Week 5 / Chapters 4 + 5 (Cost Advantage + Differentiation Advantage) Flashcards
Chapter 4: Cost Advantage
Chapter 4: Cost Advantage
Two “generic” strategies for offering unique value
to customers:
1) Cost advantage
2) Differentiation Advantage
1) Cost advantage
Wins with customers by reducing its prices below all
of its competitors, thereby allowing it to gain market share
The cheapest price possible with minor innovative ideas or tech options
Sources of Cost Advanatage
1) Economies of Scale or Scope
2) Leaning and Experience
3) Proprietary knowledge
4) Input Costs
5) Differential business model
1) Economies of Scale or Scope
Greater unit volume allows firms to have lower costs by:
• spreading fixed costs across more units
• specialization of equipment and people
A reduction in costs per unit due to increases
in efficiency of production as the number of goods being produced increases.
Economies of scale arise from four principal sources:
1) the ability to spread fixed costs of production,
2) The ability to spread nonproduction costs,
3) Specialization of equipment,
4) Specialization of people.
2) Leaning and Experience
Greater cumulative volume drives cost differences due to greater learning and experience within companies with more cumulative experience
in production.
3) Proprietary knowledge
Some companies develop proprietary knowledge in the production of their product or service, which leads to a cost advantage.
4) Input Costs
Some companies may have lower input costs than others due to:
• greater bargaining power over suppliers or labor
• superior cooperation with suppliers (including lower transaction costs)
• sourcing from low-cost locations (e.g., country comparative advantage)
• preferred access to inputs
5) Differential business model
Eliminating activities or steps in the value chain or using a different set of activities altogether may allow a firm to deliver a product or service at lower cost.
Fixed cost of production
Costs such as plant and equipment, which are relatively fixed, meaning that they do not increase with
an increase in the number of units produced.
In fact, some research has shown that the best predictor of whether an industry is global (meaning that firms in the industry expand to compete on a global basis) is:::
the company’s R&D costs as a percentage of sales
**The higher a firm’s R&D costs as a percentage
of sales, the more incentive the firm has to expand globally to spread those costs across more
customers
General and administrative costs (G&A)
Expenses and taxes that are directly related to the
general operation of the company, and executive salaries, general support, and taxes related to
the overall administration of the company.
**include the costs of accounting, finance, human resource management, and the chief executive
and her staff.
Task specialization
Breaking a large process into smaller
tasks that require specialized knowledge.
Employee specialization
Increased efficiency that results when employees perform a narrow range of tasks over and
over again, leading them to acquire specialized knowledge that helps them complete the task
more efficiently.
Scale curve
Figure 4.1 Economies of Scale
A graphic representation of the relationship
between cost per unit and scale (volume) of production in a given time period.
Minimum efficient scale
The smallest level of output (unit volume) that a plant or firm can produce to minimize its longrun
average costs. In a graphic presentation of output/unit
volume (x-axis) and cost per unit
(y-axis), it is the output level
where costs per unit flatten and
no longer continue going down
with increased output.
Diseconomies of scale
An increase in marginal cost when output is increased.
Why? In large organizations, diseconomies of scale can happen because large plants become very complex to manage. This increase in size and complexity tends to lead to increased waste and lower employee motivation, which, in turn, leads to increased supervision costs
Also, in times of economic downturn, they have difficulty spreading the cost when demand decline
During a downturn, how to lower costs to avoid diseconomies
Some firms with heavy fixed costs have moved to reduce the risks of large fixed costs
by shifting more of their cost structure from fixed cost to variable cost
1) One way they do this is by outsourcing more of their activities
2) Another way they may convert fixed to variable costs is by leasing
equipment on a short-term basis, allowing them to turn equipment back to the lessor if
demand is low.
Economies of Scope
The average total cost of production decreases as a result of increasing the number of different goods produced.
Opening multiple stores in a mall under the same mothership can allow for negotiation of leases and shipping / transportation
2) Learning and Experience
2) Learning and Experience Beyond This
Basic saying for this
“practice makes perfect”
Learning and Experience
These companies are relying on the fact that humans can perform tasks more efficiently—more quickly, with greater dexterity—the more a task is repeated which can also lead to the employee becoming effective at finding ways to complete the task
The Learning Curve
The concept that labor costs per unit decrease
with increases in volume due to learning. New skills or knowledge can be quickly acquired initially, but subsequent learning becomes much slower.
*The learning curve is more complex than a scale curve to calculate because it requires gathering data on the cumulative volume of a given product or service produced
Experience curve
requires cumulative volume data
A representation of the relationship between cumulative volume and product cost.
