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252 Chapter 6 Cost Analysis

servers, software, and telecommunications (together constituting over 10 per-

cent of capital expenditure), rather than in the traditional “bricks and

mortar” of factories, assembly lines, and equipment. To date, a number of

firms—Microsoft, Google, Cisco Systems, Oracle, eBay, Facebook, and

YouTube, to name a few—have taken advantage of information economies to

claim increasing shares of their respective markets, thus, benefiting from

sharply declining average unit costs.

E-commerce also benefits from significant economies of scale in cus-

tomer acquisition and service. In many e-commerce markets there has been

a land-rush-like frenzy to acquire customers (often by offering a variety of

free services). These customers come at a high initial fixed cost but have a

very low marginal cost of servicing them. In addition, demand-side exter-

nalities mean that customers receive greater value as the population of other

customers increase. This is true in online sites ranging from job-search to

business-to-business commerce to online classified ads. For instance, such

economies of scale provide eBay and Google with dominant positions in

online auctions and search, respectively. In turn, economies of scale in dis-

tribution means that at large enough scale, taking orders online, holding

inventories in centralized facilities, and shipping direct to customers is

cheaper than selling the same item at a retail outlet. The online sales clout

of Amazon is an obvious case in point.

Economies of Scope

Most firms produce a variety of goods. Computer firms, such as IBM and

Toshiba, produce a wide range of computers from mainframes to personal

computers. Consumer products firms, such as Procter & Gamble and General

Foods, offer myriad personal, grocery, and household items. Entertainment

firms, such as Walt Disney Corporation, produce movies, television programs,

toys, theme park entertainment, and vacation services. In many cases, the jus-

tification for multiple products is the potential cost advantages of producing

many closely related goods.

A production process exhibits economies of scopewhen the cost of pro-

ducing multiple goods is less than the aggregate cost of producing each item

separately. A convenient measure of such economies is

Here, C(Q 1 , Q 2 ) denotes the firm’s cost of jointly producing the goods in the

respective quantities; C(Q 1 ) denotes the cost of producing good 1 alone and

similarly for C(Q 2 ). For instance, suppose producing the goods separately

means incurring costs of $12 million and $8 million, respectively. The total cost

SC

C(Q 1 )C(Q 2 )C(Q 1 , Q 2 )

C(Q 1 )C(Q 2 )

.

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