Low-Cost Production – Definition

Cite this article as:"Low-Cost Production – Definition," in The Business Professor, updated December 10, 2019, last accessed August 5, 2020, https://thebusinessprofessor.com/lesson/low-cost-production-definition/.

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Low-Cost Producer Definition

A low-cost producer is a company in a specific industry that provides goods or services at the lowest price. The low-cost producers make use of economies of scale to implement their low price strategies. They exploit by delivering their products or services at a lower cost than that found in the overall market while increasing their market size in the industry.  The move ensures competitive pricing leading to higher earnings.

On the other hand, the low-cost producers can as well price their products similar to that of their competitors, and be able to maintain a wider profit margin on assets. The move puts them in a position where they are able to invest a significant amount in things such as capital improvement, research, and development, among others.

A Little More on What is a Low-Cost Producer

Consumers are most of the time-sensitive when it comes to price changes. For this reason, they are more likely to do their shopping at the stores with the lowest price offer, especially if the product is relatively similar.

Note that the costs of products generally consist of variable and fixed costs such as production, logistics, manufacturing, and corporate overhead. In the manufacturing industries, the total cost of products sold comprises of material costs of about 55-60%. What this means is that the total cost of goods sold will include both direct and indirect costs to do with producing and delivering a service or a product.

Generally, only a few firms within the industry benefit from this status, and it makes them have a competitive advantage over the other firms in the industry. Low-cost producer firms are in a position to price their products as well as services way below that of their competitors and still yield higher profits on assets.

How It Works

A low-cost producer provides a substitute product or service at a cost lower than that of its competitors in the industry. They are capable of pricing their products to be at par with that of the general market or slightly below, a move that undercuts their rivals in the industry. By doing so, they increase their share in the market and at the same time, raise their earnings.

The goods and services provided at a lower cost are mostly consumer staples.  They have a high rate of consumption, which means that they are in high demand. Good examples of such products include food, household items, beverages, cleaning products, and any other item that cannot be cut out by consumers.

Note that low-cost producers dedicate more of their efforts on a few segments of consumers to help them maintain their low costs, generate market share, as well as maintaining high-profit margin.

A Low-Cost Producer Example

Example 1

Chain Aldi is one good example of a low-cost producer. It has a footprint way smaller if compared to the average supermarket. However, it is in a position to compete with well renown competitors that operate on a large scale.

Chain Aldi does offer a small selection of products, manufactured under its brand name. It is also able to cut down the price of its products way below that of its rivals. When you visit its aisles, you will realize that the stocked items are products that consumers purchase on a daily basis.

Example Two

Wal-Mart is also another good example of a low-cost producer that has massive economies of scale. It has over 11,000 retail outlets in 27 counties, spread out in different locations operating under different banners. Wal-Mart has unique strategies in place that make it impossible for its rivals in the general market to keep up. By procuring and purchasing the products it sells on its own, it is able to cut down the cost of its products.

Also, since the company has a massive footprint, it is in a position to exercise control over its suppliers. In addition, the company runs its distribution using a network that is less expensive. Wal-Mart has also been able to invest heavily in technology. The technology enables it to be up to date with the base of its customers. The move gives the company a competitive edge, allowing it to meet the needs of its customers at their shops and online.

Generally, low-cost producers are people who have already invested heavily in the capital. By doing this, they have been able to increase production or reduce the cost of production to achieve volume demands.

Whichever way, what is important is that a good amount of capital expenditure is involved. The leadership strategy can lead to a competitive advantage. The reason is that customers will always prefer to buy from a low-cost producer a move that puts them at the top of its competitors as far as market share is concerned.

Becoming a Low-Cost Producer

To become a low-cost producer, you have to meet certain requirements. Generally, there are high market entry barriers. So, to be competitive in the market, it means that you must have enough reserves. It is the capital that will enable you to achieve economies of scale so that you can have a price advantage over your competitors.

In other words, to become a low-cost producer, you need to have a good amount of capital. The reason why most companies do not become low-cost producers is that the capital requirement is always high capital.

However, those who are able to achieve this, they also need to invest in technology to be able to keep the cost of production down, as they boost their output. What is important is that companies have to ensure that they do not sacrifice their brand name and that they are always keeping up with demand.

References for “Low-Cost Producer

https://www.investopedia.com/terms/l/low-cost-producer.asp

www.businessdictionary.com/definition/low-cost-producer.html

https://link.springer.com/10.1007%2F1-4020-0612-8_528

https://www.mbaskool.com › Concepts › Finance and Economics

https://news.morningstar.com/classroom2/course.asp?docId=144752&page=3…

https://dictionary.cambridge.org/example/english/low-cost-producer

https://www.advisorperspectives.com/…/understanding-the-competitive-advantage-of-l…

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