Why do companies create multiple products and services? How can consulting practices grow by developing new offerings while reducing risk? What are the limits or disadvantages of creating new consulting services?
I believe all of those questions can be better answered by understanding one key economic idea: Economies of scope. Let's start with the definition.
Economies of scope exist where an organization reduces the cost per unit sold by producing a bigger variety of products or services.
This idea was first explored by John Panzar and Robert Willig in a 1977 article entitled “Economies of Scale in Multi-Output Production”. When people hear about it, they often think about the much more popular idea of "economies of scale". They're related, but not the same.
Economies of scale are characterized by volume. The bigger your output (units produced or clients you sell to), the more you reduce your marginal cost. It's a key advantage for large companies such as Walmart, Amazon, Boeing, Toyota, Intel, and so on.
Economies of scope, on the other hand, are characterized by variety. Producing several different offerings is more cost-effective to a firm than producing fewer products and services. Or producing each one of them separately.
To benefit from economies of scope, you don't need scale. That's why it is a much more useful concept for boutique consulting firms that might not have access to, or the ability to serve, a large number of clients.
To keep this email brief, I want to quickly focus on answering three questions:
Economies of scope can occur because the products or services are co-produced, they share the same processes, or they share the same resources:
You might be thinking: "Got it, but why should I worry about decreasing my marginal costs when I take in just a dozen clients every year?"
This question can actually spark interesting discussions with consultancy partners, but let’s try to keep it short here. The concrete and direct benefits of economies of scope for boutique consultancies are two:
If a service becomes outdated or less effective to generate results for clients, you can continue to promote other offerings while you work on making changes.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 quickly identify any shifts in market demand. And with several services, a rejection of a new offering never puts your business at risk.
But too much medicine will overdose the patient. 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.
The average cost falls until a certain point. A consultancy that offers too many products and services might begin to see an increase in the average cost of each offering. This is what John Panzar and Robert Willig called “diseconomies of scope”.
But why is that true? How does creating a service list longer than a Thai restaurant menu hurt boutique consultancies?
There are three main factors diseconomies of scope include:
Having only one service offering sabotages your growth. Too many will hurt your margins and add unneeded complexity to your consulting business. The challenge is to reach the right balance.
How much is enough? Check the “One Question” section.
“Economies of scale and scope (...) are both types of learning.
Economies of scale are the advantages that can result when repeatable processes are used to deliver large volumes of identical products or service instances. Scaling relies on interchangeable parts either in the product itself, or in the delivery mechanisms, in the case of intangible services.
Economies of scope are the advantages that can result when similar processes are used to deliver a set of distinct products or services.
As a first approximation, you could say that economies of scale result from learning the engineering, while economies of scope result from learning the marketing. The first is primarily a one-front war between a business and nature. The second is primarily a two-front war where a business fights nature on one front, and market incumbents on another.”
SPI’s latest research shows that new services were responsible for 25 to 30% of revenue among professional services firms. This includes projects sold to both existing and new clients.
When was the last time you reflected on how to package your expertise in multiple ways to help clients solve new problems and/or make them comfortable with the exchange of value?
I sometimes get asked by partners: “Do you have any data on what the ideal number of offerings for a boutique like mine (8 people, close to $1 mi/year rev) is? What's the sweet spot?”
My answer is always the same: No, I don't have data. And, as Venkatesh’s quote clarified, there's no sweet spot.
When I'm helping boutique consultancies rethink their offering mix, these are some questions that typically come up:
These decisions can create economies of scope for your consulting business. They may reduce the average unit cost of serving a client and increase your margins. But they are, essentially, marketing questions.
This is why there's not a single solution to the question "how many offerings should you promote?" It's not an engineering problem, like the ones you have when scaling production inside a factory. The market changes, your clients' needs and preferences change, and you do your best to adapt.
As Venkatesh puts it, improving your offering mix is a learning problem. The more you learn, the better your services will be accepted in the market. If you haven’t asked yourself this question recently, invest some time into exploring it - feel free to drop me a line if you need help in the process.