Cost leadership strategy defines the efforts of a company to be the cheapest provider of a particular service or product in a given market to be more competitive. The cost leadership theory argues that lowering operating costs enables a company to offer lower prices and gain a competitive edge. However, implementing low-cost leadership is challenging because it involves constantly scanning the market and working on reducing the company's prices to compete but being cognizant of the cost of operation. Besides, one must consider how reducing the prices will impact the organization and the profit margin. It is an effective strategy for most big companies that have a big market share and financial strength. However, it does not suit small businesses because it may jeopardize their overall cost of operation, making it hard to stay afloat.
Cost leadership strategy's main focus warrants a firm to check on its pricing mechanism and narrow it down as per the market demands. However, this requires focusing on a niche with a high demand for services or products. Failure to comprehensively analyze the demand of the particular market may result in losses because reducing the prices will be ineffective. Besides, it may not attract the projected number of customers, further reducing revenue from sales. Also, the strategy works when the company strives to spend less on research and advertising projects. Advertising can be as little as email marketing, but it effectively attracts and retains customers. The strategy is effective because all the processes or operations are cost-efficient.
The main assumptions of competitive strategy are that large companies can lower prices and continue making profits. This is because large niche market, coupled with minimal marketing costs. However, these assumptions may not be entirely true. Lower prices do not mean the company is making huge profits, but they make a steady profit. As such, it becomes difficult to quantify them due to other operating costs. Also, these companies may not focus on a single market but try to invest in other markets to continue making profits. The marketing budget may also be low, but in the long run, it could prove to be quite substantial.
Advantages and Disadvantages of Cost Leadership
The advantages of cost leadership include:
- It helps the company to gain new customers and increase its market share. Customers are more likely to select a company that offers quality products or services that meet their budget or are sold at a lower cost. However, the services or products must have the desired value for the customer to consider them.
- The strategy offers the chance to have a continuous profit because the lowered prices would attract more customers. It offers the company the desired margins to make profits, create low-cost operations within their industry and gain strong value in the long run.
- It helps the organization reduce competition in the market. If the company focuses on a particular product or service and reduces the prices, it will have a competitive edge against other players in the industry. The other players will have to re-think their strategies, and if they decide to take a similar approach without proper planning or financial strength, they are likely to fail.
- It improves the sustainability of the business through greater efficiency. If the organization makes a profit on a specific niche, it may be able to compensate for other operational costs that may be important for the sustainability of the business.
The drawbacks of cost leadership include:
- Lack of proper research can lead to financial cuts that may affect some critical areas such as customer service. The company may shift its focus on the price of the product, forgetting about the customer service sector, which is important for retaining customers.
- It reduces product creativity or innovation because the company focuses on the same product. A business is likely to stick by these products because it makes a profit; hence, they may not see the need to introduce new products or be innovative.
- The approach can be copied by other players in the market, making it difficult to sustain it for a long time. This is particularly true in cases where the business lack proper arrangements to keep lowering the prices and still make profits.
Cost Leadership vs Price Leadership
Price leadership refers to a scenario where prices increase or decrease are influenced by a dominant firm, with other firms having no option but to accept and adopt the new rates if they want to remain competitive. The dominant firm acts as a pacemaker or leader in the industry, with other small firms having to adopt or follow it because it has the lowest production costs. The airline industry is an example that applies the price leadership approach. The big players have the power to influence the market by determining the prices of the services. Overall, the main features of price leadership are:
- Barometric, where a certain organization is more adept at detecting shifts in applicable market forces than others, allowing it to respond efficiently and be a benchmark.
- Dominant, where a firm has the majority of the market share, making it easy to manipulate the prices.
- Collusive, where dominant firms determine the prices in the market after a mutual understanding, with small firms having no choice but to follow the set prices.
Cost and price leadership strategies focus on the prices of products and services, having a market share of the business, and making a profit. Also, these methods seek to reduce the cost of operations but continue making a profit. However, the cost leadership approach is an internal strategy by an organization trying to have an edge in the market. In contrast, price leadership takes an external approach whereby the dominant firms set a particular price that other firms should follow. Cost leadership is a marketing strategy conducted by a firm to make more profit by gaining more customers by lowering its prices. In contrast, in price leadership, dominant firms set price rules that other small businesses have to adopt.
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