INSTITUTE OF PROFESSIONAL EDUCATION AND RESEARCH

ASSIGNMENT

ONMANAGERIAL ECONOMICS (ECONOMIES OF SCOPE)

SUBMITTED TO: SUBMITTED BY: PROF. A.K. SHARAN GAURAVSAWLANI

ROLL NO.14PGDM TRIM-1

ECONOMIES OF SCOPE

INTRODUCTION:

“Economies” of “Scope” was introduced into the economics literature by Baumol, Panzar and willig in 1982 for use in determining whether a firm might advantageously produce a variety of products and services or whether it would be better to spin some of them off for production by separate entities. An economy of scope is a term that refers to the reduction of per unit costs through the production of wider variety of goods or services.

Baumol in 1982 define economies of scope to be present between two products (y1, y2) if the cost of producing both products by one firm is less than the cost of producing them separately in specialized firms. Mathematically economies of scope is represent if

C (y1, y2) < C1 (y1, 0) + C2 (0, y2),

Where C (y1, y2) is the cost of joint production by the diversified firm, and C1 (y1, 0) and C2 (0, y2) are the respective costs of production of y1 and y2 by two specialized firms. So, the degree of economies of scope (DES) for the firm x is defined as

(DES) x= C1 (Y1, 0) + C2 (0, Y2) – C (Y1, Y2)C (y1, y2)

If (DES)x > 0 implies that firm x Exhibits economies of scope, if (DES)x < 0 implies diseconomies of scope, and (DES)x = 0 means that the cost are additive in nature.

An economic theory stating that the average total cost of production decreases as a result of increasing the number of different goods produced.

For example, McDonalds can produce both hamburgers and French fries at a lower average cost than what it would cost two separate firms to produce the same goods. This is because McDonald’s hamburgers and French fries share the use of food storage, preparation facilities, and so forth during production.

Another example is a company such as Proctor & Gamble, which produces hundreds of products from razors to toothpaste. They can afford to hire expensive graphic designers and marketing experts who will use their skills across the product lines. Because the costs are spread out, this lowers the average total cost of production for each profitability. 1.

Economies of scope are conceptually similar to economies of scale. Whereas 'economies of scale' for a firm primarily refers to reductions in average cost (cost per unit) associated with increasing the scale of production for a single product type, 'economies of scope' refers to lowering average cost for a firm in producing two or more products. The term and concept development are due to Panzar and Willig (1977, 1981) Here, economies of scope make product diversification efficient if they are based on the common and recurrent use of proprietary knowhow or on an indivisible physical asset. For example as the number of products promoted is increased, more people can be reached per dollar spent. At some point, additional advertising expenditure on new products may start to be less effective (an example of diseconomies of scope).Related examples and distribution of different types of products, product bundling, product lining, and family branding.

If a sales force is selling several products they can often do so more efficiently than if they are selling only one product. The cost of their travel time is distributed over a greater revenue base, so cost efficiency improves. There can also be synergies between products such that offering a complete range of products gives the consumer a more desirable product offering than a single product would. Economies of scope can also operate through distribution efficiencies. It can be more efficient to ship a range of products to any given location than to ship a single type of product to that location.

Further economies of scope occur when there are cost-savings arising from by-products in the production process. An example would be the benefits of heating from energy production having a positive effect on agricultural yields.

A company which sells many product lines, sells the same product in many countries, or sells many product lines in many countries will benefit from reduced risk levels as a result of its economies of scope. If one of its product lines falls out of fashion or one country has an economic slowdown, the company will, most likely, be able to continue trading.

Not all economists agree on the importance of economies of scope. Some argue that it only applies to certain industries, and then only rarely

WHY ECONOMIES OF SCOPE MATTERS

Similar to economies of scale, economies of scope provide companies with a means to generate operational efficiencies. However, economies of scope are often obtained by producing small batches of many items (as opposed to producing large batches of just a few items). Because they frequently involve marketing and distribution efficiencies, economies of scope are more dependent upon demand than economies of scale. This is often what motivates manufacturers to bundle 2.

Products or to create a whole line of products under one brand. Although economies of scope are often an incentive to expand product lines, the creation of new products is often less efficient than expected. The need for additional managerial expertise or personnel, higher raw materials costs, a reduction in competitive focus, and the need for additional facilities can actually increase a company's per-unit costs. When this happens, it is often referred to as diseconomies of scope.

