BUSINESS LEVEL strategIES: For some industries, cost advantage is the predominant basis


For some industries, cost advantage is the predominant basis for competitive advantage — in commodities there is limited opportunity for competing on anything else. But even where competition focuses on product differentiation, intensifying competition has resulted in cost efficiency becoming a prerequisite for profitability. Some of the most dramatic examples of companies and industries being transformed through the

pursuit of cost efficiency are in sectors where competition has increased sharply due to deregulation, such as airlines, telecommunications, banking and electrical power generation.

Some scholars view the simultaneous pursuit of differentiation and low cost as a key element in the creation of ‘blue ocean’ opportunities. Common to the success of Japanese companies in consumer goods industries such as cars, motorcycles, consumer electronics and musical instruments has been the ability to reconcile low costs with high

quality and technological progressiveness.

For most goods and services, alternative process technologies exist.

A process is technically superior to another when, for each unit of output, it uses less of one input without using more of any other input.

Where a production method uses more of some inputs but less of others then cost efficiency depends on the relative prices of the inputs.

For example, the budget airlines such as AirAsia (refer to this chapter’s scene setter) implemented a different process using different inputs in comparison with traditional airlines. Their cost advantage was created by: choosing an alternative, less expensive airport (e.g. in Paris, Orly instead of Charles de Gaulle); using one type of aircraft

(modern, with low maintenance costs); flying simple routes; and using online

booking to minimise the fees to agencies.

•When in 1980 Porter first introduced the three generic strategies: cost advantage, differentiation and focus, many academics and practitioners questioned whether it was possible to use successfully both cost advantage and differentiation.

•Initially, Porter’s response was negative.

•He argued that an attempt to create advantage via low costs and differentiation would lead companies to the position of ‘stuck in the middle’ where companies achieve neither cost leadership nor differentiation.

•Differentiation adds to cost.

•If differentiation narrows a company’s segment scope, it also limits the potential for exploiting scale economies, thus limiting the opportunities for cost advantage.

•One way of reconciling differentiation with cost efficiency is to postpone differentiation to later stages of the company’s value chain.

•Economies of scale and the cost advantages of standardisation are frequently greatest in the manufacturing of basic components.

•Modular design with common components permits scale economies while maintaining considerable product variety.

•New manufacturing technologies and the internet have redefined traditional tradeoffs between efficiency and variety.

What is their secret? How is the strategy

behind such performance?

The business model of Smiggle is simple,

it is based on bright stylish stationery and storage products which not only

make a working place more organised, but also energizes their users by bringing

colour in their everyday life. The target market of Smiggle is young teenegers

who can afford its merchandise, most of which is priced at below $20. Smiggle,

acquired by Just Group, Australiasia’s most exciting fashion and appareal

retailer in 2007, became the group’s only non-clothing business but shares many

of the “affordable fast fashion” attributes of clothing stable mates,

such as Jay Jays and Dotti.

The brand with its frequently changing

range of funky products is very popular among children and young people. The

company always keeps their customers excited by continuously introducing new

products or re-introducing “old favourites” in a modern presentation. As the

Just Group managing director Jason Murray explained, the company” has that

lipstick factor of cheering you up for not very much money”.

Using the value chain to identify

opportunities for differentiation advantage involves four principal stages:


a value chain for the company and the customer. It may be useful to consider not just the

immediate customer, but also companies further downstream in the value chain.

If the company supplies different types of customers — for example, a steel

company may supply steel strip to automobile manufacturers and white goods

producers — draw separate value chains for each of the main categories of


•Identify the drivers of uniqueness in each activity. Assess the company’s potential for differentiating its product by examining each activity in the company’s value chain and identifying the variables and actions through which the company can achieve uniqueness in relation to competitors’ offerings.

•Select the most promising differentiation variables for the company. Among the numerous drivers of uniqueness that can be identified within the company, which one should be selected as the primary basis for the company’s differentiation strategy?

•Locate linkages between the value chain of the company and that of the buyer. The objective of differentiation is to yield a price premium for the company. This requires that the company’s differentiation creates value for the customer.

•There is little point in identifying the product attributes that customers value most if the company is incapable of supplying those attributes.

•Similarly, there is little purpose in identifying a company’s ability to supply certain elements of uniqueness if these are not valued by customers.

•The key to successful differentiation is matching the company’s capacity for creating differentiation to the attributes that customers value most.

•For this purpose, the value chain provides a particularly useful framework.

Successful differentiation involves

matching customers’ demand for differentiation with the company’s capacity to

supply differentiation

Analysing demand begins with understanding why customers buy a product or service.

