Lecture Outline

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Lecture Outline
Strategic Management and Competitive
Advantage Jay B. BarneyWilliam S. Hesterly
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Chapter 5
Cost Leadership
PMBA February 15, 2006
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Chapter Objectives (1 of 2)

• Define cost leadership.
• Identify six reasons firms can differ in their
  costs.
• Identify four reasons economies of scale can
  exist and four reasons diseconomies of scale can
  exist.
• Explain the relationship between cost advantages
  due to learning curve economies and a firms
  market share, as well as the limitations of this
  logic.
• Identify how cost leadership helps neutralize
  each of the major threats in an industry.

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Chapter Objectives (2 of 2)

• 6. Identify the bases of cost leadership that are
  more likely to be rare and costly to imitate.
• Explain how firms use a functional organizational
  structure to implement business-level strategies
  like cost leadership.
• Describe the formal and informal management
  controls and compensation policies firms use to
  implement cost leadership strategies.
• Explain how international operations can affect a
  firms cost position.

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The Strategic Management Process
External Analysis
Strategic Choice
Strategy Implementation
Competitive Advantage
Mission
Objectives
Internal Analysis
Business Level Strategy
Corporate Level Strategy
How to Position a Business in the Market?
Which Businesses to Enter?
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Business Level Strategies

• Two Generic Business Level Strategies
• Cost Leadership
• Generate economic value by having lower costs
  than competitors
• Example Wal-Mart
• Product Differentiation
• Generate economic value by offering a product
  that customers prefer over competitors products
• Example Harley-Davidson

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Cost Leadership Strategy

• Cost Leadership
• Is a generic competitive strategy
• It is a cost advantage over the competition
• For the firm, it means
• Focus on realizing a (sustainable) cost advantage
  over the competition
• It is not necessarily lower prices than
  competitors

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Examples of Firms With a Cost Leadership Strategy
Wal-Mart
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Examples of Firms With a Cost Leadership Strategy
Dell
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Examples of Firms With a Cost Leadership Strategy
Dollar Store
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Examples of Firms With a Cost Leadership Strategy
Casio
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Examples of Firms With a Cost Leadership Strategy
AirTran and Soutwest Airlines
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Understanding Cost Advantage

• Managers need to understand who has the cost
  advantage in their market
• It could be the focal firm
• Develop a strategy to exploit the advantage
• It could be a competitor
• Develop a strategy to either capture the
  advantage or compete on some other basis

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Signs That A Company Is Pursuing a
Cost-Leadership Strategy

• Standardized Products
• Where standardization cost efficiency
• Dominant Cultural Values Concern Efficiency, Cost
  Control
• Vision of Ideal Model of Efficiency
• Machine efficiency
• Organizational efficiency
• Or both

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Why Cost Leadership Matters
Competitive Market
ATCind
ATCff
D
P
Above Normal Economic Returns
Q
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Video Case
North American Tool Die
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Sources of Cost Advantage(1 of 6)

• Economies of Scale
• Average cost per unit falls as quantity increases
  
• Until the minimum efficient scale is reached
• The optimal volume of production is reached when
  the average costs per unit of production is
  minimum
• Are a cost advantage because competitors may not
  be able to match the scale because of capital
  requirements (barrier to entry)
• International expansion may allow a firm to have
  enough sales to justify investing in additional
  capacity to capture economies of scale

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Sources of Cost Advantage(2 of 6)

• Diseconomies of Scale
• Are an advantage for those who do not have
  diseconomies of scale
• Sources of Diseconomies of Scale
• Physical limits to efficient size
• Managerial diseconomies
• Worker motivation
• Distance to markets and suppliers

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Source of Cost Advantage(3 of 6)

• Learning Curve Economies
• A firm gets more efficient at a process with
  experience
• The more complicated/technical the process, the
  greater the experience advantage
• International expansion may propel a firm down
  the experience curve because of higher volumes
• Economies of scale focuses on the relationship
  between the volume of production at a given point
  in time and average unit costs
• The learning-curve focuses on the relationship
  between the cumulative volume of production and
  average unit costs

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Source of Cost Advantage(4 of 6)

• Differential Low-Cost Access to Productive Inputs
• May result from
• Historybeing in the right place at the right
  time
• Being first to marketesp. foreign markets
• Natural endowmentowing a mineral deposit
• Locking up a sourcebuying all its output
• Power over suppliers

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Source of Cost Advantage(5 of 6)

• Technology Independent of Scale
• May allow small firms to become cost competitive
• Advantage typically accrues to the owner of the
  technologymay or may not be the ones who
  actually use the technology
• Size of the advantage depends both on how
  valuable and protectable the technology is
• Example Vegetable Inspection

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Source of Cost Advantage(6 of 6)

• Policy Choices
• Firm gets to choose how they will serve the
  market
• Well offer level of quality that is inexpensive
  to produce
• Firms can make policy choices that give people
  incentives to reduce cost at every opportunity

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When Does a Cost Leadership Strategy Work
BestSlide 1 of 2

