Chapter 4- Cost Advantage

1. wage rates 2. exchange rates 3. raw material and energy costs

3 areas where differences can occur that will allow price of inputs to vary significantly

1. market share does not guarantee substantial cost advantages 2. spillovers of knowledge to rivals lower their costs of learning 3. aging equipment can impede continues learning and cost advantages

3 limitation of the experience curve

1. R&D 2. advertising 3. general and administrative costs

3 types of non production costs that can be spread to reach economies of scale

1. ability to spread fixed costs of production 2. ability to spread non production costs 3. specialization of equipment 4. specialization of people

4 principle sources where economies of scale arise

1. greater bargaining power over suppliers or labor 2. superior cooperation with suppliers 3. sourcing from low-cost locations 4. preferred access to inputs

4 sources of lower input costs

1. growth/investment strategy 2. pricing strategy 3. cost-management strategy 4. acquisition strategy

4 strategic implications of scale/experience curve

1. exercising strong bargaining power over suppliers 2. cooperating especially well with suppliers 3. getting inputs from low-cost locations 4. arranging better access to inputs than other companies have

4 ways that companies achieve cost advantage through lower-cost inputs

1. use a pull system: avoid overproduction 2. just-in-time delivery: reduce inventory 3. level out the workload: smooth production 4. use visual controls: illuminate problems and reduce defects 5. find the bottleneck: increases productivity

5 key principles of toyota production system

1. economies of scale 2. learning and experience 3. proprietary knowledge 4. input costs 5. different business models

5 sources of cost advantage

cost advantage strategy

allowed by companies who rely on fact that humans can perform tasks more efficiently the more a task is related and helps people become more effective at completing task

cost synergies

amount by which costs will likely decrease if two firms combine their volume/scale. scale curve can be useful to predict

diseconomies of scale

an increase in marginal cost when output is increased

task specialization

breaking a large process in to smaller tasks that require specialized knowledge

learning curve

concept that labor costs per unit decrease with increases in volume due to learning. new skills or knowledge can be quickly acquired initially, but subsequent learning becomes much slower

ensuring causality

confirming that there is not a third variable that may be causing both profitability and market share to increase simultaneously besides the reason of scope/scale and experience

general and administrative costs

expenses and taxes that are directly related to the general operation of the company, the executive salaries, general support and taxes related to the overall administration of the company

different business model

firm can deliver a product or service at a lower cost by eliminating activities or steps in the value chain or using a different set of activities altogether

growth/investment strategy

first movers in a fast growing market will secure a widening cost advantage. firm's must grow as fast, or faster, than rivals or be at a cost disadvantage

scale curve

graphic representation of the relationship b/w cost per unit and scale (volume) of production in a given period. at some point costs per unit no longer decrease with increases in volume

learning and experience

greater cumulative volume drives cost differences due to this increasing within companies with more cumulative experience in production

economies of scale

greater volume unit allows firms to have lower costs by spreading fixed costs across more units, specialization of equipment and people

employee specialization

increased efficiency that results when employees perform a narrow range of tasks over and over again, leading them to acquire specialized knowledge that helps them complete the task more efficiently

experience/volume drives lower costs per unit of experience/volume

industries that contain this will have relationship between market share and profitability

proprietary knowledge

information that is not public and that is viewed as the property of the holder. can lead to cost advantage without scale or output being involved

relative market share (RMS)

is reasonable proxy for relative cumulative experience: of leader relative to next largest follower, of all followers relative to leader

economies of scale

reduction in costs per unit due to increases in efficiency of production as the number of goods being produced increases

experience curve

representation of the relationship between cumulative volume and product cost

inputs

resources such as people, raw materials, energy, information, or financing that are put into a system to obtain a desired output

pricing strategy

scale/experience curve used: -as a basis for market share based on pricing strategy -as a basis for planning future prices -as a basis for pricing a production run or contract

benchmarking/cost analysis

scale/x-curves can be plotted for a company and its competitors to assess how well each company is managing its costs. companies that fall above the regression line may not be managing costs well

acquisition strategy

scale/x-curves provide data on how much costs will likely decrease (Cost synergies) if two firms combine their volume/scale

minimum efficient scale

smallest level of output that a plant or firm can produce to minimize its long run average costs. in graphic presentation of output/unit volume (x-axis) and cost per unit (y-axis) it is the output level where costs per unit flatten and no longer continue going down w/ increased output

proprietary knowledge

some companies develop this in the production of their product or service which leads to a cost advantage

cost advantage strategy

strategy for offering unique value where a firm reduces its prices below all of its competitors, thereby allowing it to gain market share

cost advantage strategy

strategy for offering unique value where firm chooses same price as competitors which results in greater profits rather than higher market share

cost advantage strategy

strategy in which the unique value offered to customers is lower-priced products or services

TPS

successful but difficult imitate production system

economies of scope

the average total cost o production decreases as a result of increasing the number of different goods produced

relative costs

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

1. eliminating steps in the value chain 2. performing completely new activities

2 primary ways in which a cost advantage can be achieved through creating a new business model

1. ability to spread fixed costs 2. specialization

2 reasons why economies of scale lower costs

1. decreasing variable costs per unit due to learning 2. decreasing fixed costs per unit due to scale

2 reasons why experience curve works

1. shift more of cost structure from fixed to variable costs 2. diversifying into businesses that are countercyclical

2 ways that firms with heavy fixed assets can respond to concern of disadvantage of economies of scale

1. purchasing volume 2. purchasing and negotiating tactics

2 main sources of bargaining power over suppliers

fixed cost of production

costs such as plant and equipment which are relatively fixed meaning that they do not increase with an increase in the number of units produced

firms with scale have advantage in economic upturns but may be at disadvantage during downturns

disadvantage of scale since firms may have more difficulty spreading fixed costs when demand declines

market share

does not guarantee substantial cost advantages b/c there is a cost to it and learning curve flattens with high experience

business model

the plan and set of activities implemented by a company to offer unique value and generate revenue and make a profit from operations

value chain

the sequence of all activities that are performed by a firm to turn raw materials into the finished product that is sold to a buyer

Toyota Production System (TPS)

toyota's proprietary knowledge that has given them a cost advantage

1. cost advantage 2. differentiation advantage

two generic strategies for offering unique value