Risks Of Cost Leadership Strategy
Abstract
Firms that effectively use the cost leadership strategy earn above the normal returns regardless of the existence of strong competitive forces. A cost leadership firm generates and maintains a valuable competitive advantage when that strategy is rare and expensive to emulate. The most important focus in successfully implementing a cost leadership strategy is all about cost reduction and efficiency in spite of value-creation. Cost leadership firms usually keep the number of corporate staff low, have sustained access to capital and capital investments as well as process engineering skills. In addition, these firms have product designs that are easy to manufacture, taut cost control systems, cost leadership philosophy and rewards for cost reduction as well as incentives based on improved or maintained quality. Despite the competitive advantages of cost leadership strategy, there are some competitive risks that accompany it. Firms that attain the highest possible results from cost leadership strategy primarily focus on a wide market where their cost leadership can create competitive advantage.
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1.0 Introduction
The intention of firms that utilize the cost leadership strategy is to target a large group of customers. Cost leadership strategy refers to an integrated set of measures that are taken to produce goods and services with characteristics that are acceptable to customers at a lowest cost, relative to that of competitors. Firms that employ the cost leadership strategy usually sell standardized goods and services to the most typical customers of the industry (Hitt, Ireland and Hoskisson, pp.106). These goods and services ought to have competitive levels of quality and differentiation in terms of characteristics and features which consequently creates value for the customers. Cost leaders concentrate at getting ways of lowering the cost of their goods and services below that of their competitors while maintaining the competitive levels of differentiation. They do this by revisiting the means on how to complete key and support activities in an effort to lower their costs.
Large portions of the total cost of production of goods and services in a firm are accounted for by the key activities which are both inbound and outbound logistics. Inbound logistics include handling of materials, warehousing and the control of inventory. On the same note, outbound logistics include collection, storage and distribution of finished products to the customers. Having a competitive advantage in terms of these logistics creates more worth for a firm that uses a cost leadership strategy rather than the differentiation strategy. Therefore, these firms may want to concentrate on these logistics in order to lower the costs of their goods and services. Firms that effectively use the cost leadership strategy more often than not, earn above the normal returns regardless of the existence of strong competitive forces (Hitt, Ireland and Hoskisson, pp.106).
2.0 Organizational attributes for cost leadership firms
Cost leadership firms usually keep the number of corporate staff low. Besides, they have sustained access to capital and capital investments as well as process engineering skills. In addition, these firms have product designs that are easy to manufacture, taut cost control systems and cost leadership philosophy. Moreover, rewards for cost reduction and incentives based on improved or maintained quality are part and parcel of these firms (Grant, pp.243). Such entities usually seek economies of scale, preferential market access and original technologies. Their main objective is to improve operational competence through cost reduction.
3.0 Strategies for cost leadership firms
Firms that wish to effectively follow a cost leadership strategy ought to maintain constant effort at reducing their cost below that of their rivals in addition to creating value for their customers. Strategies for cost reduction include putting up facilities with high efficiency levels. Additionally, the firm in question should establish taut control of overhead and production costs (Jalan, pp.328). Furthermore, the costs of product research and improvement have to be adequately minimized along with that of sales made and services provided. Another beneficial strategy with respect to cost leadership is to invest in the most effective and efficient manufacturing technology (OpenLearningWorld.com, para.2).
4.0 Sources of cost advantage
A cost leadership firm generates and maintains a valuable competitive advantage when that strategy is rare and expensive to emulate. Such firms stress on cost reduction in all activities that they undertake. The competitive advantage of such cost leadership firms is that customers are price sensitive and not keen on value differentiation. In addition, their rivals find it an uphill task to match lower prices immediately in case the cost leadership firms decide to reduce the cost of their products. The cost advantage of a firm prevails due to factors such as economies of scale, learning curve, disparities in access to low-cost inputs, technological advantages as well as policy choices (Eldring, pp.8).
4.1 Economies of scale and the learning curve
The size of a firm is the primary source of its cost advantage. A correlation exists between the size of a firm based on the volume of production and the costs measured based on the average costs for each unit of production (English, pp.85). It bears noting that there are a number of aspects that result in economies of scale. A case in point is the relationship between volume of production and the manufacturing machines. The level of production dictates the type of machines to be used. Moreover, volumes of production are directly proportional to degree of employee specialization. Employee specialization results in division of labor and this is linked with cost advantages.
