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FREE online courses on Business Strategies - Business Strategy - Cost-Leadership Strategy


Companies that choose a cost-leadership strategy offer relatively standardised products with features or characteristics that are acceptable to customers--in other words, with a minimum level of differentiation--at the lowest competitive price. This means that companies offer standardised products to an industry's typical customer. Customers receive value when a company successfully implements a cost leadership strategy.


Companies that wish to be successful by following a cost-leadership strategy must maintain constant efforts aimed at lowering their costs (relative to competitors' costs) and creating value for customers.  Cost-reduction strategies include:

  • Building efficient-scale facilities
  • Establishing tight control of production and overhead costs
  • Minimising the costs of sales, product research and development, and service
  • Investing in state-of-the-art manufacturing technologies


Implementing and maintaining a cost leadership strategy means that a company must consider its value chain of primary and secondary activities and effectively link those activities, if it is to be successful.  The critical focus in successfully implementing a cost leadership strategy is on efficiency and cost reduction, regardless of the value-creating activity.


As noted in Figure below, the company's focus throughout each of its primary and secondary value-creating activities is on:

  • simplification of processes and procedures
  • achieving efficiency and effectiveness
  • reducing costs
  • monitoring the costs of activities provided by others that interface with the company's inbound and outbound logistics



Figure: Cost Leadership Strategies


Figure: Choices that determine costs


However, companies following cost leadership strategies cannot completely ignore sources of differentiation that customers value when producing standardised products.  These include styling, minimal levels of service, and product quality.


Differentiating Features That Lower Buyer Costs

A company doesn't have to price to make it cheaper for a buyer to use its product.  An alternative is to incorporate features and attributes into the company's product/service package that

Reduce the buyer's scrap and raw materials waste. Example of differentiating feature: cut-to-size components.

Lower the buyer's labour costs (less time, less training, lower skill requirements). Examples of differentiating features: snap-on assembly features, modular replacement of worn-out components.

Cut the buyer's downtime or idle time. Examples of differentiating features: greater product reliability, ready spare parts availability, or less frequent maintenance requirements.

Reduce the buyer's inventory costs.  Example of differentiating feature: just-in-time delivery.

Reduce the buyer's pollution control costs or waste disposal costs. Example of differentiating feature: scrap pickup for use in recycling.

Reduce the buyer's procurement and order-processing costs.  Example of differentiating feature: computerised on-line ordering and billing procedures.

Lower the buyer's maintenance and repair costs. Example of differentiating feature: superior product reliability.

Lower the buyer's installation, delivery, or financing costs.  Example of differentiating feature: 90-day payment same as cash.

Reduce the buyer's need for other inputs (energy, safety equipment, security personnel, inspection personnel, other tools and machinery).  Example of differentiating feature: fuel-efficient power equipment.

Raise the trade-in value of used models.

Lower the buyer's replacement or repair costs if the product unexpectedly fails later.  Example of differentiating feature: longer warranty coverage.

Lower the buyer's need for technical personnel. Example of differentiating feature: free technical support and assistance.

Boost the efficiency of the buyer's production process.  Examples of differentiating features: faster processing speeds, better interface with ancillary equipment.

Source: Adapted from Michael E. Porter, Competitive Advantage (New York: Free Press, 1985).


A company that successfully implements a cost leadership strategy can earn above-average returns even when the five competitive forces are strong.


  1. Rivalry with Existing Competitors Achieving the lowest cost position means that a company's competitors will hesitate to compete on the basis of price because, in the event of a price war, the low cost company will continue to earn profits after its competitors compete away their profits.


  1. Bargaining Power of Buyers (Customers) Achieving the low cost position provides some protection against powerful customers who attempt to drive down prices.  If customers attempt to drive prices below the cost of the next most efficient company, that company might choose to exit the market (rather than remain and earn below average profits), leaving the low cost company with a monopoly position.  If that happens, customers would lose any bargaining power, as the monopoly company would be in a position to raise prices.


  1. Bargaining Power of Suppliers  Because they have achieved the lowest cost position in the industry, the cost leadership strategy enables a company to absorb a greater amount of cost increases from powerful suppliers before it must raise prices charged to customers.  This may enable the company to be alone among its competitors in earning above-average returns.  In addition, a low-cost leader that also has a dominant market share may be in a position to force suppliers to lower prices or to hold down the level of price increases, and thus reduce the power of suppliers.


  1. Potential Entrants  Companies successfully following cost leadership strategies generally must produce and sell in large volumes to earn above-average returns.  And, with a continuous focus on efficiency and reducing costs, low-cost leadership companies create barriers to entry.  New entrants must either enter the industry at a large scale (large enough to achieve the same economies of scale as the next lowest cost company) or be satisfied with average profits until they move sufficiently far down the experience curve to match the efficiencies of the low-cost leader.


  1. Product Substitutes The low-cost leader is in a more attractive position relative to substitute products than are other companies in the industry.  To retain customers, the low-cost leader can more easily reduce prices to maintain the price-value relationship and retain customers.


Despite the attractiveness of the cost leadership strategy, it is accompanied by risks.

Technological innovations by competitors could eliminate the low-cost leader's cost advantage.

Overly focusing on process efficiency may cause the low-cost leader to overlook significant changes in customer preferences.

Competitors may successfully imitate the low-cost leader's value chain configuration.


In the event of any of the above, the low-cost leader is challenged to increase value to customers.  This may mean reducing prices or adding product features without raising prices.  However, if prices are reduced too low, it may be difficult for the company to earn satisfactory margins and customers may resist any price increases.



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