STRAT 5701 Week 5 - Cost Leadership

Risks of cost-leadership strategy

1) Dramatic technological change could take away your cost advantage 2) Competitors may learn how to imitate value chain advantages 3) focus on efficiency could cause cost leader to overlook changes in customer preferences 4)

Learning Curve Economies

A firm gets more efficient at a process with experience The more complicated/technical the process, the greater is the experience advantage International expansion may propel a firm down the experience curve because of higher volumes Ex: Fuel injectors, texas instruments MAYBE COSTLY to imitate, RARE

When does a low=cost strategy work?

A low-cost strategy works when: - price competition is vigorous - large market size - product is standardizes to readily available from many firms - there are few ways to achieve differentiation that have value to buyers - buyers incur low switching costs

Implementing a cost leadership strategy

A strategy is only as good as its implementation Strategy is implemented through structure and control: - Structure: the division of management responsibilities and the establishment of reporting relationships - Control: policies intended to influence behavior -- align the interest of the individual with the interests of the organization

Policy Choices

- Determines what PRODUCTS and what PRICES -Firms get to choose how they will serve the market -We'll offer the level of quality that is inexpensive to produce. -Firms can make policy choices that give people incentives to reduce cost at every opportunity. (ex: walmart telling employees to not interact with customers) Ex: southwest airlines MAYBE COSTLY to imitate, LESS RARE

Sources of Cost advantage

- Economies of Scale - less rare - Learning Curve Economies - rare - Differential Low-Cost Access to Productive Inputs - rare - Technology Advances Independent of Scale - hardware (less rare), software (rare) - Policy Choices - less rare

cost leadership strategic choices

- The overriding goal of the cost leader is to increase efficiency and lower its costs relative to rivals - The cost leader does not try to take the lead in product innovations - The cost leader positions its products to appeal to the "average" customer

Southwest airlines' different policy choices

- limited use of travel agents - Short haul point to point routes - secondary airports - Limited passenger service - no first class - limited assigned seating - no connections with other airlines - standardized fleet of 737s - fast turnarounds

Diseconomies of Scale

DO NOT RESULT IN COST LEADERSHIP!!!!! It results from pushing factories TOO hard) Occur when firms become too large and bureaucratic Are a RISK of international expansion Ex: Crown Cork & Seal LOW COST to duplicate, LESS RARE

Technology Advantages Independent of Scale

Investing in latest advances - production technology, eg: substituting equipment for labor through automation • may allow small firms to become cost competitive • advantage typically accrues to the "owner" of the technology—may or may not be the ones who actually use the technology • size of the advantage depends both on how valuable and protectable the technology is Ex: Pilkington Glass Hardware - MAYBE COSTLY to duplicate, LESS RARE Software - COSTLY to imitate, RARE

Differential Access to Low-Cost 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 ex: Walmart negotiating with P&G for lowest prices COSTLY to imitate, RARE

U-form structure

CEO > departments Lower administrative costs Preferred by cost-leaders

The only person in a functional organization who has to have a multifunctional perspective is the COO. CEO. marketing manager. CFO.

CEO.

Economies of Scale

Cost per Unit falls as quantity increases -- until the minimum efficient scale is reached Are a cost advantage because competitors may not be able to match the scale because of capital requirements (barrier to entry) - result in volume discounts - employee specialization - specialized machinery - cost of plant & equip decline with size International expansion may allow a firm to have enough sales to justify investing in additional capacity to capture economies of scale LOW-COST to duplicate, LESS RARE

Informal Organizational Controls for management

Culture Attitudes Leadership styles

A source of cost advantage will lead to competitive advantage is that source is:

VRIO: Valuable, Rare, costly to Imitate, Organized (Implemented appropriately)

what are productive inputs?

any supplies used by a firm in conducting its business activities; they include, among other things, labor, capital, land, and raw materials

Why cost leadership matters (competitive market curve)

in a competitive market, demand curve is flat because there's a set price in the market.... What determines quantity, then, is Actual Total Cost curve Really efficient cost leaders find ways to shift down the cost curve BELOW the industry average (ATCind)

In order to create a cost advantage, the cost of acquiring low-cost productive inputs must be ________ the cost savings generated by these factors. greater than or equal to greater than less than equal to

less than

Organizational controls and cost leadership

management controls and compensation policies can be focused on cost reduction Supply contracts that stipulated cost reductions over time Tight credit policies Austere travel policies (e.g. no first class) Bonuses tied to cost reduction targets Ex: Walmart, IKEA, Southwest

Learning-curve-cost advantages are restricted only to firms in services industries. restricted only to firms in extraction industries. restricted only to manufacturing firms. not restricted to manufacturing.

not restricted to manufacturing.

forward pricing

Firms engage in an activity called "forward pricing" when they establish, during the early stages of the learning curve, a price for their products that is lower than their actual costs, in anticipation of lower costs later on, after significant learning has occurred.

Porters Generic Value Chain

Inbound logistics > Operations > outbound logistics > Mktg & sales > After-services Sales

Organization for cost-leadership strategy

Few layers, simple reporting relationships, focus on functions,

Potentially COSTLY to imitate

1. Differential access to inputs 2. Processes and routines that have been developed over time 3. Proprietary software 4. Protected or unobservable technology 5. UNOBSERVABLE value chain cost improvements 6. UNIQUE bundle of cost-reducing activities

Types of Firm differentiation

1. Product difference - preference for the firm's output - people might be more willing to pay a premium ex: Nordstrom, Harley-Davidson 2. Cost Leadership - lower costs of production/distribution ex: Primark, Walmart

Formal Organizational Controls for management

Budgeting policies Credit policies Spending policies Travel policies Purchasing policies

Business Level vs. Corporate Strategy

Business Level Strategy: How to position a business in the market? Actions firms take to gain competitive advantages in a single market or industry Corporate level strategy: which business to enter? actions firms take to gain competitive advantages by operating in multiple markets or industries simultaneously

A firm that chooses a cost-leadership business strategy focuses on gaining advantages by reducing its costs to a level equal to all of its competitors. True False

False

Compensation at cost-leadership firms is usually tied directly to product innovation and customer service efforts. True False

False

________ levels of production are associated with ________ levels of employee specialization. High; high Low; high Low; moderate High; low

High; high

NOT costly to imitate

Non-proprietary or highly observable technology Observable value chain improvements

Michael Porter: What is Strategy?

Strategy is a unique and valuable position. Strategy requires tradeoffs. Strategy involves creating "fit" among a company's activities

VRIO - Organization (basics)

Structure: 1) the division of management responsibilities 2) the establishment of reporting relationships Control: policies intended to influence behavior Compensation: incentives for behavior

Competitive Advantage

The ability to create more economic value then competitors

Relative Cost Analysis

The analysis of how a firm's costs compare to its competitors for various activities in its business model.

Even the best formulated strategy is competitively irrelevant if it is not implemented. True False

True

Large transportation costs can offset cost reductions attributable to the exploitation of economies of scale in manufacturing. True False

True

T/F: cost leadership reduces the threat of rivalry

True

T/F: cost leadership can reduce the threat of buyers/suppliers

True - Being a cost leader deters backward vertical integration by buyers

A firm that chooses a ________ focuses on gaining advantages by reducing its cost below all of its competitors. product-differentiation business strategy diversification strategy corporate strategy cost-leadership business strategy

cost-leadership business strategy