Many companies are operating under the false assumption that diversifying their product lines will automatically lead to cost savings, according to a new study from the University of Surrey. This misconception could be costing firms millions each year, as new findings suggest that traditional methods of evaluating economies of scope are fundamentally flawed.
The research, published in the Annals of Operations Research, shows that traditional methods for evaluating cost savings from diversification – known as "economies of scope" – are flawed. These methods typically compare the costs of producing multiple products together with producing them separately but fail to account for key efficiencies from shared resources.
Instead of using overly simple calculations that often lead to inaccurate and inflated cost estimates, the study proposes a more accurate way of assessing production costs.
As an example, companies thinking of expanding into new markets by producing both smartphones and tablets need to look beyond simple cost-sharing assumptions and consider the complexity of supply chain management, resource allocation, and production bottlenecks, or they could find their desired cost savings evaporate, to be replaced by unexpected hidden costs like inefficiencies and quality issues.
To test their approach, the researchers created two virtual companies specialising in different products, based on data from existing diversified businesses. By comparing the costs of these specialised firms with the costs of joint production, they provided a clearer picture of when diversification truly saves money.
Dr Mehdi Toloo, co-author of the study and Reader in Business Analytics at the University of Surrey, said:
“Many businesses are stuck in old ways of thinking about cost efficiency. Our study challenges these outdated ideas and offers practical advice to help companies make smarter decisions about their operations and strategies.
“We looked at how companies that make different products can save money by making those products together instead of separately. Our new method helps us find out if making two products together is cheaper than making them in different companies. We found that some companies really do save money by producing together, while others end up spending more.”
The findings show that companies relying on outdated methods may be wasting resources and missing opportunities to cut costs. By using this updated approach, businesses can more accurately evaluate whether producing multiple products together is truly cost-effective, instead of blindly following outdated processes.
The research also highlights the importance of rethinking decisions around mergers and producing multiple products. It provides clear guidance on how companies can avoid inefficiencies and improve profitability in today’s competitive markets.
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