The Costs

Cost Leadership Strategy

Companies that choose a Cost-Leadership Strategy offer relatively standardized 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 standardized 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
· Minimizing the cost 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 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.

However, companies following cost leaderships strategies cannot completely ignore sources of differentiation that customers value when producing standardized products. These include styling, minimal levels of service, and product quality.

A company that successfully implements a cost leadership strategy can earn above average returns even when the five competitive forces are strong:

1.- 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.

2.- 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 then 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.

3.- 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 the 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.

4.- 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.

5.-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 in process efficiency may cause the low-cost leader to overlook significant changes in customer preferences. Competitors may successfully imitate the 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.

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