Low-Cost Producer

What Is a Low-Cost Producer?

A low-cost producer is a company that provides goods or services at a low cost. In general, low-cost producers utilize economies of scale to execute their low price-strategy. Consumers who are sensitive to price changes will more likely shop at stores that offer the lowest prices — especially if the good or service is relatively homogeneous.

Low-cost producers have another option: To price the goods or services at the same level as their competitors and maintain a wider margin.

How Low-Cost Producers Work

A low-cost producer is capable of making a substitute good or providing a substitute service for a lower cost than other companies. They can price their goods on par with or just below the market, undercutting their competition. By doing so, companies can increase their market share and raise profits.

These goods and services are usually consumer staples which are in high demand. They tend to have readily available substitutes provided by many competitors in the marketplace. Consumer staples produced by low-cost producers generally include household items, cleaning products, food, beverages — any items that consumers cannot cut out. Specialty goods such as jewelry, high-end cars, and certain types of clothing generally do not have low-cost producers.

Unlike larger their larger competitors, many low-cost producers tend to concentrate on one or a few different consumer segments, which can help them keep their costs down, generate market share, and keep profits high.

Take supermarket chain Aldi, for example. Its footprint is much smaller than the average supermarket, yet it's still able to compete with its big-name rivals on a large scale. It offers a much smaller selection of goods, most of which are produced under its generic brand name, and the company is able to slash prices well below its competition. Walk through its aisles, and you'll notice they're stocked with items people tend to buy on a regular basis.

How to Become a Low-Cost Producer

The requirements to become a low-cost producer are great since there is quite a high barrier to entry in the market. Being this competitive in the market means raising capital or having enough in reserves to achieve economies of scale large enough to provide a distinct price advantage over competitors. This requirement is one reason why many companies are not able to be low-cost producers.

Becoming a low-cost producer has a high barrier to entry because it requires a great amount of capital.

Once this is achieved, companies will need to invest in technology that will keep production costs down, while boosting output. An important caveat is that firms need to ensure they keep up with demand and don't sacrifice their brand name.

Example of Low-Cost Producer

Walmart is likely the best example of a low-cost producer with massive economies of scale. The company operates about 11,443 retail locations under different banners in 24 countries. Walmart has several strategies in place making it impossible for its competition to keep up. It's able to bring down the cost of goods it sells by procuring and buying on its own. And because of its massive footprint, Walmart can exert a lot of control over its suppliers.

The company is also able to run distribution through a fairly inexpensive network and has invested greatly in its technology, keeping up to date with its customer base. Doing so gives the company an edge, allowing it to better cater to the consumers who shop in store and online.