Stock Shastra #9: Only a company with the lowest cost can compete on price and win

In a highly competitive market, companies try to be unique in many ways. While some may emerge as strong brands, some gain exclusive rights by way of patents/trade secrets. Again, there are a few companies that manage to gain exclusive control over an area/product/service and a few who have the advantage of high switching costs. There are also a few companies who stand out by pricing their products/services so competitively that it differentiates it

So what exactly is this advantage?

Consider the example of Nirma. By the 1980s Nirma catapulted to the top-slot over Surf, then a well-established detergent powder by HUL.  So how did Nirma achieve this? It achieved this by pricing its detergent at an unbelievable low-price, compared to Surf. It was the lowest-price detergent powder, then. But was its quality the same as Surf’s? – No, may not be, but the detergent fulfilled the essential job of cleaning, with an acceptable quality that customers were happy with. With indigenous processes, low-cost packaging, low-profiled marketing and attractive pricing, Nirma quickly emerged as dominant market player. This is the power of being able to price competitively.

But this may not hold true always. Ever wondered what Uninor is aiming to do by coming up with such low tariffs? Its tag line – 24 x 7 Badalta Discount Plan clearly indicates that it wants to emerge as a telecom provider that is differentiating on the price front., to attract a large number of users. Though, this may work well as an entry-level strategy, it may/may not be successful for the long-term. Unless the company has some significant cost advantages, this low-pricing strategy is not likely to last in the long-term.

So, to summarize, companies cannot survive only with a price-low strategy. It may work well as an entry-level strategy to grab your first chunk of consumers, but the low-price strategy all by itself, isn’t a long lasting one. The company has to also make money/ profits out of it. Pricing attractively coupled with earning great profits out of it is a long-lasting strategy. But a difficult one!!!

So how do companies make this a winning strategy for the long-term?

The answer is Stock Shastra #9: Only a company with the lowest cost can compete on price and win. Being the lowest-cost producer (having significant cost advantages), when coupled with large volumes helps a company grow its sales & profits, even when it prices its products competitively. With a big chunk of the Indian consumers being highly price sensitive; this advantage helps establish the company as an important/significant player in that segment

1) Working on high-volumes: What happens when a company offers very low & attractive prices for its product/service, so low that nobody can match? Very obviously, it attracts a large number of customers which leads to increased sales volumes. For this the company needs to gear up everything for the large volumes i.e. procurement, manufacturing, selling etc in such a manner that it gives them a cost advantage.

2) Working on a cost-leadership strategy i.e. the lowest-cost producer: This can be achieved by

a) Working on low-costs for everything; procuring raw material, low manufacturing expenses, low selling & marketing expenses etc

b) Having the power to negotiate lower costs with its suppliers. This power usually comes from long-term relations with suppliers, placing orders well in advance (by forecasting demand).

c) If the company’s been lucky enough to get their assets really cheap (maybe while starting up)

d) Inventing a cost-effective process

Two famous text-book examples that have sustained this competitive advantage for years is Wal-Mart and Dell Computers. Wal-Mart’s rise to massive market capitalization from its modest beginnings was largely a result of its aggressive cost controls which enabled it  price lower than competing retail outlets. Dell Computers has been able to offer computers at very low prices mainly due to the JIT model followed by them. This involves not even being in possession of the raw materials needed to fulfill an order until that order is placed and still capable of filling orders in a short period of time. This helps minimize inventory costs. The company can also negotiate favorable component costs due to its size whereas its direct-sales distribution system allows it to sell PCs more efficiently than rivals who use resellers.

An Indian company that exemplifies this advantage is Amul. Amul has been a market leader for the last 4 decades now. It adopted a low-cost strategy for selling its products like ice-cream, butter etc & has since then emerged a winner in this segment. It has a cost advantage as it gets milk directly from a large number of farmers. Amul has always been known for providing value-for-money products, with no compromise on quality.

In a particular industry, you are likely to find only such player existing; who has managed to convert its low cost of operations into attractive pricing & hence earn profits out of it. For example: It is unlikely to have  another Wal-Mart in the same segment

Which companies in India have this advantage?

Consider Big Bazaar a part of Pantaloon Retail (India) Ltd. provides consumers the experience of shopping at a mall/supermarket giving them acceptable quality and service at the lowest prices. Its tag very rightly suggests the same – Is se SASTA aur ACCHA kahin nahi !

Tata Motors (for its cars) is also known to provide good quality cars at very low costs. This started with Tata Indica which provided the public with an affordable alternative to the Maruti 800. Infact just hours before the car was launched, Maruti called for a press conference announcing price cuts across its lineup and introduction of more cheaper variants, fearing its bread and butter model, Maruti 800 was in trouble! And now with the introduction of Tata Nano, they have carried the tradition further.

Meet us next week with Stock Shastra #10, where we will talk about the importance of having a respectable management.


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10 Responses to “Stock Shastra #9: Only a company with the lowest cost can compete on price and win”

  1. 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

  2. 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

  3. 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.

  4. Team_MoneyWorks4me 02. Jul, 2010 at 9:42 am

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

  5. Team_MoneyWorks4me 02. Jul, 2010 at 9:49 am

    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

  6. Team_MoneyWorks4me 02. Jul, 2010 at 9:57 am

    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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