Cost Leadership Strategy

Cost Leadership Strategy

Cost Leadership Strategy Jonathan Poland

A cost leadership strategy is a business plan that aims to reduce unit costs for a product or service to the lowest level among all competitors in an industry. This is typically achieved by becoming more efficient than the competition in a number of ways, such as using cheaper materials, streamlining production processes, or implementing advanced technologies. By reducing unit costs, a company that employs a cost leadership strategy can offer its products or services at a lower price than its competitors, making it more attractive to consumers and giving it a competitive advantage in the market.

Automation

The use of systems and robotics to reduce the amount of labor that goes into the production of a product or delivery of service. General corporate overhead can also be automated. For example, a firm that completely automates customer billing such that human involvement is minimal.

Know-How

Knowledge and knowledge processes can reduce costs. For example, an unusually skilled customer service representative may increase customer satisfaction at a hotel more than expensive renovations to rooms.

Organizational Culture

Organizational culture has a significant impact on productivity, risk management and cost reduction efforts. For example, a CEO who takes economy class flights to set an example for frugality across a firm.

Tools

Tools such as application software, equipment and machines can dramatically improve the productivity of employees. For example, a farmer with a combine harvester that breaks down once every 10 years will be more productive than a farmer with a combine harvester than breaks down every 5 hours.

Scale

Unit costs tend to drop as you achieve greater scale. This is known as economies of scale. For example, a farmer managing 500 acres of apple trees may produce a bushel of apples for $4 where a farmer managing 5 acres has costs of $7 a bushel.

Sourcing

Cost leadership depends on low input costs such that purchasing is an important consideration. Purchasing benefits from economies of scale whereby you are likely to get a bigger discount if you buy more. For example, a big box retailer that purchases a million units of shampoo a month for $2 a bottle where a family corner store buys the same product for $4 because they only purchase 20 units a month.

Location

Location has a large impact on costs such as land, labor, electricity and supplies. For example, a hotel 4 blocks from a beach may cost $5 million where a hotel the same size on the beach represents a $50 million investment. This gives the further hotel far less capital costs such as interest expense such that its cost for offering room inventory is fundamentally lower.

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