Ch 4: Cost Advantage

Acquisition Strategy

Scale curve can be useful to predict cost synergies or the amount costs are likely to decrease if two firms combine their volume/scale

2 Strategies for Unique Value

1) Cost Advantage 2) Differentiation Advantage

Cost Advantage Strategy

Wins customers by reducing its price below its competitors therefore gaining market share -or same price which results in greater profits not market share

3 Principle Sources of Economies of Scale producing Cost Advantage

1) Ability to spread nonproduction costs 2) Specialization of Equipment 3) Specialization of People

5 Sources of Cost Advantage

1) Economies of Scale or Scope 2) Learning and Experience 3) Input Costs 4) Different Business Model 5) Proprietary Knowledge

Example of Company that Changed Business Model to create Cost Advantage

1) Panasonic has advantage over Sony because opts to spend only half of what they do on RD and just imitates their technology 2) Amazon competed with Barnes and Nobles by selling books online

4 ways companies achieve cost advantage through lower input costs

1) Strong bargaining power over suppliers 2) Cooperating well with suppliers 3) Getting inputs from low cost locations 4) Having better access to inputs

Scale curve

A graphic representation of the relationship between cost per unit and scale (volume) of production in a given period -Service companies have scale curves that show how the cost to serve customers decreases as the number of customers served increases -However, when costs per unit no longer decrease with increase in volume at a point called minimum efficient scale

Different Business Model

Achieve cost advantage through an entirely new business model. This is achieved by either: 1) Eliminating steps in the value chain 2) Performing completely new activities

Proprietary Knowledge

Information that is not public and viewed as the property of the holder (ex. patent)

Why does market share not necessarily lead to greater profitability?

Market share is a key driver of profitability. However market share is earned and is not easily purchased. Can be earned by low-cost strategy or offering a superior product. Greater market share could lead to lower costs per unit

Pricing Strategy

Company uses experience curve to anticipate future costs at different volumes of production. If cost is lower at greater volume, company may want to aggressively price items now to gain market share and achieve lower cost per unit in the future

Relative Costs

Costs incurred by one company compared to the costs paid by a competitor

Law of Experience

Costs per unit decrease with increases in cumulative volume of production -Cost per unit of a standard product declines by a constant percentage (10-30%) each time accumulation output doubles -Volume more important to success in manufacturing than service industries

Fixed Production Costs

Costs such as plant and equipment which are relatively fixed meaning that they do not increase with an increase with units produced

Inputs

Resources such as people, raw materials, energy, information, etc. that are put in to a system to obtained a desired output

How are experience curve and scale curve different?

Scale curve is A graphic representation of the relationship between cost per unit and scale (volume) of production in a given period whereas Experience curve is relationship of cost per unit (including costs other than labor) and cumulative volume

Experience Curve

Shows how costs per unit change with increases in cumulative volume produced. Requires cumulative volume like learning curve -Costs drop with increases in cumulative volume due to economics of scale, but also learning -If done on the same period experience curve and learning curve would be the same -Representation of relationship between cumulative volume and product costs -Captures effects of economies of scale better than learning curve because it includes ALL COSTS, not just labor

Economies of Scale

When an increase in company size (measured in volume of production) lowers the company's average cost per unit produced -A reduction in costs per unit due to increases in efficiency of production as the number of goods being produced increases -can create a cost advantage for large firms over small

Employee Specialization

Increased efficiency that results when employees perform a narrow range of tasks over and over again leading to acquired specialized knowledge that helps them complete tasks more efficiently

Cost-management strategy

Allows companies to asses how well they are doing at managing costs compared to their competitors -relative cost

Cost Synergies

Amount by which costs will likely decrease if two firms combine their volume/scale -Often influences if acquisition occurs

Diseconomies of Scale

An increase in marginal cost when output is increased -occurs when large plants become very complex to manage leading to increased waste and lower employee motivation -Big firms can be at a disadvantage during economic downturns because its harder to spread fixed costs. Some firms try to shift some fixed costs to variable costs by outsourcing or leasing equipment short term

Task Specialization

Breaking a large process into smaller tasks that require specialized knowledge

Growth/Investment Strategy

Experience curves are steeper in faster growing markets. Firms in a market with a steep curve have an imperative to grow as fast or faster than their rivals so they don't end up with a cost disadvantage. Indicates a firm should do whatever is necessary to become market share leader

Learning Curve

The concept that the labor costs per unit decrease with increases in volume due to learning. New skills or knowledge can be quickly acquired initially but subsequently learning becomes much slower -harder to calculate than scale curve because requires gathering data on cumulative volume of a given product produced since company started making the product

Minimum Efficient Scale

Smallest level of output (unit volume) that a plant/firm can produce to minimize its long-run average costs. Where costs per unit flatten and no longer continue going down with increased output

Economies of Scope

The average total cost of production decreases as a result of increasing the number of different goods produced -Unlike Economies of scale, they lower costs by expanding scope of its operations to related activities so costs can be shared as opposed to increasing production volume of a specific activity -2 business activities with in the same company is less costly then if they operated separately