Nevertheless, when done correctly, economies of scope can help companies gain a significant competitive advantage. Not only do they trim expenses on a per-unit basis and improve profitability, but they can also force less cost-efficient competitors out of the industry or discourage would-be rivals from even entering the market

HOW ECONOMIES OF SCOPE WORKS:

Let’s assume Company XYZ strictly manufactures vacuum cleaners. What would happen if the company decided to branch out into brooms? Adding brooms to the product line would allow XYZ to spread certain fixed costs over a larger number of units. Thus, the company could reach more customers with its advertising budget, its sales force could be used to sell both products, brooms could be stored and shipped from the firm's existing vacuum warehouse, and the company's factory could turn leftover broom bristles into cleaning brushes for its vacuums. Furthermore, XYZ could then market itself as a "cleaning products" company rather than just a "vacuum" company.

In this example, XYZ increased the variety of items produced rather than increasing the number of vacuum cleaners produced. As a result, the company's advertising, selling, and distribution costs may generally remain the same, but its number of products sold will increase. The cost of producing multiple products simultaneously is often less than the costs associated with producing each product line independently. Therefore, because the firm has managed to reduce its total costs per unit produced, XYZ could become more profitable.

ECONOMIES OF SCOPE IN AGRICULTURE MARKETING RESOURCE CENTRE

The economies of scope can be further defined as the process of reducing the cost of resources and skills for an individual business enterprise by spreading the use of these resources and skills over two or more enterprises.  As shown in Figure 1, the cost for an enterprise is cut in half if the resources are used in two enterprises rather than just one.  If the use of the resources is spread over three enterprises, the cost per enterprise is reduced to a third.

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Figure 1: Economies of Scope

Economies of Scope Examples

The cost of a combine can be spread over several crop enterprises because, in many cases, the only thing needed to harvest another crop is a different combine head.  Another combine does not need to be purchased for each additional crop enterprise.  The same combine can be used to harvest corn, soybeans, wheat, barley, oats, canola, sunflowers, etc.

As a farmer, agronomic skills can be used in the production of two or more crops.  Being a seed dealer and a farmer means that the knowledge gained about seed selection can be used both as a salesperson and a farmer.  The same can be said about farmers who sell crop insurance.

Economies of scope exist if a firm can produce several product lines at a given output level more cheaply than a combination of separate firms each producing a single product at the same output level. Economies of scope differ from economies of scale in that a firm receives a cost advantage by producing a complementary variety of products with a concentration on a core competency. While economies of scope and scale are often positively correlated and interdependent, strictly speaking the benefits from scope have little to do with the size of output.

For instance, in the paper products industry it is common for large firms to produce their own pulp, the primary ingredient in paper, before manufacturing the paper goods themselves. However, smaller firms may have to purchase pulp from others at a higher net cost than the large companies. The savings from producing both pulp and paper would be an economy of scope for the large producers, although the large companies probably also have economies of scale that make it feasible to invest in pulping operations in the first place. 4.

In another example, banks have economies of scope when they offer a variety of related financial services, such as retail banking and investment services, through a single service infrastructure (i.e., their branches, ATMs, and Internet site). Clearly, the costs of providing each service separately would be much greater than the costs of using a single infrastructure to provide multiple services.

Research concerning hospitals has suggested that other types of services, such as pediatric care, may have economies of scope. With increasing competition and emphasis on service, economies of scope are necessary for hospitals to provide these services profitability.

METHODS TO GAIN ECONOMIES OF SCOPE:

There are various methods such as,

The first one is flexible manufacturing. Flexibility is the ability to introduce new products in the same category by changing the design mix for instance. This allows quick and Low cost switching of one product line to another and enables multiple productions with the same plant in order to meet the changing demand of the market such as in the case of seasonable products. The producer can add a variety of new products to their current production line. The scope of products increases offering a barrier to entry for new firms and a competitive synergy for the firm itself

The next method is what we call Diversification where the firms adopt diversification strategy by extending existing capabilities, resources and expertise for greater competitiveness with the purpose of acquiring economies of scope between various business units. The cost savings result when a business transfers expertise in one business to a new business. The businesses can share operational skills, technical know-how and key competencies in production. This will maximize limited constraints. 

Owing to labor specialization with the passage of time, a garment factory in a military set up can also extend the capacity to meet the demands of the various other forces such as Navy, Air Force, and Police, scouts, cadets, bank security forces and so forth engaged in the security sector leading to economies of scope in the apparel production.

