Maximizing Cost Leadership

In business strategy, cost leadership relates to setting a firm’s cost of sale / production at an acceptable level relative to similar businesses in the same sector. It is not a cost reduction strategy per se. Cost leadership is usually driven by business size, scale, technological capability, scope, cumulative experience and/or profitability. The ultimate goal of cost leadership strategy is to identify and exploit opportunities to improve company value and profitability.

There are several approaches to formulating a cost leadership strategy. These include internal strategy and external strategy. Internal strategy occurs when company management identifies opportunities for cost savings through consolidation, streamlining or reorganization. While this may result in short-term cost savings, the long-term impact on company value and profitability may be adverse.

A cost leadership strategy that exploits opportunities in generics is referred to as generic cost reduction strategy. Generic cost reduction strategies provide flexibility, cost effectiveness and a faster return on investment. These strategies can be effective when they are adapted to address particular company needs, market conditions and financial constraints. Examples of generic strategies include financial cost reduction, fuel cost reduction, fixed asset cost reduction and production cost improvement. Examples of generic strategies that cannot effectively address or cost control challenges include dimensional cost reduction, fixed cost reduction and fixed asset cost reduction.

On the other hand, cost leadership strategy that relies on specific competitive advantages can be referred to as differentiation. The key to differentiation is identifying and exploiting companies’ competitive advantages, which can be done through the development of market share, market positioning or innovation. The development of specific brand names, service or product families or process is a powerful means for differentiation. A number of companies have used innovative brand name creation to achieve significant cost reductions. Some examples include Unilever (ampoo), Reckitt (colognes) and Coca-cola (fizzy drinks). Merck & White (Proactive) and K-Mart (perfume) have also made a name for themselves through consistent innovation and cost cutting, especially in health care cost management.

In addition, differentiation enables companies to maintain and regain market share lost to price competition or economic downturns. These companies have successfully reduced cost of production through innovation and sustained market share in their core markets. Examples of cost leadership competitors include Wal-mart and grocery store chains, which have maintained and improved market shares over the past few years. A Wal-mart example includes the adoption of supply chain and customer management strategies, which have reduced cost of manufacturing and delivering products to end users. A grocery store example includes adoption of automated order processing, optimized supply chain and increased focus on customer loyalty and customer satisfaction.

A generic strategy is often adopted to address cost issues in specific markets. Examples of generic strategies include Yum! Brands’ (Taco Bell, KFC, Subway) and Sherwin-Williams’ (Sterlingwood, Pringles) brands. However, the adoption of a generic strategy can be risky if it is not well aligned with business objectives.