Learning and experience curve slopes tend to be steeper in the early stages of production
because learning occurs more rapidly in the early stages of production
An experience curve does a better job of capturing learning effects than a scale curve, because it is based on cumulative volume, like the learning curve. But it also does a better job of capturing the effects of economies of scale than a learning curve does, because it includes all costs, not just labor
Law of experience
Costs per unit decrease with increases in
cumulative volume of production.
The Relationship Between Market Share and Profitability in Retail Industries
The logic was as follows: the higher the company’s
volume (its market share), the lower the costs per unit, and the better the profit performance
The initial conclusion from studies on the market share/profitability relationship was that
if a company wants to increase its profitability, it should increase its market share
What are Scale and Experience Curves used for?
Scale and experience curves are useful tools for making practical strategic decisions about
growth and investment strategies, pricing strategies, strategies for managing costs, and acquisition
strategies.
Relative cost
The costs incurred by one company compared to the
costs paid by a competitor.
Proprietary Knowledge
Information that is not public and that is viewed as the property of the holder.
Example: Toyota making cars better than GM, Ford
Example: TATA cars patenting technologies
4) Lower Input Costs
Beyond this
Inputs
Resources such as people, raw materials, energy,
information, or financing that are put into a system (such as an economy, manufacturing plant,
computer system, etc.) to obtain a desired output.
Labour, capital, land too
Four primary ways that companies achieve cost advantage through lower-cost inputs:
(1) exercising strong bargaining power over suppliers, (2) cooperating especially well with suppliers,
(3) getting inputs from low-cost locations
(4) arranging better access to inputs than other companies have.
Bargaining Power over Suppliers
The most important way that companies get lower-cost inputs
There are two main sources of bargaining power:
1) buying a lot from the supplier
2) using successful negotiating tactics
1) buying a lot from the supplier / Purchasing Volume
Indeed, as a rule of thumb, suppliers are known to drop prices by 5 percent to 10 percent with a doubling of purchased volume.
2) using successful negotiating tactics / Purchasing and Negotiating Tactics
Even when two firms purchase similar volumes
of inputs, one of the firms may have negotiation skills and purchasing tactics that allow it
to get inputs at lower prices
Example: Walmart spreads its purchases across numerous suppliers, so that no
one supplier has a dominant market share in any particular product category
(2) cooperating especially well with suppliers
Toyota is known for working cooperatively with suppliers to get lower-cost and higher-quality inputs.
(3) getting inputs from low-cost locations
The price of inputs can vary significantly between locations because of differences in wage rates, exchange rates, or raw material or energy costs.
(4) arranging better access to inputs than other companies have.
particular inputs—it can get them more easily than other companies can.
For example, drilling
oil in Saudi Arabia requires only the simplest drilling technologies, because drilling is less complicated
in the desert and oil is more frequently found relatively close to the surface.
5) Different Business Model or Value Chain
Slides beyond this
Business model
The plan and set of activities implemented by a company to offer unique value and generate revenue and make a profit from operations.
Value chain
The sequence of all activities that are performed by
a firm to turn raw materials into the finished product that is sold to a buyer.
There are two basic ways to create a new business
model:
1) to eliminate activities or steps in the value chain
2) to perform different activities altogether
Eliminating Steps in the Value Chain
One reason Ryanair has a cost advantage over other airlines in Europe is because it does not
offer any in-flight meals, pillows, blankets, or even air-sick bags.
By not offering these items, Ryanair not only doesn’t have to purchase the items itself, but it also is able to significantly reduce the labor costs associated with getting meals on and off its airplanes or laundering blankets and pillows.
Performing Completely New Activities
In 1995, Amazon.com began
to sell books in a completely different way—over the Internet. It was much cheaper for
Amazon to build a few large warehouses, take orders online, and ship books directly to the
customers’ homes than to do the things Barnes & Noble was doing: building superstores,
hiring employees to staff the stores, and buying and storing inventory
CHAPTER 5 Differentiation Advantage
CHAPTER 5 Differentiation Advantage
When customers go to purchase a product to get a job done, they tend to consider two factors:`
- The way a product is differentiated from other products to perform the job (or jobs) they want done
- The price of the product
Product Differentiation
A strategy whereby companies attempt to gain competitive advantage by offering value that
is not available in other products or services or that other products don’t do as well.
