Cost AdvantageThe Experience CurveExamples of Experience CurvesThe Importance of Market ShareDrivers of Cost AdvantageEconomies of Scale: The Long-Run Cost Curve for a PlantThe Costs Developing New Car Models (including plant tooling)Scale Economies in Advertising: U.S. Soft DrinksCost Advantage in Short-Haul Passenger Air TransportKey Stages in Applying the Value Chain to Cost Analysis: The Case of Automobile ManufactureApplying the Value Chain to Cost Analysis (continued)Slide 12Dynamic vs. Static Approaches to ManufacturingRecent Approaches to Cost ReductionCost AdvantageCost 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 managing costsOUTLINEThe Experience CurveThe Experience CurveThe “Law of Experience”The unit cost value added to a standard product declines by a constant % (typically 20-30%) each time cumulative output doubles.Cost per unit of output (in real $)Cumulative Output1992199419961998200020022004Examples of Experience CurvesExamples of Experience Curves100K 200K 500K 1,000K 5 10 50 Accumulated unit production Accumulated units(millions) (millions) 1960 Yen15K 20K 30KPrice Index50 100 200 30070% slope75%Japanese clocks & watches, 1962-72 UK refrigerators, 1957-71The Importance of Market ShareThe Importance of Market ShareIf all firms in an industry have the same experience curve, then:Change in relative costs over time = f (relative market share)This supported by PIMS data:BUT: - Association does not imply causation- Costs of acquiring market share offset the returns to market shareROS (%)-2 0 5 100-10 10-20 20-30 30-40 over 40Market Share (%)Drivers of Cost AdvantageDrivers of Cost AdvantagePRODUCTION TECHNIQUESPRODUCT DESIGNINPUT COSTSCAPACITY UTILIZATIONRESIDUAL EFFICIENCYECONOMIES OF LEARNINGECONOMIES OF SCALE• Organizational slack; Motivation & culture; Managerial efficiency• Ratio of fixed to variable costs• Speed of capacity adjustment• Location advantages• Ownership of low-cost inputs • Non-union labor• Bargaining power• Standardizing designs & components• Design for manufacture• Process innovation• Reengineering business processes• Increased dexterity• Improved organizational routines• Indivisibli\ties• Specialization and division of laborEconomies of Scale: The Long-Run Cost Curve for a PlantEconomies of Scale: The Long-Run Cost Curve for a PlantUnits of outputper periodMinimumEfficientPlant SizeCost perunit ofoutputSources of scale economies:- technical input/output relationships- indivisibilities- specializationThe Costs Developing New Car Models (including plant tooling)The Costs Developing New Car Models (including plant tooling) $ billionFord Mondeo/ Contour 6GM Saturn 5Ford Taurus (1996 model) 2.8Ford Escort (new model 1996) 2Renault Clio (1999 model) 1.3Chrysler Neon 1.3Honda Accord (1997 model) 0.6BMW Mini 0.5Rolls Royce Phantom (2003 model) 0.310 20 50 100 200 500 1,000 Annual sales volume (millions of cases)Advertising Expenditure ($ per case)0.02 0.05 0.10 0.15 0.20CokePepsiSeven UpDr. PepperSpriteDiet PepsiTabFrescaDiet RiteDiet 7-UpSchweppesSF Dr. PepperDespite the massive advertising budgets of brand leaders Coke and Pepsi, smaller brands which incur the highest advertising costs per unit of salesScale Economies in Advertising: U.S. Soft DrinksScale Economies in Advertising: U.S. Soft DrinksCost Advantage in Short-Haul Passenger Air TransportCost Advantage in Short-Haul Passenger Air TransportCosts per Available Seat-Mile (1993)Southwest Airlines United Airlines (cents) (cents)Wages and benefits 2.4 3.5Fuel and oil 1.1 1.1Aircraft ownership 0.7 0.8Aircraft maintenance 0.6 0.3Commissions on ticket sales 0.5 1.0Advertising 0.2 0.2Food and beverage 0.0 0.5Other 1.7 3.1Total 7.2 10.5Key Stages in Applying the Value Chain to Cost Analysis: The Case of Automobile ManufactureKey Stages in Applying the Value Chain to Cost Analysis: The Case of Automobile ManufactureSTAGE 1. IDENTIFY THE PRINCIPLE ACTIVITIESSTAGE 2. ALLOCATE TOTAL COSTSPURCH-ASINGPARTSINVEN-TORIESR&DDESIGNENGNRNGCOMPONENTMFRASSEMBLYTESTING,QUALITYCONTROLGOODSINVEN-TORIES SALES & MKITGDISTRI-BUTIONDEALER &CUSTOMERSUPPORTApplying the Value Chain to Cost Analysis (continued)Applying the Value Chain to Cost Analysis (continued)PURCH-ASINGPARTSINVEN-TORIESR&DDESIGNENGNRNGCOMPONENTMFRASSEMBLYTESTING,QUALITYCONTROLGOODSINVEN-TORIESSALES&MKITGDISTRI-BUTIONDEALER &CUSTOMERSUPPORT --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 -- Capacity utilization under warrantyPrices 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’--Purchases per --No. & frequency of new -- Degree of automation willingness to wait supplier models -- Sales / model -- Bargaining power -- Wage levels-- Supplier location -- Capacity utilization STAGE 3. IDENTIFY COST DRIVERSApplying the Value Chain to Cost Analysis (continued)Applying the Value Chain to Cost Analysis (continued) PRCHSNG PARTS R&D COMPONENT ASSMBY TESTING GOODS SALES DSTRBTN DLR INVNTRS DESIGN MFR QUALITY INV MKTG CTMR Consolidation of orders to increasediscounts, increases inventoriesDesigning different models aroundcommon components and platformsreduces manufacturing costsHigher quality parts and materialsreduces costs of defectsat later stagesHigher quality in manufacturingreduces warranty costsSTAGE 5. RECCOMENDATIONS FOR COST REDUCTIONSTAGE 4. IDENTIFY LINKAGESDynamic vs. Static Approaches to ManufacturingDynamic 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