Cost leadership: When a company sells cheap and makes money

Summary

This video script explores the cost leadership strategy, which involves producing goods or services at a lower cost than competitors to attract price-sensitive customers. It explains how companies can achieve this by focusing on efficiency, leveraging economies of scale and scope, optimizing process design, and lowering input costs. Several examples, including Boeing, Walmart, and McDonald's, highlight how businesses reduce unitary costs by increasing production, outsourcing labor, and minimizing services. Ultimately, cost leadership requires constant improvements in operational processes to maintain a competitive advantage in the market.

Takeaways

• 💡 Cost leadership strategy focuses on offering products or services at lower prices than competitors.
• 📉 Companies using this strategy win price-sensitive customers, but often have lower profit margins per unit.
• 🏭 To sell at lower prices, companies must focus on efficiency in their operations.
• 📊 Economies of scale are key to reducing unit costs; larger production spreads fixed costs over more units.
• ✈️ An example of economies of scale is Boeing's success with the 747 compared to Concorde, which failed due to low production numbers.
• 🧀 Economies of scope involve savings from producing complementary products under one roof, like P&G's acquisition of Gillette or producing milk and cheese together.
• ⚙️ Process design improvements can lead to cost reductions by increasing efficiency, as seen with Ford's Model T assembly line.
• 🛠 Success in cost leadership requires aligning process technologies with organizational structure, product design, and management systems.
• 🌍 Firms with lower input costs, such as those benefiting from lower wages in developing countries, can gain a significant cost advantage.
• 🏢 Companies like Walmart, IKEA, Amazon, and McDonald's achieve cost leadership through strategies like outsourcing, minimal services, and efficient operations.

Q & A

What is the main goal of a cost leadership strategy?

The main goal of a cost leadership strategy is to produce products or provide services at a lower cost than competitors, thereby attracting price-sensitive customers and gaining a larger market share.

What is the trade-off for companies that adopt a cost leadership strategy?

The trade-off is that while companies sell more units due to lower prices, they also earn lower margins per unit, which can reduce overall profitability unless they maintain a high volume of sales.

How do economies of scale help companies lower their costs?

Economies of scale allow companies to lower unitary costs by spreading fixed costs over a larger number of units, thus reducing the cost per unit as output increases.

What are fixed costs, and how do they relate to economies of scale?

Fixed costs are expenses that do not change regardless of how many units are produced. Economies of scale reduce the cost per unit by spreading these fixed costs over a larger quantity of output.

Can you provide an example from the airline industry that illustrates economies of scale?

An example is Boeing 747, where the development costs were spread across 1,415 aircrafts, making the project profitable. In contrast, Concorde was unprofitable because only 20 planes were built, despite similar development costs.

What is an economy of scope, and how does it differ from an economy of scale?

An economy of scope is a cost-saving advantage that arises when producing complementary products under the same operations. Unlike economies of scale, which focus on increasing output to reduce costs, economies of scope focus on producing multiple products efficiently together.

What role does process design play in achieving cost leadership?

Process design plays a crucial role in cost leadership by finding ways to reduce input for each unit of output. Efficient processes can dramatically lower production costs, as seen in the example of Ford's Model T assembly line.

How do companies benefit from lower input costs, and what are some sources of these advantages?

Companies benefit from lower input costs by paying less for raw materials, labor, or procurement, which gives them a cost advantage over competitors. This can come from lower wage rates, access to cheaper raw materials, or better supplier negotiations.

What are some examples of companies that have successfully implemented a cost leadership strategy?

Companies like Walmart, IKEA, Amazon, McDonald's, Dell, Zara, and Southwest Airlines are well-known for pursuing cost leadership strategies, focusing on efficiency and offering lower-priced products and services.

What challenges do companies face in maintaining a cost leadership strategy in highly competitive markets?

The challenge is that cost leadership requires constant focus on efficiency and process redesign. In competitive markets, it's difficult to maintain a cost advantage without continuous innovation and optimization of operating processes.

Outlines

00:00

💰 Cost Leadership: A Strategy for Price Sensitivity

The first competitive strategy discussed is cost leadership, where a company aims to produce cheaper products or services than its competitors. By sustaining lower costs, cost leaders can offer lower prices and attract price-sensitive customers, who represent a significant portion of the market. However, lower prices result in lower profit margins, which means companies need to find ways to operate efficiently. One way to achieve efficiency is through economies of scale—spreading fixed costs across a large number of units, as seen in industries like aviation, where building more planes can reduce the per-unit cost. Another approach is achieving economies of scope by producing complementary products, as illustrated by P&G's acquisition of Gillette. Process design is also critical, with companies like Ford reducing costs through more efficient production methods. Walmart, McDonald's, and Toyota are examples of firms that align their organizational structures with their process technologies for maximum efficiency.

