Cost leadership is a position in which a business organization or firm achieves cost-efficiency that enables it to present itself as the cheapest manufacturer or provider of a particular product in a specific industry or market, thereby giving it a competitive advantage.
The concept was first introduced by Michael E. Porter in his Four Generic Strategies. Note that cost leadership is different from price leadership, which is a position in which a dominant firm determines the price of a product and price changes in a particular market.
As a Source of Competitive Advantage: How Does Cost Leadership Give a Firm an Advantage Over Its Competitors?
Note that cost leadership is a business-level strategy generally aimed at achieving a competitive advantage by specifically developing and implementing ways to lower the costs of operations in an entire industry or a particular market.
A firm that achieves this position can reduce its price to make its product more attractive to its consumers and generate a high volume of sales. The implications of cost leadership collectively center on reducing competition and raising entry barriers for new entrants in the market.
The specific advantages or benefits of cost leadership include increasing the market share of a firm, better profits and higher salaries for its employees, improving the sustainability of the entire operation, and creating more capital for growth and expansion.
It can also influence the intensity of competitive rivalry. An industry with a dominant cost leader can dictate the prices in the market, thereby achieving price leadership, attracting more talents through better compensation, or pursuing other strategies aimed at innovation.
Existing competitors would have a hard time achieving the same level of profits and even the operational capabilities of a cost leader. This firm can also discourage aspiring competitors from entering an established market because of its industry dominance.
Dimensions of Cost Leadership Strategy: How Can A Firm Become A Cost Leader in a Particular Industry or Market?
Remember that cost leadership is a position in which a firm has managed to become cost-efficient or lowered the costs of its operations, thereby allowing it to pursue other strategies or programs aimed at outmaneuvering its existing and aspiring competitors.
Porter identified three dimensions that represent three general ways to achieve cost leadership or build a strategy to become a cost leader. These are high asset utilization, low direct and indirect costs, and control over the value chain. Below are further details:
• High Asset Utilization: This dimension involves using existing assets to their full capacities to spread fixed costs over a large number of product units. An example would be maximizing the production capacity of a production facility.
• Low Direct and Indirect Costs: This dimension can be achieved by offering high volumes of standardized products, offering no-frills or straightforward products, and limiting product customization or personalization.
• Value Chain Control: This dimension corresponds to analyzing and optimizing the different facets of operation such as supply and procurement management, accounting and finance, information technology, sales and marketing, inventory management, and human resource management, among others.
A specific cost leadership strategy essentially lists and expounds the specific tactics and actions a firm will implement or has implemented to become a cost leader or retain its position as a cost leader. Below are some pointers on how to become a cost leader:
• Production Efficiency: A cost-efficient production is a condition that enables a firm to produce goods or deliver services at the lowest possible cost. Production efficiency is achievable through standardization of processes, using innovation and technology, eliminating bottlenecks, identifying and reducing wastes, outsourcing, and investing in human resources and relevant equipment and machinery, among others.
• Supply Chain Management: Another way to achieve cost leadership is through effective supply chain management that includes access to best supplies or production inputs, managing and lowering the bargaining power of suppliers, building and maintaining relationships with suppliers through formal agreements, optimizing the entire supply chain, and vertical integration.
• Economies of Scale: The scale of operation of a firm can determine whether or not it has a cost advantage over its competitors. Some businesses have become large enough in terms of operational size, production output, distribution channels, and market share and market reach to render the costs of their production and operation almost negligible when compared with the costs shouldered by smaller businesses.
• Brand Equity and Brand Loyalty: Firms can also lower the costs associated with marketing their products later in their business tenure if they succeed in creating a strong brand and a loyal pool of customers. A strong brand equity and established brand loyalty would lessen the expenses associated with promotional strategies including advertising and specific sales strategies.
• Cumulative Experience: Leadership and management capabilities collectively represent another way to achieve cost leadership. A more experienced firm is fundamentally a more efficient organization. The depth of its experience can be determined by its technical capabilities, the expansiveness of its business networks, decision-making competencies, and the knowledge pool of its top management personnel and the entire workforce.
Notable Examples of Cost Leaders: What Are Some Examples of Companies that Have Become Cost Leaders in their Industry or Market?
Fast-food companies represent a prime example of firms that have maximized the utilization of their assets to offer food and beverage products that are cheaper than other types or forms of restaurants. Fast-food restaurants have centralized facilities for bulk production.
These restaurants also have a solid logistics route for storing supplies or inputs and distributing final products across their respective branches. Note that this is also similar to the model employed by so-called fast-fashion companies.
Both fast-food and fast-fashion companies also have demonstrated production efficiency stemming from their economies of scale and solid supply chains to enable them to become cost leaders, especially in the entire restaurant industry.
Several Chinese manufacturers of consumer electronic devices have low direct and indirect costs because of their standardized production processes designed for the production of a high volume of standardized products. Original equipment manufacturers are good examples.
These manufacturers also have large-scale production capabilities and access to suppliers or production inputs. Some of these firms produce their worn brands while others sell their products for rebranding by other companies.
Multinational producers of processed food products are examples of firms that have strong control over their value chain. They have access to inexpensive production inputs, utilization of production facilities capable of high output volume, and inexpensive labor costs.