Chapter 04
Building Competitive Advantage
Through Functional-Level Strategy
Building Competitive Advantage
Through Functional-Level Strategy
functional-level strategies aimed at improving the
effectiveness of a company’s operations and,
gain ability to attain superior efficiency, quality,
innovation, and customer responsiveness.
Achieving Superior Efficiency
A company is a device for transforming inputs
(labor, land, capital, management, and
technological know-how) into outputs (the
goods and services produced). The simplest
measure of efficiency is the quantity of inputs
that it takes to produce a given output; that is,
efficiency = outputs/inputs. The more
efficient a company is, the fewer the inputs
required to produce a given output and the
lower its cost structure will be. Put another
way, an efficient
company has higher productivity, and
therefore lower costs, than its rivals.
Steps that companies can take at the
functional level to increase their
efficiency and thereby lower their cost
structures.
✓Efficiency and Economies of Scale
✓Efficiency and Learning Effects
✓Efficiency and the Experience Curve
✓Efficiency, Flexible Production Systems,
and Mass Customization
✓Marketing and Efficiency
Economies of scale are unit cost reductions
associated with a large scale of output. One
source of economies of scale is the ability to
extend fixed costs over a large production
volume.
For example, Microsoft spent approximately $5
billion to developed its Windows operating
system, Windows Vista. large scale economies by
spreading the fixed costs associated with
developing the new operating system over the
huge unit sales volume it expects for this system
(95% of the world’s 250 million personal
computers use Microsoft operating systems).
These scale economies are significant because
of the small incremental (or marginal) cost of
producing additional copies of Windows Vista.
Once the master copy has been produced,
additional CDs containing the operating
system can be produced for a few cents. The
key to Microsoft’s efficiency and profitability is
to increase sales rapidly enough that fixed
costs can be spread out over a large unit
volume so that substantial scale economies
can be realized.
Another source of scale economies is
the ability of companies producing
in large volumes to achieve a
greater division of labor and
specialization. Specialization is said
to have a favorable impact on
productivity, mainly because it
enables employees to become very
skilled at performing particular
tasks.
Example of Ford’s Model T car. The world’s first
mass-produced car, the Model T Ford, was
introduced in 1923. Until then, Ford had made
cars using an expensive hand-built craft
production method. By introducing mass
production techniques, the company achieved
greater division of labor and specialization, which
increased employee productivity. Ford was also
able to increase the fixed costs of developing a car
and setting up
production
machinery over a
large volume of
output. As a
result of these
economies, the
cost of
manufacturing a
car at Ford fell
from $3,000 to
less than $900 .
Figure which shows
that as a company
increases its output,
unit costs fall. This
process comes to an
end at an output of
Q1, where all scale
economies are
exhausted. Indeed, at
outputs of greater than
Q1, the company may
meet diseconomies of
scale, which are the
unit cost increases
associated with a large
scale of output.
Diseconomies of scale occur primarily
because of the increasing bureaucracy
associated with large-scale enterprises
and the managerial inefficiencies that
can result. Managers must know not
only the degree of economies of scale
but also where diseconomies of scale
begin to occur
Efficiency and Learning Effects: Learning
effects are cost savings that come from
learning by doing. Labor, for example,
learns by repetition how best to carry out
a task. Therefore, labor productivity
increases over time, and unit costs fall as
individuals learn the most efficient way to
perform a particular task. Japanese
companies like Toyota are noted for
making learning a central part of their
operating philosophy.
Learning effects tend to be more
significant when a technologically
complex task is repeated because there
is more to learn.
Although learning effects are normally
associated with the manufacturing
process, there is every reason to
believe that they are just as important
in service industries.
Strong evidence of learning effects in a
financial institution. The study looked at a
newly established document-processing
unit with 100 staff members and found
that, over time, documents were processed
much more rapidly as the staff learned the
process. Overall, the study concluded that
unit costs cut down every time the
cumulative number of documents
processed doubled.
In terms of the unit cost
curve of a company,
although economies of scale
involve a
movement along the curve
(say, from A to B in Figure),
the realization of learning
effects implies a downward
shift of the entire curve (B
to C in Figure ) as both labor
and management become
more efficient over time at
performing their tasks at
every level of output.
Efficiency and the Experience Curve The
experience curve refers to the systematic
lowering of the cost structure, and
consequent unit cost reductions, that have
been observed to occur over the life of a
product. According to the experience -
curve concept, unit manufacturing costs
for a product typically decline by some
characteristic amount each time
accumulated output of the product is
doubled.
This relationship was first observed in the
aircraft industry, in which it was found
that each time the accumulated output
of airframes was doubled, unit costs
declined to 80% of their previous level.
Thus, the fourth airframe typically cost
only 80% of the second airframe to
produce; the 8th airframe only 80% of
the 4th; the 16th
only 80% of the
8th; and so on.
increasing a company’s product
volume and market share will
lower its cost structure relative to
its rivals.
