Barney 5e IM Ch4

4
Cost Leadership
INTRODUCTION
Chapter 4 marks the beginning of Section 2 of the textbook. This section covers
business level strategies . This is the beginning of the “Strategic Choices” element of the
strategic management process. As such, you should clearly signal to students that you have
taken them through external and internal analysis. Students are now ready to begin learning
about how to use external and internal analysis to make important strategic decisions.
Business level strategy refers to the strategic choices managers make about how to
position a specific business and/or product line to gain competitive advantage in a single
market or industry. Recall the business level strategy decisions in the Stanley Black &
Decker example from Chapter 1. Stanley Black & Decker must make strategic decisions
about how to position small appliances and power tools. Of course, managers’ decisions
concerning the positioning of businesses will be influenced by the results of their external
and internal analyses.
Cost leadership and product differentiation are the two business level strategies
covered in this text. These two strategies are sometimes referred to as generic business level
strategies because they represent heuristically two extremes that a firm could choose to
pursue. However, as with most of the concepts covered in this course, some firms are better
able to gain competitive advantage by pursuing these generic strategies than other firms.
 Teaching Points
• Explain the logic of strategic choices following internal and external analysis
in the strategic management process.
• Remind students of what business level strategy is.
• Explain that low cost leadership and product differentiation are two ways of
positioning a business to achieve competitive advantage.
• Offer a brief outline of your discussion of cost leadership:
1) Benefits of cost leadership
2) Sources of cost advantages
3) Cost leadership and competitive advantage
4) Cost leadership and organizational structure
5) Summary of cost leadership
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Chapter 4: Cost Leadership 83
Slide 4-2
Use this slide to show how strategic choices can be categorized as business level strategy
issues and corporate level strategy issues. Explain that business level strategic choices are
concerned with the positioning of specific businesses. Corporate level strategic choices deal
with decisions about which businesses to enter and how to enter them.
Slide 4-3
This slide shows the two generic business level strategy choices of cost leadership and
differentiation. Explain that this chapter covers cost leadership and the next chapter will
cover product differentiation.
The following Discussion and Activity is a fun way to engage students’ attention in
thinking about how and why firms choose to position their products in various ways in the
market.
Discussion & Activity: The Plastic Bag Activity

This activity requires some advance preparation on your part. Go to a
grocery store and find that store’s offering of plastic garbage bags. You will
usually find a range of several bags including a high end, heavy duty bag with
pull strings, a lighter weight bag with pull strings, a bag with a tapered
opening that can be tied by pulling the tapered corners together, a bag that
comes with twist-ties, and a very plain bag with no closure apparatus
whatsoever. Choose several of the bags to represent a good cross section,
but focus on the extremes—make sure you get the cheapest one. It will be
helpful if you can get more than one bag that is at the obvious low end of the
market. This may cost a few dollars, but it’s an investment; you’ll be able to
refer to these bags several times throughout the semester. Make sure to note
the price per package, the number of bags in each package, and the per bag
price of each type of bag.
Take these bags to class, but before you show the bags, ask students
if they can name brands of garbage bags. They will most likely be able to
name Glad and Hefty. Now show the boxes and each type of bag to the
students. Explain the package sizes and prices.
Ask students if they have had any experience with the expensive
versus cheap garbage bags. You will usually get at least one impressive,
perhaps gross, story about garbage bags. Ask the students why anyone
would ever buy the inexpensive (cheap) bags. Ask them why anyone would
ever pay the super premium you seem to be paying for the high priced bags.
These questions and the ensuing discussion will help the students realize that
not all consumers are alike and different consumers have different needs and
motivations for buying bags.
Now ask the students what they think the basis of competition is for
the producers of each type of bag. Make sure the point is made that some
producers are competing on quality and others are competing on price. Ask
the students which companies have to be concerned about the costs of

84 Chapter 4: Cost Leadership
production. The point should be made that costs matter for everyone but
they matter more for those who are competing on price. Point out that the
students didn’t know the brand names of the cheap bags. Even though they
didn’t know the names of the cheap bags, the cheap bag producers are
making enough money to stay in business.
Explain that the high-end bag producers and the low-end bag
producers are positioning themselves in the market in fundamentally
different ways. This is business level strategy. Some are trying to compete
on differentiation and some are trying to compete on cost leadership. Point
out that both strategies can work in a single market. Both strategies can
generate economic value.
Note: It may well be the case that the manufacturers of high-end
bags also produce the low-end bags under different names. Ask students
why we as consumers don’t know this for sure.
THE BENEFITS OF COST LEADERSHIP

Learning Define Cost Leadership
Objective 1
As the name implies, a cost leadership strategy is intended to generate competitive
advantage by achieving costs that are lower than all competitors. Our definition of
competitive advantage is: the ability to create more economic value than competitors. A
firm with lower costs than competitors creates more value because of the greater difference
between the firm’s costs and the price the firm is able to charge (i.e., higher profit margins).
 Important Points:
1) In a market where competitive pressures (e.g., a commodity-type
product) do not allow one firm to charge higher prices than other firms,
the firm with a cost advantage will be able to generate more value than
competitors.
Slide 4-4
Use this slide to illustrate that a cost leadership position vis-à-vis competitors will allow the
focal firm to have average total costs (ATCff) that are less than the industry average total
costs (ATCind). Thus, an above normal return is possible. Also, point out that the focal firm
does not have to charge a lower price—it can enjoy a wider margin than competitors.
Finally, use this graphic to illustrate why competitors would not want to engage in a price
war with the cost leader. If other firms have higher cost (such as the industry average total
cost), they can never win a price war with the cost leader.
2) Cost leadership is not necessarily synonymous with low price. It is true,

by definition, that the cost leader in a market can charge the lowest price
and still have a positive profit. However, a firm pursuing a cost
leadership strategy would want to have the advantage of the lowest costs
without being forced to charge the lowest price.

