COMPETITIVE ADVANTAGES (Chapter 11)

< Pricing strategy must fully exploit your competitive

advantages -- in fact, should further them

< Two types of competitive advantage

(low) cost low price

high profit
contribution
(differentiated)
product price premium

< Other types of competitive advantage: focus, synergy,

first mover, etc., can be reclassified
 Cost Advantages

< Cost control should be an ongoing activity. However, it is not

sufficient to provide a sustainable cost advantage -- excessive
cost control may be counterproductive

< Basis for a cost advantage is efficient use of resources --

resulting in economies of scope, scale, experience, focus,
and logistical integration

< Coordination of pricing with suppliers, while not based on

efficient use of resources, can lead to effective pricing. Proper
consideration of supplier costs
1. ECONOMIES OF SCOPE

< Result from synergies available in the firms product

portfolio

< An important form of synergy is shared costs

Examples:

convenience stores
airline reservation systems

< New products can be designed to exploit economies of

scope
2. ECONOMIES OF SCALE

< Result from efficiencies in manufacturing, distribution,

administration leading to lower costs per unit

< Two different types of scale economies -- size and

extent -- implication of each type of scale economy for
pricing strategy is different -- see illustration (Ex. 11.3)

< Determining if scale economies exist requires

estimating price sensitivity of buyers

< A firm should fully exploit all available scale

economies -- because they provide a sustainable cost
adv -- can accomplish by limit entry pricing

< With declining demand, scale economies become scale

diseconomies
 Exhibit 11.1 Scale Economies of Different Size

Moderate Size

Unit Cost

0 10 20 30 40 50 60
Unit Sales

Large Size
Unit Cost

0 10 20 30 40 50 60
Unit Sales
Exhibit 11.2 Scale Economies of Different Extent

Moderate Extent

Unit Cost

0 10 20 30 40 50 60
Sales as % of Market

Large Extent
Unit Cost

0 10 20 30 40 50 60
Sales as % of Market
3. ECONOMIES OF EXPERIENCE

< Result from cost reductions brought about by

accumulated production experience (learning by
doing)

< Economies of experience are exponential; i.e., a 20%

reduction in unit costs for 100% increase in cumulative
volume (see illustrations of the experience curve)

< Experience curve cost reductions apply to labor, capital

investment, R & D, marketing; i.e., across the board

< Experience curve cost reductions can lead to innovative

pricing strategies

< Problems with experience curve pricing?

 Exhibit 11.4 A Typical Experience Curve

Unit Cost

0 Accumulated Volume
4. ECONOMIES OF FOCUS
< Result from concentrating marketing effort on selected
products/markets -- thereby reducing marketing costs

< Offer an option to companies unable to generate

economies by other means

< Requires constant monitoring of size & growth

direction of chosen product/market

5. ECONOMIES OF LOGISTICAL INTEGRATION

< Result from better coordination of your production, R
& D, etc., with your suppliers

< Also by better coordination with your channel

members (distributors) -- can redesign product to
facilitate efficient distribution
 Coordination of Pricing with Your Suppliers

(Cost Integration Efficiencies)

< Underlying principle behind cost integration efficiencies is

that when entire production/mfg. chain operates efficiently,
costs are properly allocated and pricing is optimal

< One source of cost integration inefficiencies is improper

transfer prices in the production/mfg. chain -- leading to
suboptimal (& non-competitive) pricing

< Key to obtaining cost integration efficiencies is to avoid

incrementalization of a suppliers fixed costs leading to their
inclusion in your price!
(Please study illustration on pages 284-287)
 Exhibit 11.5 Inefficiencies in Transfer Pricing
Current Price, 10% Price Cut,
Costs, Sales 30% Sales Increase Change
Independent Manufacturing, Inc.
Current unit sales 1,000,000 1,300,000
Price $2.00 $1.80
Variable materials cost $1.20 $1.20
Variable labor cost $0.20 $0.20
Fixed cost $0.40 $0.31
Contribution margin $0.60 $0.40
% CM 30% 22%
Annual pretax profit $200,000 $120,000 ($80,000)
Alpha Parts, Inc.
Current unit sales 1,000,000 1,300,000
Price $0.30 $0.30
Variable cost $0.05 $0.05
Fixed cost $0.20 $0.15
Contribution margin $0.25 $0.25
Annual pretax profit $50,000 $125,000 $75,000
Beta Parts, Inc.
Current unit sales 1,000,000 1,300,000
Price $0.90 $0.90
Variable cost $0.35 $0.35
Fixed cost $0.40 $0.31
Contribution margin $0.55 $0.55
Annual pretax profit $150,000 $315,000 $165,000
 Exhibit 11.6 Efficiency from Cost Integration

Current Price, 10% Price Cut,

Costs, Sales 30% Sales Increase Change
Integrated Manufacturing, Inc.

Current unit sales 1,000,000 1,300,000

Price $2.00 $1.80

Variable materials cost None None
Variable labor cost $0.60 $0.60
($0.20 + $0.05 + $0.35)
Fixed cost $1.00 $0.77
($0.40 + $0.20 + $0.40)

Contribution margin $1.40 $1.20

% 70% 67%

Annual pretax profit $400,000 $560,000 $160,000

 Product Advantages

< Result from being able to differentiate your product from the
competition; thereby reducing price sensitivity through the
unique value effect

< Provide a better guarantee from competitive price cutting

than cost advantages

< Various means are available for achieving product

differentiation

Continuous Innovation

Product Augmentation

First Mover Advantages