How to make low cost your competitive advantage

1 The bottom line

Find the one cost that dominates your system and build the whole company around beating rivals on it. Rivals who accept that cost as a fact of life cannot match a company designed around attacking it.

2 Key takeaways

• Find the cost line that dominates your system and put most of your thinking there. A small saving on a minor line cannot beat a rival who attacks the big one.
  • Shipping a barrel of oil cost more than refining it, so John D. Rockefeller, Standard Oil12:27 spent his thinking time on transport.
  • Rocket materials were about 2% of the typical price, so Elon Musk, SpaceX6:11 went after the other 98%.
• Pick the price first, then make the company fit it. A target price forces you to remove waste instead of passing it on to customers.
  • Henry Ford, Ford Motor Company56:51 asked how to build a Model T at $300 when it cost about $490.
  • Ingvar Kamprad, IKEA1:13:00 wanted every range to include items priced at least 50% below competing products.
• Measure your costs more closely than your rivals do. You cannot attack a cost you cannot see.
  • Carnegie's monthly reports tracked labor, waste, scrap, defects and idle furnace time, while rivals had little idea what happened inside their plants Andrew Carnegie, Carnegie Steel40:06.
  • A vendor quoted $120,000 and 18 months for the Falcon 1 actuator, and SpaceX built it for $3,900 Elon Musk, SpaceX7:21.
• Own or redesign the stage where the cost sits. Suppliers who bake profit into every tier will not give you a 10x cost cut.
  • SpaceX ended up building about 80% of its hardware in-house Elon Musk, SpaceX9:38.
  • Google pays roughly a 50% margin on TPUs while others pay Nvidia around 80%, a 2x markup against a 5x markup Larry Page, Sundar Pichai and Google3:37:40.
• Turn the savings into volume and lower prices that rivals cannot follow. More volume drops unit cost, which pays for the next price cut.
  • Carnegie's losses in downturns were the smallest of his rivals because his factory stayed full Andrew Carnegie, Carnegie Steel40:56.
  • At Texas Instruments, Morris Chang set low starting prices and cut them every quarter, even when the market did not demand it Morris Chang, TSMC33:01.

Control your expenses better than your competition. This is where you can always find your competitive advantage.

Sam Walton, Walmart

2.1 Find the biggest cost in your system

A cost advantage starts with knowing where the money goes, then going after the largest piece.

• Look for the big expense that everyone else treats as a fact of life. John D. Rockefeller, Standard Oil20:00
  • Refining needed almost no capital and had no barriers to entry, so Rockefeller looked for the largest expense to find an edge Rockefeller12:27.
  • He built beside both a railroad and a river, because water shipping was 50% cheaper than rail Rockefeller12:27.
  • Other refiners grumbled about transport costs and small shipments but accepted them. Rockefeller raised volume, borrowed more and built another refinery to gain bargaining power Rockefeller20:00.
• Break the price down to its raw materials to see how much of it is process. Elon Musk, SpaceX6:11
  • Musk asked what a rocket is made of and what those materials cost on the commodity market.
  • The cost sat in supplier markups, custom designs that could not reach scale and hardware thrown away after each flight. None of these are laws of physics.
  • A car's raw materials are maybe 20 to 30% of sticker price, against about 2% for a rocket SpaceX6:11.
  • In AI, chips are over half of data center cost, so supplier margin matters a lot Google3:37:40.
• Hunt for middlemen who stack their margin on your product. John D. Rockefeller, Standard Oil50:50
  • Rockefeller found retailers added as much as 5 cents a gallon. Standard bought land, built tanks, made its own barrels and tank wagons, and delivered to consumers' doors Rockefeller50:50.
  • Butler Brothers took roughly a 25% markup on everything, so Sam Walton found manufacturers and loaded goods straight into a trailer on his truck Sam Walton, Walmart41:20.
  • Ortega believed integrating design, manufacturing, distribution and stores would cut stacked margins by 70 to 80% Amancio Ortega, Inditex23:00.
  • Boxed Windows had a 29% gross margin against 75% through OEMs. By 2007 OEM and Enterprise channels were 85% of revenue Microsoft1:56:00.

