Lecture 4 Cost Advantage Strategies SN

7/31/2019 Lecture 4 Cost Advantage Strategies SN

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Managing Strategy

Lecture 5

Cost Advantage Strategies


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Objectives

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After pre-reading, class participation and reflection,you will be able to:

Explain the concept ofgeneric strategies in

relation to competitive advantage Discuss how an organisation can build and

sustain cost advantages

Discuss how an organisation can designappropriate structureandcontrol systemstosupport a cost leadership strategy


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Mission Objectives

ExternalAnalysis

InternalAnalysis

StrategicChoice

StrategyImplementation

CompetitiveAdvantage

The Strategy Process

Barney and Hesterly (2008:5)


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Strategic ChoiceGrant (2010:19)

RATE OFRETURN TO

EXCEED THECOST OFCAPITAL

How do wemake

money?

INDUSTRYATTRACTIVE-NESS

Whichbusinessesshould webe in?

COMPETITIVE

ADVANTAGE(positioning)

How shouldwe

compete?

CORPORATESTRATEGY

BUSINESSSTRATEGY

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The Concept of Competitive Advantage

Porter, M.E. (1985) Competitive Advantage. New York: Free PressExtract in de Wit and Meyer (2004), Reading 5.1

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The advantage that the firm aims to establish

and sustain vis-a-vis competitors through:

delivering acombinationof price & qualityvaluedby the target group of buyers

better than the competition

hence generating superior profit levels for the

firm


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Consumersurplus

Profit margin

Additional costs of the

producerCosts of the lowest cost

producer

The value pyramidWhite (2004:275-277)

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Price the produceractually charge

Lowest costthe producercan achieve

The price the customeris willing to pay


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High volume business vs.

high margin business

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Michael Porters Generic Strategies

(1980) Competitive Strategy

(1985) Competitive Advantage

COMPETITIVE ADVANTAGE

Lower Cost Differentiation

COMPETITIVE

SCOPE

BroadTarget

NarrowTarget

CostLeadership

Differentiation

Focus

Grant (2010:222-224)


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Based on:Bowman, C. and Faulkner, D.O. (1996) Competitive and Corporate Strategy.

PRICE HighLow

DifferentiationFocused

differentiation

Low price/low added

value

Strategiesdestined for

ultimate failure

PERCEIVEDADDED

VALUE

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5

6

8

Hybrid

Low

price

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High

Low

1

2

3

Market Positioning: Bowmans Clock:

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Bowmans Strategy Clock

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Sources of Competitive AdvantageGrant (2010:223)

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COST

ADVANTAGE

DIFFERENTIATIONADVANTAGE

COMPETITIVEADVANTAGE

Cost advantage: a firms unit costs (costs per unit ofoutput) are lower relative to its competitors unit costs.

Cost advantage is the result of multiple determinants ofunit costs (cost drivers).


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Cost Drivers (1)Grant (2010:231-234); White (2004:305-309)

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Economies of scale & scope

o How much of each product - unit costs fall as volumeincreases

o

Sources of cost reduction: input-output relationships;indivisibilities; specialization

o How many products - fixed costs can be spread

Learning curve economies

o Individual level: increased skills & improved problemsolving

o Organizational level: improved coordination &development ofroutines


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Cost Drivers (2)Grant (2010:234-237)

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Process technologies

o A superior process technology uses, for each unit of

output, less of some inputs without using more of others

Product design

o Must be consistent with the generic strategy, e.g.inexpensive to deliver

o Design-for-manufacture designing products for easeof production, e.g. through reduction of the number of

component inputs


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Cost Drivers (3)Grant (2010:238-239)

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Capacity utilizationo particularlyimportant if the ratio of fixed to variable

costs is high

o goal: optimalmatching of supply and demand

Input costso Locational differences, e.g. offshoring to low-wage

countries, closeness to raw materials or sources ofintermediate inputs

o Strong bargaining power or good supplierrelationships

The balance of cost drivers varies greatly acrossindustries, firms, and activities within a firm.


