Price or market competitiveness of a product or business depends on its cost competitiveness. Cost competitiveness implies two things-cost efficiency and cost effectiveness. Explain the concept of cost efficiency of an organization. Analyse the major determinants of cost efficiency.
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| Cost Efficiency |
Major determinants of Cost Efficiency:
- Economies of Scale: We know from economics that economies of scale are the most conventional and, also a very important source of cost efficiency. In manufacturing organizations, fixed cost (per unit of output), which initially remains very high, starts going down progressively as output increases. Because of this, average cost of output decreases as output increases, or the scale of operations increases. This also means increase in capacity utilization of plant and machinery. In non-manufacturing organizations or non-manufacturing activities, economies of scale can be effected through mass advertising, mass marketing, extensive distribution, etc. Economies of scale can also be achieved through global partnering and global networks. Many MNEs sustain their competitiveness in the market through scale advantage.
- Supply Cost: Costs of raw materials and various inputs constitute supply cost. Inputs generally include raw material inputs or intermediate inputs and energy inputs. In an extended sense, these inputs can include factor inputs like labour also. In highly raw material-intensive industries like steel, cement and non-ferrous metals, supply costs constitute a very high proportion of total cost of the product and, therefore, become a very important determinant of the level of cost efficiency. In these industries, location influences supply cost because transportation becomes a significant component of total raw material cost. This is the reason why, in these industries, many plants are located near the raw material source or mines. This gives cost advantage to companies. In such industries, ownership of raw material can also give definite cost advantage. This is why steel manufacturers like Tata Steel and nonferrous metal manufacturers, like NALCO, BALCO, and HINDALCO, have their own captive sources of raw materials (ores). In fact, NALCO, primarily because of its captive sourcing of high quality bauxite, is one of the lowest cost producers of aluminum in the world. Even in those industries which are not highly raw material-intensive, supply cost management becomes an important determinant of cost advantage or cost disadvantage. Inventory (of raw materials, components and spares) planning and management are also part of this. Companies are becoming increasingly aware of this. The automobile sector is a good example. All Japanese automobile manufacturers have established close linkages with their vendors – suppliers of automobile ancillaries – through different kinds of partnerships and alliances and implementation of JIT principles. Maruti in India is also a very good example. Companies are also reducing the number of vendors to make the raw material supply chain more cohesive and cost efficient.
- Product/Process Design: Product design starts at the R&D stage even if it is an imitation. Many feel that product design is the first step in efficient cost management, because the nature of the product determines, to a large extent, the raw material and other input requirements and supply cost. Cost Efficiency in production processes can be achieved through better process engineering, increase in productivity which depends partly on the technology level, and with better working capital management. Many companies have achieved cost efficiency through these methods.
Cost competitiveness through product design need not, however, be confined to manufacturing or production process alone. Innovative product design can lead to cost saving through its influence on other parts of the value chain also like distribution or after-sales service. Canon proved this in its battle with Xerox. Xerox’s competitive advantage was built on its service and support network. Canon designed a copier which needed far less servicing and, through this, made one of the strong competence areas of Xerox largely redundant. In the process, Canon also achieved cost efficiency by spending much less on its service network.
- Experience: Experience in any activity in an organization can be an important source of cost advantage or cost efficiency—be it manufacturing or any other functional area. Many studies have been conducted to establish the relationship between cumulative experience gained in an organization and its unit cost. The relationship is generally expressed as an inverse relationship between cumulative output and unit cost—unit cost decreases as cumulative output increases.
- Economies of Scale: We know from economics that economies of scale are the most conventional and, also a very important source of cost efficiency. In manufacturing organizations, fixed cost (per unit of output), which initially remains very high, starts going down progressively as output increases. Because of this, average cost of output decreases as output increases, or the scale of operations increases. This also means increase in capacity utilization of plant and machinery. In non-manufacturing organizations or non-manufacturing activities, economies of scale can be effected through mass advertising, mass marketing, extensive distribution, etc. Economies of scale can also be achieved through global partnering and global networks. Many MNEs sustain their competitiveness in the market through scale advantage.
- Supply Cost: Costs of raw materials and various inputs constitute supply cost. Inputs generally include raw material inputs or intermediate inputs and energy inputs. In an extended sense, these inputs can include factor inputs like labour also. In highly raw material-intensive industries like steel, cement and non-ferrous metals, supply costs constitute a very high proportion of total cost of the product and, therefore, become a very important determinant of the level of cost efficiency. In these industries, location influences supply cost because transportation becomes a significant component of total raw material cost. This is the reason why, in these industries, many plants are located near the raw material source or mines. This gives cost advantage to companies. In such industries, ownership of raw material can also give definite cost advantage. This is why steel manufacturers like Tata Steel and nonferrous metal manufacturers, like NALCO, BALCO, and HINDALCO, have their own captive sources of raw materials (ores). In fact, NALCO, primarily because of its captive sourcing of high quality bauxite, is one of the lowest cost producers of aluminum in the world. Even in those industries which are not highly raw material-intensive, supply cost management becomes an important determinant of cost advantage or cost disadvantage. Inventory (of raw materials, components and spares) planning and management are also part of this. Companies are becoming increasingly aware of this. The automobile sector is a good example. All Japanese automobile manufacturers have established close linkages with their vendors – suppliers of automobile ancillaries – through different kinds of partnerships and alliances and implementation of JIT principles. Maruti in India is also a very good example. Companies are also reducing the number of vendors to make the raw material supply chain more cohesive and cost efficient.
- Product/Process Design: Product design starts at the R&D stage even if it is an imitation. Many feel that product design is the first step in efficient cost management, because the nature of the product determines, to a large extent, the raw material and other input requirements and supply cost. Cost Efficiency in production processes can be achieved through better process engineering, increase in productivity which depends partly on the technology level, and with better working capital management. Many companies have achieved cost efficiency through these methods.
Cost competitiveness through product design need not, however, be confined to manufacturing or production process alone. Innovative product design can lead to cost saving through its influence on other parts of the value chain also like distribution or after-sales service. Canon proved this in its battle with Xerox. Xerox’s competitive advantage was built on its service and support network. Canon designed a copier which needed far less servicing and, through this, made one of the strong competence areas of Xerox largely redundant. In the process, Canon also achieved cost efficiency by spending much less on its service network.
- Experience: Experience in any activity in an organization can be an important source of cost advantage or cost efficiency—be it manufacturing or any other functional area. Many studies have been conducted to establish the relationship between cumulative experience gained in an organization and its unit cost. The relationship is generally expressed as an inverse relationship between cumulative output and unit cost—unit cost decreases as cumulative output increases.
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