Economies of scale and economies of scope are two related – but distinct – concepts that can help reduce the cost associated with manufacturing a product. The difference arises on whether you are reducing costs from increasing the number of a particular product that is produced (economies of scale), or whether you are reducing the costs because of making different products (economies of scope).
Economies of scale: How costs decline
Economies of scale arise from savings that are achieved as the volume of production increases – the more you make of a product, the lower the cost per item. Common sales economies include:
- Purchasing materials at a better rate: There may be volume discounts in the raw materials, arising from better bargaining power, savings on delivery, or other cost savings relative to small or one-off purchases.
- Fixed costs are spread over a larger number of products: There are likely fixed costs in operating, inured irrespective of the number of products produced. These may include the rent on a facility, the cost of machinery, or the cost of developing the product. When you manufacture a larger volume of products, these costs are spread over a much larger number of products, in turn pulling the fixed cost allocated to each product lower.
- Labor cost per unit declines: Beyond costs that are entirely fixed, there are certain variable costs that may decline the greater volume that you produce. Greater volumes may allow more efficient routines to be implemented, potentially reducing the labor component of each product produced
Economies of scope: How it is different from scale advantages
While economies of scale arise for producing large quantities of the same or similar products, economies of scope come from operating in different product areas. There may be cost savings that arise from diversifying to operating in multiple similar but different product areas (i.e., related diversification). Such economies of scope include the potential to acquire materials in larger volumes across the different product lines, sharing advertising across product lines, or other capabilities that can be shared between different areas of the firm.
Key distinction to remember
The key point to remember is that while scale economies come from doing lots of the same thing, economies of scope come from doing lots of different things.
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