Cost Advantage Process - Essay Example

Productivity provides opportunities - from a complex machine center operation to even routine tasks like collecting stores or selecting a channel for distribution. It is one of the drivers behind the success of suggestion-box schemes, where employees with hands-on experience are rewarded for suggestions for improving efficiency.

Capacity utilization:
Resources of a firm in the form of different assets like men, machinery, money, etc. are put to different levels of utilization. It is possible to improve the levels and achieve a better balance to reduce fixed/variable costs per unit, with better volumes.

Linkages:

This explains the interrelationship between activities both within and without a firm. At the broadest level, the critical path method (CPM) or project evaluation and review techniques (PERT) can be seen as the typical study of linkages in project planning operations. The idea is to see that wastage and inefficiency are eliminated in completing different tasks that have dependencies. The Japanese inventory control system, just-in-time (JIT), is typical of the examples of deriving cost efficiencies of input supplies, a process in which even suppliers’ value activities are studied and improved upon to create a win-win situation for both.

Interrelationships:
This is the process of identifying the interrelationship of activities of the different units of a firm, which are amenable to improved efficiencies e.g., administration, recruitment/training, or purchases.
Integration:
Popularly called backward and forward integration processes, this identifies activities upstream or downstream of the current operations to locate opportunities for integration that would result in cost efficiencies/value addition or both. For example, a steel rerolling unit may examine setting up facilities for steel melting (backward) or end-product fabrication (forward).

Timing:

First-mover or late-mover advantages/disadvantages play a role in operational costs. First-movers gain brand advantage and enjoy premium prices but may be tied up with expensive/obsolete machinery or methods over time; Late-movers learn from the mistakes of early-movers, and employ more modern and efficient machines but have to fight entrenched players to gain market share. Also, market conditions and seasonal factors influence operations and underscore the importance of timing.
Finally, a firm’s discretionary policies as per its objectives and goals, and institutional factors of agencies like the local/state/national governments and creditors, drive the cost advantage of a firm. Porter’s analysis also emphasizes the interplay of the different cost drivers and searches for scope for improved efficiencies, going beyond the conventional cost accounting method. In other words, for gaining cost advantage, it is less important to know ‘how much’ an activity costs than ‘why so much’.

2. Analyzing and deciding on steps

The competitor enjoys an average price premium of 0.6% and lower costs of 0.5% on account of maintenance and scrap, resulting in a net higher pre-tax margin of 5.1%, compared to my 4%. These cost benefits accrue to him due to the modern machinery employed by him. Since replacing my 30-year-old machinery or charging higher prices is ruled out, I have to look for alternative ways to generate more revenue to improve my returns. Thus, I have to work to gain more market share by emphasizing my lower prices and promoting superior value for money to customers. At the same time, I must improve volumes and reduce scrap generation to generate more output. Securing higher sales by utilizing existing resources more cost-effectively and efficiently would result in improved margins.

The first step in the process is to analyze if the capacity utilization of machinery is at optimum levels. If not, verify whether this was due to mechanical wear and tear, faulty production planning, insufficiently trained workmen, or a combination of all.

My machinery is decades-old but very usable, depreciation costs are negligible and I must cash in on this advantage vis-à-vis my competitor. Most machinery and tooling can be upgraded at nominal costs by replacing worn-out parts and putting in energy-efficient drives. This is much more economical compared to buying new machinery. Upgraded machinery can produce more and this would necessitate a relook at the planning process to plug gaps. In this process, all steps from the raw materials stage to finished-product shipping including outsourced components need to be reviewed to achieve cost efficiencies as described earlier in this paper. Similarly, better-skilled workmen not only produce more but cause fewer rejections. Hence I would audit their skills and arrange to retrain them where necessary.

The next step in the process is to market higher volumes of production without changing prices. For this purpose, I would gear up the marketing team to emphasize the superior value that customers get for their money, based on my firm’s long association with the market. To conclude, there is scope for gaining cost advantage through marginal investment, improved planning, and retraining workmen. Read More