Advantages and Disadvantages of Cost Leadership Strategy

Michael E. Porter, in his 1985 book “Competitive Advantage: Creating and Sustaining Superior Performance,” discussed four competitive strategies. These strategies are – Cost Leadership, Differentiation, and Focus strategy (Cost Focus and Differentiation Focus). According to Porter, each of these strategies is capable of giving a competitive advantage to a company in a market. Like with any other thing, each of these strategies has been their own advantages and disadvantages. In this article, we will take a look at the advantages and disadvantages of the Cost Leadership strategy.

Before we detail the advantages and disadvantages of the Cost Leadership strategy, let’s understand the Cost Leadership strategy.

Cost Leadership Strategy – What it is?

A company following this strategy uses economies of scale and makes production efficient enough to reduce the product and service costs lower than that of rivals. This strategy basically means leading an industry in terms of the cost of production.

Ikea and Walmart are very good examples of firms practicing this strategy. These companies make huge profits by mass-selling their products for less than the competitors.

Cost Leadership Strategy: Advantages

Below are the advantages of the Cost Leadership strategy:

For Company

Loyal Customers

Low costs always encourage customers to stick to a brand unless other brands are offering something extra. It ensures that the firm has a strong and more market presence.

Absorb Price Rise

A firm enjoying cost leadership is in a better position to absorb any increase in price from suppliers. Their low-cost structure helps them to absorb the price rise without marginally passing the same to the end user.

Entry Barriers

This strategy helps to create significant entry barriers to discourage new entrants. It helps existing companies in the industry.

For Customers/Industry

Price Stability

It helps to bring price stability in the industry.

Lower Price

Customers get the product or service at a lower price.

Cost Leadership Strategy: Disadvantages

Below are the disadvantages of the Cost Leadership strategy:

For Company

Huge Investment

Implementing a low-cost strategy requires a company to make big investments to boost its production capabilities. So, such investments make this strategy expensive to implement.

Temporary Entry Barrier

A key downside of this strategy is that competitors can easily imitate it. Once the competitors are able to achieve similar cost advantages, the entry barrier is broken. It could result in the cost leader losing its competitive advantage in the short run.

Losing Dominant Position

Companies adopting this strategy focus mainly on reducing per-unit costs. It could lead to overlooking other crucial factors, such as research and development, studying market trends, and the macro environment. Overlooking these factors could lead to the company losing its hold on the market in the long term.

Final Words

Cost Leadership is a very effective strategy. A company that is able to successfully achieve this strategy could ensure long-term success. The biggest risk, however, to a company following this strategy is that rivals could imitate the cost reduction strategies. Thus, it is very crucial for the cost leader to continuously find ways to reduce the cost.

Sanjay Borad

Sanjay Bulaki Borad

MBA-Finance, CMA, CS, Insolvency Professional, B'Com

Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

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