2.2 Set the price first and work backward

Fix a price that wins customers, then force every cost to fit it.

• Name the price and make the company reach it. Henry Ford, Ford Motor Company56:51
  • Ford cut the price to where he believed more sales would result, then worked out how to build the car at that price.
  • He never considered any cost as fixed.
  • After he brought prices down to $750 and $600 from $2,000 and $1,000, sales rose from 1,500 to almost 8,500 Ford46:08.
• Design products backward from a price that makes buyers stare. Ingvar Kamprad, IKEA1:13:00
  • Kamprad wanted items at least 50% below competing products, yet still good quality and good looking.
  • He made every co-worker responsible for cost, from designers and buyers to warehouse staff Kamprad13:25.
  • IKEA reinvented the Lack table with board-on-frame construction from scrap wood. It sells for $9.99 in the US, and IKEA sells almost 20 million a year IKEA1:13:00.
  • The Poang chair fell from about $350 in 1988 to around $130 today IKEA1:13:00.
• Aim your lower price at the leader's customers. Phil Knight, Nike9:26
  • Knight told Onitsuka that shoes reaching American stores at prices that undercut Adidas could be hugely profitable Knight9:26.
  • HP's first audio oscillator sold for under $100 against $400 from General Radio, and it won the Disney order David Packard, Hewlett-Packard23:37.
  • Qualcomm pitched carriers that CDMA fit three to five times more subscribers on the same spectrum. That margin let a carrier cut prices and win customers Irwin Jacobs and Andrew Viterbi, Qualcomm1:17:10.
  • Pacific Telesis put up $1 million for a prototype in 1989, and 9x and Ameritech signed in 1990 Qualcomm1:17:10.
• Meet a slump with a lower price, and never with lower quality. Henry Ford, Ford Motor Company55:38
  • Ford said a manufacturer must get the price down to what people will pay, and he did it by eliminating waste.
  • Walton found that an item bought at 80 cents earned more profit at $1.00 than at $1.20, because he sold three times as many Sam Walton, Walmart44:30.
  • Walmart's gross margin today is about 24%, against the roughly 33% every store earned before discounting Walmart44:30.

2.3 Measure costs better than your rivals

You can only beat rivals on a cost you can see, so build the instruments first.

• Install cost accounting for every process and every worker. Andrew Carnegie, Carnegie Steel42:48
  • Carnegie found manufacturers learned their results only when the books were balanced at year end. He said it felt like "moles burying in the dark."
  • He insisted on weighing and accounting so he knew each department's cost and what each man at the furnaces saved or wasted.
  • Every manager opposed it and it took years to install, but it let him compare one man against another Carnegie42:48.
  • His accounts showed that heating large masses of iron wasted almost half the material in older furnaces, so the new ones paid for themselves Carnegie44:15.
• Judge every part by what it should cost, not what it costs today. Elon Musk, SpaceX and Tesla14:58
  • The idiot index is the ratio of a finished part's cost to its raw materials. A high ratio means the process, not physics, is the problem.
  • Musk quizzed engineers on the best and worst parts by this index and threatened resignations for not knowing it.
  • Tom Mueller's team made a critical engine valve themselves after a supplier balked at the budget SpaceX7:21.
  • Rockets cost at least 50 times their materials Musk14:58.
• Count the tiny savings, because volume multiplies them. Henry Ford, Ford Motor Company53:51
  • Ford said one cent saved on each part would amount to millions a year, so he carried calculations to the thousandth of a cent.
  • Walton chose the name Walmart because fewer letters meant cheaper signs to buy, light and repair Sam Walton, Walmart39:45.
  • Saving 10 steps a day for each of 12,000 employees saves 50 miles of wasted motion every day Ford53:51.
  • Walmart boasted administrative costs of 2% of revenue Walmart39:45.
• Delete before you optimize, and automate last. Elon Musk, SpaceX and Tesla1:03:38
  • Musk's order is: question every requirement, delete parts and steps, simplify, speed up cycle time, then automate.
  • The order matters because most teams optimize and automate things that should not exist.
  • He says that if you do not add back at least 10% of what you deleted, you did not delete enough Musk1:03:38.
  • Ford looked for a way to remove one part whenever someone proposed adding one Ford19:21.

