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Cost LeadershipCost Leadership

Chapter 4Chapter 4

Cost Leadership

2


Copyright © 2006 Pearson Prentice Hall. All rights reserved. Copyright © 2006 Pearson Prentice Hall. All rights reserved. Strategic Management & Competitive Advantage - Barney & HesterlyStrategic Management & Competitive Advantage - Barney & Hesterly 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

3



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

Cost Leadership

4



Why Cost Leadership Matters

D

ATCind

Q

P

Competitive Market

ATCff

Above NormalEconomicReturns

Cost 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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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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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

Cost Leadership

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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

Cost Leadership

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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

Cost Leadership

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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 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

Cost Leadership

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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

Cost 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)

Cost Leadership

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Value of a Cost Advantage

Threat ofRivalry

Threat of Entry Threat of Buyers

Threat ofSuppliers

Threat ofSubstitutes

• increases capitalrequirementsfor entrants

• competitors rationallyavoid price competition

• limits attractivenessof substitutes

• increasesimportance of the

focal firm to thesupplier

• lowers incentivesfor buyers to

verticallyintegrate

Cost Leadership

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Duplication of a Cost AdvantageThe cost associated with duplication of cost advantage:

Economies of Scale



Technology

Policy Choices

Differential Input Access

Source of Cost AdvantageHistory Uncertainty Social

Complexity

Not Not Not

Not Not Not

Somewhat Not Not

Not Somewhat Somewhat

Somewhat Not Not

Very likely to be costly

Not Likely to be costly


Likely to be costly


Policy Choices

Cost 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)

Cost 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)

Cost 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

Cost Leadership

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Organizational Structure

Three Organizational Structures

Simple

Functional

Multi-Divisional

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 firm grows in size and complexity

Simple Structure


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

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Production

Finance

R&D

Accounting MarketingHuman

Resources

Chief Executive Officer

Functional Structure


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 ofvice presidents, etc.—information is filtered through layers

• CEO balances coordination & competition amongdivisions

Cost Leadership

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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

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 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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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

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 Reinforce Formal and Informal Management Controls

• office decor

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

Cost Leadership

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Summary

Business Level Strategy

Cost Leadership Product Differentiation

Cost Advantages

Economies of Scale



Differential Input Access

Technology

Policy Choices

Competitive AdvantageDepends on Meeting

VRIO Criteria

Emphasis onOrganization

(Implementation)

Structure &Control

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