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Low Cost Strategy
A pricing strategy in which a company offers a relatively low price to stimulate demand and gain market share. It is one of three generic marketing strategies (see differentiation strategy and focus strategy for the other two) that can be adopted by any company, and is usually employed where the product has few or no competitive advantage or where economies of scale are achievable with higher production volumes.
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Low-Cost Producer: Definition, Strategies, Examples
Ariel Courage is an experienced editor, researcher, and former fact-checker. She has performed editing and fact-checking work for several leading finance publications, including The Motley Fool and Passport to Wall Street.
What Is a Low-Cost Producer?
A low-cost producer is a company that provides goods or services at a low cost. In general, low-cost producers utilize economies of scale to execute their low price-strategy. Consumers who are sensitive to price changes will more likely shop at stores that offer the lowest prices—especially if the good or service is relatively homogeneous.
Low-cost producers have another option: To price the goods or services at the same level as their competitors and maintain a wider margin.
How Low-Cost Producers Work
A low-cost producer is capable of making a substitute good or providing a substitute service for a lower cost than other companies. They can price their goods on par with or just below the market, undercutting their competition. By doing so, companies can increase their market share and raise profits.
These goods and services are usually consumer staples which are in high demand. They tend to have readily available substitutes provided by many competitors in the marketplace. Consumer staples produced by low-cost producers generally include household items, cleaning products, food, beverages—any items that consumers cannot cut out. Specialty goods such as jewelry, high-end cars, and certain types of clothing generally do not have low-cost producers.
Unlike larger their larger competitors, many low-cost producers tend to concentrate on one or a few different consumer segments, which can help them keep their costs down, generate market share, and keep profits high.
Take supermarket chain Aldi, for example. Its footprint is much smaller than the average supermarket, yet it's still able to compete with its big-name rivals on a large scale. It offers a much smaller selection of goods, most of which are produced under its generic brand name, and the company is able to slash prices well below its competition. Walk through its aisles, and you'll notice they're stocked with items people tend to buy on a regular basis.
How to Become a Low-Cost Producer
The requirements to become a low-cost producer are great since there is quite a high barrier to entry in the market. Being this competitive in the market means raising capital or having enough in reserves to achieve economies of scale large enough to provide a distinct price advantage over competitors. This requirement is one reason why many companies are not able to be low-cost producers.
Becoming a low-cost producer has a high barrier to entry because it requires a great amount of capital.
Once this is achieved, companies will need to invest in technology that will keep production costs down, while boosting output. An important caveat is that firms need to ensure they keep up with demand and don't sacrifice their brand name.
- A low-cost producer is a company that uses economies of scale to provide goods or services at a low cost.
- These goods and services are usually consumer staples which are in high demand such as household items, food, and beverages.
- Becoming a low-cost producer requires a large amount of capital and other technological advancements to boost production and cut down on costs.
- Walmart is one of the world's most well-known low-cost producers.
Example of Low-Cost Producer
Walmart is likely the best example of a low-cost producer with massive economies of scale. The company operates about 11,443 retail locations under different banners in 24 countries. Walmart has several strategies in place making it impossible for its competition to keep up. It's able to bring down the cost of goods it sells by procuring and buying on its own. And because of its massive footprint, Walmart can exert a lot of control over its suppliers.
The company is also able to run distribution through a fairly inexpensive network and has invested greatly in its technology, keeping up to date with its customer base. Doing so gives the company an edge, allowing it to better cater to the consumers who shop in store and online.
Walmart. " Location Facts ." Accessed April 1, 2021.
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What Is Low-End Disruption? 2 Examples
- 13 Jan 2022
How do successful businesses get pushed out of markets they once dominated? The theory of disruptive innovation—coined by Harvard Business School Professor Clayton Christensen—explains how smaller businesses can disrupt incumbents by entering at the bottom of a market with a low-cost business model.
According to Christensen, who teaches the online course Disruptive Strategy , there are three types of innovation :
- Sustaining innovation , in which a company creates better products to sell for higher profits to its best customers
- Low-end disruption , in which a company enters at the bottom of an existing market and offers a lower-priced product with acceptable performance, ultimately capturing its competitors' customers
- New-market disruption , in which a company creates and claims a new segment in an existing market by catering to an underserved customer base, slowly improving in quality until the incumbent businesses’ products are obsolete
Low-end and new-market disruption are examples of disruptive innovation, differentiated by their relationships with the existing market. New-market disruption occurs when an innovative product creates a new market segment, whereas low-end disruption enters at the bottom of the existing market to provide a “good enough” product to an overserved audience.
Understanding how disruption works can enable you to avoid it if you work at an incumbent business or drive it if you’re a new entrant. Here’s a closer look at one type of disruptive innovation: low-end disruption.
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What Is Low-End Disruption?
Low-end disruption occurs when a company uses a low-cost business model to enter at the bottom of an existing market and claim a segment. As the entrant company claims the lowest market segment, the incumbent company typically retreats upmarket where profit margins are higher.
“Almost always, when low-end disruptions emerge, it creates a situation where the leaders in the industry actually are motivated to flee rather than fight you,” Christensen says in Disruptive Strategy. “That’s why low-end disruption is such an important tool to create new growth businesses: The competitors don’t want to compete against you; they just walk away.”
3 Characteristics of Low-End Disruption
Three characteristics separate low-end disruption from other innovation types:
- It offers “good enough” quality by market standards, but not the best. Customers at the top of the market likely won’t be interested in this product, making it seem non-threatening to incumbent businesses.
- It targets consumers at the bottom of the market. These are people overserved by the current product offerings—that is, they don’t need all the bells and whistles that come with an expensive price tag.
- It makes a profit at lower prices per unit sold than the incumbent businesses. This is essential because, as long as the profit margins are lower than incumbents’ products, they won’t be motivated to fight the entrant for market share. The incumbent businesses’ pursuit of profit is the causal mechanism that enables entrants to continue to move upmarket.
Related: 3 Examples of Disruptive Technology That Are Changing the Market
2 Examples of Low-End Disruption
Low-end disruption happens more often than you might think. Some of your favorite brands likely had to disrupt an incumbent business to get where they are today.
“[Low-end] disruption is how Canon attacked Xerox,” writes Christensen in The Huffington Post , “how Walmart and Target bested the department stores; how Southwest drove so many major airlines into bankruptcy; how Sony defeated RCA, and how Apple crippled Sony.”
Here are two examples of low-end disruption that offer insights for both new entrants and incumbent businesses.
1. 3D-Printed Real Estate
A low-end disruption emerging in the real estate construction market is 3D printing technology. 3D printers use digital files as blueprints to deposit layer upon layer of material—often concrete—in a specific design to construct a building.
A 3D-printed two-bedroom home can cost between $4,000 and $10,000 to construct, much less expensive than homes built using manual labor. Because 3D printers can create a home on-site, transportation fees are eliminated. Labor costs are also much lower compared to traditional construction jobs because the machine does all the hard labor. This also cuts the risk of costly human error and instances of injury. Despite the price of the 3D printer itself, this method of constructing homes is extremely cost-effective.
This low-cost method of building houses is most useful in deeply impoverished and disaster-stricken areas. The people in need of homes in those places don’t need fancy, large, or architecturally beautiful houses—they just need structurally sound homes.
3D printing has entered at the bottom of the real estate construction market, claiming the lowest segment: people who need homes that are “good enough.”
There’s speculation that 3D printing construction companies may continue to move upmarket, improving the quality of 3D-printed homes as they do so. By using a low-cost business model, 3D printing construction companies can motivate incumbent manual construction companies to flee upmarket. This disruptive technology is one to watch.
2. Toyota and General Motors in the Auto Industry
Another example of low-end disruption is Toyota’s entrance into the automobile industry. Up until 1957, General Motors (GM) controlled half of the United States auto market and was making strides internationally. GM’s strategy was to create a breadth of products to appeal to many audience types.
Toyota, a Japanese car manufacturer, released its first model—called the Corona—in 1957. The Corona wasn’t a luxury car, instead appealing to customers at the bottom of the auto market. It was a “good enough” vehicle at a reasonable price.
General Motors had models that targeted wealthier customers willing to pay for higher-quality cars, so it wasn’t motivated to fight Toyota for share of the lowest market segment.
Over the years, Toyota released new models—the Tercel, Corolla, Camry, Avalon, and 4-Runner—appealing to higher market segments and pushing GM further upmarket. Eventually, Toyota released the Lexus, a high-quality, luxury car that directly competed with GM for the highest market segment. This is near-successful low-end disruption.
The interesting twist is that GM survived—although not without losing billions of dollars and, eventually, CEO Rick Wagoner. In typical low-end disruption scenarios, the incumbent company is pushed out of the market by the disruptor and fails. GM, however, shifted its focus to the bottom of the market and produced small, energy-efficient vehicles when backed into the industry’s highest profit market segment. Poised to be disrupted, GM repositioned itself as the disruptor.
Because low-end disruption requires a business model that yields a lower profit than incumbent companies’—in addition to an economic recession—GM’s profits took a nosedive to the tune of $85 billion. When the company filed for bankruptcy in 2009, Wagoner asked the US government for funding to get it back on its feet. The government granted it with the condition that Wagoner resign.
Christensen disagrees with the forced resignation of a manager who successfully led a company through disruption.
“In reality, the decisions to retreat upmarket in the face of disruptive attack were made at General Motors in the 1970s and 80s by CEOs Thomas Murphy and Roger Smith,” Christensen writes in The Huffington Post . “Wagoner inherited the legacy of their having ignored the disruptive nature of the threats they faced. He and his team have done a remarkable job of working out of it—though much remains to be done.”
Under new management, GM remains one of the world’s most powerful auto companies, thanks in no small part to Wagoner’s decision to disrupt the disruptor rather than be extinguished.
Crafting Strategies for Disruption
These examples offer nuggets of wisdom for both entrants and incumbents. Still, one lesson rings true for both: A foundation in the theory of disruptive innovation can be the difference between a business that survives and one that fails.
Whether you’re approaching disruption from the perspective of an incumbent business or a new entrant, learning about types of disruptive innovation can enable you to craft strategies to prepare for or drive disruption.
Are you interested in driving innovation for your organization? Explore our six-week course Disruptive Strategy to learn the tools, frameworks, and intuition to develop winning strategies.
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How to Design a Winning Business Model
- Ramon Casadesus-Masanell
- Joan E. Ricart
Smart companies’ business models generate cycles that, over time, make them operate more effectively.
Most executives believe that competing through business models is critical for success, but few have come to grips with how best to do so. One common mistake, the authors’ studies show, is enterprises’ unwavering focus on creating innovative models and evaluating their efficacy in standalone fashion—just as engineers test new technologies or products. However, the success or failure of a company’s business model depends largely on how it interacts with those of the other players in the industry. (Almost any business model will perform brilliantly if a company is lucky enough to be the only one in a market.) Because companies build them without thinking about the competition, companies routinely deploy doomed business models.
Moreover, many companies ignore the dynamic elements of business models and fail to realize that they can design business models to generate winner-take-all effects similar to the network externalities that high-tech companies such as Microsoft, eBay, and Facebook often create. A good business model creates virtuous cycles that, over time, result in competitive advantage.
Smart companies know how to strengthen their virtuous cycles, undermine those of rivals, and even use them to turn competitors’ strengths into weaknesses.
The Idea in Brief
There has never been as much interest in business models as there is today; seven out of 10 companies are trying to create innovative business models, and 98% are modifying existing ones, according to a recent survey.
However, most companies still create and evaluate business models in isolation, without considering the implications of how they will interact with rivals’ business models. This narrow view dooms many to failure.
Moreover, companies often don’t realize that business models can be designed so that they generate virtuous cycles—similar to the powerful effects high-tech firms such as Facebook, eBay, and Microsoft enjoy. These cycles, when aligned with company goals, reinforce competitive advantage.
By making the right choices, companies can strengthen their business models’ virtuous cycles, weaken those of rivals, and even use the cycles to turn competitors into complementary players.
This is neither strategy nor tactics; it’s using business models to gain competitive advantage. Indeed, companies fare poorly partly because they don’t recognize the differences between strategy, tactics, and business models.
Strategy has been the primary building block of competitiveness over the past three decades, but in the future, the quest for sustainable advantage may well begin with the business model. While the convergence of information and communication technologies in the 1990s resulted in a short-lived fascination with business models, forces such as deregulation, technological change, globalization, and sustainability have rekindled interest in the concept today. Since 2006, the IBM Institute for Business Value’s biannual Global CEO Study has reported that senior executives across industries regard developing innovative business models as a major priority. A 2009 follow-up study reveals that seven out of 10 companies are engaging in business-model innovation, and an incredible 98% are modifying their business models to some extent. Business model innovation is undoubtedly here to stay.
That isn’t surprising. The pressure to crack open markets in developing countries, particularly those at the middle and bottom of the pyramid, is driving a surge in business-model innovation. The economic slowdown in the developed world is forcing companies to modify their business models or create new ones. In addition, the rise of new technology-based and low-cost rivals is threatening incumbents, reshaping industries, and redistributing profits. Indeed, the ways by which companies create and capture value through their business models is undergoing a radical transformation worldwide.