Four major categories of differentiation
(1) different product/service features,
(2) superior quality or reliability,
(3) convenience,
(4) brand image
(1) different product/service features,
- The product does a “better job” of meeting a customer need on existing product features
- The product does “more jobs” for the customer than other products.
- The product does a “unique job” that nothing else does.
- The product does a “better job” of meeting a customer need on existing product features
Some companies differentiate their products
by focusing on one particular feature and doing a better functional job than other products
of providing value on that particular feature
Example: Dyson Vacuum cleaners are better at sucking
- The product does “more jobs” for the customer than other products.
In some cases, a product might not do a better functional job but simply does more jobs, or meets more needs, for customers than competitor offerings.
For example, Facebook did a job that the other social networking sites did not do when it gave users the
ability to alert their friends about their “relationship status,” a particularly important piece of information for teenagers and college students.
- The product does a “unique job” that nothing else does.
Some products do a completely unique job that other products simply do not do. Rather than simply doing existing jobs better or doing more of jobs than
other products, they offer a completely new feature to the market.
Example: Disney theme parks are the only places you can go to see Mickey Mouse or ride the
Pirates of the Caribbean to see Captain Jack Sparrow.
Mass customization
When a company mass-produces the various modules of the product and then allows the customer
to select which modules will be combined together.
(2) superior quality or reliability,
Category 2 of differentiation
The product doesn’t necessarily do a better job as far as performance on existing features. It doesn’t do
more jobs than other products, and it doesn’t do a unique job. It simply lasts longer.
(3) convenience,
Category 3 of differentiation
Another differentiator used by companies is making their products more convenient to find and
purchase
Example: Starbucks is an example of a company that succeeds, in part, through convenience (they’re fucking everywhere)
Network effects
When some products or services are more convenient to use because there is a large network of other users.
Example: Facebook having so many users makes it enticing for more to join
(4) brand image
Category 4 of differentiation
Definition: When products are differentiated through marketing, via advertisements, promotions,
and other marketing activities.
Interestingly, numerous studies have shown that the more people are exposed to something, be it a brand, company, or product, the more they come to trust it.
Mere exposure effect
a psychological phenomenon by which people tend to develop a preference for things merely because
they are familiar with them.
Prestige brands
When products are differentiated by being associated with positive qualities in the minds of customers.
How to Find Sources of Product Differentiation
Two major ways:
1) customer segmentation
2) mapping the consumption chain
Customer Segmentation
Grouping customers based on
similar needs.
Customer segments
Groups of people who share similar needs
and thus are likely to desire the same features in a product.
Groups of people who share similar needs
and thus are likely to desire the same features in a product.
The first problem is that they may
add features, and costs, to their products that some groups of customers don’t really want and
don’t want to pay for.
The second problem is that they may not add features that certain groups
care about and would be willing to pay for, potentially losing market share to rival firms that do
offer those features.
Marketers typically segment markets in one of three ways:
- Based on various attributes or the price of products
- Based on attributes of the individuals or companies
who are customers, including demographics
or psychographics - Based on attributes of the customer’s circumstance, or what is called the job-to-be-done view, an alternative way of segmenting customers that has emerged recently
Product Attributes
For example, customers looking to buy motorcycles may place different value on different attributes,
such as power (speed), reliability, ease of handling, gas consumption, or customizability.
By assessing the relative importance that customers put on different attributes, and grouping
customers based on what they want in those attributes, it may be possible to design products
to meet the needs of that customer segment
Demographics/Customer Attributes
Popular ways to segment the consumer market include by age, socioeconomic status (e.g., income), education, profession, and ethnic group
For example, teenagers might be considered one segment of the market because they are viewed
to be similar in terms of what they want from certain types of products or services
Mapping the Consumption Chain
Identifying all the steps through which customers pass,
from the time they first become aware of your product to the time when they finally have to dispose of it or discontinue using it.
How Do Consumers Become Aware of Their Need for a Product or Service?
The first step in the consumption chain occurs when customers become aware that
they need a product or service. A company may be able to differentiate its product if it can
find a unique way to make consumers aware of a need
Table 5.2
Mapping the Consumption Chain
How Do Consumers Find Your Offering?
After potential customers are aware
that they have a need for a product, they then must find it.
Companies can differentiate their
offering if they can make the search process easier for customers by making it less complicated,
more convenient, or less expensive
How Do Consumers Make Their Final Selections?
After a consumer has narrowed down the possibilities, they must make a choice. This is the time when product attributes typically dominate, and it is critical to ensure that consumers are aware of features
that differentiate a product
A comparison list
makes it easier for consumers to see which product has more features, or has the features they
care about the most
How Do Customers Order and Purchase Your Product or Service?
