Cost and differentiation · printable packet

A cost strategy needs a genuinely lower full cost a unit; differentiation needs a premium that covers the extra cost of being different and that customers will pay; premium costs at a discount price are the trap between them.

Paper packet. Every task here also exists on screen, where it is checked automatically; answers written on paper are not assessed by Nydus. When you are back at a device, enter your answers there.

1. What you will learn

You will compute the contribution of a plain, a differentiated and a trapped option, find the premium a difference must earn and the range of prices that justify it, check a cost strategy against the full cost of a unit, and sort businesses by strategy.

2. What you already have

A position names the basis on which the business wins, and an advantage says why it can. Two broad bases underlie most positions: being cheaper to run, or offering something customers will pay more for. Each has arithmetic, and it is the arithmetic of contribution and full cost you already know.

3. Words for this lesson

4. Each strategy has a condition

Term	What it means
Cost strategy	Winning by having genuinely lower unit costs than rivals, so a lower price still earns.
Differentiation	Winning by offering something customers value enough to pay more for.
Premium	The extra price customers pay for the difference.
Full cost a unit	The variable cost of a unit plus its share of the fixed costs.
The trap	The cost of a differentiated product sold at the price of a cheap one.

A cost strategy works only if the unit cost really is lower. Monica buys direct from two farms, pays no shop rent and has one helper: her cost per basket is below the supermarket's, so a lower price still leaves contribution. A business that merely wants to be cheapest, without lower costs, pays for each discount out of its own contribution.

A differentiation strategy works only if the premium covers the extra cost of being different. Maya's plain mug costs 10 dollars to make and sells at 20: 10 dollars of contribution. A dishwasher-tested version costs 5 dollars more. To earn at least as much, it must sell for at least 20 + 5 = 25 dollars — and cafés must be willing to pay that. If they will pay 32, the difference earns 17 a mug.

The trap is doing the expensive thing at the cheap price: the tested mug at 20 dollars earns only 5. A business with premium fittings and discount prices, or premium parts at budget prices, earns less than either strategy done properly.

Another way: table

Maya's three options.

Option	Unit cost	Price	Contribution
Plain mug	10	20	10
Tested mug, premium price	15	32	17
Tested mug, plain price	15	20	5

Another way: steps

Name the strategy the business is claiming.
For a cost strategy, work the full cost of a unit and compare it with the planned price.
For differentiation, add the extra cost to find the lowest premium price.
Compare that price with what customers say they will pay.
If neither condition holds, the business is in the trap.

5. The method, step by step, and how to check it

Checking a cost strategy. Share the month's fixed costs — rent, wages, the stall fee — over the month's expected sales, add the variable cost of a unit, and compare that full cost with the price the strategy needs. Monica's produce costs 9.50 a basket; her pitch and helper cost 1,600 a month over 1000 baskets, 1.60 a basket; the full cost is 11.10. A price of 15, a dollar under the supermarket, leaves 3.90 a basket. Her cost strategy is real.

Checking differentiation. Add the extra cost of the difference to the plain version's cost. The lowest price that keeps the plain version's contribution is the plain price plus that extra cost. Then set it against what customers have said, or shown, they will pay.

Check the cost strategy by asking what happens if sales fall by a fifth: the fixed costs spread over fewer units, and the full cost rises. A cost strategy that only works at full volume is fragile. Check differentiation by asking whether the premium was measured or hoped.

6. The range of prices that makes a difference worth it

A difference is worth making when there is a price that both covers its extra cost and is one customers will pay. The lowest such price is the plain price plus the extra cost; the highest is what customers will pay. Between them is the range; if the lowest is above the highest, the range is empty and the difference should not be made, however much the owner likes it.

Maya's range runs from 25 to 32. A price near 25 earns little more than the plain mug and may bring more cafés; a price near 32 earns much more a mug and may lose some. Where in the range to price is a question for the customers course's price tests; the strategy question is only whether the range exists.

