Cost Leadership – Mastering Strategic Management

Cost leadership is an effective business-level strategy to the extent that a firm offers low prices, provides satisfactory quality, and attracts enough ... Skiptocontent Chapter5:SelectingBusiness-LevelStrategy CostLeadership Describethenatureofcostleadership. Understandhoweconomiesofscalehelpcontributetoacost-leadershipstrategy. Knowtheadvantagesanddisadvantagesofacost-leadershipstrategy. TheNatureoftheCost-LeadershipStrategy Itistemptingtothinkofcostleadersascompaniesthatsellinferior,poor-qualitygoodsandservicesforrock-bottomprices.TheYugo,forexample,wasanextremelyunreliablecarthatwasmadeinEasternEuropeandsoldintheUnitedStatesforabout$4,000inthe1980s.Despiteitsattractivepricetag,theYugowasadismalfailurebecausethecarwassopoorlymadethatdriverssimplycouldnotdependonthecarfortransportation.YugoexitedNorthAmericaintheearly1990sandcloseddownentirelyin2008. Figure5.3CostLeadership[Imagedescription] IncontrasttofirmssuchasYugowhosefailurewasinevitable,costleaderscanbeverysuccessful.Afirmfollowingacostleadership strategyoffersproductsorserviceswithacceptablequalityandfeaturestoabroadsetofcustomersatalowprice(Figure5.3“CostLeadership”). Thiscombinationofanappropriatepriceandvalueissometimesreferredtoasastrongvalueproposition.PaylessShoeSource,forexample,sellsname-brandshoesatinexpensiveprices.Itslow-pricestrategyiscommunicatedtocustomersthroughadvertisingsloganssuchas“WhypaymorewhenyoucanPayless?”and“Youcouldpaymore,butwhy?” Firmsengagingincost-leadershipstrategyseektocombinelowper-unitprofitwithlargesalestomakeaprofit. Typically,butnotalways, theytendtomarkettoalargepopulationbaseoranichewithahighdemandvolume. Figure5.4:ListenersofthepopularradioshowCarTalkvotedtheYugoasthe“worstcarofthemillennium.” PerhapsthemostfamouscostleaderisWalmart,whichhasusedacost-leadershipstrategytobecomethelargestcompanyintheworld.Thefirm’sadvertisingsloganssuchas“AlwaysLowPrices”and“SaveMoney.LiveBetter”communicateWalmart’semphasisonpriceslashingtopotentialcustomers.Meanwhile,WalmarthasthebroadestcustomerbaseofanyfirminNorthAmerica.Approximately100millionofusvisitaWalmartinatypicalweek(Zimmerman&Hudson,2006). Incredibly,thismeansthatroughlyone-thirdofAmericansarefrequentWalmartcustomers.Thishugecustomerbaseincludespeoplefromalldemographicandsocialgroupswithinsociety. In2014,Walmart facedstiffcompletionfromdollarstorechainscoupledwithgrowingcompetitionfromAmazon.comandInternetshoppingasmoreandmorepeopleshoponline.Walmarthasbeensharpeningitsfocusoneverydaylowpricesandfurtherpushingthatstrategyabroad.Interestingly,Walmart’ssuccesshasbeensomewhatlimitedintheirinternationalexpansionefforts.Havingexhaustedthepotentialsalesmarketforbig-boxstores,withover90 percent ofNorthAmericanslivingwithinfifteen minutesofaWalmart,thecompanyisplanningtoaccelerategrowthplansforsmallerNeighborhoodMarketsandWalmartExpressstoresthatcatertoshopperslookingformoreconveniencewithfreshproduceandmeatandhouseholdandbeautyproducts(Anderson,2014). Costleaderstendtosharesomeimportantcharacteristics.Theabilitytochargelowpricesandstillmakeaprofitischallenging.Costleadersmanagetodosobyemphasizingefficiencyateverystepofthevaluechain:production,manufacturing,sales,andcustomerservice.AtSmitty’sRestaurants,forexample,customersareservedcheapmeals quicklytokeepboothsavailableforlatercustomers.Aspartoftheefforttobeefficient,mostcostleadersspendlittleonadvertising,marketresearch,orresearchanddevelopment.Smitty’s,forexample,limitsitsadvertisingtobillboardsalonghighways,a$2membershipcardfor10percent