Editing Economies of scope

{{Use American English|date = February 2019}}
{{Short description|Efficiencies formed by variety of products or services offered}}
{{Use dmy dates|date = February 2019}}

'''Economies of scope''' are "efficiencies formed by variety, not volume" (the latter concept is "[[economies of scale]]").<ref name=hbr>{{cite news|author1=Joel D. Goldhar|author2=Mariann Jelinek|title=Plan for Economies of Scope|url=https://hbr.org/1983/11/plan-for-economies-of-scope|work=Harvard Business Review|date=November 1983|access-date=2020-05-08}}</ref> In the field of [[economics]], "economies" is synonymous with cost savings and "scope" is synonymous with broadening production/services through diversified products. Economies of scope is an economic theory stating that [[Average cost|average total cost (ATC)]] of production decrease as a result of increasing the number of different goods produced.<ref name="econ" /> For example, a [[filling station|gas station]] primarily sells gasoline, but can sell soda, milk, baked goods, etc. and thus achieve economies of scope since with the same facility, each new product attracts new dollars a customer would have spent elsewhere.<ref name=econ>{{cite news|title=Economies of scale and scope|url=http://www.economist.com/node/12446567|newspaper=The Economist|date=October 20, 2008}}</ref> The business historian [[Alfred_D._Chandler_Jr.|Alfred Chandler]] argued that economies of scope contributed to the rise of American business corporations during the 20th century.<ref>{{cite book |last1=Chandler |first1=Alfred Dupont |title=Scale and scope: the dynamics of industrial capitalism |date=2004 |publisher=Belknap Press of Harvard Univ. Press |location=Cambridge |isbn=978-0674789951 |edition=7. print}}</ref> 

==Economics==
The term and the development of the concept are attributed to economists John C. Panzar and Robert D. Willig (1977, 1981).<ref name="Scope">{{cite journal|author1=John C. Panzar|author2=Robert D. Willig|title=Economies of Scale in Multi-Output Production|journal=[[Quarterly Journal of Economics]] |date=1977 |volume=91 |issue=3 |pages= 481–493 |doi= 10.2307/1885979 |jstor= 1885979}}</ref><ref name=scope81>{{cite journal|author1=John C. Panzar|author2=Robert D. Willig |title= Economies of Scope|journal=[[American Economic Review]]|date=May 1981 |volume=71 |issue=2 |pages=268–272 |jstor= 1815729}}</ref> Their 1981 article notes that they had coined the term several years previously, and felt that its logic was "intuitively appealing".<ref name=scope81 />{{rp|268}}

Whereas economies of scale for a firm involve reductions in the [[average cost]] (cost per unit) arising from increasing the scale of production for a single product type, economies of scope involve lowering average cost by producing more types of products. Hofstrand notes that the two types of economy "are not mutually exclusive".<ref>Hofstrand, D., [https://www.extension.iastate.edu/agdm/wholefarm/html/c5-205.html Economies of Scope], ''Iowa State University: University Extension'', updated March 2019, accessed on 2 October 2024</ref>

Economies of scope make [[Diversification (marketing strategy)|product diversification]] efficient, as part of the [[Ansoff Matrix]], if they are based on the common and recurrent use of proprietary know-how or on an indivisible physical asset.<ref>{{cite journal|last1=Teece|first1=David J.|title=Economies of Scope and the Scope of the Enterprise|journal=Journal of Economic Behavior & Organization|date=September 1980|volume=1|issue=3|pages=223–247|doi=10.1016/0167-2681(80)90002-5}}</ref> For example, as the number of products promoted is increased, more people can be reached per unit of money spent. At some point, however, additional [[advertising]] expenditure on new products may become less effective (an example of the opposite effect, diseconomies of scope). Related examples include [[distribution (business)|distribution]] of different types of [[product (business)|products]], [[product bundling]], [[product lining]], and [[family branding]].

Economies of scope exist whenever the [[total cost]] of producing two different products or services (X and Y) is lower when a single firm instead of two separate firms produces by themselves.<ref>{{Cite web|last=Lukas|first=Erica|date=23 April 2014|title=Horizontal Boundaries of the Firm|url=https://pt.slideshare.net/EricaLukas/the-horizontal-boundaries-of-the-firm/2|website=slideshare}}</ref>

:<math> TC(QX + QY) < TC(QX) + TC(QY)</math>

The degree of economies of scope (DSC) formula is as follows:

:<math>DSC={TC(q1)+TC(q2)-TC(q1,q2) \over TC(q1,q2)} </math>

If <math>DSC > 0</math>, there are economies of scope. It is recommended that two firms [[cooperate]], or systems merge, to produce together.