 The third dimension is Merges for instance; pharmaceutical firms encourage research and development through funding in order to bring new products to the market. Firms involved in drug discovery realize economies of scope by sustaining diverse portfolios of research projects that capture both internal and external knowledge spillovers.

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CRUX OF ECONOMIES OF SCOPE:

In terms of industrial organization, economies of scope are present in enterprises that develop and manufacture a variety of related products. Such corporations extend expertise in core competencies or technologies to the full range of products related to those core competencies or technologies. Economies of scope differ from economies of scale in that the enterprise enjoys a cost advantage from manufacturing generally limited quantities of a variety of products based on a core expertise, rather than concentrating that core expertise on manufacturing large quantities of one product. That is, economies of scope may be realized when it is cheaper to produce one product in conjunction with other products than to produce that product alone.

General Motors Corp. (GM) provides an excellent example of a corporation with broad economies of scope. The core competency of GM rests in the development and fabrication of products powered by gasoline- or diesel fueled engines. The firm operates six automobile groups: Cadillac, Buick, Oldsmobile, Pontiac, Chevrolet, and Saturn. Each enterprise is engaged in the production of cars powered by internal combustion engines. This core competency is extended to larger vehicles through its GM Truck division—which manufactures small- and medium-size utility trucks and larger semi-trailer tractors—and to railroad locomotives through its Electro Motive division. In addition to conventional- and diesel-engine products, GM until recently enjoyed a position in a related propulsion technology, turbine engines, through its Allison division, which built a variety of turbojet engines for use in aircraft and power generation.

Ford Motor Co. was organized similarly across product lines, controlling the Ford, Lincoln, and Mercury automobile lines as well as the Ford Truck division. For a period during the 1930s, and again during World War II, Ford manufactured not only aircraft engines but also complete aircraft.

General Electric also achieved significant economies of scope around turbine engine technology, providing the company with significant positions in power-generating equipment, nuclear power, and jet engines.

During the 1980s General Dynamics provided an example of economies of scope within defense technology, specifically as it related to defense electronics. General Dynamics controlled the nation's largest nuclear submarine company, Electric Boat, the former Chrysler battle tank division, and Convair, manufacturer of F-111 and F-16 aircraft and numerous rocket systems.

AT&T is a company initially organized solely around a single business, telecommunications technology, operating on the principle of economies of scale.

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Once the largest telecommunications company in the world, its recent forays into computer technology, wireless mobile telephone, and broadband data communications represent a transformation in which core competencies are being extended to related businesses.

Zenith Electronics Corp. provides an example of the opposite transformation. Once involved in television and radio production, computers, lighting systems, and cable communications, representing economies of scope, Zenith has shed all but its television and cable businesses, choosing to concentrate its expertise only in those areas where it is exceptionally competitive.

Economies of scope have been realized in a number of industries, including telecommunications and the health-care industry. One should not conclude, however, that bigger is necessarily better. Studies of big banks, for example, that were operating efficiently, have shown that they often became more inefficient as they grew larger through consolidations and mergers. Problems associated with managing complex businesses can prevent companies from realizing the benefits of economies of scope.

Like the condition of economies of scale, economies of scope provide an enterprise with opportunities for significant cost savings. Economies of scope achieve this, however, not through increases in the scale of manufacturing apparatus, but through increases in the scope of those applications into related fields. This situation provides numerous consumer benefits by enabling technological developments in one area to be tested and applied to other areas. The result is faster application of new technologies to a wider range of products and greater product value to the consumer.

ECONOMY OF SCOPE V/S ECONOMY OF SCALE

Generally speaking, economies of scale is about the benefits gained by the production of large volume of a product, while economies of scope is linked to benefits gained by producing a wide variety of products by efficiently utilising the same Operations. Each of these business strategies their strengths and weaknesses, will be discussed in details in this paper."Economies of scale" has been known for long time as a major factor in increasing profitability and contributing to a firm's other financial and operational ratios. Mass production of a mature, standardised product can apply the most efficient line-flow process and standard inputs for reducing the manufacturing cost (per unit). Mass manufacturing is also associated with a significant market-share, and a tight supply-chain management (up to vertical integration with suppliers and retailers).

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To maintain the market share the market leader should come with continuous product improvements, so to sustain demand and avoid its dropping, following the product's maturity in the Product Life-Cycle (PLC).

