Name: Inderpal Singh Chadha

Roll No: 07

Economies of Scope

"Economies of scope" is relatively a new approach to business strategy, and is heavily based
on the development of high technology. Economies of scope, as defined by using same processes for
producing similar products, can fit the batch-flow or group-technology processes; nevertheless, for
best results the flexible-manufacturing should be adopted. Computer Integrated Manufacturing (CIM)
allows lowering the setup-time and required tuning between products, so to be economically efficient
for small batches of non-standardised products. In other words, companies can compete on product
customisation and short lead-time.

In terms of industrial organization, economies of scope are present in enterprises that develop
and manufacture a variety of related products. Such corporations extend expertise in core
competencies or technologies to the full range of products related to those core competencies or
technologies. Economies of scope differ from economies of scale in that the enterprise enjoys a cost
advantage from manufacturing generally limited quantities of a variety of products based on a core
expertise, rather than concentrating that core expertise on manufacturing large quantities of one
product. That is, economies of scope may be realized when it is cheaper to produce one product in
conjunction with other products than to produce that product alone.

Firms commonly produce more than one product. Oil firms like ONGC and Bharat Petroleum
produce both petroleum and chemical products; drug firms like Ranbaxy and Gloxosmith produce
both vaccines and tranquillizers; and publishers like Times of India and Dainik Prakashan produce
both newspapers and magazines. In many cases, firms obtain production or cost advantage when
they produce more than one product. These advantages sometimes arise because certain production
facilities used to make one product can also be used for another product, or because by-products
resulting from the making of one product are useful in making other products.

Economies of scope exist when the cost of producing two (or more) products jointly is less
than the cost of producing each one alone. For example, suppose that J K Bearings Pvt Ltd produces
100 milling machines and 50 lathe machines per year at a cost of Rs. 100 lacs, whereas if a firm
produced 100 milling machines alone, the cost would be Rs. 75 lacs, and if it produced 50 lathes
alone, the cost would be 50 lacs. In this case the cost of producing both the milling machines and
lathe machines is less than the total cost of producing each separately. Thus, there are economies of
scope.

To gauge the extent of economies of scope, the following measure is sometimes calculated:

S= {C(Q1)+C(Q2)-C(Q1+Q2)}/C(Q1+Q2)

where S is the degree of economies of scope, C(Q1) is the cost of producing Q1 units of the
first product alone, C(Q2) is the cost of producing Q2 units of the second product alone, and C(Q1+Q2)
is the cost of producing Q1 units of the first product in combination with Q 2 units of the second product.
Name: Inderpal Singh Chadha
Roll No: 07

If there are economies of scope, S is greater than zero because the cost of producing both products
together – C (Q1+Q2) – is less than the cost of producing each alone – C(Q 1) + C(Q2). Clearly, S
measures the percentage of saving as a result of producing them jointly rather than individually. Thus,
in case of J K Bearings Pvt Ltd:

S={(75+50-100)/100} = 0.25

which means that there is a 25% saving of this sort.The larger the value of S, the bigger the
economies of scope.

To managers, it is very important that economies of scope be recognised and exploited. A

firm’s managers must constantly be alert to the potential profitability of extending its product line, or of
adding new product lines. For example, a small airline may find its regularly scheduled passenger
service can be profitably supplemented by providing cargo services, since the cost of flying both
passengers and cargo is much less than that of specialising in either passengers or cargo services.

Examples to illustrate Economies of Scope

General Motors Corp. (GM) provides an excellent example of a corporation with broad economies
of scope. The core competency of GM rests in the development and fabrication of products powered
by gasoline- or diesel fueled engines. The firm operates six automobile groups: Cadillac, Buick,
Oldsmobile, Pontiac, Chevrolet, and Saturn. Each enterprise is engaged in the production of cars
powered by internal combustion engines. This core competency is extended to larger vehicles through
its GM Truck division—which manufactures small- and medium-size utility trucks and larger semi-
trailer tractors—and to railroad locomotives through its Electro Motive division. In addition to
conventional- and diesel-engine products, GM until recently enjoyed a position in a related propulsion
technology, turbine engines, through its Allison division, which built a variety of turbojet engines for
use in aircraft and power generation.

Ford Motor Co. was organized similarly across product lines, controlling the Ford, Lincoln, and
Mercury automobile lines as well as the Ford Truck division. For a period during the 1930s, and again
during World War II, Ford manufactured not only aircraft engines but also complete aircraft.

General Electric also achieved significant economies of scope around turbine engine technology,
providing the company with significant positions in power-generating equipment, nuclear power, and
jet engines.

During the 1980s General Dynamics provided an example of economies of scope within defense
technology, specifically as it related to defense electronics. General Dynamics controlled the nation's
largest nuclear submarine company, Electric Boat, the former Chrysler battle tank division, and
Convair, manufacturer of F-111 and F-16 aircraft and numerous rocket systems.

Cachon and Harker (2002) found that scale economies are so powerful that to provide a strong
motivation for outsourcing, too; even though the outsourcing contractors are not allowed reaching the
same scale as the outsourcer. Dobson and Yano's (2002) article is an in-dept scholarly analysis of the
Name: Inderpal Singh Chadha
Roll No: 07

factors associated with economies (and diseconomies) of scale and economies (and diseconomies) of
scope. The authors argue that mass-customisation, which means broader product lines, "may help to
increase market share and may allow higher prices to be charged, but they also cause challenges
associated with diseconomies of scope" such as setup time.

Economies of scope have been realized in a number of industries, including tele-communications

and the health-care industry. One should not conclude, however, that bigger is necessarily better. A
diseconomy of scope is when the opposite happens. For example, in many strategy games, groups of
units move at the speed of the slowest element in them. In this case, fast units are less useful
because they are in the same group as slow ones. Also studies of big banks, for example, that were
operating efficiently, have shown that they often became more inefficient as they grew larger through
consolidations and mergers. Problems associated with managing complex businesses can prevent
companies from realizing the benefits of economies of scope.

To conclude, economies of scope provide an enterprise with opportunities for significant cost
savings. Economies of scope achieve this, however, not through increases in the scale of
manufacturing apparatus, but through increases in the scope of those applications into related fields.
This situation provides numerous consumer benefits by enabling technological developments in one
area to be tested and applied to other areas. The result is faster application of new technologies to a
wider range of products and greater product value to the consumer.