The business environment today is quite fast paced. The economy has changed rapidly and there is a need for organisations to implement competitive advantage. Organisations adhering to this principle need to take care of three key areas;
- Identifying sources of competitive advantage
- Implementing competitive advantage
- defending competitive advantage
Companies need to identify which parts of their organisation will help them achieve sustainable competitive advantage. Firms have the choice of using finances and their budget to get an edge over their competitors. They could also consider their human resource segment. Another alternative is through implementation of technological changes. With all these options available, it can become tricky for organisations to balance the three aspects. (Porter, 1985)
How to achieve sustainable competitive advantage through cost leadership
Cost leadership is all about lowering cost consequently lowering prices of commodities. Organisations that implement cost leadership look for methods and approaches that will reduce the amounts spent during production. Reducing production costs has two main benefits to the Company: First of all, the company will attain higher profit margins thereby achieving its goals. Secondly, the organisation can afford to lower prices and this will give them an edge over all other competitors in their business environment. (Baird, 1994)
Achieving cost leadership through economies of scale
Cost leadership can be implemented in a number of ways; companies can use economies of scale. There are links between volume and cost of production; the more a company produces, the less their cost of production. However, there is an optimum volume beyond which firms cannot minimise their cost of production. This aspect of cost leadership can be achieved through various routes. For example, Companies that produce large numbers of items are able to take advantage of specialised equipment. This will go a long way in ensuring that more products are produced with less finance. A suitable company is the Harley Davidson Automobile Company based in the US. Initially, the Company was started as a small venture at the pioneer’s backyard. Cost of production was quite high because most automated equipments require large numbers of cars. The Company could not afford this and started experiencing low profit margins. But after identifying their dilemma, the Company was able to obtain more sources of funding and increased its volume of production; it could now take advantage of specialised equipment. The Company continued with this strategy and today, it is America’s most successful motorbike manufacturer. (Smith, 2003)
Economies of scale in cost leadership can also be implemented through the use of larger manufacturing plants. When companies have huge manufacturing operations, then they are able to reduce their cost of production per unit item. This scenario was witnessed by the FedEx Corporation. Initially, the Company started its operations with fourteen jet aircrafts. But it expanded its production area and equipments. This was why the Company could expand into many parts of the world i.e. it became international. The Company realised that with increased numbers of competitors (these include DHL, Purolator Courier, United States Postal Service and Emery Airborne Freight) there was the increased rivalry and the it had to come up with a strategy that would give it an additional advantage over others. This was achieved through expansion that eventually allowed the Company to use more airplanes for delivery. This meant that they could accommodate more parcels and letters. Therefore, the firm had the go ahead to decrease the costs of their services. (Magaritis, 2001)
Economies of Scale can also be achieved by taking advantage of specialisation of the employees. Research has shown that when Companies exercise division of labour, then chances are they will become efficient in their levels of production. Companies that apply this principle are Chinese toy manufacturers. These Companies realise that most employees have their own field of specialisation. Some focus on sewing, others gluing, others deal with assembling. These companies made it their duty to let certain employees specialize in their Fields. Consequently, their employees were faster and more efficient. Employees produced more goods and these Companies were able to achieve cost leadership. This is the reason why toys from China are cheaper than most other toys in the world. (Grant, 2005)
Lastly, economies of scale and overhead costs can be merged. Companies that take advantage of this strategy are able to spread their overall costs across higher numbers of units. These will mean that they can afford to lower their prices. (Benter and Booms, 1981)
Companies should also be aware of diseconomies of scale. There are physical limitations on the physical expansion a Company can undertake. Companies who want to take advantage of cost leadership ought to know the maximum level which their expansion plans can reach. For example, some manufacturing processes can only be stretched to a certain extent. Otherwise further expansion will only cause more harm than good. (Barney, 1991)
Diseconomies of scale can also present companies with restrictions when trying to achieve cost leadership. A company that is undergoing expansion may experience problems when trying to go global. This will normally come in the form of ineffective managerial positions. Most Companies lack the ability to efficiently manage higher numbers of employees. This case was witnessed by the Gap Inc. Company. The Company is a clothing retail shop with branches all over the world. But This Company rapidly expanded without taking into account the diseconomies of scale. There were too many Gap clothing affiliates but managers did not adjust to this change in Company structure. Consequently, the Company has lost face; they provide a range of goods without providing the market with an outstanding feature. The rapid expansion should have been complemented with management restructure. The Company is currently looking for an efficient and capable general manager to bring back thee Company to what it was before its rapid expansion plans. (Porter, 1985)
Firms should also be aware that employees get demotivated when implementing division of labour. Cost leadership is implemented through specialisation. However, this causes monotony and leaves little room for creativity. Consequently, such workers will loose morale to complete their tasks and this will affect the overall profits gained by the Company. Some of the alternatives that companies can use to correct this problem include;
- participation schemes
- Quality circles
Companies that implement this strategy should make sure that the distances they have to travel to reach their suppliers and markets are considered. Organisations that plan on expanding their levels of production need to ascertain that the new locations for manufacture are not too far away from their locations. This is because when transportation costs are too high, companies will have to pay a lot in terms of transport and this will offset any decreases in cost associated with increased levels of production. (Dyer and Ernest, 1991)
The learning curve is quite similar to economies of scale. The difference is that the former strategy focuses on the kind on cumulative volume in comparison to average costs of each product. On the other hand, economies of scale focus on volume but at a specific point in time. This is then compared to average unit costs of production. The learning curve can be implemented in the same way as the economies of scale. (Porter, 1985)