"Economies of scope" is relatively a new approach to business strategy, and is heavily based on the development of high technology. Economies of scope, as defined by using same processes for producing similar products, can fit the batch-flow or group-technology processes; nevertheless, for best results the flexible-manufacturing should be adopted. Computer Integrated Manufacturing (CIM) allows lowering the setup-time and required tuning between products, so to be economically efficient for small batches of non-standardised products. In other words, companies can compete on product customisation and short lead-time.

A case study at GM shows that new competition can reduce firm's market share and its benefits from economies of scale (Howell, 2003). The author argues that the main problem was the neglect of innovation, as a side-effect of GM's strategy (until the Japanese cars entered the US market, in the late 1970s). Cachon and Harker (2002) found that scale economies are so powerful that to provide a strong motivation for outsourcing, too; even though the outsourcing contractors are not allowed reaching the same scale as the outsourcer. Dobson and Yano's (2002) article is an in-dept scholarly analysis of the factors associated with economies (and diseconomies) of scale and economies (and diseconomies) of scope. The authors argue that mass-customisation, which means broader product lines, "may help to increase market share and may allow higher prices to be charged, but they also cause challenges associated with diseconomies of scope" such as setup time.

Ang and Lin (2001) bring a case study from the financial industry, and the ways economies of scope and economies of scale work for mutual fund offerings. At Fidelity, an example of economies of scope at work, investors had the option for high diversified portfolio at the same institution. But aiming at cost reduction (which is of interest to clients and investors), the economies of scope did not provide the desired objectives, while economies of scale did, in the case of mutual funds. Trying to find the ideal conditions for economies of scale and economies of scope, the authors say that a single-product firm should pursue the economies of scale. However, economies of scope for a two-product firm is said to exist "if the cost of producing the two products jointly is less than producing the same products separately". When it comes to three or more products, the number of production combinations increases, so evaluation of the economies of scope becomes more complicated and requires more data to analyse.

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Advocating for a different view of the economies of scope and scale, Peppers and Rogers (1995) put the customers under the spotlight. They argue that market share can be seen as share of customer, pursuing customer differentiation rather than product differentiation, managing customers and not only products and more emphasis on economies of scope at the expense of scale.

As expected, between these two approaches there is a "grey area", in which firms found a way to enjoy both worlds of economies of scale and scope. Mass-customisation, I believe, provides few similar customised products (the concept behind economies of scope) along with operating mass-production and controlling large market share for each of these products.

Economies of scale are reductions in average costs attributable to production volume increases. They typically are defined in relation to firms, which may seek to achieve economies of scale by becoming large or even dominant producers of a particular type of product or service. A distinction can be made between internal and external economies of scales. Internal economies of scale occur when a firm reduces costs by increasing production. External economies of scale occur when an entire industry benefits from expansion; for example, through the creation of an improved transportation system, a skilled labour force, or by sharing technology.

Economies of scope are reductions in average costs attributable to an increase in the number of goods produced. For example, fast food outlets have a lower average cost producing a multitude of goods than would separate firms producing the same goods. This occurs because the preparation of the multiple products can share storage, preparation, and customer service facilities (joint production).

FACTORS ASSOCIATED WITH ECONOMIES AND DISECONOMIES OF SCOPE

The authors argue that mass-customization, which means broader product lines, "may help to increase market share and may allow higher prices to be charged, but they also cause challenges associated with diseconomies of scope" such as setup time. Economies of scope have been realized in a number of industries, including tele-communications and the health-care industry. One should not conclude, however, that bigger is necessarily better. A diseconomy of scope is when the opposite happens. For example, in many strategy games, groups of units move at the speed of the slowest element in them. In this case, fast units are less useful because they are in the same group as slow ones. Also studies of big banks, for example, that were operating efficiently, have shown that they often became more inefficient as they grew larger through consolidations and mergers. Problems associated with managing complex businesses can prevent companies from realizing the benefits of economies of scope.

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To conclude, economies of scope provide an enterprise with opportunities for significant cost savings. Economies of scope achieve this, however, not through increases in the scale of manufacturing apparatus, but through increases in the scope of those applications into related fields. This situation provides numerous consumer benefits by enabling technological developments in one area to be tested and applied to other areas. The result is faster application of new technologies to a wider range of products and greater product value to the consumer.

