Review: Classes Objective of Business. Intro. Prisoners’ Dilemma (Game Theory intro) What is Strategy? IBP: Cost strategy, KSF changed, Constraints on options. Resources & Capabilities. Starbucks: Customer Buying? Value Chain - internal view, How much of the money can WE make, Growth Perils. A-B: Power of consistent, unique strategy; power of leader; potential environmental change? External view: Printer Industry. cont’d.

Review: New tools. Use Insights from to develop POA 4 C’s, PEST 5 Forces => Market Attractiveness, can combine w/ Competitive Strength => Corporate Strategy Key Success Factors Life Cycle Scenarios, option value Value Equivalence Line - Strategic Groups & competing w/in and between, p

Cost Advantage Economies of experience curve and the benefits of market share Sources of cost advantage Using the value chain to analyze costs Current approaches to cost efficiency OUTLINE

The Experience Curve The “Law of Experience” The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles. Cost per unit of output (in real $) Cumulative Output

Examples of Experience Curves 100K200K 500K 1,000K Accumulated unit production Accumulated units (millions) 1960 Yen 15K 20K 30K Price Index % slope 75% Japanese clocks & watches, UK refrigerators, Inflation?

The Importance of Market Share If all firms in an industry have the same experience curve, then: relative costs = f (relative market share) This is supported by PIMS data: BUT:- Association does not imply causation - NOT the objective of business - Costs of acquiring market share tend to offset the returns to market share - Fallacy of composition = rivalry ROS (%) over 40 Market Share (%)

Drivers of Cost Advantage PRODUCTION TECHNIQUES 106 to 6 hrs!! Mgt matters PRODUCT DESIGN INPUT COSTS CAPACITY UTILIZATION MANAGERIAL/ ORGANIZATIONAL EFFICIENCY ECONOMIES OF LEARNING ECONOMIES OF SCALE drives concentration, global Organizational slack Ratio of fixed to variable costs Costs of installing and closing capacity Location advantages Ownership of low-cost inputs Bargaining power Supplier cooperation Design for automation Designs to economize on materials Mechanization and automation Efficient utilization of materials Increased precision Increased dexterity Improved coordination/ organization Indivisibilities-lumpy CapEx,RD,Adv Specialization and division of labor Limits: diffrnttn, flex, motvtn&coordntn

Economies of Scale: The Long-Run Cost Curve for a Plant Units of output per period Minimum Efficient Plant Size Cost per unit of output Sources of scale economies: - technical input/output relationships - indivisibilities - specialization

The Costs of Product Development: New Autos of the 1990s $ billion Ford Escort (1997 model)2 Ford Mondeo/ Contour 6 Ford Taurus (1996 model)2.8 GM Saturn 5 Chrysler Neon 1.3 Honda Accord (1997 Model)0.6 Renault Clio (1999 model)1.3 Rolls Royce (1998 Silver Seraph) 0.33 B. to E.

Scale Economies in Advertising: U.S. Soft Drinks Despite the massive advertising budgets of brand leaders Coke and Pepsi, smaller brands incur the highest advertising costs per unit of sales ,000 Annual sales volume (millions of cases) Advertising Expenditure ($ per case) CokePepsi Seven up Dr. Pepper Sprite Diet Pepsi Tab Fresca Diet Rite Diet 7-Up Schweppes SF Dr. Pepper

Cost Advantage in Short-Haul Passenger Air Transport Costs per Available Seat-Mile (1993) Southwest Airlines United Airlines (cents) Wages and benefits Fuel and oil Aircraft ownership Aircraft maintenance Commisions on ticket sales Advertising Food and beverage Other Total

Key Stages in Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES STAGE 2. ALLOCATE TOTAL COSTS PURCH- ASING PARTS INVEN- TORIES R&D DESIGN ENGNRNG COMPONENT MFR ASSEMBLY TESTING, QUALITY CONTROL GOODS INVEN- TORIES SALES & MKITG DISTRI- BUTION DEALER & CUSTOMER SUPPORT

Applying the Value Chain to Cost Analysis (continued) PURCH- ASING PARTS INVEN- TORIES R&D DESIGN ENGNRNG COMPONENT MFR ASSEMBLY TESTING, QUALITY CONTROL GOODS INVEN- TORIES SALES & MKITG DISTRI- BUTION DEALER & CUSTOMER SUPPORT --Plant scale for each -- Level of quality targets -- No. of dealers component -- Frequency of defects -- Sales / dealer -- Process technology -- Level of dealer -- Plant location support -- Run length -- Frequency of defects -- Capaciity utilization under warrenty Prices paid --Size of commitment -- Plant scale --Cyclicality & depend on: --Productivity of -- Flexibility of production predictability of sales -- Order size R&D/design -- No. of models per plant--Customers’ --Putchases per --No. & frequency of new -- Degree of automation willingness to wait supplier models -- Sales / model -- Bargaining power-- Wage levels -- Supplier location -- Capacity utilization STAGE 3. IDENTIFY COST DRIVERS

Applying the Value Chain to Cost Analysis (continued) PRCHSNG PARTS R&D COMPONENT ASSMBY TESTING GOODS SALES DSTRBTN DLR INVNTRS DESIGN MFR QUALITY INV MKTG CTMR Consolidation of orders to increase discounts, increases inventories Designing different models around common components and platforms reduces manufacturing costs (GM) Higher quality parts and materials reduces costs of defects at later stages Higher quality in manufacturing reduces warranty costs STAGE 5. RECCOMENDATIONS FOR COST REDUCTION STAGE 4. IDENTIFY LINKAGES

Dynamic vs. Static Approaches to Manufacturing 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 - 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 PRODUCTION SYSTEM MANAGEMENT OF TECHNOLOGY DYNAMICSTATIC

Recent Approaches to Cost Reduction 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 (Follow an order) CORPORATE RESTRUCTURING BUSINESS PROCESS REENGINEERING