Economies of scope broaden rather than narrow the focus of an organization. It’s like choosing to be a generalist rather than a specialist. While this may seem to apply more to commercial organizations, it does apply to just about any type of organization.
This post seeks to define economies of scope which, like economies of scale, has its limits; at some point it can become diseconomies of scope.
Broader Enterprises Define Economies of Scope
Economies of scope occur when a business widens its scope of activity. Each additional enterprise, or area of endeavor, added to the scope of the business decreases the cost/unit for each enterprise.
For example, in the Economies of Scope Diagram at right, the business may expand its economies of scope by introducing new but related product lines.
Here’s how economies of scope would work, as depicted in the diagram:
- With only one product line (one ‘enterprise’), the cost per unit is C1
- Adding a second product line decreases costs per unit to C2
- Adding a third product line decreases costs per unit to C3
Notice that at a certain point, the number of enterprises actually begins to create inefficiencies. The curve reverses itself and starts sloping upward – indicating diseconomies of scope.
By Contrast, Narrow Scope Defines Economies of Scale
Economies of scale occur when a business narrows its scope of activity, like focusing on one product. Each additional unit of the same product sold and produced typically results in a reduction of the average cost/unit. The amount of reduction depends on the characteristics of the business.
As an example, shown in the Economies of Scale Diagram at right, the business focuses on increasing volume of a single product, where the cost to produce an additional unit decreases as volume increases.
Here’s how economies of scale would work, as depicted in the diagram:
- A volume of 350 units results in an average cost per unit of C1
- A volume of 600 units results in an average cost per unit of C2
- A volume of 1,150 units results in an average cost per unit of C3
Notice that at some point the economies of scale reverses – and, like with the limits of economies of scope, you actually experience diseconomies of scale. At a certain point, the average cost per unit actually reverses and begins to increase due to inefficiencies resulting from having too much volume.
How to Define Economies of Scope and Strategic Fit
Economies of scope and strategic fit are closely linked. It is easy enough to think of how a business can expand its scope. It is another thing altogether to expand it economically, and that’s what strategic fit is all about.
The Ansoff Matrix is one framework that can help discern how and when to expand scope of the enterprise.
The following are some types of things to look for in identifying the potential for economies of scope using strategic fit:
- Decrease production costs – Complementary production processes are a common way to reduce marginal and average production costs. It may be that sizing different elements of the production process does not exactly match sales volume. Excess capacity on the production line, or on segments of the process, can be filled with other products at reduced cost.
- Turn waste to product – This is a good one especially in materials businesses. The production of the core product may result in production of ‘waste’. This waste may be valuable in other areas, and so productizing the waste represents a great opportunity for economies of scope.
- Decrease distribution costs – Achieving volume with distributors can be a challenge. Delivering more of the right products to distributors can increase volume to a level that decreases average distribution costs.
- Increase efficiency – There are many ways! For example, shipping to retailers of a broader product line can make transportation more efficient.
- Increase product variety – This is best achieved when the products are ‘adjacent’. That means there is some overlap in benefit, such as an ability to offer choices to customers in the same sales cycle.
- Offer hierarchy of products – One well-known way of capturing more sales, and at optimal pricing, is to broaden scope and offer a high, medium, and low version. Rather than a “one size fits all approach”, buyers can choose high, medium, or low feature sets that more precisely matches their needs and pay accordingly.
- Improve customer satisfaction – Satisfying customer needs at a more granular level is only possible with a variety of offerings. Economies of scope result when the business offers more choice of the right kinds of products. This better satisfies the needs of customers and brings economies of scope.
- Reduce business risks – Economies of scope is the answer to the warning “Don’t put all of your eggs in one basket.” Enterprises and products come and go over time. Having some breadth reduces the risk of being tied to closely to one cycle.
Each of the listed items has one thing in common: strategic fit. There is some close commonality between the existing business and the opportunity for economies of scope that make it an attractive strategic fit that will bring economies of scope.
Applicability of Economies of Scope to Projects
Economies of scope represents a big opportunity for a strategic project manager to deliver value, and to implement or suggest new ways to deliver value.
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Here are specifics in the three big areas of project management:
- Portfolio Management – Creating a risk adjusted portfolio of projects that address strategic underpinnings of the business is the ultimate purpose of portfolio management. With economies of scope, the portfolio of products will closely parallel the portfolio of businesses designed to deliver economies of scope.
- Program Management – In a business with economies of scope, programs will likely have the flexibility and potential to realize economies of scope. There could be opportunities to create related beneficial efforts within the program, spin them off elsewhere in the business, or to seek partners for a win-win relationship.
- Project Management – Managers of projects always need to be aware of the underlying strategic drivers, such as economies of scope, of their projects. In addition, if they are agile enough in their thinking, they can recognize opportunities for economies of scope that reveal themselves in the course of implementing their projects.
Having a grasp of the concept of economies of scope is of great benefit to a strategic project manager. Project managers can contribute by ensuring that there is alignment at the organization, team, and individual level. Portfolio and program managers can help manage risks for project success by ensuring alignment across the elements of the 7S framework.
Further Learning on Economies of Scope
Finding economies of any sort is a challenge and skill unto itself. It is a part of basic strategy and closely related to Michael Porter’s Five Forces Framework and Value Chain Advantage.
In more rapidly changing conditions, it is part of the ideas in shorter lived strategic advantages as explained by Strategic Agility. Even First Mover Advantage can bring benefits not only through economies of scale but also economies of scope.
You are invited to comment: Does Economies of Scope play a roles at your organization, commercial or not, and on your projects?
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