Determining the Relative Cost of Competitors

The value chain is the basic tool for determining competitor costs. The first step in determining competitor costs is to identify competitor value chains and how activities are performed by them. The process is the same as that employed by a firm to analyze its own value chain. In practice it is often extremely difficult to assess competitors’ costs because the firm does not have direct information. It is usually possible to estimate directly the cost of some of a competitor’s value activities from commonly available public data as well as from interviews with buyers, suppliers and others. For example, a firm can often learn the number of salespersons a competitor employs as well as their approxi- mate compensation and expense account allowances. In this way, the costs of some of the competitor’s value activities can be built up to yield an accurate but partial picture of the competitor’s costs.

For value activities where a competitor’s costs cannot be estimated directly, the firm should employ comparisons between itself and the competitor. This requires that the relative position of the competitor with respect to the cost drivers of the value activities in question be determined. A firm then uses its knowledge of cost behavior to estimate differences in the competitor’s costs. For example, if local share drives logistical costs and the competitor has a higher local share, the competitor probably possesses a cost advantage in that value activity. If the firm can estimate the scale curve for logistical costs, the share difference provides a way of estimating the extent of the firm’s disadvantage.

Given the extent to which determining a competitor’s costs involves estimates and deduction, it is sometimes only feasible to estimate the direction, and not the absolute magnitude, of the relative cost difference with a competitor in a value activity. However, this can still prove extremely useful, since the firm can combine the direction of difference with knowledge of the proportional size of each value activity to develop a general picture of a competitor’s relative cost position.

A firm can typically improve the accuracy of estimates of competitors’ costs by examining several competitors simultaneously. Information disclosed by one competitor can be cross-checked against the disclosures of other competitors and used to test the consistency of scale curves or other cost models for a particular value activity. In fact, analyzing a firm’s cost behavior and determining the relative costs of competitors is often an iterative process.

Source: Porter Michael E. (1998), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press; Illustrated edition.

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