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 is a key entry/m obility barrier, and the cost of replicating scale is often high because competitors must  buy share.
  • 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 are often difficult for a firm to detect and require coordination across organizational lines or with inde­ pendent suppliers and channels.
  • Proprietary 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 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 advan­ tage, 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 simpli­ fied 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 m ajor 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 endur­ ing advantages while competitors struggled to respond. Japanese alumi­ num producers would gain a similarly durable cost advantage in alumi­ num 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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