Economics of Strategy

Analyzing Cost and Differentiation Positions

Analyzing Cost Positions

• Two major methods– disaggregate the various cost measures– identify cost drivers

Disaggregating Costs

• by behavior

• by classes of inputs

• by activity

...by behavior

• Useful for decision-making, particularly exit and entry decisions

• Classify as fixed, variable, or semi-fixed costs

• Focus on time framework for the particular decision

…by classes of inputs

• Traditional Accounting– manufacturing expenses

• Direct material costs + direct labor costs+ indirect manufacturing costs

– non-manufacturing expenses• selling, advertising, promotion, administrative,

R&D

• Usually reported as SGA (selling and general administrative expenses)

Direct Material Costs

• costs of materials found in the final product– beer

• hops, sugar, yeast, water, bottles, caps

Direct Labor Costs

• costs of labor traceable to the physical production of the product

Indirect Manufacturing Costs

• all costs not in the above two categories– indirect labor costs– materials overhead– general factory administrative personnel– facilities and equipment costs– engineering costs

Activity-Cost Analysis

• Assign costs to activities in the value chain

• McKinsey Business System Framework– technology– product design– manufacturing– marketing– distribution– service

Cost Drivers

• those related to firm size or scope

• those related to cumulative experience

• those independent of firm size or scope or cumulative experience

• those related to the organization of transactions

Cost Drivers - firm size or scope

• economies of scale

• economies of scope

Cost Drivers - cumulative experience

• learning curves

Cost Drivers - not related to scale, scope, or cumulative experience

• input prices

• location

• economies of density

• complexity/focus

Cost Drivers - not related to scale, scope, or cumulative experience

• process efficiency

• discretionary policies

• government policies

Cost Drivers - organization of transactions

• Holdup

• Leakage of private information

• Coordination problems

• Agency Costs

Suggestions

• View the firm as a collection of activities– cost savings can come from factors affecting

the activity itself– cost savings can come from a rearrangement of

the flow or order of the activities

• Technology almost always provides opportunities for cost reductions and if it doesn't yield them it will soon be gone

Analyzing Benefit Drivers

• increase perceived benefits to consumers

• five major categories of drivers

Physical characteristics

• performance

• quality

• durability

• features

• ease-of-use

• aesthetics, color, style

Ancillary Characteristics

• service after the sale– warranty– customer service– product training– support services

Sale or Delivery Characteristics

• conditions for financing the product

• spatial location of sales facilities

• speed of delivery

• conditions of delivery

• return policies

• pre-sale product explanations

Consumer expectations/perceptions

• stability of the company

• customer loyalty

Subjective image

• psychological attachments formed by– peer groups– advertising– packaging– labeling– popularity– culture

Analyzing Benefit Drivers

• Customer Perception Map– p. 524, figure 13.5