Economies of Scope
Saturday, May 29th, 2010By Leslie Pratch
When I was getting my M.B.A., I outlined what I considered most useful to digest the curriculum and to help my classmates who were preparing to interview for consulting firms. Nearly a decade later, I realize these notes may be helpful to new M.B.A. students as well as to those in their second year at Chicago Booth who are boning up for interviews with consulting firms. I offer them freely and if they are helpful, encourage your use of them, especially if you are pursuing a leadership position in a consulting firm.
Economies of Scope occur when the total cost of producing two goods is less within one company than within separate companies.
Why do economies of scope exist?
(1) Indivisibility: Manufacturing multiple products allows firm more fully to utilize plant capacity
(2) Shared inputs can be applied to products produced at different plants
(a) Specific examples of economies of scope: R&D spillovers
(b) Hub and spoke network economies of scope:
(i) An airline that serves a route such as Indy-Chicago as part of a hub and spoke network in which Chicago is the hub will have a lower average cost than an airline that only serves the Indy-Chicago route point-to-point—more people will travel the Indy-Chicago route because they can get to other destinations in the network.
(3) What Cost Drivers Exist, Independent of Scale, Scope, and Cumulative Experience?
(a) Location
(b) Infrastructure
(c) Coordination
(d) Economies of Density
(i) Focus of production activities (many products versus few products)
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Leslie Pratch, Ph.D. is a clinical psychologist with an M.B.A. in Strategy and Finance and a B.A. in Religion from Williams College. She works with boards of directors and private equity investors to select and develop executives. She can be reached at (312) 464-7919 or email her at leslie@pratchco.com or visit www.pratchco.com.
