7.14 : Economies of Scope

Economies of scope refer to a firm's cost advantages by producing a wider variety of products rather than focusing on a single product. Economies of scope are achieved when the total cost of producing multiple products together is less than the sum of producing each product independently. This production efficiency is primarily possible due to sharing common resources across the different types of outputs. This includes skilled labor, an efficient managerial team, or advanced technologies that can be used across different products.

Procter & Gamble, a leading conglomerate in consumer goods, uses its marketing expertise to promote multiple products, such as personal care items, alongside pharmaceutical products. Honda has specialized knowledge in internal combustion engines. It uses this expertise to improve the production of engines for a diverse set of products, including cars, motorcycles, lawnmowers, and snow blowers.

Economies of scope offers the opportunity for diversification. For instance, a carrier traditionally focusing on freight shipping might expand into passenger transport or provide logistical support services for other transport companies.

Diseconomies of scope occur when a firm incurs higher average costs by producing multiple products. For example, if a drug company chooses to make two drugs in the same factory, it must complete a stringent cleaning of all equipment to avoid cross-contamination whenever it switches production from one drug to the other. This specific and expensive cleaning step would not be required if they produced only one type of drug.