June 27, 2013

Cost Leadership Competitive Strategy

Barney and Hester

In general, a firm has a competitive advantage when it is able to create more economic value than rival firms. Economic value is simply the difference between the perceived benefits gained by a customer that purchases a firm's products or services and the full economic cost of these products or services. (Barney and Hester, Page 11)

How a firm can create competitive advantage?

A firm can keep its cost same as the competitor, but can increase the benefits gained by a customer by enhancing the product benefits.

The other alternative is to keep the product benefit similar to the competitors, but reduce the cost of production and distribution operations.

Porter says, a company has to make a strategic choice between the two, he means that to be successful with any of these choices, the company has to spend significant amount of time in identifying and developing innovative solutions that support the strategic choice and both can't be pursued by a single business unit.

Who are the cost leaders in various industries.

Ryanair, Southwest Airlines
Walmart in retail sales
Timex and Casino in watches
BIC in disposable pen and razor market
Hyundai in automobile
Tata Steel in steel industry
Many cement plants
RBC Bearings   http://www.rbcbearings.com/aerospace/index-intro.htm

Sources of Cost Advantage

1. Size and economies of scale
2. Size and diseconomies of scale
3. Experience difference and learning-economies
4. Access to low-cost resources
5. Technological advantages independent of scale
6. Policy choices

Management controls in implementing cost leadership

Management controls imply plans, measurements and control actions.

Cost leadership firms are characterized by very tight cost-control systems. It means, there is detailed planning, frequent measurement of actual costs, and control actions to come out with more detailed plans to achieve cost targets or replanning the higher level plans to reach the still higher level plans. Control action could imply, more experienced managers take over the responsibility of an activity that is behind target.

Target achievement is provided incentives. Failure to achieve plans and targets is noticed and disincentives are in place to minimize them. Managers who fail to achieve targets can't have a long career.

Thompson and Strickland

A low cost provider's strategic target is meaningfully lower costs than rivals.  In making efforts to create cost advantage, managers must take care to include features and services that buyers consider essential. Companies have to achieve cost advantage in ways difficult for rivals to copy or match.

The cost advantage can be turned into higher profit margin in two ways.  In option 1, the price is reduced strategically below rivals to get profitable higher volumes. In option 2, the price is maintained and higher profits are realized due to less costs.

Achieving Lower Costs - Value Chain Framework

To be a cost leader, the firm must have its cumulative costs across its value chain at lower figure than rivals.

The two ways to accomplish this are:

1. Eliminate some cost producing activities from the value chain.
2. Have more efficiency in the value chain activities compared to rivals.

Cost Drivers
Cost of value chain activities is reduced by controlling the cost drivers. There are nine major cost drivers that come into play in determining the costs of various activities in the value chain.

1. Economies or diseconomies of scale
2. Learning curve effects
3. The cost of key resource inputs
4. Links with other activities in the company or industry value chain
5. Sharing opportunities with other organizational or business units within the enterprise.
6. Vertical integration and outsourcing
7. First mover advantages and disadvantages
8. The percentage of capacity utilization
9. Strategic choices and operating decisions