Question

First explain what is the difference between an economy of scale and an economy of scope? Then identify a recent merger/acquisition and use it to and explain if the merger/acquisition predominately about gaining economies of scale or economies scope?

Answer 1

Economies of scale are the advantage in production due to enlarged economic activity. It may arise as a result of increase in plant size or output level. In a firm during shortrun the fixed factors remains the same. For example if the firm productive capacity is 2000 units and when the firm increase its production from 100 to 2000 units the fixed factor cost remaining the same. Thus with the increase in production the average cost of production tends to decline. Likewise the average variable cost is also declines due to the operational efficiency. Thus the firm gains from cost reduction. This is cost reduction advantage is termed as economies of scale.

Economies of scope on the other refer to the cost advantage due to the multiple products in a firm rather than producing a single product. The distribution of cost over the two or more product reduces the average unit cost. The basic difference between the economies of scale and economies of scope can be briefly discussed as follows.

1. The strategy of economies of scale involves the gaining of cost advantage by increasing the level of output of a single product.

But the economies of scope involve the cost advantage by spreading the production activity over a wide range of products.

2. In economies of scale, the average unit cost declined in the case of a single product.

But on the other hand in economies of scope the average unit cost declined on multiple products.

3. The economies of scale arise from the change in volume of output.

But the economies of scope arise from the application of varieties in production.

4. The economies of scale is an old strategy and it has been used by the firms since a long time.

The economies of scope are a newly evolved strategy.

5. The economies of scale is product standardization.

The economies of scope are product diversification.

6. To get the advantage of economies of scale, big plant size is required.

In economies of scope the same plant size is needed not be big, the advantage can be obtained in a small plant size but to apply the production of diversified products.

The merger and acquisition are two different economic activities. In merger is the amalgamation of two companies. After merger the two distinct corporate entities act as a single firm. But in acquisition one corporate entity taken over the other. In both the case the object is the wealth maximization. The merger and acquisition both gives the advantage of economies of scale and economies of scope.

The case study of many of the corporate entities shows that they are gaining through the merger and acquisition.

Take the merger history of Reebok by Adidas in 2005. In 2005 Adidas merged with Reebok America which has an estimated value of $3.78 billion. Before the merger Reebok was severely hit from the competition from Nike, Adidas and Puma. The merger between Adidas and Reebok was a great relief to Reebok as Adidas offered to pay over 34% premiums over the last closing price. The merger enlarged the market share of the new Adidas Reebok in U S. Before the merger the market share of Adidas was 8% and that of Reebok was 11%. But after the acquisition the market share of Adidas-Reebok raised to 21%.

Adidas is a German company but Reebok is an American origin. Adidas is a sports item manufacturing company while Reebok is concentrated in lifestyle. The merger helped Adidas to expand its distribution chain across North America where Reebok made its runway. The increased operation of Adidas-Reebok helped the company to reduce its cost and thus the benefit of economies of scale. After the merger the Adidas-Reebok enlarged its production from a single form to a multiple level. This helped it to achieve the advantage of economies of scope.

The merger of acquisition helps the companies in several ways. The capacity of parent company is enhanced which make the company to get the advantage of economies of scale or scope. Merger or acquisition usually reduces the disadvantage from cut-throat competition. By merger or acquisition the parent company is able to avoid the competition from its best rival firm. The merger or acquisition helps the companies to survive the recession or tough period. Both enables a company for achieving the advantage of diversification. By merger or acquisition one company is diversifying its productive activity and thus gets the advantages of economies of scope. The merger and acquisition combine the location of business operation and enables large scale production which reduce operational cost of companies.