Economies of Scope
What is Economies of Scope?
Economies of scope exist when it is cheaper to produce several products together than to produce each separately.
They arise from sharing inputs, facilities, or expertise across product lines (e.g., a dairy making milk and cheese). Economies of scope are about variety of products, whereas economies of scale are about volume of a single product.
Economies of Scope: a worked example
A dairy is deciding whether to run one plant or two. Producing 10,000 gallons of milk on its own costs $40,000. Producing 12,000 pounds of cheese on its own costs $30,000. Producing both in the same plant, sharing the herd, the chilling equipment, and the delivery trucks, costs $56,000. Separate production would cost 40,000 plus 30,000, or $70,000, so joint production saves 70,000 minus 56,000, or $14,000. The standard scope measure divides that saving by the joint cost: 14,000 divided by 56,000 equals 0.25, so the dairy has 25 percent economies of scope. Any positive value counts. Had the joint plant cost $75,000 because the two lines fought over the same chilling capacity, the measure would be 70,000 minus 75,000 over 75,000, or negative 0.067, a diseconomy of scope.
The mistake students make with economies of scope
A merger memo promising cross selling gets read as economies of scope. The two claims sit on different sides of the ledger. Scope is a statement about cost, that one firm making milk and cheese together spends less than two firms making them apart, with the quantity of each held fixed. Selling more cheese because the milk customers are already in the shop raises revenue, and it can be worth having, but it is not a scope economy. Check that the claimed gain shows up as a lower cost of producing the same output before reaching for the term.
Economies of Scope questions
What is the formula for economies of scope?
The scope measure equals the cost of producing each product separately, minus the cost of producing them together, all divided by the cost of producing them together. Written out for two products, that is C(A) plus C(B) minus C(A,B), over C(A,B). A positive result means economies of scope, a value of zero means the pairing changes nothing, and a negative result means diseconomies of scope.
What is the difference between economies of scale and economies of scope?
Economies of scale come from volume, producing more of a single product so that fixed costs spread over more units and long run average cost falls. Economies of scope come from variety, producing two or more different products together so that a shared input serves both. A bakery that halves its unit cost by doubling loaf output has scale, while a bakery that saves by using the same ovens for bread and pastries has scope.
What causes economies of scope?
Shared inputs cause them. A single distribution network, one brand and sales force, one research team, one expensive machine, or a by-product of one process that feeds another can all serve several product lines at once. The cost of that input gets paid once and split across products, so joint average cost lands below the sum of standalone costs. When no input can be shared, adding product lines simply adds cost.
Related terms
Common comparisons
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