What is Cost Leadership?
In his 1985 book, “Competitive Advantage: Creating and Sustaining Superior Performance”, Michael Porter identifies three generic business strategies. These approaches can be applied to products or services across all industries, and in companies of varying sizes. One of these, “Cost Leadership”, is a strategy based on being the lowest cost producer in an industry, for a certain quality of product.
A leading company will either sell products at average industry prices to earn more margin than its competitors or sell at below industry prices to gain more market share. A cost effective business should also be able to weather any resulting price war whilst remaining profitable.
Businesses Doing it Right
A number of companies have been able to grow their margins despite the economic climate. One example is Whitbread. The UK based organisation, which owns popular brands such as Costa Coffee and Premier Inn, has demonstrated that there is potential to do well during a recession. By offering relatively inexpensive food and hotel prices, the group has managed to continue its expansion and raise its share value by more than a quarter in the past year.
Whitbread has effectively implemented the right model at the right time and taken advantage of the current demand for less expensive hotel and dining experiences. In order to provide these services in a cost effective manner, Whitbread has focused on improving procurement practices, menu management and labour scheduling.
A key element of this strategy was the launch of several ‘Skill Academies’, which provide training for managers and team members in improving operational and cost efficiencies. Another example of Whitbread’s cost leadership approach is the company’s use of e-auctions to minimise the impact of rising commodity prices. The process allowed Whitbread to avoid paying a 16 per cent price hike for a key commodity – potatoes. This approach saved the company an estimated £400,000 per year.
Successful Cost Leadership Initiatives
4C Associates is currently driving a variety of innovative cost transformation projects for several clients. The most recent is Project Flow, a Network Optimisation initiative being carried out to reduce empty miles and increase efficiency within the clients’ supply chain. CAST modelling tool was used to gather all relevant data on ingoing and outgoing transport flows from client factories and distribution centres. Geo-mapping techniques were then used to match outbound customer deliveries with inbound raw material deliveries in order to leverage the benefits of round trip pricing. Initial savings of 18 per cent were achieved on transportation costs.
Another 4C project, “Bondi”, is a broad brush cost reduction and cash release exercise across all categories, all geographies and all suppliers with spend over £100k. Suppliers were further segmented by their effective impact to business in case of non-supply. Different negotiation strategies were then adopted for each different segment. The project entailed requesting a 4.7 per cent price decrease and harmonisation of payment terms towards the 75 days standard (excluding small businesses).
One of the key elements behind a successful cost leadership strategy is fostering a mentality which encourages innovation. The best way to reduce expenditure is to look at cost from a different angle. An example of this is a driving school which employs one brand of car. By supplying cars to the motoring school, the vehicle manufacturer is effectively advertising its products to every learner driver using the school. In this situation which party should be compensating the other?
The airline industry has long been striking profitable deals with airports to keep certain routes open. Ryanair in particular has championed the notion of looking at costs in an innovative manner. The Irish airline’s business strategy was pioneered by Southwest Airlines and made up of four guiding principles: employ a single type of plane to keep costs down, constantly review overheads, turn aircraft around as quickly as possible and abandon point’s schemes.
In 2002, Ryanair secured a significant discount on the purchase of 100 Boeing 737-800 jets with the option to buy a further 50. With newer, more fuel efficient planes than many of its rivals, Ryanair was able to charge lower fares and fill planes with passengers, who might not spend a huge amount on tickets but spend profitable sums on food and hotel reservations.
Ryanair has introduced a number of measures which helped the business to a profit of €503m in the past financial year. These include, being the first airline to implement baggage charges, working to eliminate the need for check in desks and cutting the weight of its aircraft. Most recently the company announced it was examining the possibility of larger aircraft doors, to speed up boarding. In a similar vein, rival airline Easyjet, is to introduce allocated seating in an attempt to secure revenue from having passengers pay to choose their seats. This consistent search for new ways to transform costs, is the essence of the cost leadership strategy.
Seeking out Opportunity
Despite the lack of optimism surrounding the current financial climate, several of the world’s leading businesses have been able to thrive. The difficult environment, in which many companies are evolving, represents a great opportunity to review, improve and revolutionise established industry practices. By adopting a new way of approaching cost, businesses can leverage innovative cost leadership practices to drive growth.