To accompany contemprory strategy analysis concepts techiniques application chapter08slides

Cost
Cost Advantage
Advantage
OUTLINE
• 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


The
The Experience
Experience Curve
Curve

The “Law of Experience”

1992
1994
Cost per
unit of
output (in
real $)

The unit cost value added to a standard
product declines by a constant % (typically 2030%) each time cumulative output doubles.

1996
1998
2000

Cumulative Output

2002

2004


Examples
Examples of
of Experience
Experience Curves
Curves

75%

100K 200K
500K
1,000K
Accumulated unit production
(millions)

UK refrigerators, 1957-71
Price Index
50 100 200 300

1960 Yen
15K
20K 30K

Japanese clocks & watches, 1962-72

70% slope

5

10
50
Accumulated units
(millions)


The
The Importance
Importance of
of Market
Market Share
Share
If all firms in an industry have the same experience curve, then:
Change in relative costs over time = f (relative market share)

ROS (%)
-2 0
5

10

This supported by PIMS data:

0-10

10-20 20-30 30-40
Market Share (%)

over 40

BUT: - Association does not imply causation
- Costs of acquiring market share offset the returns to market
share


Drivers
Drivers of
of Cost
Cost Advantage
Advantage
ECONOMIES OF SCALE

ECONOMIES OF LEARNING

PRODUCTION TECHNIQUES
PRODUCT DESIGN

INPUT COSTS

• Indivisibli\ties
• Specialization and division of labor
• Increased dexterity
• Improved organizational routines
• Process innovation

• Reengineering business processes
• Standardizing designs & components
• Design for manufacture
• Location advantages
• Ownership of low-cost inputs
• Non-union labor
• Bargaining power

CAPACITY UTILIZATION

• Ratio of fixed to variable costs
• Speed of capacity adjustment

RESIDUAL EFFICIENCY

• Organizational slack; Motivation &
culture; Managerial efficiency


Economies
Economies of
of Scale:
Scale: The
The Long-Run
Long-Run
Cost
Cost Curve
Curve for
for aa Plant
Plant

Sources of scale economies:
- technical input/output relationships
- indivisibilities
- specialization
Cost per
unit of
output

Minimum
Efficient
Plant Size

Units of output
per period


The
The Costs
Costs Developing
Developing New
New Car
Car Models
Models
(including
(including plant
planttooling)
tooling)

Ford Mondeo/ Contour

GM Saturn
Ford Taurus (1996 model)
Ford Escort (new model 1996)
Renault Clio (1999 model)
Chrysler Neon
Honda Accord (1997 model)
BMW Mini
Rolls Royce Phantom (2003 model)

$ billion
6
5
2.8
2
1.3
1.3
0.6
0.5
0.3


Scale
Scale Economies
Economiesin
inAdvertising:
Advertising:U.S.
U.S.Soft
SoftDrinks
Drinks

Advertising Expenditure ($ per case)
0.02
0.05
0.10
0.15
0.20

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

Schweppe
s
SF Dr. Pepper
Diet 7-Up

Tab
Diet Pepsi

Diet Rite
Fresca
Seven Up
Dr. Pepper

Sprite

Pepsi
10

20

50

100

200

500

Annual sales volume (millions of cases)

Coke
1,000


Cost
Cost Advantage
Advantage in
in Short-Haul
Short-Haul
Passenger
Passenger Air
Air Transport
Transport
Costs per Available Seat-Mile (1993)
Southwest Airlines
(cents)
Wages and benefits
2.4
Fuel and oil
1.1

Aircraft ownership
0.7
Aircraft maintenance
0.6
Commissions on ticket sales
0.5
Advertising
0.2
Food and beverage
0.0
Other
1.7
Total
7.2

United Airlines
(cents)
3.5
1.1
0.8
0.3
1.0
0.2
0.5
3.1
10.5


Key
Key Stages

Stages in
in Applying
Applying the
the Value
Value
Chain
Chain to
to Cost
Cost Analysis:
Analysis: The
The Case
Case of
of
Automobile
Automobile Manufacture
Manufacture
STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES

PURCHASING

PARTS
INVENTORIES

R&D
TESTING,
COMPONENT
ASSEMBLY
DESIGN
QUALITY
MFR

ENGNRNG
CONTROL

GOODS
INVENTORIES

SALES DISTRI- DEALER &
&
BUTION CUSTOMER
MKITG
SUPPORT

STAGE 2. ALLOCATE TOTAL COSTS


Applying
Applying the
the Value
Value Chain
Chain to
to Cost
CostAnalysis
Analysis
(continued)
(continued)
STAGE 3.
IDENTIFY
COST
DRIVERS
defects

PURCHASING

PARTS
INVENTORIES

--Plant scale for each
component
-- Process technology
-- Plant location
-- Run length

-- Level of quality targets
-- Frequency of defects

-- No. of dealers
-- Sales / dealer
-- Level of dealer
support
-- Frequency of

-- Capacity utilization

under warranty

R&D
COMPONENT ASSEMBLY TESTING,
DESIGN
QUALITY
MFR

ENGNRNG
CONTROL

Prices paid
--Size of commitment
depend on:
--Productivity of
-- Order size
R&D/design
--Purchases per
--No. & frequency of new
supplier
models
-- Bargaining power
-- Supplier location

GOODS
INVENTORIES

-- Plant scale
-- Flexibility of production
-- No. of models per plant
-- Degree of automation
-- Sales / model
-- Wage levels
-- Capacity utilization

SALES
&
MKITG

DISTRI- DEALER &
BUTION CUSTOMER
SUPPORT

--Cyclicality &
predictability of sales
--Customers’
willingness to wait


Applying
Applying the
the Value
Value Chain
Chain to
to Cost
CostAnalysis
Analysis
(continued)
(continued)
STAGE 4. IDENTIFY LINKAGES

Consolidation of orders to increase
discounts, increases inventories

PRCHSNG

PARTS
INVNTRS

R&D
DESIGN

Designing different models around
common components and platforms
reduces manufacturing costs

COMPONENT
MFR

Higher quality parts and materials
reduces costs of defects
at later stages

ASSMBY TESTING GOODS
QUALITY
INV

SALES DSTRBTN DLR
MKTG
CTMR

Higher quality in manufacturing
reduces warranty costs

STAGE 5. RECCOMENDATIONS FOR COST REDUCTION


Dynamic

Dynamic vs.
vs. Static
Static Approaches
Approaches to
to
Manufacturing
Manufacturing
DYNAMIC
PRODUCTION
SYSTEM

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

MANAGEMENT
OF
TECHNOLOGY

STATIC

- 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


Recent
Recent Approaches
Approaches to
to Cost
Cost Reduction
Reduction

CORPORATE
RESTRUCTURING

BUSINESS
PROCESS
REENGINEERING

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