Horizontal Boundaries of the Firm:

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Horizontal Boundaries of the Firm Economies of
Scale and Scope Chapter 2
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Economies of Scale and Scope
Economies of Scale
The concept of economies of scale provides
the primary connection between technology and
firm competitive strategy
Numerous definitions, but the most useful seems
to be Economies of scale exist when average
cost is declining.
Important to distinguish between long-run and
short-run notions of economies of scale.
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Long-run shape of the average cost curves
dictated by existing state of knowledge.
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Short-run technology (quasi-) fixed and
embodied in plant and capital investment (e.g.
business design)
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Long-run economies of scale impact industry
structure and are only relevant in the pre-entry
stage.
Short-run economies of scale, affect operating
decisions and are relevant to post-entry stage
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Economies of Scope
Economies of scope exist when there are cost
savings associated with a broadening of a firms
scope of activities.
Increases in the number of products or services
produced
Formally, economies of scope exist if
C(Y1,Y2) lt C(Y1,0) C(0,Y2)
In essence, joint production is less costly than
production of single product lines
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An example of Economies of Scope
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Sources of Economies of Scale and Scope
Indivisibilities and fixed-cost spreading
specialization (increased productivity of
variable inputs)
Inventories
The cube-square rule
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Indivisibilities and Fixed-Cost Spreading
Spreading of product-specific costs
Trade-offs among alternative technologies
Indivisibilities more likely with capital
intensive technology
The division of labor is limited by the extent of
the market
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Scale Advantage and Capacity Utilization
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Specialization
Efficiency gains via specialization of function?
Organizational efficiencies
Inventory Management
Cost of inventory management can decline with
size of firm
Smaller inventory as a percentage of total sales
Cube Square Rule (2A3)
Ratio of surface area to volume declines
geometrically
Can convey technical economies in distribution
and storage
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Other Sources of Scale
Spreading of marketing and advertising costs
Reputation effects
Research and development costs
Purchasing economies
Complementarities and Strategic Fit
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Sources of Economies of Scope
Utilization of excess capacity (especially in the
presence of indivisibilities)
Utilization of fixed marketing/retailing
costs/infrastructure
Exploitation of reputation and brand identity
Common terms used in (implicitly) discussing
economies of scope include
Leveraging core competencies
Competing on capabilities
Mobilizing assets
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Sources of Diseconomies of Scale
Labor Costs and Firm Size
Incentive and Bureaucracy costs
Spreading of Specialized Resources
Conflicting Out
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Learning Curves
Learning Curves account for the cost advantages
associated with experience and know-how
Can occur at the individual level
Can occur at the organizational level
Learning curve advantages can be manifest in
Lower costs
Higher quality
 Efficient pricing or competition policies 
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Learning Curve
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Progress Ratio
Measures the decline in average cost when
cumulative output is doubled.
PR AC1/AC2
Median for U.S. is about 0.80, which implies a
reduction in unit cost of 20 for each doubling
of cumulative output.
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