Cost Leadership

This strategy is one in which a firm sets out to be the low cost manufacturer or product within its industry. Normally, the competitive scope of such a firm is broad i.e. it serves several market segments at the same time and may even operate in related industries.

In this strategy, existence of multiple market segments for the firm is important which can enable it to seek a cost advantage position in the industry. This cost advantage may accrue from several factors like economies of scale in production and distribution of the product, preferential access to raw material sources as also to intermediaries, patents, linkages within the value chain, product mix, etc.

Generally low cost products sell a standard or basic or no frills product and place considerable emphasis on reaping scale or absolute cost advantage from all sources. For example, a typical low cost detergent powder manufacturer will not use expensive composite packaging or LDPE (i.e. plastic molded packs) but will use low cost basic packaging material like cheap plastic bag to pack the product.

Likewise a low cost TV manufacturer will not invest resources in setting up its own elaborate service centers equipped with tools and service personnel all over the country. Rather it may ask its dealers to provide this service. Also, manufacturers of these will not look for expensive dealers but for those who will not necessarily have large space and are willing to work at low margins. Such a manufacturer may not even spend financial resources on advertising his brand in the expensive mass media-newspaper and television – but may use low cost promotional inputs like handbills, posters and point of purchase material.

Thus, a low cost seeker can not and should not attempt at doing things that may enhance its cost structure in any of its primary or support activities. Rather it should aim at deriving economies of scale in both these activities.

If a firm is able to achieve cost leadership and sustain it over a period of time and is also able to command prices at or near the industry average, it would be an above average performer with a healthy bottom line – both in terms of sales and profits. However, to emerge or remain competitive, it is important that the firm is the cost leader and not a cost leader and that its product are perceived, identical or near identical to that of other firms within the industry. In other words, parity on the bases of differentiation vis-à-vis its competitors is important, if the firm has to have higher market share, sales and profitability within the industry.

Continuing with the example of the television manufacturer, if other firms’ brands are preferred or differentiated on the basis of service, quality and technology, then the former cannot derive competitive advantage over others just on the basis of low cost. This will become more critical if the target market gave higher weight age to these two factors than to the cost (price) of the television set. This may be further compounded if other firms are vertically integrated to the source of principal raw materials, i.e.’ the picture tube and the circuit board and hence their manufacturing cost is low. Some of these firms may even be deriving economies in their R&D or distribution or even transportation and warehousing (outbound logistics) through multi-factories located near the major markets.

Thus the strategy of cost leadership may not be sustainable if:

1. Competitor firms imitate (which is much more possible today).

2. Technology changes occur leading to change in customer preferences and also to manufacturing process thereby giving a competitive advantage to firms that take a technology jump.

3. Other bases, like linkages in the value chain or proprietary technology, for cost leadership gets eroded. In the marketing area, if the low cost channel ceases to exist because of environmental factors or even channel members motivation, then the firm’s strategy of cost leadership may become unviable as it will have to either give higher margins to the channel member or spend resources to create brand pull.

4. The firm loses proximity in differentiation. Proximity in differentiation refers to the price discount necessary to achieve an acceptable market share that does not offset the cost leader’s cost advantage. No-w the fi0rm may lose this proximity if other firms offer greater discounts to their customers or higher margins to intermediaries, than to the cost leader.’

5. The firm’s product is not perceived by customers to be at par with others either because of technology, features or service.

6. There are other firms (cost focusers like small scale firms) that achieve even lower costs in the served market segment.