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Transcript of Cost Leadership Copyright © 2008 Pearson Prentice Hall. All rights reserved. 4-1 Chapter 4.
Cost LeadershipCost Leadership
Copyright © 2008 Pearson Prentice Hall. All rights reserved. Copyright © 2008 Pearson Prentice Hall. All rights reserved. 4-4-11
Chapter 4Chapter 4
Cost Leadership
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Cost LeadershipCost Leadership
Copyright © 2008 Pearson Prentice Hall. All rights reserved.Copyright © 2008 Pearson Prentice Hall. All rights reserved. 4-4-22
Mission Objectives
ExternalAnalysis
InternalAnalysis
StrategicChoice
StrategyImplementation
CompetitiveAdvantage
The Strategic Management Process
Business LevelStrategy
Corporate LevelStrategy
How to Position aBusiness
in the Market?
Which Businessesto Enter?
Cost Leadership
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Cost LeadershipCost Leadership
Copyright © 2008 Pearson Prentice Hall. All rights reserved.Copyright © 2008 Pearson Prentice Hall. All rights reserved. 4-4-33
Business Level Strategies
Two Generic Business Level Strategies
Cost Leadership:
• generate economic value by having lower coststhan competitors
Product Differentiation:
• generate economic value by offering a productthat customers prefer over competitors’ product
Example: Wal-Mart
Example: Harley-Davidson
Cost Leadership
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Cost LeadershipCost Leadership
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Why Cost Leadership Matters
D
ATCind
Q
P
Competitive Market
ATCff
Above NormalEconomicReturns
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Cost LeadershipCost Leadership
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Understanding Cost Advantage
Managers need to understand who hasthe cost advantage in their market
• it could be the focal firm
• it could be a competitor
• develop a strategy to exploit the advantage
• develop a strategy to either capture theadvantage or compete on some other basis
Cost Leadership
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Cost LeadershipCost Leadership
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Sources of Cost Advantage
Economies of Scale
• average cost per unit falls as quantity increases-until the minimum efficient scale is reached
• are a cost advantage because competitors maynot be able to match the scale because of capitalrequirements (barrier to entry)
• international expansion may allow a firm to haveenough sales to justify investing in additionalcapacity to capture economies of scale
Cost Leadership
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Cost LeadershipCost Leadership
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Sources of Cost Advantage
Diseconomies of Scale
• are an advantage for those who do not havediseconomies of scale
• occur when firms become too large and bureaucratic
• are a risk of international expansion
Example: Nucor Steel
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Cost LeadershipCost Leadership
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Sources of Cost Advantage
Learning Curve Economies
• a firm gets more efficient at a process with experience
• the more complicated/technical the process,the greater the experience advantage
Example: Fuel Injectors
• international expansion may propel a firm down theexperience curve because of higher volumes
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Cost LeadershipCost Leadership
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Sources of Cost Advantage
Differential Low-Cost Access to Productive Inputs
• may result from:
• history—being in the right place at the right time
• being first into a market—esp. foreign markets
• natural endowment—owning a mineral deposit
• locking up a source—buying all of its output
Example: Quantity Carpet Buys
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Cost LeadershipCost Leadership
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Sources of Cost Advantage
Technology Independent of Scale
Example: Vegetable Inspection
• may allow small firms to become cost competitive
• advantage typically accrues to the ‘owner’ of thetechnology—may or may not be the ones who actuallyuse the technology
• size of the advantage depends both on how valuableand protectable the technology is
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Cost LeadershipCost Leadership
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Sources of Cost Advantage
Policy Choices
• firms get to choose how they will serve the market
• we’ll offer level of quality that is inexpensive toproduce
• firms can make policy choices that give people incentives to reduce cost at every opportunity
Example: Southwest Airlines
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Cost LeadershipCost Leadership
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Cost Leadership & Competitive Advantage
A source of cost advantage will lead to competitive advantage if that source is:
• Valuable
• Rare
• Costly to Imitate
• Organized (Implemented Appropriately)
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Cost LeadershipCost Leadership
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Value of a Cost Advantage
Rivalry
Entry Buyers
SuppliersSubstitutes
• increases capitalrequirementsfor entrants
• competitors rationallyavoid price competition
• limits attractivenessof substitutes
• increasesimportance of the
focal firm to thesupplier
• lowers incentivesfor buyers to
verticallyintegrate
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Cost LeadershipCost Leadership
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Rareness of a Cost AdvantageThe rareness of a source of cost advantagedepends heavily on the industry life cycle:
Economies of Scale
Diseconomies of Scale
Learning Curve Economies
Technology
Policy Choices
Differential Input Access
Not Rare Rare
Emerging Mature
Rare Rare
Not RareRare
Rare Rare
Not RareRare
Rare Rare
Generally…
