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After reading the course materials, including Mukerjee?

Directions

 After reading the course materials, including Mukerjee  (2016) (a good overview of the factors for competitive advantage!), apply the most relevant two elements of a value chain analysis to an organization of your choice. Justify your choice of elements as to why they are important for that organization.

Describe one or two strategic tactics the organization might try (or already uses) based on the value chain analysis and justify why the tactic is useful as a competitive advantage tool. 

Strategic Management

Jeff Dyer

Third Edition

Chapter 3

Internal Analysis: Strengths, Weaknesses, and Competitive Advantage

Professor’s Goals for this Lecture 

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:  

– the homework assignment involving calculating an experience curve in semiconductors  

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)  

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry  

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Technical innovations

Flowers and Trees—the first cartoon to use 3 color Technicolor technology, 1932

Snow white—the first full length feature in 1937

Fantasia—1940, the first film in stereophonic sound

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The following are more technical innovations that Disney pioneered. Students will be familiar with Snow White and Fantasia (both from their own childhood viewing and the opening vignette), and so these slides can provide a quick quiz and test of student retention.

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Huge innovation, huge risk

Disneyland

The Happiest Place on Earth

Copyright ©2020 John Wiley & Sons, Inc.

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1957—Disneyland opens. Disneyland is not only a great technical innovation (lots of new technology from the imagineers in developing really cool rides and attractions).

Disneyland was also a huge business innovation, and a huge risk. First, to finance Disneyland, Walt began producing weekly TV programs, when it was not at all clear that TV would become a major medium of communication.

Second, in the 1950s theme parks were all local, and many were shabby and poorly run. Remember, the U.S. Interstate system is in the early days of its construction, having been funded only a year earlier, and jet air travel only began in 1954. It was not at all clear that a theme park could become a national draw and attraction.

It was a huge success, from the day that it opened. Walt made one huge mistake in setting up Disneyland, however, in that he only bought 160 Acres of land for the park. They avoided that mistake with their next purchase, buying more that 27,000 acres.

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The Value Chain

Value Chain- A visual description of the steps required to turn raw materials into finished products and/or services. The value chain also describes key functions of

the firm linked to each stage and functions that span the productive activities of the firm.

Copyright ©2020 John Wiley & Sons, Inc.

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The Resource-Based View

Resources- All assets, capabilities, organizational processes, firm attributes, information, knowledge, and so on, controlled by a firm that enable the firm to conceive of and implement strategies that improve its efficiency and effectiveness.

Assets- Tangible or intangible resources or factors of production that create economic value for the firm when employed.

Four categories of resources are important contributors to competitive advantage:

Copyright ©2020 John Wiley & Sons, Inc.

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Physical resources, such as plant or equipment

2. Financial resources, such as free cash flow

3. Human resources, including employee and management skills and talents

4. Intangible resources, the intangible assets held by firms, such as brands and patents.

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Physical Resources

Financial Resources

Human Resources

Intangible Resources

The Resource-Based View (continued)

Capabilities- The procedures, processes, and routines firms employ in their activities.

Operating Capabilities- Procedures, processes, or routines for delivering value to customers, employees, suppliers, or investors.

Dynamic Capabilities- Procedures, processes, and routines that continuously expand existing resources or improve operating capabilities.

Priorities- A firm’s values and rankings of what is most important.

Copyright ©2020 John Wiley & Sons, Inc.

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CREATING A SUSTAINABLE COMPETITIVE ADVANTAGE: VRIO MODEL

Value- Worth or utility.

Rarity- To be uncommon, or not available to other competitors.

Inimitability- An attribute of a resource that describes the degree of difficulty a competitor would face in copying, imitating, or mimicking the value of that resource

Positive Network Externalities- When the value of a product increases with the number of users.

Virtuous Circle- When more sellers attract more buyers, who, in turn, attract more sellers.

Organized to Exploit- The degree to which the legal, administrative, and operating structure of the firm allows it to capture the rents generated by resources.

Copyright ©2020 John Wiley & Sons, Inc.

