Cost leadership strategy: pros and cons

Firms that compete on price and address a broad target market are pursuing a price competition strategy. cost leadership. Many of them rely on economies of scale to achieve efficiency.

How are economies of scale achieved?

Economies of scale are created when the cost of providing goods and services decreases as more items can be sold.. This is because costs are spread over a larger number of products.

What is a cost leadership strategy?

Cost leadership is a term used when a company projects itself as the cheapest manufacturer or supplier of a particular product or raw material relative to the competition. The strategy is difficult to implement because constant efforts are needed to reduce costs at all levels in order to remain competitive.

For many, cost leadership is a part of the marketing strategy. Although it is very effective in gaining market share and attracting customers' attention, it is difficult to implement.

In fact, following the decision to adopt a cost leadership strategy, the company's management team must constantly work to reduce cost not just for one product, but for the whole range of products in the company's portfolio. Process costs must be kept under control and the use of automated solutions is key to this..

Cost leadership does not mean that a company produces inferior quality goods at comparatively cheap prices, as this would lead to failure. To implement this strategy, a firm has to produce goods of acceptable quality and specific to a group of customers at a much lower or competitive price than other firms producing the same product.

Which companies use the cost leadership strategy?

It is often the larger companies that are the cost leaders, as they are in a position to demand price concessions from their suppliers and negotiate more advantageous payment terms. All these benefits translate into lower prices in the shop, the best way to attract large volumes of consumers looking for the best deal.

However, it is necessary to not to confuse a strategy of cost leadership with:

• Inferior quality of goods and services: IKEA is an example of the successful implementation of such a strategy and yet no one doubts the quality of their proposal, both in terms of materials and design.
• The strategy followed for the entire business offer: for example, in the case of Dunkin Donuts the cost leadership strategy is implemented with the sale of coffee, not with its flagship product. However, its cheap coffee is its main source of revenue and the means it has to stand up to competitors such as Starbucks.
• The lack of advertisementsWhile it is true that most cost leaders spend little on advertising, market research or research and development, there are examples of the opposite. McDonald's is one of them.

Cost leadership strategy: advantages and disadvantages

Each strategy offers advantages that companies can leverage to increase their success and, by the same token, all of them also have drawbacks that can slow down their expansion. The same is true for the strategy for cost leadership.

Its main advantage is that the emphasis on efficiency puts businesses that choose to follow this strategy in a good position and enables them to withstand price competition from rivals. In addition, if you have a high market share, you can generate even higher profits.. And not only that, The strength of such players in the market acts as a barrier to entry for new firms..

But it is not all about benefits.

In opting for a cost leadership strategy, there are also trade-offs to be considered.:

• The drop in sales that could occur if the perception of quality becomes too low.
• The need to secure high sales volumes in order to be able to continue in spite of the low margins.
• The delay that this policy may cause, which It would drive businesses with a cost leadership strategy in place away from early adoption of the latest market trends.
• The rigidity of a system that is not prepared to adapt to change with agility. if it wants to maintain its efficiency.

Do you already know if your business might be interested in a cost leadership strategy?