What is Cost Leadership Strategy?

Written by Scott Wilson

what is cost leadership strategy

What is cost leadership strategy? Cost leadership is a strategy in business of pursuing a competitive advantage in your market by offering products or services at the lowest costs in your category. A cost leadership strategy is one way to increase market share while increasing profits, but it requires excellent leadership skills to implement effectively.

Cost leadership isn’t a quality that is associated with an individual. Instead, it’s a position that a company can assume within its overall marketplace. Cost leadership involves creating processes that allow you to deliver goods or services at the lowest cost in your segment. This is often, although not always, a first step to lowering your pricing to undercut competitors.

It can be a risky strategy but also a very effective one. In a fast-paced marketplace with global supply chains and dynamic consumer consciousness, the play for low-rung on the cost totem pole is complicated. But cost leadership winners win big. Walmart, McDonald’s, Ikea… each is a global juggernaut that has mastered the cost leadership approach to business.

Cost leadership is all about squeezing out efficiencies in producing and delivering products and services. And creating efficiency is something that organizational leaders excel at.

What is Cost Leadership Strategy?

chess, king and coinsCost leadership is all about lowering your costs so far that your competitors can’t match you while still staying in business. When it’s costing you $5 to produce your widget but your closest competitor has to spend $6 for the equivalent, you end up with all kinds of big advantages.

The clearest and most common way to leverage cost leadership is to drop prices below a level that your competition can sustain, driving them out of the market.

But cost leadership can be used to exercise leverage in other ways, too:

You can pursue cost leadership through a number of different tactics:

Ultimately, it requires finding a sustainable way to have the lowest costs in your market segment.

What Must a Cost Leadership Strategy Accomplish to Be Successful?

tablet and paperAny executive can lower prices to rock bottom and watch sales take off. But for cost leadership strategy to be an effective business strategy, a company has to be able to cut costs while still maintaining both operational cash flow and profitability. And that’s a needle to thread that requires genuine leadership.

The typical risks of a cost leadership strategy include:

Declining profit margins – Lowering pricing without finding corresponding ways to lower the costs of goods and services inevitably chips away at profit margins. In some cases, this is a momentary dip on the way to economies of scale, but in other cases, cost leaders get stuck with low profits and less cash flow to continue expanding.

Reductions in product or service quality – In order to keep profit margins up, some companies may skimp on their product or service standards. While this can be effective if consumers aren’t sensitive to a particular standard, it can also rapidly lead to declining market leadership and lost customers.

Production expansion or growth constraints – Cost leadership strategies are vulnerable to any kind of shock or mis-step in growth. If the market shifts before you come to dominate it, you are left without future prospects and also without the cash reserves to shift with it.

Sensitive to operational efficiencies and input costs – By trimming production and operations costs to the bone, organizations pursuing cost leadership strategy leave themselves open to shocks from any disruption to those costs. Any operational hiccup can put you in the read; a supplier that raises prices can suddenly make cost leadership untenable.

Commoditization risks – Some cost leadership strategies end up being victims of their own success—having lowered product or service costs, companies may find that they have created price sensitivities among consumers and are unable to raise prices. At the same time, competitors may have found similar ways to create efficiencies and become able to compete at the lower price point. You’re stuck with low-margins for the foreseeable future.

Running those risks successfully can lead to huge benefits for any organization that has the right leadership to make it happen.

How Organizational Leadership Degrees Help You Master Cost Leadership Strategy

how degrees helpOrganizational leadership training offers many of the skills that it takes to be successful in a focused cost leadership strategy.

More than many strategies, cost leadership absolutely requires a big-picture, long-term perspective of your business and your industry that accounts for all the factors. That’s exactly the sort of vision and analytical approach that OL embraces. You’ll learn how to assess both your market and your company to weigh all of the important factors that go into cost leadership. And you’ll have the planning skills to develop a complete cost leadership strategic plan.

Equally important is the ability to sell that plan to investors, other senior leaders, and staff. And organizational leadership strategy puts a premium on those strategic communication skills. You’ll already know how to craft a winning pitch that will get people on board. And you’ll have both the interpersonal skills and the behavioral insights you need to find the right ways to motivate your staff to make it all work.

Cost leadership is only one of many different strategic approaches that a good organizational leader will consider. It may not be the easiest, but with the training to assess the overall business environment and the internal capabilities of your team, it’s a winner for strong business leaders.