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Thinkers

 

Cost transparency – or not

Companies are becoming more open about their supply chains, but costs are the last frontier. A new study co-authored by Dr Vincent Mak and Dr KC Raghabendra at Cambridge Judge looks at when a company should be more transparent about its cost of production.

Closeup from transparent piggy bank with two euro coins on pink background. ideal for websites and magazines layouts

Companies are very eager to tell the world certain things about their products, sometimes informative and sometimes hype: bigger, better, improved and “clinically tested” are just some of the claims common in advertisements.

Firms have traditionally been tight-lipped, however, when it comes to their supply chain processes and costs – claiming that such information is commercially confidential, so disclosure would give rivals a competitive edge. Yet even this historic secrecy is now loosening as companies eager to show social responsibility are disclosing more information about workplace safety compliance, environmental footprint and supplier information.

Costs are often a conspicuous holdout to this greater transparency, but a study co-authored at Cambridge Judge Business School concludes that cost disclosure in some circumstances can benefit a company by providing a competitive edge or helping in market differentiation. This particularly is the case when “products are of low perceived quality and relatively high unit cost.”

The paper built an analytical model on cost transparency, then tested it in a laboratory experiment involving 308 participants from a university in Singapore.

The working paper – “Adopting cost transparency as a marketing strategy: analytical and experimental exploration” – is co-authored by Dr Wei Shi Lim of the National University of Singapore Business School; Dr Vincent Mak, Reader in Marketing & Decision Sciences at Cambridge Judge; Professor Christopher Tang of UCLA Anderson School of Management; and Dr KC Raghabendra, who recently earned his PhD at Cambridge Judge and is an Assistant Professor at Rollins College in Florida.

Dr Vincent Mak
Dr Vincent Mak

Vincent Mak, Reader in Marketing & Decision Sciences at Cambridge Judge Business School, discusses some of the study’s findings:

Cost transparency works in a monopoly situation if the consumers’ reference price and the firm’s costs are all relatively high. In that case, revealing the costs will not make the firm appear to be earning an unfairly high profit, and will instead attract more consumers to buy from it. Consider the practice of ride-sharing firm Uber before it faced competition from Lyft and other companies. At that time, consumers were using the relatively high taxi fare as the reference price, while Uber was paying its independent drivers as much as 80 per cent of the revenue collected from the passengers. Uber was thus very willing to be transparent about this “labour cost” to consumers.

However, cost transparency is not advisable in a monopoly situation if the perceived quality is very high while the actual costs are relatively low, as is common among exclusive luxury brands. With high perceived quality and relative low unit costs, our model finds that luxury good makers should not disclose their cost information – and that’s in fact the usual practice in this sector.

In a duopoly situation with a large difference in quality, both firms can benefit from opaqueness on costs. By avoiding transparency, both players in a duopoly can set different prices in order to segment the market; but when quality differentiation shrinks, competitive pricing loses its potency so both firms can benefit through greater transparency – because this transparency becomes a different lever for market differentiation.

The competition between big clothing retailer Gap and challenger Everlane is illustrative. Everlane’s website boasts of its “Radical Transparency” – and in fact it breaks down the cost of common items such as a tote bag: $32.94 for materials, $30.78 for labour, $3.00 for transport, $5.27 for duties and $2.16 for hardware, for a total true cost of about $74 which Everlane marks up to $165.00 for retail. Gap is far longer established, and it enjoys a higher perceived quality edge, so it is beneficial for Everlane to focus on transparency. For Gap, its perceived quality edge allows it to remain opaque without worrying so much about being penalised for a higher selling price.