Cost leadership is one of the primary bases for competing. By focusing on reducing the cost of your operations, you can charge a lower price for your goods or services, and in turn, capture the most cost-conscious customers.
Economies of scale
Economies of scale are one of the primary means of achieving a low-cost position. Economies of scale arise from savings that are achieved as the volume of production increases – the more you make of a product, the lower the cost per item. Common examples of economies of scale include:
- Purchasing materials at a better rate: There may be volume discounts in the raw materials, arising from better bargaining power, savings on delivery, or other cost savings relative to small or one-off purchases.
- Fixed costs are spread over a larger number of products: There are likely fixed costs in operating, inured irrespective of the number of products produced. These may include the rent on a facility, the cost of machinery, or the cost of developing the product. When you manufacture a larger volume of product, these costs are spread over a much larger number of products, in turn pulling the fixed cost allocated to each product lower.
- Labor cost per unit declines: Beyond costs that are entirely fixed, there are certain variable costs that may decline the greater volume that you produce. Greater volumes may allow more efficient routines to be implemented, potentially reducing the labor component of each product produced
Economies of scope
While economies of scale arise for producing large quantities of the same or similar products, economies of scope come from operating in different product areas. There may be cost savings that arise from diversifying to operating in multiple similar product areas. Such economies of scope include the potential to acquire materials in larger volumes, sharing advertising across product lines, or other capabilities that can be shared.
Another way of achieving a low-cost position is to engineer it out of the product, applying design for manufacture principles. There may be different materials that can be used, ways of simplifying the manufacturing process, or approaches to remove assembly cost. When really trying to eliminate cost from the operations to be able to offer the lowest costs to customers, it is important to actively take this into account when designing the product.
Different product features and service characteristics
Companies focused on cost may reconfigure the product features and the services provided. There may be certain characteristics, common on more expensive offerings, that can be scrapped to cater to a more price-conscious consumer.
More efficient operations
Finally, there may be further ways of achieving cost savings through a more efficient setup. It is not uncommon for there to be a lot of wastage in firms – unnecessary tasks that are performed, duplication, or inefficiencies in the operations. If firms are able to systematically improve the operations relative to competitors, or come up with a re-configuration to the value chain that eliminates certain costs, it may be possible to come up with a more efficient setup.
Final thoughts: Cost-leadership is about achieving low cost, not (just) low price
It is easy to fall into the trap of thinking that a ‘low-cost’ strategy is just about underpricing your competitors. While price may be the primary basis on which your firm competes, ultimately success requires achieving low cost in the firm’s operations to be able to sustain that low-price point.
Simply undercutting the price of competitors, without a more efficient setup, is unlikely to drive long-term success. If competing firms lower underlying setup, while undercutting them may momentarily drive sales, these better setup firms will ultimately be better placed to achieve an even lower price.
Economies of scale and economies of scope are two related – but distinct – concepts. This article explores the differences.
This article explores examples of some of the primary cost savings that come from increased volumes.
This article unpacks how economies of scale can act as a barrier to new firms entering a market, with examples of disadvantages new firms face.
This article explores the mindset to succeed in cost leadership – a dedication to reducing costs throughout the organization.
This article explores two related, concepts – economies of scale and diseconomies of scale – with examples of the differences.
Will diversifying allow you to gain better bargaining power with your suppliers? This article explores the possibilities of economies in purchasing from increasing the scope of the firm.
This article explores the differences between economies of scale and learning effects, as well as how scale can also lead to greater cumulated learning.
Practical approaches to help reduce costs from your operations, to increase your profit margins, or become a cost leader.
Where do cost-saving synergies come from? This article explores opportunities for savings from related diversification.