Economies of scale and economies of scope

This note is primarily directed to students. It is the third in a series on strategic cost analysis. Economies of scope is a term related to economies of scale. I will argue that economies of scope is not a very helpful concept in strategic management.

Apologies, but this note is not very structured :)



Difference between economies of scale and scope. The difference between economies of scale and economies of scope is fuzzy. If a company produces one product, the term economies of scale is used. If the company produces different products that are not very similar, the term economies of scope is used. Thus if a bank offers both savings products and insurance products, the term economies of scope is used. If the bank only sells savings products we are dealing with economies of scale. However, it is possible to talk about different savings products, e.g. savings account, bonds, exchange traded funds. For one analyst this might be economies of scale and for another economies of scope. Personally, I would probably call it economies of scope, because savings accounts and exchange traded funds are really different. This little paragraph hopefully illustrates that it is impossible to clearly delineate the two terms.

However, just like economies of scale, economies of scope are mainly driven by the spreading of fixed costs over a larger volume of products. In other words, for practical purposes it might not matter which term your really use.

Note that for economies of scope to occur, there should be some similarities in the value chain of handling the different products. If the different products do not share any activities in the value chain, then there can be no economies of scope at all.

Cost-saving synergies is a better term to use. The term economics of scope originates from microeconomics. A related term in strategic management is synergies. If there are economies of scope, we can, by definition, also say that there are cost saving synergies. Personally, and for clarity, I prefer to use this term rather than economies of scope, but both terms are used.

Cost-saving synergies will occur at some of the different activities in the value chain. The analyst can identify in which activities synergies will occur and, thus, can estimate their size. Here it should be noted that synergies could be negative. If a company tries to product too many different products it will run into inefficiencies. It would be very logical to call this diseconomies of scope, but neither the economists nor anyone else is using that term.

Synergies can be either cost-saving or revenue-enhancing. Only the former type is equivalent to economies of scope. Synergies is normally a term used for corporate strategy, not business unit strategy.