Organizational Implications of the Cost Leadership Strategies

Abstract

Included by M. Porter in the category of the generic competitive strategies, the cost leadership strategies still present interest for the researchers in the strategic management domain, a research domain on which many research studies have focused. In this context, the present paper describes new tendencies concerning the need, the advantages and the difficulties of application of this type of strategies. In an environment based increasingly more on competition, where the banking and the economic crisis influence the purchasing power of the population, the application of a cost leadership strategy is opportune and gives the firms the opportunity to survive in the long run. At the same time, use of modern methods of operations management favor the efficient application of the cost leadership strategies.

Headnote

Abstract

Included by M. Porter in the category of the generic competitive strategies, the cost leadership strategies still present interest for the researchers in the strategic management domain, a research domain on which many research studies have focused. In this context, the present paper describes new tendencies concerning the need, the advantages and the difficulties of application of this type of strategies. In an environment based increasingly more on competition, where the banking and the economic crisis influence the purchasing power of the population, the application of a cost leadership strategy is opportune and gives the firms the opportunity to survive in the long run. At the same time, use of modern methods of operations management favor the efficient application of the cost leadership strategies.

Keywords: competitors, competitive strategy, competitive advantage, cost leadership strategy

JEL Classification: D21, D22, L11, L22, M21

Introduction

Elements of competitive strategy were formulated for the first time in the 1970s [Ghemawat, 1999]. The spectacular increase of the raw matter prices and the bankruptcy of many companies were just as many motives for the elaboration of certain studies, strategic analyses by the consulting companies and the academic environments. Notions such as cost and differentiation, around which the competitive strategies were elaborated in the 1980s, were implicit notions in the concept of entry barriers, formulated by J. Bain [1956] and in the concept of business system - forerunner of the value chain - formulated by the McKinsey consultancy firm, as a strategic analysis instrument.

M. Porter [1980] and W. Hall [1980] were the first to state that in order to be successful, the enterprises need to choose to fight based on costs, based on differentiation or based on focalization.

The results of M. Porter's researches concerning the competitive strategies were published in two fundamental works (Competitive Strategy: Techniques for Analyzing Industries and Competitors [1980] and Competitive Advantage. Creating and Sustaining Superior Performance [1985]), in which the American professor inventoried three generic competitive strategies: the cost leadership strategy, the differentiation strategy and the focalization strategy, sometimes called niche strategy.

At the basis of the competitive strategies are the competitive advantages that a company has or wishes to obtain. These strategies have a decisive role in the determination of the global performance level of the company because, indeed, the overall competitiveness of an enterprise largely depends on its capacity to efficiently fight with the competitors, in each of the activity domains in which it has chosen to be active.

Under these circumstances, the goal of our qualitative research is to evaluate the consequences of the use of the cost domination strategy on organizational management, in the present context of changes in the business environment, starting from the analysis of the cost advantage sources and taking into account the advantages and the limitations of these strategies. In this sense, we have used as research methods: induction, deduction, and the analysis of certain reference works in this domain.

1. Main sources of cost advantage

When an enterprise aims to obtain a competitive advantage from the domination strategy by low costs, there are three possibilities (Johnson et al., 2008: pp. 271-272):

* to conquer a market share superior to the market shares of the competitor companies - the cost advantage results from the economies of scale;

* to focus on those aspects of the value chain appreciated by the buyers and to externalize the company functions that can be more efficiently realized in this way;

* to use the high sensitivity of the clients to the price and to obtain a cost advantage that would be hard to imitate by the rival companies.

If an enterprise has low prices, and it is therefore leader in costs, it can offer sale prices lower than those of the rival companies, at the same time keeping the same price level. On the other hand, if the fight for competitiveness in the sector grows and the companies start to fight based on the sales price, then the leading company - the one with the lowest cost per product - will be able to face the competitors better than the rival companies of the sector, and will consequently have a better possibility of conquering and defending the market shares.

In order to obtain advantages from costs, it is necessary that the total production expenses for the whole value chain be lower than the total of the expenses for each of the value chains of the rival companies. This is possible in two ways (Porter, 1980):

* the thing should be done better than the rival companies do it, the operations of the value chain should be carried out more efficiently and the factors determining the level of the expenses in the value chain should be correctly managed;

* the company's value chain should be corrected up to the unification of the operations or the renunciation to very costly chain activities.

The main cost-advantage sources are presented in table 1.

2. Cost-reduction options and the organizational implications

The strategic business unit, the company practicing the low cost strategy and wishing to fight against rival companies has several cost-reduction options (Apud. Pellicelli: p.423; Aaker: p.84; Porter, 1985: p.36):

* produce products and services that do not contain superfluous elements (nofrills products). The constructive simplification of the product or service, by eliminating the components that the buyer considers superfluous is a first way of reducing the costs. There is, however, the risk that the rival companies might add another element to their product and manage, in this way, to gain a better position on the market. The strategy is successful especially if the strongest rival companies are made uncomfortable, because they cannot reduce their performances, either because of the clients who demand these performances, or because their operational system cannot change them easily. In this situation, there is the risk that the rival companies, for instance, may constitute an autonomous production unit, coming on the respective market with high-quality no-frills products;

* change the constructive configuration of the product and the service. A new, more reliable, simpler configuration of the product or service, with fewer components, with a simpler maintenance may create a cost advantage.

