1. Critically Discuss The StrategicCritically Discuss The Strategic Implications OfVarious Cost-Implications OfVarious Cost- Output Relationships.Output Relationships. Students: Ali Khan Asha Akram ThangVu Thiago Resende

2. AgendaAgenda Introduction Definitions Types of Costs Elasticity of Demand Long Run x Short Run Relationship Between Types of Costs Cost Models x Companies Strategy Economies of Scope Coca-Cola Case Study and Pepsi Summary Conclusion References 3. IntroductionIntroduction Resource sacrificed to achieve a specific objective is simplest definition of cost Costs are incurred for ejection of an output which will generate profit Different cost concepts and terms are important in many contexts, including strategy formation and decision making in all areas of value chain Understanding of costs helps decision makers or managers in such issues as : How much to spend on specific activity e.g research and development or marketing and promotions What will be the effect of production increase or new product designs on manufacturing costs How demand of product will affect costs How already incurred costs can be utilized in manufacturing or production processes to avoid increase in costs How certain costs can be avoided in certain situations to benefit from costs relationship to output How to deal with costs when demand is lower 4. DefinitionsDefinitions Total Costs Fixed Costs Variable Costs Semivariable Costs Cost Cost Object Cost Pool Direct Costs Indirect Costs Cost Allocation Step Costs Source: Akram, Khan, Resende, 2012 5. The Demand CurveThe Demand Curve What is law of demand and how does demand curve look like? The law of demand states that quantity demanded moves in the opposite direction of price (all other things held constant). Demand curve indicates quantity at various price and the highest price the market will bear for given output. Source: Adapted from Investopedia, 2011 6. Elasticity of DemandElasticity of Demand The demand is elastic if > 1 The demand is inelastic if < 1 The demand is unitary elasticity if = 1 Source: QuickMBAeconomics, 2011 7. Short-Run and Long-Run Cost FunctionsShort-Run and Long-Run Cost Functions What is the different between long-run and short-run cost function? The short run is a period of time in which the quantity of at least one input is fixed and the quantities of the other inputs can be varied. Normally in U-shape. The long run is a period of time in which the quantities of all inputs can be varied. Relationship Long run cost curve (LAC) is the lower envelope of the SACs Source: Economicsconcepts, 2012 8. Example to clarify short-run and long-run cost function: Hockey stick manufacturer will need: Raw materials Labor Machinery A factory How do you expect these element affect the company in term of short-run and long-run cost? Short-Run and Long-Run Cost FunctionsShort-Run and Long-Run Cost Functions 9. Theres many types of relationships: Examples of RelationshipsExamples of Relationships Relationship Between Marginal Cost Total Costs Marginal Cost Marginal Product of Labour Marginal Cost Average Costs Law of demand Total Cost and output Change in infrastructure Total Costs Fixed Costs Variable Costs Fixed, Variable and Total Costs Units Output We have chosen this one to explain cost relationships 10. Relationship Between Types of CostsRelationship Between Types of Costs Variable, Fixed and Total costs x Units Output Costofproduction Units Output0 X Y TVC Regardless how fast is the production, FC will not change. TFC TC Theres a relationship, if the production grows, so VC will grow. Total Costs = Total Fixed Costs + Total Variable Costs Source: Adapted from GalaxyEduPlanet, 2011 11. Relationship Between Types of CostsRelationship Between Types of Costs Variable, Fixed and Total costs x Units Output Costofproduction Units Output0 X Y TFC TC Increase TC and prejudice your profit Acquisition of a new factory Options: 1.Improve the actual production 2.Double shifts to produce more 3.Outsource 4.Increase the production dramatically Source: Resende, 2012 12. Companies Strategy x Cost ModelsCompanies Strategy x Cost Models The 4 Generic Strategies by Michael Porter COST FOCUS DIFFERENTIATION FOCUS PRODUCT DIFFERENTIATION COST LEADERSHIP Narrow MarketBroad MarketHigherBenefitsEqualBenefits BASISOFADVANTAGE Source: Adapted from the book Competitive Strategy - PORTER, Michael. 