Blog

Cost Leadership Strategy: Four Valuable Techniques For Lower Costs


For a small business to achieve the lowest costs possible, special attention must be given to all the activities in the business starting from procurement of materials until the final sale to the final customer. It is said that today competition is not depended from business to business but from supply chain to supply chain. Lower costs among all the members in the supply chain will allow lower prices from the final retailer and increase demand without decreasing profit margins. Different strategies will help a small business to acquire a cost leadership strategy in any industry. The most common strategies, used by many small firms, include economies of scale and learning, business process reengineering, product design and buying materials in bulk.

 

Cost leadership strategy:

Economies of scale exist when proportionate increases in the amount of inputs result in lower unit costs. In the production of any good a certain amount of fix costs will be involved for the establishment of a production plant. Such costs are warehouse facilities, the actual machines producing the goods, different vehicles used for transportation, overheads, such as electricity, and many more which are essential for the production of goods. The more you produce, the lower the cost of each unit produced because the fixed costs are spread. For this reason it is suggested that businesses should run at full capacity. Underutilization will raise unit costs, but also, pushing output beyond full-capacity will also create inefficiencies and thus higher unit costs.  Boeing found that out from costs like overtime pay, premiums for night and weekend shifts, increased defects and higher maintenance.

Of course, manufacturing is not the only area in which economies can be implemented. Economies can be achieved also in areas such as human personnel usage, advertisement and new product development

If your employees can perform in their full potential, more can be produced with less. Thus, before you consider on hiring more employees to increase revenue you should think first whether each employee performs at its maximum potential. If not you should persuade and motivate them to increase their efforts, in a result, the business gets more revenue without increasing costs

Also, the creation of a national advert includes high costs both in the development and the publishment on national networks. The bigger the business is the bigger is the spread of its advertising costs over its revenues. Advertising is considered as a fixed cost and in the case of a National TV advert the cost will be the same for any firm in the industry despite its size. Imagine two businesses creating a TV ad which costs 100 million each. The first business has 500 million sales while the second has 200 million sales. From this example it’s obvious that the creation of the ad from the first business will be way more profitable than that of the second business. Despite me showcasing big numbers here the same applies for smaller businesses where you have to subtract many zeroes from the numbers. In any way, every business should remember that it’s important to compare the spread of its costs among revenue.

A great example of this concept is the past consolidation in the world car industry that resulted because of the huge costs associated with new product development. Many Small and medium size companies merged because they didn’t have enough sales volume to cover those costs. The same occurred in the airplane industry.

I have been talking a lot about mostly big companies and while it seems that this technique will work better the bigger you are, you need to remember that cost is not the only priority for a business. For example, responding to you environment is also critical.  If we argue that firm competition is a race among competitors, we could say that small businesses have the advantage because they don’t have big costs and thus have the flexibility to surpass sudden changes in the economic, political or legal environment. Also small firms are able to avoid motivation and coordination problems that large businesses face because of the huge number of employees they have.


Economies of learning:
The human race has been able to evolve in the past thousand years mainly because of its ability to learn. We learn from our mistakes and thus improve by learning. The same occurs on our everyday personal and business life. Through repetition we can achieve individual skills and organization routines specialized to provide dexterity and problem solving that each organization faces every day, which ultimately may convert into a cost leadership strategy.

The ability to learn will increase productivity by doing more of the right things and less of the wrong things that can have a great effect on costs. In a few words, use less and produce more. This concept is closely related to whether a business relies more on automated or manual processes. Using technology to achieve a process can lower the degree of error while a manual process, usually involving the use of human power can be vulnerable to error. Choosing manual against automated is matter of pricing the relative inputs. For example, Dell’s plant in Texas is fully automated while in china it’s much more labour intensive because wages are 90% lower than wages in Texas.

On the other hand, Toyota’s lean production had greater productivity gains that technological innovation cannot offer. Mainly because of the Japanese ability to learn in small steps, rather than in big steps compared to western countries. They are able to improve their learning through a concept called Kaizen that includes continuous innovation, without an ending, rather than radical.


Operational and commercial processes evolve over time without direction or systematic appraisal of their efficiency or effectiveness. Small businesses can use Business process reengineering to restructure their business and focus on activities that are profitable and able to reduce waste. First, begin with the question “if we was beginning now, how would we design this process?”. Combining several jobs into one, allowing employees make decisions and recognize that processes have multiple versions for different situations are examples of redesigning a system to be more efficient and productive. Also, give great attention to the product design. Design your products and services to be functional and low cost by focusing on simplicity rather than on complexity. Provide simple aesthetics that can attract a wider target audience rather than a small group of them. Thus, allow decreased production costs and create a product that can attract a wider target audience.

Buying in bulk can have a huge effect on costs. The more you buy the more your suppliers will be willing to offer lower prices. Also, where you buy from is an important aspect too. For example buying from China will be way cheaper than buying from Italy. People have the perception that products from China have a lower quality than other countries but this notion is increasingly no longer valid.

 

The effects of the cost leadership strategy will depend on how good the leadership is from the leader. A good leader will be able to influence its employees to do what is best for the business and thus improve its performance. Following these guidelines, a small business can decrease its costs and achieve the benefits of a cost leadership strategy in its industry. Low costs will allow the firm to decrease its prices and increase the demand for its products and services. In turn, this will initiate a chain reaction where increased demand will allow even lower costs because of the increase in production and revenue.

1 Comments

  1. Pingback: Differentiation Strategy: The Successful Approach | The Small-Business Course

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>