3) Firms in a market have a strong incentive not to compete on price with

the low cost leader. This is akin to the old boxing adage that: One’s
success in the ring has a lot to do with choosing one’s opponent.
Firms have a strong incentive to compete on cost (not price) because of the
advantages explained above. Therefore, firms enjoying cost advantages typically face strong
competitive pressures on their cost positions. The durability of cost advantages will be
discussed later in the Cost Leadership and Competitive Advantage section.
► Example: Wal-Mart’s Cost Advantages
Wal-Mart has always been focused on achieving the lowest possible costs.
As the firm began to expand and grow there were two main sources of cost
advantage: 1) a growth pattern of rural locations surrounding distribution
centers, and 2) information technology. Wal-Mart’s careful selection of rural
locations created cost advantages because of relatively cheap land and very
efficient distribution through its distribution centers. Stores were typically
located along interstate highways and/or heavily traveled crossroads. There
was usually very low demand for the land purchased for these locations
because other retailers were uninterested in rural locations. However, these
stores had incredible drawing power. People flocked to the stores in search
of low prices and a wide product offering. Distribution was also relatively
inexpensive because Wal-Mart’s trucks could easily get to these locations
from interstate highways. One large distribution center could efficiently
handle all the stores within a day’s drive.
These location advantages were coupled with Wal-Mart’s information
technology, which was always state-of-the-art. Highly efficient inventory
management, facilitated by IT systems, allowed Wal-Mart to achieve costs
significantly lower than its competitors. Wal-Mart knew which items were
selling and which were not. It knew how much of which products were
needed and where they were needed. And, it could distribute these products
quickly and efficiently.
Wal-Mart has heavily advertised low prices. People tend to associate
Wal-Mart with low prices. However, careful shoppers in some markets have
realized that competitors sometimes offer lower prices, especially on food
items. Thus, it would appear that Wal-Mart is in the enviable position of
having low costs but not having to charge the lowest prices on all products
all the time.
This pricing advantage can be very frustrating for competitors. Wal-
Mart has a policy of beating competitors’ prices whenever a customer points
out that a competitor has a lower price. If a competitor attempts to compete
vigorously on price, Wal-Mart will simply lower its price and it can better
afford to do so. One store manager from a competing food retailer stated
his frustration this way:
“People just assume that Wal-Mart has the lowest prices on everything, but
they don’t. I have sent professional shoppers to compare prices and we have

better prices on many items. But, if I advertise lower prices on any specific
item, Wal-Mart will beat my price and I’m worse off.”
Wal-Mart is able to offer low prices and still make a profit because of
its low costs. One remarkable aspect of Wal-Mart’s success is that it has
operated in a business that is highly competitive. Wal-Mart appears to have
achieved competitive advantage with its cost leadership strategy.
 Teaching Points
• Refer to the Ryanair example from the opening case in the chapter and the
Wal-Mart example above to help explain the three Important Points above.
• Emphasize that firms can achieve competitive advantage in very competitive
markets through cost leadership.
• Ask students about their experiences at Wal-Mart.
• Do they think Wal-Mart always has the lowest prices?
• Ask students how they would respond to Wal-Mart if they were the manager
of a competing store.
SOURCES OF COST ADVANTAGES

Learning Identify Six Reasons Firms Can Differ in Their Costs
Objective 2
Managers facing a strategic decision about how to position a business within an
industry need to understand several fundamental cost issues. A sound understanding of
these issues will help managers determine whether their focal firm is likely to generate
competitive advantage by competing on cost. Alternatively, managers may recognize that
other firms have a clear cost advantage and therefore their focal firm should choose to
compete on some other basis—such as product differentiation.
 Important Point: Sources of cost advantage should be analyzed very objectively.

Finding out that the focal firm is not likely to have a cost advantage may be just as valuable
as finding out that the focal firm is likely to have a cost advantage.
Slide 4-5
Use this slide to make the Important Point above. Explain that the development of an
appropriate strategy depends on knowing who has the cost advantage.
Six Sources of Cost Advantage
The textbook offers detailed coverage of six sources of cost advantage. Therefore, we
suggest that you simply offer a brief explanation of each one of these sources and move on
to a discussion of how managers can determine if these sources of cost advantage are likely
to lead to competitive advantage.
Learning
Objective 3

Identify Four Reasons Economies Of Scale Can Exist and Four Reasons Diseconomies Of Scale Can
Exist
Economies of Scale
• exist if the average per unit cost of production falls with an increase in the
quantity produced
• exist because of the ‘fixed’ nature of some costs
• suppose the investment cost of a machine is $50,000—whether the machine
produces 1,000 pieces or 10,000 pieces the investment cost is the same, the
per unit cost falls from $50 to $5
• fixed overhead costs may be spread over larger volumes of production—
lowering per unit cost of production
• imply that there is some minimum efficient scale—firms that operate at the
minimum per unit cost will have an advantage over firms that have not
reached the minimum efficient scale
• exist because of specialized machines and the specialization of employees
• may be achieved through international expansion that increases sales to the
point that minimum efficient scale may be reached
Slide 4-6
Use this slide to make the points above. Emphasize the fact that economies of scale are
most effective as a cost advantage and barrier to entry, when the necessary increments of
capacity would push industry capacity beyond industry demand.
Diseconomies of Scale
• arise as production moves beyond the minimum efficient scale—average per
unit cost increases as quantity produced increases
• the firm (or business) has become too large
• physical diminishing returns to scale—machines able to handle larger
volumes may be prone to more defective pieces and/or may be so
expensive as to result in higher average per unit costs
• transportation costs—trying to cover a vast geographic area from a
very large plant may contribute to diseconomies of scale
• human factors—overly bureaucratic, de-motivated
• may result from international expansion if bureaucracy increases and/or if
the necessary scale of production exceeds the minimum efficient scale
Slide 4-7
Make sure students understand that diseconomies of scale are an advantage to those firms
who do not suffer from them. Nucor Steel had several cost advantages, one of which was
the fact that the large integrated mills were experiencing diseconomies of scale in the parts of
the market that Nucor served (light structural steel, rebar, etc.).
Learning Explain the Relationship between Cost Advantages Due to Learning Curve Economies and a Firm’s
Objective 4 Market Share, as well as the Limitations of this Logic

Learning Curve Economies

• result from people learning a production process so that they get better at the
process
• result from cumulative experience
• do not suffer from diseconomies—costs continue to fall with increasing
cumulative experience
• typically increase as market share increases—however, market share may be
expensive to acquire, potentially offsetting learning curve economies
• may be accelerated through international expansion because of larger
volumes
Slide 4-8
Emphasize that learning curve economies are greater in processes that are more
complicated—where learning matters more. One of the Big Three U.S. automakers licensed
technology from Robert Bosch, a German company, to produce fuel injectors. The basic
terms of the agreement were that Bosch would share new technology within six months of
any such new technology being put into production. As a result of this agreement, the U.S.
company was always behind Bosch in both quality and price because Bosch was essentially
guaranteed a learning curve advantage. Eventually the U.S. company exited the fuel injector
business and purchased its fuel injectors from Bosch and/or Nippondenso, a Japanese
manufacturer.
Differential Low-Cost Access to Productive Inputs

• result when firms are able to access inputs at less cost than competitors
• are one of the main motivations behind international expansion—low cost
labor and raw materials have often been the target of international expansion
• usually result from some historical artifact—being the first firm to discover
the value of a raw material and being able to lock up the source
• are very difficult to achieve if the input is found in competitive markets
where the value of the input is known and is subject to any form of bidding
Slide 4-9
This is an excellent place to emphasize the importance of the international context. Firms
often look to foreign markets for low-cost access to inputs, especially labor. Point out that
the standard of living improves in the foreign markets and eventually another country usually
develops a low cost advantage. One practice in the carpet business that is indicative of a
differential low-cast access to inputs-advantage occurs when a retail flooring chain buys all
the output of a mill in a particular style of carpet. The retail chain gets a low price on the
carpet and no competitor can sell that particular carpet.
Technological Advantages Independent of Scale

• arise when a technology allows a firm to produce something at lower cost
than competitors who do not possess the technology

• fresh vegetable packing operations have traditionally relied on manual

inspection of the produce—new technology allows much faster,
more reliable, lower cost inspection by passing ultra-violet light
through the produce and using pneumatic devices to discard bad
produce from the production line
• can sometimes be acquired by firms from developing economies by
partnering with international partners from developed economies
Slide 4-10
Point out that new technology can sometimes cancel scale advantages. Use the vegetable
inspection example from above. This technology is in use in the potato packing business.
Instead of paying several laborers to inspect potatoes as they pass over a conveyor,
processing companies can invest in this technology that greatly reduces cost. While there is
certainly economic value in the technology for potato processors, most of the value is being
captured by the firm that invented and produces the inspection machinery.
Policy Choices
• may create cost advantages in two ways:
1) firms may decide to produce low cost, highly standardized products and
compete on price, and/or,
2) firms may develop a cost conscious culture in which managers and other
employees are given incentives to constantly look for ways to reduce per
unit costs (increase efficiency)
Slide 4-11
Emphasize the fact that firms are free to make a wide range of policy choices. However,
over time firms tend to have less and less freedom in making policy choices because of
organizational rigidity. Firms can experience a cost advantage from policy choices either
because they were lucky in making good policy choices in the first place or they can remain
flexible so that they can make policy choices on an ongoing basis. Southwest Airlines
adopted human resource policies that have contributed to their cost advantage (cross
functional work practices, hiring practices, incentive systems, etc.) Other large airlines cannot
effectively make these policy choices at this point in time because of unions, traditional,
psychological contracts, etc. Thus, Southwest’s policy choices are a source of cost
advantage.

 Teaching Points
• Point out that it is important for students to know these sources of cost
advantage well, even though you may have covered them quickly—tell
students you assume they have read the book carefully.
• Emphasize that a good strategic choice is dependent on knowing which firms
in a market are likely to have a cost advantage—whether the focal firm or
competitors.
• Emphasize that international expansion may be used to develop some of
these sources of cost advantage. Conversely, international competitors may
also possess and/or develop these sources of cost advantage.
• Ask students to identify Wal-Mart’s cost advantages. Point out that many of
Wal-Mart’s cost advantages were policy choices in the beginning. Now, Wal-
Mart enjoys scale advantages. As suggested in the opening case of the
chapter, Ryanair is also a good example of a cost leader.
COST LEADERSHIP AND COMPETITIVE ADVANTAGE

The textbook takes a novel approach in explaining how a cost leadership position
may generate competitive advantage. The VRIO model is applied to the cost advantage a
firm may have. Recall from Chapter 3 that a resource, in this case the source of a cost
advantage, may lead to competitive advantage if it meets the VRIO criteria. The ‘Value’
question is addressed by using the environmental threats model to explain how a cost
advantage may generate value for a firm. Thus, the environmental threats model is nested
within the VRIO model—very clever indeed.
 Important Point: Students need to be clear about how the VRIO and the
environmental threats models are being used here to analyze the competitive advantage
implications of a cost advantage. The logics of these models from earlier chapters are being
applied to help determine if a firm is likely to have a sustainable competitive advantage due
to a cost advantage.
Learning Identify How Cost Leadership Helps Neutralize Each of the Major Threats in an Industry
Objective 5
The Value of Cost Leadership
 Important Point: As you begin this discussion, make sure students understand
that this analysis would be used after it has been determined that the focal firm has a cost
leadership position stemming from a source of cost advantage as described above. Also,
students should understand that if competing firms are found to have cost advantages, the
same logic could be applied to them in explaining why the focal firm probably would not be
able to generate a competitive advantage based on cost leadership.
Environmental Threats Model. The value of a cost advantage can be explained, at

least in part, by showing how the cost advantage may help to neutralize threats in the
external environment. If a cost advantage helps to neutralize one or more of the threats,
then the cost advantage would be considered ‘valuable’ within the VRIO model.

Slide 4-12
Make sure students understand that the logic of the VRIO model can be applied to a source
of cost advantage. Explain that a source of cost advantage could lead to temporary
competitive advantage if it’s valuable and rare, or sustainable advantage if it’s valuable, rare,
and costly to imitate.
Threat of Entry
• a cost advantage presents a barrier to entry because would-be entrants face the
investment cost of matching an incumbent’s cost position
• incumbents typically face lower opportunity costs because they have made
a series of investments over time that are now sunk costs, whereas entrants
face relatively higher opportunity costs with a large one-time investment
to enter a new business
• the threat of entry by international competitors should be taken into account
Threat of Rivalry
• a cost advantage can be used to manage the threat of rivalry
• a recognized cost leader can establish a price in a competitive market and
other firms will not rationally go below that price, thus reducing rivalry
• an unrecognized cost leader can choose to either:
1) meet the competitive price and enjoy wider margins than competitors
without alarming competitors with lower prices, or
2) offer a lower price to gain market share from competitors—this is
rational only if the increased market share offsets the lower margins
• if a firm chooses to offer lower prices, then it can expect increased rivalry
• a lower price strategy gives competitors incentive to focus on lowering
costs which may put the focal firm’s cost advantage in jeopardy
• thus, the focal firm should carefully analyze the likely responses of
competitors
Threat of Substitutes
• a cost leader’s market offering is more attractive if the price to consumers is less
than the price of substitutes
• cost leaders are in a position to respond with lower prices, if necessary, to
keep their offerings more attractive vis-à-vis substitutes
Threat of Suppliers
• cost leaders in a market typically have large market share—meaning they will be
important customers to the suppliers in the industry
• the threat of suppliers will be reduced because of the suppliers’ desire to
keep the cost leader as a customer—nobody wants to lose their best
customers
• cost leaders will be better able to absorb price increases than higher cost
competitors, thus the threat of suppliers is greater for higher cost competitors
than for the cost leader

Threat of Buyers
• cost leaders in a market typically have large market share—meaning they will
probably be among the largest, most powerful suppliers in an industry
• buyers will naturally be more dependent on such supplier firms
• a cost leadership position will create a disincentive for buyers to vertically
integrate backwards for all the reasons listed in the Threat of Entry section
• cost leaders can more easily absorb demands for lower prices or increased service
and/or quality from powerful buyers compared to higher cost competitors
Slide 4-13
Use this slide to help you make the points listed above. The overall point is that a cost
advantage may insulate a firm, to an extent, from industry forces.
 Teaching Points
• Emphasize that a single source of cost advantage may be valuable for

multiple reasons (i.e., it neutralizes more than one threat).
• Emphasize the importance of signaling a cost advantage. Note that the
ability of a cost advantage to neutralize threats often depends on other firms
knowing about the cost advantage.
• Point out that firms have strong incentives to compete vigorously on cost
because of the many sources of value associated with a cost leadership
position.
Learning Identify the Bases of Cost Leadership that are More Likely to be Rare and Costly to Imitate
Objective 6
Rarity of Sources of Cost Advantage
The source of a cost advantage will confer competitive advantage only if the source is rare.
Remember that we said the starting point in this competitive advantage analysis of a cost
advantage is at the point where it has been determined that the focal firm has a cost
advantage. Well, by definition, if a firm has a cost advantage it must be relatively rare. The
real question then becomes, “How long is it likely to remain rare?” Of course, answering
this question is really a matter of assessing the costs of imitation, which will be addressed in
the next sub-section. However, it is useful to understand why a source of cost advantage is
rare at a given point in time.
In most cases, the rareness of a source of cost advantage at a given point in time is
dependent on the interaction of two things: 1) the life cycle stage of the industry, and 2) the
imitability of the source of the cost advantage. Some sources of cost advantage will be rare
in the emerging stages of an industry and then become less rare as the industry matures—
some will remain rare. Yet other sources may be rather common in the emerging stage of an
industry and become more rare as the industry matures—some will remain common.

The Sources of Cost Advantage
Economies of Scale:
• are less likely to be rare in emerging industries because multiple firms are
discovering where the minimum efficient scale is
• may become more rare as the industry matures if the minimum efficient scale
is discovered to be quite large and if industry demand roughly equals industry
capacity—such that an incremental plant at minimum efficient scale would
vastly exceed industry demand—this is even more likely as an industry
declines
Diseconomies of Scale:
• are likely to be rare in emerging and mature industries because most firms
will not exceed the minimum efficient scale
• may become less rare in a declining industry if demand falls sharply leaving
most firms with excess capacity—this is not a likely scenario
(Remember diseconomies of scale refer to other firms, not
the focal firm)
Learning Curve Economies:

• are likely to be rare in an emerging industry because the first-mover is
moving along the learning curve ahead of competitors
• are likely to become less rare as the industry matures as competitors also
move along the learning curve—as the learning curve flattens the advantage
of more cumulative experience lessens
Differential Low-Cost Access to Inputs:

• may be rare in emerging industries if the inputs themselves are rare, such as
mineral deposits or input factor markets that are of limited size, otherwise
there is not likely to be differential low-cost access
• may arise (and be rare by definition) as the industry matures if a firm is able
to tie-up sources of supply by acquiring suppliers or forming exclusivity
agreements with suppliers
Technology Advantages:
• are likely to be rare in emerging industries as the new technologies are
developed
• usually become less rare over time as duplication occurs or as competitors
are able to buy the same technology—some technology can remain rare if the
firm is able to protect its proprietary nature, especially software technology as
opposed to hardware technology
Policy Choices:
• valuable policies may be rare in emerging industries as many different firms
establish various policies—some firms will adopt policies that prove to be
valuable and others will adopt policies that prove to have little, if any, value
• some valuable policy choices will remain rare if those policies are 1) difficult
to observe and/or understand, or 2) if the adoption of those policies is costly
for competitors because of path dependency—other airlines face a large cost

disadvantage in attempting to adopt some of Southwest Airlines’ human
resource policies
Slide 4-14
Make sure students understand that there is no hard and fast rule about the rareness of a
cost advantage. These are general patterns—there will be exceptions. For example, it could
be that a firm estimates the minimum efficient scale correctly very early in the life cycle of
the industry, in which case that firm’s cost advantage would be rare in the emerging stage.
 Teaching Points
• Remind students that external analysis is necessary to help them understand

who has a cost advantage and whether or not the advantage is rare.
• Emphasize that few firms in a market must hold a cost advantage if it is to be
a source of competitive advantage. In other words, a firm must have a cost
advantage compared to most, if not all, other firms in a market.
• Point out that the rareness of a cost advantage will likely be a fleeting thing—
subject to changes as the industry moves through the industry lifecycle.
• Some firms will want to make their cost advantage known to competitors to
signal a barrier to entry. Other firms will want to keep their cost advantage
secret in an effort to preserve its rareness. This can make external analysis
difficult.
• A firm would want to compete on cost only if it had a cost advantage vis-à-
vis its relevant competitors and only if that advantage is rare—and costly to
imitate as explained below.
Imitability of Sources of Cost Advantage
The resource-based view logic introduced in Chapter 3 holds that a firm’s cost advantage
will generate competitive advantage only if competitors face a cost disadvantage in
attempting to imitate the cost advantage. Understanding the imitability of a source of cost
advantage is important from at least two perspectives. First, if the focal firm is found to
have a cost advantage, managers would want to know if that advantage is costly for
competitors to imitate. Second, if a competitor is found to have a cost advantage, managers
of the focal firm would want to know if the focal firm faces a cost disadvantage in imitating
the source of cost advantage.
 Important Point: Any of the sources of cost advantage described in this chapter
may be costly to imitate depending on the conditions that gave rise to the advantage in the
first place, and on the conditions faced by would-be imitators. Conversely, circumstances
could make any of the sources of cost advantage less costly to imitate.
Several conditions that give rise to low costs and high costs of imitation are
presented below. Keep in mind that each of these conditions could affect more than one of
the sources of cost advantage.

Low Cost Imitation Conditions
Unbalanced Industry Capacity and Demand

• when an industry has excess demand, economies of scale advantages are
imitated at relatively low cost because competitors have an incentive to
expand capacity
• when an industry has excess demand, learning curve advantages are less costly
to imitate because there is room in the market for several firms to be moving
down the learning curve simultaneously (this is observed in the memory chip
industry)
• when an industry has excess capacity, diseconomies of scale advantages will
disappear more rapidly because firms operating beyond the minimum
efficient scale will quickly realize their diseconomies and correct them
Non-Proprietary Technology
• technology cost advantages based on technology that is not owned and
tightly controlled by the focal firm will be less costly to imitate, especially if
vendors can sell the technology to the focal firm’s competitors
Highly Observable Technology

• technology advantages based on technology that is highly observable can be
imitated at lower cost, even when the technology is proprietary because
competitors can more easily see a way around the protection (patents)
Transactional Exchange
• cost advantages such as differential low cost access to inputs and policy
choices that are based on transactional exchanges (purely arm’s length
transactions) are easily imitated
• Example: The bonus policy of an appliance manufacturer that has a cost
advantage because it uses a bonus system with production line employees to
reduce defective parts can easily be imitated.
Slide 4-15
This slide lists the conditions under which imitation is not likely to be costly. Be sure to
explain the notion of transactional exchange (arm’s length, unsophisticated transactions
where personal relationships do not matter much). Explain that these conditions can affect
one or more of the sources of cost advantage.
High Cost Imitation Conditions
Balanced Industry Capacity and Demand

• economies of scale advantages are more costly to imitate in balanced
industries because would-be imitators face a lower net benefit if they add
industry capacity (excess capacity will lead to lower overall prices for output,
lowering the net benefit of entry)—economies of scale present a barrier to
entry

• diseconomies of scale may be more difficult to recognize for firms that have
expanded beyond the minimum efficient scale, making the advantage for the
focal firm more durable
Path Dependence (Historical Uniqueness)

• cost advantages that developed through a set of unique historical
circumstances may be very costly, if not impossible, to imitate
• Example: A grain elevator built decades ago along the Columbia River in
Washington State provides a cost advantage for its owners. The elevator
occupies the only location for miles along the river in which an elevator
could be built without incurring tremendous earth-moving expenses.
Protected Technology
• a technology protected by patent, copyright, trademark, etc. will present a
higher cost of imitation than unprotected technologies—although such
protection does not guarantee that imitation will not occur
Highly Unobservable Technology (Causal Ambiguity)

• a cost advantage based on a relatively unobservable technology will present a
high cost of imitation to competitors because they will not know what to
imitate
Relational Exchange (Social Complexity)

• cost advantages that stem from socially embedded exchanges are more costly
to imitate because competitors face the cost (or impossibility) of recreating
socially complex relationships
• Example: Suppose the appliance manufacturer in the example above had a
corporate culture based on years of experience and life long employees that
encouraged low defect rates. Such an advantage would be much more
difficult to imitate than an advantage based simply on paying people for
lower defect rates.
Slide 4-16
Use this slide to explain the conditions that lead to high costs of imitation. Make the point
that the focal firm would want there to be high costs of imitation if it currently has a cost
advantage. Emphasize that with some effort managers can know, or least make an educated
guess, about the costs of imitation of a source of cost advantage. Re-emphasize that only
those sources that are difficult to imitate will lead to sustainable competitive advantage.
► Example: Low Cost Advantage of U.S. Catfish Gets Challenged
Although catfish was a regional favorite in parts of the Southern U.S., it was
generally considered an undesirable ‘trash’ fish by many consumers in the
U.S. until the 1980s. Based on the knowledge that catfish are hardy
creatures, enterprising farmers began digging ponds on their land to raise
catfish in a controlled environment. These farmers soon discovered that

catfish could be produced at a considerable cost advantage compared to

other species of fish. Consumers had to be convinced that farm-raised
catfish was good tasting and healthy. In time, the marketing efforts of catfish
producers and processors paid off. By 2000, the catfish market had grown to
over $600 million in the U.S. Catfish was widely available in grocery stores
and restaurants. It was widely viewed as a low cost alternative to farm-raised
trout and salmon.
The successful development of the catfish market in the U.S. was a
direct result of the cost leadership strategy pursued by producers. Catfish are
very efficient at converting low cost feed into body mass, making their
cultivation a natural ‘cost leadership’ strategy. The feed used to grow catfish
is primarily a by-product of other food manufacturing operations, thus
making the feed relatively inexpensive. Furthermore, the cost of the land
used in catfish production is typically very low. Labor costs in the rural
South further enhanced the cost advantage of raising catfish.
In 1994, the U.S. began to normalize trade relations with Vietnam.
By 1998, trade barriers that had made the export of catfish to the U.S.
unprofitable for Vietnamese producers had been removed. Imports of
Vietnamese catfish into the U.S. exploded between 1998 and 2001 from 0.6
million pounds to 17 million pounds. Early on, this imported catfish was
sold primarily in ethnic markets to Vietnamese immigrants. However, the
low price of Vietnamese catfish soon caught the attention of large U.S.
grocers.
Vietnamese catfish producers had several important cost advantages
over U.S. producers. In fact, the very cost advantages that U.S. catfish
producers had over the producers of other farm-raised fish were now
advantages enjoyed by Vietnamese producers. Feed was less costly in
Vietnam. Labor was a fraction of the U.S. cost. For many Vietnamese
farmers there were no land costs associated with catfish production because
the farmers simply used nets that floated under their houseboats—they were
already living on the Mekong River.
U.S. catfish producers quickly became suspicious that Vietnamese
producers were ‘dumping’ (selling below cost) catfish in the U.S. market.
This was very difficult to prove because it was impossible to get actual
production costs because of the industry structure (1000’s of very small
producers) and Vietnamese government policy. Production costs in India
and Bangladesh were used to impute production costs to Vietnam. Based on
these imputed costs, it was determined that the Vietnamese were guilty of
dumping. Penalties ranging from about 32% to 65% were imposed on
various Vietnamese importers. Vietnamese producers were also prohibited
from calling their product catfish. They were forced to use the traditional
names of Basa and Tra. (Aguiar, Anh, & Davies, 2005, The Agifish Case:
International Trade Dispute and Market Opportunities for Catfish in the
Mekong Delta. 15th World Food and Agribusiness Symposium and Forum,
Chicago, IL).
There is no question that Vietnamese producers have a significant
cost advantage over U.S. producers. Capital requirements and labor costs in
Vietnam are a small fraction of U.S. costs. Most of these cost differences
stem from cultural and lifestyle differences. The standard of living

