Cost LeadershipCost Leadership
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Chapter 4Chapter 4
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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 productthat customers prefer over competitors’ product
Example: Wal-Mart
Example: Harley-Davidson
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
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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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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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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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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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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 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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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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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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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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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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Organizational Structure
Three Organizational Structures
Simple
Functional
Multi-Divisional
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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
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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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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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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
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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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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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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