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A cost advantage strategy leverages unique capabilities and resources to reach lower costs, allowing a company to offer a lower price to grow market share or make more profit than competitors at the industry average price.
What it is: A company can use economies of scale, learning, experience, proprietary knowledge, lower-cost inputs, or a different business model to generate lower costs than their competitors in the industry. Achieving a lower cost position in the industry is the essence of a low-cost strategy.
What it does: A low-cost strategy allows a company to achieve a higher profit than the average competitor in the industry when selling at the industry average price or grow market share by selling products at prices below the industry average. Increased profits or increased market share without sacrificing industry average profits are valuable outcomes to a low-cost strategy. Either scenario can create increased total earnings for a company with a low-cost strategy.
How it is used: Companies that have achieved a low-cost position will often use that low cost to lower their prices without lowering their profit. With a lower price, a company can grow their market share and increase revenues and larger total profits. Another approach is to use the lower costs to increase the percentage of profit per dollar of revenue. Therefore, the low-cost competitor can make more profit while retaining the same revenue as competitors. Either approach causes the low-cost competitor to make either more total profits than the average competitor in the industry.
Where: Large undifferentiated industries often have a low-cost leader who ends up being the largest market share leader. Because customers will not pay for differentiated products, the way to make more money than the other competitors in the industry is to have a lower cost. Many companies leverage that lower cost by selling at a lower price than the industry average, allowing them to grow market share and total revenue while maintaining the industry average profitability. You can also use a low-cost position in a differentiated industry by using proprietary knowledge or scaling to make the differentiated products at a lower cost than other competitors.
Why: The low-cost producer in an industry can never be put out of business by competitors because they can never lower their prices as low as the low-cost producer. There is safety in being the low-cost producer as long as your product meets the minimum standard of quality and performance required by the buyers in the industry.
Where it shouldn't be used: In the luxury industry, where brand image is the driver of the purchase decision, a low-cost provider will, most of the time, be unable to compete with the more differentiated competitors.
Any restrictions: Low-cost positions are hard to sustain. Competitors will quickly meet investments in unsustainable low-cost strategies. Look for sustainable capabilities to continue competitive advantage in low-cost positions.
Warnings: Lowering costs to the extent that you no longer meet the customers’ minimum requirements will cause you to lose market share to your competitors.
Product Costing (See section 4 topics 2 and 3)
Gather data: Define all of the activities that cost money and resources to complete.
Determine which of these activities are completed by each competitor.
Manufacturing production activities, including both fixed-cost and variable-cost inputs
Research and development to create, innovate, and develop products and applications
Supply chain to purchase and manage raw material inventory, finished goods inventory, shipping, terminalization, customer service, accounts receivable, etc.
Human resource, benefits, and people management expenses
Sales and marketing people and expenses for attracting, converting, and monetizing customers
Governance and overhead costs and resources
Many other costs too numerous to mention
List all of the activities that cost money and resources for each necessary function in your company.
Research to determine where competitors’ activities might be different from yours and map their projected activities.
Estimate where competitor activities can be completed for a lower cost or resources and determine why they can do this.
Analyze the data: Determine your own cost of producing and supplying your product and where it differs from your competitors by adding up the costs of each activity.
Using the data above, calculate your own cost per activity and the total cost of providing your product for sale.
Determine each activity where competitors could have different costs per activity.
Using the differences estimated from the analysis above, project how different your competitors' costs are for the same activities.
Estimate the cost of unique activities for each competitor
Add up the costs of all activities and determine the total cost for each competitor.
Interpret the results: Compare the cost positions of each competitor and determine who has a low-cost position.
Economics of scale: When you have more production, you can spread your fixed costs across a larger volume, achieving a lower fixed cost per unit produced.
Learning and experience can create cost reductions over time. See the "How to Create a Scale or Experience Curve" demonstration video.
Proprietary knowledge can create competitive cost positions. This could be process knowledge, patented process positions, formulation experience, etc.
Different business models can create cost advantages by eliminating activities or modifying the activities to reduce the required resources.
Try to identify what factors drive the lower costs for yourself and each competitor. Common drivers of lower-cost include the following:
Look for activities you can change or ways you could complete activities for lower cost.
Present results: Showing income statements for each competitor as an overview. They have tables that compare the activities of each competitor and their projected cost per activity.
There are three levels of output representation and recommendations. Each of the options below has its role and primary audience:
Detailed tables depicting the different activities and associated costs and their impact on total costs. These tables can detail a single product, compare products, or compare between competitors. These are for engineers and those managing the manufacturing process.
Charts and graphs that highlight sources of costs and depict differences between products and competitors. All managing functions can use this information (marketing, HR, finance, etc.).
Recommendations supported by key charts and graphs or targeted tables that highlight why the recommendation should be implemented. These presentations are for top managers making decisions about resource allocation.
This content is provided to you freely by Ensign College.
Access it online or download it at https://ensign.edtechbooks.org/projectbased_internships/cost_advantage_strategy.
