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Advantages of Cost Leadership Strategy

Discuss about the Business Strategy Module Tata Nano company.

Critically discuss the pros and cons encountered by Tata Nano company in the deployment of the cost leadership strategy.

Cost leadership concept used in business strategy is developed by Michael Porter for establishing the competitive advantage, with a goal of providing product or services at lowest cost in the industry. Using the cost leadership strategy, Tata Nano uses the lowest cost of operation on the market which is also based on the company size, scale, efficiency and cumulative experiences. The car is mounted with a 624cc engine which provides 50 miles for a gallon of fuel.

“It is basically ‘safe, affordable and all-weather transport’.”

Ratan Tata using the cost leadership strategy accomplished his vision of introducing a small car within the range of $2500 (?1 lakh), as an affordable family car.

“It was a strong statement coming from an Innosighter. After all, we have been talking about the disruptive potential of the “people’s car” — priced as low as $2,000  for years.”

The approach is indeed effective as it visions to capture the medium to small income-class people thereby offering a scope of acquiring luxury automobile (car) at affordable cost.

With the adoption of this strategy, Tata Nano gained several advantages which include achieving high asset turnover. The company produced the cheapest car from the mother plant and manufactured the complete car by using FIAT, which is the best disruptive engine technology of the current time. Low direct and indirect operating cost is maintained by the company with measures like lowering the bargaining power of suppliers as 97% of the parts are sourced locally, and there are 20 companies for the supply of 70% of its components. In the initial stage, the company could make very little profit, as it could not meet the sales target and economy scale. This is reflective with their total sales from 2009 to 2011 as 110,794 units.

“It’s been a rough season for Tata Motors’ much-publicized “people’s car,” the Nano. In November, while overall auto sales in India’s booming economy rose more than 22%, Tata sold only 509 Nanos, down precipitously from the 9,000 it sold the previous July, news that’s been trumpeted in disparaging headlines from New York to Sydney.”

However, later it could drive the attention of the middle class, and it is reflective in the 2012 report where the sales of two fiscal years reveal 70,000 units. It is noteworthy to mention that India is the world’s second largest manufacturer of motorcycles, with annual sales excelling 8.5 million by 2009, and hence the vision of Tata to provide affordable cars which can replace the motorcycles, also symbolises that India up rises in terms of affordable luxury items. In conjunction with the cost leadership, it is noteworthy to mention that Tata Nano adopted Blue Ocean Strategy, in which the market space remains uncontested. Moreover, the competition to this product is also found to be irrelevant as they capture the new market demand by offering a leap value with streamlining of the cost.

Disadvantages of Cost Leadership Strategy

“Expectations could not have been more public for what the Sydney Morning Herald’s Amrit Dhillon referred to as “the pop star of the car world.”

On the other hand, similar leadership is considered to be difficult by other companies, as bringing technology innovation at the minimal price will be difficult for other automobile companies.

However, despite these advantages, there are certain disadvantages which the company has to suffer after the launch of the product. The production of small car Tata Nano was announced to be produced in Singur in West Bengal in 2006 by Tata Motors, which proved to be a failure due to land controversy, which in turn leads to shifting of production plan as well as a delay in production of its first 100,000 cars for more than 18 months. Moreover, due to the change in factory location led to delay in project which ultimately resulted in decrease in production volume.

“On the other, large initial demand required the company to build the car at scale from the outset, which proved publicly problematic when the company ran into problems purchasing land for a new factory in West Bengal.”

Moreover, the prime target of Tata Nano are the price-sensitive customers, who choose the product because of less price. Thus, there is always a chance of lower customer loyalty, as the company has its nearest competitor Maruti 800. Tata Nano has a reputation of cost leader, which ultimately made a reputation of low quality. Instead of the usual pair, it has only one windscreen wiper and it has no fuel filler cap, excluded power steering and power brakes and no airbags. Now in the present day, to equip the car with more luxurious and necessary features, the company has added to the cost, which eventually dissatisfied the price sensitive customers.

