To accompany contemprory strategy analysis concepts techiniques application chapter08slides

Cost Advantage• Economies of experience curve and the benefits of market share • Sources of cost advantage • Using the value chain to analyze costs • Current approaches to managing cost

Cost Advantage

• Economies of experience curve and the benefits

of market share

• Sources of cost advantage

• Using the value chain to analyze costs

• Current approaches to managing costs

OUTLINE

The Experience Curve

The Experience Curve

The “Law of Experience”

The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles.

Cost per

unit of

output (in

real $)

Cumulative Output

1992

1994

1996

1998

2000

2002 2004

Examples of Experience Curves

70% slope 75%

Japanese clocks & watches, 1962-72 UK refrigerators, 1957-71

The Importance of Market Share

If all firms in an industry have the same experience curve, then:

Change in relative costs over time = f (relative market share)

This supported by PIMS data:

BUT: - Association does not imply causation

- Costs of acquiring market share offset the returns to market share

0-10 10-20 20-30 30-40 over 40

Market Share (%)

Drivers of Cost Advantage

PRODUCTION TECHNIQUES

PRODUCT DESIGN

INPUT COSTS

CAPACITY UTILIZATION

RESIDUAL EFFICIENCY

ECONOMIES OF LEARNING

ECONOMIES OF SCALE

• Organizational slack; Motivation &

culture; Managerial efficiency

• Ratio of fixed to variable costs

• Speed of capacity adjustment

• Location advantages

• Ownership of low-cost inputs

• Non-union labor

• Bargaining power

• Standardizing designs & components

• Design for manufacture

• Process innovation

• Reengineering business processes

• Increased dexterity

• Improved organizational routines

• Indivisibli\ties

• Specialization and division of labor

Economies of Scale: The Long-Run

Cost Curve for a Plant

Economies of Scale: The Long-Run

Cost Curve for a Plant

Units of output per period

Minimum Efficient Plant Size

Cost per

unit of

output

Sources of scale economies:

- technical input/output relationships

- indivisibilities

- specialization

The Costs Developing New Car Models

(including plant tooling)

The Costs Developing New Car Models

(including plant tooling)

$ billion

Ford Mondeo/ Contour 6

GM Saturn 5

Ford Taurus (1996 model) 2.8

Ford Escort (new model 1996) 2

Renault Clio (1999 model) 1.3

Honda Accord (1997 model) 0.6

Rolls Royce Phantom (2003 model) 0.3

10 20 50 100 200 500 1,000

Annual sales volume (millions of cases)

Coke Pepsi

Seven Up

Dr Pepper Sprite

Diet Pepsi Tab

Fresca Diet Rite

Diet 7-Up

Schweppe

s SF Dr Pepper

Despite the massive advertising budgets of brand leaders Coke and Pepsi, smaller brands which incur the highest advertising costs per unit of sales

Scale Economies in Advertising: U.S Soft Drinks

Scale Economies in Advertising: U.S Soft Drinks

Cost Advantage in Short-Haul

Passenger Air Transport

Cost Advantage in Short-Haul

Passenger Air Transport

Costs per Available Seat-Mile (1993)

Southwest Airlines United Airlines (cents) (cents)

Wages and benefits 2.4 3.5

Aircraft ownership 0.7 0.8

Aircraft maintenance 0.6 0.3

Commissions on ticket sales 0.5 1.0

Food and beverage 0.0 0.5

Key Stages in Applying the Value Chain to Cost Analysis: The Case of

Automobile Manufacture

Key Stages in Applying the Value Chain to Cost Analysis: The Case of

Automobile Manufacture

STAGE 1 IDENTIFY THE PRINCIPLE ACTIVITIES

STAGE 2 ALLOCATE TOTAL COSTS

PURCH-ASING

PARTS INVEN-TORIES

R&D DESIGN ENGNRNG

COMPONENT MFR

ASSEMBLY TESTING,QUALITY

CONTROL

GOODS INVEN-TORIES

SALES &

MKITG

DISTRI-BUTION

DEALER & CUSTOMER SUPPORT

Applying the Value Chain to Cost Analysis

(continued)

Applying the Value Chain to Cost Analysis

(continued)

PURCH-ASING

PARTS INVEN-TORIES

R&D DESIGN ENGNRNG

COMPONENT MFR ASSEMBLY

TESTING, QUALITY CONTROL

GOODS INVEN-TORIES

SALES

&

MKITG

DISTRI-BUTION

DEALER & CUSTOMER SUPPORT

Plant scale for each Level of quality targets No of dealers

component Frequency of defects Sales / dealer Process technology Level of dealer Plant location support Run length Frequency of defects

Capacity utilization under warranty

Prices paid Size of commitment Plant scale Cyclicality &

depend on: Productivity of Flexibility of production predictability of sales

Order size R&D/design No of models per plant Customers’

Purchases per No & frequency of new Degree of automation willingness to wait

supplier models Sales / model

Bargaining power Wage levels

Supplier location Capacity utilization

STAGE 3.

IDENTIFY

COST

DRIVERS

Applying the Value Chain to Cost Analysis

(continued)

Applying the Value Chain to Cost Analysis

(continued)

PRCHSNG PARTS R&D COMPONENT ASSMBY TESTING GOODS SALES DSTRBTN DLR INVNTRS DESIGN MFR QUALITY INV MKTG CTMR

Consolidation of orders to increase

discounts, increases inventories

Designing different models around common components and platforms reduces manufacturing costs

Higher quality parts and materials reduces costs of defects

at later stages

Higher quality in manufacturing reduces warranty costs

STAGE 5 RECCOMENDATIONS FOR COST REDUCTION

STAGE 4 IDENTIFY LINKAGES

Dynamic vs Static Approaches to

Manufacturing

Dynamic vs Static Approaches to

Manufacturing

Artisan mode: Scientific Management Mode:

- problem solving - quest for “one best way”

- employee knowledge creation - people matched to tasks

- employee control over product - incentives and penalties to

- product and customer ensure conformity to objectives orientation - planning and control by staff

- continuous incremental - science driven improvement - focused around corporate R&D

- market needs pull technology departments

- product and process innovation- emphasis on product Innovation

- teamwork and cross-functional and big projects collaboration

PRODUCTION

SYSTEM

MANAGEMENT

OF

TECHNOLOGY

DYNAMIC STATIC

Recent Approaches to Cost Reduction

Dramatic changes in strategy and structure

to adjust to the business conditions of the 1990’s Key elements:

• Plant closures

• Outsourcing

• Delayering and cuts in administrative staff

The fundamental rethinking and radical redesign of business processes to achieve dynamic improvements in performance

e.g.:-• Several jobs combined into one

• Steps of a process combined in natural order

• Minimizing steps, controls, and reconciliation

• Use case managers as single points of contact

• Hybrid centralization/ decentralization

CORPORATE

RESTRUCTURING

BUSINESS

PROCESS

REENGINEERING