Cost Cost Advantage Advantage OUTLINE • Economies of experience curve and the benefits of market share • Sources of cost advantage • Using the value chain to analyze costs • Current approaches to managing costs The The Experience Experience Curve Curve The “Law of Experience” 1992 1994 Cost per unit of output (in real $) The unit cost value added to a standard product declines by a constant % (typically 2030%) each time cumulative output doubles 1996 1998 2000 Cumulative Output 2002 2004 Examples Examples of of Experience Experience Curves Curves 75% 100K 200K 500K 1,000K Accumulated unit production (millions) UK refrigerators, 1957-71 Price Index 50 100 200 300 1960 Yen 15K 20K 30K Japanese clocks & watches, 1962-72 70% slope 10 50 Accumulated units (millions) The The Importance Importance of of Market Market Share Share If all firms in an industry have the same experience curve, then: Change in relative costs over time = f (relative market share) ROS (%) -2 10 This supported by PIMS data: 0-10 10-20 20-30 30-40 Market Share (%) over 40 BUT: - Association does not imply causation - Costs of acquiring market share offset the returns to market share Drivers Drivers of of Cost Cost Advantage Advantage ECONOMIES OF SCALE ECONOMIES OF LEARNING PRODUCTION TECHNIQUES PRODUCT DESIGN INPUT COSTS • Indivisibli\ties • Specialization and division of labor • Increased dexterity • Improved organizational routines • Process innovation • Reengineering business processes • Standardizing designs & components • Design for manufacture • Location advantages • Ownership of low-cost inputs • Non-union labor • Bargaining power CAPACITY UTILIZATION • Ratio of fixed to variable costs • Speed of capacity adjustment RESIDUAL EFFICIENCY • Organizational slack; Motivation & culture; Managerial efficiency Economies Economies of of Scale: Scale: The The Long-Run Long-Run Cost Cost Curve Curve for for aa Plant Plant Sources of scale economies: - technical input/output relationships - indivisibilities - specialization Cost per unit of output Minimum Efficient Plant Size Units of output per period The The Costs Costs Developing Developing New New Car Car Models Models (including (including plant planttooling) tooling) Ford Mondeo/ Contour GM Saturn Ford Taurus (1996 model) Ford Escort (new model 1996) Renault Clio (1999 model) Chrysler Neon Honda Accord (1997 model) BMW Mini Rolls Royce Phantom (2003 model) $ billion 2.8 1.3 1.3 0.6 0.5 0.3 Scale Scale Economies Economiesin inAdvertising: Advertising:U.S U.S.Soft SoftDrinks Drinks Advertising Expenditure ($ per case) 0.02 0.05 0.10 0.15 0.20 Despite the massive advertising budgets of brand leaders Coke and Pepsi, smaller brands which incur the highest advertising costs per unit of sales Schweppe s SF Dr Pepper Diet 7-Up Tab Diet Pepsi Diet Rite Fresca Seven Up Dr Pepper Sprite Pepsi 10 20 50 100 200 500 Annual sales volume (millions of cases) Coke 1,000 Cost Cost Advantage Advantage in in Short-Haul Short-Haul Passenger Passenger Air Air Transport Transport Costs per Available Seat-Mile (1993) Southwest Airlines (cents) Wages and benefits 2.4 Fuel and oil 1.1 Aircraft ownership 0.7 Aircraft maintenance 0.6 Commissions on ticket sales 0.5 Advertising 0.2 Food and beverage 0.0 Other 1.7 Total 7.2 United Airlines (cents) 3.5 1.1 0.8 0.3 1.0 0.2 0.5 3.1 10.5 Key Key Stages Stages in in Applying Applying the the Value Value Chain Chain to to Cost Cost Analysis: Analysis: The The Case Case of of Automobile Automobile Manufacture Manufacture STAGE IDENTIFY THE PRINCIPLE ACTIVITIES PURCHASING PARTS INVENTORIES R&D TESTING, COMPONENT ASSEMBLY DESIGN QUALITY MFR ENGNRNG CONTROL GOODS INVENTORIES SALES DISTRI- DEALER & & BUTION CUSTOMER MKITG SUPPORT STAGE ALLOCATE TOTAL COSTS Applying Applying the the Value Value Chain Chain to to Cost CostAnalysis Analysis (continued) (continued) STAGE IDENTIFY COST DRIVERS defects PURCHASING PARTS INVENTORIES Plant scale for each component Process technology Plant location Run length Level of quality targets Frequency of defects No of dealers Sales / dealer Level of dealer support Frequency of Capacity utilization under warranty R&D COMPONENT ASSEMBLY TESTING, DESIGN QUALITY MFR ENGNRNG CONTROL Prices paid Size of commitment depend on: Productivity of Order size R&D/design Purchases per No & frequency of new supplier models Bargaining power Supplier location GOODS INVENTORIES Plant scale Flexibility of production No of models per plant Degree of automation Sales / model Wage levels Capacity utilization SALES & MKITG DISTRI- DEALER & BUTION CUSTOMER SUPPORT Cyclicality & predictability of sales Customers’ willingness to wait Applying Applying the the Value Value Chain Chain to to Cost CostAnalysis Analysis (continued) (continued) STAGE IDENTIFY LINKAGES Consolidation of orders to increase discounts, increases inventories PRCHSNG PARTS INVNTRS R&D DESIGN Designing different models around common components and platforms reduces manufacturing costs COMPONENT MFR Higher quality parts and materials reduces costs of defects at later stages ASSMBY TESTING GOODS QUALITY INV SALES DSTRBTN DLR MKTG CTMR Higher quality in manufacturing reduces warranty costs STAGE RECCOMENDATIONS FOR COST REDUCTION Dynamic Dynamic vs vs Static Static Approaches Approaches to to Manufacturing Manufacturing DYNAMIC PRODUCTION SYSTEM Artisan mode: Scientific Management Mode: - problem solving - quest for “one best way” - employee knowledge creation - people matched to tasks - employee control over product - incentives and penalties to - product and customer ensure conformity to objectives orientation - planning and control by staff - continuous incremental MANAGEMENT OF TECHNOLOGY STATIC - science driven improvement - focused around corporate R&D - market needs pull technology departments - product and process innovation- emphasis on product Innovation - teamwork and cross-functional and big projects collaboration Recent Recent Approaches Approaches to to Cost Cost Reduction Reduction CORPORATE RESTRUCTURING BUSINESS PROCESS REENGINEERING Dramatic changes in strategy and structure to adjust to the business conditions of the 1990’s Key elements: • Plant closures • Outsourcing • Delayering and cuts in administrative staff The fundamental rethinking and radical redesign of business processes to achieve dynamic improvements in performance e.g.:• Several jobs combined into one • Steps of a process combined in natural order • Minimizing steps, controls, and reconciliation • Use case managers as single points of contact • Hybrid centralization/ decentralization ... CONTROL GOODS INVENTORIES SALES DISTRI- DEALER & & BUTION CUSTOMER MKITG SUPPORT STAGE ALLOCATE TOTAL COSTS Applying Applying the the Value Value Chain Chain to to Cost CostAnalysis Analysis (continued)... DEALER & BUTION CUSTOMER SUPPORT Cyclicality & predictability of sales Customers’ willingness to wait Applying Applying the the Value Value Chain Chain to to Cost CostAnalysis Analysis (continued)... Other 1.7 Total 7.2 United Airlines (cents) 3.5 1.1 0.8 0.3 1.0 0.2 0.5 3.1 10.5 Key Key Stages Stages in in Applying Applying the the Value Value Chain Chain to to Cost Cost Analysis: Analysis: