Chapter 4

Cost Leadership

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 Cost
Cost Leadership
Leadership

The Strategic Management Process

External
Analysis

Strategic Strategy Competitive

Mission Objectives
Choice Implementation Advantage

Internal
Analysis

Business Level Corporate Level

Strategy Strategy

How to Position a Which Businesses

Business to Enter?
in the Market?
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 Cost
Cost Leadership
Leadership

Business Level Strategies

Two Generic Business Level Strategies

Cost Leadership:
• generate economic value by having lower costs
than competitors
Example: Wal-Mart

Product Differentiation:
• generate economic value by offering a product
that customers prefer over competitors’ product
Example: Harley-Davidson
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 Cost
Cost Leadership
Leadership

Understanding Cost Advantage

Managers need to understand who has

the cost advantage in their market

• it could be the focal firm

• develop a strategy to exploit the advantage

• it could be a competitor

• develop a strategy to either capture the

advantage or compete on some other basis

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 Cost
Cost Leadership
Leadership

Sources of Cost Advantage

Economies of Scale
• average cost per unit falls as quantity increases
-until the minimum efficient scale is reached

• are a cost advantage because competitors may

not be able to match the scale because of capital
requirements (barrier to entry)

• international expansion may allow a firm to have

enough sales to justify investing in additional
capacity to capture economies of scale

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 Cost
Cost Leadership
Leadership

Sources of Cost Advantage

Diseconomies of Scale
• are an advantage for those who do not have
diseconomies of scale

• occur when firms become too large and bureaucratic

• are a risk of international expansion

Example: Nucor Steel

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 Cost
Cost Leadership
Leadership

Sources of Cost Advantage

Learning Curve Economies

• a firm gets more efficient at a process with experience

• the more complicated/technical the process,

the greater the experience advantage

• international expansion may propel a firm down the

experience curve because of higher volumes

Example: Fuel Injectors

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 Cost
Cost Leadership
Leadership

Sources of Cost Advantage

Differential Low-Cost Access to Productive Inputs

• may result from:

• history—being in the right place at the right time
• being first into a market—esp. foreign markets
• natural endowment—owning a mineral deposit
• locking up a source—buying all of its output

Example: Quantity Carpet Buys

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 Cost
Cost Leadership
Leadership

Sources of Cost Advantage

Technology Independent of Scale

• may allow small firms to become cost competitive

• advantage typically accrues to the ‘owner’ of the

technology—may or may not be the ones who actually
use the technology

• size of the advantage depends both on how valuable

and protectable the technology is
Example: Vegetable Inspection

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 Cost
Cost Leadership
Leadership

Sources of Cost Advantage

Policy Choices

• firms get to choose how they will serve the market

• we’ll offer level of quality that is inexpensive to
produce
• firms can make policy choices that give people
incentives to reduce cost at every opportunity

Example: Southwest Airlines

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10
 Cost
Cost Leadership
Leadership

Cost Leadership & Competitive Advantage

A source of cost advantage will lead to
competitive advantage if that source is:

• Valuable

• Rare

• Costly to Imitate

• Organized (Implemented Appropriately)

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 Cost
Cost Leadership
Leadership

Value of a Cost Advantage

Entry Buyers
• increases capital • lowers incentives
requirements for buyers to
for entrants vertically
integrate
Rivalry

Substitutes • competitors rationally Suppliers

avoid price competition
• limits • increases
attractiveness importance of the
of substitutes focal firm to the
supplier

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 Cost
Cost Leadership
Leadership

Rareness of a Cost Advantage

The rareness of a source of cost advantage
depends heavily on the industry life cycle:
Generally…
Emerging Mature
Economies of Scale Not Rare Rare
Diseconomies of Scale Rare Rare

Learning Curve Economies Rare Not Rare

Differential Input Access Rare Rare

Technology Rare Not Rare
Policy Choices Rare Rare
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 Cost
Cost Leadership
Leadership

Imitability of Sources of Cost Advantage

Conditions largely determine if a source of cost

advantage will be costly to imitate
Low Cost Conditions
Unbalanced Industry Capacity and Demand

Non-Proprietary Technology

Highly Observable Technology

Transactional Exchange

(A cost advantage can be easily imitated)

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 Cost
Cost Leadership
Leadership

Imitability of Sources of Cost Advantage

High Cost Conditions
Balanced Industry Capacity and Demand

Path Dependence (Historical Uniqueness)

Protected Technology

Highly Unobservable Technology (Causal Ambiguity)

Relational Exchange (Social Complexity)

(A cost advantage cannot be easily imitated)

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 Cost
Cost Leadership
Leadership

Summary
Business Level Strategy

Cost Leadership Product Differentiation

Cost Advantages
Competitive Advantage
Depends on Meeting
Economies of Scale VRIO Criteria
Diseconomies of Scale
Emphasis on
Learning Curve Economies Organization
Differential Input Access (Implementation)

Technology
Structure &
Policy Choices Control

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