Companies with the lowest cost can compete on price and win
With a big chunk of Indian consumers being highly price sensitive, the low-price strategy helps a company to stand out, attract consumers and establish itself as a significant player in its segment.
Consider the example of Nirma. By the 1980s, Nirma catapulted to the top slot over Surf, then a well-established detergent powder. Nirma achieved this by pricing its detergent at an unbelievably low price compared to Surf. Its quality wasn’t the same as that of Surf, but it did the essential job of cleaning, and customers were happy with it. With indigenous processes, low-cost packaging, low-profile marketing and attractive pricing, Nirma quickly emerged as a dominant market player. This is the power of being able to price competitively.
Being the lowest-cost producer (having significant cost advantages) when coupled with large volumes helps a company grow its sales and profits, even when it sets prices of its products competitively.
- High volumes: For this, the company needs to gear up procurement, manufacturing, selling, etc. in a way that gives them a cost advantage.
- Cost-leadership strategy, i.e. the lowest-cost producer: This can be achieved by
- Working on low costs for everything — raw material, manufacturing, selling and marketing.
- Having the power to negotiate lower costs with its suppliers. This power usually comes from long-term relationships with suppliers, by placing orders well in advance.
- Getting assets really cheap (maybe during the start-up phase).
- Coming up with a cost-effective process.
Two famous textbook examples of this moat are Wal-Mart & Dell Computers. Wal-Mart’s rise was largely a result of its aggressive cost controls which enabled it to set prices lower than competing retail outlets. Dell Computers has been able to offer computers at very low prices mainly due to the Just-in-Time model followed by them — minimising Inventory Costs. It could also negotiate favourable component costs due to its size, and its direct-sales distribution system allows it to sell PCs more efficiently.
An Indian company with this moat is Amul. Amul has been a market leader in the milk and milk product category for the past five decades now. It provides value-for-money products, with no compromise on quality. It has a cost advantage, as it gets milk directly from a large number of farmers. A new player that uses this strategy is D-Mart (Avenue Supermarts Ltd). It achieves this by limiting the number of brands and SKUs (stock keeping units) for each product depending on the customers specific to the location. Their strategy is to reduce all kinds of costs to attract shoppers. While an old strategy, what makes them stand out successfully (so far) is impeccable execution.
Low-price strategy may work well as an entry-level strategy, but by itself, it isn’t a long-lasting one. The company also has to make money/profits. The combination of attractive pricing and great profits is a long-lasting strategy — but a difficult one to implement! And you are likely to find only one such player in a particular industry with this moat.
Do you have investments in companies that have the ability to price competitively? Find a few companies with this moat, and add them to your Stock Watchlist.
If you liked what you read and would like to put it in to practice Register at MoneyWorks4me.com. You will get amazing FREE features that will enable you to invest in Stocks and Mutual Funds the right way.