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