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Cost Leadership

Copyright 2008 Pearson Prentice Hall. All rights reserved. 4-1

Chapter 4

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Cost Leadership

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Cost Leadership


Mission Objectives

ExternalAnalysis

InternalAnalysis

Strategic

Choice

Strategy

Implementation

Competitive

Advantage

The Strategic Management Process

Business LevelStrategy Corporate LevelStrategy

How to Position aBusiness

in the Market?

Which Businessesto Enter?

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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 product

that customers prefer over competitors product

Example: Wal-Mart

Example: Harley-Davidson

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Why Cost Leadership Matters

D

ATCind

Q

P

Competitive Market

ATCff

Above NormalEconomicReturns

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Understanding Cost Advantage

Managers need to understand whohasthe 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

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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

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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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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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Differential Low-Cost Access to Productive Inputs

may result from:

historybeing in the right place at the right time

being first into a marketesp. foreign markets

natural endowmentowning a mineral deposit

locking up a sourcebuying all of its output

Example: Quantity Carpet Buys

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Technology Independent of Scale

Example: Vegetable Inspection

may allow small firms to become cost competitive

advantage typically accrues to the owner of thetechnologymay 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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Policy Choices

firms get to choose how they will serve the market

well offer level of quality that is inexpensive toproduce

firms can make policy choices that give peopleincentives to reduce cost at every opportunity

Example: Southwest Airlines

d h

d h

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Cost Leadership & Competitive Advantage

A source of cost advantage will lead tocompetitive advantage if that source is:

Valuable

Rare

Costly to Imitate

Organized (Implemented Appropriately)

C L d hi

C L d hi

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Value of a Cost Advantage

Rivalry

Entry Buyers

SuppliersSubstitutes

increases capitalrequirementsfor entrants

competitors rationallyavoid price competition

limitsattractivenessof substitutes

increasesimportance of the

focal firm to thesupplier

lowers incentivesfor buyers to

vertically

integrate

C t L d hi

C t L d hi

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Rareness of a Cost Advantage

The rareness of a source of cost advantagedepends heavily on the industry life cycle:

Economies of Scale



Technology

Policy Choices

Differential Input Access

Not Rare Rare

Emerging Mature

Rare Rare

Not RareRare

Rare Rare

Not RareRare

Rare Rare

Generally

C t L d hi

C t L d hi

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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)

C t L d hi

C t L d hi

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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)

C t L d hip

C st L d ship

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Implementing a Cost Leadership Strategy

A strategy is only as good as its implementation

Strategy is implemented through organizational

structure and control:

structure: 1) the division of managementresponsibilities, and 2) the establishment ofreporting relationships

control: policies intended to influence behavioralignthe interests of the individual with the interests of theorganization

Cost Leadership

Cost Leadership

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Organizational Structure

Three Organizational Structures

Simple

Functional

Multi-Divisional

Cost Leadership

Cost 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 firmgrows in size and complexity

Simple Structure


Cost Leadership

Cost Leadership

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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

Cost Leadership

Cost Leadership

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Production

Finance

R&D

Accounting MarketingHuman

Resources

Chief Executive Officer

Functional Structure


Cost Leadership

Cost Leadership

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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 of

vice presidents, etc.information is filtered through layers

CEO balances coordination & competition amongdivisions

Cost Leadership

Cost Leadership

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Multi-Divisional Structure (M-Form)

Strategic

Planning

Corporate

Finance

Corporate

R&D

Corporate

Marketing

ProductionFinance R&D Accounting

HumanResources

Division Division Division

Marketing

Chief Executive Officer

CorporateHuman

Resources

Cost Leadership

Cost Leadership

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The Functional Structure and Cost Leadership

specialization within functions facilitates cost reduction

CEO can use this structure to:

ensure best cost reduction practices areshared among divisions

allow and encourage decision-making by those

who are in the best positions to do sothoseclose to decisions

ensure that functions are coordinating efforts inpursuit of a common strategy

Cost Leadership

Cost Leadership

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Organizational Controls

Policies intended to influence behavior by aligningthe interests of the individual with the interests ofthe organization

Management Controls

Formal Informal

culture budgeting policies

credit policies

spending policies

travel policies

purchasing policies

attitudes

leadership styles

Cost Leadership

Cost Leadership

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Compensation Policies

stock options

bonuses based on:

cost reduction

financial performance

non-monetary awards

vacations

parking places

Compensation Policies Should ReinforceFormal and Informal Management Controls

office decor

Cost Leadership

Cost Leadership

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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

Cost Leadership

Cost Leadership

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ost Leadershipost Leadersh p

Summary

Business Level Strategy

Cost Leadership Product Differentiation

Cost Advantages

Economies of Scale



Differential Input Access

Technology

Policy Choices

Competitive AdvantageDepends on MeetingVRIO Criteria

Emphasis on

Organization(Implementation)

Structure &Control

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