demanded by Vietnamese producers and laborers is vastly different from that
demanded by U.S. producers and laborers.
The catfish market is a good example of how cost leadership
positions may change with new market entrants. In this case, we observe
that economies of scale and learning curve cost advantages may become
obsolete in the face of competitors who face a different set of constraints.
Whereas large U.S. producers benefited from economies of scale and
learning curve advantages, extremely small Vietnamese producers quickly
learned to produce at much lower costs in a market environment that was
fundamentally different from that faced by U.S. producers.
 Teaching Points
• Make sure students understand that analyzing the imitability of cost

advantages is important whether the focal firm has a cost advantage or a
competing firm has an advantage.
• Emphasize that circumstances surrounding a cost advantage may make that
advantage costly to imitate or rather easy to imitate—the point being that
one cannot conclude that the type of cost advantage is automatically either
costly to imitate or easy to imitate.
• Encourage students to consider how circumstances may change over time.
For example, a very balanced industry may become unbalanced if demand
changes rapidly, thus changing the costs of imitation.
• Refer to the catfish market example to call attention to the fact that
international competition may entail circumstances that can make sources of
cost advantage more or less costly to imitate. Also, point out that what U.S.
producers saw as dumping was probably a matter of Vietnamese producers
being willing to accept much smaller returns than U.S. producers.
Implementing Cost Leadership through Organizational Structure and Control
Managers intending to pursue a cost leadership strategy must consider several important
organizational issues. Recall the experiences of General Lee at Gettysburg during the Civil
War. Great strategy without sound implementation is not great strategy at all. The eventual
success of a cost leadership strategy depends on the appropriate implementation of that
strategy within an organization.
Organizational structure refers to how management responsibilities are divided and
the reporting relationships among various managers. Organization control refers to the
policies a firm adopts to give people incentives to behave in certain ways. These policies are
intended to align the interests of employees with the interests of the organization. Structure
and control issues must be addressed if a strategy is to be successfully implemented.
Slide 4-17
Emphasize the importance of implementation—yet again. Make sure students understand
the concepts of organizational structure and control.

Organizational Structure. Students will understand the functional structure best if

they understand the organizational structure alternatives. Three basic organizational
structures are: simple, functional, and multi-divisional. An organization in which one
person, or perhaps a small partnership, performs all business functions is using a simple
organizational structure. A small family-owned (mom and pop) grocery store is a good
example. One or two people handle all the necessary business functions. One or two
people can handle the purchasing, merchandising, bookkeeping, financing, marketing, etc.
Slide 4-18
Use this slide to introduce students to the three organizational structures. Explain that you
are introducing all three at this point so that they have some context throughout the
remainder of the course.
Slide 4-19
This slide explains the simple structure. Point out that the simple structure is appropriate for
very small and simple businesses. Make sure that students understand that most start up
firms skip this structure and begin with a functional structure.
The functional structure simply means that the organization is structured around
the business functions that must take place for the firm to succeed. Suppose the family-
owned grocery store has expanded to several stores. Now it makes sense to have one person
responsible for purchasing, one person responsible for all the accounting, one person
responsible for all the marketing, etc. A manager is assigned responsibility for each business
function. This manager reports to the CEO who has overall responsibility for the company.
Slides 4-20 and 4-21

Use these slides to explain the functional structure. Discuss implications of the
specialization within functions (efficiency). Emphasize the role of the CEO in setting
strategy and coordinating the efforts of the various functions.
The multi-divisional structure is a replication of the functional structure across two

or more divisions. Each division has a manager of each of the functions who report to a
division manager who then reports to the CEO of the company. Suppose the family-owned
grocery business has grown to the point that it makes sense for the company to have its own
warehousing and transportation business. The multi-division structure would be adopted by
appointing a division manager for the grocery business and a division manager for the
transportation business. Within each division there would be an accounting manager, a
purchasing manager, a finance manager, a marketing manager, etc.
Slides 4-22 and 4-23

These slides explain the M-Form structure. Explain that moving to an M-Form in the face
of a growing, more complex organization is a way to coordinate the management functions

of many individuals. Point out that even though the organization may be using the M-Form,
at the business level the functional structure is still being used.
Learning Explain How Firms Use a Functional Organizational Structure to Implement Business-Level Strategies
Objective 7 Like Cost Leadership
The functional structure and cost leadership. It should be noted that functional
structure is used to implement strategy at the business level in organizations of significant
size, whether the overall organization is using a functional or multi-divisional structure. If
the organization is using the functional structure (meaning there are no divisions), then the
CEO is the only person who has an enterprise-wide perspective. If the organization is using
the multi-divisional structure, then within each division the division manager is the only
executive with a division- or business-level perspective. This arrangement implies two
notable characteristics of the functional structure. First, the CEO or division manager is the
only executive tasked with responsibility for the whole enterprise or business. The
functional structure is sometimes referred to as the U-form structure, which stands for
“unitary” because of the singularity of the CEO’s perspective. Second, the functional heads
are able to specialize in their respective functions. The specialization within functions is a
large part of what makes this structure attractive to firms pursuing cost leadership strategies.
 Important Point: The CEO or division manager is responsible for setting

strategy and ensuring that the efforts of each functional manager are appropriately aligned to
carry out the strategy. Thus, the CEO must balance the benefits of specialization within
functions and the benefits of coordination across functions in the pursuit of a cost
leadership strategy.
The functional structure can be fine-tuned to help achieve low costs by:
1) having the CEO manage the coordination of the functions so that cost reducing
activities can be shared across functions
2) allowing decisions to be made by those best able to reduce the cost of a product
and/or process—not requiring that all decisions be cleared by the CEO—few
layers of reporting relationships
3) allowing functional managers to streamline their respective functions
4) keeping each function narrowly focused—realizing gains from specialization
Slide 4-24
Point out that with a cost leadership strategy, the firm needs to be organized so that
efficiency and cost reduction are facilitated. By delegating functional authority, the CEO is
able to focus on strategic issues and the coordination of the functions.
Learning Describe the Formal and Informal Management Controls and Compensation Policies Firms Use to
Objective 8 Implement Cost Leadership Strategies
Organizational control. Organizational controls can take the form of management

controls and compensation policies. Management controls refer to policies governing the
way things are done in the organization. These policies may be very formal or they can be