Yet most enterprises haven’t fully come to grips with how to compete through business models. Our studies over the past seven years show that much of the problem lies in companies’ unwavering focus on creating innovative models and evaluating their efficacy in isolation—just as engineers test new technologies or products. However, the success or failure of a company’s business model depends largely on how it interacts with models of other players in the industry. (Almost any business model will perform brilliantly if a company is lucky enough to be the only one in a market.) Because companies build them without thinking about the competition, they routinely deploy doomed business models.
A business model comprises choices and consequences.
Our research also shows that when enterprises compete using business models that differ from one another, the outcomes are difficult to predict. One business model may appear superior to others when analyzed in isolation but create less value than the others when interactions are considered. Or rivals may end up becoming partners in value creation. Appraising models in a stand-alone fashion leads to faulty assessments of their strengths and weaknesses and bad decision making. This is a big reason why so many new business models fail.
Moreover, the propensity to ignore the dynamic elements of business models results in many companies failing to use them to their full potential. Few executives realize that they can design business models to generate winner-take-all effects that resemble the network externalities that high-tech companies such as Microsoft, eBay, and Facebook have created. Whereas network effects are an exogenous feature of technologies, winner-take-all effects can be triggered by companies if they make the right choices in developing their business models. Good business models create virtuous cycles that, over time, result in competitive advantage. Smart companies know how to strengthen their virtuous cycles, weaken those of rivals, and even use their virtuous cycles to turn competitors’ strengths into weaknesses.
“Isn’t that strategy?” we’re often asked. It isn’t—and unless managers learn to understand the distinct realms of business models, strategy, and tactics, while taking into account how they interact, they will never find the most effective ways to compete.
What Is a Business Model, Really?
Everyone agrees that executives must know how business models work if their organizations are to thrive, yet there continues to be little agreement on an operating definition. Management writer Joan Magretta defined a business model as “the story that explains how an enterprise works,” harking back to Peter Drucker, who described it as the answer to the questions: Who is your customer, what does the customer value, and how do you deliver value at an appropriate cost?
Other experts define a business model by specifying the main characteristics of a good one. For example, Harvard Business School’s Clay Christensen suggests that a business model should consist of four elements: a customer value proposition, a profit formula, key resources, and key processes. Such descriptions undoubtedly help executives evaluate business models, but they impose preconceptions about what they should look like and may constrain the development of radically different ones.
Our studies suggest that one component of a business model must be the choices that executives make about how the organization should operate—choices such as compensation practices, procurement contracts, location of facilities, extent of vertical integration, sales and marketing initiatives, and so on. Managerial choices, of course, have consequences. For instance, pricing (a choice) affects sales volume, which, in turn, shapes the company’s scale economies and bargaining power (both consequences). These consequences influence the company’s logic of value creation and value capture, so they too must have a place in the definition. In its simplest conceptualization, therefore, a business model consists of a set of managerial choices and the consequences of those choices.
Companies make three types of choices when creating business models. Policy choices determine the actions an organization takes across all its operations (such as using nonunion workers, locating plants in rural areas, or encouraging employees to fly coach class). Asset choices pertain to the tangible resources a company deploys (manufacturing facilities or satellite communication systems, for instance). And governance choices refer to how a company arranges decision-making rights over the other two (should we own or lease machinery?). Seemingly innocuous differences in the governance of policies and assets influence their effectiveness a great deal.
Consequences can be either flexible or rigid. A flexible consequence is one that responds quickly when the underlying choice changes. For example, choosing to increase prices will immediately result in lower volumes. By contrast, a company’s culture of frugality—built over time through policies that oblige employees to fly economy class, share hotel rooms, and work out of Spartan offices—is unlikely to disappear immediately even when those choices change, making it a rigid consequence. These distinctions are important because they affect competitiveness. Unlike flexible consequences, rigid ones are difficult to imitate because companies need time to build them.
Take, for instance, Ryanair, which switched in the early 1990s from a traditional business model to a low-cost one. The Irish airline eliminated all frills, cut costs, and slashed prices to unheard-of levels. The choices the company made included offering low fares, flying out of only secondary airports, catering to only one class of passenger, charging for all additional services, serving no meals, making only short-haul flights, and utilizing a standardized fleet of Boeing 737s. It also chose to use a nonunionized workforce, offer high-powered incentives to employees, operate out of a lean headquarters, and so on. The consequences of those choices were high volumes, low variable and fixed costs, a reputation for reasonable fares, and an aggressive management team, to name a few. (See “Ryanair’s Business Model Then and Now.”) The result is a business model that enables Ryanair to offer a decent level of service at a low cost without radically lowering customers’ willingness to pay for its tickets.
Ryanair’s Business Model Then and Now
This depiction of Ryanair’s business model in the 1980s highlights the airline’s major choices at the time: offering excellent service and operating with a standardized fleet. The airline was forced to redesign its business model in the face of stiff competition.
Ryanair’s current business model rests on the key choices of offering customers low fares and providing nothing free. The rigid consequences include a reputation for fair fares and low fixed costs. Ryanair’s choices are aligned with its goals, generate cycles that reinforce the business model, and are robust given that it has been operating as a low-cost airline for 20 years.
Click here for a larger image of the graphic.
How Business Models Generate Virtuous Cycles
Not all business models work equally well, of course. Good ones share certain characteristics: They align with the company’s goals, are self-reinforcing, and are robust. (See the sidebar “Three Characteristics of a Good Business Model.”) Above all, successful business models generate virtuous cycles, or feedback loops, that are self-reinforcing. This is the most powerful and neglected aspect of business models.
Three Characteristics of a Good Business Model
How can you tell if a business model will be effective? A good one will meet three criteria.
1. Is it aligned with company goals?
The choices made while designing a business model should deliver consequences that enable an organization to achieve its goals. This may seem obvious until you consider a counterexample. In the 1970s, Xerox set up Xerox PARC, which spawned technological innovations such as laser printing, Ethernet, the graphical user interface, and very large scale integration for semiconductors. However, Xerox PARC was notoriously unable to spawn new businesses or capture value from its innovations for the parent due to a distressing lack of alignment with Xerox’s goals.
2. Is it self-reinforcing?
The choices that executives make while creating a business model should complement one another; there must be internal consistency. If, ceteris paribus, a low-cost airline were to decide to provide a level of comfort comparable to that offered by a full-fare carrier such as British Airways, the change would require reducing the number of seats on each plane and offering food and coffee. These choices would undermine the airline’s low-cost structure and wreck its profits. When there’s a lack of reinforcement, it’s possible to refine the business model by abandoning some choices and making new ones.
3. Is it robust?
A good business model should be able to sustain its effectiveness over time by fending off four threats, identified by Pankaj Ghemawat. They are imitation (can competitors replicate your business model?); holdup (can customers, suppliers, or other players capture the value you create by flexing their bargaining power?); slack (organizational complacency); and substitution (can new products decrease the value customers perceive in your products or services?). Although the period of effectiveness may be shorter nowadays than it once was, robustness is still a critical parameter.
Our studies show that the competitive advantage of high-tech companies such as Apple, Microsoft, and Intel stems largely from their accumulated assets—an installed base of iPods, Xboxes, or PCs, for instance. The leaders gathered those assets not by buying them but by making smart choices about pricing, royalties, product range, and so on. In other words, they’re consequences of business model choices. Any enterprise can make choices that allow it to build assets or resources—be they project management skills, production experience, reputation, asset utilization, trust, or bargaining power—that make a difference in its sector.
The consequences enable further choices, and so on. This process generates virtuous cycles that continuously strengthen the business model, creating a dynamic that’s similar to that of network effects. As the cycles spin, stocks of the company’s key assets (or resources) grow, enhancing the enterprise’s competitive advantage. Smart companies design business models to trigger virtuous cycles that, over time, expand both value creation and capture.
For example, Ryanair’s business model creates several virtuous cycles that maximize its profits through increasingly low costs and prices. (See the exhibit “Ryanair’s Key Virtuous Cycles.”) All of the cycles result in reduced costs, which allow for lower prices that grow sales and ultimately lead to increased profits. Its competitive advantage keeps growing as long as the virtuous cycles generated by its business model spin. Just as a fast-moving body is hard to stop because of kinetic energy, it’s tough to halt well-functioning virtuous cycles.
Ryanair’s Key Virtuous Cycles
Cycle 1: Low fares >> High volumes >> Greater bargaining power with suppliers >> Lower fixed costs >> Even lower fares
Cycle 2: Low fares >> High volumes >> High aircraft utilization >> Low fixed cost per passenger >> Even lower fares
Cycle 3: Low fares >> Expectations of low-quality service >> No meals offered >> Low variable costs >> Even lower fares
However, they don’t go on forever. They usually reach a limit and trigger counterbalancing cycles, or they slow down because of their interactions with other business models. In fact, when interrupted, the synergies work in the opposite direction and erode competitive advantage. For example, one of Ryanair’s cycles could become vicious if its employees unionized and demanded higher wages, and the airline could no longer offer the lowest fares. It would then lose volume, and aircraft utilization would fall. Since Ryanair’s investment in its fleet assumes a very high rate of utilization, this change would have a magnified effect on profitability.
It’s easy to see that virtuous cycles can be created by a low-cost, no-frills player, but a differentiator may also create virtuous cycles. Take the case of Irizar, a Spanish manufacturer of bodies for luxury motor coaches, which posted large losses after a series of ill-conceived moves in the 1980s. Irizar’s leadership changed twice in 1990 and morale hit an all-time low, prompting the new head of the company’s steering team, Koldo Saratxaga, to make major changes. He transformed the organization’s business model by making choices that yielded three rigid consequences: employees’ tremendous sense of ownership, feelings of accomplishment, and trust. The choices included eliminating hierarchy, decentralizing decision making, focusing on teams to get work done, and having workers own the assets. (See the exhibit “Irizar’s Novel Business Model.”)
Irizar’s Novel Business Model
When Irizar—a Spanish cooperative that manufactures luxury motor coach bodies—created a radically different business model, it made several innovative choices.
- Workers own assets and contribute financially to join Irizar
- Teams set their own goals and choose leaders
- No bosses, only coordinators
- Flat hierarchy, with only three levels
- No overtime pay
- Decentralized decision making
- Shared information and transparency about performance
- No walls inside plants or offices; no assigned parking spaces
- Tenure after three years of probation; no evaluation or firings thereafter
- No clocking in and out
- Only one product for all markets
- Most repetitive tasks outsourced
- Relatively high product prices
- Pay scale ratio of just 3:1
- Some profit (or loss) sharing every year
These choices have led to innovation, high quality, and excellent service, generating high sales volume as well as customer loyalty.
Irizar’s main objective, as a cooperative, is to increase the number of well-paying jobs in the Basque Country, so the company developed a business model that generates a great deal of customer value. Its key virtuous cycle connects customers’ willingness to pay with relatively low cost, generating high profits that feed innovation, service, and high quality. In fact, quality is the cornerstone of Irizar’s culture. Focusing on customer loyalty and an empowered workforce, the company enjoyed a 23.9% compound annual growth rate over the 14 years that Saratxaga was CEO. Producing 4,000 coaches in 2010 and generating revenues of about €400 million, Irizar is an example of a radically different business model that generates virtuous cycles.
Competing with Business Models
It’s easy to infuse virtuousness in cycles when there are no competitors, but few business models operate in vacuums—at least, not for long. To compete with rivals that have similar business models, companies must quickly build rigid consequences so that they can create and capture more value than rivals do. It’s a different story when enterprises compete against dissimilar business models; the results are often unpredictable, and it’s tough to know which business model will perform well.
Take, for instance, the battle between two of Finland’s dominant retailers: S Group, a consumers’ cooperative, and Kesko, which uses entrepreneur-retailers to own and operate its stores. We’ve tracked the firms for over a decade, and Kesko’s business model appears to be superior: The incentives it offers franchisees should result in rapid growth and high profits. However, it turns out that the S Group’s business model hurts Kesko more than Kesko’s affects the S Group. Since customers own the S Group, the retailer often reduces prices and increases customer bonuses, which allows it to gain market share from Kesko. That forces Kesko to lower its prices and its profits fall, demotivating its entrepreneur-retailers. As a result, Kesko underperforms the S Group. Over time, the S Group’s opaque corporate governance system allows slack to creep into the system, and it is forced to hike prices. This allows Kesko to also increase prices and improve profitability, drive its entrepreneur-retailers, and win back more customers through its superior shopping experience. That sparks another cycle of rivalry.
Companies can compete through business models in three ways: They can strengthen their own virtuous cycles, block or destroy the cycles of rivals, or build complementarities with rivals’ cycles, which results in substitutes mutating into complements.
Strengthen your virtuous cycle.
Companies can modify their business models to generate new virtuous cycles that enable them to compete more effectively with rivals. These cycles often have consequences that strengthen cycles elsewhere in the business model. Until recently, Boeing and Airbus competed using essentially the same virtuous cycles. Airbus matched Boeing’s offerings in every segment, the exception being the very large commercial transport segment where Boeing had launched the 747 in 1969. Given the lumpiness of demand for aircraft, their big-ticket nature, and cyclicality, price competition has been intense.
How Airbus Bolstered Its Business Model
Companies can often strengthen their business models to take on competitors more effectively. Airbus’s business model initially fell short because Boeing could reinvest profits from its 747, which enjoyed a monopoly in the very large commercial transport segment. In 2007, Airbus launched the 380 to compete in that segment—strengthening its virtuous cycle relative to Boeing’s.