“He went on to detail how in the late 1990s he bought a used Maruti 800 for about Rs 1,05,000 (about $2,250). The car had features the base Nano lacks like a cassette player and air conditioning. He sold it in 2001 for Rs. 95,000 (or about $2,000).”

Importantly, soon after sales, the technical difficulties and servicing problem related issues also arises within one year, that makes the customer unsatisfied. On the other hand, the rivalry companies offered genuine price with cost differentiation in terms of managing quality along with price, such as H800 from Hyundai, Maruti Cervo prices within 1.6 to 2 lacs offer potential threat to the Tata Nano. According to a report by Akhtar et al. (2013), the customer survey suggested that Nano remains in-between competition with motorcycles, whereas products from rivalry companies are comparatively expensive, but offer valuable services and product longevity, because of which Tata Nano’s share in market goes down. Overall, the cost leadership dictate only offering of affordable car, which fails to maintain the quality consideration and thus reduced its attractiveness in front of younger generation having more buying power and desiring for quality aspects. Thus, Nano does not seems to be a car to have attracted its targeted market, and even they felt the car lack certain necessary features. The prime features in the car like power steering, air-conditioning and electric windows are not in the car for the customers, which made the customers to think twice before purchasing.  

Industry Attractiveness for New Players

“A cheap car that’s not really cheap. A safe car whose safety has been questioned. A poor people’s car that poor people aren’t buying. That sounds like a failure, certainly.”

Assess the industry attractiveness to a new player who is interested in this segment. Porter 5 forces, discuss what are the other factors you need to consider when entering into a new industry.

Rivalry with Existing Competitors – According to the case given, the new product should hold minimum cost as that of established companies. In the present case, the new player interested in the similar segment of the low-cost car (automobile), Tata Nano and having the cost leader’s advantage. Rivals such as Maruti Alto, Maruti 800, and Hyundai i10 are on the same price level, targeting the same group of customers. These rivalry companies have lower significance with regard to cost leadership, these companies have a better advantage in terms of cost differentiation as their prices range from 1.6 to 2 lacs which are comparatively higher, but they have a better advantage in terms of quality aspect. Most of the customers prefer qualitative advantage with a minimum increase in price, which prevents regular servicing of the car. Thus, there is extremely high risk and threat from the rivalry and existing companies, which as a result might decrease market attractiveness.

“Then it turned out that the car doesn’t really sell for 1 lakh. In fact, the New York Times reports, a fully equipped Nano sells for only about $800 less than the Suzuki Alto, which “has a bigger engine, more storage space and a longer track record than the Nano.” That last factor is particularly important in the wake of dramatic accounts of some Nanos bursting into flames, an unfortunate irony for a car touted as a “safe.”

Bargaining power of the buyers - The newer market can also take advantage of global stratification by affiliating with Third World countries for outsourcing of parts, obtaining skilful labours, which later can be assembled for selling in Indian market. With such provision, it would be easier to reduce the unit price. Providing the product with minimum price and streamlined features leave the customers with less bargaining power and there is moderate risk which consequently increases market attractiveness.

Bargaining power of Suppliers - The new product should source all its parts as reasonable cheap price, which would lessen the chance of vendors to use their power. Importantly, the quality aspect of these products must be retained that can manifest the quality aspect as well as the cost consideration for their products. As the company includes only 20 companies for supply of its majority of components and most of them are sourced locally, lowers the bargaining power of these suppliers. This as a result decreases unit cost and also threat of suppliers and increases market attractiveness. Notably, the provision of global stratification for selection of suppliers is applicable in this regard as well.

“But low price and lower quality is not necessarily quite the same as low cost, no frills.”

Threat of potential entrants - The new product can resist the entrance of new products by becoming cost competitive on a large scale, and the new entrants will take time for moving down the learning curve. Ford, Hyundai, and Renault Nissan are planning to release car at $7600, $3700, and $3000 respectively.  Maruti 800 is already established in the market. Therefore, there is threat from potential entrants into market and chance of reduction in market attractiveness.

“Price at around €5000, the car was certainly not ultra-cheap, but it was certainly competitive.” 

