It takes a lot of money to look this cheap, said Dolly Parton. Like others in the Low Cost Leadership category, Dolly Parton is big business.
The Cost Leader strategy is the domain of big business. Small firms are not normally resourced to achieve cost leadership (which requires scale).
The strategy was most prominently promoted by Michael Porter, a Harvard Management Professor who published his generic marketing strategies in his 1980 text Competitive Strategy: Techniques for Analyzing Industries and Competitors. The models which Porter proposed are still common frameworks in use today.
Porter argued that firms essentially had three generic strategic options. These options were cost leadership, differentiation or a focus strategy whereby a firm would focus its resources on a narrow defined segment of the market (a niche). He warned that the firms that did not clearly fit into one of these generic options would find themselves in no-mans land with no clear strategic direction and, as a consequence, were less likely to experience competitive advantage.
The Porter framework, while useful for industries that are unlikely to be subjected to disruptive technologies is perhaps not so useful to those that are. The model assumes that the status quo of an industry will remain. But more recent, innovative competitors are not following the Porter model, preferring instead to find ways to upend large competitors by redefining (or creating entirely new) product categories that threaten the share of large-scale leaders.
The principles of cost leadership, explored in this post, are however as relevant today as when they were created in the 1980s. The cost leader in a category is still an important position.
Depending upon the industry, this position may be occupied by a number three brand which is unable to compete against the feature-rich offers of the market leader and major challenger, or it has been a late entry into an established market and thus has lost the opportunity to secure leadership or main challenger status.
For example, the first cars in Australia were imported from the United Kingdom and America and, following WW2 the first all-Australian car, the Holden, rolled off the manufacturing plant. It wasn’t until the early 1960s that Toyota started manufacturing locally. By this time, brand reputations of cars were already established. To this day, the Asian car companies have been largely unsuccessful in competing against the European reputation for engineering and design, but they are able to compete on cost. Asian cars are able to be produced at lower cost.
For more homogenous markets, where products are viewed as commodity items, the cost leader may well be the market leader.
The Principles of Cost Leadership.
The fundamental principle of a low cost leader is that it gains competitive advantage from being able to produce and/or source product at the lowest or most efficient cost. Throughout every stage, from the product’s inception to sale, costs are shaved as the business seeks to achieve cost advantage.
There is only one cost leader in any given category. Being one of several low cost producers leaves a business vulnerable to attack from other low cost producers.
Having a low cost advantage does not always lead to low price, of course. Some companies that are very good at managing their costs sell their wares at competitive parity, thus enjoying greater margins than their competitors. In this environment, the low cost business sets industry-standard pricing and brands its products to compete alongside other comparable brands in the category. Its success is measured by its profit.
This position is different to the no-frills, budget brand that seeks to cut costs to a minimum and pass savings on to customers in the form of lower prices. In this environment, money is not spent on additional features or extras. The market offer is a product of reasonable quality at a competitive price (the value for money position).
Having a low cost advantage provides a business with the go-to-market choice between a no-frills offer and a branded product. Which direction a business chooses will depend upon such factors as:
- where competitors are currently positioned in the market.
- whether low cost leadership can be sustained.
- who the target market is and their propensity to buy low cost items.
- its internal level of marketing and branding skill.
Success on this strategy is often dependent on being able to take advantage of:
ECONOMIES OF SCALE:
Usually, the product needs to be produced in large volume, made available to a very large customer base and distributed through the most extensive distribution network possible. A cost leader normally enjoys substantial market share.
PREFERENTIAL ACCESS TO IMPORTANT INPUTS.
Important inputs might include raw materials, process engineering, technology, components or skills. This creates a barrier to a competitor copying the cost leader.
RIGOROUS AND ONGOING ATTENTION TO COST REDUCTION.
Low cost leaders often continually invest in technology and process reengineering that applies to all aspects of the business to strip out cost and maintain the cost-led edge over competitors. Processes that do not contribute towards cost reduction (or minimisation) may be outsourced to third parties.
Academics argue that low costs allow firms to sell relatively standardised products that offer features acceptable to many customers at the lowest competitive price and such low prices will gain competitive advantage thus increase market share. Whether a cost leadership strategy is sustainable depends on the ability of another competitor to match or develop a cost base than is lower than the cost leader.
The lowest cost base must be able to be sustained if leadership is to continue.
The Low Cost Leader Strategy.
- Shave costs off every aspect of the value chain.
- Continually invest in attacking costs.
- Product and sell products of reasonable standard.
- Brand positioning depends on level of marketing and branding skill, competitors and environmental factors.