What Must a Cost-leadership Strategy Accomplish to Be Successful?

Affiliate 5: Selecting Business-Level Strategy

Cost Leadership

1. Describe the nature of toll leadership.
2. Understand how economies of calibration assist contribute to a cost-leadership strategy.
3. Know the advantages and disadvantages of a cost-leadership strategy.

The Nature of the Cost-Leadership Strategy

It is tempting to think of cost leaders every bit companies that sell inferior, poor-quality goods and services for rock-bottom prices. The Yugo, for example, was an extremely unreliable car that was fabricated in Eastern Europe and sold in the United States for near $4,000 in the 1980s. Despite its attractive price tag, the Yugo was a dismal failure because the car was and so poorly made that drivers merely could non depend on the motorcar for transportation. Yugo exited Due north America in the early 1990s and closed downwards entirely in 2008.

Effigy 5.3 Price Leadership [Image description]

In contrast to firms such as Yugo whose failure was inevitable, cost leaders can exist very successful. A firm post-obit a strategy offers products or services with adequate quality and features to a broad set of customers at a low price (Figure 5.iii "Price Leadership").  This combination of an advisable price and value is sometimes referred to as a potent value proposition. Payless ShoeSource, for example, sells proper name-brand shoes at inexpensive prices. Its low-price strategy is communicated to customers through advertizing slogans such as "Why pay more when you can Payless?" and "Yous could pay more, but why?"

Firms engaging in cost-leadership strategy seek to combine depression per-unit profit with large sales to make a profit.  Typically, but not always, they tend to market to a big population base or a niche with a high demand book.

Effigy five.4: Listeners of the popular radio show Machine Talk voted the Yugo every bit the "worst car of the millennium."

Perhaps the almost famous toll leader is Walmart, which has used a cost-leadership strategy to go the largest company in the world. The firm's advertising slogans such as "Always Depression Prices" and "Relieve Money. Live Better" communicate Walmart's emphasis on price slashing to potential customers. Meanwhile, Walmart has the broadest client base of any firm in North America. Approximately 100 1000000 of us visit a Walmart in a typical calendar week (Zimmerman & Hudson, 2006). Incredibly, this means that roughly one-third of Americans are frequent Walmart customers. This huge customer base includes people from all demographic and social groups within society.

In 2014, Walmart faced stiff completion from dollar store chains coupled with growing contest from Amazon.com and Internet shopping as more and more people store online. Walmart has been sharpening its focus on everyday low prices and farther pushing that strategy abroad. Interestingly, Walmart's success has been somewhat limited in their international expansion efforts. Having exhausted the potential sales market for big-box stores, with over 90 per centum of North Americans living within 15 minutes of a Walmart, the company is planning to accelerate growth plans for smaller Neighborhood Markets and Walmart Express stores that cater to shoppers looking for more convenience with fresh produce and meat and household and beauty products (Anderson, 2014).

Cost leaders tend to share some important characteristics. The power to charge depression prices and nonetheless make a profit is challenging. Toll leaders manage to do and then by emphasizing efficiency at every step of the value chain: product, manufacturing, sales, and client service. At Smitty's Restaurants, for example, customers are served cheap meals quickly to proceed booths available for later customers. As office of the effort to be efficient, well-nigh cost leaders spend little on advertisement, market place inquiry, or research and evolution. Smitty'south, for example, limits its ad to billboards forth highways, a $2 membership carte du jour for 10 percent discounts, and its website. Meanwhile, the simplicity of Smitty'due south menu requires petty research and development.Walmart spent approximately $2.3 billion on ad in 2013.  This is a huge number, only Walmart is so large that its advertising expenses equal just a tiny fraction of its sales.

Many cost leaders rely on to achieve efficiency. Economies of scale are created when the cost of goods and services decreases as a firm is able to increase production. Near companies practise feel some economics of scale initially; for a coffee shop, the most expensive cup of coffee they make every day is the commencement!  Notwithstanding, for some firms such as a new hydro generation plant or the latest Lady Gaga CD,there are huge start-upwards or fixed costs (remember, the cost of making the first Lady Gaga CD is mayhap $250,000; the 2nd, one cent; the tertiary, 1 cent…).  T he average costs fall the more than electricity is generated or CDs are printed—economies of scale.

When cost leaders become big companies, it tin give them sufficient market power to demand cost concessions from their suppliers. Walmart is notorious for requiring suppliers, such as Procter & Chance, to sell appurtenances to Walmart for lower and lower prices over time. In its defence, Walmart invests considerable resources and efforts to help suppliers find ways to reduce costs. Walmart then seeks to pass on most of these savings to customers in the course of reduced prices.

Advantages and Disadvantages of Cost Leadership

Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well every bit disadvantages that may undermine their success. In the case of cost leadership, one advantage is that toll leaders' emphasis on efficiency makes them well positioned to withstand price competition from rivals (Figure 5.five "Executing a Low-Price Strategy"). Kmart and Zellers'southward ill-fated attempt to engage Walmart in a cost state of war concluded in disaster, in function because Walmart was so efficient in its operations that it could live with smaller turn a profit margins far more easily than Kmart or Zellers could.