Historically, Boeing held the upper hand because its 747 enjoyed a monopoly, and it could reinvest those profits to strengthen its position in other segments. Analysts estimate that the 747 contributed 70 cents to every dollar of Boeing’s profits by the early 1990s. Since R&D investment is the most important driver of customers’ willingness to pay, Airbus was at a disadvantage. It stayed afloat by obtaining low-interest loans from European governments. Without the subsidies, Airbus’s cycle would have become vicious.
With the subsidies likely to dry up, Airbus modified its business model by developing a very large commercial transport, the 380. To dissuade Airbus, Boeing announced a stretch version of the 747. However, that aircraft would cut into the 747’s profits, so it seems unlikely that Boeing will ever launch it. Not only does the 380 help maintain the virtuousness of Airbus’s cycle in small and midsize planes, but also it helps decelerate the virtuousness of Boeing’s cycle. The increase in rivalry suggests that the 747 will become less of a money-spinner for Boeing. That’s why it is trying to strengthen its position in midsize aircraft, where competition is likely to become even tougher when sales of the 380 take off, by developing the 787.
Weaken competitors’ cycles.
Some companies get ahead by using the rigid consequences of their choices to weaken new entrants’ virtuous cycles. Whether a new technology disrupts an industry or not depends not only on the intrinsic benefits of that technology but also on interactions with other players. Consider, for instance, the battle between Microsoft and Linux, which feeds its virtuous cycle by being free of charge and allowing users to contribute code improvements. Unlike Airbus, Microsoft has focused on weakening its competitor’s virtuous cycle. It uses its relationship with OEMs to have Windows preinstalled on PCs and laptops so that it can prevent Linux from growing its customer base. It discourages people from taking advantage of Linux’s free operating system and applications by spreading fear, uncertainty, and doubt about the products.
In the future, Microsoft could raise Windows’ value by learning more from users and offering special prices to increase sales in the education sector, or decrease Linux’s value by undercutting purchases by strategic buyers and preventing Windows applications from running on Linux. Linux’s value creation potential may theoretically be greater than that of Windows, but its installed base will never eclipse that of Microsoft as long as the software giant succeeds in disrupting its key virtuous cycles.
Turn competitors into complements.
Rivals with different business models can also become partners in value creation. In 1999, Betfair, an online betting exchange, took on British bookmakers such as Ladbrokes and William Hill by enabling people to anonymously place bets against one another. Unlike traditional bookmakers who only offer odds, Betfair is a two-sided internet-based platform that allows customers to both place bets and offer odds to others. One-sided and two-sided businesses have different virtuous cycles: While bookmakers create value by managing risk and capture it through the odds they offer, betting exchanges themselves bear no risk. They create value by matching the two sides of the market and capture it by taking a cut of the net winnings.
Over the past decade, Ladbrokes’ and William Hill’s gross winnings have declined, so Betfair has hurt them, but not as much as expected. Because Betfair has improved odds in general, gamblers lose less money. They then place more wagers, and when bookies pay out, bettors gamble again, feeding a virtuous cycle. This has expanded the British gambling market by a larger proportion than just the improvement of odds might suggest. The better odds Betfair offers also help traditional bookmakers gauge market sentiment more accurately and hedge their exposures at a lower cost. When a new business model creates complementarities between competitors, it is less likely that incumbents will respond aggressively. The initial reaction from bookmakers to Betfair was hostile, but they have become more accommodating of its presence ever since.
Business Models vs. Strategy vs. Tactics
No three concepts are of as much use to managers or as misunderstood as strategy, business models, and tactics. Many use the terms synonymously, which can lead to poor decision making.
To be sure, the three are interrelated. Whereas business models refer to the logic of the company—how it operates and creates and captures value for stakeholders in a competitive marketplace—strategy is the plan to create a unique and valuable position involving a distinctive set of activities. That definition implies that the enterprise has made a choice about how it wishes to compete in the marketplace. The system of choices and consequences is a reflection of the strategy, but it isn’t the strategy; it’s the business model. Strategy refers to the contingent plan about which business model to use. The key word is contingent; strategies contain provisions against a range of contingencies (such as competitors’ moves or environmental shocks), whether or not they take place. While every organization has a business model, not every organization has a strategy—a plan of action for contingencies that may arise.
Consider Ryanair. The airline was on the brink of bankruptcy in the 1990s, and the strategy it chose to reinvent itself was to become the Southwest Airlines of Europe. The new logic of the organization—its way of creating and capturing value for stakeholders—was Ryanair’s new business model.
Changing strategic choices can be expensive, but enterprises still have a range of options to compete that are comparatively easy and inexpensive to deploy. These are tactics—the residual choices open to a company by virtue of the business model that it employs. Business models determine the tactics available to compete in the marketplace. For instance, Metro, the world’s largest newspaper, has created an ad-sponsored business model that dictates that the product must be free. That precludes Metro from using price as a tactic.
Think of a business model as if it were an automobile. Different car designs function differently—conventional engines operate quite differently from hybrids, and standard transmissions from automatics—and create different value for drivers. The way the automobile is built places constraints on what the driver can do; it determines which tactics the driver can use. A low-powered compact would create more value for the driver who wants to maneuver through the narrow streets of Barcelona’s Gothic Quarter than would a large SUV, in which the task would be impossible. Imagine that the driver could modify the features of the car: shape, power, fuel consumption, seats. Such modifications would not be tactical; they would constitute strategies because they would entail changing the machine (the “business model”) itself. In sum, strategy is designing and building the car, the business model is the car, and tactics are how you drive the car.
Strategy focuses on building competitive advantage by defending a unique position or exploiting a valuable and idiosyncratic set of resources. Those positions and resources are created by virtuous cycles, so executives should develop business models that activate those cycles. That’s tough, especially because of their interactions with those of other players such as competitors, complementors, customers, and suppliers that are all fighting to create and capture value too. That’s the essence of competitiveness—and developing strategy, tactics, or innovative business models has never been easy.
- RC Ramon Casadesus-Masanell is a professor at Harvard Business School and the author, with Joan E. Ricart, of “How to Design a Winning Business Model” (HBR January–February 2011).
- JR Joan E. Ricart ( [email protected] ) is the Carl Schroder Professor of Strategic Management and Economics at IESE Business School in Barcelona.
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Strategy & Leadership
ISSN : 1087-8572
Article publication date: 8 March 2011
The authors warn of an emerging competitive crisis. Multinationals are disrupting competitors and pioneering new price points and applications in the developed world with low‐cost offerings created for rapidly developing economies. This paper aims to address this issue.
The paper explains how smart low‐cost players invest in true innovation targeted at the large, low‐income segments of the population.
The paper charts a process for implementing low‐cost innovation.
Corporate leaders too often underestimate the power of low‐cost models to affect their business and wrongly focus their innovation on new products that are more sophisticated, and, thus, more expensive than the models they replace.
A low‐cost innovation might cannibalize some of your current profit, but, most likely, it will also expand your market scope in a significant way.
- Competitive advantage
- Cost reduction
- Value chain
Kachaner, N. , Lindgardt, Z. and Michael, D. (2011), "Innovating low‐cost business models", Strategy & Leadership , Vol. 39 No. 2, pp. 43-48. https://doi.org/10.1108/10878571111114464
Emerald Group Publishing Limited
Copyright © 2011, Emerald Group Publishing Limited
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Low- cost strategy (also Low-cost price) is a pricing strategy characterized by low prices of goods and services using various saving methods. The company skillfully reduces real costs, which contributes to more customers and thus increases its sales.For example, two companies produce the same product , sell at the same price , but a company with lower costs will earn more because it has a greater profit on sales  .
These companies don't pay attention to the quality but the number of goods and services sold. This is how the market of "cheap companies" is shaped. The strategy is hassle-free , because the only tool it uses is to minimize costs. It is important to have large capital, high technical capacity and invest in the latest technologies that save costs  .
By focusing on reducing costs, we become a low-cost provider. It has a strong competitive approach that displaces companies sensitive to price changes. The cost advantage over rivals is the basis for applying this strategy. Companies choosing the assortment suggest products that the buyer considers necessary. To implement the strategy and become a low cost provider, you need to achieve its maximum effectiveness . The strategy introduced should be difficult to kick or match with rivals  .
Examples of low cost strategy
Here are a few examples of companies that have successfully implemented a low-cost strategy:
- Walmart : Walmart has long been known for its low prices, achieved through economies of scale, efficient supply chain management , and a focus on process efficiency .
- Ryanair : The Irish budget airline has successfully implemented a low-cost strategy by offering no-frills flights, low prices, and charging for additional services such as baggage and seat selection.
- IKEA : The furniture retailer offers a wide range of affordable products, achieved through efficient supply chain management, economies of scale, and a focus on simplicity and function over form.
- Amazon : Amazon's low-cost strategy is based on efficiency and economies of scale, achieved through its advanced logistics and distribution network , and automation in warehouses.
- Southwest Airlines : the company has been known for its low prices, achieved through a focus on efficiency, a no-frills approach, and a simplified fleet of aircraft.
- Aldi : The German supermarket chain Aldi has a well-established low-cost strategy, this is achieved through its focus on own-brand products, efficient supply chain management, and minimal store design.
- Dollar General : The discount retailer offers a wide range of products at low prices, achieved through a focus on cost-effective sourcing and efficient store operations.
Variants of implementing the low-cost strategy
The company has two options to implement a low-cost strategy  :
- Using a lower price to attract sensitive price buyers and thus force price reductions among competitors, to increase total profits
- Maintaining the current price comparable to other low-priced rivals by using lower costs and thereby increase the profit margin on each unit sold and return on investment
In wider meaning of this term whe can find more ways a company can implement a low-cost strategy :
- Economies of scale : By producing a large volume of goods or services, a company can spread fixed costs over a larger number of units, resulting in a lower cost per unit .
- Process efficiency : A company can use efficient technology , automation, and streamlined processes to reduce the cost of production .
- Outsourcing : A company can outsource certain functions or production to countries where labor and materials are cheaper.
- Supply chain management : A company can negotiate better deals with suppliers and optimize its logistics to reduce the cost of raw materials and transportation.
- Lean management : A company can use Lean management principles to eliminate waste and improve efficiency in production, resulting in lower costs.
- No-frills : A company can offer a no-frills version of a product or service which is less expensive but less feature-rich or luxurious than its competitors.
- Volume discounts : A company can offer volume discounts to customers who buy large quantities of goods or services, reducing the cost of sales .
Benefits of low cost strategy
A low cost strategy can provide several benefits for a business, including:
- Increased competitiveness : By keeping costs low, a business can offer products or services at a lower price than its competitors, making it more attractive to price-sensitive customers.
- Increased market share : Lower prices can attract more customers, allowing the business to increase its market share.
- Improved profitability : By keeping costs low, a business can increase its margins and improve its overall profitability.
- Reduced risk : A low cost strategy can reduce the risk of financial loss if market conditions change or demand for the business's products or services decreases.
- Greater flexibility : A low- cost structure can also give a company more flexibility in its operations, allowing it to respond more quickly to changes in the market.
- Easier to scale : A low-cost business model is often easier to replicate and scale to other locations or markets.
Risks of low-cost strategy
Companies that strive for low-cost as cheap manufacturers or service providers are becoming a heavy burden for the company. Low-cost strategy is vulnerable to risks such as  :
- Constantly introduced technological changes are a big problem for earlier investments because they cease to be valid
- Risks associated with imitation by later companies that use the cheap learning method
- By minimizing costs, companies don't pay attention to individual needs and preferences of customers
- Companies due to unforeseen cost inflation , which negatively affects the company's tendency to offset product differentiation through cost leadership
Therefore, implementing a low-cost strategy can come with certain risks, such as:
- Quality issues : In an effort to reduce costs, a company may cut corners on quality, which can lead to customer dissatisfaction and a loss of reputation.
- Dependence on low-cost suppliers : A company that heavily relies on low-cost suppliers may become vulnerable to supplier disruptions or price increases.
- Price wars : If a company's low-cost strategy leads to lower prices in the industry , competitors may respond by also lowering prices, leading to a price war and reduced profits for all companies involved.
- Brand perception : A company that is known for low prices may struggle to attract premium customers or to increase prices in the future.
- Limited market : A low-cost strategy may only be successful in price-sensitive segments of the market and may not be sustainable in the long-term.
- Cost escalation : A company may find it difficult to maintain low costs in the long run due to factors such as wage inflation , increased competition, and supply chain disruptions .
- Reliance on cost cutting : A company that is heavily focused on cost cutting may not invest enough in research and development, marketing, or other areas that are important for long-term growth.
It is worth mentioning Porter's theory. He distinguished two strategies to increase long-term competition on the market. The first model is characterized by minimizing costs at a level lower than that of the competition, thus increasing the profit margin. Costs are reduced most often when using economies of scale . Companies offer a standard product, without any additions. It is worth adding that there is only one place on the market for one company that applies this strategy, and then I become a cost leader. The rest of the competition most often loses market share or changes strategy. Another model concerns the reduction of costs for research and development as well as advertising and marketing . The second strategy Porter mentioned was to create unique products. The strategy is aimed at loyal brand customers, offering them a unique design and best quality products  .
