What are economies of scope? (Plus why it's important)
By Indeed Editorial Team
Published 13 April 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Economies of scope is a principle that refers to the combination of two or more production processes to create new products. It's important not to confuse this with economies of scale, which is another concept used to help decrease a company's costs. Understanding how a company can consolidate its existing practices using economies of scale often leads to a much more efficient production process and higher profit margins. In this article, we explain what this principle means, share how to achieve it and list some of the advantages of this practice.
What are economies of scope?
Economies of scope are the potential scenarios that can occur when an organisation increases their production to two or more types of goods. Often, the aim is to reduce overall costs, especially when the cost of creating each type of good individually is more than it would be together. It's an important way for a company to maximise its profits, as it has more than one means of income but less to pay for production.
One example of an economy of scope could involve the use of a boat that ships freight across to the Isle of Man and another boat that carries passengers. Under this model, having one boat that carries both freight and passengers would be much more efficient. This is because it cuts down on the number of journeys that each boat has to do and reduces fuel costs.
How are economies of scope achieved?
There are a number of ways to use this important principle. These include:
One example of an economy of scope is co-production. This refers to how companies use the production process of one type of product to produce another type of product. Often, these can be by-products, but they still have their own market value. This is one of the most effective ways an organisation can maximise its profits whilst also keeping down production costs. For example, if a business creates pieces of dried fruit, a by-product could be the fruit oil produced from the peel. Businesses can then bottle this up as fruit oil for skincare or culinary industries.
Another way an organisation can adjust according to this theory is through a merger. Mergers happen when one company combines with a similar company to become a single entity. If they create the same product or use similar equipment, they can save money by combining their resources as economies of scope dictates. An example of this might involve two car companies merging. They then have one set of resources that can produce a variety of different models and generate more profit.
Shared inputs refer to either the sourcing or storing of a product. Most businesses typically share their inputs to produce another product. This is because there's no added cost when sharing how they have collected or stored the original with another product.
An example of this is an equipment hire business introducing drilling tools to its leasing options, which already includes access and lifting equipment. There would be no extra cost for the business to store these items as it has the necessary space at its warehouse. Also, the company already has online systems in place for customers to make bookings and arrange delivery. This means that the company doesn't need to hire another building or implement a new booking system to extend its offering.
Complementary production refers to the process of two means of production working together. They can even have direct interaction with one another. This typically means that the creation of a second product is much faster, as it's based on the first product. The creation of the second product would come at little to no extra expense to the company, as they already have the fundamentals in place from the first product. This allows the business to access higher profit margins as they have a second product to sell.
An excellent example of this is the production of clothes. A company could establish itself for its production of t-shirts before extending their line to also produce a range of sweatshirts. This means that they have more than one product to sell, which is being created from nearly the same means of production. They may be available in a much faster time compared to starting from scratch. Not only does this satisfy the principle of economies of scope, but a company has an added means of profit.
Advantages of this principle
Here are several advantages to learn more about:
Reduced waste: By operating under the economies of scope principle, an organisation has less waste. In some cases, it can even sell its by-products as a new product, which can also enhance its sustainability efforts.
Rapid responses: Economies of scope often have speedier response times to changes in the market. For example, if jumpers suddenly become trendier than hoodies, a business can move more of their production over to this side of the industry without forming a new production line.
Fewer employees: By using complementary production processes, a business doesn't need to hire as many new employees. Often, they can have an employee managing the input of one combined production rather than two different employees for two separate processes.
Lesser training: Less time needs to go into the training of new employees if production practices are similar. Rather than learning two separate processes for two different types of production, they only need to learn one type of process.
Reduced risk: If an organisation established itself through the creation of one specific product, there is less risk associated with selling a like-minded product. This is because the company already has experience in selling this type of product and likely has a loyal customer base.
Drawbacks of economies of scope
There are some drawbacks associated with using this principle to be aware of. These include:
Less experience with newer products: Depending on how a company tries to expand their line, it may experience some problems in the first instance. The second product may not be as successful as the established product, for example, which can reduce the brand's value if it's not managed quickly.
Loss of image: By expanding too fast into too many types of products, a company may risk damaging their reputation. This can dilute the brand's value, especially if the business was initially built upon a particular niche.
Disorganisation: If a company becomes fixated on trying to expand their economies of scope, they can risk doing so too fast, making it more challenging to find success. This could be through accumulating expansion costs that they can't pay, for example.
Doesn't help the economy: One benefit of this scope method for business is that they don't have to take on as many employees. This same benefit, though, also means fewer job opportunities.
Economies of scope examples
There are many major organisations who already put this method into practice to increase profits. Here are some examples of the types of businesses that benefit from this method:
Distilleries or breweries often sell hand sanitiser or other like-minded cleaning products as a by-product. They use the ethanol that doesn't go into their alcoholic beverages to reduce waste, whilst also returning a profit. In some cases, this can save the organisation money, as they don't have to find a safe way to dispose of this flammable liquid. As people become more aware of personal health and self-care, the demand for hand sanitiser has increased, which means the production of this by-product is a profitable economy of scope.
Many large shoe companies have adopted a complementary production process, turning their existing adult shoes into a range of children's shoes. These designs prove popular with children, but also with adults who have smaller feet and require smaller shoe sizes. This economy of scale example is profitable because brands don't have to invest in creating a whole new product or change their production process. Instead, they're able to appeal to a new demographic and earn a greater profit margin by altering the processes they already have in place.
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