Analysing customer demand enables an organisation to determine

which product characteristics have the potential to create value for customers,

customers’ willingness to pay for differentiation, and a company’s optimal

competitive positioning in terms of differentiation variables

The problem with analysing product

differentiation in terms of measurable performance attributes is that it does

not delve very far into customers’ underlying motivations. It is important to

analyse not only the product and its characteristics, but also customers,

their lifestyles and aspirations, and the relationship of

the product to these lifestyles and aspirations.

Indeed, the value conferred by leading

consumer brands such as Louis Vuitton, Gucci, Coca-Cola, Harley-Davidson,

Mercedes-Benz and Virgin is less a warranty of the reliability and more an

embodiment of identity and lifestyle. For these brands, advertising and

promotion have long been the primary means of influencing and reinforcing

customer perceptions. Increasingly, consumer goods companies are seeking new

approaches to brand development that focus less on product characteristics and

more on ‘brand experience’, ‘shared values’ and ‘emotional dialogue’.

Many Australian companies take serious

consideration of social and psychological factors when positioning themselves

in the market. For example, the Peters Ice Cream brand, despite a change of

ownership to the multinational corporation Nestlé, is perceived as an

Australian national company that does not exploit low-cost labour and other

resources in emergent economies. Australia’s leading grocery retailer

Woolworths positions itself as the ‘Fresh Food People’.

While a large proportion of organisations intuitively use cost advantage strategy, it

offers a less secure basis for competitive advantage than does differentiation due to many factors and trends.

The growth of international competition has revealed the fragility of seemingly well-established positions of domestic cost leadership. Cost advantage is also vulnerable to new

technology and strategic innovation.

Sustained high profitability is associated more with differentiation than cost leadership


the peculiar features and practical ways of implementing differentiation.

The potential for differentiating a product or service is partly determined by its physical characteristics.

For products that are technically simple

(a pair of socks, a brick), that satisfy uncomplicated needs (a corkscrew, a

nail), or must meet rigorous technical standards (a spark plug, a thermometer),

differentiation opportunities are constrained by technical and market factors.

Products that are technically complex (a

plane), that satisfy complex needs (a vehicle, a holiday), or that do not need

to conform to particular technical standards (wine, toys) offer much greater

scope for differentiation.

Beyond these constraints, the potential

in any product or service for differentiation is limited only by the boundaries

of the human imagination.


extends beyond the physical characteristics of the product or service to

encompass everything about the product or service that influences the value

customers derive from it.

This means that differentiation includes

every aspect of the way in which a company relates to its customers.

In analysing differentiation opportunities, we can distinguish tangible and intangible dimensions of


Tangible differentiation is concerned

with the observable characteristics of a product or service that are relevant

to customers’ preferences and choice processes.

These include size, shape, colour,

weight, design, material, and technology.

Opportunities for intangible

differentiation arise because the value that customers perceive in a product or

service does not depend exclusively on the tangible aspects of the offering.

A useful tool to analyse costs. It provides a strong basis for strategic

decision making


examples to explain the process

Every business may be viewed as a

collection of interrelated and interdependent value-creating activities and the

company or even the business unit is too big for effective analysis of cost


A value chain analysis of a company’s

cost position comprises the following stages:


the company into separate activities. Determining the appropriate value chain

activities is a matter of judgment. It requires understanding the chain of

processes involved in the transformation of inputs into output and its delivery

to the customer.


the relative importance of different activities in the total cost of the


Our analysis needs to focus on the activities that are the major sources of cost.

In disaggregating costs, Michael Porter suggests the detailed assignment of

operating costs and assets to each value activity. Though the adoption of

activity-based costing has made such cost data more available, detailed cost

allocation can be a major exercise.


costs by activity. To establish which activities the company

performs relatively efficiently and which it does not, benchmark unit costs for

each activity against those of competitors.


cost drivers. For each activity, what factors determine

the level of cost relative to other companies? For some activities, cost

drivers are evident simply from the nature of the activity and the composition

of costs.


linkages. The

costs of one activity may be determined, in part, by the way in which other

activities are performed.


opportunities for reducing costs. By identifying areas of comparative

inefficiency and the cost drivers for each, opportunities for cost reduction

become evident.

Some scholars view the simultaneous pursuit of differentiation and low cost as a key element in the creation of ‘blue ocean’ opportunities. Common to the success of Japanese companies in

consumer goods industries such as cars, motorcycles, consumer electronics and

musical instruments has been the ability to reconcile low costs with high

quality and technological progressiveness.

Whereas segmentation is a feature of

market structure, differentiation is a strategic choice by a company.

•A segmented market is one that can be partitioned according to the characteristics of customers and their demand.

•Differentiation is concerned with a company’s positioning within a market (or market segment) in relation to the product, service, and image characteristics that influence customer choice

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