ACHIEVING A LOW COST POSITION

by Donald V. Potter

Most business people think primarily of physical costs – that is, the cost to serve a customer. Factors such as purchases, people, and capital give us the conventional view of who holds the low-cost position in any industry.

However, a second, less understood type of cost, the cost of share movement, is more important and holds the key to achieving the true low-cost position.

Already Low-Cost with Customers You Own

“The cost of share movement holds the key to achieving the true low-cost position.”

The low-cost position to serve any customer is virtually always held by the current supplier. Because customers resist change, they can be taken away only by a competitor who offers a much better deal — either better performance or a lower price. Offering that better deal requires an investment that usually offsets any apparent function advantages one company holds over another.

In mature markets, the cost differences between the strongest and weakest competitors, as a percentage of sales, is seldom anything like 10%. Yet the cost of breaking into an established relationship and taking away the customer is usually at least 10%. This 10% can come in the form of additional costs to offer better product or service performance or in the form of unusually large price discounts.

Owning a customer is a tremendous economic advantage. A competitor can almost never achieve enough difference in physical cost to offset the cost of making much share move especially when, as is often the case, competitors are of approximately the same size. Why, then, does share move? The overwhelming reason that share shifts is that the customer’s supplier failed him in some way.

To Keep Costs Down, Keep Customers

You are already the low-cost supplier to customers you own. To keep your costs down, do nothing that will jeopardize your current customer relationships.

Retaining your current customers is key for two reasons.

First, your physical costs are spread across your customer base. Reducing cost is of no value if at the same time you shrink the customer base. Cost cutting fails when managers focus too directly on costs, without considering the costs’ impact on customers. If cutting results in the loss of customers that cover your cost base, the cuts don’t make business sense.

Second, any customer you lose is one you would have to invest to regain. Once you lose a customer to a competitor, it is you who must invest the extra cost to recapture the customer relationship.

Invest to Build Market Share

The low-cost position with virtually any customer is held by the current supplier. But the low-cost position overall should be the supplier with the greatest market share. That supplier owns the most customers, and also benefits from physical scale advantages.

To secure a low-cost position, then, it may be worthwhile to take share, even if you must invest to overcome customer inertia.

Three Steps to the Low Cost Position

Achieving a true low-cost position requires:

Keeping the customers you have. Above all, stop share loss.
Gaining new customers to build your share.
Reducing physical costs in ways that won’t cause customer erosion.

If a company fails on the first two steps, even superb performance on the third won’t matter.

Implications for Hostile Markets

In evaluating a cost position, management would want to consider:

Is the company failing in any important relationships today?
Could the company be gaining more net share by losing fewer customers?
Are unit costs declining as unit volume grows?

(Note: This Perspective was written in the context of the economy in 1991. While some of the companies may have changed their policies or indeed no longer exist, the patterns they exhibit still hold today.)