Overall Cost Leadership Strategy

What is Cost Leadership?

Cost leadership is a concept developed by Michael Porter, used in business strategy. It describes a way to establish the competitive advantage. Cost leadership, in basic words, means the lowest cost of operation in the industry. The cost leadership is often driven by company efficiency size, scale, scope and cumulative experience

Porter’s Generic Strategy Model

Porter's generic strategies are ways of gaining competitive advantage.The model says that competitive advantage can be gained by the following ways:• Cost Leadership Strategy• Differentiation Strategy• Focus Strategy

Cost Leadership StrategyThe main objectives of Cost Leadership Strategy are:

• Increasing profits by reducing costs, while charging industry-average prices

• Increasing market share through charging lower prices, while still making a reasonable profit on each sale because you've reduced costs

• It involves being the leader in terms of cost in the industry or market. Simply being amongst the lowest-cost producers will leave the company wide open to attack by other low cost producers who may undercut their prices and therefore block the company’s attempts to increase market share.

• The price paid by the customers is not low; it is the industry average.

• Cost Leadership is never to initiate a price war

Achieving Cost Leadership

Companies that are successful in achieving Cost Leadership usually have:

1. Access to the capital needed to invest in technology that will bring costs down

2.Very efficient logistics

3. A low cost base (labor, materials, facilities)

4. Economies of Scales and Value Creating Activities

Value-Creating Activities Associated with the Cost Leadership Strategy

Cost Leadership StrategyIn relationship to the Porter’s Five Forces

• Existing Rivalry Rivals hesitate to

compete on the basis of price

• Bargaining Power of Buyers (Customers)

Powerful buyers can force cost leader to

reduce prices up to a point

• Bargaining Power of Suppliers

Cost leaders can absorb suppliers price increases

Cost Leadership StrategyIn relationship to the Porter’s Five Forces

Potential EntrantsEfficiency can serve as a barrier to entry

Product SubstitutesCan reduce prices when faced with substitutesCompetitive RisksInnovations by competitors can quickly eliminate cost advantage.Competitors may learn how to successfully imitate a cost leader’s strategy

Cost Drivers: Cost-Leadership

• Cost Leadership:

Cost of input factors, economies of scale, and learning-curve and experience-curve effects

Competitive advantage = economic value created (V-C) > competitors Walmart vs. Kmart Dell vs. Compaq, Gateway, & HP

Example-RyanAir

• The “Southwest Airlines of Europe”

“Lowest-cost airline in the world”

No window shades on older planes,

seats don’t recline, etc.

Fares as low as $8

Numerous fees and surcharges: pillows, blankets, check-in, etc.

20+% of revenues flow from ancillary

services

Ryanair Sample Revenue Calculation

Ticket Price, $8

Checking Two Bags, $45

Online Check-in, $7.50

Credit Card Fee, $6

Subsidy from More Expensive Flights,

$5.50

Pillow & Blanket, $5

Priority Boarding, $4

1 Bottle of Water, $3.50 Ad Revenue, $2

Revenue $87Cost $70

Profit $17

Ticket Price, $8

Checking Two Bags, $45

Online Check-in, $7.50

Credit Card Fee, $6

Subsidy from More Expensive Flights,

$5.50

Pillow & Blanket, $5

Priority Boarding, $4

1 Bottle of Water, $3.50 Ad Revenue, $2 Ticket Price, $8

Checking Two Bags, $45

Online Check-in, $7.50

Credit Card Fee, $6

Subsidy from More Expensive Flights,

$5.50

Pillow & Blanket, $5

Priority Boarding, $4

1 Bottle of Water, $3.50 Ad Revenue, $2

Revenue $87Cost $70

Profit $17

Revenue $87Cost $70

Profit $17

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