- ↑ Diaconu L., (2009), p.81
- ↑ Diaconu L., (2009) p.82-84
- ↑ Diaconu L., (2009) p. 82-84
- ↑ Baldwin D., (2014)
- ↑ Tanwar R., (2013), p.17
- ↑ Porter M.E., 1998, p.11-14
- Baldwin D. (2014), Strategy: Low Cost or Differentiation
- Diaconu L. (2009), Strategic options of the low-cost companies ,Faculty of Economics and Business Administration in Romania, Romania
- Kankam-Kwarteng C.,Osman B., Donkor J. (2019) Innovative low-cost strategy and firm performance of restaurants: The moderation of competitive intensity , Emerald Publishing Limited
- Porter M.E. (1998), Competitive advantage : Creating and Sustaining Superior Performance The Free Press, New York,
- Tanwar R. (2013) Porter’s Generic Competitive Strategies , IOSR Journal of Business and Management
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The Benefits of a Low-Cost Business Model
A low-cost business model is one in which the company's operations are designed to minimize overhead costs while still producing competitive, quality products or services. It is a strategy that allows the business to stay competitive in the market while keeping the costs of operation low. This approach can be quite beneficial for small businesses and startups that need to watch their budgets.
In this blog post, we will take a closer look at the benefits of a low-cost business model and how it can help businesses of all sizes. We will explore topics such as cost savings, improved efficiency, and increased customer satisfaction.
- Low-cost business models can help businesses stay competitive in the market while keeping the costs of operation low.
- Cost savings, improved efficiency, and increased customer satisfaction are all benefits of low-cost business models.
- A low-cost business model can help businesses of all sizes maximize their profits and efficiency.
A low-cost business model can help companies increase their cost savings. This can be achieved by reducing expenses, reducing labor costs, and finding cost efficiencies.
Reducing expenses can be done through sourcing cheaper supplies, finding better prices for services, negotiating better terms with vendors, or finding more cost-effective ways to accomplish tasks. For example, trading in an expensive software for a cheaper version, or cutting back on unnecessary travel can be great ways to reduce expenses.
Reduced Labor Costs
Reducing labor costs can be done in a few different ways. Companies can outsource tasks to countries with lower wages, or hire freelancers for short-term needs. Additionally, companies can reduce the number of full-time employees they have, and rely more heavily on part-time staff or contractors.
Cost efficiencies can be gained by streamlining processes, eliminating wasteful spending, and finding ways to reduce or even eliminate inefficiencies. For example, businesses can use technology like automation or artificial intelligence to increase productivity, and develop cost-saving protocols to save money. Additionally, businesses can review their existing processes and work to identify any redundancies that can be elimintated.
The low-cost business model offers numerous advantages by reducing risk in multiple areas. When considering financial outlays, companies can make an informed decision on when to invest in resources. With this model, the initial capital outlay required to get off the ground is often significantly lower.
Less Capital Outlay for Inventory, Equipment, etc.
Companies are able to make decisions on when to invest in the necessary equipment to run their business. With the lower start-up cost, businesses can take a measured approach addressing only the items critical for moving in the right direction. By purchasing only the necessities, organizations are able to spread out their costs, ultimately minimizing the initial financial outlay.
Lower Financial Risk
The low-cost business model reduces financial risk independently. Organizations are able to scale their costs as the business grows. With curated spending and higher-than-expected returns, businesses can ensure that their finances are not overextended.
Lower Risk of Overstocking or Obsolescence
With fewer upfront costs, organizations often have the ability to purchase only the inventory and equipment they need to start their business. This helps reduce the risk of overstocking and obsolescence, allowing businesses to stay abreast of the latest market trends. Much like the low financial outlay, companies are able to purchase inventory and equipment only when necessary.
A low-cost business model leads to streamlined processes and a more efficient organization. Specifically, low-cost business models give companies an enhanced ability to compete, increased productivity, and reduces waste.
Enhanced Ability to Compete
A low-cost business model gives companies the ability to compete more effectively against larger rivals. Low-cost businesses can use a leaner structure and more efficient processes to avoid the high costs associated with larger businesses. This means that low-cost businesses can often undercut competitors on price, while still maintaining a strong quality of product or services. This makes it easier for low-cost businesses to win over customers and out-compete their larger rivals in the marketplace.
Low-cost business models lead to increased productivity by streamlining processes and eliminating unnecessary overhead costs. Without the need to maintain expensive offices or staff, low-cost businesses can focus their time and resources on their core mission. Low-cost businesses can also take advantage of technology to automate processes, which further reduces their need to spend money on staff and resources.
A low-cost business model also reduces waste. By eliminating the need to maintain excess infrastructure and staff, low-cost businesses can reduce their total output of waste products. This helps reduce their environmental impact and encourages the adoption of sustainable practices. It also reduces their overall costs, making a low-cost business model much more attractive for companies who are looking to reduce their overhead expenses.
Using a low-cost business model, a company can increase its reach in a number of ways. From gaining access to a wider customer base to the ability to quickly respond to changes in the market, the low-cost business model offers numerous advantages.
Wider Customer Base
A low-cost business model allows companies to target customers on a larger scale. Thanks to the lower costs, companies can spend more of their resources on marketing and advertising, thereby expanding their reach within the customer base and allowing them to attract more customers. The lower-cost business model also enables companies to invest in more products, which further boosts their customer base.
Ability to Quickly Respond to Changes in the Market
The lower costs associated with a low-cost business model also provide companies with the flexibility and agility needed to quickly respond to changes in the market. This allows them to stay competitive and capitalize on opportunities that may arise.
This flexibility also allows companies to experiment with new products and introduce them quickly to the market. This in turn allows them to test their products and services with customers, get feedback, and make adjustments before a product or service is officially launched.
Improved Customer Satisfaction
The success of any business is determined by its ability to satisfy its customers. A low-cost business model has the potential to provide a number of tangible benefits for those it serves.
Lower Costs Provide a Competitive Advantage
Low cost companies have the advantage of being able to offer competitive prices to their customers. Customers can often find better deals because of companies’ ability to keep costs low. A low-cost business model also allows businesses to be more competitive by reducing the cost of goods and services, allowing them to pass those savings on to their customers.
Flexibility in Pricing Practices
A low-cost business model also gives businesses the ability to be flexible in their pricing. Companies can offer discounts and promotions, or they can offer discounted prices to certain customers. This flexibility also ensures that businesses remain competitive while also providing good value to their customers.
The benefits of a low-cost business model are numerous and it is an excellent tool for ensuring customer satisfaction. By keeping costs low and being flexible with pricing, businesses can offer competitive prices to their customers and maintain the loyalty of their customers.
Low-cost business models offer companies a large range of benefits. They allow companies to reduce overhead costs, increase efficiency and profitability, give them more freedom when it comes to managing resources, and make them more competitive in their respective marketplaces. Additionally, low-cost business models can be used to supplement existing services or launch new ones without a huge upfront cost. Ultimately, businesses seeking to gain a competitive edge in their respective industry should consider the advantages of a low cost business model before investing in more expensive alternatives.
Businesses today need to think strategically and invest wisely. Adopting a low-cost business model not only helps you lower overhead costs, but also presents a great opportunity to gain an advantage over your competitors. By engaging in tighter cost control, businesses will be able to improve their bottom line and increase their competitive edge in the marketplace.
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La nouvelle revue du travail
Accueil Numéros 12 Corpus – Low cost Introduction to Low Cost theory
Introduction to Low Cost theory
1 The term “low cost” has become ubiquitious in modern discourse and is used in reference to anything relatively inexpensive and/or easy to do. The concept has permeated most if not all spheres, with the media constantly applying it in discussions as wide-ranging as sports, football teams, funeral parlours, banks or investment funds. In opposition to these representations, however, the present Corpus seeks to demonstrate that these are approximations glossing over historical realities, starting with the complexity of the factors involved in the creation of low cost goods and services.
2 It is true that the low cost concept generally refers to a good or service that is relatively affordable for persons or groups possessing little economic capital. It is also more intellectually stimulating to focus on production processes occurring in specific spatio-temporal spheres without forgetting to highlight an object’s positioning in the market that it seeks to conquer.
Defining “low cost”
3 The practice of lowering prices to gain market share is nothing new. In sectors as diverse as restaurants, perfume, transportation vehicles, property and even education, goods and services have long been segmented by price. In Europe 300 years ago, for instance - a time when it seems anachronistic to talk about mass “consumption” - there were probably very few areas where the lower classes enjoyed the material or immaterial goods that the upper classes did. Conversely, it is possible nowadays to find cheaper bread or fish in modern large retail outlets or local neighbourhood stores without a low cost strategy being at work. In other words, it has been often unclear in both the past and the present to what extent pricing differences exemplify a low cost concept or some other phenomenon.
4 Bona fide low cost discussions necessarily cover both the technical manufacturing process involved in making a good or service and the price competition that is a key aspect of this strategy. In opposition to traditional commercial offers, low cost production draws from two highly inter-related principles (Combe, 2011):
- Radical simplification in a good or service reduced to its core functionality (hence lacking in luxury, comfort or aesthetics). Point-to-point air or train journeys (with less room, fewer services and any extras incurring a charge), the design-manufacturing of “basic” automobiles, goods delivered to customers in their original packaging (or on palettes in hard discount supermarkets), etc.
- Drastically reduced input costs (cheap materials and components, minimised labour costs). This implies massive reliance on subcontracting and all kinds of methods being used to reduce labour costs, including moving productive activities to countries where tax policy is more capital-friendly.
- A simplification of work applying advanced Taylorian and Fordian logic, culminating in an intensification of labour;
- Localisation or delocalisation of productive activities towards cheap labour countries, being territorial spaces reputed for paying low direct wages and offering little if any social protection;
- Intensive reliance on subcontractors, often firms lacking any union representation and where the workforce is paid as little as possible (due to disadvantageous employment contracts and other forms of precarity) and lacks the kinds of benefits often found in larger companies. Here work contracts are often replaced by commercial contracts, self-employment and/or piecework arrangements. Air transport and the digital platform economy offer many examples of these practices.
- 1 A gig refers to payments made to musicians for a show they do. The gig economy is one where worker (...)
5 The low cost paradigm has also started to converge with the digital platform economy model, as witnessed by the spectacular rise in the number of minicabs competing with taxis or courrier cyclists making home deliveries. This attests to a real invention in (or renovation of) markets, specifically based on an offer of low cost goods and a deterioration in the working and employment conditions of the workers affected (who sometimes struggle to get re-classifed as employees instead of independent contractors). The often lower prices associated with this gig economy 1 are associated with much worse working conditions for warehouse employees (i.e. Amazon); with customers doing more of the work themselves and incurring greater household expenses (Dujarier, 2008); and/or with consumer shaving to undergo a “commercial education” (Tiffon, 2013). A number of other changes are also part of this trend towards more and more work being moved on-line, with the Nouvelle Revue du Travail devoting a special issue to the topic in its upcoming autumn 2018 issue.
Elements of continuity
6 The low cost concept means a new way of producing things and setting prices. It does not, however, imply a total lack of continuity with previous productive organisations. An article by Cyrine Gardes about hard discounting in the food industry speaks about elements of change but also of continuity within the mass retail sector in general. Similarly, an article by Severin Muller on generic medicine manufacturing shows that the activity is not entirely different from the way original medicine is made but that labour intensification and precarisation has progressed more with the former than the latter. Similarly, the problems Ryanair had with its pilots (cancelling thousands of flights in summer 2017 after many pilots left to earn more elsewhere) led it to work more closely with trade unions in a timid attempt to “normalise” industrial relations (see article by Louis-Marie Barnier and Jean Vandewattyne).
7 In other words, although the global low cost economy is based on very different principles, the implementation thereof in the goods and services manufacturing processes has reproduced and (even more importantly) deepened the lean production paradigms that many prime contractors and their subcontractors already pursue worldwide. For example, intelligent product design using fewer materials (article by Martin Krzywdzinski, Grzegorz Lechowsk and Ulrich Jürgens) is nothing other than the culmination of a revolution that started more than 20 years ago (Womack et al, 1992; Midler, 1994). Indeed, some or all of the ordinary ingredients found in lean or frugal production (just-in-time, teamwork, employees’ subjective mobilisation, employment deregulation, subcontracting, delocalisation towards cheap labour countries, etc.) are or can be deemed pertinent to a low cost approach, despite the terrible absence of quantified data about the different ways these outcomes are achieved.
8 Examing situations on a case-by-case basis, it becomes clear that contrary to the dominant Fordist model, a low cost approach might also involve using lean production to achieve comfortable profit margins even when manufacturing short series (Durand 2004; 2017). More broadly, textbook cases of low cost practice include the automotive industry (see Dacia example detailed in Tomasso Pardi’s article), Kwid (see reference in this NRT issue’s appendix to a book by Christophe Midler et al, 2017) or India and China (aforementioned article by Martin Krzywdzinski et al). Articles cover other sectors - like air transport (Louis-Marie Barnier and Jean Vandewattyne), rail transport (Marnix Dressen), generic medicine manufacturing (Severin Muller) or hard discounting (Cyrine Gardes) - focus on radical revisions in the techniques used to produce goods and services.
