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Create a Meaningful Cost Advantage

When a company has a meaningful cost advantage, it has contrived a business model that’s more efficient than the competition. If you’ve ever had to compete with a company that can deliver the same thing as you for less, you’ve experienced the power of a meaningful cost advantage.

This cost efficiency can be leveraged in the form of lower prices to the consumer in order to gain market share, to build a war chest to ward off competitive attacks, or in the form of higher margins.

Even more powerful is a business model combining a well marketed product delivered by a true low-cost provider. A true cost advantage is difficult to overcome, especially in a price-sensitive market. A company that can create a meaningful cost advantage is playing with a stacked deck. Some examples include:

  • The most difficult offshore oil drilling costs as much as $50/barrel to produce versus Saudi Arabian oil that costs only $2/barrel to produce.

  • Producers of plastics and fertilizer near cheap U.S. natural gas sources are currently enjoying prices three times lower than in China or Europe.

  • Walmart’s obsession with keeping operating costs low has resulted in the most efficient distribution system in the industry. Walmart can always sell a product for less than competitors, because it costs them less to purchase (volume) and distribute.

  • Toyota created significant savings by adopting lean manufacturing principles before its competitors were forced to follow its lead.

  • A software developer created a system to divide development into manageable pieces, allowing unpaid college interns to develop a new version of the product for free.

  • Company stores or outlets that sell goods without distributors can shift margin from one division to another, creating margin subsidies.

You can create a cost advantage in many ways. Three of the most common methods are economies of scale, smart use of technology, and leveraging the value chain. You can also create meaningful cost advantage by

  • Developing superior purchasing power or ability. Companies like Walmart have a reputation for beating the lowest prices out of vendors.

  • Selecting better vendors. Sometimes you can find an alternative vendor whose products are significantly cheaper than the industry norm.

  • Hiring less expensive employees. This isn’t a commentary on the benefits or detriments of low-wage employees. However, some companies have found operational methodologies that utilize lower-paid employees with equal effectiveness as their competitors’ higher-paid employees.

    A software developer hires most of its staff directly out of college. Most competitors have no interest in recent grads because of the need to train and the time needed to get them up to full speed. This software company has created a training and selection process that allows it to effectively hire these lower-paid grads.

  • Cultivating virtual work environments. Citibank used to rent large office buildings and fill them with thousands of customer service reps. Now Citibank leverages voiceover Internet technology to allow workers around the globe the ability to handle calls from their living room.

  • Creating a superior process. McDonald’s has consistently improved its operational processes in order to be more efficient than its competitors.

  • Creating a culture of cost containment like Walmart.

  • Working harder than your competitors. Creating a hard-working business culture can translate into a lower cost of operation.

  • Controlling trade secrets, intellectual property, or patents. A manufacturer created a custom piece of testing equipment that increased throughput five times. Use of this machine lowered the cost of production $0.20 per unit. Because none of the competitors had the machine, they all had a higher cost of production.

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