Economies of Scope – Definition

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Economies of Scope Definition

Economies of scope refer to lowering the average cost of goods and services by producing different products simultaneously. It is different from economies of scale where producing large quantity of products could decrease of average cost of production.

In the case of economies of scope, cost reduction can be achieved by producing more types of products rather than quantities of a single product.

For example, McDonald’s achieve cost efficiency from producing both French fries and hamburgers. The costs of production is reduced because french fries and hamburgers share inputs such as food storage, labor, and other production factors.

A Little More on What are Economies of Scope

Large firms aiming to achieve economies of scope attempt to cut their cost and achieve operational efficiency through a diversification strategy.

The company may achieve efficiencies by producing complementary goods and services. This allows the company to reduce the average and marginal cost in the long run. Complementary goods can be described as goods whose use depends upon other goods.

The company may also produce same product in different varieties for its ends users. For example, Proctor and Gamble used diversification strategy for its simple paper product by expanding its product line to numerous ends user such as consumer and hospital to achieve economies of scope.

Another way to achieve economies of scope is by merging or acquiring another company. Merging or acquiring another company enables the company to combine different product lines which diminishes their marginal and average cost.

Benefits of economies of scope, aside from operational efficiencies include: new customer acquisition and retention and reduced product line risk.

References for Economies of Scope

Academic Research on Economies of Scope

  • Economies¬†of¬†scope¬†and the¬†scope¬†of the enterprise, Teece, D. J. (1980).¬†Journal of economic behavior & organization,¬†1(3), 223-247. Based on the theoretical framework developed by Willamson, it was posited that the cost effectiveness of economies of scope does not have a definite significance on the scope of the business enterprise. This paper tries to investigate the rudiments of an efficiency-based theory of diversification. The theory rests on the idea that if economies of scope are based on the recurrent utilization of production inputs (tangible and intangible), then multiproduct enterprise or diversification is a productive way of organizing economic activities.
  • Economies¬†of¬†scope, Panzar, J. C., & Willig, R. D. (1981).¬†The American Economic Review,¬†71(2), 268-272. The authors created the term ‚Äėeconomies of scope‚Äô several years ago to describe a basic property of production: cost savings estimated from the scope not scale of the organization. The first part of this article shows that the author‚Äôs definition accurately characterizes the conditions that led to the development of multiproduct firms in competitive markets.
  • Institutions of higher education as multi-product firms:¬†Economies¬†of scale and¬†scope, Cohn, E., Rhine, S. L., & Santos, M. C. (1989) The review of economics and statistics, 284-290. Economists have acknowledged the multidimensional nature of higher education. The cost and production analysis of Institutions of Higher Education (IHE) have universally been regarded as unidirectional ignoring the multi-product nature of IHE. The main purpose of this article is to determine the multiple output cost function of IHE and calculate the economies of scale and scope of IHEs.
  • Economies¬†of scale and¬†scope¬†at depository financial institutions: A review of the literature, Clark, J. A. (1988) Economic Review,¬†73(8), 17-33. Due to recent changes in laws and regulations, banks and other depository financial institutions have had increased opportunities to enlarge their operations. This article investigates whether increased opportunities for growth will result in cost reduction. By studying the production and cost conditions that triumphed in the past, the author arrived at the conclusion that small, specialized institutions enjoy greater cost advantage than larger, diversified depository institutions.
  • Inter‚Äźtemporal¬†economies¬†of¬†scope, organizational modularity, and the dynamics of diversification, Helfat, C. E., & Eisenhardt, K. M. (2004).¬†Strategic Management Journal,¬†25(13), 1217-1232. The paper investigates the ability of diversified firms to benefit from both intra-temporal and inter-temporal economies of scope. However, much more emphasis is placed on inter-temporal economies of scope achieved by firms, through the redeployment of resources between contemporaneous businesses over time. This fact clearly outlines the distinction between intra and inter-temporal economies of scope. Therefore, the ability to obtain inter-temporal economies of scope through flexibility and variety of use of the resources posits that corporations do not need a high degree of coordination to benefit from related diversification.
  • Scale and¬†scope economies¬†in the multi-product banking firm, Gilligan, T., Smirlock, M., & Marshall, W. (1984). Journal of Monetary Economics,¬†13(3), 393-405. The objective of this article is to determine the bank cost functions that identify the multi-product nature of banking firms. This has been difficult in existing studies as the multiproduct nature of banks has been suppressed or hidden as a single output function. There is evidence to suggest that the cost function is characterized by economies of scope. The impacts of this discovery are discussed, and expansions of this method are proposed in this article.
  • Economies¬†of¬†scope¬†and¬†economies¬†of agglomeration, Goldstein, G. S., & Gronberg, T. J. (1984). Journal of Urban Economics,¬†16(1), 91-104. An urban agglomeration is the centralization of economic activities in a particular location. This article investigates the concept of agglomeration economies and its possible effects on industrial organization and urban structure. The concept of economies of scale is examined from a theoretical and empirical point of view. Based on the theory of multiproduct firms formulated by Panzar and Willig, the authors recommend an alternative perception of agglomerative economies.
  • Economies¬†of scale and¬†economies¬†of¬†scope¬†in multiproduct financial institutions: A study of British Columbia credit unions, Murray, J. D., & White, R. W. (1983).¬†The Journal of Finance,¬†38(3), 887-902. The study investigates the implications of economies of scale, economies of scope and other production characteristics in multiproduct financial institutions. A survey was carried out and the result depicted that quite a number of the credit unions in the sample experience substantial increasing returns to scale as they increase the level of production, cost saving and competitive advantage in their lending activities. Therefore, any decree that restricts the ability of credit unions to expand and diversify will lead to increased operating cost in the multiproduct financial institutions.
  • Economies¬†of scale and¬†economies¬†of¬†scope¬†in multiproduct financial institutions: Further evidence from credit unions, Kim, H. Y. (1986).¬†Journal of Money, Credit and Banking,¬†18(2), 220-226. By acknowledging the multiproduct nature of credit union, Murray and White were able to study the economies of scale and economies of scope for British Columbia‚Äôs credit unions. This article discusses the problems associated with economies of scope and scale in the credit union. It also provides new evidence for the expansion of the model developed by Murray and White.
  • A composite cost function for multiproduct firms with an application to¬†economies¬†of¬†scope¬†in banking, Pulley, L. B., & Braunstein, Y. M. (1992). The Review of Economics and Statistics, 221-230. The authors propose a composite cost function which merges a log-quadratic input and quadratic output price structure. This composite model is effective for evaluating subadditivity, economies of scale and other multiproduct properties. The benefits of the composite model are confirmed when they are applied to the economies of scope in banks.
  • Multimarket contact,¬†economies¬†of¬†scope, and firm performance, Gimeno, J., & Woo, C. Y. (1999).¬†Academy of Management Journal,¬†42(3), 239-259. This paper incorporates the efficiency and competitive effects of product-markets scope choice into an all-inclusive representation of economic performance. This representation was empirically tested in the U.S airline industry. The paper also shed lights on the mutual reliance existing between multipoint competition and economies of scope.

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