Low cost practices
9 Clearly, low cost strategies have a direct effect on one core economic institution – labour. This includes direct impacts upon employees working in low cost companies but also a “contagion” phenomenon where traditional firms (parent companies or prime contractors) align their employment and working conditions with low cost companies to whom they delegate certain activites. It is true that not all low cost companies possess a subsidiary status (e.g. hard discounters like Aldi or Lidl; airlines like Ryanair). Still, it should be recognised that these “independent” companies are also laboratories experimenting with ideas aimed at increasing productivity, inspiring in turn bigger companies operating in the same sector. And where low cost subsidiaries have been created, one main issue that arises is whether prime contractor or parent company employees will ultimately be deprived of their social safety network and whatever rights they have earned. Air France employee unions have shown an awareness of this reality, explaining their mobilisation since 2015 in response to the creation of bargain basement subsidiaries (Transavia or Joon). Using language formulated by Peter Doeringer and Michael Piore (1971), the primary segment of companies and administrations has good reason to fear the encroachment of low cost production.
10 This raises a number of questions, namely whether this type of activity - when it has not been delocalised - mobilises a workforce that might be deemed typical (in terms of gender, age, nationality, education, etc.) compared to similarly ordinary activities, and whether the same kind of collective conflicts and specific negotiations have been observed in branches, sub-branches or professions where the low cost paradigm has had an influence.
11 Lastly, one risk exuding from the low cost approach is the progressive contamination of an entire branch and all its ancillary activities. SNCF French national railways, for instance, depicts its iDTGV and Ouigo subsidiaries as responses to competition from Easyjet on the Paris-Marseille route, which used to be one of the SNCF’s more lucrative lines. Ouigo might be portrayed here as offering a “parallel” structure where it is easier to get employees to accept new rules that are always less generous than the ones found in the parent company where these new organisations had been designed. In addition and as demonstrated in Marnix Dressen’s article about SNCF, successive initiatives associated with each low cost innovation cause further deterioration in the services being offered.
12 Studies in this Corpus also reveal customer segmentation policies that have led to a deterioration in working and employment conditions. One robust hypothesis here is that a more or less direct relationship exists between product markets and associated labour markets. In turn, this raises questions about the attributes of intermediary (so-called “middle-cost”) goods producers in areas like passenger air transport – being the same product up-market move, everything else remaining equal, as the one occurring in the Chinese and Indian automotive industries and analysed in the article by Martin Krzywdzinski et al. In other words, it is hard to analyse low cost practices without delving into questions relating to consumption and consumer preference motives. These are focal points in this special issue’s Controverse section, featuring contributions from Franck Cochoy, Marie Plessz and Diane Rodet, in conversation with François Sarfati.
13 This series of observations raises questions about how low cost product or service customers – who are also workers – feel about the contradictions they are experiencing. As consumers they have an interest in lower costs hence prices, but as workers (whether employed or “independent”) they will suffer from the lower wages paid over the medium or long term and/or from the labour intensification that often accompanies cuts in service or product prices. The question at this level is how producers-consumers navigate this low cost dilemma when developing their preferences and arbitrating between different spheres within their private lives. The real issue here may be one of split identities.
Low cost factors driving new macro-economic regulations
- 2 It might also be averred that the low cost paradigm contributes to environmental degradation since (...)
- 3 A model that might be called, in macro-economic language, post-Fordian given its break from the pr (...)
14 One specific question is whether the low cost phenomenon helps to maintain or even raise the purchasing power of working classes whose income levels have suffered due to the new distribution of wealth exemplifying the Western world. The 2007 Beigbeder report assigned a purchasing power lever function to the low cost paradigm. Similarly, there is the question whether low cost products give working class populations access to goods and services that they could never have bought before (flights, new cars, etc.) 2 . If so, they might be partially represented as a substitute for the cash-stricken Keynesian state (Guez, 2003), providing a solution that “smoothes over” social contradictions, being the role that states used to perform before losing the functions they were previously allocated. From this perspective, a low cost approach offsets some of the cuts in social benefits and public service. The end result is a new regulation where “classes of masses” (Gaggi & Nadurzzi, 2006) are induced to rely on low cost services and goods (Carolan, 2015) in the vague hope of maintaining their standard of living (with low cost consumption serving as an alternative to the collective mobilisation for higher wages). Social integration becomes the aim here, a function partially structured by the unending quest for objects of consumption that will allow people to identify with the social class that is immediately above their own (Gaggi & Nadurzzi, 2006). In this sense, low cost offers support the emergence of a new socio-economic regulation model 3 based on certain principles:
- Tendency for most workers to experience a loss of income (reduction in nominal wages and in the social protections offered by the Keynesian state in crisis),
- Low cost approach leading to cost and price cutting (partially explained by the aforementioned reduction in labour costs)
- Preservation of working class purchasing power due to unemployed being offered state benefits, funded by the middles classes and complementing workers’ own consumption.
15 This depressive model leads to a twofold social segmentation, reinforcing the inequalities between beneficiaries of financial income vs. workers in general, and increasing the gap between the middle classes who fund the state and the more deprived social categories subsidised by it. Social equilibrium is largely based here on social integration encouraged by consumption, a not insignificant part of which involves low cost products and even services coming from low wage countries.
16 This equilibrium must overcome one hurdle right from the start, namely to whom products and services can be sold if working class incomes fall as the low cost paradigm spreads and undercuts direct or indirect wages. The question here is whether the price competition enabling a few low cost operators to enter and conquer new markets (cf. article by Patrick Dieuaide) creates sufficient change so that the people working in these sectors benefit as well. This then leads to a new bottom-up socio-economic regulation where workers can more or less maintain their standard of living. The macroeconomic observation here is that this strategy – involving an intensification of labour and above all a reduction in workers’ benefits (especially healthcare and pension rights) – is beneficial to shareholders and other powerful stakeholders with an interest in low cost firms or digital platforms. It is a kind of regulation intended to reproduce healthy profits in the real economy without generating excessive social protest given the new modes of productive mobilisation used by employee and especially neo-independent workers isolated in the execution of their tasks.
17 This casts a new light on the social and political events marking recent decades, often referred to as an “economic modernisation” era, especially 2016-2018 when, in France for instance, a host of new “Work laws” were enacted. In reality, the reforms all tried to apply the 2007 Beigbeder report recommendations that worker rights be adapted to a “new economy” characterised by digital platforms and low costs. Pioneers in this area, like Ryanair or Uber, will always have less to fear from court cases given that their conception of production relationships are increasingly being integrated into legislation.
18 In some cases, the low cost good or service niche is also something that new entrants (i.e. hard discount retail chains) think they can use to gainmarket share. Conversely and as shown in Patrick Dieuaide’s opening article entitled Strat é gies low cost et relation d’emploi , a low cost strategy can be used to dominate markets and keep new entrants at bay. The low cost offer that SNCF mobilités ’ developed, for instance, was also a way to keep new operators out of the French long-distance rail market. This is supposed to be completely open to competition in 2020 but the company hopes in this way to discourage potential rivals.
19 The low cost model has markedly changed both how things are produced - often accentuating trends that were already identifiable in the lean production paradigm – and consumers’ representation thereof. It has tended to transform large segments of the population into consumers constantly seeking good deals and better value for money, creating an incentive in all areas of human activity to minimise upfront investments and maximise utility. This is meant to turn a person into a rational homo œconomicus whose mental structures are no longer shaped by a public service ethos but by a Trip Advisor culture. It may be excessive to attribute a “civilising” function to the low cost paradigm, one based on “anthropological transformation” and where certain social categories with great online abilities yet little economic capital are incentivised to constantly seek better value for money by focusing on price considerations alone. In this hypothesis, consumers (who are also workers) get totally confused and agree to lower quality products and services since they are cheaper – even though, as wage-earners themselves, it is hardly in their interest to see general wage levels stagnate or even fall. Nor is it in their interest for employment and working conditions to deteriorate. Yet these outcomes are inevitable in the low cost universe.
20 The dossier that follows will also show that despite the clear commonality of certain elements, a wide variety of industrial branches and companies have been affected by this phenomenon, relating to the geneology of initiatives, their timing, the types of actors involved and, to a lesser extent, the target audience. The big question here, for a number of reasons, is whether all industrial goods and service activities are destined to succumb sooner rather than later to this low cost revolution. Economic actors’ strategy has always consisted of draining everything they can from a system, implying under the present circumstances that it might be possible to offer the upper middle classes (customers enjoying substantial economic capital) costly and prestigious top-of-the-range goods or services – with some experts considering that low cost flights, to only take this example, are unlikely to exceed 40 to 50% of the air travel market (depending on the segment). Conversely, low cost operaters will also offer the lower middle and working classes goods and services that further accentuate the “crisis” in public services (i.e. air or rail transport), the limit here being disadvantaged populations’ solvency. Note that this summary categorisation can be partially combined with certain generational and spatial situational criteria (i.e. differences between capital and provincial regions).
21 As far as equity holders are concerned, low cost and customer segmentation strategies constitute one instrument among the many others they possess in their toolkit. The delocalisation of jobs to countries characterised by cheap labour – but involving products that are not bottom-of-the-range - is an activity that still has a lot of upside. In the service arena, sectors worth paying attention to include call centres, software design and documentary medical expertise. Even top-of-the-range industrial activities can be made on the other side of the world (i.e. i-Phones). All of these outcomes might well be able to co-exist in a world defined by the growing domination of low cost business strategies.
Beigbeder Charles (2007), Le « low-cost » : un levier pour le pouvoir d’achat , Rapport remis par Charles Beigbeder à Luc Chatel, Secrétaire d’État chargé de la consommation et du tourisme. [En ligne] https://www.economie.gouv.fr/files/finances/presse/dossiers_de_presse/lowcost071212/lowcost.pdf
Carolan Michael (2015), Cheaponomics , Le coût élevé des produits bon marché , Paris, De Boeck.
Combe Emmanuel (2011), Le low cost, Paris, La Découverte.
Doeringer Peter, Piore Michael ( 1985), International Labour Markets and Manpower Analysis , With a new introduction, New York, Armonk Heath, London, M.E. Sharpe Inc.
Dujarier Marie-Anne (2008), Le Travail du consommateur : de McDo à eBay, comment nous co-produisons ce que nous achetons ? , Paris, La Découverte.
Durand Jean-Pierre (2004), La Chaîne invisible. Travailler aujourd’hui : du flux tendu à la servitude volontaire , Paris, Le Seuil.
Durand Jean-Pierre (2017), La Fabrique de l’homme nouveau. Travailler, consommer, se taire ? , Lormont, Éditions Le Bord de l’Eau.
Gaggi Massimo et Narduzzi Edoardo (2006), La fin des classes moyennes. Ou la naissance de la société lowcost, Paris, Éditions Liana Levi.
Guex Sébastien (2003), La politique des caisses vides [État, finances publiques et mondialisation], Actes de la recherche en sciences sociales . vol. 146-147, p. 62-69.
Midler Christophe (1994), L’Auto qui n’existait pas , Paris, Interéditions.
Midler Christophe, Jullien Bernard et Lung Yannick (2017), Innover à l’envers. Repenser la stratégie et la conception dans un monde frugal , Paris, Dunod.
Tiffon Guillaume (2013), La Mise au travail du client, Paris, Economica.
Womack James P., Jones Daniel T. et Roos Jones (1992), Le Système qui va changer le monde , Dunod.
1 A gig refers to payments made to musicians for a show they do. The gig economy is one where workers are paid for the tasks they perform (i.e. per journey, per delivery).
2 It might also be averred that the low cost paradigm contributes to environmental degradation since it increases the consumption of certain fossil fuels. Examples include the carbon footprint associated with air travel and a few other industries. This critique differs, however, from one focused on reducing social inequality.
3 A model that might be called, in macro-economic language, post-Fordian given its break from the previous capital-labour distribution compromise. From a production perspective, however, the model remains deeply Fordian, seeing how lean management principles – pushing the Ford assembly line concept to its very limit (Durand, 2004) – continue to dominate the organisation of production and labour.
Pour citer cet article
Marnix Dressen et Jean-Pierre Durand , « Introduction to Low Cost theory » , La nouvelle revue du travail [En ligne], 12 | 2018, mis en ligne le 01 mai 2018 , consulté le 04 septembre 2023 . URL : http://journals.openedition.org/nrt/3488 ; DOI : https://doi.org/10.4000/nrt.3488
PRINTEMPS – université Versailles Saint-Quentin-en-Yvelines
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What Is the Chief Difference Between a Low-Cost Provider Strategy and a Focused Low-Cost Strategy?
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Different Types of Pricing Strategy
Strategies to overcome marketing threats, pricing strategy examples.
- New-Product Pricing Vs. Market-Penetration Pricing
- Differentiated Marketing Strategy Vs. Undifferentiated
What kind of strategy have you adopted for your business? Before you decide whether you want a low-cost strategy, do you know what other options you have available to you? This is where the idea of a competitive strategy comes in.
What Is a Competitive Strategy?
A competitive strategy is simply anything a business does in order to gain a competitive advantage over its competitors. It is a good thing for the consumers in the market because it gives them added value. Sometimes, that added value comes in the form of lower prices and sometimes it comes in the form of increased services and benefits, which ultimately justifies the higher prices that they have to pay.
In a general sense, there are four possible competitive strategies that a business can implement: The main strategies are actually two, and the other two are simply variations on the main strategies.
The two main strategies you can adopt as a business are that you focus either on costs or on differentiation. When you focus on costs, then you try to become a low-cost provider. When you focus on differentiation, then you look to compete by adding extra value to your customers that they won’t find in your competitors. In other words, you are focusing on areas other than cost to set yourself apart from the competition.
The other two strategies are simply variations on the first two. For cost, you can either lower your costs in a broad sense or you can lower them only for a specific niche. The same goes for differentiation.
