Low-Cost Business Model
Mar
In short, the low-cost business model is based on a strategy by which the business offers low prices in order to instigate demand, thus gaining market share. This business model can be adopted by virtually any company, but it is usually indicated in cases when there is no (or little) competitive advantage or when it is easier to achieve scale with production volumes, so they apply the cost leader strategy.
Companies adopting this model often aim to beat the competition on costs by implementing a low-cost plan that focuses on becoming the lowest-cost provider in the market. By doing so, they can offer more affordable products or services while maintaining profitability.
In such cases, the focus shifts toward economies of scale, and the supply chain becomes a critical element of success. Companies following a cost-provider strategy ensure that their operations are optimized for efficiency, enabling them to offer products or services at lower prices than competitors. This is often coupled with a pricing strategy that undercuts rivals and solidifies their position as a cost provider.
In addition, some businesses implement a differentiation strategy alongside a low pricing strategy to offer unique value at a lower price point. Successful strategic planning enables companies to fine-tune their approach and achieve a competitive edge by balancing cost control and differentiation. This combination of cost advantage and product uniqueness plays a key role in gaining a competitive edge and positioning companies for long-term success and profitability.
Contents
Low-Cost Business Model Canvas
- Low-Cost Customer Segments: Price-sensitive consumers are the main target of low-cost businesses, but you can say that this is pretty much a mass market as well;
- Low-Cost Value Propositions: Low-cost businesses offer no-frills products or services for which the non-essential features have been removed to keep the price low, applying a cost strategy that focuses on efficiency and affordability;
- Low-Cost Channels: Digital stores, like companies, own e-commerce websites and aggregators. Physical stores at airports or high-traffic areas can also be part of the channel strategy;
- Low-Cost Customer Relationship: Usually self-service to avoid high human resources costs. Customer support, especially if they can be outsourced for low-cost call centers, further enhances the provider strategy aimed at minimizing operational expenses;
- Low-Cost Revenue Streams: Low-cost prices attract students and other price-sensitive customers, but the extra services for non-essential services or product features are what increase profit margins;
- Low-Cost Key Resources: The most important asset is having standardized processes and equipment in place. The operational cost must be minimized and, therefore, optimized through strategic planning and efficient use of resources;
- Low-Cost Key Activities: Since the low price attracts customers, operating the business to deliver value with a low-cost structure is key. This involves the careful management of the supply chain to ensure that costs remain low without compromising on quality;
- Low-Cost Key Partners: A good partnership with suppliers, especially equipment suppliers, can make a big difference in achieving economies of scale and maintaining a provider that meets the demands of low-cost consumers;
- Low-Cost Cost Structure: Operations and human resources are the highest costs in this model. This is where strategic research and planning can help in identifying areas where cost reduction is possible, ensuring long-term sustainability.
What is cost advantage?
Simply put, a business may employ the cost advantage when it is able to manufacture some product or provide some service at a lower cost than its competitors. They can apply this advantage in two ways:
- By lowering their prices below the competition, they thus attract more customers and gain market share. The low margins will be, then, compensated by higher sales volumes;
- Pricing their products equally to their competition but having a cheaper cost structure, thus making more profit.
In order to develop a cheap cost structure, these companies benefit from:
- Low-cost raw materials,
- Sustainable processes, technologies, and operations,
- Efficient distribution,
- Low-cost sales strategy,
- Outsourced services,
- Lean manufacturing strategies.
Whether your customers are regular folks or millionaires, people will always compare prices and enjoy low prices and discounts. So, it is a valuable strategy to increase traffic towards your business.
For everyday shoppers, low prices provide accessibility and affordability. The low-cost business model has some challenges and benefits, especially when combined with a differentiation approach to stand out in competitive markets.
Advantages of the Low-Cost Business Model
Bigger Profit
When you develop a lean cost structure, you can have greater margins than other companies will usually achieve. This way, you are offering a strong value proposition to your customers — the exact product/service at a lower price — and assuring a bigger profit
Improved Market Share
As said above, customers often consider acquiring a product/service at a lower price, especially when they see the same value as the competitors. Their first choice is the exact value proposition at a lower cost. Over time, this choice will lead to more businesses, enhancing a more significant market share.
Sustainable Business
Whenever you have a lean cost structure, you are reducing the risks and threats that your business may face. That turns your company into a more sustainable and secure business. Mainly because if some crisis happens that causes a price war, your company is already prepared for the circumstances.
Reinvested Capital
Over time, the bigger margins may provide a nice capital and resources reserve. This reserve can be used for many purposes, such as reinvesting profits into the company and fomenting growth or expansion.
Reduced Competition
When your company can offer a low-cost product or service, it forces the competitors to struggle to reach the same price or lower. But, for an already structured business, it is not usually easy to transform itself to achieve cost leadership. Sometimes, the necessary alterations may make it impossible for competitors to survive, especially new entrants.
Increased Sales
As mentioned above, many times, cost leadership will attract traffic to your business. This will increase your sales. Especially at the beginning of the venture, paying for the early investments any company needs to make to start running is very helpful.
Close Relationships
To cut costs, one of the most efficient strategies is to keep close communication with the audience to discover their needs and expectations, avoiding unnecessary and unsuccessful investments. This will also provide close relationships with suppliers, because the company is able to provide information, thus ensuring the best price and material and creating a long-term, trustful relationship.
Disadvantages of the Low-Cost Business Model
Price War
The competitors may lower their prices to beat yours. Then, you may experiment with a dose of your own medicine: you may need to battle to sell the cheapest, and once you reach your lowest price, you might lose profit. The solution can be to let your audience understand that you have a low price, not necessarily the lowest one.
Poor Supplier Relationships
As mentioned, this strategy may enhance your relationship with suppliers and vendors. But, on the other hand, if you struggle to reach your bottom price, making it hard for them to keep up with prices and deliveries, they may give up on you or hand you poor materials to maintain the price.
Low-profit margins
If you can’t handle a price war, crisis, or even negotiations with your suppliers, you may end up in a not-so-lean cost structure, resulting in low profit margins. Besides the low income, you will have little capital to reinvest in your business.
Poor Quality Perception
Once you choose to offer a low price, your audience often perceives the low price as low quality. This way, you may find it hard to introduce new products or services, especially those requiring a higher price due to the quality. Your customers may not believe you can offer a higher-quality product/service.
Harmful Financial Cuts
To maintain a low-cost business model, you may need to cut some costs to keep up the budget, and these cuts sometimes can harm your operations or your value proposition, making the service poor or the operations slow, just to mention some.
Reduced Innovation
Usually, R&D will be perceived as expensive in a low-cost business model. This may compromise the chances of making innovative products reach the market. Little capital means little possibility for innovations, since the business can’t risk investing in new — and possibly risky — ideas.
Large Volume of Sales Required
Cost leadership depends closely on a large volume of sales to keep up its profitability. So, this strategy is usually employed by big brands, such as Costco or Walmart. Local businesses are hardly able to apply that.
The benefits and challenges presented prove that the low-cost business model can indeed be used to create a unique competitive advantage — but the strategy may not be adequate for any kind of business, since it reduces the chance for the company to adapt to any new circumstances.