CONCLUSION:

CASE STUDY

ECONOMIES OF SCOPE AND ECONOMIES OF SCALE IN SOFTWARE COMPANIES:

SCALING UP SOFTWARE DEVELOPMENT

Software development, as currently practiced, is slow, expensive and error prone, often yielding products with large numbers of defects, causing serious problems of usability, reliability, performance, security and other qualities of service.

According to the Standish Group [Sta94], businesses in the United States spend around $250 billion on software development each year on approximately 175,000 projects. Only 16 percent of these projects finish on schedule and within budget. Another 31 percent are cancelled, mainly due to quality problems, for losses of about $81 billion. Another 53 percent exceed their budgets by an average of 189 percent, for losses of about $59 billion. Projects reaching completion deliver an average of only 42 percent of the originally planned features.

These numbers confirm objectively what we already know by experience, which is that software development is labor intensive, consuming more human capital per dollar of value produced than we expect from a modern industry.

Of course, despite these shortcomings, the products of software development obviously provide significant value to consumers, as demonstrated by a long-term trend of increasing demand. This does not mean that consumers are perfectly satisfied, either with the software we supply, or with the way we supply it. It merely means that they value software, so much so that they are willing to suffer large risks and losses in order to reap the benefits it provides. While this state of affairs is obviously not optimal, as demonstrated by the growing popularity of outsourcing, it does not seem to be forcing any significant changes in software development methods and practices industry-wide. 10.

Only modest gains in productivity have been made over the last decade, the most important perhaps being byte-coded languages, patterns, and agile methods. Apart from these advances, we still develop software the way we did ten years ago. Our

methods and practices have not really changed much, and neither have the associated costs and risks.

This situation is about to change, however. Total global demand for software is projected to increase by an order of magnitude over the next decade—driven by new forces in the global economy—like the emergence of China and the growing role of software in social infrastructure, by new application types like business integration and medical informatics, and by new platform technologies like Web services, mobile devices, and smart appliances.

Without comparable increases in capacity, it seems inevitable that total software development capacity is destined to fall far short of total demand by the end of the decade. Of course, if market forces have free play, this will not actually happen, since the enlightened self interest of software suppliers will provide the capacity required to satisfy the demand.

Facing the Changes Ahead, Again

What will change, then, to provide the additional capacity? It does not take much analysis to see that software development methods and practices will have to change dramatically.

Since the capacity of the industry depends on the size of the competent developer pool and the productivity of its members, increasing industry capacity requires either more developers using current methods and practices, or a comparable number of developers using different methods and practices.

While the culture of apprenticeship cultivated over the last ten years seems to have successfully increased the number of competent developers and average developer competency, apprenticeship is not likely to equip the industry to satisfy the expected level of demand for at least two reasons:

We know from experience that there will never be more than a few extreme programmers. The best developers are up to a thousand times more productive than the worst, but the worst outnumber the best by a similar margin [Boe81].

As noted by Brooks [Bro95], adding people to a project eventually yields diminishing marginal returns. The amount of capacity gained by recruiting and training developers will fall off asymptotically.

The solution must therefore involve changing our methods and practices. We must find ways to make developers much more productive.

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Innovation Curves and Paradigm Shifts

As an industry, we have collectively been here before. The history of software development is an assault against complexity and change, with gains countered by losses, as progress creates increasing demand. While great progress has been made in a mere half century, it has not been steady. Instead, it has followed the well known pattern of innovation curves, as illustrated in Figure 1 [Chr97].

Figure 1. Innovation Curves

Typically, a discontinuous innovation establishes a foundation for a new generation of technologies. Progress on the new foundation is initially rapid, but then gradually slows down, as the foundation stabilizes and matures. Eventually, the foundation loses its ability to sustain innovation, and a plateau is reached. At that point, another discontinuous innovation establishes another foundation for another generation of new technologies, and the pattern repeats. Kuhn calls these foundations paradigms, and the transitions between them paradigm shifts [Kuh70]. Paradigm shifts occur at junctures where existing change is required to sustain forward momentum. We are now at such a juncture.

