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