# How to reduce the cost of production per unit through economies of scope? A stunning concept to produce more of the available resources by spending less!

Economies of scope are efficiencies!

The joint production of a variety of products using same manufacturing facilities costs less than the cost of producing them separately.

The reason for these is various overhead costs, financial as well as organizational economies, which are shared among the products. The more the variety or diversification of products is, the less the average cost for them will be!

Economies of Scope are visible when a business utilizes specialized resources to produce a variety of goods and services. It is also observed as reduced average cost per unit associated with increasing the scale of production for a single product type, economies of scope mean, lowering the average cost for a firm in producing two or more products.

## A Few Definitions of Economies of Scope

“When the total cost of producing two types of outputs together is less than the total cost of producing each type of output separately” –Michael Baye

“Reduction in long-run average and marginal costs, due to the production of similar or related goods or services where the output or provision of an item 'A' reduces the cost of item B”–BusinessDictionary.com

“Economies of scope exist when the total cost of using the same production facilities to produce two or more goods is less than that of producing these goods at separate production facilities” –Thomas J Weber

## A simple mathematical expression

C1 (Q1, 0) + C2 (0, Q2) > TC (Q1, Q2)

Where,

C1 (Q1, 0) =Total Cost when Product A is produced only

C2 (0, Q2) = Total Cost when Product B is produced only

TC (Q1, Q2) =Total Cost when the both products are produced jointly

## Exploiting the opportunity – An Example

A pizza shop on the corner makes pizzas only. The shop owner Jimmy faces an average cost of \$10 per pizza. A nearby cake maker, Betty spends \$10 to make a cake for her customers. Betty is good at baking and operating the oven while Jimmy is skilled at garnishing and handling cooking ingredients. They merge their businesses into a single shop.

Now, their shop produces both pizzas and cakes at an average cost of \$7 for both. Economies of scope made this production cost saving possible. They used to pay electricity, water, gas, etc. bills separately for their shops before the merger. Besides reducing rent cost, the usage of the same oven and cutlery enabled them to save more bucks.

There is another quite vital approach to make you use this concept to reduce average per unit cost through spreading of cost over various product lines.

Let’s say; you have been using a ‘heavy’ electricity generator to run your bottle manufacturing plant. Currently, you have just one product line, making bottles for your business customer, a cold drink maker. You have been earning a less than satisfactory profit. You want to reduce your cost along with more market penetration and more revenues.

You assess that the significant cost of your revenues is, the fuel cost of your electricity generator. Suppose, for some reason you have no option but to keep using this generator.

Currently, the generator related cost is spreading over only one product line. You add more three more product lines one by one in few months by introducing a range of medicinal syrup bottles, for rum and another for juice bottles. At the end of the season, you compare your revenues with the total costs and see a considerable reduction in average manufacturing cost per bottle.

In the following diagram, you can see the costs for units, shrinking from C1, C2, C3, and C4 as the result of adding product lines respectively.

This cost reduction occurred, because of spreading of electricity generator cost over four product lines!

• Economies of Scope can aid in your business success through Risk Spreading. Introducing new products or services into new markets may protect against failure of current products and markets due to any mishap.
• It also provides with the capability to move into comparably higher growth profitable industries, assuming if the current industry has been declining.
• Having better Economies of Scope can grant you better access to capital markets as it enhances your company’s image.
• If a product line fails you may stick to other or will have the ability to add new one

Production possibility frontier

Production possibility curve & Shifts

Scarcities of resources and management

Production Frontiers by Rolf Fare

## What do you Think?

You are welcome with your opinion.

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