7. Which one fits a small business?

Most small businesses cannot win a pure cost strategy against larger rivals, who buy in bulk and spread fixed costs over far more sales. Where a small business does have lower costs — no rent, a direct supplier, a family workforce — a cost strategy can work locally, but it must be checked, not assumed.

Differentiation fits more often, because the advantages small businesses hold — know-how, relationships, a specialty — are exactly what customers pay more for. But the premium must be tested against what customers will pay, and the extra cost must be counted honestly.

8. Differences that cost little

The cheapest differences to make are often the ones customers value most. Bright Home Cleaning's pass guarantee costs about 12 dollars a job because apartments rarely fail; what customers pay for is the certainty, not the rare re-clean. Northside Repairs' 'back for Monday' promise costs nothing extra in parts, only a change in how the week's bench time is planned. Maya's dishwasher test costs a few dollars in glaze and a year of patience.

Look for differences of this kind first: a promise the business can keep because of how it already works, a record it already has, a specialty it has already built. Each gives a premium with little extra cost, so the range of workable prices is wide. Differences bought with expensive materials or extra staff time give a narrow range, and are easiest for a rival with more money to match.

The arithmetic is the same either way — the lowest premium price is the plain price plus the extra cost — but a small extra cost leaves room for the price to sit comfortably inside what customers will pay, even if the estimate of what they will pay turns out to be generous.

9. Watching the strategy once it is chosen

A strategy is a prediction about costs and prices, and both move. A cost strategy is watched through the full cost a unit each month: if rent rises, or volume falls so the fixed costs spread over fewer units, the gap below the rival's price narrows, and the monthly review should notice before the gap closes. A differentiation strategy is watched through the premium: are customers still paying it, and is the extra cost still what it was? A supplier's price rise on the special glaze moves the lowest premium price up without anyone deciding anything.

Two figures on the monthly sheet are enough: the full cost of the main product against its price, and the share of sales made at the premium price. When either moves for two months running, the strategy needs a second look.

The second look asks the same questions as the first, with fresh figures: is the full cost still below the price the strategy needs, and does a range of workable premium prices still exist? A strategy that passed a year ago can fail today without the owner changing anything at all, because the rent, the suppliers or the rivals changed instead. That is why the check is repeated on a timetable rather than only when something already feels wrong.

10. How businesses drift into the trap

Few owners choose the trap; they drift into it one small decision at a time. A cleaner starts bringing eco-friendly products because a customer asked, then uses them everywhere, without changing the price. A café upgrades its beans, then its milk, then its cups, and keeps its prices because the chain up the road is cheaper. Each step is small and pleasant; together they turn a healthy contribution into a thin one.

The defense is a rule: every addition to cost is costed a unit and paired with a price decision. Either the price rises to carry it, or the addition is dropped, or the owner writes down why the lower contribution is worth it — to win a particular customer group, for example — and checks in three months whether it did.

11. In the world: a coffee van stuck in the middle

A coffee van at a railway station charged 2.80 for a flat white, 20 cents under the chain café inside the station, and its owner prided herself on single-origin beans, organic milk and compostable cups. Business was busy and she was always short of money.

A friend who kept books for small businesses worked her figures. Beans, milk and cup came to 0.95 a coffee, against 0.60 for the ordinary equivalents. The van's pitch fee, insurance, fuel and loan came to 2,400 a month, and she sold about 4,000 coffees, so each carried 0.60 of fixed cost. The full cost of a coffee was 1.55; before her own wages, each coffee earned 1.25, and after she paid herself for a sixty-hour week almost nothing was left.

She was in the trap: premium ingredients at a discount price. She had two honest ways out. Switching to ordinary ingredients at 2.80 would add 0.35 a coffee, 1,400 a month. Keeping the ingredients and raising her price to 3.40, above the chain, would add 0.60 a coffee if she kept most of her customers. She asked her regulars, who mostly chose her for the coffee, and moved to 3.40 with a sign explaining the beans and the milk. She lost about one customer in ten, and her monthly earnings rose by more than 1,500.

