Cost Leadership Strategy

This strategy involves the firm winning market share by appealing to cost-conscious or pricesensitive customers. This is achieved by having the lowest prices in the target market segment, or at least the lowest price to value ratio (price compared to what customers receive). To succeed at offering the lowest price while still achieving profitability and a high return on investment, the firm must be able to operate at a lower cost than its rivals. There are three main ways to achieve this.

The first approach is achieving a high asset turnover. In service industries, this may mean for example a restaurant that turns tables around very quickly, or an airline that turns around flights very fast. In manufacturing, it will involve production of high volumes of output. These approaches mean fixed costs are spread over a larger number of units of the product or service, resulting in a lower unit cost, i.e. the firm hopes to take advantage of economies of scale and experience curve effects. For industrial firms, mass production becomes both a strategy and an end in itself. Higher levels of output both require and result in high market share, and create an entry barrier to potential competitors, who may be unable to achieve the scale necessary to match the firms low costs and prices.

The second dimension is achieving low direct and indirect operating costs. This is achieved by offering high volumes of standardized products, offering basic 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. Overheads are kept low by paying low wages, locating premises in low rent areas, establishing a cost-conscious culture, etc. Maintaining this strategy requires a continuous search for cost reductions in all aspects of the business. This will include outsourcing, controlling production costs, increasing asset capacity utilization, and minimizing other costs including distribution, R&D and advertising. The associated distribution strategy is to obtain the most extensive distribution possible. Promotional strategy often involves trying to make a virtue out of low cost product features.

The third dimension is control over the supply/procurement chain to ensure low costs. This could be achieved by bulk buying to enjoy quantity discounts, squeezing suppliers on price, instituting competitive bidding for contracts, working with vendors to keep inventories low

using methods such as Just-in-Time purchasing or Vendor-Managed Inventory. Wal-Mart is famous for squeezing its suppliers to ensure low prices for its goods. Dell Computer initially achieved market share by keeping inventories low and only building computers to order. Other procurement advantages could come from preferential access to raw materials, or backward integration.

Some writers assume that cost leadership strategies are only viable for large firms with the opportunity to enjoy economies of scale and large production volumes. However, this takes a limited industrial view of strategy. Small businesses can also be cost leaders if they enjoy any advantages conducive to low costs. For example, a local restaurant in a low rent location can attract price-sensitive customers if it offers a limited menu, rapid table turnover and employs staff on minimum wage. Innovation of products or processes may also enable a startup or small company to offer a cheaper product or service where incumbents' costs and prices have become too high. An example is the success of low-cost budget airlines who despite having fewer planes than the major airlines, were able to achieve market share growth by offering cheap, no-frills services at prices much cheaper than those of the larger incumbents.

A cost leadership strategy may have the disadvantage of lower customer loyalty, as pricesensitive customers will switch once a lower-priced substitute is available. A reputation as a cost leader may also result in a reputation for low quality, which may make it difficult for a firm to rebrand itself or its products if it chooses to shift to a differentiation strategy in future.

Differentiation Strategy

Differentiate the products in some way in order to compete successfully. Examples of the successful use of a differentiation strategy are Rolex watches, Apple Computer, and Mercedes-Benz automobiles.

A differentiation strategy is appropriate where the target customer segment is not pricesensitive, the market is competitive or saturated, customers have very specific needs which are possibly under-served, and the firm has unique resources and capabilities which enable it to satisfy these needs in ways that are difficult to copy. These could include patents or other Intellectual Property (IP), unique technical expertise (e.g. Apple's design skills or Pixar's animation prowess), talented personnel (e.g. a sports team's star players or a brokerage firm's

star traders), or innovative processes. Successful brand management also results in perceived uniqueness even when the physical product is the same as competitors. This way, Chiquita was able to brand bananas, Starbucks could brand coffee, and Nike could brand sneakers. Fashion brands rely heavily on this form of image differentiation.

