Another strategic option is to try to shift more of the basis for differentiation to aspects of product performance that can be added by investments in technology and fixed assets. In turn, average costs rise sharply as new capital investments are made and cause a squeeze on profit margins and a need to raise selling prices. 1. 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. In such cases, cite the price of prior purchase and note if it was competitive or based on catalog price or other. Joseph A. Pechman (Cambridge, Mass. Either way, you lock into a low-cost position with fewer dollars of fixed asset investment. 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. 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. Exhibit II Value chains for U.S. and Japanese steel companies: a comparison between 1956 and 1976. 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). Highly skilled labor 3. During years of chronic inflation, the managers of XYZ Corporation developed the habit of raising prices to cover rising costs and defend profit margins. Here the strategy options are more complex. The Brookings Institution, 1981), p. 173. As a result, steel companies must either refurbish their inefficient mills or close them down. By narrowing the product line, the company can allocate expensive production capacity to its most attractive items and market segments. The goal is to be the very best in your field. After all, something is compelling for consumers to do business with them. Competitive advantages can be found almost anywhere. A perfectly competitive firm can sell as large a quantity as it wishes, as long as it accepts the prevailing market price. 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. To be sure, they can never get a guarantee of future tuition costs, or the prospective price tag on their retirement home, or charges for large medical needs. 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 You will have to adjust if, while pushing capacity to the limit, you find operating costs beginning to creep up. 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. 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. Each seller and buyer takes the price as determined. In 1976, the price of gas fuels went up 35.2%, while that of crude petroleum increased only 8%. 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. 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. 3, 12–13; © 1970 by New York University Press. This activity appraisal can be applied on commercial transactions, business or proposed policy, or an impending project. Rising capital costs will hit your company hard if you rely on a differentiation strategy to win market share. It is likely, of course, that a substantial portion of any cost disadvantage a company has lies within its own in-house cost structure. In business school, we learned that companies need to develop sustainable competitive advantages. 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. Next, you assess the long-run shifts in the cost position of your competitors relative to your own. Many electric utility executives have begun to push the use of this approach. 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. Furthermore, suppose that all the firms in this industry are identical and that a representative firm’s total cost is: TC = 100 + 5q + q2 Some restaurants thrive because of their location. Despite the tediousness of this job, the value chain pays off by exposing the cost competitiveness of your position and the attendant strategic alternatives. Higher margins can be expected both from having a favorable cost position and from “trading up” the use of existing capacity. 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. In the North American pulp and paper industry, a $100 per ton production cost difference exists between higher-cost new facilities and less costly, fully depreciated mills.1. 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