Economies of scope refers to the cost savings and efficiencies generated  by the joint production or distribution  of final goods and services. Rather than specializing in a single product,  a firm can promote  its profitability as well as control some of its market risks by diversifying its product  line to take advantage of inherent and acquired economic, technical, and organizational advantages. In the late 19th and early 20th centuries, large firms noticeably began to develop into multibusiness firms; but less conspicuously and often on a much smaller scale, other individual manufacturers with comparable incentives became multiproduct firms. Profit maximizing remains a core assumption in standard  business models and firms that produce related products can often do so at lower average production costs.

The basis for the joint production of goods, or economies of scope, can vary in the particular  but generally it occurs when a manufacturer utilizes common material inputs (including specialized labor skills) within  existing  production  and  managerial  facilities to fabricate related final goods. Consequently,  a particular  firm can become more efficient and more profitable in production without  necessarily altering the size or scale of its operations.

Since multiproduct firms  have  the  capability  to start  and  stop  production relatively quickly, it also suggests that even in situations where there are a limited number  of firms, a market  may nevertheless  be fairly competitive in practice. However there are situations where there are trade-offs between economies of scale and scope, so the relative mix and number of specialized and integrated  establishments  and/or firms  can  be  influenced  by relative  market  conditions. Efficiency is ultimately promoted  by improved coordination and managerial advances, but given that technological variances persist across various sectors of the economy, there will likely not be a standardized model of firm specialization and integration.

The ability of a particular  operating  unit to engage in joint production will be inhibited by any inadequate and undependable  flows in the inputs  needed  in the production process, but given sufficient resources and market conditions,  a firm could reliably use its assets to manufacture,  market,  and distribute  different  but related goods. There are technical and market benefits for producing  different  yet related  goods, since the manufacturer’s advantages are centered  in its abilities to employ its existing and often specialized resources at full capacity and thus cost efficiency as well as to diversify its product offerings enough so the firm might avoid or at least delay market saturation.  A manufacturer operating below capacity can reduce its variable or operating costs somewhat but its fixed or overhead costs remain even with idle production facilities. The firm’s relative efficiency (its average cost of production) can be measured  by summing  its fixed and variable costs relative to its level of output.

Firms  with  sizable  fixed  costs  cannot   realistically  afford  to  underutilize   production  capacity. For instance,  consider  the example of an electronics manufacturer that develops an integrated  circuit to be used in a line of high-quality and long-lasting handheld electronic calculators. The technical expertise needed to design and build their integrated  circuitry may well have required  significant overhead (fixed) costs, but if the firm intends to manufacture only electronic  calculators,  it faces higher  average costs once they have saturated the existing calculator market. On the other hand, the manufacturer’s available workforce, production facilities, and technical innovations  may find application  in any number  of related products  (such as electronic watches, musical instruments, cameras, and other digital devices) that  could  be  efficiently and  profitably  manufactured, marketed,  and distributed  by the firm within its existing resources and organization.

Economies of scale and scope played a significant role in the  years from  around  1880 until  the  start of World  War I as big business began to dominate several industries including oil, steel, chemicals, electricity, machinery, automobiles, and tobacco. Several of these  industries  had  been  transformed not only by the adoption of continuous-process production techniques  and  more  functional  interchangeable parts but also by the implementation of more sophisticated  and professional forms of business organization.  Economies of scale, cost savings, and  efficiencies related  to  the  same  activity, often get more  widespread  notice  than  do economies  of scope, but this may be due more  to the sensationalism of bigness rather  than  the  realization  that  it is more  practical  for many firms to consider  scope ahead of scale as a means to reduce costs.

Bibliography:   

  1. Elizabeth Bailey and  Ann  Friedlaender, “Market  Structure   and  Multiproduct  Industries,”  Journal  of Economic Literature  (September  1982);
  2. Alfred D. Chandler, Scale and  Scope: The Dynamics  of Industrial Capitalism  (Harvard/Belknap,  1990);
  3. Mary Edwards, Regional and  Urban  Economics and  Economic Development: Theory and Methods (Auerbach Publications, 2007);
  4. Hajargasht, T. Coelli, and D. S. Rao, “A Dual Measure of Economies of Scope,” Economics Letters (v.100/2, 2008);
  5. John Panzar and Robert Willig, “Economies of Scope: In Sustainability Analysis,” American Economic Review (May 1981);
  6. Burkhard Schwenker  and  Stefan  Botzel, Making Growth Work: How Companies Can Expand and Become More Efficient (Springer, 2007);
  7. David Teece, “Economies of Scope and the Scope of the Enterprise,” Journal of Economic Behavior and Organization (September 1980).