* do cost reduction activities by means of an operational management:

- use cheap raw matters, materials, energy;

- use ways of distribution generating lower costs, for instance by using new distribution channels, the company could reduce its costs by comparison to those of the rival companies;

- use cheaper labor force: de-location of the production in regions, geographic areas where the labor force is cheap, such as, for instance countries from South-East Asia;

- use fiscal credit facilities provided by the "host" State;

- implement innovations in the production processes; the accent needs to be put on continual innovations;

- reduce the fixed costs, whose immediate consequence decreases the profitability threshold; beside the advantages resulted from the price, this measure increases the flexibility of the production;

- use the advantages resulted from the application of the economies of scale;

- use of the experience curves; the more the company repeats a certain activity, the lower the costs become due to the appearance of the economies of scale, the learning by repeating the same operations by the executants, the accumulation of knowledge;

- practice low-costs, which means a cost reduction philosophy - this begins in the designing of the products, continues in their production and ends only when the product has been abandoned;

- create a low cost culture; it is necessary to develop a culture (value system) constantly involving all the employees in order to highlight the most advantageous solutions in point of cost-reduction.

The operationalization of the cost leadership strategies at the Dacia factories by means of modern methods specific of the operational management ("kaizen" - method of continual improvement at the work bench, "poka-yoke"- method of prevention of human or machine errors that might generate work accidents or unintentional destruction of goods, "monozukuri" - method to diminish the purchase cost of the car, while also improving quality and "dojo" - areas simulate real life situations so that new employees can learn in an easier and more effective manner how to avoid hazardous situations or how to adopt adequate behavior) allowed the firm, in January 2014, to set a new trade record, with sales of almost 430,000 vehicles.

There is a connection between the features of the cost leadership strategies and the organizational implications, in the sense that each generic strategy involves a certain organization (table 2).

A low-cost strategy supposes stable technologies, which makes it inapplicable in the sectors where the technological innovations concerning the processes and the products are frequent.

If the company is not vigilant in point of cost-control, the leader company, by low costs, will find itself in the situation of the rival company, which benefits of a favorable competitive position compared to the companies A and B, having a potentially favorable cost position, its real cost being nevertheless higher - because of the costs of the production factors not taken into account, bad operationalization, bad cost surveillance etc. (figure 1).

Usually, most of the buyers sensitive to the price choose the cheapest product. On the markets where the competition revolves around the price, low costs comparatively to the costs of the rival companies constitute a serious competitive advantage (Vagu&Stegaroiu, 2005: p.181).

There are five types of price strategies that can be used by the companies within the cost domination strategy (Strategor, 2005: p.134-138; Sicard, 1994: pp. 123-127):

* the strategy of accepting a loss to impose a product on the market or the dumping strategy;

* the strategy of reducing the prices at the same rhythm as the costs;

* the price umbrella strategy by maintaining the initial level of the prices in order to leave free access to the potential competitors;

* the strategy of practicing a very low launch price to catch up with the leader companies;

* the abandon strategy, practiced by companies that observe that they cannot manage to conquer a favorable position on the market and can decide to progressively withdraw from the respective market.

3. Advantages and risks of the cost domination strategy

The cost leadership strategy protects the company [Gervais, 2003: p. 126]:

* against the aggressions of the rival companies, since when the rival companies have exhausted their resources in the conflict, due to the low costs, the company can continue to obtain profit;

* against the strong clients, since the clients cannot exert their power of influence except by managing to find rival companies that propose lower prices;

* against the strong providers, since a slightly increased cost increases the flexibility when one has to face the price increase of the production factors. The increase of the product quantities leads to the decrease of the costs and, consequently, in the case of an equality of conditions, a growth of the profits of the leading enterprise occurs, allowing the growth of its capacity of making more investments for development. Availing itself of a larger share of the market, the leader company, by low costs, increases its power of negotiation with the providers.

In the past, for a long time, the technical progress made obsolete different technologies based on large quantities of products and provided the same advantages (experience curves) to other companies producing in smaller quantities. The tendencies in the surrounding environment may change and the enterprises that have become leaders in costs, through the localization of the products in countries where the price of the labor force is lower suffer the risks generated by the exchange fluctuations, by protectionist measures of the States where they are selling their products and by the rival companies producing in countries where the cost of the labor force is lower. Yet, the practice of the last three decennia has shown that the enterprises of Western Europe, which implanted, during the period 1980-2000, their productions in industrializing countries from Central and Eastern Europe had to review their policies following the increase of the costs of the labor force in the respective countries.

A conclusive example is the transfer from Germany to Romania of the mobile phone production by Nokia, the Finnish company, at the beginning of the year 2000, later on this company having to close its enterprise from Romania following the hard competition coming from other companies.

Conclusion

In order to keep its cost advantage, the dominant company needs to ceaselessly fight for an increase of its productiveness, a decrease of its supply costs and must pay attention to the limitation of the experience transfer to rival companies. It needs to identify its cost advantages, make them perennial and defend itself against the possible threats.

A better competitiveness of the Romanian firms could be the result of innovation in process management, but should also be supported by administrative reforms allowing the construction and preservation of the competitive advantages by the minimization of the costs.

The application of cost domination strategies in organizational management:

* a clear definition of the responsibilities;

* a well-structured organization;

* use of management by objectives;

* a very developed management control and oriented towards strictly following the costs.

* frequent and detailed control-related records;

* an intense surveillance of the use of the labor force;

* use of value analysis and of cost audit.

At the same time, the development of IT applications for computer-assisted design, production robotization, on-line training of the human capital, online stock management, distribution and service favor the efficient application of the cost domination strategies.

In a World Bank Report [World Bank, 2013], Romania is situated on the 73rd position out of 189 economies in point of the regulations that affect private sector firms, in particular small and medium-size enterprises. The report presents quantitative indicators on 11 areas of business regulation, Romania obtaining lower scores for: getting electricity (rank 174), dealing with construction permits (rank 136), paying taxes (rank 134), resolving insolvency (rank 99) and trading across borders (rank 76).

Under these circumstances, Romania will need to take measures meant to reduce the bureaucracy in these domains in order to increase the attractiveness of the business environment for the entrepreneurs.

References

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