This week I'm writing about economies of scope. You can read what they are here, and how they are produced here. The natural question at this point is: "why should a boutique consulting firm care about decreasing its marginal cost of serving clients?"
I expect to give you a more holistic answer by the end of the week, but the concrete and direct benefits of economies of scope for boutique consultancies are two:
- Financial Performance & Competitive Edge
- Financial Security & Predictability
Financial Performance & Competitive Edge
As a firm increases the number of its offering (either by packaging co-produced products and services, or identifying new ones that share common processes or resources), the average cost of promoting and delivering each offering decreases. And this leads to a higher profit margin on each new engagement sold.
Now, this higher margin allows partners to make different business decisions. You can hire new people or systems to improve delivery. The higher margins also allow you to subsidize smaller transactions to enter a new market or get your foot in the door of a dream client, for example.
However you choose to act on it, economies of scope will directly impact your earnings and your ability to differentiate in your space.
Financial Security & Predictability
A stronger financial performance, when well-managed, naturally leads to stronger financial security. Just like you can reinvest higher margins in the business, you can also keep the money in the bank. Increasing the number of months of cash will provide you with peace of mind and the ability to get through tough times.
But there's also a direct effect here. By marketing and delivering a variety of offerings, a firm diversifies its sources of revenue. And this reduces the risk associated with product/service failure.
If a service becomes outdated or less effective to generate results for clients, you can continue to promote other offerings while you work on making changes. You gain the ability to identify much faster any shifts in market demand. And with several services, a rejection of a new offering never puts your business at risk.
But if you push the engine too hard, it will damage the engine. Keep increasing the number of offerings in your consultancy forever, and the benefits disappear. After a threshold, the more services you add, the more your marginal costs go up.
I'll talk about diseconomies of scope tomorrow.