Cost Leadership - Strategies, Advantages, Disadvantages

Disadvantages of Cost Leadership Strategy · 1. Financial cuts · 2. Product innovation · 3. Customer feedback · 4. Copycats · 5. Substandard quality. Home»Marketingmanagementarticles»CostLeadership–Strategies,Advantages,Disadvantages Insimpleterms,costleadershipcanbeexplainedaswhenacompanytriestogetacompetitiveedgebyreducingthepriceoftheproduct.Forexample,ChinesemobilebrandslikeXiaomiandOppousecostleadershipstrategyandchargetheirproducts,whichareprimarilymobilephones,verylesscomparedtootherslikeGoogleandApple. Manycompaniestrytoachievecostleadershipbyreducingtheiroperationcostsothattheiroverallpricesarereducedwithoutreducingtheprofitmargin.Thisbringsthepriceoftheproductlowerthanthatofthecompetitors. Today’sbusinessenvironmentisverycomplexbutasophisticatedonebecausethecustomerisouraboutdifferentchoicesthatareavailabletothem.Competitivepricingisoneoftheguaranteedwaysbywhichcompetitorsdistinguishthemselves.Costleadershipisefficientlyexecutedbycompaniesthathaveminimalproductioncosts. Walmartisanotherexamplethatrunsthecostleadershipstrategyefficiently.TheoperationsofWalmartaresoefficient,andtheyhavesuchavastdistributionnetworkthatthereabletogetpreferentialpricingontheproductswhichtheysaidtothecustomersfaristhisthenotherretailers.AnyproductwhichcanbeobtainedatWalmartiscomparedwithanyotherSupermartliketargetwillhavethepricedifferencewiththelowercostbeingthatofWalmart. TableofContents StrategiestoachieveCostLeadership1.EconomiesofScale2.SizeAdvantages3.Technology4.RawMaterialsAdvantagesofCostLeadershipstrategy1.Betterprofitability2.Marketshare3.Businesssustainability4.Morecapital5.ReducescompetitionDisadvantagesofCostLeadershipStrategy1.Financialcuts2.Productinnovation3.Customerfeedback4.Copycats5.Substandardquality6.Notforeveryproduct7.CapitalAvailability StrategiestoachieveCostLeadership Theprimaryprincipleincostleadershipistohavetheproductsatalowercostcomparedtocompetitorpricing.Therearedifferentwaysthatanorganizationcanachievealowercostfortheirproducts.Followingareafewofthecostleadershipstrategies: 1.EconomiesofScale Asthenamesuggestsproducingmoreproductswillreducetheper-unitcost.Companieswithhighvolumebusinessescanachieveeconomiesofscale.Itwillnotbepossibleforsmallcompaniestoachievecostleadershipwitheconomiesofscale.Walmartisanexamplethatmeetscostleadershipbyeconomiesofscale. 2.SizeAdvantages Anotherstrategythatfewoftheorganizationsuseistoincreasetheirpurchasingpower.Inotherwords,iftheyincreasetheamountofmoneythatwasgiventothesuppliers,thentheyhavemorechanceofextractinguniquedetailsfromthemwhichwillturnouttobecost-efficient. 3.Technology Innovativeandcost-effectivetechnologies,coupledwithimprovedmethodsofproduction,areasignificantsourceforcuttingthecosts.Technologyupgradesareendless.Thereisavitaltechnologyupgradeeveryfewweeks,andifcompaniesunderstanditandutilizeitfortheirproduct,thenitwillresultinreducingtheirper-unitcostoftheproduct. Theuseofartificialintelligence,newsoftware’sandimprovedhardwareoracombinationofbotharefewofthemethodswhichcanbeusedtoimprovetheproductionfacilitiesandtherebyreducetheproductioncost.Theuseoftechnologywillnotonlyreducecostsbutalsoreducethechanceoferrorwhichmayhavehappenedbecauseofhumanintervention. 4.RawMaterials Theoperatingcostsandmanufacturingcostoftheproductdependdirectlyonthevalueofrawmaterials.Ifthecostofrawmaterialincreases,thisautomaticallyfluctuatesthepriceoftheproduct.Toreducethecostofprocurementofrawmaterials,thecompanycaneitherbargainforabetterpriceortrytogetaccesstorawmaterialsbythemselves. Thiswillreducethecostsofmanufacturingandinturn,thefinishedproduct.Loweringthecostofrawmaterialsorundertakingtheirproductionwillhelptheorganizationtoreducethevalueoftheproductandgaincostleadershipinthemarket. AdvantagesofCostLeadershipstrategy 1.Betterprofitability Costleadershipisfocusedonprovidingproductswithlowoperatingcosts.Byreducingtheproductioncost,higherprofitmarginsareavailablefortheorganization.Comparedtocompetitiveproducts,Thepriceoftheproductwillalwayshaveamoresignificantmargin. Thecompanywithcostleadershipwillalsohavehigherbargainingpowerovercompetitors. 