Three As The three As stand for the three distinct types of global strategy. Adaptation seeks to boost revenues and market share by adapting the firms products or services to the local context. Aggregation attempts to deliver economies of scale by creating regional or sometimes global operations; it involves standardizing the product or service offering, grouping together activities such as development, production and marketing at a regional level or by languages, etc. Arbitrage is the exploitation of differences between national or regional markets, often by locating separate parts of the supply chain in different places for instance, call centres in India, factories in China and retail stores in Western Europe.

Because most border-crossing enterprises will draw from all three As to some extent, the framework can be used to develop a summary scorecard indicating how well the company is globalizing. However, because of the significant tensions within and among the approaches, its not enough to tick off the boxes corresponding to all three. Strategic choice requires some degree of prioritizationand the framework can help with that as well.

The AAA triangle:

The three As are associated with different organizational types. If a company is emphasizing adaptation, it probably has a country-centred organization. If aggregation is the primary objective, cross-border groupings of various sorts- global business units or product divisions, regional structures, global accounts, and so on - make sense. An emphasis on arbitrage is often best pursued by a vertical, or functional, organization that pays explicit attention to the balancing of supply and demand within and across organizational boundaries.

We must remember that not all three modes of organizing can take precedence in one organization at the same time. And although some approaches to corporate organization (such

as the matrix) can combine elements of more than one pure mode, they carry costs in terms of managerial complexity. A few leading-edge companies are pursuing AA strategies, such as Tata Consultancy Services (aggregation and arbitrage) and P&G (adaptation and aggregation). IBMs case: Some companies have emphasized different As at different points in their evolution. For example, IBM traditionally focused on adaptation and was organized into small, fairly complete branches of IBM in different countries. Subsequently, when its activities increased at a much larger international scale, IBM chose to aggregate the different countries into regions. It is only more recently that IBM has been involved in arbitrage, specifically, in exploiting wage differences.

Philips Medical Systems case: (PMS) Philips Medical Systems (PMS) offers a good opportunity to see how the AAA triangle can help companies devise good global strategies in lieu of its competitors. PMS is much smaller than its other two major competitors in the diagnostic- imaging industry. PMS has been focusing largely on connecting its disparate parts and it has also lagged behind its competitors in arbitrage activities. For example, PMS began its manufacturing joint-venture in China in 2004, with the export operations scheduled for 2006 at levels that were achieved by its competitor GE in 2001.

Given its historical emphasis on adaptation and its competitive position, it would be very difficult for PMS to beat its competitors, GE and Siemens, in terms of aggregation or arbitrage front. Two AA strategy choices adaptation + aggregation or adaptation + arbitrage are probably more promising. In addition, of course, there is always room for creativity in changing the game: thus, PMS has also tried a lateral shift to a new business area, personal medical devices, which combine its strengths in medical systems and in consumer electronics. The broader point of this example is that the appropriate emphasis across the AAA strategies depends on industry conditions and competitive position.

Adaptation
Increase market share by adjusting parts of a companys business model to be suitable for local markets. Some level of adaptation is necessary for virtually all products; adaptation could be because of local regulations or because of customer demand. For example, McDonalds has to change its menu in some countries; it cannot sell pork in Saudi Arabia and beef in Indian outlets because these are forbidden in the dominant culture of these countries.

Adaptation approaches

Variation: making changes in products, services, policies, and positioning. Example: Googles issues with Chinas censorship laws and McDonalds example above. McDonalds started to sell coffee in UK restaurants and Lassi (a traditional local Indian drink) in India because Indians do not drink coffee with food.

Focus: concentrating on particular stages of the value chain or market segments to reduce impact across regions Example: a firm can focus on teenagers in one country while it can focus on middle age segment in other. For example, Nissan Micra is considered a low budget car in UK but is considered a middle income segment car in India. Thus, the product may remain the same but the firm may focus on different segments in different countries. Take LOreal for example, it sells hair colour products to consumers in UK through stores like Tesco because in UK hair coloring is also done at home by girls themselves. However; in countries like India, hair colouring is mainly done in saloon and hence target for hair coloring products in India are hairdressers and not the consumers.

