According to Porter, there are three core strategies for competitive positioning: cost leadership, differentiation, and focus.
Cost leadership is straightforward, as the player rolling this out will become the lost-cost producer in the industry.
As Porter highlighted, a cost leader has to have a broad scope (and scale). Indeed, the broad scope is a key element of cost leadership, in the first place.
A cost leader simply will be able to offer among the lowest priced products in the industry, because it achieved cost leadership.
Therefore, the cost-leader isn’t such because it started a price war. Quite the opposite, the cost leader is such, because thanks to its broad industry reach, efficiency, and scale can sell its products at a lower price and yet make margins.
In short, the low-priced product is the effect of cost leadership.
The cost leader has to keep an eye on differentiation as well. Thus, there isn’t a pure cost leader, meant able to be such without differentiation.
A cost leader has to be at least comparable or perceived as such, to enable the cost leader to have enough margins for long-term sustained advantage.
- What are the key elements for cost leadership?
- Cost leadership vs differentiation vs focused
- Cost leadership examples
- Key takeaways:
- Other cost leadership examples
- Other frameworks from Michael Porter
What are the key elements for cost leadership?
While the sources of cost advantage can vary, based on the structural characteristics of the industry, there are some elements that help to build up cost leadership.
- Economies of scale.
- Proprietary technology.
- Preferential access to raw materials.
- And more.
Cost leadership stems from industry dominance, as more cost leaders in the same industry, according to Porter, can lead to fierce competition and price wars.
Cost leadership vs differentiation vs focused
Porter posited that the relative position of a firm within an industry determined whether its profitability was above or below the industry average. Profit that was consistently above average could result in sustainable competitive advantage, which Porter noted could be attained via low-cost products or differentiation of some kind.
When these sources of competitive advantage are combined with the scope of business activities that support them, three strategies for obtaining above-average performance emerge.
The cost leadership strategy offers two choices for businesses:
- Reduce costs to increase profits whilst selling products at industry-average prices.
- Reduce costs to increase market share whilst still making a worthwhile profit.
Note that cost leadership is only concerned with minimizing the cost of delivering a product or service. The price that is paid by the consumer is covered is irrelevant.
Cost leadership is only effective for companies that offer the lowest prices in their industry. Those that sell above these prices are more likely to be undercut by their competitors, which hinders their ability to increase market share.
As a result, cost leadership tends to be associated with various characteristics of market-leading companies, such as:
- Economies of scale.
- Access to abundant capital for investment in new technologies.
- A low-cost base in terms of raw materials, labor, and infrastructure.
This strategy calls on the business to differentiate itself from the competition. Products and services with superior features, durability, support, or functionality are the most obvious form of differentiation, but a company may also stand out in the following ways:
- High brand equity and recognition among consumers.
- Industry-wide product distribution that occurs via all major channels.
- Effective marketing strategies, incorporating such things as ads and sponsorships.
The differentiation strategy can be further divided into three sub-strategies:
- Sophistication (higher prices, higher perceived value) – this form is common in the auto industry. Mercedes differentiates itself on status and luxury, while Toyota can charge more because of the reliability of its vehicles and TQM customer satisfaction approach.
- Purification (lower prices, lower perceived value) – such as budget airline EasyJet or Indian automotive multinational Tata.
- Hybrid (lower prices, higher perceived value) – the best example of hybrid differentiation is IKEA, which can sell affordable furniture thanks to its extremely efficient supply chain management.
The focused strategy is normally used by small and medium-sized companies. Unable to compete on price or differentiation in the broader market, these companies focus on a particular niche market and take the time to understand the target audience in detail.
They tend to build a smaller but no less devoted following, which makes niche entry unattractive to a larger competitor. It’s important to note that focus on its own is not enough to sustain a competitive advantage. Once a business enters a niche, it must choose either the price or differentiation strategy.
