Why Being the Low Cost Provider is a Recipe for Failure
Posted by Brad Smith
In business school, you talk a lot about competitive advantages.
These are like castle moats that protect your business from the competition.
They are sustainable advantages that help you defend your position.
One of the most well known competitive advantages people talk about is low cost.
If you can be cheaper than other companies, then you can win.
This may be true in the short term. But it won’t get you very far.
Low cost is no longer a competitive advantage. Here’s why you can’t be the low cost provider, and how to fix it.
Image courtesy of J from the UK
The Decline of Competing on Low Cost
Technology has leveled the playing field.
It’s dramatically lowered the barriers of entry. It’s easier and cheaper than ever before to start a company from scratch, and grow it into a thriving business in just a few years.
Competition from direct competitors, and indirect alternatives is at an all time high.
Globalization has reduced the importance of location.
Unless you’re hyper-local (i.e. coffee shops, dry-cleaners, etc.), then you probably don’t even need a physical office.
There are just too many problems with trying to compete long-term by providing the lowest cost solution.
1. Increasing Disruption of Business Models
What worked last year, probably won’t work tomorrow.
This is a classic lesson from The Innovator’s Dillemma.
A new product/service comes along that offers a solution that’s good enough, but massively less expensive because they don’t have the same cost structure.
So customers begin flocking to that new service. Competition can’t compete on that level because they have entrenched business expenses that they’re stuck with.
Think about Netflix vs. Blockbuster.
2. No Profit Margins to Invest in Tomorrow
Low cost providers compete because they’re able to keep their operating costs very, very low.
So unless you have a radically new way of doing things (point 1 above), then you’re stuck in this downward spiral.
Wal-Mart has massive scale. So they can do this while keeping costs extraordinary low. Most likely, you can’t match their scale. So you can’t compete on the same levels.
The problem is that when you keep your costs low to squeeze out that extra profit, other areas suffer.
Such as customer service (pay your employees less), your product (the quality standards of your offering), and most importantly, future profits (R&D).
No matter what business you’re in, you have to invest in finding ways to make more money in the future. For simplicity, let’s call this Research and Development (R&D).
It’s gives you the ability to find how you’ll make more money in the future, and it’s how you carve out a real competitive advantage to really defend yourself.
But if there’s no excess profit after paying your operating costs, then you have no money to invest.
3. The Customers You Attract Aren’t Loyal
Finally, people chasing low cost aren’t loyal to you… they’re loyal to the bottom line.
This is all about behavior and physcology. But it’s undoubtedly true.
Do people shop at Wal-Mart because they love how clean it is, and how friendly and knowledgeable the staff is?
No way! They shop there because it’s cheaper than their available alternatives.
That’s a really, really, really hard way to build a brand. For two reasons.
- Price concious people don’t care about you or your brand… they care about how much it costs.
- The people who are loyal and who have money to spend, don’t want to do business with a company that’s poorly run and has a bad product/service.
The key to building a sustainable company is through maximizing the lifetime value of your customers… not always going out and finding new ones.
The limitations of a low cost strategy force you to only provide one type of service.
And there’s one kind of customer who wants that service… the wrong kind to build a business.