Economies of scope

Several years ago we coined the term of to describe a basic and intuitively appealing property of production: cost savings which result from the scope (rather than the scale) of the enterprise. There are economies of scope where it is less costly to combine two or more product lines in one firm than to produce them separately. While the concept itself is not completely novel, especially since multiproduct firms are the rule rather than the exception in our economy, we have attempted to make this terminology precise, both in common parlance and in theoretical analyses. Although our definition of economies of scope does not correspond exactly to joint production in the Marshallian sense, we show, in Section I, that it precisely characterizes the conditions which lead to the formation of multiproduct firms in perfectly competitive markets. However, this formal equivalence, in and of itself, provides only limited insight into the tangible forces which make it feasible and profitable to form multiproduct enterprises. In the classic works of John Clark, Eli Clemens, and others, it was suggested that the origins of the multiproduct firm spring from the opportunity to exploit some type of excess capacity. This notion seems to imply that, when there are economies of scope, there exists some input (if only a factory building) which is shared by two or more product lines without complete congestion. Section II examines this issue in general and with a micro model of the technology which explicitly posits the presence of a sharable, input. Whenever the costs of providing the services of the sharable input to two or more product lines are subadditive (i.e., less than the total costs of providing these services for each product line separately), the multiproduct cost function exhibits economies of scope. Nevertheless, the precise nature of such economies of sharing has profound implications for how the boundaries and scope of the firm may be affected by transactions costs, market failures, and other Coasian considerations. In general, the presence of a quasi-public input mandates the existence of multiproduct firms at some level in the chain of production, even if there are no imperfections in the market for the input itself. However, if the shared-input services are undifferentiated among end uses, multiproduct firms result from the failure of the market to sustain efficient vertical disintegration, as discussed by George Stigler.