Strategic Management
Jeff Dyer
Third Edition
Chapter 4
Cost Advantage
Professor’s Goals for this Lecture
There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:
– the homework assignment involving calculating an experience curve in semiconductors
– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)
– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry
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Two Generic Strategies
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Companies typically choose between one of two “generic” strategies for offering unique value to customers: cost advantage or differentiation advantage. By designing cars
to be manufactured at the lowest cost possible, and by designing a distribution system to get the cars to customers at the lowest cost possible, Tata has a cost advantage over every other carmaker in India, which allows it to sell the Nano at the lowest price.
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Cost advantage
Differentiation advantage
The Cost Advantage Strategy
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Cost Advantage Strategy
A firm reduces its prices below all of its competitors, thereby allowing it to gain market share.
A firm may choose the same price as competitors, which results in greater profits rather than higher market share.
Sources of Cost Advantage: Economies of Scale
Economies of Scale
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Learning and Experience Effects
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Lower Costs due to Proprietary Knowledge
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Lower Input Costs
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Different Business Model
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Summary of the sources of cost advantage. If we were going to do a logic tree and what drives cost advantage, there are these five things that I would point to as one way to organize that logic tree as to why companies have cost advantage. It’s because of economies of scale, it’s because of learning and experience effects, lower cost due to prior knowledge, lower input cost or a different business model.
One of the first things to appreciate is how you solve various different kinds of problems for a company or how you help them by understanding how to do cost analysis.
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First electronic bank (FEB) provides a store credit card to Frys electronics.
After 3 years, 25% of Frys customers have a Frys credit card but growth has slowed
Should FEB:
A) Spend more on marketing to increase penetration of the card at Frys
B) Spend money on marketing to get other store client customers to adopt a store credit card provided by FEB
What analysis would you recommend to FEB to determine what, if any, they should spend on marketing to get new customers?
Additional Mini-Case
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Q: Fry’s Electronic Bank does store credit cards for First Electronic Bank. After a number of years, 25 percent of Fry’s customer base have a Fry’s credit card, but growth is slow. So, should First Electronic Bank spend more money on marketing to increase penetration of the Fry’s card, should they spend money on marketing to get other store client customers to adopt the credit card provided by First Electronic Bank, and what analysis would you give FEB to determine what, if any, they should spend to get new customers?
A: as we think about this,
