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 output. 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 economics 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 operationalized 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, firms select related diversification as their corporate-level strategy in an attempt to exploit economies of scope between their various business units. The 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 that utilize similar raw material inputs and/or manufacturing processes as well as distribution and logistics channels.
MERGERS. The merger wave in the United States today is, in part, an attempt to create scope economies. Pharmaceutical companies frequently combine forces to share research and development expenses to bring new products to market. According to research by Henderson and Cockburn in 1996, 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 same corporate umbrella, exist whenever it is less costly for two or more businesses to operate under centralized management than to function independently.
Cost savings opportunities can stem from interrelationships anywhere along businesses' value chain. As firms become linked in supply chains, particularly as part of the new E-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. The scope economies can also help a firm to reduce risks.
Further Reading:
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.
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. 4th ed. Cincinnati, Ohio: 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.
Woodall, P. "Survey: The New Economy: Falling Through the Net?" The Economist. September 23, 2000.