With a low-cost strategy, you can only win if you are the company with the lowest cost in the market. If a bunch of companies are selling products in that area, which, for all intents and purposes, are identical, then the company that sells the products at the lowest prices will get the greatest number of customers.
If you can keep your costs low, then you will benefit from such a strategy. If a bunch of companies sell identical products at the same price, the company that can keep its costs low will have the highest profit margin, and will emerge the winner. This advantage is crucial because it allows the company that can keep its costs low to explore strategies to maintain that advantage and even increase it.
The company could try new marketing methods, for example, or increase its current marketing efforts. It could try to get better positions in retail stores so its products do better than those of competitors. It can invest in research and development to improve its products. However, the most powerful thing it can do to keep its competitors out of the market is to reduce its prices.
In fact, if you think about it, all companies in any given market that have higher costs only stay on in those markets because the lower cost companies let them. If the lower cost companies chose to, they could squeeze these higher cost companies out of the market by reducing their prices. The higher cost businesses would not be able to compete and would have to shut down. This is a strategy that has often been used to force competition out of the market.
This kind of strategy is a no-frills strategy. All you’ll be looking to do is to minimize your costs in order to give the lowest prices to your customers and allow them to save. You should have high technical capacity and plenty of capital and invest in the latest cost-saving technologies in order to be able to pull this off well.
In most cases, the very first companies that manage to significantly lower their costs end up being market leaders because they grow their market share and utilize their capacities well, which pushes their costs even lower due to economies of scale.
There is something to be said for this strategy, as far as the size of the business is concerned, and in fact, that is the basis upon which the strategy is divided into the broad and niche versions.
Low-Cost Provider Strategy
A low-cost provider seeks to sell its products at the lowest price it can, while still making a profit so that it can draw customers to the market. This is the broad version of the low-cost strategy because such companies try to appeal to a broad market. They will look boost their sales volumes as high as they can by attracting as many different types of customers to buy as many different types of their products as they can.
Obviously, such a company would have to be large in order to be able to pull the strategy off. It would need to have multiple product lines that appeal to a wide range of customer types and it would need to have very high production capacity in order to meet demand and generate high sales volumes. Small businesses might find it difficult to pull off this kind of strategy.
Focused Low-Cost Strategy
If a small business cannot appeal to the broader market, what is a small business to do? It focuses on a niche, of course. While a small business cannot feasibly achieve low prices on all of its products, it can try and focus on a small niche and try to be the lowest cost provider in the market for that specific niche. This is much easier to do and can help distinguish a small business for a specialty that could catapult it into massive growth. That is the essence of the difference between the two strategies. In the first you seek to lower costs everywhere, in the other you pick your battles and charge normal prices for everything else.
At the heart of differentiation is the belief that you need to position yourself in a unique, clear way in the market in order to attract customers. You want the market to perceive you as being a higher value provider than your competitors. Note the distinction between value and price. If you can convince the customer that you are providing them with more value than the next guy, then you can charge them a higher price.
Differentiation strategies work in market circumstances in which the customers aren’t just focused on price, but where they consider other aspects, as well, before they make a purchase. Consequently, this kind of competitive strategy tends to work better in certain markets than in others.
When you decide to adopt this strategy, you should understand the needs and preferences of your customers to a ‘t’. You should, therefore, be constantly innovating in order to keep up with those needs and preferences. Another thing you should work on building is your brand, including how visible it is and how well it is positioned.
General Differentiation vs. Focused Differentiation
Here again, just like with cost, you can either differentiate yourself in a broad sense or in a particular niche. If you tend to be a large company that focuses on a specific line or specific lines of products, then you can differentiate yourself in a broad sense so that customers recognize your brand in every product they buy from you. A good example here is Apple, which sells phones and computers while also offering various services. They have differentiated themselves in a broad sense so that every Apple product feels different, superior actually, from other products in its category.
You can also differentiate yourself in a particular niche. Have you ever loved going to a particular restaurant just for a specific item on their menu, such as their burger, or their milkshake and what have you? That is niche differentiation. The restaurant isn’t the best at every food it makes, but it’s certainly the best at one or two.
This kind of niche differentiation is particularly common with social media platforms. While Instagram, Facebook, and Instagram are all social media platforms that allow most of the same stuff (posting text, images, videos, live streaming, and engagements), they have all targeted specific niches in order to differentiate themselves. Instagram is for photos, Twitter for small shareworthy posts, and Facebook for longer posts and videos. That is part of what makes each of them so distinct in the world of social media.
- University of Cambridge: Porter's Generic Competitive Strategies (ways of competing)
- Monash University: Low Cost Strategy
Nicky is a business writer with nearly two decades of hands-on and publishing experience. She's been published in several business publications, including The Employment Times, Web Hosting Sun and WOW! Women on Writing. She also studied business in college.
Differentiated business strategies, rationales for marketing strategies, competitive business strategies, four methods of competitive advantages, examples of management strategies for a cake bakery business, target market identification, five types of business-level strategies, what is competitive orientation, cost leadership & competitive advantage, most popular.
- 1 Differentiated Business Strategies
- 2 Rationales for Marketing Strategies
- 3 Competitive Business Strategies
- 4 Four Methods of Competitive Advantages
Long-Haul, Low-Cost: Can This Business Model Ever Succeed?
THE ART OF FLYING | Jun 16, 2021 12:00:00 AM | by Avgeek
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Heavily debated for its sustainability, the long-haul, low-cost (LHLC) model for airlines is a question that remains unanswered. Nearly every wave in the history of commercial aviation brings to the forefront another attempt to crack the LHLC business model.
The Covid era is no different — pressure on travel budgets, pent-up demand, fear of flying via major hubs, and high supply of used/unsold aircraft (Including new aircraft types like the A321LR) make this attempt more tempting and one to watch.
With the end and proceeding rebirth of the model in the Norwegian skies, JetBlue’s transatlantic operations expected to operate in “Mint” condition, startups like Moov and Ryan Air’s expected long-haul diversification, the coming years will see the best in the game trying to make LHLC successful across the Atlantic.
In the east Air Asia X with its restructure, and Scoot backed by SIA remain resilient. In the all-premium space, we have La Compagnie operating its niche business model.
Learning from the Past (We Go Way Back)
Interestingly the lessons & problems of the past remain very relevant even in 2021.
Almost all literature studying this model refers back to its pioneer, Freddie Laker and his SkyTrain. Launched on September 26, 1977, SkyTrain was the world’s first long-haul, low-cost carrier. It offered services between New Yorks JFK and London’s Gatwick airport.
Morell (2008) mentions all the important characteristics of the SkyTrain that have become key adaptations for low cost carriers today.
- High Density seating (Single Class): The SkyTrain configured its DC10 with 345 seats in an all economy cabin. At the time this was one of the only airlines to do so, especially on a long-haul international route. This is one of the key characteristics of low cost carriers today.
- Point-to-Point service: SkyTrain offered no connections at either end of the route. Another key aspect of today’s LCCs model. Many LHLC in the current environment however do offer low-cost connections as part of their model.
- Ancillary Revenue (No Frills) : The second major source of revenue for low-cost carriers today and a key differentiation with the traditional network carrier. LCCs not only generate ancillary revenue from charging for services like catering and baggage which would be available for free traditionally, they reduce important operational costs in relation to weight and turnaround times.
Laker’s SkyTrain failed to cope with the aggressive pricing of the network carriers and regulatory delays. Other factors like the economic climate at the time and exchange rate debts also contributed to the demise (Francis et al 2007).
Morell (2008) speaks about the failed experiment of People Express, which commenced operations in 1983. A different and more evolved model from SkyTrain, the airline offered low-cost connections at its base in Newark.
It also charged for baggage at a rate of $3 per bag, as a source of ancillary revenue. It did not survive because of poor management, over expansion and lack of finances.
"Common reasons of failure for the LHLC model have been cost of capital (Aircraft financing) and rising fuel prices, intense competition from network carriers, poor network planning and poor cost planning."
Oasis Hong Kong operated from Hong Kong to London Gatwick. The Oasis experiment looked viable initially. With an original plan to operate a high-density single class 747-400, it changed to operating the same aircraft in a two-class configuration (Morell 2008). One of the main reasons of failure was the non-availability of connections at either end of the route (JLS 2015).
There have been many other LHLC failures over time. Zoom, Flynas, and the latest being Norwegian. We have also had airlines attempt all premium LHLC, MAXjet Airways, Eos Airlines and SilverJet, to name a few.
Common reasons of failure for the LHLC model have been cost of capital (Aircraft financing) and rising fuel prices, intense competition from network carriers, poor network planning and poor cost planning.
Transferability of LCC Cost Models to LHLC
LCC carriers have been successful in reducing their cost base due to a combination of key factors like in-flight services, aircraft and crew utilization, seating configuration, use of secondary airports, digital & direct distribution and more.
While many of these cost benefits are not directly transferable to long haul, eg. LHLC carriers cannot gain significant cost advantages from fuel costs and aircraft utilization in comparison to traditional network carriers, some do remain.
It remains key for LHLC carriers to keep in-flight service costs at a minimum, operate from secondary and tier two/three airports & have a lean fleet plan.
The impact of covid on the sustainability of the LHLC model remains to be seen. While on one hand demand for international travel has taken a severe hit, the cost of aircraft are expected to dip anywhere from 5-25%.
Tighter traveler budgets and pent-up demand in mature markets like the US & Europe could also be a boon for the model.
Different Type of LHLC Carriers and Low Cost Alliances
Even within the LHLC umbrella, there are different models that have been tried and tested over time. Some more successful than others. Evidence suggests that LHLC works better with partner carriers.
Two of the best examples are Scoot, part of the SIA group, and Air Asia X part of the larger Air Asia network. We then have standalone startups like Norwegian, Flynas, and WOW air.
"Evidence suggests that LHLC works better with partner carriers."
Partner airlines share the burden of certain costs and benefit from feeding other carriers in the common network operating from common hubs. Singapore Changi & Kuala Lumpur International are both great examples of how different airlines’ models can interconnect at these points.
Network consolidation is one way the LHLC model can compete with traditional network carriers and the big three alliances.
Alliance models like the Value Alliance in the far east provide an encouraging platform for low-cost carriers to compete with traditional network models and capture maximum share from the newly formed middle class in these regions.
Key Factors in Determining the Success of the Model
While it is hard to pin down exactly what is needed to make LHLC a success, some key themes are given below.
Aircraft Type: The choice of aircraft is key in determining the success of a LHLC plan. Airlines are usually torn between older aircraft types that burn more fuel, however, come at a cheaper price (Air Asia X’s choice of the A330) or newer aircraft models that cost more, however, provide more savings in fuel costs (Norwegian and Scoots’ choice of 787s).
As a result of network carriers being aggressive with pricing against new LHLC airlines, it is important to be in a cash rich position off the bat, cheaper aircraft like the A330 for Air Asia X at its start proved to be a success for this reason.
"Airlines are usually torn between older aircraft types that burn more fuel, however, come at a cheaper price or newer aircraft models that cost more, however, provide more savings in fuel costs."
A new reality is the single aisle long haul aircraft like the A321LR, which could potential solve both these issues, with a reasonable capacity to manage niche new routes. Narrow-body, long-range aircraft might be the missing piece of the LHLC puzzle.
Network: Partnerships and consolidated networks have proved to be necessary in order to compete with the big three alliances and traditional network carriers. While LHLC carriers focus on stimulating demand on certain niche flows, it is important to have a strong base of flows with beyond and behind connections that serve as cash cows.
Niche international routes would also be the latest to recover in a post-Covid world. Remaining adaptive and having seasonal schedules remains a key differentiating factor.
Ancillary Revenue: As with LCCs, the model calls for maximum focus on ancillary revenues. Traditional ancillaries like baggage, in-flight services like food and wi-fi along with newer innovative solutions in the space of on-board digital marketing.
The possible success of bigger ideas like the Air Asia “Mega App” combining travel with other services into a type of lifestyle is an exciting possibility in the near future.
Long-haul, low-cost carriers must not only achieve cost advantages, but also be competitive and protect themselves against network carriers cross-subsidizing low fares to be successful (Francis et al 2007).
It is important for LHLC carriers to generate feed at either end of the route to allow passengers more flexible options and increase load factors (Tony Fernandes, CAPA TV 2016).
"Long-haul, low-cost carriers must not only achieve cost advantages, but also be competitive and protect themselves against network carriers cross-subsidizing low fares to be successful."
Even though cost is a key consideration, it is important for LHLC carriers to increase RPKs either through their premium cabins or other revenue sources as that helps maintain competitiveness and profits.
A key factor always overlooked is that LHLC & LCC models need to maintain their “startup mindset,” it is the ability to change strategies, being adaptive and adjust to new market and consumer realities that is the key competitive advantage low-cost models have against network carriers, or as some would say “The Southwest way.”
Sources: *Morrell, P. (2008) ‘Can long-haul low-cost airlines be successful?’, Research in Transportation Economics, 24(1), pp. 61–67. doi: 10.1016/j.retrec.2009.01.003.
*Francis, G., Dennis, N., Ison, S. and Humphreys, I. (2007) ‘The transferability of the low-cost model to long-haul airline operations’, Tourism Management, 28(2), pp. 391–398. doi: 10.1016/j.tourman.2006.04.014.