2.4 Rebuild the system around the cost

Once you know the big cost, change who does the work, how wide the range is, and where the money is spent.

• Make or own the stage where suppliers' profit sits. Elon Musk, SpaceX9:38
  • SpaceX kept getting prices and timelines that did not fit its cost targets, so it built most hardware itself. It was not an ideological choice.
  • Tesla made its own key components to control quality, cost and supply chain Elon Musk, Tesla24:02.
  • Jeff Dean calculated voice search for a billion Android phones would need double Google's data centers, so Google built the TPU in 15 months Google1:45:11.
  • A NASA study found Falcon 9 cost roughly 440 million to develop, versus an estimated three to 10 times that with traditional contractors SpaceX9:38.
  • Rockefeller bought tank cars from the cash-strapped Erie Railroad. Standard got first call, paid a lower freight rate and collected rent when the railroad used them for other refineries Rockefeller, Standard Oil30:41.
• Build your own distribution if rivals borrow someone else's. Sam Walton, Walmart1:31:00
  • Kmart, Woolco and Target came from existing chains and used their parents' warehouses. Walmart had to build from scratch, so it designed everything around lowest cost and cash flow.
  • Its distribution centers broke bulk orders and re-boxed them daily for each store, and later its own trucks carried them. That let Walmart price below Kmart and still profit.
  • Kmart had 250 stores and $800 million in sales by about 1967 against Walmart's roughly $10 million. Kmart went bankrupt in 2002 Walmart1:31:00.
  • Rockefeller fought pipelines, then built his own once he saw they were the most efficient way to move oil. He said, "You cannot fight a technological phenomenon" Rockefeller53:10.
• Standardize the product and narrow the range. Elon Musk, SpaceX12:37
  • SpaceX built one Falcon 9 in volume and published a User's Guide so customers designed to its spec. It bet customers wanted low prices even more than custom solutions.
  • Southwest flew only the Boeing 737, so staff and aircraft were easy to swap, parts inventory shrank and supplier negotiating improved Herb Kelleher, Southwest Airlines29:00.
  • Sol Price carried fewer items because they cut labor in ordering, receiving, stocking and checkout. Payroll and benefits were about 80% of a retailer's operating cost Sol Price, Price Club37:12.
  • Southwest ran 84 employees per aircraft versus 115 to 160 for the rest of the industry Southwest29:00.
  • Price Club carried about 3,000 items against roughly 50,000 at a typical grocery or discount store Price Club37:12.
  • Gwynne Shotwell got conservative buyers like NASA and the Pentagon to accept the standardized model Gwynne Shotwell, SpaceX29:28.
• Spend only where customers feel it, and fix problems the cheap way. Ingvar Kamprad, IKEA1:32:20
  • IKEA leaves backs and undersides unfinished because spending there would only raise the price.
  • Southwest's receipts were being thrown away as tickets. Instead of a $2 million ticketing system, it printed that this is a ticket in bold red letters Herb Kelleher, Southwest Airlines31:59.
  • Pixar fixed the story in a cheap story reel, revising the script about eight times, before any expensive 3D work began Pixar, Disney2:08:11.
  • SpaceX's Merlin 1D runs around a million against 20 to 25 million for a Russian RD-180, with 95% of theoretical efficiency for 80% cost reduction SpaceX8:37.
  • Google ran on cheap commodity servers and replicated data. Hardware failure ran over 10% a year versus a 3 to 4% industry average, and the system still worked Larry Page and Sergey Brin, Google1:04:54.

2.5 Turn the cost lead into scale rivals cannot close

Low cost feeds volume and lower prices, and each turn of that loop widens the gap.

