Gaining Cost Advantage

A firm has a cost advantage if its cumulative cost of performing all value activities is lower than competitors' costs. A firm's relative cost position is a function of:

  • the composition if its value chain versus competitors'
  • its relative position vis-a-vis the cost drives of each activity.

There are two major ways to achieve a cost advantage:

  1. Control cost drivers. A firm can gain and advantage with respect to the cost drivers of value activities representing a significant proportion of total costs.
  2. Reconfigure the value chain. A firm can adopt a different and more efficient way to design, produce, distribute, or market the product.

Controlling Cost Drivers

Some generalizations about how controlling each of the ten cost drivers can lead to cost advantage in a activity are as follows:

Controlling scale.
Means for accomplishing this include:
  • gain the appropriate type of scale
  • set policies to reinforce scale economies in scale-sensitive activities
  • exploit the types of scale economies where the firm is favored
  • emphasize value activities driven by types of scale where the firm has an advantage
Controlling learning
Means for accomplishing this include:
  • manage with the learning curve
  • keep learning proprietary (such as backward integration to protect know-how, controlling employee publications or other forms of information dissemination, retaining key employees, strict non-disclosure provisions in employment contracts)
  • learn from competitors
Controlling the effect of capacity utilization
Means for accomplishing this include:
  • level throughput (such as peak load or contribution pricing, marketing activity, line extensions into less cyclical products, or into products that can intermittently utilize excess capacity, selecting buyers with more stable demand or demands that are counterseasonal or countercyclical, ceding share in high demand periods and regaining it in low demand periods, letting competitors serve fluctuating segments, sharing activities with sister business units with a different pattern of needs)
  • reduce the penalty of throughput fluctuations
Controlling linkages
These include:
  • exploit cost linkages within the value chain
  • work with suppliers and channels to exploit vertical linkages
Controlling interrelationships
Means for accomplishing this include:
  • share appropriate activities
  • transfer know-how in managing similar activities
  • Controlling integration. Both integration and deintegration offer the potential of lowering costs.
Controlling timing
Some of important ways for accomplishing this include:
  • exploit first-mover or later-mover advantages
  • time purchases in the business cycle
Controlling discretionary policies
Means for accomplishing this include:
  • modify expensive policies that do not contribute to differentiation
  • invest in technology to skew cost drivers in the firm's favor (e.g., developing low-cost processes, facilitating automation, low-cost product designs)
  • avoid frills
Controlling location
The optimal location of activities changes overtime.
Controlling institutional factors
Firms can influence institutional factors such as government policies and unionization.
Procurement and cost advantage
A number of possible changes in procurement can reduce costs:
  • tune specifications of purchased inputs to meet needs more precisely
  • enhance bargaining leverage through purchasing policies
  • select appropriate suppliers and manage their cots
Reconfiguring the Value Chain
Reconfiguring value chains stem from a number of sources, including: a different production process, differences in automation, direct sales instead of indirect sales, a new raw material, major differences in forward or backward vertical integration, shifting the location of facilities relative to suppliers and customers, new advertising media.
Reconfiguration downstream
Reconfiguration of downstream activities can reduce cost substantially.
Cost advantage through focus
A focus strategy may also provide a means for achieving a cost advantage that rests on using focus to control cost drivers, reconfiguring the value chain, or both.

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Generic Business Unit Strategies
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