Playing To Win
Racing to the Bottom
Faux ‘Low Cost’ Strategies
A reader asked me about pursuit of low cost strategies generating unproductive ‘races to the bottom.’ Because the question reminded me of the prevalent misunderstandings around the concept of cost leadership strategies, I decided to answer the reader’s question and go a bit deeper and broader in this Playing to Win/Practitioner Insights (PTW/PI) piece. It is called: Racing to the Bottom: Faux ‘Low Cost’ Strategies. All previous PTW/PI can be found here.
Race to the Bottom
The term ‘race to the bottom’ is generally seen to have been coined by legendary Supreme Court Justice Louis Brandeis in a 1933 judgment. His use of it was in the context of jurisdictions attempting to entice companies to move or set up shop in them with evermore lax regulations — racing to the bottom of regulatory oversight.
Today in business, the term ‘race to the bottom’ refers to companies cutting costs, prices and customer value to compete with one another — resulting in a sick industry that serves no one well, whether customers, companies, shareholders, employees, or society in general.
The reader was certainly right that there are lots of races to the bottom out there, whether in air travel, apparel, Android smartphones, or small sedans. In each industry, the emphasis is on taking out costs to improve price competitiveness, which just begets copycat competitive responses and, depending on the state of evolution, an ever-worsening customer experience — with US air travel being the perfect exemplar.
But the cycle is the result of their pursuit of faux low cost strategies, not the real thing.
What is a Low Cost Strategy?
To understand why it isn’t, we need to dive into the true nature of low cost strategies. The source, of course, is Michael Porter who introduced the notion of ‘generic strategies’ in his 1980 masterpiece Competitive Strategy. He described three generic strategies: low cost, differentiation, and focus. For what it’s worth, I have always believed that a better way conception is that it is a two-by-two matrix with differentiation vs. low cost strategies on one axis and narrow vs. broad on the other.
In a cost leadership or low cost strategy (I generally use the latter term but you should use whichever you prefer), the company opens a meaningful and sustainable cost gap with all relevant competitors. That is, for the customers you are targeting, you produce their desired offering at a meaningfully lower cost than any competitor. To be a real cost leadership strategy, it needs to conform with the fundamental rule of strategy: if opposite of your choice is stupid on its face, it isn’t a strategy choice. The great low cost strategies that have stood the test of time are all underpinned by choices for which the opposite is definitively not stupid on its face.
Vanguard’s seminal choice was to not have investment managers who choose the stocks for your mutual funds — it would offer only index funds based on the composition of an existing stock index, such as the S&P 500. How do we know that it was a strategic choice? It is because every other competitor employed investment managers to pick the composition of their mutual funds. And it was a strategic choice that enabled Vanguard to have a dramatically lower cost position because it didn’t incur that cost item at all. It didn’t figure out how to drive down the cost of investment management. It eliminated that cost entirely. Vanguard had other cost advantages as well, but that choice produced a big one.
From inception, Costco (and merger partner, Price Club) chose only going to stock items with very high turns — i.e., that sold frequently. Because these items sold very often, Costco could mark them up at a low rate and still earn enough gross margin dollars per foot of shelf space to achieve target profitability (i.e., an item marked up 10% that turns 12 times a year earns the same gross margin dollars as an item marked up 40% that turns only 3 times a year.). How do we know that it was a strategic choice? Costco’s competitors put a wide array of products on their shelves, some with low turns, some with average turns, others (like the ones at Costco) with high turns. The average profitability across the competitors’ selections was acceptable, but their strategies incurred a very high cost of the shelf space for the low turning items. By not incurring those high costs, Costco is able to price its items at lower prices, attracting consumers which grew its scale monumentally, which reduced its costs still more, and so on…
IKEA made a choice to sell unassembled furniture removing cost of assembly and a big chunk of logistics costs from its structure — compared to its competitors who made the opposite choice.
Southwest chose to fly one aircraft type in a point-to-point (not hub and spoke) route structure with travel agents excluded from booking, and more — all choices completely different than its competitors and drove a dramatically lower cost structure. Meanwhile, its mainline competitors engaged in a race to the bottom on their costs — without making the unique sort of choices Southwest made.
All great cost leaders make choices for which the opposite is definitively not stupid on its face — it is what everyone else does. And it generates much lower costs than all competitors. Does the resulting offer appeal to all customers? Hell no! But for many, it is just perfect!
Faux Low Cost Strategies
Faux low cost strategies are ones in which the company makes choices about costs where the opposite isstupid on its face. These companies drive out waste. They outsource activities that outside providers can do more cheaply. They streamline processes. They deploy information technologies. They merge with competitors to reduce corporate overhead costs. They source from low-cost jurisdictions, etc.