very informal. Formal management controls are things like budgeting processes where the
cost of a product may be projected and closely tracked to determine if the product is being
produced at the budgeted cost. Such a control focuses attention on constantly striving to
lower the cost of the product. Another formal management control would be a policy
stipulating who can approve expenditures of various amounts. A firm’s credit policies and
executive travel policies are also formal management controls.
Informal management controls include things like cultural norms and attitudes. The
cost conscious behavior of employees who turn off lights when leaving a room and
minimize production waste by frequently calibrating machines is indicative of informal
management controls. Informal management controls play an important role in re-enforcing
more formal management controls aimed at cost reduction.
 Important Point: Most successful cost leaders have strong cultural norms that
focus the attention of employees on achieving low costs. Southwest Airlines and Wal-Mart
are two good examples of firms whose cultures encourage employees to constantly pursue
low costs. In both of these examples, this attitude toward cost reduction is traceable to the
founder of the firm. Herb Kelleher and Sam Walton understood that low cost was critical to
the success of their companies—and they made sure that a culture developed in their
respective companies that focused on cost reduction.
Slide 4-25
Emphasize that organizational controls are policies that are intended to influence, perhaps
even constrain, behavior in an organization. The overall idea is to get people to do things in
a way that is simultaneously in their own self-interest and in the interests of the organization.
Point out that management controls can be formal or informal. Informal controls can be
just as powerful as formal controls, sometimes more powerful.
Compensation policies. Compensation policies provide a level of organizational control

by giving employees incentive to behave in certain ways. Bonuses based on cost reduction
are often used to encourage employees to cut costs. These bonuses may be based on
individual performance or on group performance. Basing bonuses on group performance
gives people the incentive to help others in their group achieve cost reduction goals. Such
compensation policies tend to reinforce both formal and informal management control
policies.
 Important Point: Managers must be careful not to provide cost reduction

incentives that go so far as to reduce quality or service in a detrimental way. For example,
piece rate compensation schemes based solely on quantity may give employees the incentive
to reduce quality. Compensation policies should be carefully scrutinized to avoid giving
employees undesired incentives.
Slide 4-26
Use this slide to explain compensation policies. Pay special attention to the non-monetary
rewards, which can have powerful motivating effects. Special parking places, corner offices,
types of chairs, etc. can all be important status symbols within organizations. Emphasize the

point that compensation policies must be carefully considered so that they do not end up
giving incentives that are counterproductive. Also, point out that compensation policies
should reinforce other management controls.
Slide 4-27
Use this slide to drive home the point that organizational controls can be used to encourage
behavior that supports a cost leadership strategy. Emphasize this point by discussing the
cases of Wal-Mart and Southwest Airlines with respect to their strong cultures that are
traceable to their founders’ vision. Also, point out that these strong cultures are well
coordinated with more formal management controls and compensation policies.
SUMMARY OF COST LEADERSHIP

The main things that you want students to go away from this class session with are:
1) an understanding of the concept of business level strategy

• the positioning of a single business, even if the firm is involved in more than
one business
2) an understanding of the benefits of a cost leadership strategy
• in a competitive market, a cost advantage may be the only way to achieve
above normal economic returns
• a cost leadership position will allow a firm to enjoy greater margins
• a cost leadership position may be a valuable barrier to competitive threats by
other firms
3) the six sources of cost advantage
• economies of scale
• diseconomies of scale
• learning curve advantages
• differential low cost access to inputs
• technology advantages independent of scale
• policy choices
4) an understanding of how a cost leadership position allows a firm to respond to the
five industry forces
5) an appreciation of the fact that a cost leadership position will lead to competitive
advantage only if the cost advantage is rare and costly to imitate
6) an understanding that a cost leadership strategy must be implemented appropriately
within the organization
7) a basic understanding of organizational structure and control
Slide 4-28
This slide allows you to build a model for the class session. Pause after each mouse click to
briefly explain your coverage of that point.

 Teaching Points
• Encourage students to commit the six cost advantages to memory.

• Remind students that a cost advantage will be a sustainable competitive
advantage only if it meets the VRIO criteria.
• Emphasize that you have focused a lot of attention on implementation issues
in this discussion.
• Remind students that it is important that they understand the concepts of
organizational structure and control.
• Successful cost leaders implement their business level strategies such that the
whole organization is focused on cost consciousness. Drive this point home
by referring again to Wal-Mart and Southwest Airlines. It seems that
everything they do is part of a systematic effort to reduce cost.
CHALLENGE QUESTIONS
4.1. Ryanair, Wal-Mart, Timex, Casio, and Hyundai are all cited as examples of firms
pursuing cost leadership strategies, but these firms make substantial investments in
advertising, which seems more likely to be associated with a product differentiation
strategy. Are these firms really pursuing a cost leadership strategy or are they pursuing a
product differentiation strategy by emphasizing their lower costs?
Yes. There is an element of both business level strategies in the actions of

these companies. However, there would be little point in their advertising if
they did not vigorously pursue cost leadership strategies. These firms need
to generate large sales volumes to fully exploit their low per unit cost
structure. Keep in mind that their advertising is not just for their intended
customers. Their advertising is an important signal to competitors as well.
As such, it is an important part of their cost leadership strategies.
4.2. When economies of scale exist, firms with large volumes of production will have lower
costs than firms with smaller volumes of production. The realization of these economies
of scale, however, is far from automatic. What actions can firms take to ensure that they
realize whatever economies of scale are created by their volume of production?
First, such firms must sell their productive output. Without sales revenue,
economies of scale are of little benefit. Second, such firms must carefully
manage the distribution of their output. Economies of scale could be
outweighed by high storage and distribution costs if firms incur significant
carrying costs for finished product inventories. Third, such firms must be
careful not to extend lenient credit terms that have the effect of making the
firm a lending institution. Customers must be given incentives to pay on
time and/or be charged an interest rate high enough to ensure that the firm’s
economies of scale are not cancelled out by the cost of carrying accounts
receivable. Finally, firms should adopt organizational control policies that