Raising the Level of Abstraction Historically, paradigm shifts have raised the level of abstraction for developers, providing more powerful concepts for capturing and reusing knowledge in platforms

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and languages. On the platform side, for example, we have progressed from batch processing, through terminal/host, client/server, personal computing, multi-tier systems and enterprise application integration, to asynchronous, loosely coupled services. On the language side, we have progressed from numerical encoding,

through assembly, structured, and object-oriented languages, to byte coded languages and patterns, which can be seen as language-based abstractions. Smith and Stotts summarize this progression eloquently [SS02]:

The history of programming is an exercise in hierarchical abstraction. In each generation, language designers produce constructs for lessons learned in the previous generation, and then architects use them to build more complex and powerful abstractions.

They also point out that new abstractions tend to appear first in platforms, and then migrate to languages. We are now at a point in this progression where language-based abstractions have lagged behind platform-based abstractions for a long time. Or, to put it differently, we are now at a point where tools have lagged behind platforms for a long time. Using the latest generation of platform technology, for example, we can now automate processes spanning multiple businesses located anywhere on the planet using services composed by orchestration, but we still hand-stitch every one of these applications, as if it is the first of its kind. We build large abstract concepts like insurance claims and security trades from small, concrete concepts like loops, strings, and integers. We carefully and laboriously arrange millions of tiny interrelated pieces of source code and resources to form massively complex structures. If the semiconductor industry used a similar approach, they would build the massively complex processors that power these applications by hand soldering transistors. Instead, they assemble predefined components called Application Specific Integrated Circuits (ASICs) using tools like the ones shown in Figure 2, and then generate the implementations.

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Figure 2. ASIC Based Design Tools7

Can't we automate software development in a similar way? Of course we can, and in fact we already have. Database management systems, for example, automate data access using SQL, providing benefits like data integration and independence that

make data driven applications easier to build and maintain. Similarly, widget frameworks and WYSIWYG editors make it easier to build and maintain graphical user interfaces, providing benefits like device independence and visual assembly. Looking closely at how this was done, we can see a recurring pattern.

After developing a number of systems in a given problem domain, we identify a set of reusable abstractions for that domain, and then we document a set of patterns for using those abstractions.

We then develop a runtime, such as a framework or server, to codify the abstractions and patterns. This lets us build systems in the domain by instantiating, adapting, configuring, and assembling components defined by the runtime.

We then define a language and build tools that support the language, such as editors, compilers, and debuggers, to automate the assembly process. This helps us respond faster to changing requirements, since part of the implementation is generated, and can be easily changed.

This is the well-known Language Framework pattern described by Roberts and Johnson [RJ96]. A framework can reduce the cost of developing an application by an order of magnitude, but using one can be difficult. A framework defines an archetypical product, such as an application or subsystem, which can be completed or specialized in varying ways to satisfy variations in requirements. Mapping the requirements of each product variant onto the framework is a non-trivial problem that generally requires the expertise of an architect or senior developer. Language-based tools can automate this step by capturing variations in requirements using language expressions, and generating framework completion code.

Industrializing Software Development

Other industries increased their capacity by moving from craftsmanship, where whole products are created from scratch by individuals or small teams, to manufacturing, where a wide range of product variants is rapidly assembled from reusable components created by multiple suppliers, and where machines automate rote or menial tasks. They standardized processes, designs, and packaging, using product lines to facilitate systematic reuse, and supply chains to distribute cost and risk. Some are now capable of mass customization, where product variants are produced rapidly and inexpensively on demand to satisfy the specific requirements of individual customers.

Can Software Be Industrialized?

Analogies between software and physical goods have been hotly debated. Can these patterns of industrialization be applied to the software industry? Aren't we somehow special, or different from other industries because of the nature of our product? Peter Wegner sums up the similarities and contradictions this way [Weg78]:

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Software products are in some respects like tangible products of conventional engineering disciplines such as bridges, buildings and computers. But there are also

certain important differences that give software development a unique flavor. Because software is logical not physical, its costs are concentrated in development rather than production, and since software does not wear out, its reliability depends on logical qualities like correctness and robustness, rather than physical ones like hardness and malleability.

Some of the discussion has involved an "apples to oranges" comparison between the production of physical goods, on the one hand, and the development of software, on the other. The key to clearing up the confusion is to understand the differences between production and development, and between economies of scale and scope.

In order to provide return on investment, reusable components must be reused enough to more than recover the cost of their development, either directly through cost reductions, or indirectly, through risk reductions, time-to-market reductions, or quality improvements. Reusable components are financial assets from an investment perspective. Since the cost of making a component reusable is generally quite high, profitable levels of reuse are unlikely to be reached by chance. A systematic approach to reuse is therefore required. This generally involves identifying a domain in which multiple systems will be developed, identifying recurring problems in that domain, developing sets of integrated production assets that solve those problems, and then applying them as systems are developed in that domain.