05:01

🌍 Globalization and Cost Advantages

The second paragraph explains how companies can gain a cost advantage through lower input costs, such as reduced wages or access to cheaper raw materials. The outsourcing industry in developing countries is a key example, with businesses transferring call centers, customer support, and other functions to these regions to benefit from lower labor costs. Several large companies, including IKEA, Amazon, and Southwest Airlines, adopt cost leadership by sourcing materials and labor from low-cost regions. These firms emphasize efficiency, such as IKEA offering minimal services and Southwest Airlines optimizing flight schedules. However, maintaining a cost advantage requires constant efficiency improvements and process redesigns to stay competitive in modern markets.

Keywords

💡Cost Leadership

Cost leadership refers to a competitive strategy where a company aims to be the lowest-cost producer in its industry. It relates to the video's theme by showing how companies can offer lower-priced products or services, gaining a competitive advantage by appealing to price-sensitive customers. Examples from the script include companies like Walmart and IKEA that implement cost leadership by keeping their operational costs low.

💡Economies of Scale

Economies of scale occur when the cost per unit decreases as the scale of production increases. This concept is crucial in the video's theme of efficiency, where large corporations can reduce unit costs by spreading fixed costs over more products. The example of Boeing producing 1,415 aircraft illustrates how spreading fixed costs over many units can reduce the cost of each airplane.

💡Fixed Costs

Fixed costs are expenses that do not change with the level of production or sales, such as rent or salaries. The script explains that companies can lower the per-unit fixed cost by producing more units, helping achieve economies of scale. The example of Boeing spreading the cost of development over many planes demonstrates this.

💡Economies of Scope

Economies of scope refer to cost savings achieved by producing multiple products together rather than separately. The video mentions that companies like P&G and Gillette, after merging, reduced costs by sharing distribution channels and logistics, thus lowering their overall expenses. This concept highlights how producing complementary products under the same roof can lead to cost reductions.

💡Process Design

Process design involves structuring business operations in a way that increases efficiency and reduces costs. The video uses Ford’s Model-T assembly line as an example of how a redesigned process can significantly cut production time and costs, thus contributing to a company’s cost leadership strategy.

💡Input Costs

Input costs are the expenses incurred to produce goods or services, including labor, materials, and resources. The video explains that lower input costs can provide a company with a cost advantage. For example, companies outsourcing labor to countries with lower wage rates can reduce their overall costs, as seen in industries like call centers and customer support.

💡Price-Sensitive Customers

Price-sensitive customers are those who prioritize price over other factors when making purchasing decisions. In the video, this group is described as the majority of the market, and companies adopting a cost leadership strategy target them by offering lower prices. Brands like McDonald’s and IKEA attract price-sensitive customers by keeping their product costs low.

💡Margins

Margins refer to the difference between the selling price of a product and its production cost. The video discusses how companies following a cost leadership strategy typically have lower margins because they sell their products at reduced prices to attract more customers. However, they compensate by selling a larger volume of products.

💡Outsourcing

Outsourcing is the practice of transferring certain business operations to external companies, often in countries with lower labor costs. The video highlights how outsourcing, particularly in developing countries, has allowed companies to reduce their personnel costs, thus contributing to a lower cost structure and competitive advantage.

💡Competitive Advantage

Competitive advantage refers to the ability of a company to outperform its rivals, often by offering lower prices or better products. The video focuses on cost leadership as one form of competitive advantage, where companies achieve superiority by maintaining lower costs through strategies like process design, economies of scale, and outsourcing.

Highlights

Cost leadership is a strategy where a company produces products or services at lower costs than competitors to attract price-sensitive customers.

Companies that follow a cost leadership strategy can win a significant market share by offering lower prices, but this often results in lower margins per unit sold.

A fundamental way to reduce unitary costs is to leverage economies of scale, which means the more units produced, the lower the cost per unit.

Fixed costs spread across a larger number of products reduce the unitary cost, benefiting companies like Boeing that mass-produce successful products.

Economies of scope occur when producing two complementary products together saves costs compared to producing them separately, as seen with Procter & Gamble's acquisition of Gillette.

Process design plays a key role in cost leadership, as more efficient processes can reduce input costs per unit of output.

Ford's Model T assembly line is a classic example of process efficiency, reducing assembly time from 106 hours to 6 hours.

For process improvements to lead to significant cost reductions, they must be paired with changes in organizational structure, management control systems, and HR management.

Companies like Walmart, McDonald’s, and Toyota have successfully matched their process technologies with efficient management systems to maintain cost leadership.

Lower input costs, such as cheaper raw materials, lower wage rates, or superior negotiation with suppliers, can give companies a significant cost advantage.

Outsourcing to countries with lower wage rates is a common practice for companies seeking a cost advantage, particularly in industries like call centers and customer support.

Companies such as IKEA minimize costs by sourcing products from countries with cheap labor and offering basic services like self-assembly furniture.

McDonald's reduces costs by hiring inexperienced staff, minimizing managers, and streamlining processes without needing trained cooks.

