Economy of Scope Explained: 3 Examples of Economies of Scope

Economies of scope are defined in the field of microeconomics as economic strategies where a person, business, or government can lower the average cost of doing business by investing in a variety of products or services.

To illustrate how this works, consider a cattle rancher. The rancher has fixed costs that come with raising cattle, such as buying land, paying property tax, and providing food and shelter for their cows. When the rancher slaughters the cows and sells them for beef, they recoup much of their costs. However, if the rancher also invests in byproducts of the cows—leather, gelatin, dairy, and even bone products—they gain a cost advantage. Expanding the range of products they can make from their source material permits ranchers to achieve economies of scope in their production process.

The logical advantage of economies of scope is that product diversification can lower the average total cost of production when compared to manufacturing a single product. Economists apply this concept whenever a business has fixed factors of production—space, labor, raw materials, taxes—and could get more out of those factors by developing co-products.

When businesses use the same raw resources to make different products, they can get more value out of the supply chain. For this reason, businesses with flexible manufacturing operations often develop new products they can make using their same raw goods, assembly lines, and management teams. Developing these related products is a simple way to produce more goods and services for a lower average cost.

The business world is filled with examples of economies of scope.

1. 1. Airlines: Passenger airlines frequently transport freight cargo underneath the plane. This optimizes the use of the plane, the fuel, and the flight crew already needed to run a passenger flight.
2. 2. Warehouses: Many warehouses store goods belonging to multiple companies, with each renting out sections based on square footage. This maximizes the physical investment in building, buying, or leasing the warehouse itself.
3. 3. Breweries and distilleries: Breweries and distilleries produce raw ethanol as a byproduct of their beer and liquor manufacturing. Some have turned this ethanol into hand sanitizer, resulting in a new profit stream.

Economies of scope and economies of scale are two ways that businesses optimize their production processes. The former prioritizes diversification, and the latter prioritizes lowering the cost of one product.

• Economies of scope: An economy of scope provides cost savings to businesses with a diversified product line. It allows for greater output with a relatively small uptick in fixed costs. With economies of scope, businesses can glean more value from the real estate, machinery, and raw goods they already own. Diversifying their product line also helps them hedge against fluctuating market trends.
• Economies of scale: An economy of scale is one in which a business lowers its marginal costs by producing additional units of the same product. This works particularly well in manufacturing, where the greatest fixed costs come from building a factory, setting up an assembly line, and hiring core employees. A factory that produces few items with these resources will have a high per-unit cost, but as the factory scales up to higher levels of production, the unit price goes down.

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