But none of that is going to produce a low cost strategy because everyone else is doing it too. They will get you a good cost position. And that is super-important for a successful differentiation strategy. But those are all choices that any competent manager would make in a similar situation. That is not strategy. Those are operating imperatives — smart things that any smart company would do. You can’t open a meaningful and sustainable cost gap with competitors by doing what they do, even if you do it a little bit better.
Timing
Sometimes timing matters a lot when it comes to the difference between a cost leadership strategy and a set of actions that simply match and/or replicate competitors.
There are some things that at the time seem like crazy things to do — that no competitor would do at that time. But that timing advantage can enable you to get a scale advantage that you never give up — like Vanguard or Amazon. Selling index funds is no longer a unique strategy. But because Vanguard started doing it so much earlier than competition, no one comes close to selling them at the scale of Vanguard. Selling goods online is no longer unique in any way at all. But selling half a trillion dollars of goods online because of a massive timing advantage is. When you start matters. And an advantaged time to start is when it is a true strategic choice.
A variant of this kind of timing advantage is to establish a presence in a low-cost jurisdiction before any competitor figures it out. That can be a distinctive choice. However, it is one that tends to be very transitory. Once Japan was a low-cost jurisdiction and it stopped being one thanks to its own success as a nation. Then it was South Korea. Now it is China — it will be somewhere else next.
The key is that the timing of a choice can make it a strategy choice that results in longer term advantage versus an operating imperative that does not.
Racing to the Bottom
The best way to spur a race for the bottom is for the competitors in an industry to drive down costs in the same way — and for each to focus on that as its hoped for way to win. That is, they each incur the same set of costs in similar ways. That approach doesn’t produce competitive advantage. However, very often each will continue to pursue that approach, believing that if it just cut costs a little bit more, it will eventually win. They will sacrifice innovation — too costly. They will sacrifice any attempt to be unique — too costly. They will commoditize their industry. And they will shape a miserable industry for all involved. That is like the US mainline US carriers today. I couldn’t believe that in 2024 when I asked a flight attendant on an American Airlines flight why the plane was so old and the amenities so poor, she quickly responded that it was a US Air plane and route — even though that merger occurred 11 years ago to ‘dramatically improve the cost competitiveness of American Airlines.’ Talk about a race to the bottom!
That is why the reader is partly right. Cost-driven strategies do cause races to the bottom — but they are faux low cost strategies, not real ones.
Practitioner Insights
Strategy is and will always be an integrated set of choices that compels desired customer action. And to produce distinctively meritorious results, those choices must be distinctive. And to be distinctive, the opposite of the choices can’t be stupid on their face.
These rules apply equally to low cost and differentiation strategies. A company does not have a low cost strategy just because it is cost effective. That is not to imply that being cost effective is unimportant. It is super important. For example, the only way to be a strong differentiator is to have no excess costs. Every dollar of wasted costs takes away from the strength of the differentiator.
But far too many companies think they are a cost leader when they are only cost proximate. I get this all the time when I give presentations on strategy to management teams. Unfortunately, many (if not most) are delusional. And it shows up in profit performance. These companies don’t produce the kind of earnings that they expect. Consequently, they are always in a mode of cutting out spending on things they dearly wish they didn’t have to cut. They are continuously in a state of disappointment.
If you want to have a real low cost strategy, you can’t simply look cost item by cost item and attempt to reduce each. Instead, you need to figure out how to remove a cost item entirely — like investment management for Vanguard or assembly for IKEA. Or you need to leverage a unique way to drive costs down on an important cost category — like selecting merchandise on the basis of high turns at Costco or designing clothes to wear out as quickly as they go out of fashion at Zara (Inditex).
To make choices such as these, you need to be bold enough to be distinct from competitors. It is always the rule — similar choices don’t produce extraordinary results. This is where the Where-to-Play choice comes to the fore. You can’t make distinctive choices compared to competitors that appeal to all customers. If you could, the opposite of your choices would be stupid on their face — because there is an obvious set of choices that wins with all customers. A set of choices can only not be stupid on its face if it alienates some customers, which competitors will serve.
As I always say, my dream for any competitive landscape is separation of competitors, not overlap. You should aim to serve some customers exceedingly well while competitors serve others equally well — whether you are a differentiator or cost leader. It is that sort of real strategy choice that averts races to the bottom. That kind of choice is better for everyone — the company, its competitors, customers, employees, and society in general.
