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Cost Advantage. Economies of experience curve and the benefits of market share Sources of cost advantage Using the value chain to analyze costs C urrent approaches to c ost efficiency. OUTLINE. Figure 8.1. The Experience Curve. 1988. 1990. Cost per unit of output (in real $). 1992.

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Cost advantage l.jpg
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


Figure 8 1 the experience curve l.jpg
Figure 8.1. The Experience Curve

1988

1990

Cost per unit of output (in real $)

1992

1994

1996

1998

2000

Cumulative Output


The experience curve l.jpg
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


Examples of experience curves l.jpg
Examples of Experience Curves

Japanese clocks & watches, 1962-72

UK refrigerators, 1957-71

1960 Yen

15K 20K 30K

Price Index

50 100 200 300

75%

70% slope

100K 200K 500K 1,000K 5 10 50

Accumulated unit production Accumulated units

(millions) (millions)


The importance of market share l.jpg
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 (%)

-2 0 5 10

0-10 10-20 20-30 30-40 over 40

Market Share (%)

BUT: - Association does not imply causation

- Costs of acquiring market share tend to offset the returns to market share


Drivers of cost advantage l.jpg
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


Economies of scale the long run cost curve for a plant l.jpg
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


The costs of product development new autos of the 1990s l.jpg
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


Scale economies in advertising u s soft drinks l.jpg
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

Diet Rite

Advertising Expenditure ($ per case)

0.02 0.05 0.10 0.15 0.20

Fresca

Seven up

Dr. Pepper

Sprite

Pepsi

Coke

10 20 50 100 200 500 1,000

Annual sales volume (millions of cases)


Cost advantage in short haul passenger air transport l.jpg
Cost Advantage in Short-Haul Passenger Air Transport

Costs per Available Seat-Mile (1993)

Southwest Airlines United Airlines

(cents) (cents)

Wages and benefits 2.4 3.5

Fuel and oil 1.1 1.1

Aircraft ownership 0.7 0.8

Aircraft maintenance 0.6 0.3

Commisions on ticket sales 0.5 1.0

Advertising 0.2 0.2

Food and beverage 0.0 0.5

Other 1.7 3.1

Total 7.2 10.5


Key stages in applying the value chain to cost analysis the case of automobile manufacture l.jpg
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


Applying the value chain to cost analysis continued l.jpg
Applying the Value Chain to Cost Analysis (continued) Case of Automobile Manufacture

--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 predictabilityof sales

-- Order size R&D/design -- No. of models perplant --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


Applying the value chain to cost analysis continued13 l.jpg
Applying the Value Chain to Cost Analysis (continued) Case of Automobile Manufacture

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


Dynamic vs static approaches to manufacturing l.jpg
Dynamic vs. Static Approaches to Manufacturing Case of Automobile Manufacture

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

DYNAMIC

STATIC

PRODUCTION

SYSTEM

MANAGEMENT

OF

TECHNOLOGY


Recent approaches to cost reduction l.jpg
Recent Approaches to Cost Reduction Case of Automobile Manufacture

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


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