12. In the world: why the largest firms win on cost

In most markets the business with the lowest costs is one of the largest, because it buys in bulk and spreads its fixed costs over far more sales. That is why small businesses that try to be the cheapest usually lose, and why the differentiation arithmetic in this lesson is the one most small businesses need.

13. Where this goes wrong

A better product sells itself at the same price. The extra cost comes out of contribution unless the price covers it.

Doing a bit of both is safest. Premium costs at discount prices is the least profitable place to be.

Customers will pay any premium for quality. Test what they will actually pay.

A cost strategy only needs a low variable cost. The fixed costs, shared over the units, are part of the cost too.

14. Bright Home Cleaning's guarantee

15. Monica's cost strategy, checked

16. Maya's range of prices

17. Your turn: Neighborhood Kitchen's compostable packaging

18. Guided practice

Maya compares three ways of selling mugs. A plain mug costs $9$ dollars to make and sells at $21$. A distinctive, dishwasher-tested mug costs $6$ dollars more to make and sells at $31$. The trap: the distinctive mug sold at the plain price. Fill in each option's contribution a mug, in dollars.

19. Guided practice

Complete the worked solution: a salon's cut sells at $79$ dollars and costs $28$ to deliver. The owner is tempted to use a premium product line costing $15$ more a cut, without changing the price. Check what it does.

20. Guided practice

Bright Home Cleaning's standard move-out clean sells at $130$ dollars and costs $45$ to deliver. Adding a guaranteed free re-clean if the apartment fails inspection would add about $9$ dollars a job on average. What is the lowest price for the guaranteed clean that keeps the same contribution, in dollars?

21. Practice

22. Practice

Maya's plain mug sells at $21$ dollars. Her dishwasher-tested version costs $6$ dollars more to make, and café owners have told her they would pay at most $32$ dollars for it. For which prices $x$, in dollars, does the tested mug earn at least as much a mug as the plain one, at a price cafés will pay?

23. Practice

Monica wants to sell her baskets 1 dollar below the supermarket's $14$. Her produce costs $10.6$ dollars a basket, bought direct from two farms. Each month she pays $500$ for the stall pitch and $1900$ for her helper, and sells 1000 baskets. Fill in the check, in dollars.

24. Somewhere new

A new sandwich shop wants to be the cheapest in the business district, selling 50 cents below the main rival's $5.1$ dollars. It expects to sell 2000 sandwiches a month; rent is $3500$ a month, wages $4300$, and ingredients $2.1$ a sandwich. Fill in the check, in dollars.

25. Lesson test

Lesson test: one question per skill, one attempt each, no hints. Your answers are checked when you submit.

26. Test question

Northside Repairs' standard service costs $48$ dollars to deliver and sells at $70$. Dev is tempted to fit premium parts costing $15$ dollars more a service, but to keep the price at $70$ to stay competitive. What would each service then contribute, in dollars? Write a loss with a minus sign.

27. What you can do now

You can say whether a business is winning on cost, on difference, or is stuck in between — and show it in dollars. Tell someone why a better product at the same price can earn less. Next: choosing a focus and what not to do.

Working for the steps left to you

	Contribution a mug, dollars
Plain mug
Distinctive mug, premium price
Distinctive mug, plain price

	Amount
Fixed costs a basket
Full cost a basket
Her price
Profit a basket at that price

	Amount
Rent a sandwich
Wages a sandwich
Full cost a sandwich
Profit a sandwich at the planned price

$\text{the trap, unless another reason is worth paying for}$

	Cost strategy	Differentiation	The trap in between
A stall buying direct from farms, with no rent, selling below the supermarket
A café charging more for handmade cups and coffee customers seek out
A salon with luxury fittings charging discount prices
A bike shop fitting premium parts at budget prices