Economies+of+scope


 * Definition**

Economies of scope occur when the total cost of producing two types of outputs together is less than the total cost of producing each type of output separately (Baye, 189).

Cost of producing Q1 and Q2 is less together than separately. Formula:

C(Q1,0) + C(0,Q2) > C(Q1, Q2)


 * Exploiting Economies of Scope**

A good way to exploit economies of scope is to expand product range and take advantage of the value of existing brands. Because all factor inputs are variable in the long-run, the scope of production can change. The nature of economies of scope can change the structure of industry competition and the profitability of supplying to consumers over time. (http://www.tutor2u.net/economics/content/essentials/economies_scale_scope.htm)


 * Potential Barrier to Entry**

Economies of scope tend to encourage large firms because efficient production requires multi-product production. Because of this, larger firms potentially have greater access to capital markets, making it more difficult for smaller firms to obtain funds. This higher cost of capital could be a possible barrier to entry. In the most extreme cases, economies of scope could result in monopoly power (Baye, 283).


 * Potential Competitive Advantage**

Economies of scope can actually help companies gain a competitive advantage. Economies of scope can help to lower expenses on a per-unit basis and enhance profitability. Economies of scope can also force companies who are not cost-efficient out of the industry. (http://www.streetauthority.com/terms/e/economies-of-scope.asp)


 * Reasons for Economies of Scope**

1. Joint use of production facilities or other inputs: Many companies share facilities or rent out their facilities or machines in order to save costs. An example of this would be a manufacturer who rents out their machines on the weekend when they are not operating.

2. Joint marketing or administration: An example of this would be for a company to advertise all of their products, creating brand awareness and brand image, rather than each product individually.

3. Production of one good provides the other as a by-product: An example would be the production of bread, which then could be used to make sandwiches. [|(http://astro.temple.edu/~pippin/Scl&Scp.htm)]


 * Achieving Economies of Scope**

Flexible manufacturing – a company’s ability to quickly and effectively switch manufacturing processes to produce new products can lead to economies of scope. The cost of switching is low, and multiple products can be produced using the same resources.

Diversification – a company’s operational expertise and specialization can be applied to other products within the organization. For instance, Proctor & Gamble is able to produce a wide range of products because they can afford to hire designers and marketers who can use their skill across product lines. Spreading out the cost to many products lowers the cost of production for each one.

Mergers – sharing of research and development expenses helps drive down costs and allow diverse portfolios of knowledge and products to be established.

Supply Chains – linking the supply chains and allowing cross-over communication between wholesalers, distributors, etc… arises the ability to eliminate costs. It is less expensive to have businesses operate their supply chains under the same umbrella rather than have operate independently. http://mba.tuck.dartmouth.edu/pages/faculty/constance.helfat/PDF%20Files/relateddiversSMJrev.pdf


 * Examples of Economies of Scope**

Home healthcare, banking, publishing, telecommunications, electronic-based B2B providers, distribution.

Automobile manufacturers use the same practices, processes, tools, and materials to design and prototype multiple products.

Economies of scope are the main means of systematic reuse in commercial construction.

Microsoft hires programmers, designers, and marketing experts and uses their experience and skills over a range of software products. As a result, Microsoft organizes resources that produce software at a lower cost than an individual can who buys all these services in markets (Parkin, 211).


 * Problems**

1. Refers to economies in which processes and materials used in one product, can be used to make other related products.

(a) economies of scale (b) lean manufacturing (c) economies of scope (d) simultaneous engineering

2. Answer: (c) economies of scope is present when it costs less to produce two related products rather than producing each one separately.

2. Which of the following is the purpose of economies of scale?

(a) Joint use of facilities (b) Joint marketing (c) Production of one good provides the other as a by-product (d) All of the above are purposes of economies of scale

2. Answer: (d) All of the selections are reasons or purposes of economies of scale.

3. True or False. When a business experiences economies of scope to such a degree that they are the only one capable of surviving and thriving in an area, a natural monopoly may develop.

3. Answer: True. A company experiencing economies of scope may develop into a natural monopoly if they are the only ones capable of efficiently and effectively producing a specialized product.

4. The merger of two pharmaceutical companies to share research and development costs is an example of a. Economies of scale b. Joint marketing c. Economies of scope d. Returns to scale

4. Answer: c Economies of scope. Sharing of resources minimizes costs and promotes an environment where ideas can flourish and then overflow without the additional expenses incurred by separate companies. Having needed and expensive technology on-hand can make life easier for

5. The area labeled "B" corresponds to which of the following: a. Economies of Scope b. Economies of Scale c. Diseconomies of Scale d. Increasing Returns to Scale

Answer: c. The increasing average cost of additional output is a reflection of diseconomies of scale. At this point, increased production is resulting is negatively impacting the costs of the company.