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Competitive advantages arise when resources or capabilities possess two attributes: Value and rarity. Two other principles determine the durability, or sustainability, of competitive advantage: Inimitability, the characteristics that make a resource or capability difficult to imitate, and an organization’s ability to exploit profit returns generated by its unique and valuable resources. Together, these four characteristics—value, rarity, inimitability, and organization to exploit profits—are often abbreviated as VRIO.

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Example: Inimitable Resources

Unique History—Coke

Path Dependence—Boeing

Complex Systems—Merck

Tacit Knowledge—Apple

Property Rights—Chevron

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Coke’s historical advantage comes from WWII, when the US military subsidized bottling plants all over the world so that soldiers could have “a coke within arm’s reach”

Boeing’s path dependence has a military origin as well. During WWII, the British focused on building fighters and the US on bombers (like the B-17). Those bombers gave Boeing the technical know how to build commercial aircraft and a lead over the British in creating safe jet travel.

The complex regulatory approval process that Merck has to endure to bring drugs to market mean that the company needs to develop and maintain a set of very complex organizational systems and routines.

Apple’s design capabilities (think of the innovations that Steve Jobs came up with) represent tacit, difficult to transfer, knowledge and skill.

Property rights, mainly land ownership and drilling rights, provide companies like Chevron with a legally protected resource base.

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Assessing Competitive Advantage with VRIO

Competitive Failure- When firms that can’t create value for their stakeholders don’t survive.

Competitive Parity- When a company survives but has no real competitive advantage over rivals.

Sustained Competitive Advantage- When firms combine the legal elements, intellectual property rights, administrative elements, and cultural elements,

allowing them to capture high profits that come from their valuable, rare, and inimitable resources, capabilities, or priorities.

Copyright ©2020 John Wiley & Sons, Inc.

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VRIO

Copyright ©2020 John Wiley & Sons, Inc.

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I’ll spend a few minutes here. The chart can easily apply to resources and capabilities. The important thing to reinforce is the last column—because this is the essence of the Diamond. Unless companies are organized to both create and exploit their resources and capabilities, their sources of competitive advantages will fade over time.

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Disney’s competitive advantage

Create content that drives repeat business

Managers can easily forget resources

Growth and expansion will always threaten the core

Copyright ©2020 John Wiley & Sons, Inc.

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It’s useful before moving on to summarize the key points of the Disney discussion. While these bullet points apply to Disney, the instructor can ask students if they can think of other companies where this has happened.

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Today’s Activity Map?

Miramax ESPN
Lucas Film Pixar Walt Disney ESPN Zone ESPN Deportes
Disneyland Disney Cruise Line 710am ESPN
Walt Disney World Resorts ABC Disney Channel The History Channel

Copyright ©2020 John Wiley & Sons, Inc.

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What would an activity map of the Disney company look like today? Is there anything at the Center? What does this imply for long term competitive advantage?

The launch of the Disney+ streaming service is a new activity. How do you think Disney analyzed this new service?

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The Company Diamond

Capabilities

Priorities

Resources

Strengths & Weaknesses

(Activities)

&

The things we do to compete

The assets we employ

The processes we use

The values that guide us

Copyright ©2020 John Wiley & Sons, Inc.

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I’m going to spend about 10 minutes here outlining and building out this slide. It’s useful to move from top to bottom. I use ESPN—one of Disney’s most successful units—to illustrate the different elements of the diamond. The purpose of this slide, and the arrows that connect all the different elements, is to help students see that competitive advantage is a complex, deliberate thing that executives construct. The text on the slide is helpful to remind students of the progression from easily observable activities, through assets and processes, and down to deep, abstract values.

For ESPN

Activities—they make movies and creative content, produce products (televise games), run theme parks, restaurants, etc.

Resources—The brands, the personalities, the contracts,

Capabilities—sports center (cutting edge, fun, engaging), seeking new venues, innovation

Values—”sports fans serving sports fans”. ESPN is pretty diligent about hiring sports fans to work for the company, and puts a lot of emphasis on finding new and creative ways to deliver sports content to their fan base.

