Pricing within a Cost Leadership Strategy

Like the differentiated product strategy, a cost leadership strategy can also be either focused or more broadly based. If a firm is seeking industry-wide cost leadership, penetration pricing often plays an active role in the strategy's implementation. For example, when the source of the firm's anticipated cost advantage depends on selling a large volume, it may set low penetration prices during growth to gain a dominant market share. Later, it maintains those penetration prices as a competitive deterrent, while still earning profits due to its superior cost position. Wal-Mart uses this strategy successfully to achieve substantial cost economies in distribution and high sales per square foot. Even when the source of the cost advantage is not a large volume but a more cost-efficient product design, a firm may set low penetration prices to exploit that advantage. Japanese manufacturers used penetration pricing to exploit their cost advantages and dominate world markets for TV sets after extensively redesigning the manufacturing production process with automated insertion equipment, modular assembly, and standardized designs.

At this point, a definite word of warning is in order. Much of the business literature implies that penetration pricing is the only proper strategy for establishing and exploiting industry-wide cost leadership. That literature is dangerously misleading. If a market is not particularly price sensitive, penetration pricing will not enable a firm to gain enough share to achieve or exploit a cost advantage. In this case, neutral pricing is the most appropriate pricing strategy and can still be consistent with the successful pursuit of cost leadership. The marketing histories of many cost leaders (for example, Honda in electric generators and R. J. Reynolds in cigarettes) confirm that industrywide cost leadership is attainable without penetration pricing. The battle for the dominant share and cost leadership in those markets and many others is fought and won with weapons such as cost-efficient technological leadership, advertising, and extensive distribution. In many cases, the battle is won even against competitors with lower prices.

Penetration pricing is not always appropriate when cost leadership is based on a narrow customer focus. If the focused firm's cost advantage depends directly on selling to only one or a few large buyers, penetration pricing may be necessary to hold their patronage. For example, suppliers that sell exclusively to Wal-Mart or to the auto industry enjoy lower costs of selling and distribution but usually have to charge penetration prices to retain that business. When, however, the firm's cost advantage is derived simply from remaining small and flexible, neutral pricing is compatible with focused cost leadership. For example, specialized component assembly is often done by small contract manufacturers that are cost leaders because their small size enables them to maintain non-union labor, low overhead, and flexibility in accepting and scheduling orders. Since those cost advantages do not depend on maintaining a large volume of orders, and since the buyers that those companies serve are more concerned about quality and reliability than about price, their pricing strategy is usually neutral. When an order requires an especially fast turnaround and the buyer has little time to look for alternatives, those same manufacturers will occasionally even skim price their services.

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