A firm with a high level of production has the economic ability to purchase and maintain specialized production machines which small firms cannot afford. In addition, a high level of production allows for the building of larger production operations. These firms are therefore in a position to put up lower-per-unit cost production operations which eventually reduces the average production costs. Besides, large volumes of production enable a firm to stretch its overhead costs over more units. Unlike economies of scale, the learning curve focuses on the correlation between the cumulative level of the level of production and average costs of each unit over time (Eldring, pp.8).
4.2 Disparity in access to low-cost inputs
Differences in access to low-cost inputs may result in cost differences between firms producing similar goods. These inputs include resources such as capital, land, raw materials and human resource (Grant, pp.243). Cost leaders may utilize the alliances formed with their suppliers so that they may get resources or raw materials that hold their general costs low. As a result, cost leadership firms are usually in a better position to use low-cost raw materials which therefore accounts for the low prices of their finished products.
4.3 Technological advantages and Policy choices
Technological advantages and Policy choices are potential sources of cost advantage which are independent of economies of scale. These technologies are not only the hardware but also the software technologies of a firm (Drury, pp.572). Software technologies include quality of management, interpersonal relationships as well as the culture of an organization. All these affect the overall economic costs of a firm. Cost leadership firms opt to produce simple standardized goods that are sold at relatively lower prices than those produced by other firms with corporate strategies (Grant, pp.242).
5.0 Sustainability of competitive advantage
Through cost leadership, competitive advantage can be sustained if consumer tastes remain constant. Moreover, this can be sustained if there are no changes in the cost of technology as well as the exogenous costs. In addition, it can be adequately maintained if the processes taken to attain low costs are rare and expensive for any other firm to copy. The sources of cost advantage that are likely to be rare include learning curve, disparities in access to low cost inputs and technological software (Wit and Meyer, pp.272). On the same note, sources of cost advantage that are unlike to be rare are economies of scale, technological hardware, policy choices and diseconomies of scale. Even when a certain source of cost advantage is rare, it must be costly to be emulated for it to sustain competitive advantage. Forms of emulation include copying and replacement.
Economies and diseconomies of scale are sources of cost advantage that may be cheaper to duplicate. On the other hand, learning curve economies, policy choices as well as technological hardware may be expensive to duplicate. Cost advantage sources that are usually expensive to duplicate are differentials low cost access to inputs and technological hardware. A firm that has a costly and rare cost advantage technology to emulate usually has a higher potential to earn above average profits (Wit and Meyer, p.272).
6.0 Competitive strengths of a low-cost firm
A firm that seeks success in the implementation and maintenance of cost leadership strategies must put into consideration the value chain of key and minor activities. The cost leader should effectively and efficiently connect these activities. The most important focus in successfully implementing a cost strategy leadership is cost reduction and efficiency in spite of value-creation (OpenLearningWorld.com, para.3). A cost leadership firm works best when there are limited ways of achieving product differentiation valuable to buyers. It is equally effective when many customers use a similar product to satisfy like needs, they go for the best price as well as when the bargaining power of customers is significant. Moreover, it is more efficient when price competition is a principle competitive force among rivals (Kozami, pp.229).
6.1 Rivalry with existing competitors
The low-cost value of goods and services is a very crucial way of dealing with competitors. The competitor will not attempt to compete with the firm that applies this strategy in terms of lowering the costs of their goods and services (Kozami, pp.230). On the other hand, the discount retailer is able to achieve strict or tight control of the cost of products in a number of ways (Hitt, Ireland and Hoskisson, pp.107). The low cost will therefore enable the cost leader to earn more profits because their rivals are more likely to quit the market.
6.2 Bargaining power of customers
Although powerful customers can pressurize cost leaders to lower prices of goods and services, these costs cannot go below the price at which the next most efficient competitor of the firm will earn average profits. On the same note, powerful customers may be able to force down the prices of the next most efficient firm. These low prices can impede the next most efficient competitor from getting average profits thus forcing the competitor to leave the market. The firm is therefore left with less competition and in a stronger position than before. Consequently, the entity attains a monopoly position forcing the customers to pay more for goods and services since it has no competitor (Hitt, Ireland and Hoskisson, pp.107). However, the most important outcome is that the customers will loose their bargaining power thus making the business entity to realize increased profits.
