Plainly, the chain’s makeup will vary from company to company as well as from business segment to business segment (product line, customer type, geographic area, or distribution channel). In these cases, it might be best to focus business strategy toward these areas, highlighting and pressing your advantage. In a slack market, low-cost companies are in the position to use a price-cutting strategy to protect their sales volume and preserve capacity utilization. It can also try to restructure the whole value chain by substituting its own distribution networks for dealers and franchises. XYZ’s predicament is shared by companies in many capital-intensive industries. Total revenue is going to increase as the firm sells more, depending on the price of the product and the number of units sold. The future holds even more competitive pricing threats; a potential breakthrough in the development of solar thermal equipment and photovoltaic cells by General Electric, Westinghouse, United Technologies, and several Japanese companies portends important new sources of even lower-cost energy substitutes. Cost competitive advantages can easily disappear with the introduction of a new competitor or new technology. : The MIT Press, 1983), pp. (XYZ is a name I am using to designate a composite of several companies.) The size of any first-mover advantage depends on the speed of increases in capital requirements, the extent of the industry’s need to add capacity to meet new market demand, and the potential for lower-cost substitutes to capture a lucrative share of the market. Conduct customer surveys to see why consumers chose your company. These two main types of competitive advantage determine whether your company succeeds by being a cost leader or by differentiating its … Joseph A. Pechman (Cambridge, Mass. Market orientation is a business approach that prioritizes identifying the needs and desires of consumers and creating products that satisfy them. Scanning the environment to determine a company's best and most profitable customers The spotlight in analyzing a company's resources, internal circumstances and competitiveness includes such questions/concerns as What are the company's resource strengths and weaknesses and its external opportunities and threats Increasing capital costs can push the incremental costs of fixed assets and capacity far above the historic cost of existing plant and equipment. Most companies are either founded on a competitive advantage or can apply certain criteria toward finding their competitive advantage. The capital costs for a new steel mill in the United States have escalated to about nine times the cost of the embedded technology.4 While production costs for new plants have dropped $60 per ton (because the amount of labor and energy necessary to produce a ton has dropped), the capital costs for a new mill are $130 per ton higher and push unit costs up a net $70, or 10% above the market price per ton of steel. Then, given the capacity you have, you try to produce at rates close to practical capacity in order to enhance the revenue productivity of your fixed investment. For example, the Canadian surplus of cheap hydroelectric power and New England’s 30% electricity surplus threaten the once sound economics of New Hampshire’s Seabrook nuclear project (whose original estimated price tag of $1 billion for units 1 and 2 has ballooned to $5.2 billion). The time of year can also impact how much Facebook ads are. In the electric utility industry, where fuel costs account for 40 to 60% of operating expenses, each power company has experienced a different net inflationary impact, depending on the particular mix of coal, fuel oil, natural gas, nuclear power, and hydroelectric generation. In business school, we learned that companies need to develop sustainable competitive advantages. The easier it is to replicate, the faster competition catches up. Each seller and buyer takes the price as determined. Access to natural resources that are restricted to competitors 2. December 1982, p. 56. After adjusting for greater sales volume, for example, operating costs in electric utilities rose an average of $4 billion each year between 1970 and 1981. Nearly every electric utility that is constructing nuclear power stations to meet future generating needs is being squeezed by escalating capital costs and a market place replete with generating capacity. From: Economics for Policymaking, Selected Essays of Arthur M. Okun, ed. Both Sun Oil and IBM have benefited from committing investment capital on a timely basis to strategic moves designed to yield strong cost positions vis-à-vis their competitors. Finally, you factor the implication of future inflation into your own costs and those of the competition. For the sake of simplicity, let’s consider three basic strategic postures relating to growth: building market share, defending the current market share, or giving up market share (taking a “shrink abandon” approach). To catch up, they considered investment to modernize existing facilities or to build new cost-competitive plants. Walmart has enormous economies of scale. It must also forecast future market volume accurately and target its market share objectives to coincide with a relatively lower-cost industry position. 7. A differentiation strategy based on the intangibles of image, buyer confidence, and brand recognition has a stronger chance of being successful when the costs of creating or maintaining the intangibles are not greatly affected by the forces of rising operating costs. Therefore, in a perfectly competitive market, the main problem for a profit-maximizing firm is not to determine the price of its product but to adjust its output to the market price so that profit is maximized. Furthermore, let’s focus the analysis on the extremes, where inflation drives up either operating costs or capital costs. To build value for the long term, you needed to develop distinct competencies that your competitors would not be able to imitate, and then find a way to apply them as an advantage in the markets in which you … Conduct a thorough market pricing analysis. The fixed costs, like administration, are spread over more units of production.Sometimes the company can … Many electric utility executives have begun to push the use of this approach. This can be roughly … A narrow customer base helps limit the need for capacity expansion and shields the company from the cost of escalating capital requirements. From my research and work with companies facing sharply rising capital requirements, I’ve seen the value of doing strategic cost analysis to identify ways to defend against, and sometimes escape, a competitive pricing trap. In such cases, cite the price of prior purchase and note if it was competitive or based on catalog price or other. By 1976, Japanese companies were producing a ton for $35 less than their American competitors.3. The major causes of the shift in cost competitiveness involved differing inflation rates in the prices for production inputs, but technological changes and higher Japanese labor productivity also worked against the United States. Performing a price analysis typically inv… whether a company's costs are competitive with close rivals depends on how the costs of its internally performed value chain activities compare with the costs of the internally performed value chain activities of close rivals which of the following is not an indicator of how well a company's current strategy is working The most common methods or criteria used to determine whether a price is fair and reasonable are: Price competition. Customers became so price sensitive that they cut their use of electricity and average loads from a rapid annual 6% to 8% growth rate down to a mature industry rate of 1% to 3%. 