cost leadership copyright © 2006 pearson prentice hall. all rights reserved. strategic management...

Cost LeadershipCost Leadership

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 4-4-11

Chapter 4Chapter 4

Cost Leadership

2



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

3



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

4



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

5




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

Cost Leadership

6




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

7




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

Cost Leadership

8




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

9




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

Cost Leadership

10



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

11



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…

Cost Leadership

12



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

13



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

14



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

15



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

18




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

19




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

20



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

21




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

22




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 copyright © 2006 pearson prentice hall. all rights reserved. strategic management...

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