• Cost Leadership Works Best When..
• Price competition among rival sellers is a
  dominant competitive force
• The industrys product is a standard,
  commodity-type item readily available from a
  variety of sellers
• When there are not many ways to achieve product
  differentiation that have value to the buyer
• When most buyers use the product in the same ways
  and have much the same needs/requirements

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When Does a Cost Leadership Strategy Work
BestSlide 2 of 2

• Cost Leadership Works Best When..
• When buyers incur low switching costs in changing
  from one seller to another and are prone to shop
  for the best price
• When buyers are large and have significant
  bargaining power

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Cost Leadership and Competitive Advantage

• A source of cost advantage will lead to
  competitive advantage if that source is
• Valuable
• Rare
• Costly to imitate
• Organized (Implemented Appropriately)

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Value of Cost Advantage
Entry
Buyers
lowers incentives for buyers
to vertically integrate
increases capital requirements for entrants
Rivalry
Suppliers
Substitutes
competitors rationally avoid price competition
increases importance of the focal firm
to the supplier
limits attractiveness of substitutes
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Rarity of Cost Advantage(1 of 2)

• Likely-to-be-rare sources of cost advantage
• Learning-curve economies of scale (especially in
  emerging businesses)
• Differential low-cost access to productive inputs
• Technological software
• Less-likely-to-be-rare sources of cost advantage
• Economies of scale
• Diseconomies of scale
• Technology hardware (unless it is proprietary)
• Policy choices

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Imitability as Sources of Cost Advantage(1 of 2)

• Conditions largely determine if a source of cost
  advantage will be costly to imitate
• Low Cost Conditions
• Unbalanced Industry Capacity and Demand
• Non-Proprietary Technology
• Highly Observable Technology
• Transactional Exchange

(Cost advantages that can be easily imitated)
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Imitability as Sources of Cost Advantage(2 of 2)

• High Cost Conditions
• Balanced Industry Capacity and Demand
• Path Dependence (Historical Uniqueness)
• Protected Technology
• Highly Unobservable Technology (Casual Ambiguity)
• Relational Exchange (Social Complexity)

(Cost advantages that cannot be easily imitated)
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Risks of Cost Leadership

• Technological change that nullifies past
  investment or learning
• Low cost learning by industry newcomers
• Inability to see required product or market
  change
• Inflation in costs

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Organizational Structure
Three Organizational Structures
Simple
Functional
Multi-Divisional
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Simple Structure

• Simple Structure
• Owner/Manager
• Owner/Manager makes all major decisions directly
  and monitors all activities
• Difficult to maintain this structure as the firms
  grows in size and complexity

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Functional Structure(1 of 2)

• Functional Structure (U-Form Unitary)
• Divides Management Responsibilities by Function
• Marketing, finance, accounting, procurement,
  production, RD, HR, logistics, etc.
• CEO is the only executive with enterprise-wide
  perspective
• CEO is responsible for strategy and coordination
  of functions

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Functional Structure(2 of 2)
Chief Executive Officer
Marketing
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Multi-Divisional Structure (M-Form)(1 of 2)

• Multi-Divisional Structure (M-Form)
• Functions are replicated in each division as
  appropriate
• This structure makes sense when the firm is
  involved in more than one business or has grown
  large enough to justify geographic divisions
• CEO has strategic responsibilities with the help
  of vice presidents, etc.---information is
  filtered through layers
• CEO balances coordination competition among
  divisions

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Multi-Divisional Structure (M-Form)(2 of 2)
Multi-Divisional Structure (M-Form)
Strategic Planning
Corporate Finance
Corporate RD
Corporate Marketing
Division
Division
Division
Finance
Accounting
Production
RD
Human Resources
Marketing
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The Functional Structure and Cost Leadership

• Specialization within functions facilitates cost
  reduction
• CEO can use this structure to
• Ensure best cost reduction practices are shared
  among divisions
• Allow and encourage decision-making by those who
  are in the best positions to do sothose close to
  the decisions
• Ensure that functions are coordinating efforts in
  pursuit of a common strategy

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Organizational Controls(1 of 3)

• Policies intended to influence behavior by
  aligning the interest of the individual with the
  interests of the organization
• Management Controls
• Formal Budgeting policies, credit policies,
  spending policies, travel policies, purchasing
  policies
• Informal culture, attitudes, leadership styles

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Organizational Controls(2 of 3)

• Compensation Policies
• Stock options
• Bonuses based on
• Cost reduction
• Financial performance
• Non-monetary awards
• Vacations
• Parking Places
• Office decor

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Organizational Controls(3 of 3)

• Organizational Controls and Cost Leadership
• Management controls and compensation policies can
  be focused on cost reduction
• Supply contracts that stipulate cost reductions
  over time
• Tight credit policies
• Austere travel policies (e.g., no first class)
• Bonuses tied to cost reduction targets
• Examples Wal-Mart and Southwest Airlines

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Summary
Business Level Strategy
Cost Leadership
Product Differentiation
Cost Advantages
Competitive Advantage Depends on Meeting VRIO
Criteria
Economies of Scale
Diseconomies of Scale
Emphasis on Organization (Implementation)
Learning Curve Economies
Differential Input Access
Technology
Structure Control
Policy Choices