September 8th, 2011

Low Cost Strategy

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Being The Low Cost Provider Is A Tricky Business

Excerpts from What’s Wrong With Your Small Business Team?

[Strategic Market Positioning]

Using the low cost provider strategy requires an assessment of the market to determine its potential for success.  A low-cost strategy works best when competitive products are identical or very similar, target customers are price-sensitive, and switching doesn’t carry a significant risk or penalty.

Toothpaste offers a prime example of a product susceptible to a low-cost strategy.  Competitors in that industry offer end products that are essentially identical.  The bulk of female customers are very price-sensitive.  And, there is no penalty for switching between brands.

How Much Longer

On the other hand, there is a penalty for breaking a cell phone contract and going to another provider. Furthermore, studies show that early adapters, electronics geeks and business users will snap up new models as soon as they come out, with little consideration for price.

The primary downside to the low cost provider strategy is lost profitability.  With razor thin margins, success hinges on increased volume and strict, uninterrupted efficiencies along the value chain. If you enter a mature market where new customers are hard to find, there is the risk that cost-cutting will fail to create a stream of new customers because there are no customers left.

In 1986, roughly 25% of all households in the U.S. owned a microwave oven. Current estimates hold that over 91% of American households own a microwave oven with an estimated 200 million in use worldwide. If you’re targeting the U.S. market with a low costs provider strategy, where are the customers coming from to give you the volume you need to offset lost margins? In addition, if anything unexpected happens to drive up costs along your value chain, you have no room to recover.

Ever wonder why the waitress keeps coming over to your table asking if you want anything else?  If the restaurant is built on a low cost provider strategy, profitability is based on the high turnover of each table, meaning the longer you sit there tying up a table, sipping on coffee, the greater the chances are the dollar volume assigned to that table will not be realized. Perhaps, the table needs to turn twenty meals a day at an average cost of $18 per meal, and there you are reading the newspaper and mulling over a two dollar cup of coffee. Somebody please pull the fire alarm.

The lesson here is simple. Study the market thoroughly to see if the low cost provider strategy is appropriate for your product or service. If it is, dive in, but only with the understanding that as the market matures, the strategy will no longer be effective and must be phased out for a more attribute-driven approach.