Cost leadership and product differentiation are the business level strategies. These two strategies are sometimes referred to as generic business level strategies because they represent heuristically two extremes that a firm could choose to pursue. However, as with most of the concepts covered in this course, some firms are better able to gain competitiveadvantage by pursuing these generic strategies than other firms.
THE BENEFITS OF COST LEADERSHIP
Define Cost Leadership
As the name implies, a cost leadership strategy is intended to generate competitiveadvantage by achieving costs that are lower than all competitors. Our definition of competitive advantage is: the ability to create more economic value than competitors. A firm with lower coststhan competitors creates more value because of the greater difference between the firm’s costs and the price the firm is able to charge (i.e., higher profit margins).
1. Cost leadership is not necessarily synonymous with low price. It is true, by definition, that the cost leader in a market can charge the lowest price and still have a positive profit. However, a firm pursuing a cost leadershipstrategy would want to have the advantage of the lowest costs without being forced to charge the lowest price.
2. Firms in a market have a strong incentive not to compete on price with the low cost leader. This is akin to the old boxing adage that: One’s success in the ring has a lot to do with choosing one’s opponent. Firms have a strong incentive to compete on cost (not price) because of theadvantages explained above. Therefore, firms enjoying cost advantages typically face strong competitive pressures on their cost positions. The durability of cost advantages will be discussed later in the Cost Leadership and Competitive Advantage section.
Example: Wal-Mart’s Cost Advantages
Wal-Mart has always been focused on achieving the lowest possible costs. As the firm began to expand andgrow there were two main sources of cost advantage: 1) a growth pattern of rural locations surrounding distribution centers, and 2) information technology. Wal-Mart’s careful selection of rural locations created cost advantages because of relatively cheap land and very efficient distribution through its distribution centers. Stores were typically located along interstate highways and/or heavilytraveled crossroads. There was usually very low demand for the land purchased for these locations because other retailers were uninterested in rural locations. However, these stores had incredible drawing power. People flocked to the stores in search of low prices and a wide product offering. Distribution was also relatively inexpensive because Wal-Mart’s trucks could easily get to these locationsfrom interstate highways. One large distribution center could efficiently handle all the stores within a day’s drive.
These location advantages were coupled with Wal-Mart’s information technology which was always state-of-the-art. Highly efficient inventory management, facilitated by IT systems, allowed Wal-Mart to achieve costs significantly lower than its competitors. Wal-Mart knew whichitems were selling and which were not. It knew how much of which products were needed and where they were needed. And, it could distribute these products quickly and efficiently.
Wal-Mart has heavily advertised low prices. People tend to associate Wal-Mart with low prices. However, careful shoppers in some markets have realized that competitors sometimes offer lower prices, especially on fooditems. Thus, it would appear that Wal-Mart is in the enviable position of having low costs but not having to charge the lowest prices on all products
all the time.
This pricing advantage can be very frustrating for competitors. Wal- Mart has a policy of beating competitors’ prices whenever a customer points out that a competitor has a lower price. If a competitor attempts to compete vigorously...