120 Part 2: Strategic Actions: Strategy Formulation
the value-chain activities and support functions that allow a firm to create value through
the cost leadership strategy. Companies unable to effectively integrate the activities and
functions shown in this figure typically lack the core competencies needed to successfully
use the cost leadership strategy.
Effective use of the cost leadership strategy allows a firm to earn above-average returns
in spite of the presence of strong competitive forces (see Chapter 2). The next sections
(one for each of the five forces) explain how firms implement a cost leadership strategy.Rivalry with Existing Competitors
Having the low-cost position is valuable when dealing with rivals. Because of the cost
leader’s advantageous position, rivals hesitate to compete on the basis of price, especially
before evaluating the potential outcomes of such competition.^56 The changes Walmart
made to attract upscale customers created vulnerability in its low-cost position to rivals.
Amazon, Family Dollar, and others took advantage of the opportunity. Amazon appears
to have become a low-cost leader, and the Family Dollar stores provide low costs and easy
access for customers. Both of these rivals have siphoned off some of Walmart’s customers.
The degree of rivalry present is based on a number of different factors such as size
and resources of rivals, their dependence on the particular market, and location and
prior competitive interactions, among others.^57 Firms may also take actions to reduce the
amount of rivalry that they face. For example, firms sometimes form joint ventures to
reduce rivalry and increase the amount of profitability enjoyed by firms in the industry.^58
In China, firms build strong relationships, often referred to as guanxi, with key stakehold-
ers such as important government officials and units, suppliers, and customers, thereby
restraining rivalry.^59Bargaining Power of Buyers (Customers)
Powerful customers can force a cost leader to reduce its prices, but not below the level at
which the cost leader’s next-most-efficient industry competitor can earn average returns.
Although powerful customers might be able to force the cost leader to reduce prices even
below this level, they probably would choose not to do so. Prices that are low enough to
prevent the next-most-efficient competitor from earning average returns would force that
firm to exit the market, leaving the cost leader with less competition and in an even stron-
ger position. Customers would thus lose their power and pay higher prices if they were
forced to purchase from a single firm operating in an industry without rivals. In some
cases, rather than forcing firms to reduce their prices, powerful customers may pres-
sure firms to provide innovative products and services as explained in the King Digital
Entertainment video game example earlier in the chapter.
Buyers can also develop a counterbalancing power to the customers’ power by thor-
oughly analyzing and understanding each of their customers. To obtain information and
understand the customers’ needs, buyers can participate in customers’ networks. In so
doing, they share information, build trust, and participate in joint problem solving with
their customers.^60 In turn, they use the information obtained to provide a product that
provides superior value to customers by most effectively satisfying their needs.Bargaining Power of Suppliers
The cost leader generally operates with margins greater than those of competitors and
often tries to increase its margins by driving costs lower. Among other benefits, higher
gross margins relative to those of competitors make it possible for the cost leader to
absorb its suppliers’ price increases. When an industry faces substantial increases in the
cost of its supplies, only the cost leader may be able to pay the higher prices and continue
to earn either average or above-average returns. Alternatively, a powerful cost leader may