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 … Only if the Government is committed to limit the rise to a creep of not much above 2 per cent can there be reasonable predictability. If the tables are turned and inflation hits operating costs unevenly while capital costs remain equal, a company can protect cost competitiveness if it: (1) innovates around troublesome operating cost components as new investments are made in plant and equipment, (2) translates the resulting cost advantage into a gain in market share, or (3) offsets any increases in operating costs that do arise with new efficiencies associated with added sales volume and higher market share. Many U.S. steel companies have seen their variable operating costs rise more quickly than those of Asian producers, and the capital costs of modernizing large, integrated mills seem prohibitive. No company can totally avoid the impact of increasing costs. Highly skilled labor 3. Sometimes the competitive advantage is only accessible through a certain target market, with a specific product or service or with a specific location. 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. The most common methods or criteria used to determine whether a price is fair and reasonable are: Price competition. To use it, a company must recast its own historical cost accounting data into the principal cost categories that eventually make up the value of its product. Increasing capital costs can push the incremental costs of fixed assets and capacity far above the historic cost of existing plant and equipment. A company's cost competitiveness is largely a function of how efficiently it manages its internally performed value chain activities and the costs in the value chains of its suppliers and forward channel allies. Observing that all its rivals were forced to do the same, XYZ felt secure in its strategy. This activity appraisal can be applied on commercial transactions, business or proposed policy, or an impending project. Of course, some companies did manage in the 1970s to avoid inflation’s trap by investing “early” in new facilities and protecting their long-run competitive position. Eventually it will enjoy lower fixed costs than competitors that add capacity later, when investment costs are higher. Because inflation affects each company in an industry differently, the first step is to diagnose your changing cost The concept of value chains is discussed and analyzed in Michael E. Porter and John R. Wells, “Strategic Cost Analysis,” unpublished working paper, Harvard Business School, 1982. 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. 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 … An airline company might have locked in a low-price fuel contract before prices rose, allowing it to price customers away from other airlines. 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). Manufacturing companies in such energy-intensive industries as pulp and paper, chemicals, and primary metals feel the competitive impact of fuel cost differences. XYZ’s profits eroded while the others’ remained buoyant. The easier it is to replicate, the faster competition catches up. Like all assets, intangible assets are those that are expected to generate economic returns for the company in the fu… Success comes to a company that accentuates long-term strategic positioning. In an industry where new fixed assets or capacity additions are expensive, a company with relatively modern facilities and adequate capacity may well find it competitively advantageous to use a focus strategy and concentrate on selected groups of buyers. Nonetheless, if your business has relatively high and rising fixed costs per unit, successful cost leadership depends on the combination—and timing—of low capital investment and productive use of fixed assets. After all, something is compelling for consumers to do business with them. Much of this can be performed through deduction and a process of elimination. To sustain the advantage, it must be able to recoup the cost suffered from temporary excess capacity when rivals finally add or replace plant and equipment at inflated costs. The key is to find cost-competitive ways to preserve the value of differentiation for the buyer and to contain customer switching by offering lower prices. In 1956, they could produce a ton of cold-rolled sheet steel for $35 less than the Japanese. Since 1975, U.S. oil companies have invested $15 billion to upgrade refineries so that they can use cheaper, more plentiful low-quality crude oil. Exhibit II Value chains for U.S. and Japanese steel companies: a comparison between 1956 and 1976. When over-all prices are rising rapidly, their exact course is bound to be unpredictable. This is where a value chain comes in. To find a lasting competitive advantage, look for something that your competitors cannot easily replicate or imitate. 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. Copyright © 2020 Harvard Business School Publishing. If we all knew that 4 per cent a year inflation would last through the next decade, nominal interest rates would probably become adjusted to levels offering a reasonable real return, and people would know how much of a consumer market basket their savings accounts could command in 1980. Higher margins can be expected both from having a favorable cost position and from “trading up” the use of existing capacity. That’s in an industry that started from a base of $20 billion in sales and $3 billion in net income. Conduct a thorough market pricing analysis. Maunders, Accounting for British Steel (Aldershot, England, Gower, 1982), p. 124. In peak shopping seasons, businesses tend to spend more on advertising. John R. Opel, IBM’s CEO, once said, “We want to be the lowest-cost producer of everything we make. When market demand is strong, the company can go along with the price increases that more growth-minded companies need to cover the incremental unit costs associated with new investments in plant and equipment. Some restaurants thrive because of their location. To catch up, they considered investment to modernize existing facilities or to build new cost-competitive plants. View Test Prep - Ch 4 quiz from MGT 590 at RMU. 