Externalization: accommodates local requirements, lowers cost, or reduces risk by transferring responsibility for parts of a companys business model to partner companies. Example: McDonalds uses franchising as well as company-owned locations. For example, a car manufacturer can use a local car service chain to provide service for its cars.

Design: reduce the cost of variation. Example: Tata Motors created a very affordable car to sell in India. Ford changed the design of its card before launching them in South East Asia and added a lot of extra features to target the middle and upper income segments as compared to targeting lower income segments in UK.

Innovation: improving the effectiveness of adaptation endeavors. Example: IKEAs flat-pack packaging has helped cut transportation costs and therefore allow the company to expand into other countries. Under adaptation and innovation, firms come up with innovative products and services to address the needs of a diverse consumer marketas shaped by demographic, economic and local factors:

McDonalds rode the baby-boomer trend in the 1960s, the swelling ranks of teenagers and the rising female labor force participation, supplying a fast and inexpensive menu. In the 1970s and the 1980s, McDonalds rode the globalization trend by transferring the American Way of Life to many countries around the world. At the same time, McDonalds adapted to the social context of each county by franchising to locals. In the 1990s and early 2000s, McDonalds made successful efforts to restore its corporate image by launching the Fast an Convenient campaign that involved the radical adjustment of the companys product portfolio to emerging food industry trendsthe re-furbish of McDonalds restaurants to achieve a banded, updated, and more natural dining environment. The fast and convenient elements of the McDonalds concept were augmented by the healthy and more natural element, by adding salads, fruits, and carrot sticks to the menu. In nowadays, McDonalds continue to broaden its product portfolio by offering high quality coffee and healthy drinks (either through its traditional restaurants or the Cafs), competing head to head with Starbucks and local cafeteriasbenefiting by local trends like austerity in Europe.

Aggregation
Involves creating economies of scale to exploit similarities Introduce economies of scale without jeopardizing local responsiveness

Aggregation approaches

Economic:

Companies distinguish between developed and emerging markets and choose

to focus on one or the other. Geographic: It involves focusing competitive interactions on a regional or global level. For example: centralizing global production in a few strategically placed plants. Cultural: for example, publishers only publish their bestsellers in a few languages, assuming readers are willing to read a book in their second language. Administrative: For example, companies looking to market new drugs in Europe must meet regulatory requirements of a few selected countries to qualify for a license to sell throughout the EU.

Arbitrage
Exploit differences between markets instead of trying to adapt to them. For example, by moving different parts of the supply chain to different places Buy low in one market, sell high in another

Economic: This aims to place different units of supply chain in different locations to benefit from low costs in those locations. Example: outsourcing and offshoring Geographic: Example: US doctors take X-rays during the day and send them to Indian doctors for interpretation overnight so the report is available in the US the following morning. Cultural: industries. Example: associating French origin with success and quality in certain

Administrative:

Example: placing acquisitions into holding companies in the Cayman

Islands to reduce tax liabilities

Which strategy should a company use?

Depends on: Financial Statements Globalization history

However, most companies will need to consider all of the strategies at different points in time.

Implementing multiple strategies: Some leading companies have implemented two or even all three of the strategies at one time. Disadvantage: the strategies have inherent tensions between them, making them hard to mix.

Combining all three of the strategies can cause a firm to: Stretch its managerial ability Be forced to operate with multiple corporate cultures Give competitors opportunities to undercut the firms competitiveness

Hence firm should: Focus on one or two of the strategies at once Make sure the strategy is a good fit for the firm Use multiple integration methods Consider externalizing integration Ex. Through joint ventures

Know when not to integrate