Firms that compete based on price and target a broad target market are following a broad cost leadership strategy. Several examples of firms pursuing a broad cost leadership strategy are illustrated below.
Table 6.2 Cost Leadership| Examples of Firms Pursuing a Broad Cost Leadership Strategy |
| Despite its name, Dunkin’ Donuts makes more money selling inexpensive coffee than it does from selling donuts. The coffee is often advertised as costing under a dollar, making Dunkin’ Donuts a low-priced alternative to Starbucks. |
| Supercuts’s website makes clear their longstanding cost leadership strategy by noting, “A Supercut is a haircut that has kept people looking their best, while keeping money in their pockets, since 1975.” |
| Payless ShoeSource is a discount retailer that sells inexpensive shoes for men, women, and children. However, they filed for bankruptcy in 2020 and closed all their stores, only operating their overseas stores. Super Shoes survives as a low cost leader. |
| Little Debbie snack cakes began when O. D. McKee started selling treats for five cents each in the early 1930s. Little Debbie cakes cost a lot more than five cents today, but they remain cheaper than similar offerings from Entenmann’s, Tastykake, and other snack cake rivals. |
The Nature of the Cost Leadership Strategy
It is tempting to think of cost leaders as companies that sell inferior, poor-quality goods and services for rock-bottom prices. This is not necessarily true, but some companies get this reputation. K-Mart, for example, had been a successful discount department store with a cost leadership strategy. As Walmart competed head to head with K-Mart, however, and offered higher quality products at the same or lower prices than its rivals, K-Mart was doomed. Its reputation for cheap, inferior products and its inability to win a price war with Walmart pushed K-Mart into bankruptcy.
In contrast to firms such as K-Mart, cost leaders can be very successful. A firm following a cost leadership strategy offers products or services with acceptable quality and features to a broad set of customers at a low price [Table 6.2]. Super Shoes, for example, sells name-brand shoes at inexpensive prices. Little Debbie snack cakes offer another example. The brand was started in the 1930s when O. D. McKee began selling sugary treats for five cents. Most consumers today would view the quality of Little Debbie cakes as a step below similar offerings from Entenmann’s, but enough people believe that they offer acceptable quality that the brand is still around eight decades after its creation.
Perhaps the most famous cost leader is Walmart, which has used a cost leadership strategy to become the largest company in the world. The firm’s advertising slogans such as “Always Low Prices” and “Save Money. Live Better” communicate Walmart’s emphasis on price slashing to potential customers. Meanwhile, Walmart has the broadest customer base of any firm in the United States. Approximately one hundred million Americans visit a Walmart in a typical week [Zimmerman & Hudson, 2006]. Incredibly, this means that roughly one-third of Americans are frequent Walmart customers. This huge customer base includes people from all demographic and social groups within society.
Cost leaders tend to share some important characteristics. The ability to charge low prices and still make a profit is challenging. Cost leaders manage to do so by emphasizing efficiency. At Waffle House restaurants, for example, customers are served cheap eats quickly to keep booths available for later customers. As part of the effort to be efficient, most cost leaders spend little on advertising, market research, or research and development. Waffle House, for example, limits its advertising to billboards along highways. Meanwhile, the simplicity of Waffle House’s menu requires little research and development.
Many cost leaders rely on economies of scale to achieve efficiency. are created when the costs of offering goods and services decreases as a firm is able to sell more items. This occurs because expenses are distributed across a greater number of items. Walmart spent approximately $3.5 billion on advertising in 2019 [Guttmann, 2019]. This is a huge number, but Walmart is so large that its advertising expenses equal just a tiny fraction of its sales. Also, cost leaders are often large companies, which allows them to demand price concessions from their suppliers. Walmart is notorious for squeezing suppliers such as Procter & Gamble to sell goods to Walmart for lower and lower prices over time. The firm passes some of these savings to customers in the form of reduced prices in its stores.
Advantages and Disadvantages of Cost Leadership
Each generic strategy offers advantages that firms can potentially leverage to enhance their success as well as disadvantages that may undermine their success. In the case of cost leadership, one advantage is that cost leaders’ emphasis on efficiency makes them well positioned to withstand price competition from rivals [Table 6.3]. Kmart’s ill-fated attempt to engage Walmart in a price war ended in disaster, in part because Walmart was so efficient in its operations that it could live with smaller profit margins far more easily than Kmart could.
Using a cost leadership strategy offers firms important advantages and disadvantages. Below, table 6.3 illustrates a few examples in relation to entertainment and leisure.
Table 6.3 Executing a Low-Cost Strategy| Advantages |
| High profits can be enjoyed if a cost leader has a high market share. An example is Kampgrounds of America, a chain of nearly 500 low cost camping franchises in the United States. |
| Low-cost firms such as many municipal golf courses can withstand price wars because high-priced competitors will not want to compete directly with a more efficient rival. |
| Disadvantages |
| If perceptions of quality become too low, business will suffer. |
| Large volumes of sales are a must because margins are slim. |
| The need to keep expenses low might lead cost leaders to be late in detecting key environment trends. |
| Low-cost firms’ emphasis on efficiency makes it difficult for them to change quickly if needed. |
Beyond existing competitors, a cost leadership strategy also creates benefits relative to potential new entrants. Specifically, the presence of a cost leader in an industry tends to discourage new firms from entering the business because a new firm would struggle to attract customers by undercutting the cost leaders’ prices. Thus, a cost leadership strategy helps create barriers to entry that protect the firm—and its existing rivals—from new competition.