Sustainability of Cost Advantage

Cost advantage will result in above-average performance only if the firm can sustain it. Improving relative cost position in unsustainable ways may allow a firm to maintain cost parity or proximity, but a firm attempting to achieve cost leadership strategy must also develop sustainable sources of cost advantage.

Cost advantage is sustainable if there are entry or mobility barriers that prevent competitors from imitating its sources. Sustainability varies for different cost drivers and from one industry to another. Some drivers, however, tend to be more sustainable than others:

  •  Scale. Scale is a key entry/mobility barrier, and the cost of replicating scale is often high because competitors must buy share.
  •  Interrelationships. Interrelationships with sister business units can force a competitor to diversify in order to match a cost advantage. If there are entry barriers into the related industries, sustainability can be high.
  •  Linkages. Linkages are often difficult for a firm to detect and require coordination across organizational lines or with independent suppliers and channels.
  • Proprietary learning. Learning is difficult to achieve in practice; it can also be hard for competitors to catch up if learning can be kept proprietary.
  • Policy choices to create proprietary product or process technology. Replicating product innovations or new production processes often poses great difficulties for competitors if innovations are protected by patents or secrecy. Process innovations are often more sustainable than product innovations because secrecy is easier to maintain.

Timing and integration can also be sources of sustainable cost advantage because they are often hard to replicate. However, their sustainability will be greatest in instances where they also translate into scale or learning advantages. Location, the pattern of capacity utilization, institutional factors, and policy choices can be sources of sustainable cost advantage in some industries, although they tend to create less sustainable cost advantage on average than other drivers. Even sources of cost advantage that are less sustainable, however, can provide formidable barriers if they interact with more sustainable drivers or with each other. Policy choices that elevate scale economies can be difficult to imitate, for example.

Sustainability stems not only from the sources of the cost advantage, but also from their number. Cost advantage derived from one or two value activities provides an alluring target for imitation by competitors. Cost leaders usually accumulate cost advantages gained from numerous sources in the value chain that interact and reinforce each other. This makes it difficult and expensive for competitors to replicate their cost position.

Gallo provides a good example of a sustainable cost leadership strategy based on these principles. Gallo’s value chain, shown in simplified form in Figure 3-3, contains numerous sources of cost advantage in many value activities. The Gallo cost advantage draws heavily on scale and proprietary technology, two of the most sustainable cost drivers. Gallo has consistently achieved a 15 percent or greater cost advantage over its major rivals. Gallo’s strength encouraged Coca- Cola’s exit from the wine industry, because Gallo’s cost advantage dampened Coke’s profitability.

The creation of a new or reconfigured value chain is a final source of sustainability in cost advantage. Competitors almost inevitably face a high cost of matching a reconfigured chain. This is particularly true for well-established competitors, who face significant mobility barriers in moving away from the industry’s traditional value chain. Iowa Beef and Federal Express, for example, have both enjoyed enduring advantages while competitors struggled to respond. Japanese aluminum producers would gain a similarly durable cost advantage in aluminum smelting if carbothermic reduction proves a success.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.

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