How can you exploit economy of scope and economy of scale for maximization of profits?

economies of scale

It becomes confusing at times to differentiate economy of scope from the economy of scale. Both terminologies look similar and can easily be termed as first cousins. Interestingly, both are different in their essence. A little explanation will help you to avoid intermingling both relevant concepts:

You can achieve economies of scope through a more extensive variety of products while economy of scale exists because of larger volumes of output. Economies of Scope efficiencies are forged by variety, not volume (Joel D. Goldhar, 1983)

However, an economy of scale becomes a reality through capabilities of a firm’s technology and access to the required resources that make average total cost fall as output increases.

It is important to understand that economy of scope is not about producing a less or greater quantity of a product, but they are about making unlike products while keeping the compliance of using the almost same plant, equipment or machinery.

For example, if you bake cakes then you can use quite similar equipment for baking donuts or biscuits. In this way, you save cost per unit because you actually increase the scope, i.e., the range of products.

Similarly, if customers already trust Head & Shoulders Shampoo, they might be more likely to purchase hair conditioners from the same company. Therefore extending the range of products that Head & Shoulders offer may benefit it through the same brand image. In this case, Head & Shoulders is enjoying Economies of Scope for two of its products via single brand image!

Product Diversification for Economy of Scope achievement

The concept of economy of scope enables us to know why the same firm produces a specific set of a vast range of products. Assume a fair demand for diversity, while making only dark chocolate bars for your customers. Would not be it a great idea of adding additional product lines using the very same equipment, with a little technical alteration, for honey, milky and vanilla flavor version of chocolate bars?

Being an entrepreneur or a production manager, Economy of scope is very important for you to understand whether a business decision regarding adding a new product line will be viable or not. If it’s feasible, go for it!

My local courier service company recently added the delivery of pets to its services. Apparently, it seems an odd idea, but actually, it went well. The company spotted a market niche and feeling confident enough about its available resources, captured it!  

Cashing in on economy of scope along economy of scale

You can exploit economy of scope and economy of scale to maximize profits for your firm with all available resources. If the first product of business eventually leads to manufacturing other related products with good economy of scope, that can have a similar effect as that of the economy of scale.

You can share your financial and organizational economies among the products or services you produce. For example, if your firm produces a range of garments for male customers, adding garments for the female in the production line may cost comparably less, because of reduced marketing and distribution costs and the bulk purchase of fabric.

You can use a similar set of processes to manufacture a range of products.

It will enable you to reduce business risk (investment risk) through diversification as if the demand of few of your products would fall due to any reason, the revenues from other products can keep you on your feet.

The repeatability of processes and accuracy may enhance your technical dexterity.

You can reduce overhead costs through reduced wastage.

The Mergers and Conglomerations to reap Economies of Scope

What Jimmy and Betty did was to exploit economies of scope. Engro, a Pakistan based corporation did the same though at an enormous scale. Its portfolio has a diversity of products like chemical fertilizers, bulk liquid chemical terminal, foods, power generation and commodity trade.

Conglomeration is a corporation that is composed of various, apparently unrelated businesses.

You may run many different business units efficiently, as a “needy” business unit may be able to use the revenue that the other business generates through different business ideas, and plans may utilize firm's capital efficiently and effectively to pick itself up.

A little warning: The textbooks use terms economies of scale and economies of scope in plural form. Some people use them informally in singular form. However, it is advisable to stick with plural form informal communications and examination.

Production Possibility Frontier

Production possibility curve & Shifts

Scarcities of resources and management

Scarcity and competitive advantage

Production Frontiers by Rolf Fare

Economies of Scope

What do you Think?

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Thanks for your interest!

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