If <math>DSC = 0</math>, there are no [[economies of scale]] nor economies of scope.

If <math>DSC < 0</math>, there are diseconomies of scope. It is not recommended for the two firms to work together.<ref name=":0">{{cite book | doi=10.1007/1-4020-0612-8_279 | chapter=Economies of Scope | title=Encyclopedia of Production and Manufacturing Management | date=2000 | page=177 | isbn=978-0-7923-8630-8 }}</ref> Diseconomies of scope means that it is more efficient for two firms to work separately since the merged cost per unit is higher than the sum of stand-alone costs.<ref name=":0" />

For a company, if it wants to achieve diversity, the economy of scope is related to resource, and it is similar to resource requirements between enterprises. Relevance supports the economy by improving the applicability of resources in the merged companies and supporting the economical use of resources (such as employees, factories, technical and marketing knowledge) in these companies.<ref name=":1">{{cite journal |last1=Arkadiy V |first1=Sakhartov |title=Economies of Scope, Resource Relatedness, and the Dynamics of Corporate Diversification: Economies of Scope, Relatedness, and Dynamics of Diversification |journal=Strategic Management Journal |date=November 2017 |volume=38 |issue=11 |pages=2168–2188|doi=10.1002/smj.2654 |s2cid=168871444 |url=https://repository.upenn.edu/cgi/viewcontent.cgi?article=1254&context=mgmt_papers }}</ref>

Unlike economies of scale, "which can be reasonably be expected to plateau into an [[Diminishing returns|efficient state]] that will then deliver high-margin revenues for a period", economies of scope may never reach that plateau, or point at all. As Venkatesh Rao of Ribbonfarm explains it, "You may never get to a point where you can claim you have right-sized and right-shaped the business, but you have to keep trying. In fact, managing the ongoing scope-learning process is the essential activity in business strategy. If you ever think you’ve right-sized/right-shaped for the steady state, that’s when you are most vulnerable to attacks."<ref name=venkat>{{cite news|author1=Venkatesh Rao|title=Economies of Scale, Economies of Scope|url=http://www.ribbonfarm.com/2012/10/15/economies-of-scale-economies-of-scope/|work=Ribbonfarm|date=October 15, 2012}}</ref>

[[Research and development]] (R&D) is a typical example of economies of scope. In R&D economies, unit cost decreases because of the spreading R&D expenses. For example, R&D labs require a minimum number of scientists and researchers whose labour is indivisible. Therefore, when the output of the lab increases, R&D [[Average cost|costs per unit]] may decrease. The substantial indivisible invest in R&D may also implies that average fixed costs will fall rapidly due to the output and sales increase. The ideas from one project can help another project (positive spillovers).<ref>{{Cite journal|last=Akerman|first=Anders|date=2018|title=A theory on the role of wholesalers in international trade based on economies of scope|journal=Canadian Journal of Economics|language=en|volume=51|issue=1|pages=156–185|doi=10.1111/caje.12319|s2cid=10776934|issn=1540-5982|doi-access=free}}</ref><ref>{{Citation|last=Hinloopen|first=Jeroen|title=Chapter 5 Strategic R&D with Uncertainty|date=2008-01-01|url=https://doi.org/10.1016/S0573-8555(08)00205-8|work=The Economics of Innovation|volume=286|pages=99–111|editor-last=Cellini|editor-first=Roberto|series=Contributions to Economic Analysis|publisher=Emerald Group Publishing Limited|doi=10.1016/s0573-8555(08)00205-8|isbn=978-0-444-53255-8|access-date=2021-04-20|editor2-last=Lambertini|editor2-first=Luca|url-access=subscription}}</ref>

[[Strategic fit]], also known as complementarity that yields economies of scope, is the degree to which, or what kind of activities of different sections of an entrepreneur corporates with each other that complement themselves to achieve [[competitive advantage]]. Throughout the strategic fit, diversified firms can merge with interrelated businesses and share the resources. These kind of corporations can limit the duplication of research and developments, provide a more planned and developed selling pipelines for businesses.<ref name=":1" />

=== Joint costs ===
The essential reason for economies of scope is some substantial [[joint cost]] across the production of multiple products.<ref>{{cite book |last1=Png |first1=Ivan |title=Managerial Economics |date=1998 |publisher=Blackwell |location=Malden, MA |isbn=1-55786-927-8 |pages=224–227}}</ref> The cost of a cable network underlies economies of scope across the provision of broadband service and cable TV. The cost of operating a plane is a joint cost between carrying passengers and carrying freight, and underlies economies of scope across passenger and freight services.