Product substitutes - Being the cost leader, the product should make investments for creating alternatives. It should purchase patents (for disruptive technology) developed by potential substitutes by lowering the price to maintain value position. However product substitute like motor-cycle has less threat to this product, as with a minor increase in price the rising population of Indian middle class customer can afford a car, which increases the market attractiveness of the product.

“Nor, it seems, is the car popular with its original target market. Nano customers are not upgrading from motorscooters, Dhillon reports; they’re people looking for a fun, trendy second car for running errands.”

It is worth mentioning that for the successful marketing and sales in the industry, the new product should adopt the strategies as similar to that of Tata Nano. Basing on the cost leadership strategy, the product should become the low-cost producer in the industry. While succeed in providing the lowest price with simultaneously achieving the profit and high return on investment, the product should also be able to operate at the lower cost than the competitors.

Within the value chain framework, access the core competencies held by Tata Nano and how this supported its competitive advantage.

The primary activities involved in the value chain framework depicts the core competencies of Tata Nano, as dictated in the below mentioned points:

Inbound logistics - It holds the long-term contract with the service providers related to agents, suppliers, contractors and transporters. Having more than 300 distribution centres all over the country, it uses the logistics more effectively than its rivals Maruti-Suzuki, Ford and Mahindra and Mahindra. For the smooth logistic operation, there are personnel at each regional office with effective storage and retrieval of goods. Thus, its innovative process of price adjustment, production, distribution strategy, and marketing makes it different from other competitive companies. 

“But really it’s not. It’s par for the course for almost every breakthrough innovation. There’s nothing unusual about a company having to adjust the price, the production process, the marketing, or even the market of a breakthrough offering.”

Operations - It includes strategic alliances related to the capital equipment manufacturing division and apprentice trainee course for effective operation and production management of Tata Motors. The company spent years for perfecting the craft of the car with the help of efficient engineers and ultimately made entry into the market with less publicity business have greater effect.

Outbound logistics - Tata Nano is operated in different locations all over the country, which includes Odisha, Maharashtra, Karnataka, Andhra Pradesh, Uttarakhand and Gujarat. It holds long term contract with the transporters for ensuring the competitive price.

“It might not have been easy, but had Tata piloted the Nano quietly, on a small scale, perhaps through a limited production run in a small city like Durgapur in West Bengal or Ranchi in Jharkand, its engineering, pricing, financing, and marketing might have been adjusted far from the limelight to suit the needs of an optimal target customer”

Marketing and sales - According to the market demand and QFD’s conducted at regular durations, Tata Nano clearly identified the product requirements, which ultimately led to innovation in the product. It provided breakthrough facilities like test drives, pre-booking, distributed manufacturing and new commercials. For marketing purposes it invested small amount equally on all the three printing invention approaches related to e-books, billboards and radio-paper products.

“A far more common path to success is the one forged by E Ink, which early on envisioned several potential applications of its printing invention- billboards, radio-paper products, and e-books.”

Notably, there also exists robust support activities involved in the value chain framework depicts the core competencies of Tata Nano, which include following elements, such as:

Technology Development- Tata Motors uses approximately 2% of its total yearly profit for the research and development process with the help of 2000 skilful engineers. It uses the widespread prototype building and testing facilities for the production process. For emphasising the technology,

“The Nano is a 5- door 4-seat car with a rear mounted 624cc engine.”

Human resources - The company increased its total workforce to approximately 23000 at the Jaguar Land Rover and recruited the highest of ever intake of more than 330 graduate trainees. From an employee engagement survey, it was found that its employee satisfaction rate increased to 65%.

“The Tata Nano is different. The diversified Indian conglomerate Tata is best known as the world’s leading tea company, but it has bought Jaguar and Land Rover from Ford in the recent past.”

Firm Infrastructure – the company has well equipped firm infrastructure for production and warehousing purpose. Large product portfolio, best in class building prototype and SAP technology is used in the firm infrastructure. 

“The Nano’s price changes, the new maintenance contract Tata is rolling out to assure buyers of quality, the test drives it’s introducing, the new smaller showrooms, and the new commercials — all widely discussed in the press — should not really be news.”

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