As the business environment become even more dynamic, a robust cost leadership strategy within the framework of corporate strategy is vital in order to ensure the success of the organization. It should provide the direction that the whole organization can pursue to secure the company’s future survival and success. There are types of generic strategies that companies must possess to achieve competitive advantage. The first generic strategy is cost leadership strategy and the others are differentiation and focus strategies. Competitive advantage can be defined as anything which gives one organization an edge over its rival in the products it sell or the services it offers.
In general, cost leadership is about being the lowest cost producer in the industry. For an organization to gain competitive advantage, it must achieve overall cost leadership in an industry it is competing in. For companies competing in a “price-sensitive” market, cost leadership is the strategic imperative of the entire organization. It is vitally important for these companies to have a thorough comprehension of their costs and cost drivers in order to pursue a cost leadership strategy. They also need to fully understand their targeted customer group’s definition of quality, usually denoted in terms of design specifications, contractual requirements, delivery and services at the lowest possible cost. Of particular importance will be for the company to attain a cost level that is low relative to its competitors.
Cost Leadership Strategy
This strategy according to Porter, involves the firm winning market share by strategizing to cost-conscious or price-sensitive customers. This is achieved by having the lowest prices in the target market segment, or at least the lowest price to value ratio (price compared to what customers receive). To succeed at offering the lowest price while still achieving profitability and a high return on investment, the firm must be able to operate at a lower cost than its rivals. There are three main ways to achieve this.
The first approach or way is achieving a high asset turnover. In manufacturing, it will involve production of high volumes of output. These approaches mean fixed costs are spread over a larger number of units of the product or service, resulting in a lower unit cost, for an example the firm hopes to take advantage of economies of scale and experience curve effects. For industrial firms, mass production becomes both a strategy and an end in itself. Higher levels of output both require and result in high market share, and create an entry barrier to potential competitors, who may be unable to achieve the scale necessary to match the firm low costs and prices.
The second way is achieving low direct and indirect operating costs. This is achieved by offering high volumes of standardized products, offering basic no-frills products and limiting customization and personalization of service. Production costs are kept low by using fewer components, using standard components, and limiting the number of models produced to ensure larger production runs. Overheads are kept low by paying low wages, locating premises in low rent areas, establishing a cost-conscious culture, etc. Maintaining this strategy requires a continuous search for cost reductions in all aspects of the business. This will include outsourcing, controlling production costs, increasing asset capacity utilization, and minimizing other costs including distribution, R&D and advertising. The associated distribution strategy is to obtain the most extensive distribution possible. Promotional strategy often involves trying to make a virtue out of low cost product features.
The third dimension is control over the supply/procurement chain to ensure low costs. This could be achieved by bulk buying to enjoy quantity discounts, squeezing suppliers on price, instituting competitive bidding for contracts, working with vendors to keep inventories low using methods such as Just-in-Time purchasing or Vendor-Managed Inventory. Wal-Mart is famous for squeezing its suppliers to ensure low prices for its goods. Dell Computer initially achieved market share by keeping inventories low and only building computers to order. Other procurement advantages could come from preferential access to raw materials, or backward integration.
Some writers claim that cost leadership strategies are only viable for large firms with the opportunity to enjoy economies of scale and large production volumes. However, this takes a limited industrial view of strategy. Small businesses can also be cost leaders if they enjoy any advantages conducive to low costs. For example, a local restaurant in a low rent location can attract price-sensitive customers if it offers a limited menu, rapid table turnover and employs staff on minimum wage. Innovation of products or processes may also enable a startup or small company to offer a cheaper product or service where incumbents’ costs and prices have become too high.
The Starbucks Company
Starbucks used mostly a differentiation strategy; however it had also used a cost leadership strategy. Its differentiation strategy was exemplified by their stores providing an experience, offering interesting coffee-related drinks in a theatrical kind of atmosphere, their unique Coffee blending and roasting process which enabled them to create an extensive product variety, their employees received great deal of training to become very knowledgeable about coffee in order to provide an exceptional service to increasingly coffee-educated consumers, and their ability to find the perfect location for their stores enabled them to maximize market share in a given area of a city and build their regional reputation which then increased their image to a national level of high prestige and status. For all these reasons, consumers were willing to pay a premium. Their cost leadership strategy was exemplified by their supply chain operations where they received the best transportation rates, and were able to achieve economies of scale by eliminating redundancy and maximize efficiency. Starbucks was also a cost leader due to its good relationship with coffee exporters who were “very anxious to become Starbucks suppliers”; a fact that enabled the company to get better prices and reduce bean-sourcing costs. The activities that created superior value for Starbuck’s retail coffee-house business were: Procurement – purchased more high quality coffee than anyone else in the world. Technological Development – a lot of research was put into the roasting and blending process to create unique tastes. Human Resource Management extensive training and educating of employees (baristas) and turning them into part of the organizational culture. Outbound Logistics – finding good Real estate to maximize market share in certain area and provide the coffee in key places to consumers.
The Nestle Company
Nestlé with headquarters in Vevey, Switzerland was founded in 1866 by Henri Nestlé and is today the world’s biggest food and beverage company. They employ around 250,000 people and have factories or operations in almost every country in the world. The Company’s strategies are guided by several fundamental principles. Nestlé’s existing products grow through innovation and renovation while maintaining a balance in geographic activities and product lines. Long-term potential is never sacrificed for short-term performance. The Company’s priority is to bring the best and most relevant products to people, wherever they are, whatever their needs, throughout their lives. Nestlé Company has aimed to build a business based on sound human values and principles. Nestlé believes in making a long-term commitment to the health and wellbeing of people in every country in the scope of their operations. At Nestlé Significant differentiation from traditional retail and less price transparency is followed. They follow this differentiation strategy to reduce the risk of complexity of supply chain and lower attractiveness for discounters. Pepsi Co merged with the Quaker Oats Company, creating the world’s fifth-largest food and beverage company, with 15 brands – each generating more than $1 billion in annual retail sales. Pepsi Co follows the differentiation strategy. Their ability to innovate is their competitive advantage. They look for opportunities to capitalize on the value of their brands by creating new products and varieties. By innovating to meet consumer needs and preferences, they fill consumption gaps and contribute to create both healthier and indulgent choices for consumers, and bringing more enjoyment to their lives.
As you can see, Nestle also uses the differentiation strategy for cost leadership strategy just like the Coca cola Company. This shows that the customers are asking for a change. They want revolution in the products. That is what these two companies are doing to keep alive and top in what they do.
As conclusion, I would like to say that cost leadership strategy is used by organizations to lower the cost used for business and enhance the productivity and profit. This is a very good strategy to be used in a business.