Page 31 - DMGT206_PRODUCTION_AND_OPERATIONS_MANAGEMENT

Production and Operations Management

Notes

2.2.1 Cost Leadership Strategy

A firm pursuing a cost-leadership strategy attempts to gain a competitive advantage primarily
by reducing its economic costs below that of its competitors. This policy, once achieved, provides
high margins and a superior return on investments.
The skills and resources required to be successful in this strategy are sustained capital investment
and access to capital; superior process engineering skills; good supervision and motivation of
its labour force; product designed for ease in manufacturing; and low-cost distribution system.

Notes The organization attempts to exploit economies of scale by aggressive construction
of efficient economies of scale through:
1. Volume of production and specialized machines
2. Volume of production and cost of plant and equipment
3. Volume of production and employees specialization
4. Volume of production and overhead costs.

This strategy requires tight cost control. This is often done by using a full costing method or
activity based costing with frequent and detailed control reports. The structure of the organization
should be clear-cut and responsibilities clearly laid out. Organizations often provide incentives
based on meeting strict quantitative targets, etc.

In order to remain a cost leader, the firm attempts to avoid those factors that can cause the
economies of scale to be affected. It has to work within the physical limits to efficient size;
worker motivation; and focus on markets and suppliers, sometimes in restricted geographical
areas. Firms that are known to have successfully used this strategy in a number of their businesses
include Black and Decker, Texas Instruments, and Du Pont.

The ‘low-cost producer’ strategy works best when buyers are large and have significant
bargaining power; price competition among rival sellers is a dominant competitive force; the
industry’s product is a standard item readily available from a variety of sellers; there are not
many ways to achieve product differentiation that have value to the buyer; and when buyers
incur low switching costs in changing from one seller to another and are prone to shop for the
best price.
A low-cost leader is in the strongest position to set the floor on market price and this strategy
provides attractive defences against competitive forces. Its cost position gives it a defence from
competitors because its lower costs mean that it can still earn returns after its competitors have
competed away their profits through rivalry. It is protected from powerful buyers because
buyers can exert power only to lower prices, and this will be possible only with the next most

26 LOVELY PROFESSIONAL UNIVERSITY