Economies of scope
Economies of scope are conceptually similar to economies of scale. Whereas economies of scale for a firm primarily refers to reductions in the average cost (cost per unit) associated with increasing the scale of production for a single product type, economies of scope refers to lowering the average cost for a firm in producing two or more products. The term and the concept's development are attributed to Panzar and Willig (1977, 1981). Here, economies of scope make product diversification efficient if they are based on the common and recurrent use of proprietary know-how or on an indivisible physical asset. For example, as the number of products promoted is increased, more people can be reached per unit of money spent. At some point, additional advertising expenditure on new products may become less effective (an example of diseconomies of scope). Related examples include distribution of different types of products, product bundling, product lining, and family branding.
If a sales force sells several products, it can often do so more efficiently than if it is selling only one product. The cost of its travel time is distributed over a greater revenue base, so cost efficiency improves. There can also be 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: it can be more efficient to ship a range of products to any given location than to ship a single type of product to that location.
Further economies of scope occur when there are cost savings arising from byproducts in the production process. An example would be the benefits of heating from energy production having a positive effect on agricultural yields.
A company that sells many product lines, sells in many countries, or both will benefit from reduced risk levels as a result of its economies of scope. If one of its product lines falls out of fashion or if one country has an economic slowdown, the company will likely be able to continue trading.
Not all economists agree on the importance of economies of scope. Some argue that the concept applies only to certain industries, and then only rarely.
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 neither necessary nor sufficient. Economies of scope are, however, a necessary condition.
As a matter of simplification, it is generally accepted that, should economies of scale and of scope both apply, as well as sunk costs or other entry barriers, then markets may have monopoly features.
- • John C. Panzar and Robert D. Willig (1977). "Economies of Scale in Multi-Output Production," Quarterly Journal of Economics, 91(3), pp. 481-493.
• _____ (1981). "Economies of Scope," American Economic Review, 71(2), 71(2), pp. 268-272. The 1981 paper gave a precise definition.
- David J. Teece (1980). "Economies of Scope and the Scope of the Enterprise," Journal of Economic Behavior & Organization,1(3), 1980, p. 223. [Pp. 223-247.] Abstract. Reprinted in David Faulkner, ed. (2002), Strategy: Critical Perspectives on Business and Management, v. 3, p. 33.