Cost Leader

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Cost Leadership:

Any organization in order to survive in a highly competitive market should be able to achieve sustainable growth and profitability. Companies that have managed to reduce costs and understand the cost technology can obtain sustainable advantage as a cost leader.

In order for any company to become a cost leader is important that the cost technology is understood and the five constituent steps are implemented and followed by the management. The five steps towards obtaining a cost leader advantage are: (1) Distinguish between economies of scale, size and scope, (2) Increase average productivity of labour, (3) Normalize wage structure, (4) Control more of the production costs, (5) Demarcate between excess and reserve capacity. Implementing those steps can take several years (even decades) e.g Canon.

A company has achieved economies of scale when the average cost (AC) declines as output increases meaning that the marginal cost of the last unit produced must be less than the average cost. In cases that capacity is constrain then AC cost curves are U shaped and cost reduces up to the Minimum efficient scale (MES). This is indicated in FIGURE 1. On the other hand when capacity does not prove to be constrain and each facility operates efficient then average costs curves can be L shaped. Even beyond MES average costs will not raise. FIGURE 2. So it is essential that companies build up their capacity, expand their plants or build new ones.

A company has achieved economies of scope when savings are achieved as it increases the variety of products so the total cost of a company producing both products x and y is less than two companies producing products x and y or : TC(Qx,Qy) < TC(Qx,0) + TC(0,Qy).

Is essential for a company to keep variable costs constant and at the same time try to achieve economies of scope. Keeping costs constant and having economies of scope can lead a company of becoming the cost leader.

Steps 2,3,and 4 as...
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