As part of the series of blogs on the low cost strategy, yesterday we discussed economies of scale. But there are other ways of achieving low costs.
One is by achieving low direct operating costs. This can be done by offering high volumes of standardized products, offering no-frills products and limiting customization and personalization of service. Production costs are kept low by using fewer components, using standard components, and limiting the number of models produced to ensure larger production runs. Henry Ford is famous for saying – “Customers can have any colour car they like, so long as it is black” (even though he did not say it).
A second way is keeping indirect costs low. Overheads can be kept low by paying low wages, locating premises in low rent areas, and/or establishing a cost-conscious culture. Ryanair has been famous (or notorious?) for this. Maintaining this strategy requires a continuous search for cost reductions in all aspects of the business.
The third way is control over the supply chain to ensure low costs. This could be achieved by bulk procurement to enjoy quantity discounts, squeezing suppliers on price, instituting competitive bidding for contracts, or working with vendors to keep inventories low using methods such as Just-in-Time purchasing or Vendor-Managed Inventory. Dell’s early success was partly based on keeping inventories low and only building computers to order. Currently this has become a high profile ethical issue, with large firms being criticised for using their market power to extend their supplier payment terms up to 90 days.
Another approach to achieving low cost is through the so-called ‘learning curve’. The learning-curve model relates the volume of production and costs over time. Whereas economies of scale focus on the relationship between the volume of production at a given point in time and average unit costs, the learning-curve focuses on the relationship between the cumulative volume of production and average unit costs.
Differential access to low cost factors of production may also create cost differences among firms producing similar products in an industry. Factors of production are any inputs used by a firm in conducting its business activities. They include labour, capital, land, raw materials, and tacit knowledge. For instance, Chinese manufacturers have been able to compete in the global market place on the basis of low cost, due to their low wage economy.
Finally a cost advantage may be achieved by the different ‘technologies’ that an operator adopts or develops to manage the business. Technologies include not only machines and equipment, but also the socio-technical systems of firms (such as the quality of relations between labour and management, organisational culture, and the quality of performance management systems). We will talk more about this in our next blog, which examines what a low cost firm looks like…