What Is Cost Parity?
Cost parity means matching prices. A company has achieved cost parity with another if it charges the same price for the same product or service. Cost parity frequently refers to the goal of matching prices with the market leader, which is the company that dominates the market for the same type of product or service.
Achieving cost parity is a process that takes time for new firms to achieve, according to the book "Systems Approaches to Managing Change." Firms must first find ways to cut their own production or service costs before achieving cost parity. To compete with market leader prices, they typically must learn to become market leaders themselves.
Achieving cost parity with the market leader often means learning how to leverage economies of scale and using experience to become more efficient. Leveraging economies of scale means gaining cost advantages from producing and selling products in higher volume. The cost of production per unit can decrease dramatically when a firm produces increased amounts of a product. A larger company typically secures materials for a lower cost, for instance. Likewise, an experienced company learns to streamline its processes and hires the appropriate number of employees to fulfill the necessary functions. These strategies allow a newer company to grow closer to cost parity with the market leader.
After a company achieves cost parity with a market leader, or holds the lowest market price, the company must continue working to maintain its position. Newer companies are likely entering the market with the same goal of achieving cost parity. While a learning curve exists, it doesn't extend indefinitely, according to the book "Strategic Management Theory." Thus, these newer companies might soon achieve parity, too. To maintain an advantage and keep prices from lowering because of market competition, a firm should cultivate additional competitive advantages such as customer service.
The concept of cost parity loses meaning when the products or services being compared have significant differences. For example, the essential differences between "clean energy" and energy derived from fossil fuels complicate the concept of cost parity in this context. Thinking of costs in a non-monetary sense, or in terms of future cleanup and restoration efforts, is essential. The price per liter of gasoline is not the true cost of this fuel, in other words.