discounts,anditswebsite.Meanwhile,thesimplicityofSmitty’smenurequireslittleresearchanddevelopment. Walmartspentapproximately$2.3billiononadvertisingin2013. Thisisahugenumber,butWalmartissolargethatitsadvertisingexpensesequaljustatinyfractionofitssales. Manycostleadersrelyoneconomiesofscale toachieveefficiency.Economiesofscalearecreatedwhenthecostofgoodsandservicesdecreasesasafirmisabletoincreaseproduction.Mostcompaniesdoexperiencesomeeconomicsofscaleinitially;foracoffeeshop,themostexpensivecupofcoffeetheymakeeverydayisthefirst! However,forsomefirmssuchasanewhydrogenerationplantorthelatestLadyGagaCD, therearehugestart-uporfixedcosts(think,thecostofmakingthefirst LadyGagaCDismaybe$250,000;the second,one cent; thethird,one cent…). TheaveragecostsfallthemoreelectricityisgeneratedorCDsareprinted—economiesofscale.  Whencostleadersbecomelargecompanies,itcangivethemsufficientmarketpowertodemandpriceconcessionsfromtheirsuppliers.Walmartisnotoriousforrequiring suppliers,suchasProcter&Gamble,tosellgoodstoWalmartforlowerandlowerpricesovertime.Inits defence,Walmartinvestsconsiderableresourcesandeffortstohelpsuppliersfindwaystoreducecosts.Walmartthenseekstopassonmostofthesesavingstocustomersintheformofreducedprices. AdvantagesandDisadvantagesofCostLeadership Eachgenericstrategyoffersadvantagesthatfirmscanpotentiallyleveragetoenhancetheirsuccessaswellasdisadvantagesthatmayunderminetheirsuccess.Inthecaseofcostleadership,oneadvantageisthatcostleaders’emphasisonefficiencymakesthemwellpositionedtowithstandpricecompetitionfromrivals(Figure5.5“ExecutingaLow-CostStrategy”).KmartandZellers’sill-fatedattempttoengageWalmartinapricewarendedindisaster,inpartbecauseWalmartwassoefficientinitsoperationsthatitcouldlivewithsmallerprofitmarginsfarmoreeasilythanKmartorZellerscould. Figure5.5ExecutingaLow-CostStrategy[Imagedescription] Beyondexistingcompetitors,acost-leadershipstrategyalsocreatesbenefitsrelativetopotentialnewentrants.Specifically,thepresenceofacostleaderinanindustrytendstodiscouragenewfirmsfromenteringthebusinessbecauseanewfirmwouldstruggletoattractcustomersbymatchingorevenundercuttingthecostleaders’prices.Thusacost-leadershipstrategyhelpscreatebarrierstoentrythatprotectthefirm—anditsexistingrivals—fromnewcompetition. Figure5.6:Challengingacostleaderinapricewarmayendupdestroyingacompany. Inmanysettings,costleadersattractalargemarketsharebecausealargeportionofpotentialcustomersfindpayinglowpricesforgoodsandservicesofacceptablequalitytobeveryappealing.ThisiscertainlytrueforWalmart,forexample.Theneedforefficiencymeansthatcostleaders’profitmarginsareoftenslimmerthanthemarginsenjoyedbyotherfirms.However,costleaders’abilitytomakealittlebitofprofitfromeachofalargenumberofcustomersmeansthatthetotalprofitsofcostleaderscanbesubstantial. Insomesettings,theneedforhighsalesvolumeisacriticaldisadvantageofacost-leadershipstrategy.Highlyfragmentedmarketsandmarketsthatinvolvealotofbrandloyaltymaynotoffermuchofanopportunitytoattractalargesegmentofcustomers.Inboththesoft-drinkand beerindustries,forexample,customersappeartobewillingtopayalittleextratoenjoythebrandoftheirchoice.Lower-endbrandsofsodaandbeerappealtoaminorityofconsumers,butfamousbrandssuchasCoca-Cola,Pepsi,Budweiser,andMolsonsstilldominatethesemarkets.Arelatedconcernisthatachievingahighsalesvolumeusuallyrequiressignificantupfrontinvestmentsinproductionand/ordistributioncapacity.Noteveryfirmiswillingandabletomakesuchinvestments. Costleaderstendtokeeptheircostslowbyminimizingadvertising,marketresearch,andresearchanddevelopment,butthisapproachcanprovetobeexpensiveinthelongrun.Arelativelackofmarketresearchcanleadcostleaderstobelessskilledthanotherfirmsatdetectingimportantenvironmentalchangesandtrends.Meanwhile,downplayingresearchanddevelopmentcanslowcostleaders’abilitytorespondtochangesoncetheyaredetected.Laggingrivalsintermsofdetectingandreactingtoexternalshiftscanprovetobeadeadlycombinationthatleavescostleadersoutoftouchwiththemarketandoutofanswers. Costleadershipisaneffectivebusiness-levelstrategytotheextentthatafirmofferslowprices,providessatisfactoryquality,andattractsenoughcustomerstobeprofitable. Whatarethreeindustriesinwhichacost-leadershipstrategywouldbedifficulttoimplement? Whatisyourfavouritecostleadershiprestaurant? Namethreeexamplesoffirmsconductingacost-leadershipstrategythatusenoadvertising.Shouldtheystartadvertising?Whyorwhynot? References Anderson,M.(2014,May15).PoorweatherdentsWal-Mart1Qresults;2Qearningsforecastmissesanalysts’expectations.Retrievedfromhttp://www.winnipegfreepress.com/business/bad-weather-hurts-wal-mart-in-1q-gives-2q-earnings-forecast-below-analysts-expectations-259358851.html Zimmerman,A.,& Hudson,K.(2006,April17).  ManagingWal-Mart:HowUS-storechiefhopestofixWal-Mart. WallStreetJournal. Imagedescriptions Figure5.3imagedescription:CostLeadership Firmsthatcompetebasedonpriceandtargetabroadtargetmarketarefollowingacostleadershipstrategy.Severalexamplesoffirmspursuingacostleadershipstrategyareillustratedbelow. IKEAisthecostleaderinthefurnitureindustry.IKEAhassuccessfullycombinedlowcostwithgoodquality,andits“democraticdesigns”thatbalancefunction,quality,design,andpricegivingIKEAacompetitiveedge. PaylessShoeSourceisadiscountretailerthatsellsinexpensiveshoesformen,women,andchildren.Theiradvertisingsloganssuchas”WhypaymorewhenyoucanPayless?”and”Youcouldpaymore,butwhy?”consistentlypreachalow-pricemessage. Supercuts’websitemakescleartheirlongstandingcostleadershipstrategybynoting,“ASupercutisahaircutthathaskeptpeoplelookingtheirbest,whilekeepingmoneyintheirpockets,since1975.” Toattractprice-sensitivecustomersawayfromcompetitors,7-Elevenstoresoffers$1.00coffeeoricedcoffee,sometimesonspecificweekdays.Addingachocolatebarorlotteryticketwouldincreasethetotalbill,andmakeupforanylossoncoffeeprices. ReturntoFigure5.3 Figure5.5imagedescription:ExecutingaLow-CostStrategy Usingacostleadershipstrategyoffersfirmsimportantadvantagesanddisadvantages.Belowweillustrateafewexamplesinrelationtoentertainmentandleisure. Advantages Highprofitscanbeenjoyedifacostleaderhasahighmarketshare.AnexampleisKampgroundsofAmerica,achainofnearly500lowcostcampingfranchisesintheUnitedStates. Low-costfirmssuchasmanymunicipalgolfcoursesCanwithstandpricewarsbecausehigh-pricedcompetitorswillnotwanttocompetedirectlywithamoreefficientrival. Disadvantages Ifperceptionsofqualitybecometoolow,businesswillsuffer. LargevolumesOfsalesareamustbecausemarginsareslim. Theneedtokeepexpenseslowmightleadcostleaderstobelateindetectingkeyenvironmentaltrends. Low-costfirms’emphasisonefficiencymakesitdifficultforthemtochangequicklyifneeded. ReturntoFigure5.5 MediaAttributionsFigure5.3:Attributioninformationforallincludedimagesisinthechapterconclusion.Yugo©AntpislicensedunderaCCBY-SA(AttributionShareAlike)licenseFigure5.5:Attributioninformationforallincludedimagesisinthechapterconclusion.Storeclosingbanner,S&B,SouthwestPlaza©BradleyGordonislicensedunderaCCBY(Attribution)licenseGenericstrategythatoffersproductsorserviceswithacceptablequalityandfeaturestoabroadsetofcustomersatalowprice. Acostadvantagecreatedwhenafirmcanproduceagoodorserviceatalowerperunitpriceduetoproducingthegoodorserviceinlargequantities. Previous:UnderstandingBusiness-LevelStrategythrough“GenericStrategies” Next:Differentiation Backtotop License MasteringStrategicManagement-1stCanadianEditionbyJaniceEdwardsislicensedunderaCreativeCommonsAttribution-NonCommercial-ShareAlike4.0InternationalLicense,exceptwhereotherwisenoted. ShareThisBook ShareonTwitter