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Cost LeadershipCost Leadership
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Imitability of Sources of Cost Advantage
Conditions largely determine if a source of costadvantage will be costly to imitate
Low Cost Conditions
Unbalanced Industry Capacity and Demand
Non-Proprietary Technology
Highly Observable Technology
Transactional Exchange
(A cost advantage can be easily imitated)
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Cost LeadershipCost Leadership
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Imitability of Sources of Cost Advantage
High Cost Conditions
Balanced Industry Capacity and Demand
Path Dependence (Historical Uniqueness)
Protected Technology
Highly Unobservable Technology (Causal Ambiguity)
Relational Exchange (Social Complexity)
(A cost advantage cannot be easily imitated)
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Cost LeadershipCost Leadership
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Implementing a Cost Leadership Strategy
A strategy is only as good as its implementation
Strategy is implemented through organizationalstructure and control:
• structure: 1) the division of managementresponsibilities, and 2) the establishment ofreporting relationships
• control: policies intended to influence behavior—alignthe interests of the individual with the interests of theorganization
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Cost LeadershipCost Leadership
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Organizational Structure
Three Organizational Structures
Simple
Functional
Multi-Divisional
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Cost LeadershipCost Leadership
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Owner / Manager
• Owner/Manager makes all major decisions directly and monitors all activities
• difficult to maintain this structure as the firm grows in size and complexity
Simple Structure
Organizational Structure
Cost Leadership
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Cost LeadershipCost Leadership
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Organizational Structure
Functional Structure (U-Form: Unitary)
• divides management responsibilities by function
• marketing
• finance
• accounting
• procurement
• production
• R&D
• HR
• logistics
• etc.
• CEO is the only executive with enterprise-wideperspective
• CEO is responsible for strategy & coordinationof functions
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Cost LeadershipCost Leadership
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Production
Finance
R&D
Accounting MarketingHuman
Resources
Chief Executive Officer
Functional Structure
Organizational Structure
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Cost LeadershipCost Leadership
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Organizational Structure
Multi-Divisional Structure (M-Form)
• functions are replicated in each division as appropriate
• this structure makes sense when the firm is involvedin more than one business or has grown large enoughto justify geographic divisions
• CEO has strategic responsibility with the help ofvice presidents, etc.—information is filtered through layers
• CEO balances coordination & competition amongdivisions
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Cost LeadershipCost Leadership
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Organizational Structure
Multi-Divisional Structure (M-Form)
Strategic Planning
Corporate Finance
Corporate R&D
Corporate Marketing
ProductionFinance R&D Accounting
Human Resources
Division Division Division
Marketing
Chief Executive Officer
CorporateHuman
Resources
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Cost LeadershipCost Leadership
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Organizational Structure
The Functional Structure and Cost Leadership
• specialization within functions facilitates cost reduction
• CEO can use this structure to:
• ensure best cost reduction practices are shared among divisions
• allow and encourage decision-making by thosewho are in the best positions to do so—thoseclose to decisions
• ensure that functions are coordinating efforts inpursuit of a common strategy
Cost Leadership
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Cost LeadershipCost Leadership
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Organizational Controls
Policies intended to influence behavior by aligningthe interests of the individual with the interests ofthe organization
Management ControlsFormal Informal
• culture• budgeting policies
• credit policies
• spending policies
• travel policies
• purchasing policies
• attitudes
• leadership styles
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Cost LeadershipCost Leadership
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Organizational Controls
Compensation Policies
• stock options
• bonuses based on:
• cost reduction
• financial performance
• non-monetary awards• vacations
• parking places
Compensation Policies Should Reinforce Formal and Informal Management Controls
• office decor
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Cost LeadershipCost Leadership
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Organizational Controls
Organizational Controls and Cost Leadership
• management controls and compensationpolicies can be focused on cost reduction
• supply contracts that stipulate cost reductionsover time
• tight credit policies
• austere travel policies (e.g., no first class)
• bonuses tied to cost reduction targets
Example: Wal-Mart & Southwest Airlines
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Cost LeadershipCost Leadership
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Summary
Business Level Strategy
Cost Leadership Product Differentiation
Cost Advantages
Economies of Scale
Diseconomies of Scale
Learning Curve Economies
Differential Input Access
Technology
Policy Choices
Competitive AdvantageDepends on Meeting
VRIO Criteria
Emphasis onOrganization
(Implementation)
Structure &Control