Economies Of Scope
There are many economic related terms that are used extensively, but their true meaning is not understood in entirety. One such example is ‘economies of scope’. Essentially it is a theory that propagates the concept that the average cost can be reduced by a company by diversifying into more than one product. The concept is utilizing the same set of resources to create more than one product. So while the product range expands the essential input resources remain pretty much same.
Origin Of ‘Economies Of Scope’
This specific term and the concept, ‘economies of scope’ was developed by the famous economists John C. Panzar and Robert D. Willig between 1977-1981. Essentially it is a theory that rationalized product diversification and the resulting cost advantage.
One of the best examples of this is perhaps the combo meals that you can get at most fast food joints like McDonalds. These firms when they make both burgers and French fries together the average cost of making the two is relatively lower that the cost of creating these two separately by two separate firms. This cost advantage comes from the fact that they are using the same kind of resources to be produced and making the second one does not involve procurement of additional facilities or instruments.
Advantages Of Economies Of Scope
As it is quite apparent in the example above, there are several obvious advantages of economies of scope.
- They help the manufacturers achieve flexibility in product mix
- Enables the manufacturer to be better prepared for changing market dynamics
- Reduces overall cost of production and limits wastage and training expenses
- Helps manufacturers control their business prospects in a more constructive fashion
- Limits risks related to slowing demand, economic upheaval and any sudden slump in the particular sector
- Distribution and marketing costs of multiple products also become cheaper as the same set of resources is put to use to achieve these
- This kind of product mix also enables effective information management
How To Achieve Economies Of Scope?
Then the question is how do you achieve this? Here are some ways to gain economies of scope.
- Diversifying in Related Field: If you are making hamburgers, diversifying into making chicken nuggets or French fries won’t be a huge challenge on resources as they would require pretty much similar apparatus. Essentially what happens, in this case, is businesses share operational skills as well as manufacturing know-how and marketing resources.
- Merger And Acquisition: This is another cost-effective means of achieving economies of scope. When an Indian automobile giant, Tata Motors wanted to diversify and expand they chose to acquire another globally present firm, Jaguar Land Rover and improved on the available resources. The amount they paid for this merger would be less than what they would have to shell out individually for establishing all of these plants in different locations across the world and look at undertaking distribution and marketing operations separately for them.
Economies of scope have often been the main impetus behind the formation of many world-famous conglomerates. It is perhaps the quickest route to achieving business diversity without incurring a huge expense.