Economies of Scale vs. Economies of Scope
Introduction
Hi! Today I will present the differences between economies of scale and economies of scope.
Main Differences
Economies of Scale
Economies of scale are when a company obtains a cost advantage by producing more of the same product. This reduces production costs because they are spread over a large number of units.
For example, a large car manufacturer can decide to spread the cost of building a factory over a large number of cars produced.
Increasing a company’s scale can offer protection in classical environments because the company can continue to increasingly build scale to their advantage.
Economies of Scope
On the other hand, economies of scope are when a company obtains a cost advantage by producing a variety of products or services.
In this case, a company can achieve cost savings by sharing common resources like marketing, distribution, and customer service.
For example, a food company that produces both peanut butter and jelly can share production and distribution facilities to reduce overall costs for both products.
This can result in lower production costs and provide greater revenue opportunities for the company.
Examples
Economies of Scale
A real-life example of economies of scale is Mars, which decided to increase its scale tremendously over the years. This was an important factor in the success of Mars.
There is also Huawei Technologies which expanded its scale a lot. It started by becoming dominant in China’s rural markets and then moved to China’s urban centres. It then started expanding abroad in emerging markets (Brazil and Russia) and then first-world countries.
Economies of Scope
A real-life example of economies of scope is electrical utility companies that start offering new technologies such as solar panels or adding more services like smart-home technologies.
Finally, Huawei Technologies also pursued economies of scope since it started by selling telecommunication equipment for big companies and then decided to also sell consumer goods.
When to Pursue Each Type?
A company should pursue economies of scale when:
- It operates in an industry where production costs are a major factor in competitiveness
- It has enough resources to invest in expanding its production capacity
- It has a strong market position
On the other hand, a company should pursue economies of scope when:
- It has a strong brand that can be leveraged across multiple product lines
- It has expertise in many areas that can be applied to different products or services
- Its customers have diverse needs and can purchase additional products from the same company
Potential Problems - Economies of Scale
One problem with economies of scale is that there can be a ceiling effect on cost savings. For example, as buildings get taller, the fixed cost of land per square metre of office space falls, but other height-related changes can eventually offset this saving (wind force, design becoming more complex and costly, increase in construction costs).
Also, as the production scale increases, coordination and management become more difficult, and this can lead to inefficiencies, mistakes, and lower quality control.
Potential Problems - Economies of Scope
Some problems with economies of scope are that:
Producing a range of products or services can be complex and difficult to manage, and this can lead to a reduction in efficiency
Moreover, offering many products or services may require employees to have a wide range of skills and knowledge, and it makes it more difficult to train employees effectively.
Finally, economies of scope can expose a company to more risks. If one product line experiences a decline in demand, the company may be less able to rely on other products to make up for lost revenue.
Concluding Remarks
Finally, I want to emphasize that before choosing to pursue economies of scale or scope, a company should be aware of the potential risks each economy presents and the type of market the company is in.
Also, a company can decide to pursue both types at the same time, for example, by expanding production capacity while also introducing new products.
Thank you!