Sometimes technology can be applied to a Company’s operating processes regardless of the level of expansion or without consideration of economies of Scale. One such Company was the Honda Automobile. This Company is a leader in development of new technologies. The Company is always coming up with better ways of running its businesses and has become a global leader in the production of motor vehicles. Most of their products are known for their affordability and this has occurred through the application of cost leadership. (Grant, 2005)
Companies can achieve cost leadership through the use of efficient technologies to manage their operations. One such Company is the Marks and Spencer Retail Company. This Company has applied technology in the procurement of products. The firm has also applied technology in coordination of services between departments. This means that there is less wastage and more efficiency thus bringing about lower production costs. On top of that, Marks and Spencer was one of the first Companies in the UK to introduce on- the -counter payments. This was quite useful in lowering costs because it meant that the Company needed fewer employees. Consequently, very little was spent in terms of labour costs and profit margins were increased. (M&S Annual report, 2007)
Another Company that applied technology in service delivery was the Amazon Corporation. This Company is exemplary in terms of cost leadership. Their customer service is conducted through technology; they have instant feedback systems sent to consumers every time they conduct business with them. The Company is also exceptional in terms of the way it can access a wide range of buyers throughout the world. Cost of production has been reduced by introducing online selling. Therefore the huge amounts of money which would have been spent in manual selling have been saved and the Company has reduced its cost of production. Amazon has also lowered overhead costs in terms of advertisement and other marketing techniques. They discovered online advertising which has gone a long way in ensuring that the Company stays ahead of its competition. The Company is well known for the ‘blogs’ that they use for this purpose. (Jeff Bezos, 2008)
Integrating cost leadership with the Porters five forces
The first thing a Company should consider when trying to implement the cost leadership strategy is the threat of Entry. Companies should make sure that they become cost leaders so as to discourage the use of lower costs as an entry strategy by new groups. When new entrants realise that they have to compete against a certain cost leader on the basis of cost, then they will opt out. Most of them may decide to use joint ventures or product differentiation as an entry strategy.
A Company that uses this strategy well is Wal-Mart. Any Company considering the retail sector in the US has to think of Wal-Mart. Consumers have been able to access goods and services which they would not afford if it was not for Wal-Mart’s low cost strategy.
Companies should also integrate threats from rivalries. They can do this by either imitating their competitor’s prices or they could decide to set their prices lower than their competitors. The former strategy is more risky than the latter because Companies that imitate their competitors prices usually get a lower market share and may record less sales. On the other hand, setting prices below those ones of their competitors will cause the Company to attract more consumers. Consequently, their sales volume will increase. However, such firms may have to pay the price by recording reduced profits. (Benter and Booms, 1981)
Organisations must not forget the role played by threats from suppliers. Suppliers can become a hindrance to the cost strategy when they sell low quality goods or when they increase their prices. If a company is a high cost firm, it may be adversely affected by suppliers’ increased prices. However, if the firm as a cost leader, then they need not worry about higher prices by suppliers because they can still be able to record high profits. Starbucks is one such Company. It has secured coffee suppliers from the African and Asian Continents. But because the nature of their commodity; coffee is quite vulnerable to market forces, suppliers increased their prices. The Company employed cost leadership strategy and is still able to stay above the competition despite supplier increases. Starbucks minimised costs by conducting all the coffee manufacturing processes within the Company rather than outsourcing or hiring external firms to do this. It was able to cut down on expenses and also to ensure that their commodities are of the highest quality. (Starbucks Corporation, 2007)
Lastly, Companies need to put in mind threats of buyers. Buyers can become a hindrance to Company profits when they demand high quality and at the same time lower prices. This can become very tricky for firms because higher quality normally implies more costs of production. Cost leaders need to make sure that they are able to produce their goods and services according to consumer demands and at the same time, they should do this at a lower price. It may become tricky for most Companies who are cost lenders because they tend to compromise on quality and concentrate on lower costs of production. This is the reason why some consumers may still opt for quality items regardless of their price. A Company that has tried to merge these two aspects well is Tesco Corporation. This Company has ensured that consumers are able to access commodities in a fast and efficient manner (quality service) at the same time; they provide these commodities at an affordable price. (Tesco, 2007)
Companies practicing the cost leadership strategy need to make changes in the way they conduct business. They need to readjust their company policies so that they can be integrated into their cost leadership strategy. Such Companies are characterised by low levels of bureaucracy. They usually need few staff members and even fewer managerial posts. Most of these Companies do not have vertical systems of management; where decisions must pass through a number of higher authorities before they can be made. Instead, such Companies are characterised by a decentralised form of management. Here all managers in the branch are given the responsibility of managing all the issues involved in their location. This means that they decide on what tactics to use in order to sustain or increase profit margins. These unit mangers have full responsibilities and my consult with higher authorities only in unique situations. (Benter and Booms, 1981)
One Company that has observed such a principle is McDonalds. This fast food Company leaves all the responsibilities to the unit managers; he must make sure that the branch is running in a cost effective manner. Reduction in bureaucracy has gone a long way in eliminating unnecessary staff members (especially in the management section) this has enabled the Company to reduce its prices and this is why it is one of the most widely known fast food companies in the world. (McDonald website, 2007) Contrary to this, there was another firm that did the exact opposite. They decided to have a hands- on – approach of all their stores despite the fact that they have them located all over the world. This is the Giorgio Armani Clothing Company. Their stores report to headquarters and this has hampered decision making processes locally. The firm has many managerial posts and is spending more than it should. Such a Company has not adhered to cost leadership principles.
