Competitive Power
Competitor reaction to an innovative new development is always uncertain, but it is to be expected. Competitors have the power to obviate the assumptions in a business plan. Ignoring this power can lead to overvaluation of the option. We have seen this factor in the Amazon case.
Prior to the innovation, some competitor reaction is already built into the economic base case; after all, the existing price structure and market share has been established in a competitive environment. Changes tend to be incremental. But a new development typically may elicit an exceptional response.
Consider a hypothetical situation. Today’s catalytic converters on automobiles must meet government-mandated emissions specifications regarding performance and durability. They require expensive noble metals, such as platinum, palladium, and rhodium. Assume that Aardvark Catalyst Co. invents and patents a new formulation that replaces more than half the noble metals with nickel and can thereby reduce its cost of goods sold by a full 50 percent. It offers the customers, automobile manufacturers, the new product at a 25 percent discount. This discount reflects half the cost savings, thereby giving the customer a compelling value proposition, while adding the other half of the savings to Aardvark’s bottom line.