• Keep volume high so fixed costs are absorbed. Andrew Carnegie, Carnegie Steel40:56
  • Carnegie's plants were the biggest and most automated. He said he would run the factory full next year even if they made but $2 per ton.
  • Jeff Bezos wrote that online selling has high fixed costs and low variable costs, which makes it hard to be a medium-sized e-commerce company Jeff Bezos, Amazon34:50.
  • Rockefeller borrowed to build giant plants and reinvested instead of taking profits out. Larger volume meant lower unit costs, and he cut the unit cost of refined oil almost in half John D. Rockefeller, Standard Oil2:13:13.
• Cut prices ahead of demand to ride the learning curve. Morris Chang, TSMC33:01
  • Chang saw new fabs had poor yields at first and needed full volume to learn fast. At Texas Instruments he cut prices every quarter even when the market did not demand it.
  • AWS cut prices 23 times by 2012 and 51 by 2015. Lower prices bring predictable orders, which lets the company fund huge lumpy capital investments Jeff Bezos, Andy Jassy and Amazon Web Services2:23:40.
  • Chang said a serious student of the curve would never plan to stop at two fabs, and that it leads to one winner in manufacturing Morris Chang, TSMC2:02:18.
  • Fabs now cost 15 to 20 billion dollars, and TSMC's planned capex went from 17 billion to 30 billion in a year TSMC1:50:56.
• Share the scale gains with customers so they trust every price. Jim Sinegal, Costco1:22:27
  • Sol Price marked up goods about 12% and earned most of his money from membership fees Sol Price, Price Club28:00.
  • Costco capped markup at 14%, and 15% for Kirkland Signature. With an 11% target margin, members capture about 89% of every dollar of supplier savings.
  • Sinegal told Bezos there are companies that work hard to charge customers more and companies that work hard to charge them less. Amazon reversed its price increases the next day Costco1:29:40.
  • Other retailers marked up 36 to 50% Price Club28:00. Costco runs at roughly 10 to 11% overhead versus about 30% at Amazon Costco2:10:34.
  • IKEA holds only about 5% of a fragmented market and is the only globally scaled furniture company. Its brand means paying less, so scale is the moat IKEA2:54:10.
• Use the cost lead to starve rivals who cannot match your margin. Coca-Cola's leaders1:31:40
  • Coke held its price at a nickel. In the Depression rivals had to raise prices while Coke stayed cheaper with a better-known brand.
  • Jensen Huang repackaged chips that failed top tests into cheaper products. That let Nvidia price low enough to force rivals into losses and keep a price leader from locking it out of the bottom Jensen Huang, Nvidia37:00.
  • Carnegie's profits reached $40 million per year after he moved to steel early and watched costs more than anyone Carnegie49:40.

2.6 Where they differ

The playbook bends with your product, your industry and how much of the chain you can control.

• How much of the chain to own depends on where the supplier margin blocks your target.
  • SpaceX built about 80% in-house because suppliers kept quoting prices incompatible with its targets Elon Musk, SpaceX9:38.
  • Microsoft went the other way, dropping the boxed retail channel for OEMs, where each OEM scaled on its own Microsoft1:56:00.
  • Zara makes more than half its output in Spain, Portugal, Turkey and Morocco, trading cheap distant factories for speed and inventory turns Amancio Ortega, Inditex29:00.
• Standardizing only works when customers value price over fit.
  • SpaceX bet that customers wanted low prices even more than custom solutions SpaceX12:37.
  • Sol Price accepted what he called an intelligent loss of sales by stocking only the 8 ounce can of oil Sol Price, Costco1:43:46.
• Whether low cost decides the winner depends on your gross margins.
  • Gavin Baker argued low cost has not usually decided tech winners, but AI companies have far lower gross margins than software. That makes supplier margin matter Google3:37:40.
  • Search later had roughly an 87% gross margin Google1:04:54.
• Frugality has limits when time is the scarcer resource.
  • Kamprad toured a store with a flashlight to avoid paying for lights Ingvar Kamprad, IKEA1:32:20.
  • Musk refused a $2,000 part he thought could be cheaper, yet approved a $90,000 plane rental because it saved a workday. He treated burn rate of about $100,000 a day as the yardstick Elon Musk, SpaceX30:50.