Economies of Scale and Scope

Systematic reuse can yield economies of both scale and scope. These two effects are well known in other industries. While both reduce time and cost, and improve product quality, by producing multiple products collectively, rather than individually, they differ in the way they produce these benefits.

Economies of scale arise when multiple identical instances of a single design are produced collectively, rather than individually, as illustrated in Figure 3. They arise in the production of things like machine screws, when production assets like machine tools are used to produce multiple identical product instances. A design is created, along with initial instances, called prototypes, by a resource-intensive process, called development, performed by engineers. Many additional instances, called copies, are then produced by another process, called production, performed by machines and/or low-cost labor, in order to satisfy market demand.

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Figure 3. Economies of Scale

Economies of scope arise when multiple similar but distinct designs and prototypes are produced collectively, rather than individually, as illustrated in Figure 4. In automobile manufacturing, for example, multiple similar but distinct automobile designs are often developed by composing existing designs for subcomponents, such as the chassis, body, interior, and drive train, and variants or models are often created by varying features, such as engine and trim level, in existing designs. In other words, the same practices, processes, tools, and materials are used to design and prototype multiple similar but distinct products. The same is true in commercial construction, where multiple bridges or skyscrapers rarely share a common design. However, an interesting twist in commercial construction is that usually only one or two instances are produced from every successful design, so economies of scale are rarely, if ever, realized. In automobile manufacturing, where many identical instances are usually produced from successful designs, economies of scope are complemented by economies of scale, as illustrated by the copies of each prototype shown in Figure 4.

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Figure 4. Economies of Scope

Of course, there are important differences between software and either automobile manufacturing or commercial construction, but it resembles each of them at times.

In markets like the consumer desktop, where copies of products like operating systems and productivity applications are mass produced, software exhibits economies of scale, like automobile manufacturing.

In markets like the enterprise, where business applications developed for competitive advantage are seldom, if ever, mass produced, software exhibits only economies of scope, like commercial construction.

We can now see where apples have been compared with oranges. Production in physical industries has been naively compared with development in software. It makes no sense to look for economies of scale in development of any kind, whether of software or of physical goods. We can, however, expect the industrialization of software development to exploit economies of scope.

What Will Industrialization Look Like?

Assuming that industrialization can occur in the software industry, what will it look like? We cannot know with certainty until it happens, of course. We can, however, make educated guesses based on the way the software industry has evolved, and on what industrialization has looked like in other industries. Clearly, software development will never be reduced to a purely mechanical process tended by drones. On the contrary, the key to meeting global demand is to stop wasting the time of skilled developers on rote and menial tasks.

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We must find ways to make better use of precious resources than spending them on the manual construction of end products that will require maintenance or even replacement in only a few short months or years, when the next major platform release appears, or when changing market conditions make business requirements change, whichever comes first.

One way to do this is to give developers ways to encapsulate their knowledge as reusable assets that others can apply. Is this far fetched? Patterns already demonstrate limited but effective knowledge reuse. The next step is to move from documentation to automation, using languages, frameworks, and tools to automate pattern application.

Semiconductor development offers a preview into what software development will look like when industrialization has occurred. This is not to say that software components will be as easy to assemble as ASICs any time soon; ASICs are the highly evolved products of two decades of innovation and standardization in packaging and interface technology. On the other hand, it might take less than 20 years. We have the advantage of dealing only with bits, while the semiconductor industry had the additional burden of engineering the physical materials used for component implementation. At the same time, the ephemeral nature of bits creates challenges like the protection of digital property rights, as seen in the film and music industries.

Conclusion

This article has described the inability of the software industry to meet projected demand using current methods and practices. A great many issues are discussed only briefly here, no doubt leaving the reader wanting evidence or more detailed discussion. Much more detailed discussion is provided in the book Software Factories: Assembling Applications with Patterns, Models, Frameworks and Tools, by Jack Greenfield and Keith Short, from John Wiley and Sons. More information can also be found at Software Factories in the MSDN Library, and at http://www.softwarefactories.com/, including articles that describe the chronic problems preventing a transition from craftsmanship to manufacturing, the critical innovations that will help the industry overcome those problems, and the Software Factories methodology, which integrates the critical innovations.

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