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Companies that choose a cost-leadership
strategy offer relatively standardised products with features or characteristics
that are acceptable to customers--in other words, with a minimum level of
differentiation--at the lowest competitive price. This means that companies
offer standardised products to an industry's typical customer. Customers receive
value when a company successfully implements a cost leadership strategy.
Companies that wish to be successful by
following a cost-leadership strategy must maintain constant efforts aimed at
lowering their costs (relative to competitors' costs) and creating value for
customers. Cost-reduction
strategies include:
- Building efficient-scale facilities
- Establishing tight control of production and overhead costs
- Minimising the costs of sales, product research and development,
and service
- Investing in state-of-the-art manufacturing technologies
Implementing and maintaining a cost
leadership strategy means that a company must consider its value chain of
primary and secondary activities and effectively link those activities, if it is
to be successful. The critical
focus in successfully implementing a cost leadership strategy is on efficiency
and cost reduction, regardless of the value-creating activity.
As noted in Figure below, the company's
focus throughout each of its primary and secondary value-creating activities is
on:
- simplification of processes and procedures
- achieving efficiency and effectiveness
- reducing costs
- monitoring the costs of activities provided by others that
interface with the company's inbound and outbound logistics
Figure: Cost Leadership Strategies
Figure: Choices that determine costs
However, companies following cost leadership
strategies cannot completely ignore sources of differentiation that customers
value when producing standardised products. These include styling, minimal levels of service, and product
quality.
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Differentiating Features That Lower Buyer Costs
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A company doesn't have to price to make it
cheaper for a buyer to use its product.
An alternative is to incorporate features and attributes into the
company's product/service package that
Reduce the buyer's scrap and raw materials
waste. Example of differentiating feature: cut-to-size components.
Lower the buyer's labour costs (less time,
less training, lower skill requirements). Examples of differentiating
features: snap-on assembly features, modular replacement of worn-out
components.
Cut the buyer's downtime or idle time.
Examples of differentiating features: greater product reliability, ready spare
parts availability, or less frequent maintenance requirements.
Reduce the buyer's inventory costs. Example of differentiating feature:
just-in-time delivery.
Reduce the buyer's pollution control costs
or waste disposal costs. Example of differentiating feature: scrap pickup for
use in recycling.
Reduce the buyer's procurement and
order-processing costs. Example
of differentiating feature: computerised on-line ordering and billing
procedures.
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Lower the buyer's maintenance and repair
costs. Example of differentiating feature: superior product reliability.
Lower the buyer's installation, delivery,
or financing costs. Example of
differentiating feature: 90-day payment same as cash.
Reduce the buyer's need for other inputs
(energy, safety equipment, security personnel, inspection personnel, other
tools and machinery). Example of
differentiating feature: fuel-efficient power equipment.
Raise the trade-in value of used models.
Lower the buyer's replacement or repair
costs if the product unexpectedly fails later. Example of differentiating feature: longer warranty
coverage.
Lower the buyer's need for technical
personnel. Example of differentiating feature: free technical support and
assistance.
Boost the efficiency of the buyer's
production process. Examples of
differentiating features: faster processing speeds, better interface with
ancillary equipment.
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Source: Adapted from Michael E. Porter,
Competitive Advantage (New York: Free Press, 1985).
A company that successfully implements a
cost leadership strategy can earn above-average returns even when the five
competitive forces are strong.
- Rivalry with Existing
Competitors Achieving the lowest cost position
means that a company's competitors will hesitate to compete on the basis of
price because, in the event of a price war, the low cost company will continue
to earn profits after its competitors compete away their profits.
- Bargaining Power of
Buyers (Customers) Achieving the low cost position
provides some protection against powerful customers who attempt to drive down
prices. If customers attempt to drive
prices below the cost of the next most efficient company, that company might
choose to exit the market (rather than remain and earn below average profits),
leaving the low cost company with a monopoly position.
If that happens, customers would lose any bargaining power, as the monopoly
company would be in a position to raise prices.
- Bargaining Power of
Suppliers Because they have achieved the lowest cost position in the
industry, the cost leadership strategy enables a company to absorb a greater
amount of cost increases from powerful suppliers before it must raise prices
charged to customers.
This may enable the company to be alone among its competitors in
earning above-average returns. In
addition, a low-cost leader that also has a dominant market share may be in a
position to force suppliers to lower prices or to hold down the level of price
increases, and thus reduce the power of suppliers.
- Potential Entrants Companies successfully following cost leadership strategies
generally must produce and sell in large volumes to earn above-average returns.
And, with a continuous focus on efficiency and reducing costs, low-cost
leadership companies create barriers to entry.
New entrants must either enter the industry at a large scale (large enough to
achieve the same economies of scale as the next lowest cost company) or be
satisfied with average profits until they move sufficiently far down the
experience curve to match the efficiencies of the low-cost leader.
- Product Substitutes The low-cost leader is in a more attractive position relative to
substitute products than are other companies in the industry. To retain customers, the low-cost leader
can more easily reduce prices to maintain the price-value relationship and
retain customers.
Despite the attractiveness of the cost
leadership strategy, it is accompanied by risks.
Technological innovations by competitors
could eliminate the low-cost leader's cost advantage.
Overly focusing on process efficiency may
cause the low-cost leader to overlook significant changes in customer
preferences.
Competitors may successfully imitate the
low-cost leader's value chain configuration.
In the event of any of the above, the
low-cost leader is challenged to increase value to customers. This may mean reducing prices or adding
product features without raising prices.
However, if prices are reduced too low, it may be difficult for the
company to earn satisfactory margins and customers may resist any price
increases.