Thus, company B farther down
the experience curve, has a cost
advantage over company A
because of its lower cost
structure. The concept is very
important in industries that mass-
produce a standardized output
(semiconductor chips). A company
that wishes to become more efficient and lower its cost structure
must try to ride down the experience curve as quickly as possible.
Efficiency, Flexible Production Systems, and
Mass Customization central to the
concept of economies of scale is the idea
that the best way to achieve high
efficiency and a lower cost structure is
through the mass production of a
standardized output.
The way to increase
efficiency and
achieve a lower
cost structure is
to limit product
variety and
produce a
standardized
product in large
volumes.
This view of production
efficiency has been
challenged by the rise of
flexible production
technologies. Flexible
production technologies
allow the company to
produce a wider variety
of end products at a unit
cost that at one time
could be achieved only
through the mass
production of a
standardized output
The effects of installing flexible production
technology on a company’s cost structure can be
dramatic.
Ford is currently introducing flexible production
technologies into its automotive plants around the
world. These new technologies should allow Ford
to produce multiple models from the same line
and to switch production from one model to
another much more quickly than in the past. In
total, Ford hopes to take $2 billion out of its cost
structure with in 4 years through flexible
manufacturing.
Marketing and Efficiency
The marketing strategy that a company adopts can
have a major impact on efficiency and cost
structure. Marketing strategy refers to the
position that a company takes with regard to
pricing, promotion, advertising, product design,
and distribution. example, riding down the
experience curve to achieve a lower cost
structure can be facilitated by aggressive pricing,
promotions, and
advertising, all of
which are the task of
the marketing
function.
If a company can
reduce customer
defection rates, it
can make a much
better return on its
investment in
acquiring customers and thereby increase
its profitability.
Another economic benefit of long-time customer
loyalty is the free advertising that customers
provide for a company. Loyal customers can
dramatically increase the volume of business
through referrals. Britain’s largest retailer, the
clothing and food company Marks & Spencer,
whose success is built on a well earned
reputation for providing its customers with
highquality goods at reasonable prices. The
company has generated such customer loyalty
that it does not need to advertise in Britain, a
major source of cost saving.
• Strategy in Action 4.1 looks at the
determinants of differences in learning effects
across a sample of hospitals performing
cardiac surgery.
• For an extended example of the benefits of
mass customization, see Strategy in Action 4.2,
which looks at mass customization at Lands’
End.
Materials Management, Just-in-Time,
and Efficiency
The contribution of materials management (logistics)
in boosting the efficiency of a company can be just
as dramatic as the contribution of production and
marketing.
just-in-time (JIT) inventory system is designed to
economize on inventory holding costs by having
components arrive at a manufacturing plant just in
time to enter the production process or to have
goods arrive at a retail store only when stock is
almost used up.
JIT inventory systems reduce the need for
working capital (because there is less
inventory to finance) and fixed capital to
finance storage space (because there is
less to store). This reduces capital
needs, increases capital turnover, and,
by extension, boosts the return on
invested capital. The drawback of JIT
systems is that they deny companies
buffer stocks of inventory.
R&D Strategy and Efficiency
The role of superior R&D in helping a company
achieve a greater efficiency and a lower cost
structure is double. First, the R&D function
can increase efficiency by designing products
that are easy to manufacture. By cutting
down on the number of parts that make up a
product, R&D can dramatically decrease the
required assembly time, which translates into
higher employee productivity, lower costs,
and higher profitability.
The second way in which the R&D
function can help a company achieve
a lower cost structure is by pioneering
process innovations. A process
innovation is an innovation in the way
production processes operate that
improves their efficiency
Human Resource Strategy and Efficiency
Employee productivity is one of the key
determinants of an enterprise’s efficiency,
cost structure, and profitability. The
challenge for a company’s human resource
function is to devise ways to increase
employee productivity. Among the choices it
has are using certain hiring strategies,
training employees, organizing the workforce
into self-managing teams, and linking pay to
performance.
Information Systems and Efficiency
With the rapid extend of computers, the explosive
growth of the Internet and corporate intranets
(internal corporate computer networks based
on Internet standards), and the spread of
highbandwidth fiber optics and digital wireless
technology, the information systems function is
moving to center stage in the mission for
operating efficiencies and a lower cost structure.
The impact of information systems on
productivity is wide ranging and potentially
affects all other activities of a company.
Infrastructure and Efficiency
A company’s infrastructure—that is, its
structure, culture, style of strategic
leadership, and control system—
determines the context within which all
other value creation activities take
place. Improving infrastructure can help
a company increase efficiency and lower
its cost structure.
