Michael Porter discussed how companies achieve competitive advantage in his book on “Competitive Advantage: Creating and Sustaining Superior Performance”. This advantage comes from a company’s products and services. Through competitive advantage, companies can increase their market share and generate more revenues. This book also suggests some strategies through which companies can achieve it.
Porter’s generic strategies come from his book. In his book, Porter suggested companies follow one of three strategies that can help them achieve competitive advantage. These are cost leadership, focus, and differentiation. Each of these has unique characteristics and enables companies to increase their business. Porter also suggests that companies must follow at least one of these strategies or risk losing valuable resources.
Of these strategies, differentiation relates to creating unique and desirable products and services. On the other hand, the focus strategy requires companies to offer specialized products and services in a niche market. This strategy can have two focuses, differentiation focus and cost focus. The last strategy is cost leadership which relates to the expenses companies incur on their products.
What is the Cost Leadership Strategy?
The cost leadership strategy involves a company making products or services at a lower cost. These products or services are usually the same as those produced by its competitors. However, through the lower costs, companies can charge lower prices, leading to a competitive advantage. The primary focus of this strategy relates to controlling costs through various techniques.
Cost leadership helps companies reduce costs and produce the least expensive goods and services. This way, they can dominate the industry with their pricing to gain a higher market share. This strategy also opens up a company’s product to a wider range of customers. In contrast, competitors may charge higher prices, which some customers cannot afford.
The cost leadership strategy focuses on production and purchasing costs. By reducing these costs, it ensures that companies can also decrease their overall expenses. Companies can also achieve it through cheaper labour or decreasing other expenditures. On top of these, companies can also reduce their costs through economies of scale. These processes help companies ensure the cost leadership strategy is effective.
The cost leadership strategy may not focus on increasing the quality of goods or services. Usually, this goal falls under the differentiation strategy, one of Porter’s generic strategies. However, it does not imply that companies will produce lower standard goods. This strategy still requires them to ensure their quality matches that of the competitor. In essence, the company must manufacture similar products and services as competitors but at a lower cost.
Overall, the cost leadership strategy focuses on decreasing production and purchasing costs. However, it may also focus on other overheads or expenses. With this strategy, companies can increase their market share and make products accessible to more customers. The cost leadership strategy can also help companies rise their profit margins in a competitive market. Usually, when the product prices are fixed, this strategy can produce significant results.
How to achieve Cost Leadership Strategy?
Achieving cost leadership does not involve a complicated process. There are various methods that companies can use to control their expenses. Usually, there are a few techniques that apply to every company. However, companies may also use any other approaches to reducing their costs. Overall, some of the ways companies can achieve the cost leadership strategy are as below.
Economies of scale
The idea behind economies of scale is straightforward. Companies incur fixed costs every time they produce goods. Sometimes, these fixed costs may occur regardless of the production level. However, they still contribute to the cost per unit of a single product. Economies of scale involve increasing production levels to ensure that the per-unit cost is minimized or reduced.
Large production runs
Most companies use a batch production system, while others may have a continuous process. Either way, they can reduce their costs by running their production for massive production. This process achieves economies of scale, as mentioned above. However, it can also help obtain raw materials at bulk discounts. This way, companies can also achieve power over suppliers.
Using cheaper resources
Cost leadership, in essence, involves reducing the overall cost incurred on a product. For most products, these costs include material and labour. By using cheaper materials and labour, companies can significantly reduce the overall expenses incurred on producing a product. This process may leader to lower quality goods. However, cost leadership concerns the costs more.
Reducing fixed costs
One of the most efficient methods of reducing costs without affecting quality is to target fixed costs. For most companies, the highest fixed cost is the rent on buildings or property. By reducing these costs, companies can significantly decrease the per-unit cost. This way, they can achieve the same results that come with economies of scale. However, it takes a different approach to cost leadership.
Improving efficiency
In most cases, companies may already get the most inexpensive labour and material. Similarly, they may not have the option to target fixed costs. Nonetheless, they can still achieve cost leadership through improved efficiency. Usually, it involves targeting processes and identifying any wastages within those. By eliminating any deficiencies, companies can significantly reduce their costs per product.
Implementing advanced technology
Technology also plays a crucial role in the costs associated with products and services. Companies can lower their costs by implementing high-level techniques in their production process. This way, they can achieve the same effect that comes with improved efficiency. Implementing advanced technology can also help produce better quality products and services.
What are the advantages of the Cost Leadership Strategy?
There are several advantages to achieving the cost leadership strategy. Some of the primary ones include the following.
More customers
Achieving the cost leadership strategy can help companies make their products more accessible to customers. In some instances, customers cannot afford every product. Through cost leadership, however, they can attract customers from lower market segments. However, it also assumes that they will decrease their prices to do so.
Create barriers to entry
One of the primary advantages of the cost leadership strategy is that it creates barriers to entry. Usually, new entrants do not have the resources to compete with cost leaders. For example, they may lack economies of scale or advanced technologies. Therefore, the cost leadership strategy allows companies to dominate the market and repel any new competition.
Win price wars
Some companies operate in a highly competitive market. In those markets, it is crucial to hold a higher market share or risk becoming defunct. Through cost leadership, companies can win more price wars since they have room to modify them. Winning these wars not only increases business but also repels competitors from competing further.
What are the disadvantages of the Cost Leadership Strategy?
The cost leadership strategy can also have many disadvantages despite its benefits. Some of the primary drawbacks of achieving this strategy include the following.
Lower customer loyalty
Cost leadership does not involve creating a brand and attracting customers to it. Instead, it focuses on gaining customers from all sources. While it can increase business, this strategy does not guarantee customer loyalty. When customers find a cheaper alternative, they are likely to switch to it due to the nature of this strategy.
Bad reputation
As mentioned above, cost leadership does not necessarily focus on product quality. Therefore, it can create a bad reputation for cost leaders in the market. Customers may associate these companies with low-quality products and services. Therefore, some customers may choose alternative products and services, which can lower profits. It can also make it more challenging to adopt a differentiation strategy in the future.
Constant competition
Cost leadership faces constant competition, which can lead to a higher workload. Companies that focus on this strategy suffer from continuous price wars. On top of that, they must continuously strive to keep their costs and prices low. This process can lead to more work and possibly higher costs. The constant competition can also create a challenging market in which companies operate.
Conclusion
Cost leadership is a strategy that comes from Porter’s generic strategies. This strategy entails reducing costs to attract customers. Usually, achieving the cost leadership strategy is straightforward. However, maintaining a cost leadership position may be more challenging. There are several advantages and disadvantages of using this strategy, as mentioned above.
