Economies of Scope for the Small Business Owner

Economies of scope have a multitude of benefits to an organization. Economies of scope have increased productivity and operating costs, a higher market share for a firm, and lower product differentiation. In essence economies of scope are the combination of all advantages. In today’s global marketplace economies of scope to encompass a broad spectrum.

One example of economies of scope is what is known as R&D budgets or research and development budgets. Large corporations invest heavily in the r&d to develop new products to compete with their large competitors. Some of these products may be related to increasing gross margin, lowering cost, or improving service. Many times large corporations look to diversify their portfolio to reduce risk and spread risks among its different businesses. Examples include General Motors and Chrysler, both of which have large numbers of dealers. At the same time it is not unusual for smaller companies to have large companies within them, often referred to as “sub-sectors.”

Examples of other economies of scope are the manufacturing decision making process itself and the associated process. For example some firms like Pfister are primarily manufacturing medicine, a narrow product design, and its associated process. Other firms like Freon are primarily from plastics, and its associated processes. There are also other types of manufacturing decisions that fall within the scope of economies of scope such as energy efficiency, financial risk management, and the like. In all cases the point is that the firm must take into consideration the full range of the firm in terms of its product design, process, and scope. This way, they can realize economies of scope.

Not all firms will be able to realize economies of scope. For instance a firm that manufactures a single product may not be able to if it doesn’t have other customers who need that particular product. Likewise, a firm that manufactures a single product may not be able to if it does not have the right distribution channels for that product. Likewise, a firm may not be able to realize economies of scope if it lacks the right information sharing systems. The point is that the firm has to realize all of its potential markets, and it must have plans for how to exploit those markets even if it manufactures its products in other locations.

Now, let’s use the example of the pharmaceutical industry as an example of what I mean. The pharmaceutical industry isn’t limited to just one product but rather has several of them. Each of these carries a different risk in terms of its market penetration. As a result, the company has to consider its total revenue and then the cost of manufacturing each product on a gross margin basis before it can determine whether or not its overall profits will be in line with the expenses required to manufacture them. While this may seem like a very complicated process, it is essential to an understanding of what I believe to be a properly captured economy of scope.

For example, take a look at the cosmetics and skin care industry. What do you see? A couple of million dollars in revenue, but no profit. So the question becomes: Are the revenues in excess of the costs of production? Of course, the answer is no – there aren’t enough consumers buying the goods.

A properly capturing economy of scope involves the creation of new markets while ensuring that consumers are able to absorb the costs of production. In fact, this is done on a very large scale with companies manufacturing their products using scale economies. In this case, they are producing enough products using standardized components to provide the average costs necessary to ensure a profit while still being far less than the price of producing those same goods in a traditional business setting.

In fact, some companies that specialize in producing over one hundred brands of cosmetics and personal care items have managed to create markets where they don’t even sell any of their own product lines. The trick is to keep the manufacturing costs low enough so that they can offer higher prices on their merchandise without cutting back on quality or variety. Once the company gets into a proper economies of scope, it doesn’t take long before it begins to produce new products that bring in even more profits. Then everyone wins.