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Chapter 6
Cost Analysis
servers, software, and telecommunications (together constituting over 10 percent 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 customer 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 externalities 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 distribution 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 justification for multiple products is the potential cost advantages of producing many closely related goods. A production process exhibits economies of scope when the cost of producing multiple goods is less than the aggregate cost of producing each item separately. A convenient measure of such economies is SC
C(Q1) C(Q2) C(Q1, Q2) C(Q1) C(Q2)
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Here, C(Q1, Q2) denotes the firm’s cost of jointly producing the goods in the respective quantities; C(Q1) denotes the cost of producing good 1 alone and similarly for C(Q2). For instance, suppose producing the goods separately means incurring costs of $12 million and $8 million, respectively. The total cost
