Cost leadership is one of the main strategies that companies use to establish a competitive advantage within their industry. If implemented correctly, it can provide a lot of benefits for businesses of all sizes. In this article, we will discuss some of the biggest cost leadership advantages and how this approach can help you grow your business.
Cost leadership is one of Porter’s four generic competitive strategies, and it defines a company that aims to become the leader in their industry in terms of costs.
In other words, their competitive advantage is related to their ability to reduce costs on production and among all areas of their business, mainly through the implementation of some of the following strategies:
- Economies of scale – the advantages that a company can obtain from increasing their product input or purchasing in bulk, which ends up decreasing the costs per unit.
- Proprietary technology – a system, software or another technology product that is property to a business or individual, giving them a competitive advantage.
- Preferential access – sometimes, companies can make agreements with third-parties to get preferential access to raw materials, allowing them to reduce costs.
And now that we have a better understanding of the concept of cost leadership, let’s take a look at some of the biggest cost leadership advantages that businesses can obtain when taking this approach:
1. Expand market size
One of the biggest cost leadership advantages that businesses can expect from this strategy is the ability to expand market size faster than companies that are using a differentiation strategy, for example.
When businesses try to gain advantage through a differentiation strategy, they are typically competing in a more premium market with high-end prices because they are able to differentiate from their competitors.
However, higher prices mean that less people can afford to purchase the product or service, which makes it harder and slower for these companies to expand their market share.
For organizations pursuing a cost leadership strategy, on another hand, this process tends to be much faster and easier. Because they are able to reduce their costs significantly, they can offer more competitive pricing, and more people are able to afford their products or services.
This gives them the possibility to grab a bigger market share.
Cost leadership advantages: RyanAir example
One of the best examples of cost leadership is RyanAir, an airline that operates more than 2,400 daily flights across 225 destinations in 40 countries. In 2021, they had the biggest seat share in Europe, scoring 22.1% versus 16.7% for Vueling and 11.8% for Iberia.
They were able to achieve that by establishing a solid cost structure that allows them to operate flights at a lower unit cost than their European competitors.
2. Business becomes more sustainable
Next on our list of cost leadership advantages that businesses pursuing this strategy can obtain is sustainability. Let me explain why.
You see, when a company is pursuing a differentiation strategy, one of the biggest differentiation strategy mistakes that it can make is selecting a unique selling proposition that’s not sustainable in the long run.
One example that I gave in the above-mentioned article is a restaurant whose point of differentiation is their location, such as being on the top of a very high building.
If they have to change their location due to unforeseen circumstances, such as rent getting too high, the company may lose its competitive advantage when it moves to a different location that may not be as attractive to their customers.
Cost leadership advantages: Sustainability
However, an established leadership in costs can be a powerful competitive advantage in the long run. Of course, it doesn’t mean that you can’t ever lose it, but it’s a lot more sustainable as long as the processes are continuously optimized.
If you’ve managed to achieve better economies of scale, technology or raw materials, and you make the most out of it, you will be able to maintain your competitive advantage for a long time.
3. Profit margin may go up
Undoubtedly, one of the biggest cost leadership advantages that companies pursuing this strategy may notice is their possibility to increase profit margins.
It’s very simple – even if your product or service has the exact same price as your competitors’, if you spend less resources to produce it, you will enjoy better profit margins and more revenue.
This is one of the reasons why achieving economies of scale and improving your internal operational processes are two very important aspects of your business strategy.
By optimizing resources, you can obtain a bigger profit for products with the same price. Or you can get even more aggressive with your strategy, and use this advantage to make your prices even lower than your competitors with the purpose of expanding market share.
4. Competition goes down
Another important aspect when it comes to cost leadership advantages is competition. As we previously discussed, industry leadership in costs may help you expand your market share and increase your profit margins even if you are offering products at similar prices to your competitors.
As you expand your market size due to decreased costs, you are able to get a bigger chunk of the pie, reducing the size of your competitors, or even eliminating the smallest ones altogether.
Additionally, while your competitors may be able to easily spot your point of differentiation if you are pursuing a differentiation strategy (and copy it), it’s not that easy to do that with cost leadership.
Because cost leadership is usually a result of optimized internal processes, your competitors don’t have this information in order to figure out how you’ve achieved that, and copy it.
5. More survivability in times of crisis
The global pandemic thought us that many businesses aren’t prepared to face such turbulent and prolonged times of crisis. When a crisis comes, the companies that are struggling the most are the ones offering premium products because they are not a first necessity for users who are struggling financially as well.
In these cases, companies that are pursuing a differentiation strategy might find it more difficult to stay competitive and remain on the market long enough to overcome the crisis. According to Stateman, one-third of small businesses across the USA closed as a result from the pandemic.
However, when a business is leading the market in terms of costs, one of the biggest cost leadership advantages that they can enjoy is more sustainability and survivability during times of crisis.
Since they have already optimized their processes and achieved competitive costs, they would have an easier time maintaining a financial sustainability even if the market isn’t looking that good.
And this was all from me for today! Thank you for taking the time to read my article on the biggest cost leadership advantages, and I hope to see you in the next one! In the meantime, if you have any questions, don’t hesitate to let me know in the comments below, or send me an email to firstname.lastname@example.org