6.3 Bargaining power of the suppliers
The limits of operation of a cost leadership firm are higher than those of the competitors. This makes the firm flexible enough to absorb the substantial price increases by their suppliers (Eldring, pp.8). This is because the cost leadership firm is the only one that may be able to pay for the increased prices and continue earning either average or above-average returns. Alternatively, cost leaders may reduce the power of their suppliers by forcing them to hold down their prices as a consequence they reduce the margins of the suppliers. Furthermore, these leaders may use alliances with their suppliers to access resources that would lower their general costs (Hitt, Ireland and Hoskisson, pp.109).
6.4 Potential entrants
While trying to hold down the costs of goods and services, the cost leader becomes progressively efficient which increases the profit limits as they serve as a vital access barrier to potential rivals. The new entrants ought to tolerate the average returns before they get the obligatory know-how to approach the efficiency of the cost leader. The limited profit margins of the new entrants make the cost leader to increase sales which in turn enables the firm to earn above average returns (Hitt, Ireland and Hoskisson, pp.109). Alternatively, new entrants may enter in to business using a different strategy so as to avoid competing on cost with a cost leader (Jalan, pp.328).
6.5 Product substitutes
A cost leader is more flexible than the rivals in case they are faced with possible product substitutes. These substitutes may be potentially attractive in terms of differentiation and cost to the customers of the firm. As a result, a cost leader is in a better position to retain customers by lowering the prices of goods and services offered (Hitt, Ireland and Hoskisson, 109). In addition to the above strengths, cost leadership organizations charge reduced prices for their products yet they make equal amounts of profit. Besides, these firms are less affected by very powerful buyers and sellers, thus they win in the cost war and are well protected from competitors (Kozami, pp.230).
7.0 Competitive risks of cost leadership strategy
Despite the competitive advantages of cost leadership strategy, there are some competitive risks that accompany it. For instance, rivals may become technologically innovative and make the processes used by the cost leader outdated (Kozami, pp.231). These innovations may enable the competitor to produce at much lower costs than the normal costs of production incurred by the cost leader. This therefore eliminates the competitive advantage of the cost leader. On the same note, the rival may produce goods with additional differentiated features and characteristics without affecting the cost of product to customers. Besides, the cost leader may focus too much at cost reduction thus failing to address the perceptions and changing preferences of customers on the levels of differentiation (Jalan, pp.328). Finally, rivals of the cost leader may fruitfully emulate the strategy of the cost leader. Unless the cost leader increases the value that the products provide, the rivals are bound to catch up with the cost leadership firm (Hitt, Ireland and Hoskisson, pp.109).
8.0 Conclusion
Firms that attain the highest possible results from cost leadership strategy primarily focus on a wide market where their cost leadership can create competitive advantage. This usually involves defining their position in the market as one of having a low-cost products compared to other similar products in the market. Therefore, firm managers have to decide whether to compete on the prices of products or on differentiating their products and services. After decision making, they should progress so as to shun from competitive disaster. It is important to consider the fact that, a firm can adopt both cost leadership as well as the differential strategy but this is only circumstantial.
Work Cited:
Drury, Colin. Management and Cost Accounting. London: Cengage Learning EMEA, 2008.
Eldring, Jan. Porter ?s (1980) Generic Strategies, Performance and Risk: An Empirical Investigation with German Data. Gutenbergring: BoD – Books on Demand, 2009.
English, James R. Applied equity analysis: stock valuation techniques for Wall Street professionals. New York: McGraw-Hill Professional, 2001.
Grant, Robert M. Contemporary strategy analysis. New york: Wiley-Blackwell, 2005.
Hitt, Michael A, R Duane Ireland and Robert E Hoskisson. Strategic management: competitiveness and globalization : concepts & cases. London: Cengage Learning, 2008.
Jalan, P K. Industrial sector reforms in globalization era. New Delhi: Sarup & Sons, 2004.
Kozami, Azhar. Business policy and strategic management. New Delhi: Tata McGraw-Hill, 2002.
OpenLearningWorld.com. "Cost-Leadership Strategy." 2010. 3 June 2010 < http://www.openlearningworld.com/olw/courses/books/Business%20Strategies/Business%20Strategy/Cost-Leadership%20Strategy.html >.
Wit, Bob De and Ron Meyer. Strategy: Process, Content, Context. London: Cengage Learning EMEA, 2010.
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Risks Of Cost Leadership Strategy. (2018, Mar 20). Retrieved from https://phdessay.com/cost-leadership-strategy/
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