Chapter 4: Business-Level Strategy 121be able to force its suppliers to hold down their prices, which would reduce the suppliers’
margins in the process. Walmart lost its way in this regard. By reducing the number and
type of products sold in Walmart stores, it reduced its bargaining power with several
suppliers. In so doing, it was unable to gain the best (lowest) prices on goods relative to
its competitors. Thus, Amazon and the Dollar Stores began winning market share from
Walmart by offering lower prices.
The fact remains that Walmart is the largest retailer in North America, thus giving the
firm a great deal of power with its suppliers. Walmart is the largest supermarket operator
in the United States, and its Sam’s Club division is the second largest warehouse club in
the United States. Collectively, its sales volume of approximately $485.7 billion in fiscal
2014 and the market penetration (more than 200 million people visit one of Walmart’s
11,000 stores each week) still allow Walmart to obtain low prices from its suppliers.^61
Some firms create dependencies on suppliers by outsourcing whole functions. They
do so to reduce their overall costs.^62 They may outsource these activities to reduce their
costs because of earnings pressures from stakeholders (e.g., institutional investors who
own a major stock holding in the company) in the industry.^63 However, “outsourcing can
create new costs, as suppliers and partners demand a larger share of the value created.”^64
Often when there is such earnings pressure, the firm may see foreign suppliers whose
costs are also lower, providing them the capability to offer the goods at lower prices.^65
Yet, when firms outsource, particularly to a foreign supplier, they also need to invest time
and effort into building a good relationship, hopefully developing trust between the firms.
Such efforts facilitate the integration of the supplier into the firm’s value chain.^66
Potential Entrants
Through continuous efforts to reduce costs to levels that are lower than competitors, a
cost leader becomes highly efficient. Because increasing levels of efficiency (e.g., econo-
mies of scale) enhance profit margins, they serve as a significant entry barrier to potential
competitors.^67 New entrants must be willing to accept less than average returns until they
gain the experience required to approach the cost leader’s efficiency. To earn even average
returns, new entrants must have the competencies required to match the cost levels of
competitors other than the cost leader. The low profit margins (relative to margins earned
by firms implementing the differentiation strategy) make it necessary for the cost leader
to sell large volumes of its product to earn above-average returns. However, firms striving
to be the cost leader must avoid pricing their products so low that they cannot operate
profitably, even though volume increases.Product Substitutes
Compared with its industry rivals, the cost leader also holds an attractive position relative
to product substitutes. A product substitute becomes a concern for the cost leader when its
features and characteristics, in terms of cost and differentiation, are potentially attractive
to the firm’s customers. When faced with possible substitutes, the cost leader has more
flexibility than its competitors. To retain customers, it often can reduce the price of its
good or service. With still lower prices and competitive levels of differentiation, the cost
leader increases the probability that customers prefer its product rather than a substitute.Competitive Risks of the Cost Leadership Strategy
The cost leadership strategy is not risk free. One risk is that the processes used by the
cost leader to produce and distribute its good or service could become obsolete because
of competitors’ innovations.^68 These innovations may allow rivals to produce goods or
services at costs lower than those of the original cost leader, or to provide additional
differentiated features without increasing the product’s price to customers.