Cost Advantage

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Cost 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 cost efficiency

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Figure 8.1. The Experience Curve
1988
1990
Cost per unit of output (in real )
1992
1994
1996
1998
2000
Cumulative Output
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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.
1994
1995
Cost per unit of output (in real )
1996
1997
1998
1999
2000
Cumulative Output
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Examples of Experience Curves
Japanese clocks watches, 1962-72
UK refrigerators, 1957-71
1960 Yen 15K 20K 30K
Price Index 50 100 200 300
75
70 slope
100K 200K 500K 1,000K 5
10 50 Accumulated unit
production Accumulated
units (millions) (millions)
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The Importance of Market Share
If all firms in an industry have the same
experience curve, then relative costs f
(relative market share) This supported by PIMS
data
ROS () -2 0 5 10
0-10 10-20 20-30 30-40
over 40 Market Share ()
BUT - Association does not imply causation -
Costs of acquiring market share tend to offset
the returns to market share
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Drivers of Cost Advantage

• Indivisibli\ties
• Specialization and division of labor

ECONOMIES OF SCALE

• Increased dexterity
• Improved coordination/ organization

ECONOMIES OF LEARNING

• Mechanization and automation
• Efficient utilization of materials
• Increased precision

PRODUCTION TECHNIQUES

• Design for automation
• Designs to economize on materials

PRODUCT DESIGN

• Location advantages
• Ownership of low-cost inputs
• Bargaining power
• Supplier cooperation

INPUT COSTS
CAPACITY UTILIZATION

• Ratio of fixed to variable costs
• Costs of installing and closing capacity

MANAGERIAL/ ORGANIZATIONAL EFFICIENCY

• Organizational slack

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Economies of Scale The Long-Run Cost Curve for a
Plant
Sources of scale economies - technical
input/output relationships - indivisibilities -
specialization
Cost per unit of output
Units of output per period
Minimum Efficient Plant Size
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The Costs of Product Development New Autos of
the 1990s

• billion
• Ford Escort (1997 model) 2
• Ford Mondeo/ Contour 6
• Ford Taurus (1996 model) 2.8
• GM Saturn 5
• Chrysler Neon 1.3
• Honda Accord (1997 Model) 0.6
• Renault Clio (1999 model) 1.3
• Rolls Royce (1998 Silver Seraph) 0.33

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Scale Economies in Advertising U.S. Soft Drinks
Despite the massive advertising budgets of brand
leaders Coke and Pepsi, smaller brands which
incur the highest advertising costs per unit of
sales
Schweppes
SF Dr. Pepper
Tab
Diet 7-Up
Diet Pepsi
Advertising Expenditure ( per case) 0.02
0.05 0.10 0.15 0.20
Diet Rite
Fresca
Seven up
Dr. Pepper
Sprite
Coke
Pepsi
10 20 50 100
200 500
1,000 Annual sales volume (millions of cases)
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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 Fuel and oil 1.1 1.1 Air
craft ownership 0.7 0.8 Aircraft
maintenance 0.6 0.3 Commisions on ticket
sales 0.5 1.0 Advertising 0.2 0.2 Food
and beverage 0.0 0.5 Other 1.7 3.1 Total
7.2 10.5
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Key Stages in Applying the Value Chain to Cost
Analysis The Case of Automobile Manufacture
STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES

RD DESIGN ENGNRNG
TESTING, QUALITY CONTROL
GOODS INVEN- TORIES
SALES MKITG
DEALER CUSTOMER SUPPORT
PARTS INVEN- TORIES
DISTRI- BUTION
PURCH- ASING
COMPONENT MFR
ASSEMBLY
STAGE 2. ALLOCATE TOTAL COSTS
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Applying the Value Chain to Cost Analysis
(continued)
--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 -- Capaciity utilization
under warrenty
STAGE 3. IDENTIFY COST DRIVERS
PARTS INVEN- TORIES
RD DESIGN ENGNRNG
TESTING, QUALITY CONTROL
GOODS INVEN- TORIES
PURCH- ASING
COMPONENT MFR
SALES MKITG
ASSEMBLY
DISTRI- BUTION
DEALER CUSTOMER SUPPORT
Prices paid --Size of commitment -- Plant
scale --Cyclicality depend on
--Productivity of -- Flexibility of production
predictability of sales -- Order size
RD/design -- No. of models per
plant --Customers --Putchases per --No.
frequency of new -- Degree of automation
willingness to wait supplier models --
Sales / model -- Bargaining power -- Wage
levels -- Supplier location -- Capacity
utilization
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Applying the Value Chain to Cost Analysis
(continued)
STAGE 4. IDENTIFY LINKAGES

• PRCHSNG PARTS RD
  COMPONENT ASSMBY TESTING GOODS
  SALES DSTRBTN DLR
• INVNTRS
  DESIGN MFR
  QUALITY INV MKTG
  CTMR
• 
  

Designing different models around common
components and platforms reduces manufacturing
costs
Consolidation of orders to increase discounts,
increases inventories
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
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Dynamic vs. Static Approaches to Manufacturing
DYNAMIC
STATIC

• 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 RD - 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
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Recent Approaches to Cost Reduction

• Dramatic changes in strategy and structure
• to adjust to the business conditions of the
  1990s
• 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