Thursday, June 3, 2010

View on Cost Leadership and Differentiation

“The dilemma between the pursuit of cost leadership and differentiation has been around for over three decades now. Until recently, it was thought that the two approaches to achieving a sustainable competitive advantage were mutually exclusive. Classic examples of cost leadership include Southwest Airlines, Nucor and Wal-Mart. On the other hand, Apple, BMW and Sony are known to be differentiators. The argument for mutual exclusivity is rather trite – if you are a cost leader, you cannot afford to provide distinguishing features or services. If you are a differentiator, the need to constantly innovate has the inevitable propensity to push up costs.

Cost leadership makes eminent sense in any industry, anytime and anywhere. Other things being the same, if your costs are less than that of competition, even in a highly competitive environment, your margins would be higher. This is particularly true of commodities such as metals or construction materials like cement.

At the same time, differentiation is critical since innovation is the most important factor for getting ahead of competition. Unfortunately, innovation has been boxed into product or service innovation. In today’s complex world, innovation can be in anything – the way you manage your people, the way you adapt to a changing environment, the way you think, and the extent to which you are willing to take risks. With this broad view of innovation, one can easily see the advantages of treading away from the beaten track.

Considering this complementarity – TQM systems as an example leading to both lower costs and a perceived higher quality enabling one to command higher prices – organizations would do well to follow an integrated strategy of simultaneously being cost leaders and differentiators. Southwest started off as a cost leader and yet has introduced several innovative ideas that make it an integrated player today. The same can be said of Toyota in automobiles and Ikea in furniture. Ikea transferring part of the value creation activities – transportation and assembly – to customers has re-defined the concept of innovation.

A word of caution would be in order. The external environment also plays a role in defining an organization’s strategy. In the Indian context, Deccan Airlines tried to replicate the low-cost model of Southwest and failed. One of the primary reasons was the lack of infrastructure. India does not have a sufficient number of small or medium-sized airports to support short-haul transportation by air. In contrast, thanks to the short distances and excellent infrastructure, Ryanair has been very successful in Europe.

Similarly, an obsession with cost leadership and practically no emphasis on innovation places a question mark on the Indian IT Enabled Services Industry. What is happening in Europe leading to significant cuts in IT spending has already forced organizations to revise their revenue projections. Consider this contrasting example. Both Microsoft and the leading Indian IT companies started at about the same time. Yet, today, the profits of Microsoft are more than the revenues of the Indian IT companies. The reason is simple. While Microsoft has focused on products, the Indian companies have focused on services. The irony is that the technocrats writing code at Microsoft are predominantly Indians.

It is time that organizations made a conscious attempt to combine the benefits of cost leadership and differentiation into an integrated strategy. That may be the only sure recipe for success.
-                        -  Dr. B.V. Krishnamurthy

Well said sir, we always have a confusion between Cost Leadership and Differentiation; and use it interchangeably. But, there is tremendous depth of difference between the two, which can be seen very explicably from the examples that have been mentioned. Organizations over the time realize that to survive in this cut-throat competition they have to be both – a cost leader and an innovator (differentiator). Many innovations have also been done in the cost leadership category, consider Tata Nano itself, whose foundation itself was led on the basis of price. Tata group have understood this requirement well and have implemented this philosophy in most of their businesses. Their revolutionary water purifier stands as an excellent example of how an innovation can serve a necessity. In a country where potable water is scarce in most of its parts, a miniscule priced water purifier will exactly fit the bill.

But, the question that evolves here is, Are all companies capable of adopting the combined approach? What’s the primary reason of the not-so good growth of Indian IT companies? Is there a maturity level at which the companies need to take up this strategy?

While venturing a new business, most of the entrepreneurs aren’t open to experiment. They want their actions to be focus on a single approach: either cost leadership or differentiation. And there are various genuine reasons supporting their stand – “am a rookie, can’t take risks”, “I need to first understand the market, I can think about this only after I’ve reached a specific stage”, “implementing both requires lot of talent which is inadequate at the moment.”

Yes, a proper combination of both and considerate planning will lead to success. However, does Indian conditions/mentality avoid us from doing so? Our initial success in the IT Services market, let to torrent trend where many companies followed the suit. We just kept ignorant on the Innovation aspect. Reason being, as long as we are making profits why care. This mentality takes a complete turn-around in MNC’s. Here you are allowed to experiment, permitted to make mistakes (and learn from it J). This is what which is required to drive new thoughts, ideas and gives you the freedom to explore.

Management as said is very vast and have colossal interconnections between the concepts. Even here, between the Innovation/cost leadership debate the concept of culture and lateral thinking evolves. We need to understand that these things are good to listen; but is more important to implement in our lives and learn. Discover the environment and execute the best practices. 


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