, infants, children, families, and women. Their brands include Kleenex, Viva, Scott, and Cottonelle napkins, paper towels, and facial tissues; Depends and Poise incontinence products; Huggies diapers and wipes; Pull-Ups, Goodnites, and Little Swimmers infant products; Kotex, New Freedom, Litedays, and Security feminine hygiene products; and a number of products for surgical use, infection control, and patient care. All of these product lines utilize similar raw material inputs and/or manufacturing processes as well as distribution and logistics channels.

Mergers

The merger wave that swept the United States in the late 1990s and early 2000s is, in part, an attempt to create scope economies. Mergers may be undertaken for any number of reasons. "As a rule of thumb," explained Rob Preston in an article about the trouble with mergers, "'scope' acquisitions—moves that enhance or extend a vendor's product portfolio—succeed more often than those undertaken to increase size and consolidate costs." Pharmaceutical companies, for example, frequently combine forces to share research and development expenses and bring new products to market. Research has shown that firms involved in drug discovery realize economies of scope by sustaining diverse portfolios of research projects that capture both internal and external knowledge spillovers.

Linked Supply Chains

Today's linked supply chains among raw material suppliers, other vendors, manufacturers, wholesalers, distributors, retailers, and consumers often bring about economies of scope. Integrating a vertical supply chain results in productivity gains, waste reduction, and cost improvements. These improvements, which arise from the ability to eliminate costs by operating two or more businesses under the same corporate umbrella, exist whenever it is less costly for two or more businesses to operate under centralized management than to function independently.

The opportunity to gain cost savings can arise from interrelationships anywhere along a value chain. As firms become linked in supply chains, particularly as part of the new information economy, there is a growing potential for economies of scope. Scope economies can increase a firm's value and lead to increases in performance and higher returns to shareholders. Building economies of scope can also help a firm to reduce the risks inherent in producing a single product or providing a service to a single industry.

BIBLIOGRAPHY

Banker, R.D., H.H. Chang, and S.K. Majumdar, S. K. "Economies of Scope in the U.S. Telecommunications Industry." Information Economies and Policy. June 1998.

Fraquelli, Giovanni, and Massimiliano Piacenzo, Davide Vannoni "Scope and Scale Economies in Multi-Utilities." Applied Economics. 10 October 2004.

Henderson, R., and I. Cockburn. "Scale, Scope, and Spillovers: The Determinants of Research Productivity in Drug Discovery." RAND Journal of Economics. Spring 1996.

Hill, M.A., R.D. Ireland, and R.E. Hoskisson. Strategic Management: Competitiveness and Globalization. Fourth Edition. South-Western College Publishing, 2001.

Kass, D. I. "Economies of Scope and Home Healthcare." Health Services Research October 1998.

Ryan, M. J. "The Distribution Problem, the More for Less (Nothing) Paradox and Economies of Scale and Scope." European Journal of Operational Research. February 2000.

Preston, Rob. "The Trouble with Mergers." Network Computing. 5 March 2005.

Woodall, P. "Survey: The New Economy: Falling Through the Net?" The Economist 23 September 2000.

Hillstrom, Northern Lights