=== Natural monopolies ===
While in the single-output case, economies of scale are a sufficient condition for the verification of a [[natural monopoly]], in the multi-output case, they are not sufficient. Economies of scope are, however, a necessary condition. As a matter of simplification, it is generally accepted that markets may have monopoly features if both economies of scale and economies of scope apply, as well as [[sunk cost]]s or other [[barriers to entry]].

===Empirical Evidence===
In a 2022 article in the ''[[Journal of Political Economy]]'', researchers used data from the [[Manufacturing in India|Indian manufacturing sector]] to estimate the economies of scope arising from factor-biased productivities that are jointly used across product lines. They found that economies of scope are important determinants of product market entry, and that they change entry probabilities by several percentage points.<ref>{{cite journal |last1=Boehm |first1=Johannes |last2=Dhingra |first2=Swati |last3=Morrow |first3=John |title=The Comparative Advantage of Firms |journal=Journal of Political Economy |date=1 December 2022 |volume=130 |issue=12 |pages=3025–3100 |doi=10.1086/720630}}</ref>

==Examples==
Economies of scope arise when businesses share centralized functions (such as finance or [[marketing]]) or when they form interrelationships at other points in the business process (e.g., [[cross-selling]] one product alongside another, using the outputs of one business as the inputs of another).<ref name=econ/>

Economies of scope served as the impetus behind the formation of large international [[Conglomerate (company)|conglomerates]] in the 1970s and 1980s, such as [[BTR plc|BTR]] and [[Hanson plc|Hanson]] in the [[UK]] and [[ITT Corporation|ITT]] in the [[United States]]. These companies sought to apply their financial skills across a more diverse range of industries through economies of scope. In the 1990s, several conglomerates that "relied on [[cross-selling]], thus reaping economies of scope by using the same people and systems to market many different products"—i.e., "selling the financial products of the one by using the sales teams of the other"—which was the logic behind the 1998 merger of [[The Travelers Companies|Travelers Group]] and [[Citigroup|Citicorp]].<ref name=econ/>

The application of information technology to manufacturing has allowed processes to become more flexible and generated more opportunities for economies of scope than were possible with older forms of technology, when equipment tended towards greater specialization in how it could be used. Goldhar and Jelinek argue that the use of computers in manufacturing generates economies of scale via the following capabilities: 

*extreme flexibility in [[product design]] and product mix
*rapid responses to changes in market demand, product design and mix, output rates, and equipment scheduling
*greater control, accuracy, and repeatability of processes
*reduced costs from less waste and lower training and [[changeover]] costs
*more predictability (e.g., maintenance costs)
*faster [[Throughput (business)|throughput]] thanks to better machine use, less [[Work in process|in-process]] [[inventory]], or fewer stoppages for missing or broken parts:
* [[Distributed control system|distributed]] [[Process control|processing capability]] made possible and economical by the encoding of process information in easily replicable software
*reduction in [[risk]]: a company that sells many [[product line]]s, sells in many countries, or both will benefit from reduced risk (e.g., if a product line falls out of fashion or if one country has an economic slowdown, the company will likely be able to continue trading).<ref name=hbr />

Goldhar and Jellinek note that higher machine speeds are now both possible and economically feasible due to the sensory and control capabilities of "smart" machines and the [[information management]] capabilities of [[computer-aided manufacturing]] (CAM) software.<ref name=hbr />

[[3D printing]] is another area which can generate economies of scope,<ref>{{cite news|last1=Lee|first1=Leonard|title=3D Printing – Transforming The Supply Chain: Part 1|url=http://insights-on-business.com/electronics/3d-printing-transforming-the-supply-chain-part-1/|work=IBM Insights on Business blog|date=April 26, 2013}}</ref> as it is an example of the same equipment producing "multiple products more cheaply in combination than separately".<ref name=hbr/>

If a sales team sells several products, it can often do so more efficiently than if it is selling only one product because the cost of travel would be distributed over a greater revenue base, thus improving cost efficiency. There can also be [[synergy|synergies]] between products such that offering a range of products gives the consumer a more desirable product offering than would a single product. Economies of scope can also operate through distribution efficiencies—i.e. it can be more efficient to ship to any given location a range of products than a single type of product.

Further economies of scope occur when there are cost savings arising from byproducts in the production process, such as when the benefits of [[cogeneration|heating from energy production]] has a positive effect on [[agricultural yield]]s.{{Citation needed|date=January 2021}}

== See also ==
*[[Economic efficiency]]
*[[Mass customization]]
*[[Theory of the firm]]
*[[Economies of scale]]
*[[Economies of density]]
*[[Joint cost]]

==References==
{{reflist}}

{{microeconomics}}

{{DEFAULTSORT:Ecovnomies Of Scope}}
[[Category:Monopoly (economics)]]
[[Category:Production economics]]