Question

How does the concepts of economies of scope and economies of scale different in relation to the merger of Strayer University and Capella University? What are the synergies that come from the economies of scope? What are the synergies that come from economies of scale?

Answer 1

For a deep understanding of this case study, we need to understand the meaning of Economies of Scope & that of Economies of Scale and then differentiate between the two in relation to the merger of Strayer University and Capella University: -

A) Economies of Scope: -

Economies of scope, takes place when the diversity of products which a firm offers increases and the resultant is a reduction in its overall costs and an increase in profits. For example, consider a passenger airline which operates and carries people from one place to another. Now this flight has enough room for carrying freight as well and the company extends its services and allows freight to be carried in the same flight. This allows for the firm to add diversity to its offerings wherein it offers passenger and freight services at the same time which reduces the overall cost of the firm, since the same cost of carrying passengers is applied even if additional freight is added, while the benefits include profits from both freight as well as passengers.

Relationship & Scope with Merger of Strayer University and Capella University

When, both the Universities come together with one another, the diversity of courses which they offer will increase. For example, the Strayer University is known for its expertise towards Management & Legal Courses, whereas Capella University is known for courses such as Healthcare, Information & Technology, Nursing etc. When, both the universities come together, they offer a diversified range of products and services to the students which in turn translates into economies of scope as explained above.

This reduces the overall costs for the new entity since, its expenditure on services such as classrooms and infrastructure remain the same, while both now with mutual understanding offer diversified courses and it helps in increasing profits while keeping costs similar.

Synergies that come from Economies of Scope: -

Synergies refers to the added success which comes from Economies of Scope. As firms, begin to add complementary goods which in the case is additional courses and infrastructure for students, it allows them to offer a variety of products or services at a fraction of the cost which it earlier used to. In this merger both the universities can offer a variety of courses at a reduced cost because they can already use the infrastructure and faculty of one another rather than starting them afresh. This allows for higher profits with no added costs.

Similarly, even if a single firm such as airline example explained above, adds complimentary services such as freight and the cost of production does not increase as much as the profits, it describes the economies of scope, wherein we offer additional complimentary products to a consumer, and this further adds to our profits.

B) Economies of Scale: -

Economies of Scale is a concept which refers to the fact that fixed costs for a firm remain the same, and as it adds more production units, the per unit cost of labour force as well as of fixed costs also begins declining. For an example, if there is production of 1 Unit of a product, the total cost that it incurs is 100$ since fixed cost remains the same. Now, if the production is increased to 10 Units, the fixed costs such as machinery, land etc. remain the same while the cost on each product reduces to 10$ per unit.

These highlights, that as a producer engages in production of additional units, its fixed costs remain the same, therefore it reduces the cost per unit and leads to higher profitability.

Relationship & Scope with Merger of Strayer University and Capella University: -

Now, talking of the merger between Strayer University and Capella University, the new formed entity, would deal with a larger number of students which they earlier used to, bringing in additional revenue for the new entity while, the cost of operations would decrease since the merger would allow for common resources to be used. For example, if there is one lab for a science project, the same may be used by both university students and this helps in reducing costs, while adding more students allows for higher profits.

Thus, we can say, that the merger would allow for catering the needs of a larger number of students at a lower cost which is what economies of scale in this case means.

Synergies that come from Economies of Scale: -

The synergy or advantage that economies of scale introduces is that the cost of operations remain the same or change slightly, while the per unit cost reduces significantly, thus allowing for higher profit margins.

Usually, costs can be divided into two parts which are fixed costs such as land, machinery etc. which remain the same no matter what be the production size, and variable costs such as labour force which may change with production levels.

As a company goes on adding additional produced units of goods and services, the fixed costs remain the same thus reducing the cost per unit while variable costs may increase but this rate is also slower than the increase in profits.

This thus means that at a higher level of production, the costs per unit decline and profits thus increase.

Conclusion: -

Economies of Scope, come from diversification of business and adding more complementary items to the list of services or products offered which lower costs, while economies of scale focus on the same product being offered to a larger audience. In this case both apply as the merger allows for each university to both diversify while at the same time offer its services to a larger target audience thus adding higher profits.