What is Cost Leadership?

//What is Cost Leadership?
What is Cost Leadership? 2017-10-02T07:10:48+00:00

Definition: Cost leadership is a strategy that companies use to achieve competitive advantage by creating a low-cost-position among its competitors. In other words, it’s a company’s ability to maintain lower prices than its competitors by increasing productivity and efficiency, eliminating waste, or controlling costs.

What Does Cost Leadership Mean?

This is no easy task. In order for a company to become a cost leader in its industry, it must manage its value chain and actively lower costs throughout the entire supply chain. Keep in mind that a cost leader can’t simply make a cheaper product. Its products must be on par with competitors otherwise consumers will stop buying them and look for better quality alternatives. Instead, a company must maintain the quality of its products while lowering the costs of production through efficiency, size, scale, scope and the learning curve.

One of the most effective ways for a company to become a cost leader is the economies of scale. We can see this with manufacturers that produce huge volumes of homogenous goods like automakers or retailers that can purchase and ship huge volumes of product together like Wal-Mart. By lowering their operating and production costs, these companies are able to offer goods to consumers at a lesser price point than their competitors and consequently increase sales.

Let’s look at a few examples.

Example

Here are a few example companies that have successfully used the cost leader approach in their industries.

McDonald’s

This fast food chain has proven to be very successful using this strategy. They keep costs low by maintaining a division of labor that allows them to employ and train inexperienced staff instead of skilled cooks. This method allows them to hire a few managers who usually receive higher wages.

WellPoint

They asked the Food and Drug Administration (FDA) to make the allergy drug Claritin available over the counter. This may have been the first time an insurer has approached the FDA with such a request. If approved, as an over-the-counter-drug, Claritin would reduce patient visits to the doctor and eliminated the need for prescriptions – two reimbursable expenses for which WellPoint would otherwise be responsible.

General Mill’s

Stephen Sanger, CEO, recently came up with an idea that helped his firm cut costs. To improve productivity, he sent technicians to watch pit crews during a NASCAR race. That experience inspired the techies to analyze their production processes. They were able to reduce the time it takes to switch one of their plant lines from 300 minutes to 20 minutes. This provided an important lesson, not only in cost efficiency but also in business as a whole: Many interesting benchmarking examples can take place far outside of an industry.

Each of these companies came up with ideas to streamline operations and cut production costs in order to offer products to consumers at a lower price than their competitors.