Southwest Airlines is one example of a company utilizing a focused competitive strategy. Instead of adopting the hub-and-spoke approach of its larger North American counterparts, the company sells short-haul point-to-point flights on less popular routes.
Cost leadership examples
Here are some recent examples of cost leadership across multiple industries.
RyanAir is an oft-cited example of cost leadership, and for good reason.
The budget airline carried more international passengers than any other airline in 2016 and in 2022, broke a monthly company record by transporting 15.4 million passengers.
RyanAir outperforms its competitors by selling air travel at the lowest unit cost possible.
To that end, the airline has the following characteristics:
- Superior bargaining power over suppliers. This minimizes operating costs.
- Little aircraft differentiation. Ryanair mostly utilizes the Boeing 737 which streamlines procedures and enables the company to order spare parts in bulk to save money.
- Superior negotiation position with airport operators. This is due to RyanAir serving less popular airports and its ability to secure lower airport fees and taxes.
- Lack of services that provide differentiation, such as free food, in-flight entertainment, premium seating, and airport lounges.
No list of cost leadership examples would be complete without McDonald’s. Cost leadership in the restaurant chain is facilitated by:
- Rapid food delivery – in essence, McDonald’s can serve more customers in an hour than its competitors. The process of making a hamburger, for instance, has been simplified and optimized over the years so that any employee can learn it quickly.
- Employee recruitment and training – McDonald’s is known to recruit teenagers who are often applying for their first job. Hiring inexperienced staff as opposed to trained cooks means the company can pay a lower wage.
- Vertical integration – compared to some of its competitors, McDonald’s favors vertical integration. The company owns the facilities that produce standardized ingredient mixes for its menu items. It also grows its own beef via contracted producers and handles its own product transportation.
Lidl is a German discount supermarket that operates almost 12,000 stores across 31 countries.
Much of the company’s success is due to the low-cost business model that has allowed it to prosper in the fiercely competitive retail industry.
The company’s cost leadership strategy is underpinned by the following factors:
- Cost minimization – to save money, Lidl uses natural light to illuminate its supermarkets whenever possible. Relative to its peers, the company also spends less on advertising and marketing campaigns.
- Lower labor costs – Lidl stores also tend to be more sparsely staffed than some competitors. Employees are trained to work in a variety of roles or departments, and store inventory is handled by automated technology that reduces the need for human intervention.
- Limited product selection – Lidl sells around 2,000 different products in each store, which is considerably less than the 20,000 found in a typical grocery store. This allows the company to order items in bulk and increase its buying power with suppliers.
- Private-label brands – of those 2,000 products, around 90% are private-label brands produced for Lidl only. By removing the middleman and having greater control over manufacturing costs, the company can save money and also sell its products for a higher margin than brand-name equivalents.
- Cost leadership, product differentiation, and cost focus are three generic strategies first described by Michael Porter in 1985.
- The cost leadership strategy involves reducing prices to increase profits or market share and is suitable for companies that offer the lowest prices in their industry. The differentiation strategy calls on the business to differentiate itself from the competition via superior products, brand equity, distribution, or marketing nous.
- The focused strategy tends to be used by small and medium-sized companies that are unable to compete on price or differentiate themselves in larger markets. Instead, they focus on building a loyal following in a particular niche.
Other cost leadership examples
Aldi uses a set of strategies to keep its prices low while maintaining a high quality:
- Aldi lists 1,300 items in each store every day, which is very limited compared to other supermarket chains. That keeps waste to a minimum.
- Aldi also stocks a lot of their own brands, with some becoming successful, which lowers the sales and marketing cost.
- 90% of the products are Aldi-exclusive brands, which makes it easy for the chain to market them, with more flexibility on price and distribution.
- ALDI in a way retains a. self-service attitude, where customers bring their own bags or can buy reusable bags at the store. Also, they must bag their own groceries. This lower the costs of serving clients for the company compared to other chains.
- Limiting store hours and keeping their stores small (about 15,000-20,000 square feet).