*Wensveen, J.G. and Leick, R. (2009) ‘The long-haul low-cost carrier: A unique business model’, Journal of Air Transport Management, 15(3), pp. 127–133. doi: 10.1016/j.jairtraman.2008.11.012.
*Bloomberg TV Malaysia (2016) AirAsia X returning to London soon: Fernandes. Available at: https://www.youtube.com/watch?v=UHUIyJr0oso
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- Zero marginal cost business models
How the technological revolution is changing industries
How does the business model of the Google search engine differ from those of DAX-listed companies such as Siemens, BASF or adidas? The answer from the point of view of a business economist is quite simple and is: through the cost structure. While Siemens & Co. have to spend a not inconsiderable portion of their sales on financing their manufacturing costs, Google's service provision costs almost nothing.
Cost structures: Digital vs. Classic
We compare Google's business model with that of a traditional industrial company - specifically an automotive manufacturer such as VW - using a simple numerical example.
In order to ensure comparability of the two different models, we focus on the relationship between variable production costs (see below for explanation), which are incurred in the creation of services or products, and sales. Overhead and fixed costs are not included in the analysis in either case.
Cost structure of a search engine
The only variable costs incurred by the search engine in providing the service are the energy costs for processing the search query. Transmission costs are not incurred by the provider, as these are borne by the customer.
- The estimated energy consumption for processing a search query is 0.0003 kilowatt hours.
- Converted to the current German price of a kilowatt hour of about EUR 0.13 (as of November 2018), the estimated cost of a single search query is EUR 0.000039.
Wir stellen nun die Energiekosten dem potenziellen Umsatz pro Suchanfrage gegenüber. Dazu müssen wir die Frage beantworten, wie viel Prozent der Klicks auf Google letztlich auf den bezahlten Anzeigen (Google AdWords) landen.
- We assume that about 1.68% of Google search queries result in a click on a Google AdWords ad.
- The click on a Google ad usually brings the company between 0.4 and 2.00 EUR (average value: 1.2 EUR).
- Google therefore converts an average of 0.02016 EUR per search query - i.e. about 2 cents.
That doesn't sound like much at first. Nevertheless, the turnover of a search query exceeds the costs by more than a factor of 500 (specifically: 516,923!).
Cost structure in automotive production
To enable a fair comparison between the business models, in a second step we determine the relationship between variable costs and sales in car production. Variable costs of car production include the consumption of goods and the energy costs for processing the materials.
- Based on current estimates, the cost of materials in the automotive industry is around 50% of the selling price.
- The exact figures are a closely guarded trade secret. In addition, the ratio between sales and cost of materials is generally higher in the luxury and premium classes than in the compact class.
Regardless of whether you are at the top end or the bottom end of the scale - the ratio of sales to variable costs hovers around the number 2. The factor is thus about 250 worse than at Google. And it doesn't matter whether we're talking about a new Bugatti model or a Skoda model that has been in production for years.
Falling marginal costs through digitization
Digital cost structures therefore have a decisive advantage over industrial cost structures. This applies not only to the Google vs. VW comparison, but to all companies that implement their business models on a digital basis. This creates a worrying gap between the business models of numerous large German companies and the potential business models that will shape the way people live and work in the future.
The reason for the change lies in the reduction of marginal costs of production triggered by software-driven production and sales processes. To understand this connection, the concept of marginal costs must first be examined in more detail.
What are marginal costs?
The cost structure of a company consists of fixed costs and variable costs.
Fixed costs are the unchanging cost components of production that are incurred month after month. These include, for example, wages and rents.
In addition, there are cost items of production that only occur when a product is actually created. The individual parts (e.g. the steering wheel) of a new VW are variable costs. These are assigned to the creation of the individual product.
Marginal costs (GK) are the costs that arise when one unit of a product is produced more. They are thus the first derivative of the cost function, i.e. the addition of fixed costs and variable costs. At first glance, this sounds complicated, but it is not.
The average costs (DK) and the variable average costs (DVK) are shown. The cost function (K(x)) is a degressive cost function - i.e. it is a cost curve in which the costs (total costs) increase to a lesser extent in relation to the change in the number of units produced.
How traditional companies are already benefiting from falling marginal costs
This will be explained by means of a simple example: A newspaper publisher can profit from the principle of decreasing marginal costs if the publisher significantly expands its output volume. Because of economies of scale, it makes a difference in price whether the publisher prints 11 newspapers instead of 10 or 1,000,001 newspapers instead of 1,000,000. It stands to reason that the 1,000,001 newspaper is significantly cheaper for the publisher than the 11.
In business administration, this relationship is referred to as "volume degression" or "economics of scale". What Bruce Henderson, the founder of the Boston Consulting Group, discovered as early as the 1970s still applies today in industrial production: the more of a product you create, the cheaper the individual components become.
Where do zero marginal cost models already work today?
Digitization in general and software development in particular are now ensuring that the rules of the game in business are changing dramatically. This is because the marginal costs of companies that rely on digital business models are almost zero from the very first product or service. And this is already the case with low output volumes.
Another example is provided by the cost accounting of the Internet giant Facebook: To understand Facebook's specific cost structure, we need to ask how much an additional customer costs Facebook to process and support. The answer is similar to Google: almost nothing.
- Admittedly, the costs for transferring and operating the servers add up over the course of a year. And heavy users with high upload data volumes cost the company more than occasional consumers.
- Nevertheless, the added energy and server costs bear no relation to the marketing revenue generated by a single user on average.
- To illustrate this relationship, it is sufficient to divide the current advertising revenues (2017: USD 10.1 billion) by the number of regular users (2.07 billion monthly users).
- The result: just under EUR 5 per year.
That doesn't sound like much at first. However, given that Facebook has a zero marginal cost business model, it is still lucrative to operate the social network. After all, Facebook was able to report a profit of almost USD 5 billion in 2017.
Zero marginal cost model affects entire industries
Now, zero marginal cost business models will not be limited to classic B2C Internet companies in the future, but will expand to more and more industries. The mobility industry (Uber) and the hotel industry (Airbnb) already have this development behind them. The extent to which other industries will be affected by this development toward the zero marginal cost model in the future will be illustrated by means of a model.
How transactions work in the market
Overall, two basic market actors and two interaction processes around the product or service can be identified for each market transaction.
- The two market players involved in an exchange process are the manufacturers and the customers.
- The producer or service provider creates and sells the product.
- At the end of each market transaction is the customer, who satisfies a specific need with his purchase.
In this model, it does not matter which product category and which market players are involved. This results in the following representation of each possible market transaction.
The definition of a zero marginal cost model states that there is a radical change in the actor and process steps. Thus, a large part of the exchange process - at least two of the three exchange levels - must change in order to trigger a change of a market towards a zero marginal cost market.
How the music industry became a zero marginal cost business model
This principle can be illustrated by the development of the music industry: The change from the vinyl record to the CD was not a change to a zero marginal cost business model. Although the product itself was digitized, the CD also ended up back in the store as a physical product. The manufacturing and distribution channels initially remained the same as before.
The change from CD to MP3, on the other hand, represented a true zero marginal cost change for the music market: For this purpose, the product "piece of music" was digitized a second time. This time in such an efficient form that it was possible to exchange music tracks on the World Wide Web even with low bandwidths. In 1999, Napster was founded by Shawn Fanning. Music could now be copied and exchanged by anyone. And all with a simple click.
This new type of file sharing changed the music industry in a dramatic way. The traditional business models of the music industry collapsed and new market players entered the market. Apple revolutionized the music market with the introduction of the IPod in 2001. Both the product "piece of music" and the distribution process were now digitized. And within a few years, the music industry had entered the age of zero marginal cost business models.
Which industries are becoming zero marginal cost markets
The industries that will be affected by this development in the future can already be guessed at today. Banks and insurance companies have long been on the threshold of the zero marginal cost market. But industrial sectors such as the automotive industry will also be affected by the change to a zero marginal cost business model. And only if the companies in the affected sectors start to deal with the implementation options and the associated technology change today will they be able to take up the race with Silicon Valley for the business models of the future.
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What Is The Cost Structure Of A Business Model And Why It Matters
The cost structure is one of the building blocks of a business model . It represents how companies spend most of their resources to keep generating demand for their products and services. The cost structure together with revenue streams, help assess the operational scalability of an organization.
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Why it’s important to know how companies spend money
There are two elements to understand about any company:
- How it makes money.
- How it spends money.
While most people focus on how companies make money. A few truly grasp how those same companies spend money.
However, understanding how companies spend money can give you insights into the economics of their business model .
Thus, once you grasp those two – seemingly simple – elements you’ll understand a good part of the logic behind the company’s current strategy .
Defining and breaking down the cost structure
In the business model canvas by Alexander Osterwalder , a cost structure is defined as:
What are the most cost in your business? Which key resources/ activities are most expensive?
In other words, the cost structure comprises the key resources a company has to spend to keep generating revenues.
While in accounting terms, the primary costs associated with generating revenues are called COGS (or cost of goods sold).
In business modeling , we want to have a wider view.
In short, all the primary costs that make a business model viable over time are good candidates for that.
Therefore, there is not a single answer.
For instance, if we look at a company like Google, the cost structure will be primarily comprised of traffic acquisition costs, data center costs, R&D costs, and sales and marketing costs.
Why? Because all those costs help Google’s business model keep its competitiveness.
However, if we had to focus on the main cost to keep Google making money we would primarily look at its traffic acquisition costs (you’ll see the example below).
This ingredient is critical as – especially in the tech industry – many people focus too much on the revenue growth of the business.
But they lose sight of the costs involved to run the company and the “price of growth .”
Defined as the money burned to accelerate the rate of growth of a startup.
Too often startups burn all their resources because they’re not able to create a balanced business model , where the cost structure can sustain and generate enough revenues to cover the major expenses and also leave ample profit margins.
Companies like Google have been pretty successful in building up a sustainable business model thanks to their efficient cost structure.
Indeed, from a sustainable cost structure can be built a scalable business model .
In the Blitzscaling business model canvas , to determine operational scalability, Reid Hoffman asks:
Are your operations sustainable at meeting the demand for your product/service? Are you revenues growing faster than your expenses?
Blitzscaling is a particular process of massive growth under uncertainty that prioritizes speed over efficiency and focuses on market domination to create a first-scaler advantage in a scenario of high uncertainty.
Reid Hoffman uses the term operational scalability as the ability of a company at generating sustainable demand for its products and services while being profitable.
Indeed, lacking the ability to build operational scalability represents a key growth limiter, and the second key element (together with lack of product/market fit ).
While most startups’ dream is to grow at staggering rates. Growth isn’t easy to manage either.
As if you grow at a fast rate, but you also burn cash at a more rapid rate, chances are your company or startup might be in jeopardy.
That is why a business model that doesn’t make sense from the operational standpoint is doomed to collapse over time!
Cost structure and unit economics
A cost structure is an important component of any business model , as it helps to assess its sustainability over time.
While a startup’s business models, trying to define a new space might not be able to be profitable right away, it’s important to build long-term unit economics.
Google cost structure case study
I know you might think Google is too big of a target to learn any lessons from it.
However, the reason I’m picking Google is that the company (besides its first 2-3 years of operations) was incredibly profitable.
Many startups stress and get hyped on the concept of growth . However, it exists a universe of startups that instead managed to build a sustainable business model .
Google is an example of a company that came out of the ashes of the dot-com bubble thanks to a hugely profitable business model :
To appreciate Google’s business model strength, it is critical to look at its TAC rate .
TAC stands for traffic acquisition costs, and that is a crucial component to balance Google’s business model sustainability.
More precisely the TAC rate tells us the percentage of how Google spends money to acquire traffic, which gets monetized on its search results pages.
For instance, in 2017 Google recorded a TAC rate on Network Members of 71.9% while the Google Properties TAX Rate was 11.6%.
Over the years, Google managed to keep its cost structure extremely efficient, and that is why Google has managed to scale up!
Part of Google’s cost structure is useful for keeping together the set of processes that help the company generate revenues on its search results pages, comprising:
- Server infrastructure: back in the late 1990s when Google was still in the very initial stage at Stanford, it brought down its internet connection several times, causing several outages. That allowed its founders to understand they needed to build up a robust infrastructure on top of their search tool. Today Google has a massive IT infrastructure made of various data centers around the world.
- Another element to allow Google to stay on top of its game is to keep innovating in the search industry. Maintaining, updating, and innovating Google‘s algorithms isn’t inexpensive. Indeed, in 2021 Google spent billions on R&D .
- The third element is the acquisition of continuous streams of traffic that make Google able to create virtuous cycles and scale up.
How do we judge the ability of Google’s advertising machine ?
I envisioned a metric called traffic monetization multiple, which is the ability of the company to monetize its traffic:
As you can notice from the above, this is a purely financial metric, which needs to be balanced out with a qualitative analysis of why the metric increased in the first place.
Indeed, it’s critical to keep into account these questions:
- Has monetization increased thanks to an improved UX? Or is monetization worsening the UX?
- Has monetization improved thanks to an increased customer base? Or has it increased due to higher prices per ad?
- Lastly, how is monetization balanced with legal risks posed by increased tracking?
All these questions are critical to answer, because, financially Google’s advertising machine seems as strong as ever.
There are hidden risks underlying it, which might, all of a sudden threaten its overall business model .
