Businesses are constantly looking for ways to get ahead of competitors, and it’s an important thing to do in such a competitive landscape. An effective cost leadership strategy is one of the most effective ways of gaining a competitive edge. By focusing on becoming the lowest cost producer in your industry, you can attract price sensitive customers, increase your market share and drive profitability.
However, implementing a cost leadership strategy comes with its own set of challenges and potential downsides. In this blog, we have taken a look at the pros and cons of cost leadership, and the hurdles that you could face when you’re implementing a successful strategy.
What is Cost Leadership?
There are a lot of terms and phrases used in business, and cost leadership is one that every business owner should be aware of. It refers to when a business makes a point of positioning itself as the industry’s lowest cost supplier of specific goods or service. For example, Ryanair is known for cheap flights, and IKEA is known for cheap furniture. In order to stay competitive, a business seeking cost leadership needs to continually work to reduce operational costs, which requires a strong strategy. But, implementing a strategy can be difficult.
There’s no denying that cost leadership is a good way to capture a target market, grab customers’ attention and solidify yourself as a market leader. But, putting cost leadership into place is a challenge. It’s about striking a balance between working hard to bring down the price of a product or service, whilst also ensuring all business offerings are just as affordable.
One key thing to remember about cost leadership is that lowering the quality to achieve lower prices can backfire. Eventually, customers will notice the poor quality and head elsewhere. To implement successful cost leadership, you need to provide goods and services that are of an acceptable quality, and available at a lower cost than your competitors.
Along with cost leadership, there’s another term to be aware of, price leadership. These are often used interchangeably, but they are two different ideas. Whereas cost leadership focuses on creating a competitive edge by reducing the cost of doing business, price leadership focuses on offering the best deal.
What Does Cost Leadership Entail?
There’s a lot that goes into cost leadership, and implementing a successful cost leadership strategy requires you to minimise costs, price goods and services strategically, and optimise business operations.
- Minimise Costs – To implement successful cost leadership, you need to minimise costs. Efficient production processes, supply chain optimisation and resource management are all key ways of minimising business costs. By minimising costs, it’s possible to reduce expenses and achieve a competitive advantage. If you’re spending less to provide goods, you can then sell those goods for less.
- Price Goods and Products Strategically – As a cost leader, you need to offer the lowest prices, set low profit margins and aim for a lot of sales. You need to establish yourself as a business that prioritises keeping things low cost for customers. You can solidify yourself within the industry as a cost leader by continuously monitoring and adjusting prices to ensure they maintain their cost advantage.
- Streamline Business Operations – Streamlining business operations is a key part of cost leadership. By looking for ways to improve processes – for example, by automating daily tasks – it’s possible to improve efficiency and reduce costs throughout the company. These reduced costs can be passed on to customers in the form of cheaper products and services.
The Pros of Cost Leadership
There are a lot of benefits that come with cost leadership, such as boosted profits and an increased competitive advantage. Here are some of the key reasons businesses prioritise cost leadership:
- It Can Boost Profits – It’s possible to increase profitability with cost leadership, and this happens through high sales volumes. It gives your business the ability to capture a wider target market and a larger market share, which makes up for the lower profit margins.
- It Gives Businesses a Competitive Advantage – Cost leadership gives businesses a competitive advantage, as customers are more likely to choose cost effective purchases. Instead of relying on standing out as being a business that offers something slightly different, you can stand out as a business that’s cheaper than competitors.
- It Hinders New Businesses – Once you have solidified yourself as a cost leader in an industry, it’s instantly harder for new businesses to do the same. Going above and beyond the cost efficiency achieved by established cost leaders isn’t easy, which makes it difficult for new businesses to compete with you.
- It Helps Businesses to Weather Economic Downturns – There’s no knowing when an economic downturn will happen, and financial instability can come without warning. When this happens, customers are less likely to splurge on products and services. If you have established yourself as a cost leader, you will find it easier to weather the storm. When an economic downturn occurs, customers will be desperately looking for affordable alternatives.
- It Keeps Businesses Flexible and Adaptable – To be a cost leader, you need to be able to quickly adapt to changing market conditions. This means developing the flexibility to adjust prices and cost management strategies at a moment’s notice, in a bid to stay competitive. If other businesses drop their prices, the flexibility and adaptability that comes with being a cost leader means that you’re able to stay in the game.
The Cons of Cost Leadership
Along with the many advantages of cost leadership, there are some downsides to be aware of. If you are thinking about implementing a cost leadership strategy, bear these in mind:
- Businesses are Open to Imitation – Though cost leadership does make it difficult for a new business to compete, it does mean that you’re at risk of imitation. If you sell goods or services that are easy to replicate, you’re at risk of other businesses swooping in and trying to undercut you. This could lead to a price war, putting your competitive advantage at risk.
- There’s Limited Flexibility in Pricing – A lot of cost leaders struggle to be flexible with pricing, because there’s only a very small profit margin to work with. This limits your business’ ability to respond to changes in raw materials and labour, which can reduce your profitability.
- It Raises Questions Over Quality – When products are offered at a low price, it can raise questions about the quality and value of them. Though customers are looking to save money, they may assume that a very low price equals very low quality. This could lead to negative brand reputation, with customers reluctant to buy.
- There’s a Lot of Competition – There’s a lot of competitor businesses in cost leadership, all of which are hoping to undercut your prices. This means that cost leadership strategies need constant work and adjustments, to ensure that your prices remain competitive and achievable.
- It’s Hard to Be Innovative – There’s not a lot of room for innovation in cost leadership. Innovation is often expensive, especially if you need to invest in research and development, which isn’t always possible if your profits are relatively low. When you’re working hard to reduce costs, there’s not a lot left over for innovation.
- Reduced Customer Loyalty is Likely – When customers are purposely looking for low prices, they are less likely to be loyal to a specific business. If one of your competitors offers a lower price, they won’t hesitate to choose them over you. This makes it difficult to build long term customer relationships, and there’s no guarantee that customers will return to your business in the future.
At Profici, we know how important it is to grow as a business, and successful cost leadership is a good way of doing this. Of course, there are other approaches, and we are here to help you along the way. To find out more about cost leadership strategy implementation, and for help growing your business, get in touch with our experts.
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