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Gathering Data for Company Diamond Analysis

Data to complete a diamond profile come from a number of sources. You can use three main types of data:

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Data to complete a diamond profile come from a number of sources. You can use three main types of data:

Archival data: Written or numeric information can be found in the library or on the Internet.

Interviews: Interviews can range from personal questions to impersonal Surveys.

Observation: Your own experiences, such as visits or use of products or services, are also valuable.

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Archival Data

Interviews

Observations

Using the Diamond Model

Copyright ©2020 John Wiley & Sons, Inc.

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Class Activity: Creating a Company Diamond

Capabilities

Priorities

Resources

Strengths & Weaknesses

(Activities)

&

The things we do to compete

The assets we employ

The processes we use

The values that guide us

Copyright ©2020 John Wiley & Sons, Inc.

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This is where I’ll have the students spend about 20 minutes. The text provides a nice reminder of the elements of the Diamond. Again, students can either develop a diamond model for the company that they are using for a semester length project, one assigned by the instructor, or they can spend 20 minutes thinking about their own competitive advantages, and how they might build a sustainable advantage over the first few years of their careers.

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Copyright

Copyright © 2020 John Wiley & Sons, Inc.

All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.

Copyright ©2020 John Wiley & Sons, Inc.

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17

Copyright

Copyright © 2020 John Wiley & Sons, Canada, Ltd.

All rights reserved.  Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein.

Copyright ©2020 John Wiley & Sons, Inc.

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18

,

Strategic Management

Jeff Dyer

Third Edition

Chapter 4

Cost Advantage

Professor’s Goals for this Lecture 

There are many types of problems that can be solved for a company by doing a cost analysis. A cost analysis can be used to solve problems as diverse as marketing (e.g., how much to spend to acquire additional customers) or HR (how much labor costs go down per unit with increases in volume). The principle tools to be learned in this chapter are designed to help the student examine the relationship between a company’s size (measured in volumes produced or market share) and cost per unit. This is primarily reinforced by teaching students how to create a scale/experience curve (both done in the same way with “cost per unit” on the “Y” axis but the scale curve uses volume for a given year on the “X” axis whereas the experience curve uses cumulative volume on the “X” axis. The students will have the opportunity to examine the relationship between scale/experience in the following assignments:  

– the homework assignment involving calculating an experience curve in semiconductors  

– Fry’s Credit Card Mini-case (in lecture); considers the relationship between total number of subscribers (X axis) and cost per subscriber (Y axis)  

– the Southwest Case (after lecture); considers the relationship between total passengers flown (or market share) and performance (profitability) in the industry  

1

Two Generic Strategies

Copyright ©2020 John Wiley & Sons, Inc.

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Companies typically choose between one of two “generic” strategies for offering unique value to customers: cost advantage or differentiation advantage. By designing cars

to be manufactured at the lowest cost possible, and by designing a distribution system to get the cars to customers at the lowest cost possible, Tata has a cost advantage over every other carmaker in India, which allows it to sell the Nano at the lowest price.

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Cost advantage

Differentiation advantage

The Cost Advantage Strategy

Copyright ©2020 John Wiley & Sons, Inc.

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Cost Advantage Strategy

A firm reduces its prices below all of its competitors, thereby allowing it to gain market share.

A firm may choose the same price as competitors, which results in greater profits rather than higher market share.

Sources of Cost Advantage: Economies of Scale

Economies of Scale

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Learning and Experience Effects

2

Lower Costs due to Proprietary Knowledge

3

Lower Input Costs

4

Different Business Model

5

Copyright ©2020 John Wiley & Sons, Inc.

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Summary of the sources of cost advantage. If we were going to do a logic tree and what drives cost advantage, there are these five things that I would point to as one way to organize that logic tree as to why companies have cost advantage. It’s because of economies of scale, it’s because of learning and experience effects, lower cost due to prior knowledge, lower input cost or a different business model.

One of the first things to appreciate is how you solve various different kinds of problems for a company or how you help them by understanding how to do cost analysis.

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First electronic bank (FEB) provides a store credit card to Frys electronics.

