Friday, 7 June 2013

Is ‘Cost Leadership’ an effective long term strategy?

Many companies experience a roller coaster ride of success. Some years they have great successes while other years can be very challenging and there can be a host of reasons for the challenges from prevailing economic conditions to new technologies disrupting markets. The question however, is how should a leader respond to these challenges and is ‘cost leadership’ a long term strategy for success? Over the years I have worked for a number of manufacturing companies where ‘cost leadership’ or ‘lowest cost producer’ was the strategic response to market challenges. These organisations faced falling income and so to make the company’s results look as best as possible the leadership team slashed investment and assets in an attempt to cut costs. However, this only succeeded in providing a poorer choice and service to customers, who added to the pain by purchasing their products and services elsewhere! I accept my examples are a small sample and not statistically significant. However, a more scientific study was conducted by Raynor and Ahmed and published in April’s issue of the Harvard Business Review. Raynor and Ahmed undertook a statistical study of thousands of companies to identify what made the exceptional performers just that. They discovered that the strategic choices of the exceptional performers over decades of success have been consistent with three elementary rules: 1. Better before cheaper. In other words it’s best to compete on differentiators other than price. 2. Revenue before cost. It is better to prioritise increasing revenue over reducing costs. 3. There are no other rules. Change anything you need to but you must follow 1 and 2 above. These rules can serve as an antidote to any leaders instinct or intuition. As with my own personal experience when income is ‘declining’, for example, it is tempting to make the business results look better by cutting assets and investment to reduce costs. But excellent companies, the research shows typically accept higher costs as the price of excellence, putting significant resources over long periods of time creating non price value and generating higher revenue. So in conclusion, drawing on my own experience and evidenced by significant research, cost leadership is not the right strategy to follow if you want long term exceptional performance.