What are economies of scope?
Economies of scope arise from expanding the firm into new areas – diversifying the operations by manufacturing or selling differing products. Economies of scope are the benefits that you derive from operating in these new areas – savings that arise relative to if the firm was split into two.
When economies of scope result in savings from greater purchasing volumes
While we usually think of purchasing savings to come from increases in scale (i.e., producing more of the same product), it is possible that there will be some savings that come from operating in different areas.
Purchasing economies come from buying the raw materials and components that go into your product in larger volumes. You may be better placed to negotiate with your suppliers (changing the relative power of the negotiation agreement due to the larger volumes), or there may be savings that derive from combining the delivery.
When you expand into a different area, it is possible that there may be savings that come from being able to order larger volumes of your input. There may for example be parts or materials that are shared across the areas – allowing you to increase the volumes that you are purchasing even though the final product may be different. Alternatively, even if the materials and components are different but bought from the same suppliers, there may be opportunities to exert greater bargaining power in the negotiation process.
Final thoughts: Will the volume increase actually result in savings
It is important to recognize that savings from greater purchasing volumes are not automatic, and are less likely when diversifying the firm, relative to just increasing the scale of producing a single product.
When diversifying, there will likely be many new materials, components, or suppliers that you are buying from to make the new products. Buying from different firms won’t increase your purchasing economies – it is only those suppliers that are shared across your business units where you benefit from increased purchasing power when diversifying the firm.
Related Articles