Company policies should also be oriented towards capital investment. Firms need to ascertain that they have adequate capital in order to implement cost leadership. For a Company to lower cost of production, they need to make changes to their process. This can be done through the methods mentioned earlier like expansion of manufacturing space, use of specialised equipment, minimising numbers of employees through specialisation, using better technology among others. All these issues need a thorough in put of capital and organisations should be prepared for this. (Barney, 1991)
Company policies need to include process engineering skills. The skills are applied in a number of areas within the Company. They can be applied in product design. Here, the Company is producing the same product but they are using a faster or easier way to produce it. On the other hand, process reengineering skills can also be used when the Companybhas introduced a different product that is easier to produce or one that requires less costs than what they were producing before. The Honda automobile manufacturer based in China is well known for this practice. They have been producing new models in the market which cost less. Some of these new models may still have similar features to other cars in the market but the difference is that they were produced through an efficient manner and this is why they can be sold at lower prices than other models in the market. (Thompson & Strickland III, 1992)
Companies need to change their policies to incorporate cost leadership through stringent controls. They can make sure that all aspects of the firm are monitored carefully. Whenever companies become careless in this area, then they leave room for resource wastage and inefficiency in production. Consequently, such companies loose a lot yet they could have been able to save. Examples of areas that need to be monitored include;
- detailed reports
Companies also need to make cost leadership their philosophy as was witnessed by Wal-Mart Corporation. It has made cost leadership a top priority and makes sure that all employees within the organisation identify with this idea. It has also incorporated it in the way it conducts its business. (Sedy, 1992)
Wal-Mart has company policies that should be emulated by other firms who would wish to become Cost leaders. First of all its slogan is “Always Low Prices. Always” This has given the Company a unique selling point because its consumers approach it with the purpose of getting good deals for whatever item they are purchasing. Consequently, the Company has continuously and consistently recorded high volume sales. The Company implements cost leadership in the following ways. First of all, it purchases goods in huge numbers; this means that it can obtain them at lower costs per unit price. Wal-Mart has chosen simplicity within its stores. Most retail companies complicate their store designs and these results in more costs, Wal-Mart decided to cut down on that production cost by employing plainness. Besides this, the Company has really cut down on employee numbers. This has been achieved through self service in almost all parts of the store. (Sedy, 1992)
The Company does not use extravagant methods when conducting business. Instead, it has created a culture of economy even among managerial posts. The business gives their managers small and cheap offices to save on costs. It also denies its managers some extravagant forms of expenditure, for example when they are required to fly to certain destination, the Company normally pay for coach rather than business class or first class. Wal-Mart encourages its managers to stay in cheap hotels and eat in affordable restaurants so as to minimise costs.
The Company has streamlined its processes through stringent monitoring exercises. It has established a Universal Product Code to monitor the flow of products from one area of production to another. Through this method, the Company can track inventory, sales and process orders. Inventory is also efficiently monitored through establishment of central distribution centres. It also has a retail link. This is a method that allows the Company to coordinate supplies through a computer system. Lastly, the Company has a huge database. This has streamlined communication between various stores located throughout the world. The database has also helped in the automation of processes. Analysis of data is now possible and the Company can now improve its method of production. All these improvements in production have helped Wal-Mart in reducing wastage hence cost of production. This is why it is an exemplary cost leader. (Sedy, 1992)
Cost leadership is a method that enables lower production hence lower price offerings for products and greater profit margins. It can be implemented through economies of scale; these are restricted through diseconomies. It can also be achieved through technology or through changes in Company Policies. Firms can also achieve cost leadership by integrating it in the porter’s five forces. They should make sure that all their prices are difficult to imitate and offer a unique selling feature. Companies that have set the pace on Cost leadership include Wal-Mart, Tesco, McDonalds, marks and Spencer, Honda Automobile, FedEx, Starbucks and Harley Davidson. These Companies have used technologies, overhead costs and efficient processes to minimise costs and maximise profits. (Amit, 2007)
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