Importance of Cost Reduction in marketing

Cost Reduction - Time to cut cost
Image: Cost Reduction – Time to cut cost

Essence of Cost Reduction

The rationale behind any firm’s decision to enter international marketing is usually to increase profitability, and this is based upon a recognition of the fact that the size of the firm’s actual market share is a primary determinant of profitability. This is supported by PIMS (Profit Impact of Market Strategy) research findings. This shows that firms with a larger market share normally have lower unit costs, and they are perceived by customers to market higher-quality products, leading to relatively higher market prices. Both of these factors result in higher profits for the firm.

Most companies in international markets have the potential to benefit from driving down costs through achieving economies of scale, exploiting the experience effect and making strategic decisions on the location or relocation of manufacturing plants within the context of worldwide operations.

Importance of Cost Reduction in marketing

The following are the importance of reduction of costs in marketing.

1. Economies of scale:

Economies of scale are obtained as a result of manufacturing additional products with the same or only slightly higher fixed costs, so that, in practice, for every additional product produced, the unit cost reduces. This is a slight oversimplification of the situation as, for example, installation of new plant might in the short term increase unit costs during the period when the plant is running at below its economic capacity. Whilst in domestic markets, the benefits from economies of scale follow directly, in international markets, these economies must more than off-set savings achieved by having local plants, which result in reduced transport costs and the avoidance of import tariffs.

2. The experience effect

Although it is less well known than economies of scale, the experience effect has potentially greater benefit for cost reduction. Its origins lie in the observation that the time needed to perform a specific task reduces as the operatives become more familiar with it. A series of studies by the Boston Consulting Group found evidence that the effect was much more widespread than this, however, and covered all aspects of business, including high and low technology, products and services, and consumer and industrial products. There is a direct relationship between the cumulative volume of production and the costs incurred in producing the same product benefits. The experience effect provides an opportunity for cost reductions, although if managers do not make a concerted effort, costs will rise.

The combined effects of economies of scale and the experience effect were seen in the electronics market, where aggressive firms slashed prices to gain market share, knowing that cost reductions would follow. For example, Sony set the price of its CD players in the US market at a third of the actual manufacturing cost, on the basis that the volume generated by increased demand would force component and assembly costs down, through a combination of these two effects. A key issue in international marketing is how best these effects can be exploited, particularly as the skills and experience are spread throughout the world. The efficient transfer of these skills and knowledge between different SBUs then becomes paramount.

3. Location of production facility

Driven by the continual need to reduce costs, companies have increasingly considered selective location or relocation of production facilities. As firms increasingly market their products globally, so their choice of manufacturing locations is determined by many other considerations than simply being close to particular markets. They might choose to locate a factory in a less developed country in order to take advantage of lower labor costs, but also they may well develop specific skills and areas of specialization in those locations. For example, a large proportion of televisions, radio, calculators, and jeans are manufactured in LDCs.

India, with 1.2 billion inhabitants, 100 million of whom are considered to represent a financially aware middle class, presents the attractive opportunity of an emerging market as well as a huge skilled but cheap workforce for multinationals seeking low-cost manufacturing bases. Thomson-CSF (France), Coca-Cola, Motorola, IBM and Hewlett Packard have all decided to set up there.

Problems associated with manufacturing in Western countries have helped to accelerate this transfer of manufacturing. Lagging productivity, reluctance to source materials and parts globally, strong unions and high standards of living were the causes of the decline in the US manufacturing base. Many regions and countries are responding to this opportunity for inward investment by marketing a variety of incentives and attractions to companies wishing to relocate.

It is not only in manufacturing that relocation of activities can benefit from lower labor costs. For instance, the introduction of fiber optic cables allows considerably more information to be transferred quickly and accurately by telecommunications, and so can lead to high labor-content jobs such as data input, order processing and invoicing being carried out in other countries. This has considerable implications for services such as insurance and banking.