Cost leadership: When a company sells cheap and makes money
Summary
TLDRThis 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
💰 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.
🌍 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.
Mindmap
Keywords
💡Cost Leadership
💡Economies of Scale
💡Fixed Costs
💡Economies of Scope
💡Process Design
💡Input Costs
💡Price-Sensitive Customers
💡Margins
💡Outsourcing
💡Competitive Advantage
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
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