- On a positive note, Google has managed to further scale, as a consequence of the pandemic. Thus, bringing its products to hundreds of millions of new users. Yet. this further scale (especially on mobile devices) has created new challenges for the company. Which is finding it harder and harder to properly index a web made of billions and billions of pages, and growing. This poses a threat in the long term, as it might reduce the quality of organic search results.
- To monetize this expanded user base, Google is serving more ads. This might work in the short term to squeeze the advertising machine. But it might make the overall experience bad in the long term. So it’s critical to balance these things out.
- To further expand its revenues, the company has also increased the price per ad. While, in the short-term, the strategy works, in the long-term, this might substantially reduce the customer base.
The points above, are some of the things you want to look at, qualitatively, to really understand what’s going on, with the changing cost structure of the company.
Netflix cost structure case study
When we look at the overall Netflix business model it’s important to understand a couple of things in order to frame its cost structure:
- The Netflix revenue model .
- And the Netflix capital expenditure.
Netflix runs an on-demand streaming platform, on top of a subscription service.
Members pay a fixed subscription monthly or yearly price, in exchange for having access to a library of content that continuously updates.
If Netflix revenues are higher than the cost that it takes to run the platform, then the platform is profitable.
Is Netflix profitable? It is indeed. However, to understand its cost structure we need to have a deeper look at Netflix’s capital expenditure.
In short, in order for Netflix to keep generating revenues in the long-term, it needs to have a library of content that is guaranteed in the coming 5-10 years.
How can the company do that?
It can do that by either licensing or producing content.
Those mechanisms have two different dynamics.
In fact, for most of its life, Netflix has been spending a massive amount of resources to license content and make it available on its platform.
This is the epitome of a platform business model .
Thus, Netflix invested capital to guarantee a continuous flow of content on top of its platform.
This advanced capital would be repaid back, with revenues coming from memberships.
This also means that for most of its history Netflix run at a negative cash flow cost structure.
Meaning that Netflix had to advance the money needed to license the content.
This money would be recouped many times over, in the long run, as the platform kept growing its members’ base.
On the other hand, starting in 2013, Netflix started to invest more and more into produced content.
What we know today as “Netflix Originals” or a library of content exclusive to paying members.
This sort of investment, while similarly, to licensing content, makes Netflix advance the costs of content, which would be recouped over the years.
It also gives the company the ability to freely distribute this content and dispose of this content over the years.
In conclusion, even though the content production investment doesn’t change the Netflix cost structure in the short term, it will change it in the long run.
Thus, we might expect Netflix to move from a cash flow negative cost structure, to a cash flow positive cost structure as it moves from the platform (investing primarily in licensed content) to a media powerhouse (as investments in produced content pass those in licensed content).
Thus, what I like to call “the mediafication” of Netflix, will be a key component of its business model advantage, in the long term.
How do we assess the evolution in this process?
This process of “mediafication” started in 2013. And while today, 66% of the content investments on Netflix are still about licensed content, the company is ramping up its investments in owned content, further.
From a formal standpoint, when new content investments in produced content will pass the license ones, we can officially call Netflix a Media Powerhouse!
And for now, it’s critical for the company to keep “arbitrating content:”
Amazon cost structure case study
When we look at the overall Amazon business model it’s important to understand a couple of things in order to frame its cost structure:
- The Amazon revenue model .
- And Amazon’s capital expenditure.
When it comes to Amazon, in particular, understanding its cost structure is a bit trickier, as the company runs a business model with many moving parts, business units, and cost structures.
In fact, it’s important to look at Amazon’s business model, according to two perspectives:
- Amazon e-commerce platform (everything that runs on top and adjacent to Amazon e-commerce).
- And Amazon Enterprise/B2B platform (Amazon AWS).
When it comes to the Amazon e-commerce platform, its primary mission is to enable variety, low costs, and a great customer experience.
Thus, Amazon runs it (as a choice) with very tight profit margins. However, this doesn’t give us a complete picture of its e-commerce cost structure.
Indeed, while the Amazon e-commerce platform has tight profit margins, it still runs with a widely positive cash flow structure.
How? Through its cash conversion cycle:
In short, Amazon is able to turn its inventories very quickly, get paid quickly by customers, and pay back suppliers with a wider term, thus enabling the company to generate wide cash margins, in the short-term, invested back into the business.
When instead, we look at Amazon’s Enterprise/B2B platform, Amazon AWS , we need to frame this in a different light:
You can see how over the years Amazon AWS profitability has been running at wide margins. As the infrastructure costs are well paid for, from its revenues.
This is true also today (2021), where Amazon AWS contributed to 55.5% of the overall Amazon operating margins.
This means, that if you were to spin off Amazon AWS from Amazon’s operations, you would get a much lower operating profit figure.
Amazon AWS, while also requiring substantial technological investments, for now, it enjoys market dominance (In 2021 Amazon AWS had revenues of over $62 billion, whereas Microsoft Intelligent Cloud, for over $60 billion, and Google Cloud, for over $19 billion) and wide margins, which might last over the next 5 years, as more startups move to AI, as a core paradigm of software companies (Amazon AWS is becoming the leading infrastructure powering up the AI and software industry).
Spotify’s cost structure analysis case study
When we look at Spotify’s cost structure, it’s important to emphasize the difference between the two main revenue streams:
- Ad-supported: free users can get unlimited music for free, but they have limited options and features. For instance, before they can skip listening to new songs or podcasts they will have to listen to the advertising. Thus advertising amortized the cost of Spotify to run the platform for free users.
- Premium: free users are channeled through a self-serving funnel that prompts them to subscribe to the paid service. Thus, enabling Spotify to monetize at wide margins the free platform, once free users become paid subscribers.
When it comes to cost structure, therefore, it’s worth noticing:
- The ad-supported business runs at tight margins, and its cost gets amortized with advertising. However, the free platform is used as a self-serving funnel to prompt free users to become paid members. In fact, chances are – if you are a paid member – you were a free user before. In short, being a free user widely increases the chances of becoming a paid member.
- The premium business, while it has a lower subscriber count, it has much wider margins. Thus, the premium platform widely pays off for the free platform.
In other words, in this specific case, the cost structure analysis helps us frame the importance of the free platform.
As if we were to analyze that from the perspective of revenues along, the free platform would not be justified.
In fact, the free platform has tight margins, and it generates costs the more it widens up.
In fact, the more free users on the platform, the more royalties Spotify has to pay back to creators for the streamed content.
Instead, the free platform needs to be judged beyond revenue generation along. And the cost structure analysis of the premium members helps us assess that.
The free users’ platform is critical to enhancing Spotify’s sales model, thus increasing the chances of free users becoming paid members.
And it plays a key role to enhance the brand and visibility of Spotify, as a consumer platform.
In short, chances are that if to become a premium member, you were a free member first.
Therefore, on the one hand, the ad-supported business is key to amplifying the brand of the company.
On the other hand, the ad-supported business is critical to funneling free users into premium members.
That is why, it’s important to perform bot a revenue model analysis , combined with a cost structure analysis .
To understand the reasons for running certain business segments, that go beyond revenues alone.
Apple: how much does an iPhone cost?
Another incredible example, of how a cost structure changes according to a business model, it’s Apple.
Apple has been among the few companies that managed to build one of the most incredible business platforms of the last fifteen years.
Indeed, we can argue, that Apple is the major business platform of the last fifteen years (since on Stage, in 2008, Steve Jobs announced the App Store, after having announced it almost a year before the iPhone).
Of course, when it comes to Apple we can easily argue that its business model depends too much on its iPhone sales and that the company managed to keep its manufacturing costs for the iPhone, by outsourcing most of the manufacture in China, while keeping the design in-house.
And those are all true facts.
Yet, Apple is the only company that managed to build such a massive business, at scale, on a device, which turned into a platform.
This completely affected the company’s cost structure.
First, let me explain what’s the difference between a product and a platform.
A product is simply a physical/digital thing that can be exchanged from the company to the customer.
A platform, instead, is something that goes beyond the physical/digital product itself, and it gains value based on the utility that can grow exponentially, of the underlying product.
This utility comes from the fact, that other people (developers, and entrepreneurs) can extend and expand the capability of the product to design features and a whole set of applications that final users find compelling.
When the iPhone transformed from a product (in 2007) to a platform (in 2008), that was the turning point.
You no longer get a commodifiable good, which over time would depreciate.
Instead, thanks to the fact that the iPhone became de facto the dominating mobile platform of the last fifteen years, it enabled Apple to use a reverse razor strategy .
In other words, other players had to gain market shares by decreasing the price of their products.
Apple could keep growing by increasing the price of the iPhone, as its utility (thanks to the App Store) grew.
This deeply affected Apple’s cost structure.
Where the company managed to keep its cost of making the iPhone low, while keep increasing its prices, as utility grew.
In addition to that, Apple successfully built a service business, on top of the iPhone, thanks to its market strength.
The service business further expanded on top of the iPhone dominance and it’s now become among the most important revenue streams for Apple.
For that, it’s critical to look at the evolution of Apple’s business model .
Today the App Store represents a 30% tax on the mobile web, which Apple is able to keep cashing out on, thanks to the success of hardware + software (Operating System) + Marketplace (App Store) what today we know as a Business Platform!
You need to understand two key elements to have insights into how companies “think” in the current moment.
The first is how they make money.
The second is how they spend money.
When you combine those two elements, you can understand the following:
- How a company really makes money (where is the cash cow, and how and if a company lowers its margins to generate more cash flow for growth ).
- Whether that company is operationally scalable.
- Where the company is headed in the next future and whether it will make sense for it to invest in certain areas rather than others!
In this article, we focused on operational scalability and cost structure, and we saw how Google managed to build an extremely efficient cost structure.
Additional Cost structure examples
Here are some more cost structure examples from a few well-known companies.
According to Statista, Walmart has a total of almost 11,000 stores around the world with a sophisticated and optimized supply chain.
The company benefits from a cost-driven structure characterized by economies of scale and scope, but it nevertheless must meet numerous expenses.
One of the main costs Walmart must absorb is labor. This is no surprise since the company at one point was the third largest employer in the world after the United States and Chinese armed forces.
Employee wages are the main component of the labor costs, but the company’s strong anti-union stance means it is frequently embroiled in various legal disputes over worker rights.
The company also spent $107.1 billion on selling, general, and administrative expenses in 2019 (around 20.5% of total revenue).
Cost of sales for the same period was $385.3 billion, which includes the cost of product transportation, warehousing, and import distribution .
As a premium manufacturer of sports cars, Ferrari utilizes a value-driven cost structure.
While it is difficult to compare exact data, manufacturing relatively bespoke vehicles by hand is more expensive than churning out thousands of the same model on a production line.
Nevertheless, estimates suggest Ferrari only makes about $6,000 in profit for each car that sells for an average price of $200,000.
Ferrari’s main costs are incurred from:
- Raw materials and parts.
- Research and development – this was the company’s most significant expense in 2016 because of expenses associated with its Formula 1 racing team.
- Labor – relatively high compared to less prestigious car brands.
- Advertising, and
- Other – which includes depreciation, overheads, markups, logistics, etc.
Wizz-Air is a Hungarian ultra-low-cost airline carrier that unsurprisingly employs a cost-driven structure to provide the most value to travelers.
Like Walmart, Wizz Air can undercut the vast majority of competition by using economies of scale.
In 2020, for example, it was offering two-hour flights for as little as $21 each way .
Wizz Air can offer these extremely low ticket prices because it chooses to collect a smaller profit from more passengers rather than earning a larger profit on fewer passengers.
This means populating each of the company’s Airbus A320s with as many seats as possible and removing business class altogether.
The aircraft themselves are also turned around as quickly as possible to ensure they spend the maximum amount of time in the air.
The company also minimizes costs with the following initiatives:
- A fleet comprised of one type of aircraft. With staff only required to be trained on one model, costs are reduced.
- Continuous leasing. This means Wizz Air has access to only the most reliable and fuel-efficient models.
- Undesirable flight times. Many of Wizz Air’s flights take off early in the morning or very late at night.
- Basic airport services. Scheduled services also operate in satellite or budget terminals that do not contain lounges or other creature comforts.
Alternatives to the Business Model Canvas
Fourweekmba squared triangle business model.
This framework has been thought for any type of business model , be it digital or not. It’s a framework to start mind mapping the key components of your business or how it might look as it grows. Here, as usual, what matters is not the framework itself (let’s prevent to fall trap of the Maslow’s Hammer ), what matters is to have a framework that enables you to hold the key components of your business in your mind, and execute fast to prevent running the business on too many untested assumptions, especially about what customers really want. Any framework that helps us test fast, it’s welcomed in our business strategy .
An effective business model has to focus on two dimensions: the people dimension and the financial dimension. The people dimension will allow you to build a product or service that is 10X better than existing ones and a solid brand . The financial dimension will help you develop proper distribution channels by identifying the people that are willing to pay for your product or service and make it financially sustainable in the long run.
FourWeekMBA VTDF Framework For Tech Business Models
This framework is well suited for all these cases where technology plays a key role in enhancing the value proposition for the users and customers. In short, when the company you’re building, analyzing, or looking at is a tech or platform business model , the template below is perfect for the job.
A tech business model is made of four main components: value model ( value propositions, mission , vision ), technological model (R&D management), distribution model (sales and marketing organizational structure ), and financial model (revenue modeling, cost structure, profitability and cash generation/management). Those elements coming together can serve as the basis to build a solid tech business model .
Download The VTDF Framework Template Here
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