Figure 5.5 Executing a Low-Cost Strategy [Image clarification]

Beyond existing competitors, a cost-leadership strategy also creates benefits relative to potential new entrants. Specifically, the presence of a cost leader in an manufacture tends to discourage new firms from entering the business because a new firm would struggle to attract customers by matching or even undercutting the cost leaders' prices. Thus a cost-leadership strategy helps create barriers to entry that protect the firm—and its existing rivals—from new competition.

Effigy 5.6: Challenging a cost leader in a price war may end up destroying a company.

In many settings, price leaders attract a large marketplace share because a big portion of potential customers notice paying depression prices for goods and services of adequate quality to exist very appealing. This is certainly truthful for Walmart, for example. The need for efficiency means that price leaders' profit margins are often slimmer than the margins enjoyed by other firms. However, cost leaders' ability to make a little scrap of profit from each of a large number of customers means that the total profits of cost leaders can be substantial.

In some settings, the demand for loftier sales volume is a disquisitional disadvantage of a cost-leadership strategy. Highly fragmented markets and markets that involve a lot of brand loyalty may not offer much of an opportunity to attract a large segment of customers. In both the soft-drink and beer industries, for case, customers appear to be willing to pay a little extra to enjoy the make of their pick. Lower-cease brands of soda and beer appeal to a minority of consumers, but famous brands such equally Coca-Cola, Pepsi, Budweiser, and Molsons still boss these markets. A related concern is that achieving a high sales book normally requires significant upfront investments in product and/or distribution chapters. Not every business firm is willing and able to make such investments.

Cost leaders tend to go along their costs low by minimizing advertising, marketplace research, and research and evolution, but this approach can prove to exist expensive in the long run. A relative lack of marketplace research can lead cost leaders to be less skilled than other firms at detecting important environmental changes and trends. Meanwhile, downplaying research and evolution can slow cost leaders' ability to respond to changes in one case they are detected. Lagging rivals in terms of detecting and reacting to external shifts can prove to exist a deadly combination that leaves cost leaders out of touch with the market and out of answers.

• Toll leadership is an constructive business-level strategy to the extent that a firm offers low prices, provides satisfactory quality, and attracts enough customers to exist profitable.

1. What are three industries in which a toll-leadership strategy would be difficult to implement?
2. What is your favourite cost leadership eating place?
3. Name three examples of firms conducting a cost-leadership strategy that use no advert. Should they start advertising? Why or why not?

References

Anderson, Yard. (2014, May 15). Poor weather condition dents Wal-Mart 1Q results; 2Q earnings forecast misses analysts' expectations. Retrieved from http://www.winnipegfreepress.com/concern/bad-conditions-hurts-wal-mart-in-1q-gives-2q-earnings-forecast-below-analysts-expectations-259358851.html

Zimmerman, A., & Hudson, G. (2006, April 17).  Managing Wal-Mart: How US-store master hopes to gear up Wal-Mart.Wall Street Periodical.

Prototype descriptions

Figure 5.3 image description: Cost Leadership

Firms that compete based on price and target a broad target market are post-obit a toll leadership strategy. Several examples of firms pursuing a cost leadership strategy are illustrated beneath.

• IKEA is the toll leader in the furniture industry. IKEA has successfully combined low cost with proficient quality, and its "democratic designs" that balance role, quality, design, and price giving IKEA a competitive edge.
• Payless ShoeSource is a disbelieve retailer that sells inexpensive shoes for men, women, and children. Their advertising slogans such as"Why pay more than when yous can Payless?" and"Y'all could pay more, but why?" consistently preach a depression-cost message.
• Supercuts' website makes clear their longstanding cost leadership strategy by noting, "A Supercut is a haircut that has kept people looking their best, while keeping money in their pockets, since 1975."
• To attract cost-sensitive customers away from competitors, seven-Eleven stores offers $1.00 coffee or iced java, sometimes on specific weekdays. Adding a chocolate bar or lottery ticket would increase the full bill, and brand upward for any loss on coffee prices.

Return to Effigy 5.3

Figure 5.5 paradigm description: Executing a Low-Cost Strategy

Using a cost leadership strategy offers firms important advantages and disadvantages. Below we illustrate a few examples in relation to entertainment and leisure.

• Advantages
  • High profits tin can be enjoyed if a cost leader has a loftier market share. An case is Kampgrounds of America, a chain of well-nigh 500 low cost camping ground franchises in the United States.
  • Depression-toll firms such as many municipal golf game courses Can withstand cost wars because high-priced competitors will not want to compete directly with a more efficient rival.
• Disadvantages
  • If perceptions of quality become also low, business will suffer.
  • Large volumes Of sales are a must considering margins are slim.
  • The need to keep expenses low might lead cost leaders to be belatedly in detecting key environmental trends.
  • Low-cost firms' emphasis on efficiency makes it difficult for them to alter quickly if needed.

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Source: https://opentextbc.ca/strategicmanagement/chapter/cost-leadership/

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