The Impact of Frictions in Routine Execution on Economies of Scope

Abstract

Research summary:Based on a detailed database of a beverages producer-distributor that expanded its product variety by leveraging its logistic network, we show that product diversification generates economies of scope and also higher operational costs. The result is an inverted-U relationship between variety and productivity: When the firm offers few additional categories, productivity grows, but as the number of categories rises, the costs of executing the operational routines increase rapidly and productivity falls. The negative effect on productivity increases if the added product category is more dissimilar to previous ones, and decreases with learning from operational experience. Our results highlight how frictions at the operational level can limit the benefits of diversification, even in the absence of other sources of diseconomies, such as increased coordination needs.Managerial summary: One of the prevalent reasons for companies to expand to adjacent product lines is attaining economies of scope. However, such growth strategy also generates operational frictions, even if the day-to-day routines do not appear to change at all. Product diversity is disruptive for routine execution, as it requires coordination and exception handling, and may ultimately overcome any efficiency obtained from growth. We estimate the relevance of such operational friction using data from a beverages distribution network. When product variety is low, additional categories do generate efficiency, but after reaching a given threshold, friction prevails. We find that operational friction increases when products are more dissimilar, but is attenuated when workers learn from their own and other's experience.

Product complexity and operational performance: A systematic literature review

“…This friction takes the form of modified work routines, increased communication, and a need to manage interdependencies in the business, all of which can erode productivity. However, the authors found evidence that these operational frictions could be reduced with more worker experience (Brahm et al, 2017).…”

“…An inverted U-shaped relationship was identified between PC (Herfindahl type index) and productivity (i.e., the natural logarithm of average drop size) in a transportation company (Brahm et al, 2017). One of the mechanisms at play in the study was operational friction, which is created by adding a variety that is dissimilar from the variety currently being offered (e.g., adding a confectionary product line when the company mostly produces beverages).…”

“…, where is the share of sales from product i and k, and is a distance function between products i and k, or similar variation (Aw and Lee, 2009;Brahm et al, 2017;Gollop, 1997;Vachon and Klassen, 2002) Entropy index…”

The Survival Benefits of Service Intensity for New Manufacturing Ventures: A Resource-Advantage Theory Perspective

“…The integration of services also requires an expanded view of a venture’s external environment to include additional competitors, suppliers, marketers, distributors, and customers (Vandermerwe and Rada 1988). These changes create the need to learn new roles and relationships, develop communication systems, refine administrative routines, and attract new qualified employees (Aldrich and Auster 1986; Brahm, Tarzijan, and Singer 2017).…”

Aligning Talent Acquisition Practices to Strategic Business Objectives

“…The execution of a strategy depends upon the ability of the leadership team to formulate effective plans, build trust, communicate purpose and intent to the employees, create and align systems for execution and track leading and lagging indicators. Brahm, Tarzijan, and Singer (2017) contend that the execution of strategy usually runs into trouble because there is a tension between expansion strategies and the operational routines required to implement them. With initial expansion, the efficiency of operational routines increases, but beyond a threshold, as expansion increases further, the gains from operational routines decline.…”