13. Strategy - Differentiation Premium price for the product Reflect the higher production costs Extra value-added features Companies Strategy x Cost ModelsCompanies Strategy x Cost Models Strategy - Cost Leadership Trying to become the lowest-cost producer in the industry Always trying to minimise costs Large-scale businesses offering "standard" products Strategy - Differentiation Focus One or a small number of target market segments Different products targeting a group of customers Valid basis for differentiation Strategy - Cost Focus Seeks a lower-cost advantage Small number of market segments The product will be basic but acceptable 14. Cliff Bowmans Strategy Clock Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Poor quality Low price Pressure from competitors Source: Mindtools, 2012 15. Coca-Cola x Pepsi Case Study Pepsi Coca-Cola The History 1931 Bankrupcy for 2nd time in 12 years. a)Partnership with Lexmark. b)License from Coca-Cola Challenge To get out of Bankrupcy and increase profits Reduce costs and maximise profits Relationship Law of Demand-Total Cost and Output a)Infrastructure of Organisation and Total Cost. b)Product Variety and Total Cost and Output. Scale or Scope Economies of Scale a)Economies of Scale b)Economies of Scope Results Reduced price to 5 cents per double sized 12- ounce bottle. Out of Bankrupcy. Profits $2.1 m by 1936. a)Reduced total cost, economies of scale. b)Reduced total cost, economies of scope. Implications Retaliation from Coca-Cola a)Employees b)Costs 16. Conclusion Cost Output Relationships show us how factors affecting output and profit are related to each other, and how they affect revenue, profits and costs. The Strategic Implications of Cost Output Relationships affect the decision making process. It is important that all factors in any Cost Output Relationship must be considered and weighed up against the available resources, such as current and fixed assets, liquid cash, what is already invested by the organisation. Also: costs, requirements, demand and elasticity, before any Strategic decision can be made. Porters 5 Forces and 4 Generic Strategies. Economies and Scale and Scope are achieved with Cost Output Relationships where the production costs are kept minimal and output maximum to have greater revenues and profit. If the organisation predicts that the change made will not be profitable for the organisation, they have the choice not to do so, and have the choice of doing things differently in other activities and having different Cost Output Relationships, which will result in greater profits. 17. Summary Costs-Definitions and how they link to each other. The Demand Curve. Elasticity of Demand. Short-Run and Long-Run Costs. Relationships between types of costs. Porters 5 Forces and Porters 4 Generic Strategies. Cost Output Relationships-Pepsi and Coca-Cola. Strategic Implications of Cost Output Relationships. Conclusions. 18. References Coca-Cola Enterprises Inc, (2007) Manufacturing and Distribution. [Internet]. Available at: < http://www1.lexmark.com/en_US/solutions/success-stories/Mfg-SC-CCE-POD.pdf> [Accessed: 01/12/12]. Pearson Education, (2004) Acquiring Economies Of Scope [Internet]. Available at:< http://wps.pearsoned.com.au/wps/media/objects/1634/1673988/4ce.htm > [Accessed: 02/12/12]. Gono.com, (2012) A BRIEF HISTORY OF PEPSI-COLA. [Internet]. Available at:< http://www.gono.com/museum2003/museum%20collect%20info/briefhistoryofpepsicola.htm > [Accessed: 03/12/12]. Lanen/Anderson/Maher (2008). Fundamentals of cost accounting 3rd edition Alnoor Bhimani, Charles T. Horngren, Srikant M.Datar, Madhav V. Rajan (2012). Management and cost accounting 5th edition Investopedia(2011). Available at:http://www.investopedia.com/terms/l/lawofdemand.asp#axzz2FPERDH8j [Accessed: 06/12/12]. Quick MBA(2011). Available at: http://www.quickmba.com/econ/micro/elas/ped.shtml [Accessed: 10/12/12]. Economicsconcepts(2012) Available at: http://economicsconcepts.com/short_run_and_long_run_cost_curves.htm [Accessed: 10/12/12]. 19. Thank you!Thank you!