1. Cost 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 cost efficiency 9

2. Figure 8.1. The Experience Curve
1988
1990
Cost per unit of output (in real $)
1992
1994
1996
1998
2000
Cumulative Output 10

3. The “Law of Experience” Cost per unit of output (in real $)
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.
1994
1995
Cost per unit of output (in real $)
1996
1997
1998
1999
2000
Cumulative Output 10

4. Examples of Experience Curves
Japanese clocks & watches,
UK refrigerators,
15K K 30K
1960 Yen
Price Index
75%
70% slope
100K 200K K ,000K
Accumulated unit production Accumulated units
(millions) (millions) 11

5. The Importance of Market Share
If all firms in an industry have the same experience curve, then:
relative costs = f (relative market share)
This supported by PIMS data:
ROS (%)
over 40
Market Share (%)
BUT: - Association does not imply causation
- Costs of acquiring market share tend to offset the returns to market share 12

6. Drivers of Cost Advantage
Indivisibli\ties
Specialization and division of labor
ECONOMIES OF SCALE
Increased dexterity
Improved coordination/ organization
ECONOMIES OF LEARNING
Mechanization and automation
Efficient utilization of materials
Increased precision
PRODUCTION TECHNIQUES
Design for automation
Designs to economize on materials
PRODUCT DESIGN
Location advantages
Ownership of low-cost inputs
Bargaining power
Supplier cooperation
INPUT COSTS
CAPACITY UTILIZATION
Ratio of fixed to variable costs
Costs of installing and closing capacity
MANAGERIAL/ ORGANIZATIONAL
EFFICIENCY
Organizational slack 13

7. Economies of Scale: The Long-Run Cost Curve for a Plant
Sources of scale economies:
- technical input/output relationships
- indivisibilities
- specialization
Cost per
unit of
output
Units of output
per period
Minimum
Efficient
Plant Size 14

8. The Costs of Product Development: New Autos of the 1990s
$ billion
Ford Escort (1997 model) 2
Ford Mondeo/ Contour
Ford Taurus (1996 model) 2.8
GM Saturn
Chrysler Neon
Honda Accord (1997 Model) 0.6
Renault Clio (1999 model) 1.3
Rolls Royce (1998 Silver Seraph) 15

9. Scale Economies in Advertising: U.S. Soft Drinks
Despite the massive advertising budgets of brand leaders Coke and Pepsi,
smaller brands which incur the highest advertising costs per unit of sales
Schweppes
SF Dr. Pepper
Tab
Diet 7-Up
Diet Pepsi
Advertising Expenditure ($ per case)
Diet Rite
Fresca
Seven up
Dr. Pepper
Sprite
Pepsi
Coke
,000
Annual sales volume (millions of cases) 16

10. Cost Advantage in Short-Haul Passenger Air Transport
Costs per Available Seat-Mile (1993)
Southwest Airlines United Airlines
(cents) (cents)
Wages and benefits
Fuel and oil
Aircraft ownership
Aircraft maintenance
Commisions on ticket sales
Advertising
Food and beverage
Other
Total 17

11. Key Stages in Applying the Value Chain to Cost Analysis: The Case of Automobile Manufacture
STAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIES
R&D
DESIGN
ENGNRNG
TESTING,
QUALITY
CONTROL
GOODS
INVEN-
TORIES
SALES
&
MKITG
DEALER &
CUSTOMER
SUPPORT
PARTS
INVEN-
TORIES
DISTRI-
BUTION
PURCH-
ASING
COMPONENT
MFR
ASSEMBLY
STAGE 2. ALLOCATE TOTAL COSTS 18

12. Applying the Value Chain to Cost Analysis (continued)
--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
STAGE 3.
IDENTIFY
COST
DRIVERS
PARTS
INVEN-
TORIES
R&D
DESIGN
ENGNRNG
TESTING,
QUALITY
CONTROL
GOODS
INVEN-
TORIES
PURCH-
ASING
COMPONENT
MFR
SALES
&
MKITG
ASSEMBLY
DISTRI-
BUTION
DEALER &
CUSTOMER
SUPPORT
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 19

13. Applying the Value Chain to Cost Analysis (continued)
STAGE 4. IDENTIFY LINKAGES
PRCHSNG PARTS R&D COMPONENT ASSMBY TESTING GOODS SALES DSTRBTN DLR
INVNTRS DESIGN MFR QUALITY INV MKTG CTMR
Designing different models around
common components and platforms
reduces manufacturing costs
Consolidation of orders to increase
discounts, increases inventories
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 20

14. 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 21

15. 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
CORPORATE
RESTRUCTURING
BUSINESS
PROCESS
REENGINEERING 22