Achieving Superior Quality
Quality can be thought of in terms of two
dimensions: quality as reliability and
quality as excellence. High-quality
products are reliable. Superior quality
gives a company two advantages. First, a
strong reputation for quality allows a
company to differentiate its products
from those offered by rivals and charge
premium price for its products.
Achieving Superior Quality
Second, eliminating defects or errors from
the production process reduces waste,
increases efficiency, and lowers the cost
structure of a company and increases its
profitability.
Attaining Superior Reliability
The principal tool that most managers
now use to increase the reliability of
their product offering is the Six Sigma
quality-improvement methodology. The
Six Sigma methodology is a direct
successor of the TQM philosophy that
was widely adopted,
first by Japanese companies and then by
American companies, during the 1980s
and early 1990s. The TQM concept was
developed by a number of American
management consultants, including W.
Edwards Deming, Joseph Juran, and A.
V. Feigenbaum.
The philosophy underlying TQM, as
articulated by Deming, is based on the
following five-step chain reaction:
1. Improved quality means that costs
decrease because of less rework, fewer
mistakes, fewer delays, and better use
of time and materials.
2. As a result, productivity improves.
3. Better quality leads to higher market
share and allows the company to raise
prices.
4. This increases the company’s
profitability and allows it to stay in
business.
5. Thus the company creates more jobs.
Deming identified a number of steps that
should be part of any quality
improvement program: A company
should have a clear business model to
specify where it is going and how it is
going to get there.
[Link] should hold the
philosophy that mistakes, defects, and
poor quality materials are not acceptable
and should be eliminated.
[Link] of supervision should be
improved by allowing more time for
supervisors to work with employees and
giving them appropriate skills for the job.
[Link] should create an
environment in which employees will not
fear reporting problems or
recommending improvements.
4. Work standards should not only be
defined as numbers or quotas but also
include some notion of quality to
promote the production of defect-free
output.
5. Management is responsible for training
employees in new skills to keep pace with
changes in the workplace.
6. Achieving better quality requires the
commitment of everyone in the company.
• Strategy in Action 4.3 describes one of the
most successful implementations of a
qualityimprovement process, GE’s Six Sigma
program.
Implementing Reliability Improvement
Methodologies
First, it is important that senior managers
buy into a quality-improvement program
and communicate its importance to the
organization.
Second, if a quality improvement program
is to be successful, individuals must be
identified to lead the program. Third,
quality-improvement methodologies
address the need to identify defects that
arise from processes, copy them to their
source, find out what caused them, and
make corrections so that they do not
return.
Fourth, another key to any
qualityimprovement program is to
create a metric that can be used to
measure quality.
Fifth, once a metric has been develop,
the next step is to set a challenging
quality goal and create incentives for
reaching it.
Sixth, shop floor employees can be a
major source of ideas for improving
product quality, so their
participation needed into a quality-
improvement program. Seventh, a
major source of poorquality finished
goods is poorquality component
parts
Eighth, the more assembly steps a
product requires, the more
opportunities there are for making
mistakes.
Finally, implementing qualityimprovement
methodologies requires organization
wide commitment and substantial
cooperation among functions.
Improving Quality as Excellence
Products can also be differentiated by
attributes that collectively define
product excellence. These attributes
include the form, features,
performance, durability, and styling of a
product.
Achieving a perception of high quality on any of
these attributes requires specific actions by
managers.
• First, it is important for managers to collect
marketing intelligence indicating which of these
attributes are most important to customers.
• Second, once the company has identified the
attributes that are important to customers, it
needs to design its products, and the associated
services, so that those attributes are alive in the
product, and it needs to make sure that personnel
in the company are appropriately trained so that
the correct attributes are emphasized.
• Third, the company must decide which of
the significant attributes to promote and
how best to position them in the minds of
consumers, that is, how to adapt the
marketing message so that it creates a
consistent image in the minds of customers.
• Finally, it must be recognized that
competition does not stand still, but instead
produces continual improvement in product
attributes and often the development of
new-product attributes.
Achieving Superior Innovation
The ability to develop innovative new products or
processes gives a company a major competitive
advantage that allows it to
(1)differentiate its products and charge a
premium price, and/or
(2)lower its cost structure below that of its rivals.
• Strategy in Action 4.4 looks at how Corning
learned from a prior mistake to develop a
potentially promising new product.
Achieving Superior Responsiveness
to Customers
Achieving superior responsiveness to
customers means giving customers
value for money. Steps taken to
improve the efficiency of a
company’s production process and
the quality of its products should be
consistent with this aim.
Focusing on the Customer
Demonstrating leadership, shaping employee
attitudes, and using mechanisms for bringing
customers into the company.
Example (Demonstrating leadership): Tom
Monaghan, the founder of Domino’s Pizza,
stayed close to the customers by visiting as
many stores as possible every week, running
some deliveries himself, insisting that other top
managers do the same, and eating Domino’s
pizza regularly
Thank You