After 3 years, 25% of Frys customers have a Frys credit card but growth has slowed

Should FEB:

A) Spend more on marketing to increase penetration of the card at Frys

B) Spend money on marketing to get other store client customers to adopt a store credit card provided by FEB

What analysis would you recommend to FEB to determine what, if any, they should spend on marketing to get new customers?

Additional Mini-Case

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Q: Fry’s Electronic Bank does store credit cards for First Electronic Bank. After a number of years, 25 percent of Fry’s customer base have a Fry’s credit card, but growth is slow. So, should First Electronic Bank spend more money on marketing to increase penetration of the Fry’s card, should they spend money on marketing to get other store client customers to adopt the credit card provided by First Electronic Bank, and what analysis would you give FEB to determine what, if any, they should spend to get new customers?

A: as we think about this, this is sort of the cost per card or per subscriber. This is our cost per customer, per subscriber, per card, or you might even think about it as a cost per transaction. If you wanted to take it down to the individual transaction, some customers or subscribers may have more transactions than others, so you can look at how your cost per transaction is changing over time. And then you look at the total number or subscribers. So now I’ve got my total number of subscribers and then I can just start plotting years.

So, I start 1995 or whatever, and I plot the first year. What was my cost per subscriber, and what was the total number of subscribers? And to get my cost per subscriber all I have to do is take my total costs, divide it by the total number of subscribers, and I’ve got my cost per subscriber. And I can do that each year! You can usually get that data off of an annual report. That’s part of the reason why I wanted you to do that assignment for today. To get a sense for this data and actually analyze it from publicly available data.

Alright so you look, you plot your one, you plot your two, and you see what this looks like. It usually doesn’t look that plain, but let’s assume that it does. You plot the best fit line, your regression line, and then that will tell you how much our cost decreases if we double our number of subscribers. We can now do a skill curve against an experience curve. So then this now tells us how much our cost will decrease. Well let’s say I am here and I am trying to figure out whether or not to invest to grow my subscribers. Now, I’m actually, if I think I can grow my subscribers, the question is how much I can grow my subscribers, but I think I can get down here. What that means is I can now look at my cost going, dropping from this to this per subscriber, I take that across all my subscribers, and I know, that’s the value of this many more customers here because I’ve now been able to drop my cost per subscriber, I’ve added a certain number of additional subscribers, if it costs me more than that in marketing, then it probably doesn’t make sense to do it. But if it costs me less than that in marketing, then it probably makes sense for me to make the investment. And the other thing you have to realize is that the marketing expense may be a one year expense, or it may be a multiple year expense if you keep them. If it’s only a one year expense, you may want to keep the money to get the additional customers, but the nice thing is now this gets built in because you have more subscribers, and your cost per subscriber is lower for everybody.

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How important is size/volume as a driver of costs (and thus profitability) in my industry?

Scale/Experience Curve analysis

Market-share/profitability analysis

Overview

Additional Mini-Case: Analyzing Cost Advantage

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If we think about this case with First Electronic Bank what you’re trying to understand is how important is increased volume as the driver of my costs. The more increased volume as the driver of my costs the more I can invest, the more I should be willing to invest in order to increase my volume. Right, so then, if Frist Electronic Bank finds that if they could double their number of subscribers, and their cost dropped by 20 percent, then they now can sort of estimate here’s how much it is worth to spend on marketing to get new customers.

And the goal is just to make sure that you’re smart about your business. That you know what happens when we increase customers, how much more money are we likely to make. If we lose customers, in an economic downturn, let’s say we lose customers, how much is that going to affect our cost per customer, or our cost per unit. So that then you can hopefully make smart decisions about how to make sure…this is one of the reasons why Southwest wanted to grow slowly, and in a controlled way. Because what they learned was that when you have lots of planes and you have an economic downturn, this actually hurts your profitability, and they didn’t want to have to lay people off, they wanted to maintain this certain kind of culture, where people felt like they had stable employment, which was very unlike many of the other airlines that had lots of layoffs. And, so, these influence the choices that you make around how quickly that you grow and how much investment we make to try and get new customers.