Southwest Airlines gains cost efficiency by reducing aircraft turnaround time at airports, organizing more flights, and optimizing its flight schedule.

Achieving cost leadership requires continuous focus on efficiency and redesigning operating processes to remain competitive in dynamic markets.

Transcripts

the first competitive strategy we'll

examine is cost leadership it's

straightforward isn't it you have to be

able to produce products or provide

services that are cheaper than the ones

offered by competitor companies if a

company adopts this strategy and

sustains costs lower than its peers than

it will succeed typically cost leaders

will sell at prices lower than their

competitors this way they will win price

sensitive customers the ones looking for

a bargain and given that price sensitive

customers are the absolute majority cost

leader firms can win a sizable market

share and sell a lot of units of the

goods they're selling however the

drawback is that the low prices of these

products mean lower margins for the firm

a margin is formed by the revenue

obtained from the sale of a product

minus the cost sustained to produce the

product so a cost to leadership strategy

means more units sold and a lower margin

per unit selling at prices lower than

competitors is a valid idea however

companies must find a way to do that if

you want to sell at a lower price then

you have to do something differently

than your peers there are several ways

to establish a competitive advantage

related to lower cost and they all have

something to do with the concept of

efficiency a cost leader must be

efficient let's see how companies can do

that one of the fundamental ways to push

down unitary cost is to leverage

economies of scale the more units of a

product are sold the lower is its

unitary cost the cost of one unit how

come well there are several costs which

are sustained only once these are the

so-called fixed costs there is an

inverse relationship between the

quantity of output and unitary costs

meaning the higher the output level the

lower the fixed cost per unit the reason

is that fixed costs are spread over a

large number of products and services

economies of scale are the main reason

for the predominance of large

corporations in most industries let's

provide an example with the airline

industry where the cost for development

of a new aircraft is huge Boeing 747 is

one of the most successful aircraft

project

because the company built 1415 aircrafts

Concorde turned out to be unprofitable

only 20 planes were built however the

cost of research and development of the

two projects is comparable right both

required engineering teams who worked

for years to design the two planes

however in the first case the cost was

spread among 1415 sales and in the

second among 20 planes this is a very

important concept the more units we

produce the lower the unitary cost we

have sustained some companies excel at

achieving economies of scope if they

operate in more than one business

certain firms can often achieve

economies of scope which pushes down

their costs even lower economies of

scope consists in a proportionate saving

gained by producing two complementary

products the cost of producing the tube

goods under the same roof is lower than

the cost of producing them separately a

good example for an economy of scope is

P Angie's acquisition of Gillette once

placed under the same roof the two

companies could use the same

distribution channels and lower their

logistics and sales expenses another

good example is the production of milk

and cheese it makes sense to produce

both products under the same roof as the

materials required for their production

can easily be combined right

another cost driver companies pay

attention to is process design we can

obtain a cost reduction from a change in

the way a process is being carried out

when less input is needed for each unit

of output provided a new process may

reduce costs dramatically the assembly

time of Ford's model-t is a great

example initially it took 106 hours to

assemble a Model T eventually when the

assembly line was improved and made much

more efficient the time was reduced to

six hours remember for a new process to

lead to efficiency it has to be combined

with changes in a company's

organizational structure product design

management control systems

HR management and so on success stories

of companies such as Walmart McDonald's

and Toyota

to match their process technologies with

their structures management systems and

product design are proof this is true

for prospective GM has been singled out

as a company that implemented a new

process technology without the

management and organizational changes GM

did not become the world's most

efficient car manufacturer which was its

primary goal moving on firms with lower

input costs can have a significant cost

advantage over their rivals lower input

costs derive from lower wage rates

access to low-cost raw materials or

inability to negotiate well with

suppliers and to excel at procurement in

today's globalized economy several

companies have taken advantage of lower

cost of personnel in developing

countries the outsourcing industry in

these countries is flourishing as call

centers customer support centres finance

and accounting divisions are being

transferred to these lower wage

countries the result from these

operations is a lower cost of personnel

over the long term and a possible source

of cost advantage cost leadership is a

strategy pursued by several large

companies Walmart IKEA Amazon McDonald's

Dell computers Zara H&M and Southwest

Airlines are some established names

you've heard and they're all focusing on

costs so for example IKEA the Swedish

furniture retailer sources its furniture

from countries where the cost of

personnel is cheap in addition the

company offers a very basic service it

doesn't assemble or deliver the

furniture it sells McDonald's uses

inexperienced staff instead of trained

cooks the company hires few managers and

safes from cost of personnel Southwest

Airlines minimizes the time its plane

spend at airports by organizing more

flights and filling up its schedule

acquiring a cost advantage is definitely

one way to go however it's difficult in

today's highly competitive markets

companies that choose this path should

focus on efficiency in all its forms and

in a continuous redesign of their

operating processes