“Our prices can’t be beat!” was a ubiquitous slogan in network television commercials. Companies like Walmart made these kinds of promises central to their business models, cementing their reputations for low prices as textbook examples of industry leaders in price competition.
Have you ever wondered how companies guarantee the lowest prices while earning a profit? Successful price leaders are often cost leaders first. Learn how cost leadership works, its advantages and risks, and ways to implement a cost leadership strategy for your business.
What is a cost leadership strategy?
A cost leadership strategy is a business plan to have the lowest production costs and other operating expenses in the industry. This approach, when successful, lets a company offer the most competitive prices in a category while maintaining healthy profit margins.
To use an example from the airline industry: Southwest Airlines deployed a successful cost leadership strategy for many years. Southwest kept its costs lower than competitors in many US markets by focusing on shorter domestic routes. This strategy allowed it to avoid costs other US-based carriers faced, such as global marketing campaigns, long-haul routes, mixed aircraft fleets, and catering to business-class travelers. Being a cost leader often let the airline offer the lowest fares on many domestic routes. This no-frills approach, in turn, became a hallmark of Southwest’s brand.
Price leadership vs. cost leadership
Price leadership and cost leadership strategies are different but related. While price leadership may focus on offering the lowest price in a category or sector, cost leadership focuses on lowering a business’s operating costs to gain a competitive edge. Cost leadership therefore may enable price leadership, because lower operating costs mean a business can cut prices while maintaining profit margins. Many price leaders are often cost leaders first, but this is not always the case.
Sometimes, companies aim for price leadership by selling goods at a reduced profit or even a loss to force competitors out of the market, broaden or solidify a customer base, or build brand loyalty. Amazon, for example, operated at a loss for many years as it expanded its market share and developed a broad base of loyal customers. In such cases, price leadership isn’t based on cost leadership.
Advantages of using a cost leadership strategy
A company might adopt a cost leadership strategy for a number of reasons, but here are a few primary ones for ecommerce businesses to consider:
Offer more competitive prices
By cutting operating costs, a company can afford to lower its prices, passing on savings to customers while still turning a profit. A cost leadership strategy can help small businesses selling widely available goods gain a competitive edge.
Gain market share
Cutting costs and lowering prices tends to increase sales, especially among customers sensitive to rising prices and looking for a better deal. By gaining customers and market share in this way, a business can take advantage of the consequent savings in cost per unit, creating a potentially profitable feedback loop.
Build resilience
A business that finds ways to minimize its operating costs is better positioned to withstand price wars or economic slumps, times when customers historically demand price concessions. If a company has already lowered and streamlined its production costs, it is better positioned to make price concessions and can attract customers away from other firms during price wars.
To be sure, cost leadership strategies have risks. If the increase in sales volume isn’t enough to make up for narrower profit margins, your company’s earnings may be put at risk.
How to implement a cost leadership strategy
- Assess your operations
- Research your competitors
- Analyze your supply chain
- Increase accuracy and innovation
- Focus on strengths and high-performing products
- Track your progress—and the market
While every brand has unique needs, adopting a cost leadership strategy requires research, careful planning, and possibly significant upfront investments in operations. Here are some ways to implement a cost leadership strategy:
1. Assess your operations
Conduct a thorough assessment of your company’s current costs, including materials, production, payroll, and marketing to identify potential savings. For instance, you may have software designed for sole proprietors, and continue the subscription even though your ecommerce business now is a corporation with many employees.
Likewise, if your company launched a marketing campaign to attract new customers last quarter but the campaign didn’t meet your conversion targets, you might rethink your marketing budget. Make sure operational costs reflect not only your company’s current state but also how it may change in the future.
2. Research your competitors
Because cost leadership is a relative position in the market, it’s critical for a business to know where its competitors stand—not only in pricing but in operational costs. A price comparison tool can be a great first step to help quickly assess where you stand as you look for ways to minimize costs.
3. Analyze your supply chain
Since each link in the supply chain adds expenses, shortening the chain by sourcing raw materials directly or with fewer intermediaries can reduce costs and help you gain a competitive advantage. This tactic is highly dependent on the type of product. Still, it’s worth reviewing each party in your supply chain and researching whether alternative suppliers or more direct sourcing is available.
4. Increase accuracy and innovation
Adopting software to reduce production errors or automate tasks may increase production efficiency and reduce costs. It may also help you save on payroll and contractors. For instance, a company using an accounting firm to file its taxes might find highly rated accounting software performs the same functions at a lower cost.
This kind of efficiency can also lay the groundwork for a company to scale its operations.
5. Focus on strengths and high-performing products
Not every product you make will be equally profitable. Narrow your focus to producing only those goods with the widest profit margins. By bringing the costs down for those, you’re more likely to have the leeway to achieve cost leadership.
Additionally, by increasing output of high-performing products, you may be able to take advantage of economies of scale. This means the unit cost of goods decreases due to buying raw materials in bulk and dividing marketing, labor, and administrative costs by the total (now higher) number of units produced.
6. Track your progress—and the market
Setting goals, metrics, and regular evaluation intervals is important for implementing a cost leadership strategy.
Awareness of larger market trends and forces is also imperative, especially as a company lowers prices or costs. For instance, production cost savings for 12-cup coffee makers might prove of little value if the market shifts to single-cup brewing systems. A global disruption or labor strike might necessitate revamping a supply chain in a different time frame than a company initially planned. Staying aware of trends among competitors and in the broader economy can help ecommerce businesses prepare for and adapt to changing markets and customer behaviors.
Cost leadership strategy FAQ
What is the main objective of a cost leadership strategy?
A cost leadership strategy can help a business drive down operational costs and gain a competitive edge in a category or sector. A successful cost leader can offer lower prices to its customers and increase market share while also maintaining profit margins.
What is the key risk of a cost leadership strategy?
When a business adopts a cost leadership approach, it must increase sales volume to maintain profit margins. If sales volume doesn’t go up as expected, low prices may erode profitability, result in losses, and even put the business’s survival at risk.
How do you become a cost leader?
There isn’t a universal roadmap for a cost leadership strategy, but employing best practices will lay the groundwork for developing a low cost strategy. Becoming a cost leader requires careful planning, market research, and seeking ways to secure a competitive edge. Although cost leadership is a relative position in a market, many businesses can gain a competitive advantage by adopting some of the cost-saving measures of successful cost leaders.