So you’re trying to answer this question, how important is size and volume as a driver of profitability to do, to understand that you have to be able to know how to do experience curve analysis, and scale curve analysis, or a market share profitability analysis.

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Economies of Scale

Economies of scale- A reduction in costs per unit due to increases in efficiency of production as the number of goods being produced increases.

Economies of scale arise from four principle sources:

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Economies of scale- A reduction in costs per unit due to increases in efficiency of production as the number of goods being produced increases.

Economies of scale arise from four principle sources: the ability to spread fixed costs of production, the ability to spread nonproduction costs, specialization of equipment, and specialization of people.

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Ability to Spread Fixed Costs of Production

Ability to Spread Nonproduction Costs

Specialization of Equipment

Specialization of People

Why Economies of Scale Lower Costs

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Why do economies of scale lower costs, ok. Well, two main reasons. One is the ability to spread fixed costs, property, plant, and equipment, but also you have non-production costs like research and development. Once you’ve made that investment to develop that new drug, if you only sell in the United States you could only spread your R&D costs over a U.S. population, whereas you’d rather spread it across a global population. A lot of times those costs really become fixed costs. And then the second reason that your costs go down with economies of scale is specialization. So, you now can have specialized machines and equipment that are designed for a specific task instead of maybe using labor, uh, or you can have people who now specialize on how to do a particular task and they get really good at it, and it’s just the whole notion of practice makes perfect, and more people can do the same task over and over, the better they will get. And that’s why costs go down with economies of scale. We see this in a lot of different industries.

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Specialization

Specialization of machines and equipment.

A firm with high volumes is able to purchase and use specialized equipment or tools that small firms simply cannot afford.

Specialization of tasks and people.

Small firms do not have the volume to create high levels of employee specialization.

When do hire specialized may not be enough work to keep them busy

Ability to Spread Fixed Costs

ProduScale is particularly valuable when investments in PPE are indivisible or “lumpy”—unavailable in small sizes.

Property, plant and equipment.

Non-Production: R&D, advertising, distribution, finance, G&A.

Economies of Scale and Scope

Scale Curve- A graphic representation of the relationship between cost per unit and scale (volume) of production in a given time period.

Minimum Efficient Scale- The smallest level of output (unit volume) that a plant or firm can produce to minimize its long run average costs. In a graphic

presentation of output/unit volume (x-axis) and cost per unit (y-axis), it is the output level where costs per unit flatten and no longer continue going down with increased output.

Diseconomies of Scale- An increase in marginal cost when output is increased.

Economies of Scope- The average total cost of production decreases as a result of increasing the number of different goods produced.

Copyright ©2020 John Wiley & Sons, Inc.

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Figure 4.1: Economies of scale

Q1

Low

High

Dis-economies of

Scale

Economies of Scale

Minimum Efficient Scale (optimal quantity)

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Economies of scale is taking, for given years, cost per unit of production and volume of production for a given year. And what we tend to find is that over time it drops, but at some point manufacturing plants become so large it’s so complex, that actually the costs start to go back up. They become very hard to manage. You have to draw workers from a larger and larger area, you have to pay more wages that in fact at some point you’re plant can become too big, and you’re costs will actually start to go up. The place where this curve starts to flatten out is what we often think of as the “minimum efficient scale”. So this is the minimum volume that we need to produce in order to be, pretty much, at the lowest cost possible. And that is where you typically want to produce. Is wherever you’re minimum efficient scale is or, any sort of production facility. Alright, so, you’re getting economies of scale, here is your minimum efficient scale where it’s flattening out, and that’s where you tend to want to, produce and then you can get to this economies of scale.

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Cost per Unit of Production 1 3 5 7 9 11 13 15 17 19 21 100 69 49 36 28 22 19 17.5 19 22 26

Volume of Production

Cost per Unit of Production

Source: Boston Consulting Group

Example: Scale Economies in Advertising: U.S. Soft Drinks

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I just wanted to note that what you can do is, you can actually do this for specific kinds of costs in a company. So you could do it for advertising, you could do it for marketing, let’s see how it works for research and development. We could pick a variety of different costs, and look at how the costs per, in this case, per case of soft drinks sold goes down as

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