Economies of Scope vs. Economies of Scale: What’s the Difference?

Economies of Scope vs. Economies of Scale: An Overview

Economies of scope and economies of scale are concepts that explain why costs are often lower for larger companies. Economies of scope focus on the average total cost of the production of a variety of goods. Economies of scale focus on the cost advantage when there’s a higher level of production for one good.

Key Takeaways

• A company that benefits from economy of scope has lower average costs because the costs are spread over a variety of products.
• A company that benefits from economy of scale has a lower average cost because costs decrease as the amount that’s produced increases.
• A company can benefit from economy of scope by merging with or acquiring other companies.
• Economy of scale is achieved with the increased output of a good or service.

Economies of Scope

The theory behind economy of scope is that the average total cost of a company’s production decreases when an increasing variety of goods is produced. Economy of scope gives a cost advantage to a company when it makes a complementary range of products while focusing on its core competencies. It’s cheaper for two products to share the same resource inputs when possible than for each product to have separate inputs.

Rail transportation provides an easy example. A single train can carry both passengers and freight more cheaply than separate trains can carry passengers on one and freight on another. Joint production reduces total input costs. One input factor’s net marginal benefit increases after product diversification.

Important

Economies of scope explain why most successful companies offer extensive lines of related products and services.

Let’s say that Company ABC is the leading desktop computer producer in the industry. Company ABC wants to increase its product line and it remodels its manufacturing building to produce a variety of electronic devices such as laptops, tablets, and phones. The cost of operating the manufacturing building is spread out across the various products so the average total cost of production decreases.

The costs of producing each electronic device in another building would be greater than just using a single manufacturing building to create multiple products.

Other examples of economies of scope can be seen in mergers and acquisitions (M&A), newly discovered uses of resource byproducts, and when two producers agree to share the same factors of production.

Economies of Scale

Economy of scale is the cost advantage a company achieves with the increased output of a good or service. There’s a negative relationship between the volume of production of goods and services and the fixed costs per unit.

Suppose Company ABC considers purchasing processors in bulk. Company DEF, the producer of the computer processors, quotes a price of $10,000 for 100 processors but the producer quotes a price of $37,500 if Company ABC buys 500 computer processors. ABC’s per unit cost is $100 if the company purchases 100 processors but its per unit cost drops to $75 if ABC buys 500 processors.

Note

The producer passes the cost advantage of producing a larger number of computer processors to company ABC. This cost advantage arises because making the processors has the same fixed cost, whether it produces 100 or 500 processors.

The marginal cost of production for each additional computer processor generally decreases when the fixed costs are covered. Additional units represent increasing profit margins at lower marginal costs. This provides companies with the ability to drop prices if necessary, improving the competitiveness of their products. Warehouse-style retailers, such as Costco and Sam’s Club, package and sell large items in bulk partly due to realized economies of scale.

Economy of scale may seem beneficial to a company, but it has some limits. Marginal costs rarely decrease perpetually. Operations can become too large at some point to keep experiencing significant economies of scale. This can force companies to innovate, improve their working capital, or remain at their present optimal level of production.

Benefits to Companies

A company that benefits from economies of scope has lower average costs because the costs are spread over a variety of products. It’s much easier for a restaurant chain to offer new dishes than to start a new restaurant chain offering these new foods. Advertising can promote multiple dishes at the same time and the new foods can be prepared and served using the same equipment and personnel. Economies of scope work best when production or consumption is complementary.

A company that benefits from economies of scale has a lower average cost because costs decrease as the amount produced increases. A company may be able to make 100 million computer chips at a lower cost per unit than one million chips. The company must spend a certain amount on research and development (R&D) for each chip, as well as money setting up each factory. Less money is required to produce additional chips. Economies of scale work best when fixed costs are high.

What’s the Difference Between Economies of Scale and Economies of Scope?

The major difference is that economies of scale create cost savings by increasing the production of one item. Economies of scope create cost savings by spreading production costs over many different items.

How Can a Company Achieve Economies of Scope?

A company can achieve economies of scope through flexible manufacturing, diversifying with related products, and merging with or acquiring other companies.

What Are Some Types of Economies of Scale?

Economies of scale can be internal or external depending on whether the changes originate from within the company or outside it. Some types of economies of scale include technical economies that affect the process or technology, purchasing economies that buy in bulk, and financial economies that borrow at a lower interest rate.

The Bottom Line

Economy of scope is a generalization of economy of scale rather than an opposing concept. Economy of scale allows a company to reduce production costs by sharing fixed overhead and other fixed costs across more units of a single good. Economy of scope enables a firm to reduce costs by sharing fixed costs between several different goods.