In the event that most buyers are sensitive to price, companies try to lead in costs, increasing efficiency and reducing costs. The strategic goal is not the maximum cost reduction in itself, but the achievement of maximum cost superiority over competitors. A company with experience in cost reduction successfully implements a cost leadership strategy.
But in the pursuit of low costs, it is necessary to simultaneously take care that the product or service contains consumer properties that are significant for buyers; if the product is inferior in its characteristics to a similar product of competitors, then it does not strengthen, but weakens the competitive position of the company. Reducing costs by reducing the consumer value of the product repels buyers. In addition, it is desirable to use methods that are difficult or impossible for competitors to reproduce. The significance of a competitive advantage in terms of costs is determined by the degree of its stability. If competitors easily find relatively inexpensive ways to reproduce the actions of the leader in terms of costs, the leadership of the latter will be short-lived and is unlikely to be able to provide him with a winning competitive position in the industry.
The cost leader has two ways to generate significant additional profits. The first way is to reduce the price of the product by reducing costs and try to attract as many price-sensitive buyers as possible. The main thing here is to keep the difference in price compared to competitors within the cost difference or, at least, to ensure an increase in total profit due to an increase in sales volume, despite the fact that the profit from the sale of individual units of the product may decrease slightly. The second way is to reduce costs, not to reduce the price and maintain the existing market share; then additional profit will be obtained by increasing the profit from the sale of each unit of the product. Accordingly, the total profit from sales and the total profitability of the company will increase.
To achieve a competitive advantage in terms of costs, the total costs of the company in the entire value chain should be less than the same indicator of competitors. This can be achieved in two ways [42 p.97]:
Surpass competitors in the effectiveness of internal value chain management and the use of cost reduction reserves in its individual links; Reorganize the company’s value chain, eliminating the most expensive links.
In the first case, the level of costs in each link of the value chain depends on many factors [42 pp.70-107]:
Scale of production; Learning and accumulation of experience; Acquisition of key resources; Connection with other links of the company’s value chain; Sharing of equipment and resources; Vertical integration instead of a contracting system; The policy of the pioneer or follower; Loading of production capacities; Choice of strategy and production solutions.
In the second case, cost advantages can be obtained by restructuring processes and tasks, reducing unnecessary costs and increasing efficiency. Value chain reorganization takes many forms:
Transition to electronic technologies; Direct sale to the end user, direct marketing; Simplification of product design; Refusal of additional accessories and consumer properties; Transition to simplified, more flexible and less capital-intensive technological processes; Refusal to use expensive raw materials and components; Relocation of production facilities; Concentration on the main needs of consumers; Reorganization of the business model to increase consistency and eliminate inefficient stages [15 p.167].
Thus, the key to success in achieving a competitive advantage in terms of costs is the constant study of all links in the value chain in search of reserves for cost reduction. Companies that have chosen a low-cost strategy should examine each cost area to identify sources of additional costs and achieve cost reduction in each link in the value chain.
Among the companies that have chosen the strategy of leadership in terms of costs are Lincoln Electric (production of welding equipment), Bic (ball pens), Black & Decker (production and trade of tools), Stride Rite (production of shoes), Beaird-Poulan (electric saws), Nucor (metallurgy), General Electric to Whirlpool (household appliances), Ameritrade (brokerage services on the Internet) [15 p.176].
A cost leadership strategy yields better results in a number of situations, such as:
Strong competition for price. Low-cost producers are in a better position to compete in prices, lower prices (to capture competitors’ market shares), maintain profitability and survive in the face of fierce price competition; Standard or intended for a wide range of consumers product. If competing products have a standard set of basic consumer properties, then fierce competition over price is inevitable, from which producers with a high level of costs suffer more than others; Impossibility of differentiation of goods. If the buyer does not distinguish between trademarks, the price becomes the main factor in making a purchase decision; Standard use of the product. If the product meets the most common consumer requirements, then the basic standard model fully satisfies the needs of buyers. In this case, consumer preferences are determined by price, and not by the characteristics or quality of the goods; Low costs for changing the brand. Low costs for the transition from one product to another provide consumers with greater freedom of choice when searching for the best price. It is easier for the cost leader to use the low price policy to retain customers; Cooperation with large customers who require a price reduction. Low-cost producers have a margin of profitability to make deals with large buyers, since even large buyers rarely manage to achieve a price reduction below the cost level; Newcomers to the market reduce prices to attract buyers and create a customer base. A low-cost company can also lower prices to retain buyers and make it harder for a new competitor to penetrate the market; the company uses its margin of profitability as a barrier to enter the market of new competitors.
As a general rule, the higher the sensitivity of buyers to the price and the more such buyers, the more effective the cost leadership strategy. The cost leader can set the lowest prices in the market. In markets where there is mainly competition on price, low relative costs are a serious competitive advantage.
The disadvantages of the cost leadership strategy are as follows: First, the cost leadership strategy is fraught with a protracted price war, in which losses due to price reductions will eventually exceed the savings, as a result of which the overall profitability of the company will decrease. Second, when choosing a cost leadership strategy, a company must remember that cost-cutting methods will not always be its exclusive property, and that it is easy for competitors to replicate them. The value of a cost leadership strategy largely depends on its resistance to copying, i.e. how difficult it is for competitors to reproduce cost reduction methods.
Third, the cost leader risks getting too caught up in cost reduction. The company will fully focus on this direction and forget about other important factors, for example, about offering additional goods and services, improving existing products, developing new methods of using the goods, possibly reducing the buyer’s sensitivity to price. While the company is working to reduce costs, the buyer can change his preferences and demand improved quality, new properties, improved service, etc.
There are other problems. Cost leadership is very fragile: a technological breakthrough or the creation of an even more cost-effective value chain model nullifies the hard-won advantage. In addition, significant investments in cost reduction “tie” the company to the technology used and the current strategy, and it cannot quickly rebuild.