In this post from Tyler Cowen and Alex Tabarrok’s blog Marginal Revolution, Cowen reports that in Shanghai it is common to find establishments that advertise and offer both foot massages and “other kinds of massages” (prostitution). Cowen refers to the dual offering of foot massages and prostitution as an economy of scope. While an economy of scale is an industry in which the average cost per unit decreases as the scale of the production increases, an economy of scope is an industry in which the average cost per unit decreases when the firm produces two or more products. Cowen explains that a business that offered prostitution and wonder bread would probably not have much success. Not only are these two products unrelated, it is likely that the presence of prostitution would stigmatize the business and discourage consumers who are only looking to buy Wonder Bread. Instead Cowen posits that another economy of scope could be prostitution and cocaine. This illicit economy of scope would likely be the result of an agreement between the business and local law enforcement officials.
Identifying potential economies of scale requires attention to both the supply and demand of the products being offered together. In terms of demand, the products should have overlapping, but not identical target demographics. In the case of the Shanghai massage parlors, the clientele for both services tends to be male. Most importantly, the products being produced should have overlapping production costs. For example, Ice Cream Sandwiches and Popsicles both require refrigeration, a fixed (refrigerator) and variable (electricity) cost. In contrast Popsicles and French Fries would probably not form an economy of scope, since there is almost no overlap between their production costs. The seller would have to pay both for refrigeration and frying equipment. Cowen notes that the Shanghai massage parlors limit their joint supply costs due to the fact that the same people who are supplying the foot massages are also supplying the prostitution. It seems like the perfect products for economies of scope are complementary goods that do not have entirely distinct supply costs.
I though this article was fairly interesting. I never considered foot massages and prostitution to be complements, but in terms of production costs, I can see that foot massages and prostitution can incur the same labor unit input. Both tasks are also service goods instead of actual material so the input of costs could actually be split to make the average cost per unit decrease when the firm produces these two products. I think the targeted consumers though will be very limited as these types of firms are intended for men meaning they won’t be earning as much profit.
Offering both foot massages and prostitution also probably encourages consumers to enter the market for prostitution who might normally not. If a customer were to go in distinctly for the purpose of receiving a foot massage he or she might be distracted by or encouraged to enter the other industry as well. As much as these goods might be complementary, there is a “package deal” kind of advertising going on in this scenario as well. Advertising is worth a lot to producers.