encourage employees to be vigilant in controlling costs and looking for ways

to reduce costs even further.
4.3. Firms engage in an activity called “forward pricing” when they establish, during the early
stages of the learning-curve, a price for their products that is lower than their actual
costs, in anticipation of lower costs later on, after significant learning has occurred.
Under what conditions, if any, does forward pricing make sense?
Forward pricing makes sense when firms have some basis for accurate
prediction of learning curve effects on costs. For example, if the firm has
had prior experience with a similar product, then forward pricing can be
undertaken with some confidence. It should be noted that firms engaging in
forward pricing are signaling to would-be competitors that costs are going to
fall such that it may not make sense to even try to compete.
4.4. When firms do engage in “forward pricing,” what risks, if any, do they face?
The most obvious risk firms face when forward pricing is that their estimate
of future costs will be wrong. If actual costs come in above the estimate, the
firm is in the position of either accepting smaller margins than expected or
raising prices—neither of which is desirable. Another risk is that
competitors may be able to achieve a lower cost, in which case the focal firm
would appear to have been charging an excessive price, which may hurt sales.
4.5. One way of thinking about organizing to implement cost leadership strategies is that
firms that pursue this strategy should be highly centralized, have high levels of direct
supervision, and keep employee wages to an absolute minimum. Another approach is to
decentralize decision-making authority—to ensure that individuals who know the most
about reducing cost make decisions about how to reduce costs. This, in turn, would
imply less direct supervision and somewhat higher levels of employee wages. Why is
this?
A more decentralized approach typically means that employees have more

autonomy and receive higher wages because more is expected of such
employees as compared to employees that are expected only to carry out
instructions.
4.6. Which of the two approaches used to implement cost leadership strategies seems more
reasonable?
Either of these approaches can be reasonable depending on the product type,

production processes, conditions faced by the firm, the available labor pool,
etc.
4.7. Under what conditions would the two different approaches for implementing cost
leadership strategies make more or less sense?

A more centralized approach would make sense with a more standardized

product, a more simple or codified production process, and a rather unskilled
labor force. On the other hand, a decentralized approach would make more
sense when the product requires modification, the production process is
complex and/or tacit, and when a relatively skilled labor force is available.
Problem Set
4.8 The economies of scale curve in Figure 4.1 can be represented algebraically in the
equation: Average costs = a + bQ + cQ2; where Q is the quantity produced by a
firm, and a, b, and c are coefficients that are estimated from industry data. For
example, it has been shown that the economies of scale curve for savings and loan
companies in the U.S. is: Average costs = 2.38 - .615A + .54A2, where A is a savings
and loan’s total assets. Using this equation, what is the optimal size of a savings and
loan? (Hint: Plug in different values of A and calculate Average costs. The lowest
possible Average costs is the optimal size for a savings and loan).
4.9 The learning curve depicted in Figure 4.2 can be represented algebraically in the
following equation: Average time to produce x units = ax-β, where x is the total
number of units produced by a firm in its history, a is the amount of time it took a
firm to produce its first unit, and β is a coefficient that describes the rate of learning
in a firm. Suppose it takes a team of workers 45 hours to assemble their first
product (a=45) and 40.5 hours to assemble their second product. When a firm
doubles its production (in this case, from one to two units) and cuts its production
time (in this case from 45 hours to 40.5 hours), learning is said to have occurred (in
this case 40.5/45 or 90% learning curve). The β for a 90% learning curve is .3219.
Thus, this firm’s learning curve is: Average time to produce x units = 45x-.3219.
What is the average amount of time it will take this firm to produce 6 products?
(Hint: Simply plug “6” in for “X” in the equation and solve). What is the total time
it took this firm to produce these 6 products? (Hint: Simply multiply the number of
units produced “6” by the average time it will take to produce these 6 products).
What is the average time it will take this firm to produce five products? What is the
total time it will take this firm to produce five products? So, what is the total time it
will take this firm to produce its sixth product? (Hint: Subtract the total time
needed to produce five products from the total time needed to produce six
products). Suppose a new firm is going to start producing these same products.
Assuming this new firm doesn’t learn anything from established firms, what will the
cost disadvantage for this new firm be when it assembles its first product? (Hint:
Compare the costs of the experienced firm’s sixth product with the cost of the new
firm’s first product).
Answer 4.8
Assume the following Savings & Loans Assets (Bank 1 = 75,000,000; Bank 2 =
135,000,000; Bank 3 = 137,350,000; Bank 4 = 156,000,000).
Average Costs Bank 1: = 2.38 - .615(S&L 1) + .54(S&L 1)2

Student answers will vary depending upon the number of and size of S&L total
assets used.
Answer 4.9
The constant for a 90% learning curve is log2 = -.152
Average amount of time to product 6 products = 59.08 minutes
Total time for this firm to product these 6 products 5.9 hours
Average time to produce 5 products: = 57.47 minutes
Total time to produce 5 products: = 4.78 hours
Total time to produce its sixth product = 1.12 hours

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4

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Discussion & Activity: The Plastic Bag Activity

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

THE BENEFITS OF COST LEADERSHIP

2) Cost leadership is not necessarily synonymous with low price. It is true,

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

3) Firms in a market have a strong incentive not to compete on price with

► Example: Wal-Mart’s Cost Advantages

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

SOURCES OF COST ADVANTAGES

 Important Point: Sources of cost advantage should be analyzed very objectively.

Six Sources of Cost Advantage

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Learning Curve Economies

Differential Low-Cost Access to Productive Inputs

Technological Advantages Independent of Scale

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

• fresh vegetable packing operations have traditionally relied on manual

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

COST LEADERSHIP AND COMPETITIVE ADVANTAGE

Environmental Threats Model. The value of a cost advantage can be explained, at

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

• Emphasize that a single source of cost advantage may be valuable for

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

The Sources of Cost Advantage

Learning Curve Economies:

Differential Low-Cost Access to Inputs:

for competitors because of path dependency—other airlines face a large cost

• Remind students that external analysis is necessary to help them understand

Imitability of Sources of Cost Advantage

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Low Cost Imitation Conditions

Unbalanced Industry Capacity and Demand

Highly Observable Technology

High Cost Imitation Conditions

Balanced Industry Capacity and Demand

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Path Dependence (Historical Uniqueness)

Highly Unobservable Technology (Causal Ambiguity)

Relational Exchange (Social Complexity)

► Example: Low Cost Advantage of U.S. Catfish Gets Challenged

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

catfish could be produced at a considerable cost advantage compared to

stem from cultural and lifestyle differences. The standard of living

• Make sure students understand that analyzing the imitability of cost

Implementing Cost Leadership through Organizational Structure and Control

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Organizational Structure. Students will understand the functional structure best if

Slides 4-20 and 4-21

The multi-divisional structure is a replication of the functional structure across two

Slides 4-22 and 4-23

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

 Important Point: The CEO or division manager is responsible for setting

Organizational control. Organizational controls can take the form of management

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

Compensation policies. Compensation policies provide a level of organizational control

 Important Point: Managers must be careful not to provide cost reduction

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall

SUMMARY OF COST LEADERSHIP

1) an understanding of the concept of business level strategy