Overall Cost leadership Strategy

Costing Assignment

Sachin Lakade:-32

Why overall cost leadership strategy

Overall cost leadership is achieved by the firm that is able to maintain the lowest costs of production and distribution within an industry.

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Firms pursuing this strategy must be effective in engineering, purchasing, manufacturing, and physical distribution. Marketing is less important.

Overall cost leadership is achieved when you offer a "standard" product, but your costs are significantly lower than the average for the industry. However, it is important that low costs must not be perceived as low quality by the customer,because in that case you will have to lower your price and this will destroy your competitive advantage. Low costs enable the leader to price its products lower than its competitors in order to win a large market share. Firms with a large share of the market are usually able to achieve lower costs through economies of scale, and the experience effect.

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Low costs are achieved in two ways
◦ More efficient production arising from experience. This occurs because doing the same thing many times leads to finding more efficient methods of production.

◦ Economies of scale. In every industry there is a most efficient size of plant, management structure and so forth.

◦ Through innovation in production methods, leading to new techniques of production or better organisation of production.

What is the Benefit: 

The lowest cost producer is able to survive in a price war. Supernormal profits generate internal finance that can be reinvested to improve quality and continue cutting costs.  Risks associated with low cost strategy are
◦ Poorly focused on customer needs. ◦ Production oriented ◦ Many routes to a low cost position can be easily copied.“ ◦ Company may not survive in price war.

Scale Effect

Economies of scale are achieved primarily through the size of operations. Large businesses have the potential to operate at lower unit costs. Large-scale plants, for example, are cheaper to build, and they yield lower operating costs per unit of output. Although the most substantial gains are usually seen in manufacturing, benefits of scale can be achieved in marketing, sales, distribution, administration, R&D, and service. The cost of raw materials and shipping can also be reduced through economies of scale.

Experience Effect

The experience effect, or "experience curve", refers to the cumulative number of units produced by a company to date. The cost of production declines 1030 percent each time the firm doubles its experience at producing the units. Businesses with large market shares typically have more experience, and consequently, lower costs.

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