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