While increasing the customer’s willingness to pay sounds like a simple enough concept, it is much more difficult to accomplish in practice than it is to talk about in theory. The structure of a company’s business model, its position in the market, or available capital and cash flow can seriously restrict a firm’s ability to engage in activities that could potentially increase the customer’s willingness to pay. Even when such resources do exist, there is never a guarantee that a tangible ROI with ever be captured.
For these reasons, many companies choose to focus on reducing cost. A company’s cost’s when properly understood and assessed represent the piece of the competitive advantage equation that can be controlled by the firm to a certain degree. One good method for cost analysis is to examine the costs associated with each step of the firm’s value chain. Below is a generic value chain for a manufacturing firm and the steps a firm should take to apply the value chain to cost analysis:
- Step 1: Identify the principal activities that make up the value chain.
- Step 2: Allocate total costs to each function within the value chain.
- Step 3: Identify cost drivers within each value function.
- Step 4: Identify linkages. How will a change in one functional area affect another?
- Step 5: Develop strategies for cost reduction