Cost leadership: Clarification, Strategies and its Examples

Until and unless you have a money-growing tree in your house, I’m sure you’ve always searched an extra place or went an extra mile, just to buy an item that’s available at a lower price. After all, most of us look at the price tag before purchasing an item because the price is what matters more than anything else.

Nevertheless, have you ever thought how companies manage to sell products at comparatively lower rates? And why do they even do so?

This is practiced with the help of a marketing strategy called cost leadership that helps you to gain a competitive advantage in a price sensitive market over your competitors.

What is meant by Cost Leadership?

Cost leadership is a business strategy of establishing a competitive advantage by having the lowest cost of operation in the industry. This business strategy is especially beneficial in a market where the price is considered as an important factor. In other words, it is company’s ability to increase productivity and efficiency, eliminate waste, or control costs by lowering prices than its competitors.

Another way to create cost leadership is through product differentiation. With product differentiation, it is easier to offer a product or service that customers prefer over their competitors product or service. The primary goal of a cost leadership strategy is to acquire quality raw materials at the lowest price .Furthermore, there is an additional necessity of quality labor who will convert these raw materials into costly goods for the consumer.

However, there are some factors that need to be taken into consideration that is; the way product’s cost differs from their price, similarly and cost leadership isn’t the same as price leadership.

Cost is the expenses incurred by a business for bringing a product or service into the market is while price is the money which the customers pay for a product or a service. Usually the value of the price is higher than the value of cost.

Hence, cost is the money which a firm GIVES to the production and introduction of a product in the market (such as labor, materials, capital, wages and other transaction costs). While price is the money which a firm GETS from that product or service (total of production costs and seller’s profit).

How can cost leadership be achieved?

Are you all set to implement a cost leadership strategy? A key to unique and effective cost leadership strategy is when it is better than the competitors .A cost leadership strategy is only considered good if its strategy is actually being implemented. This means your business must be organized and all your team members should be active regarding it.  Certain aspects like management controls, budgeting policies, establishing a company culture aligned with cost leadership as well as spending policies and credit policies should be implemented well.

Business owners need to analyze who has the cost advantage in their market. Is it a competitor? A local company? With the help of this information you will then be able to compete on pricing or by differentiation.

If you are first into a market or if your business is in the right place at right time then you might not need to have the lowest prices and can directly focus on differentiation.

 Southwest Airlines is a perfect example of differentiation and low-cost strategy. The airline is known for a fun and delightful flying experience with lower prices.  They even give advantage like free snacks which many other airlines have cut out who charge more expensive fares.  This allows them to compete on lower cost and differentiate themselves with extra benefits and a fun flying experience, unlike other airline. Absolutely great strategy indeed.

Cost leadership Strategies

Here are some cost leadership strategies to establish and maintain an upper hand:

Economies of scale: The costs of production decreases when there is efficient production. Size of the company matters a lot in economies of scale. Hence, larger the business, lower is the costs.

Size Advantage: Rise in purchasing power is a major outcome of size advantages. More money given to the suppliers, more the chances of getting unique deals that become advantages.

Technology: Effective and innovative technologies as well as methods of production are a major deal in reducing costs. So, better the technology used by a company, more are its chances of remaining a cost leader in the long run.

Raw materials: Depending on the amount of access a business has over the basic raw materials required for production, costs can be greatly reduced. So, more the access of a business to potential raw materials, more are its chances of reducing costs as compared to competitors.

Focus:  To be a cost leader in the market, a company doesn’t need to be huge. More the company focuses to render the goods, more are its chances of becoming a cost leader in that field.

Operating efficiency: Efficiency can be boosted by getting more tasks done in comparatively lesser time .So, lesser the amount of money and time that a business spends on getting a task done, more are its chances of coming out as an effective and cost-advantaged company.

These were some ways through which companies can reduce costs and improve their chances of becoming cost leaders in the market. Now, let’s talk about some of the successful cost leaders in present market.

Examples of Cost Leadership Companies

Wal-Mart

Wal-Mart follows an economic value model by having low costs because of their capability to buy in large quality and it has become successful cost leader in their market. So, to offer a different motorcycle product than their existing competitors they have used their cost leadership strategy.

Aldi

This company has been successful in cutting down the excesses at every point of production and it uses a no-frills marketing strategy too. Which in turn will be able to provide the consumers with quality products at low prices.

Amazon

Amazon offers maximum value for its customers at the lowest price and wraps its business around the customers wherein they find it to be a reliable portal for their online shopping needs.

McDonald’s

This fast food chain practices a division of labor by employing and training inexperienced staff instead of skilled cooks and thus manages to cut huge amounts of costs from the salaries of its employees. This method allows them to hire a few managers who usually receive higher wages.

General Mill’s

CEO of General Mill, Stephen Sanger came up with an idea to reduce cost .To improve overall productivity, he sent technicians to observe pit crews during a NASCAR race which indeed influenced the techies to analyze their production processes. They were successful to reduce the time it takes to switch one of their plant lines from 300 minutes to finally 20 minutes.

It is not necessary that cost leadership is always full of advantages, it do consist of many drawbacks. Cost leadership can cause financial cuts in critical areas that may harm the business. Moreover it also reduces product innovation as R&D seems like an extraneous cost, reduces the importance of consumer feedback., encourages a lower quality product to be offered to the market, and cannot be applied to every product or service, requires a large volume of sales to be successful and capital that may not be available, also it disregards the time and importance of market research.

Overall the advantages and disadvantages of the cost leadership styles show us that this process can be used to create a unique competitive advantage. It will also help the organization to adapt to the changing circumstances. Cost leadership must also carefully manage to generate the profits that are possible. Finally, there is a significant risk taken with this method that even a deep understanding of internal functioning cannot solve.