2.Marketshare Achievinghigherprofitmarginswillautomaticallyhelptheorganizationtogainanimprovedmarketshare.Budget-consciouscustomerswhowantqualityandvaluewillbeabletoaffordyourproduct. Ifyouhavethegoodsorserviceswhichhavethelowestcostamongthecompetitorsandalsoanacceptablevaluewhichisaroundtheaverageofotherproducts,thentheywillbeconsideredforthepurchasefirst.Astimegoes,theseleaderscangetmorebusinessevenfromamaturemarket. 3.Businesssustainability Thefinancialratesaresignificantlyreducedwhenthecostorlowerforthebusiness.Businesssustainabilitybecomesanadvantagecomparedtocompetitorsandevenwhentheeconomicconditionsarenotinfavor. Wheneverthereisatradewarorapricewar,thenthecompanieswhicharedoingbusinesswiththelowestcostwillhavehigherchancesofsurvival. 4.Morecapital Costleadershipisessentialtopromotetheavailabilityofcapitalresources.Althoughthecostofretailgoodsislow,itispossibletoretainhighercapitalonlybecauseofhighermarginsfromeachtransaction. Ifeverysuchproductgivesahighermarginthen,overtime,itcanbeusedformultiplepurposes.Suchcapitalwhichisaccumulatedovertimecanbeusedforinvestmentinnewventuresorfurthergrowthoftheorganization. 5.Reducescompetition Ifacompanyimplementsthecostleadershipstylesuccessfully,thenitwillbeadvantageousforthatcompany,butthecompetitorsmaynotsurviveinthelongterm. Initially,tosurvive,competitorsmayreducethepriceandbringdowntoyourlevel,butinthelongrun,noteverybusinesscansustainwithsimplyreducingcostswithoutemployingapropercostleadershipstrategy.Thiswillallowyoutodominatethemarketovertime. DisadvantagesofCostLeadershipStrategy 1.Financialcuts Itisalwayscommendablethatanorganizationsustainsinthecostleadershipstrategy.Thebudgetaccumulatedfromthecostleadershipcanbeusedinmanyalternativewaysforthegrowthoftheorganization,butthereisalsoadangerinthestrategy. Thereducedcostsmayaffecttheessentialandcriticalareasofthecompaniesactcustomerservice.Althoughthepriceisexcellent,thecustomerswhobelieveinthecustomerservicewillneverventureintobuyingyourproduct. 2.Productinnovation Oneofthefirsteffectsthatcostleadershipstrategyhasisontheresearchanddevelopmentteam.Formanycompanies,researchanddevelopmentseemlikeanunbearablecost. Thisresultsincuttingthefundsforresearchanddevelopment,whichwillultimatelyresultininferiornewproductsreachingthemarket.Withfewerchancesofinnovationcost,leadershippromotesthesameproductatareducedcost. 3.Customerfeedback Whenthecompaniesfocusonlyonthepriceoftheproductthatisofferedtothecustomers,thentheytendtoignorethemarketshiftsintheproducts.Customersalwayschangetheirpreferencesandtestoversometime. Ifthecompanydecidestomaintainthesameproductorserviceatareducedcost,thenitmayfindthatmanycustomersarewillingtopaymoreandshiftedtocompetitiveproductsbecausethey’reabletomeettheirchangingneeds. 4.Copycats Costleadershipisalwaysgoingtobetemporary.Onceacompanyfromanindustrybeginstouseacostleadershipstrategyforhigherprofitmargins,thenallothercompetitorswillenterintothesamegamebycopyingthesametechniqueandreducetheirpricesaswell. Newtechnologieswillbeobsoleteinafewyears,evenifmoneyisinvestedintheirRNDdepartments. 5.Substandardquality Cost-cuttingisnotaneasyprocess.Oncetheobviousitemscanbefoundwhicharecut,thentheworkofcostleadershipbegins.Eitherisoverqualityrawmaterialsarerequiredtoincreasetheprofitmargin,ortheremaybeachangeinthebudgetoftheadvertisingandmarketingdepartmentwhichmayimpactthenewcustomersobtained. Somecompaniescutthecostoftheiremployeestorecovertheexpenses.Allsuchstrategieswillleadtosubstandardproductseitherintermsofitsqualityoritssupport. 6.Notforeveryproduct Costleadershipstrategycannotbeappliedtoeveryproductorservice.Especiallywhenkeepingitsqualitythesame.Anexemplaryproductcannotremainthesameandhastoturnintoanacceptableonewhenemployedwithacostleadershipstrategy. ForpremiumbrandslikeAppleandGoogle,thecostleadershipstrategycannotbeusedasitmaybackfire.Thequalityprovidedbythesebrandsisbecausetheychargemorethannaturalproductsandtorecovertheircostsofresearchanddevelopmentandmanufacturingcosts.Withlowprices,theycannotfunction.Hencethecostleadershipstrategyisnotforeveryproduct. 7.CapitalAvailability Everycompanycannotstartitsbusinesswithacostleadershipstrategy.Theyhavetohavesufficientprofitstocovertheadditionalexpensesifany.Sincecostleadershipstrategydirectlyaffectstheworkingcapitalandprofitabilityoftheorganization,thereshouldbeadequatefundsavailabletotaketheheat. Evenifitdoesn’tworkoutinthelongrun,capitalavailabilityshouldbeenoughthattheorganizationshouldbeabletostartthisthrough. 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