Another way to differentiate a product is to make the process of ordering and purchasing more
convenient
Example: Amazon one click purchase
One potential benefit of making your product more convenient to order is your company
can create a switching cost, especially for repeat customers
How Is Your Product or Service Delivered and/or Installed?
Customers sometimes need to have products that they purchase delivered, installed, or assembled.
Transporting and assembling products are stumbling blocks for customers, so these services can be
a source of differentiation
Example: RC Willey 48 hour guaranteed delivery
How Is Your Product Stored?
When it is expensive, inconvenient, or even dangerous
for customers to have a product simply sitting around, a company has the potential to differentiate
the product by providing better or easier storage options.
Example: easily foldable treadmills
What Do Customers Need Help With When They Use Your Product?
Sometimes a customer will need assistance when using a product or service.
A company can differentiate on that dimension if it understands what kind of help customers need and can provide that assistance more effectively than other companies
Example: Butterball’s 24-hour Turkey Talk-Line fields questions from thousands of these customers every
Thanksgiving
What If Customers Aren’t Satisfied and Need a Return or Exchange?
While many companies focus on the customer through the sale and installation of a product, others realize that long-term loyalty requires attention to customers’ needs throughout their experience with a product.
Handling problems well when the product doesn’t work out for a customer can be as important as meeting the need that motivated the initial purchase
Example: Nordstrom’s no hassle returns
How Is Your Product Repaired, Serviced, or Disposed Of?
As many users of technologically sophisticated products will attest, repair experiences—both good and bad— can influence a lifetime of subsequent purchases.
Example: This is particularly true if you are highly
inconvenienced because the product fails to work properly, as is the case of an elevator (nobody
wants to get stuck in an elevator)
New Thinking: Achieving Low Cost and Differentiation
Despite the concern that Porter expresses about being “stuck in the middle,” some companies
have found ways to succeed through differentiation and cost leadership
Example, Intel was able to successfully differentiate its microprocessors through superior processing speed and with its “Intel Inside” and “Pentium” branding
Assessing Differentiation Performance
“What metric can I use to assess how well my differentiation strategy is working?”
The answer to that question lies in whether you can satisfy customers to such a degree that they
are willing to recommend your company (or product) to a friend or colleague.
Net promoter score: a tool that can be used to assess how well a differentiation strategy is working to turn customers into promoters of a company’s offering
Strategy in Your Career: What Is Your Unique Value?
You want to be a differentiator
Every “job” has three dimensions. Which of the following is NOT one of those three dimensions
Aesthetical
For a luxury high-end product, which of three “job” dimensions is not as important?
Functional
Example: What is Walmart Value proposition
3C Strategy for Harley-Davidson
Providing a wide selection of low priced products at convenient locations to price-sensitive consumers
OR from the slides
Everyday low prices for a broad range of goods that are always in stock in convenient locations
3C Strategy for Harley-Davidson
Harley Davidson provides a wide selection of personalized, unique motorcycles with customizable attributes to individuals with an interest in adventure and community
The generic business strategies of cost and differentiation represent a fundamentally different approach to creating and sustaining a competitive advantage because dedifferentiation is usually _______
Costly
Three jobs of a product
Functional: Yummy treat
Social job: Appease my kids
Emotional job: Commute companion, happiness, belonging, community
Barriers to imitation are ________ by firms through developing unique resources and capabilities
created
Barriers to imitation are primarily of two types:
–Barriers to cost imitation (e.g., access to inputs, scale, experience)
–Barriers to product/service imitation and accessing customers (e.g., features, patents, brands, convenience, etc.)
Barriers to imitation also act as _____
barriers to entry
When a company chooses a low cost strategy, it will be successful by keeping its focus on cost to the exclusion of everything else
False
It is more than just low cost
“practice makes perfect” applies to which cost advantage?
Learning and experience
Which of the following is true about economies of scale
Cost / unit is lower
Which of the following is not a way to lower input costs?
Building a new business model
What are the two generic strategies for offering unique value to customers
Differentiation advantage and cost advantage
Two products with the exact same technical features can be differentiated because of customer percpetion?
True
Which of the following is not one of the three dimensions of a job?
Aesthetic
For a luxury high-end product, which job dimension is least important
Functional
Which of the following would be least effective to differentiate product features
Have products that do less-expensive jobs
Which of the following best characterizes a product that is differentiated with quality or reliability
The product lasts longer
