Investment Shastra

How to Choose Good Stocks: Look for Companies with the Lowest Cost

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
    1. Working on low costs for everything — raw material, manufacturing, selling and marketing.
    2. 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.
    3. Getting assets really cheap (maybe during the start-up phase).
    4. 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.

Read Also: ‘Check if it has an excellent track record and is worth buying

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10 comments

  • it is offcourse a well defined &well thought conclusion for companies to stay strongly
    in the market for their survival,better would be at the same time ,a well researched
    fullproof mechanism could be evolved to advise & suggest the innocent investors as to
    where to invest their money both for short term as well as for a long term to fetch surely atleast
    25-300% return after paying off all short of expenses/taxes as a return.
    thanks & regards,
    kailash thakur

  • stock shastra is really very beficial for those who r running business/industry.this elobrates
    in details as to hw survive in the business realm by taking resort to low costing,low profit margin & better quality.really a vast chunk of population ,say 75-80% of indian population live in rural area,whose income level is lower as compared to town-dwelling population,the discussed companies have followed this keeping in their mind to catch hold of rural consumers.
    apart from this,share market have got very important role in indian economy.this cannot be left to the mercy of speculators alone,this market must be lawfully controlled in the interest of general vast numbers of small investors too.
    so the advise for right choice of shares which r both fundamentally & financially both sound,must take place as yr suggestio/advise menu/list.
    thanks & regards.
    kailash thakur,retd.joint commissioner

  • Hello,
    this version talks about Amul as an Indian company. I think you wanted to refer to Gujarat Co-operative Milk Marketing Federation (GCMMF) as the company here, which owns Amul brand.

  • Yes, you are absolutely right. We preferred using the Amul name as it is known all over, that way. Thanks.

  • Thanks for your appreciation, Sir. You are absolutely right, since the stock market is such a speculative place, it is always better to invest in companies that are both fundamentally and financially sound, and at the same time undervalued.
    Thanks

  • This full-proof mechanism involves finding fundamentally strong companies (as you mentioned in your earlier comment) with a good business model. At the same time, they should be undervalued, i.e available at a discount. Few of the companies we have given in our company shastras are value companies. Please go ahead and read them as they will help you analyse and understand these companies better. If you have any queries/suggestions on this, please do let us know.
    Thanks

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