3. But the capital investment costs for such construction were so high that XYZ could expect to earn an attractive return on its investment only by selling products at prices well above the going level—prices that its rivals could continue to undercut. To understand why this is so, consider the basic definition of profit:Since a perfectly competitive firm You may find it hard to hold onto your share of the market and, more important, you probably can’t invest your way out of the cost disadvantage in the short run (because the new capital requirements are unattractively high and leave no room for a return on investment at going market prices for the product). Success comes to a company that accentuates long-term strategic positioning. This is where a value chain comes in. Because every company within an industry has a slightly different cost structure for manufacturing inputs, varied inflation rates for these inputs can open up important cost differentials between competitors. Next, you assess the long-run shifts in the cost position of your competitors relative to your own. Their risk of falling into the pricing trap is lower, and they are more secure in raising prices when short-run cost changes squeeze profits. Ashland Oil figures it will reduce raw materials costs by 20% to 25% through a $240 million upgrading of its refineries. Evaluating how well the present strategy is working B. Scanning the environment to determine a company's best and most profitable customers C. Assessing whether the company's cost structure and customer value proposition are competitive D. Evaluating whether the company is competitively stronger or weaker than key … The following graph shows the cost curves for a firm in a perfectly competitive market. And we now expect to begin realizing the productivity gains…made possible by our sizable investments.”6 The investment move allows IBM to take the offensive with its pricing strategy. Highly skilled labor 3. Exhibit II shows a simplified value chain comparison of the shifting costs and competitive advantage between U.S. and Japanese steel producers from 1956 to 1976. Companies in perfect competition are considered to be price takers, meaning that they have no scope to set prices—this is the reason why marginal profit is equal to marginal cost. A number of power companies, increasing generating capacity at capital costs three to five times higher than those for facilities brought on in the 1970s, are nervous about whether the high fixed-cost charges for these new facilities will allow them to be price competitive with other electric energy suppliers. For example, if it’s losing out because of a competitive disadvantage in the cost of purchased inputs, the company’s strategic options are to negotiate with suppliers for more favorable prices, integrate backward to gain control over material costs, use lower-priced substitute inputs, or make up the difference by initiating cost savings elsewhere in the total value chain. This hold share strategy can work under conditions of strong or weak market demand. A marketing strategy is a business's general scheme for developing a customer base for the product or service the business provides. Companies that don’t build new plants can gain a competitive advantage if they are able to use a higher percentage of existing capacity to produce the extra volume needed to maintain market share. In the next phase of strategic cost analysis, the company has to assess how rising cost pressures will affect its growth objectives and market share potential. (a) (1) The contracting officer shall obtain certified cost or pricing data only if the contracting officer concludes that none of the exceptions in 15.403-1(b) applies. In 1956, they could produce a ton of cold-rolled sheet steel for $35 less than the Japanese. XYZ was caught squarely in a competitive pricing trap. One analytical approach is to compare your own cost structure with that of your rivals to discover who has been most affected by operating cost and capital cost changes. In the first place, inflation deprives people of the opportunity to save in a form that gives them a predictable command over future consumption goods. After all, your competitive advantage is, by definition, something your competitors do not have. Companies also consider the huge research and development (R&D) costs incurred to bring a drug to market, a consideration that often leads to high prices for new drugs. Unchecked inflation can radically change the whole cost structure of an entire industry. But these risks are much less serious than those associated with general inflation. There are limits to how much more buyers will pay for a product that is fancier than its rivals’. When rising costs hit the operating-cost side of the value chain harder than the capital side, a company can still be successful in pursuing a strategy of being the low-cost producer if it can find ways to innovate around the components of operating costs most susceptible to inflation. In 1976, the price of gas fuels went up 35.2%, while that of crude petroleum increased only 8%. At IBM, top management decided that the economic impact of rising operating costs would outweigh that of escalating capital costs. Observing that all its rivals were forced to do the same, XYZ felt secure in its strategy. Though small at first, the cost disparities that emerge can over time create big shifts in cost competitiveness and competitive advantage. For example, if you want to be the low-cost producer in the market but you anticipate rising capital costs as a major problem, your company’s best bet is either to build early (if demand projections are bullish) or not to build new plants at all (if the market is mature). Avoiding pricing traps requires a strategic view of the present cost structure, of how the structure changes, and of the implications for gaining a sustainable competitive advantage. 2. Because it is committed to cost-containing retrenchment and won’t encounter capacity-induced cost increases, a company can simply sell under the price umbrella of rivals and enjoy a long “cash harvest” as competitors raise prices to compensate for the higher costs associated with capacity expansion or capacity replacement. As a result, steel companies must either refurbish their inefficient mills or close them down. By including the impact of costs both inside and outside the company, the value chain helps the manager understand the sum total of the shifting cost economies up and down the whole market spectrum. The opportunity for safe saving is lost in a period of sizable and unpredictable price increases. An aluminum producer with plant facilities in the Pacific Northwest today can manufacture more aluminum with fewer dollars than a producer in the Midwest. A company can show the makeup of costs all the way from the raw materials phase to the end price paid by the ultimate customer on a value chain (see Exhibit I).5 Strategic cost analysis cannot be restricted to one’s own internal costs because economywide inflation often affects suppliers and distribution channels. Higher margins can be expected both from having a favorable cost position and from “trading up” the use of existing capacity. 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