When it comes to the standard strategies dictating a business’ operation, there are a few distinct camps into which almost all businesses fall:
- Some create a superior product, offering it at a premium price point
- Some aggressively target a specific niche market, relying on brand loyalty and high enthusiasm from a small segment of market share
- Some employ the cost leadership model
What Is Cost Leadership?
The cost leadership strategy is utilized by some of the world’s largest companies and should be carefully understood by any business with a product — whether it plans to implement the method or not.
A cost leadership strategy targets a specific, large customer majority within major demographics and markets. Purchasing decisions made by this customer majority are based on the product’s price point rather than brand loyalty.
Companies employing a cost leadership strategy concentrate on winning market shares by offering acceptable-quality products at lower prices than their competition. This is accomplished by optimizing a few key components of their business.
- Maintaining the lowest price point often means accepting thin profit margins. Companies must scale their sales volumes to where even a slim margin, repeated over a large number of sales, can maintain profitability.
- To protect as much profit as possible, these companies must stress efficiency in every part of their operation. Cost leadership companies aggressively improve upon their processes, leverage long-term relations with vendors to reduce costs over time, and quickly scale their operations, taking advantage of bulk and wholesale pricing.
Examples of Cost Leadership Strategy Companies
There are countless examples of companies that have both successfully and unsuccessfully attempted to implement cost leadership techniques. A few of the most notable include:
- Walmart epitomizes the cost leadership model, offering thousands of products at the lowest prices. This vast, international organization serves more than 100 million customers every week. Walmart built a brand dynasty with the potential to effectively outcompete its rivals for years.
- IKEA carved out a sweet spot in the retail industry as a cost-effective but trendy resource for a wide variety of household products including furniture, cookware, and more. IKEA effectively branded itself by keeping its prices low and products at acceptable quality that will not jeopardize its profit margins.
- Waffle house cultivated a brand offering inexpensive food to be served at all hours. The company maintains profits at low sales margins by strategically placing its restaurants along long-distance driving routes and simplifying its menu.
Pros of Cost Leadership Strategy:
The nature of a cost leadership strategy forces firms to scale their operations. Businesses benefitting most from implementing this strategy either sell a relatively standardized product or already possess an adequate market share and steady volume of sales. These companies are poised to streamline their processes, undercutting the competition.
- Utilizing a cost leadership strategy makes it very difficult for competition to enter the marketplace, allowing for market domination. Without pre-existing momentum, it’s almost impossible for newcomers to survive long enough to effectively undercut the cost leader. It is difficult to challenge cost leadership companies once they have gained momentum due to how they naturally scale.
Cons of Cost Leadership Strategy:
- This strategy hinges on a company cutting production costs and producing acceptable products, not exemplary ones. As a result, cost leadership principles cannot be applied to elite brands. Additionally, companies whose perceived quality dips from ‘acceptable’ to ‘low’ could jeopardize their customer base.
- With the mass consumer base making purchasing decisions based almost entirely on the lowest price point, this strategy does not foster brand loyalty. Should a competitor enter the market with lower prices and sizable sales momentum, customers could easily be wooed away.
- A cost leadership model requires a large volume of sales for a business to maintain profitability. Companies must navigate and apply operational scaling to achieve sustainability before running out of capital.
- A cost leadership strategy does not readily allow time for any detailed market research or product development. Since companies need to scale quickly, companies that employ this model could be more susceptible to environmental or market changes due to lack of company maneuverability and slow reaction time.
When effectively managed, cost leadership companies can become highly successful and generate tremendous profits. However, they also face complex challenges that necessitate significant risk taking. The key to utilizing the strategy is to acquire an in-depth, multilayered understanding of its inner workings before diving in.
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