What it means
The idea is simple: sharing is cheaper than duplicating. A bakery that already has ovens, delivery vans and shop staff can add cakes to its bread range at a lower extra cost than a brand-new cake business would face.
The shared assets are paid for once but used to make more than one product. Economies of scope are often confused with economies of scale, but they are different.
Scale savings come from producing more of the same thing, so the cost per unit falls as volume rises. Scope savings come from producing a wider variety, so the cost of the whole range is lower than the cost of making each product alone.
Typical sources of scope savings include shared production lines, a single sales team selling several products, one distribution network and common brand or technology costs. A bank that sells current accounts, mortgages and insurance through the same branches and customer database is a good example.
The marginal cost of cross-selling to an existing customer is far lower than the cost of finding a new one. Managers use the idea when deciding whether to diversify, acquire another business or add a new product line.
If the combined cost is lower than the sum of the separate costs, there is a financial case for combining them. If there are no shared resources, there is no scope saving and the new line has to justify itself on its own.
Scope can also work against a company. Managing many products can bring complexity, a loss of focus and conflicts over shared resources, which is sometimes called diseconomies of scope.
A business that stretches too far may find its costs rising rather than falling. It is worth remembering that the saving is not automatic.
Someone has to plan how the shared assets will be used, and the extra products must fit the capacity that is available. Where this is done well, scope savings can be a lasting advantage that smaller, single-product rivals find hard to copy.
In practice
Real-world examples
Example 1
A dairy that makes milk also turns the cream into butter and the whey into protein powder. The collection lorries, the processing plant and the quality-control staff are shared by all three products. The cost of adding the extra products is much lower than building separate plants for each.
Example 2
An accounting firm that already audits companies adds tax advice and consulting for the same clients. The partners know the clients' businesses, so they spend less time on research and the firm shares its offices and software across all services. Revenue per client rises without a matching rise in cost.
Example 3
A streaming company uses the same technology platform, billing system and customer service team for films, music and podcasts. Launching the podcast service needs only new content and some extra staff, not a new infrastructure. The finance team records a lower cost per subscriber across the combined service.
Think of it
Economies of scope means doing more things together is cheaper than doing them separately.
Formula
Calculation
Degree of economies of scope = (Cost of producing A alone + Cost of producing B alone - Cost of producing A and B together) / Cost of producing A and B together
Suppose a company would spend $600,000 a year making product A on its own and $500,000 a year making product B on its own. Producing both together on shared equipment and staff costs $880,000.
Separate cost = 600,000 + 500,000 = $1,100,000.
Saving = 1,100,000 - 880,000 = $220,000.
Degree of economies of scope = 220,000 / 880,000 = 0.25, or 25%.
A positive result means there are economies of scope; a negative result would mean the products are cheaper to make separately.Case study
Seen in the real world
Riverbend Foods is an illustrative, fictional company that sold frozen pizzas from a single factory. The sales director proposed adding frozen garlic bread, but the board worried about the cost of a separate production line.
The finance manager compared two options. Making the garlic bread in a new standalone plant would cost $700,000 a year to run, while adding it to the existing site, using the same freezers, warehouse and delivery routes, would cost $430,000 a year.
The saving of $270,000 was the economy of scope, and the board approved the shared option. The illustrative lesson is that the case for adding a product often rests on the assets it can borrow from the existing business.
Watch out
Common mistakes
- Confusing economies of scope with economies of scale, when scope is about variety and scale is about volume.
- Assuming that any diversification creates savings, even where the products share no resources.
- Ignoring the extra complexity of managing a wider range, which can erase the saving.
Questions
People also ask
What is an example of economies of scope?
A supermarket selling groceries, clothing and banking services through the same stores and brand shares many costs across the different lines.
How do I know whether a business has economies of scope?
Compare the cost of producing the products separately with the cost of producing them together, and see whether the combined cost is lower.
Can there be diseconomies of scope?
Yes, if a company becomes too diversified, the added complexity, coordination and loss of focus can push the combined cost above the separate costs.