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The value chain within an organisationSource: Adapted with the permission of The Free Press, a Division of Simon & Schuster Adult Publishing Group, f rom Competitive Advantage: Creating and Sustaining Superior

Performanceby Michael E. Porter. Copyright 1985, 1998 by Michael E. Porter. All rights reserved

Value Chain (Porter 1985)


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Using the Value Chain to Analyse Costs

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Establish for each activity:

o Its relative importance in the total unit cost

o Its cost drivers

o Linkages, i.e. how its costs influence costs inother activities and vice verse

o Opportunities for reducing costs based on theidentified linkages & cost drivers

Each activity in the value chain has a distinct coststructure determined by different cost drivers...


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Cost Advantage Strategy

A business level strategy intended to decreasethe firms cost per output unit relative to thecompetitors cost per output unit

Hence cost leadership strategy is about:o understanding the factors (cost drivers) that

influence the firms unit costs in the particular

industry context & relative to competitors

o searching for new ways to improve the firmscost efficiency

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The Value of Cost AdvantagesBarney & Hesterly (2008:126-128)

Threat of Entry:economies of scale

increase capital

requirements

for entrants Rivalry:competitors

avoid price

competition

Threat ofSubstitutes:limit attractiveness

of substitutes

Threat ofSuppliers:larger volumes

increase the

importance of the

firm to suppliers

Threat of Buyers:lower incentives

for buyers to

switch suppliers

or verticallyintegrate

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Building Cost Advantage

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Study the competition typical costs & how they areachieved

Adopt best-practice technology it can impact costlevels & may secure a first mover advantage

Considerlocations and manage relationships

Improve the cost structure

Encourage efficiency (cost savings)

in all parts of the value chain

involving every employee motivate them & employindividual knowledge


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The Challenges of OrganizationStrategy Implementation

Grant (2010:180-191)

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Specialization defining organizational units to achieveoptimal efficiency, e.g. on the basis of common tasks,product, geography, etc.

Cooperation creating incentives & controls toencourage pursuit of organizational objectives & dealwith potentially conflicting goals

Coordination- creating controls to achieve optimal

combination ofspecialization & operational autonomy foreach unit

The adopted strategy defines how these challengesneed to be addressed


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The Question of OrganizationStrategy Implementation

The VRIO framework: A firm must be appropriatelyorganized to exploit the potential competitive advantagestemming from its resources & capabilities.

Organization refers to reporting structures, formal &

informal management controls, and compensationpolicies.

The firms organization must reinforce thebusinessstrategy it complements the other resources of the

firm by defining the ability & incentive of the HR to exploitthem

o e.g. the full benefits from new process technologiestypically require system-wide changes in organization

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Production

Finance

R&D

Accounting MarketingHuman

Resources

Chief Executive Officer

Organizing for Cost Advantage:

Functional Structure (1)Grant (2010:191-192)

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AKA U-form (unitary) hierarchy

Management responsibilities divided by function


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Functional Structure (2)

Specialization facilitates cost reduction

Centralization - the CEO is the only executive withenterprise-wide perspective & responsible for strategy -

canensure:

o efficient decision-making

o coordinationof functions efforts in pursuit of a

common strategyo sharing of the best cost reduction practicesamong divisions

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Compensation Policies

Reinforce management controls through

performance incentives, e.g.:o bonuses

o vacations

o office perks

Focused on cost reduction: performance

incentives are directly tied to cost-reducingefforts, i.e. link rewards to output based on:

o cost reduction

o financial performance

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Limitations of Cost Advantage Strategies

White (2004:325-329)

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Standardized products - the firm must be one of theleaders to gain above normal profits

Cost drivers are often easily imitated

Many cost factors change quickly, e.g. exchangerates, technology & design

It neglects the growing importance ofcustomization,which involves:

o increased costs

o more attention to the customer


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Competitive StrategyRisks of the Generic Strategies

Lecture 4 Cost Advantage Strategies SN

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