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. December 1982, p. 56. A marketing strategy is a business's general scheme for developing a customer base for the product or service the business provides. By 1976, Japanese companies were producing a ton for $35 less than their American competitors.3. 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. < Previous Question 1 Next > Two useful tools for determining whether a company's customer value proposition. When Southland first bought sites in the 1960s, few other companies were competing for the kind of location it needed. 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 A narrow customer base helps limit the need for capacity expansion and shields the company from the cost of escalating capital requirements. To add insult to injury, XYZ’s rivals no longer went along with industrywide price increases; even when such hikes became timely, the other companies raised their prices by a smaller percentage than XYZ or delayed them altogether. It's impossible to determine whether lowering costs or increasing revenue is more important across the board for all companies. Interestingly enough, a company with a long-term shrink-abandon strategy may be able to benefit handsomely from sharply rising costs for new plants and equipment. 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. If you increase the number of units sold at a given price, then total revenue will increase. 3. A unique geographic location 4. ABC assigns job costs based on the actual use of resources, enabling firms to price their products appropriately, determine in which markets they can compete effectively, make better capital allocation decisions, and calculate the incremental costs associated with potential courses of action. After all, your competitive advantage is, by definition, something your competitors do not have. In countering these strategies, the Sun Company decided not to upgrade its Pennsylvania refinery and gambled that the industry’s shift to low-quality crude would leave Sun ample access to high-quality crude and that the price difference between high-quality crude and low-quality crude would not average the $6 to $7 per barrel that the other companies had used to justify their investments. Economies of scale are cost reductions that occur when companies increase production. Such a move may produce a durable competitive edge, especially if it catches competitors by surprise. 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. Season. Virginia Electric and Power Company, for example, will mothball a nuclear power plant, despite a $540 million initial investment, because the estimated final price tag has risen from $1.2 billion to $5.1 billion. Each seller and buyer takes the price as determined. More significant, however, is how the phenomenon of rising costs can, over time, produce strategically relevant shifts in a company’s cost structure and cost competitiveness. To illustrate the strategic payoff of constructing a value chain, look again at Exhibit I. XYZ couldn’t count on price hikes to cover its still slowly rising costs because its volume-conscious rivals were aggressively using price as a weapon to gain market share. 6. Making these kinds of investments “early” can mean major savings in capital costs; Standard Oil of California, which spent $1.3 billion to upgrade its Pascagoula, Mississippi refinery in 1981 and 1982, has estimated that the same improvement would have cost $2 billion in 1983. Once a secure geographic monopoly—and essentially a commodity business—the electric utility industry is now in the throes of price warfare in the wholesale and bulk power market segments, with low-cost producers in a position to take business away from higher-cost suppliers. The increased demand for ad space results in a competitive marketplace, which can lead to aggressive bids and bigger campaign budgets that inflate the cost of advertising … Cost realism analysis Cost examination Price realism analysis Cost analysis 6) If an offeror is expected to be exempted from submitting cost or pricing data, you should: [Determine whether to use price analysis or cost analysis to evaluate the … (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. XYZ was caught squarely in a competitive pricing trap. The LCOE can also be regarded as the minimum constant price at which electricity must be sold in order to break even over the lifetime of the project. Robert W. Crandall, The U.S. Steel Industry in Recurrent Crisis (Washington, D.C. If the inflationary combination results in a company expecting higher relative capital costs but lower operating costs and if its industry has good growth prospects and a mature technology, then there is a potential first-mover advantage from adding new capacity early. There are some constraints on this strategy. Brignall, and A.R. 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. 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. Price patterns across fuel types have varied widely from fuel source to fuel source and from year to year. It is likely, of course, that a substantial portion of any cost disadvantage a company has lies within its own in-house cost structure. The success of differentiation strategies in an environment of rapidly rising operating costs varies according to the basis for differentiation. Either way, you lock into a low-cost position with fewer dollars of fixed asset investment. You will have to adjust if, while pushing capacity to the limit, you find operating costs beginning to creep up. Most companies are either founded on a competitive advantage or can apply certain criteria toward finding their competitive advantage. The investment is expected to pay a good return through the use of lower-cost crude oil and improved refining technology to increase the yields of higher-margin products. 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