Willingness to Pay and Supplier Opportunity Cost

COMPETITIVE ADVANTADGE (HBR)

Willingness to Pay and Supplier Opportunity Cost

A customer’s willingness to pay for a product or service is the maximum amount of money a customer is willing to part with in order to obtain the product or service. A customer considering the purchase of a portal crane from Harnischfeger would be willing to pay as much as $7.5 million for it. If it cost more than that, the customer would be better off buying the forklifts for $1 million and paying the extra $6.5 million to operate them.

The concept of supplier opportunity cost is symmetrical to willingness to pay. It is the smallest amount a supplier will accept for the services and resources required to produce a good or service. We call this an “opportunity cost” because it is dictated by the best opportunities a supplier has to sell its services and resources elsewhere. In the example, the actual cost that Harnischfeger incurred to deliver a portal crane was $2.5 million. We don’t know the lowest amount the company’s suppliers would have accepted, but we will speculate that it was not far below $2.5 million—say, $2.0 million.

Added Value

The added value of a firm is the maximal value created by all participants in a transaction minus the maximal value that could be created without the firm.

Under a condition known as unrestricted bargaining, the amount of value a firm can claim cannot exceed its added value.

There are two basic ways a firm can establish an advantage:

 First, it can raise customers’ willingness to pay for its products without incurring a commensurate increase in supplier opportunity cost.

Second, it can reduce supplier opportunity cost without sacrificing willingness to pay. Either approach establishes the wider wedge that can define competitive advantage.

Differentiation=we mean that it has boosted the willingness of customers to pay for its output—that it commands a price premium.

Dual competitive advantage= A strategy based on providing a superior product while achieving a lower cost than the competition.

The tension between cost and willingness to pay is not absolute: Some firms can discover ways to produce superior products at lower cost and thus achieve a dual competitive advantage.

For instance Apple has a dual competitive advantage (better product and free softwares).

Catalog  activities (Chain Value)

A firm’s managers generally analyze activities in four steps:

First, they catalog the firm’s activities.

Second, they examine the costs associated with each activity, and they explore differences in rivals’ activities to understand how and why their own costs are higher or lower.

Third, they analyze how each activity generates customer willingness to pay, and they study differences in competitors’ activities to examine how and why their customers are willing to pay more or less.