Strategies for Staying Cost-Competitive

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Strategies for Staying CostCompetitive

Arthur A. Thompson, Jr.

Harvard Business Review

No. 84117


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HBRJANUARYFEBRUARY 1984

Strategies for Staying Cost Competitive

Arthur A. Thompson, Jr.

During years of chronic inflation, the managers of and a deep recession set in. A buyers marketemerged. XYZ couldnt count on price hikes to coverXYZ Corporation developed the habit of raising

prices to cover rising costs and defend profit margins. its still slowly rising costs because its volume-con-scious rivals were aggressively using price as a(XYZ is a name I am using to designate a composite

of several companies.) Observing that all its rivals weapon to gain market share. XYZs profits erodedwhile the others remained buoyant. To add insultwere forced to do the same, XYZ felt secure in its

strategy. to injury, XYZs rivals no longer went along withindustrywide price increases; even when such hikesThen deflation began, market demand slackened,became timely, the other companies raised their

prices by a smaller percentage than XYZ or delayedNo company can totally avoid the impact of increasing costs.And most managers have learned to adjust to the effect inflation them altogether.has on current operating costs. But few have factored it into their XYZ was caught squarely in a competitive pricingcompetitive strategies. And most managers, particularly those in trap. The companys managers believed that compet-capital-intensive industries, have not paid enough attention to

itors held a cost advantage. To catch up, they consid-the way increasing capital requirements affect their ability to

ered investment to modernize existing facilities orcompete in the long run.As a result of research and consulting work he has done with to build new cost-competitive plants. But the capital

a number of capital-intensive companies, this author thinks that investment costs for such construction were so highany organization can better its strategic position despite, and that XYZ could expect to earn an attractive returneven because of, inflation. He recommends that managers do a

on its investment only by selling products at pricesstrategic cost analysis to identify the severity of the impact of

well above the going levelprices that its rivalsinflation on their companies competitive positions, as well ason the positions of rival companies. In this article, he takes the could continue to undercut.

reader step by step through a diagnosis and analysis of changing XYZs predicament is shared by companies incost patterns as well as through the formulation of a strategic

many capital-intensive industries. In the Northsolution.American pulp and paper industry, a $100 per ton

Mr. Thompsonis theJohnR. MillerProfessor ofBusinessAdminis-production cost difference exists between higher-tration at the University of Alabama, where he specializes in

strategic management, competition analysis, and the economics cost new facilities and less costly, fully depreciatedof the corporation. He has written nine books and published mills.1articles in more than 20 professional and trade journals. This is Many U.S. steel companies have seen their vari-the first article he has written for HBR.

able operating costs rise more quickly than those ofAuthors note: I wish to thank Michael E. Porter and Paul Achleit-

Asian producers, andthe capital costs of modernizingner for their helpful comments on drafts on this article.Editors note: All references appear at the end of the article. large, integrated mills seem prohibitive.

Copyright 1984 by the President and Fellows of Harvard College. All rights reserved.


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Once a secure geographic monopolyand essen- consumer. This involves constructing a value chain,a diagram that shows the value added at each steptially a commodity businessthe electric utility in-

dustry is now in the throes of price warfare in the in the whole market process and exposes shiftingcost components. Next, you assess the long-runwholesale and bulk power market segments, with

low-cost producers in a position to take business shifts in the cost position of your competitors rela-tive to your own. Finally, you factor the implicationaway from higher-cost suppliers. Nearly every elec-

tric utility that is constructing nuclear power sta- of future inflation into your own costs and those ofthe competition.tions to meet future generating needs is being

squeezed by escalating capital costs and a market- This kind of analysis provides the backdrop forformulating an effective strategy and defense to helpplace replete with generating capacity. A number of

power companies, increasing generating capacity at you avoid (or escape from) the competitive pricingtrap, whether you want to become the low-cost pro-capital costs three to five times higher than those

for facilities brought on in the 1970s, are nervous ducer in the industry, focus your sales efforts on aparticular segment of the market, or differentiateabout whether the high fixed-cost charges for these

new facilities will allow them to be price competitive your product from your competitors.with other electric energy suppliers.

For example, the Canadian surplus of cheap hydro-Identifying shifts in key cost components

electric power and New Englands 30% electricitysurplus threaten the once sound economics of New Sustained inflation leaves an imprint on current

operating costs as well as on the cost of fixed assetsHampshires Seabrook nuclear project (whose origi-nal estimated price tag of $1 billion for units 1 and and new capacity. No operating component remains

unmarked, whether purchased materials, direct labor2 has ballooned to $5.2 billion). In the same way, asurplus of generating capacity in the Pacific North- costs, maintenance, energy, salaries, fringe benefits,

transportation, marketing, or distribution costs. Un-west, exacerbated by projected rate increases of 100%to 200%, has brought the once strong Washington checked inflation can radically change the whole

cost structure of an entire industry. After adjustingPublic Power Supply System to bond default andeven to the brink of bankruptcy. The future holds for greater sales volume, for example, operating costs

in electric utilities rose an average of $4 billion eacheven more competitive pricing threats; a potentialbreakthrough in the development of solar thermal year between 1970 and 1981. Thats in an industry

that started from a base of $20 billion in sales andequipment and photovoltaic cells by General Elec-tric, Westinghouse, United Technologies, and several $3 billion in net income. The $44 billion increase

over 11 years spawned round after round of rate in-Japanese companies portends important new sourcesof even lower-cost energy substitutes. creases, pushing rates in 1982 some 200% to 300%

higher than in 1970. Customers became so price sen-Of course, some companies did manage in the1970s to avoid inflations trap by investing early sitive that they cut their use of electricity and aver-age loads from a rapid annual 6% to 8% growth ratein new facilities and protecting their long-run com-

petitive position. Both Sun Oil and IBM have bene- down to a mature industry rate of 1% to 3%.More significant, however, is how the phenome-fited from committing investment capital on a

timely basis to strategic moves designed to yield non of rising costs can, over time, produce strategi-cally relevant shifts in a companys cost structurestrong cost positions vis-a-vis their competitors.

A company that finds itself in a trap like XYZs and cost competitiveness. To begin with, companiesusually experience a different rate and pattern of costcan do something to get out of it. From my research

and work with companies facing sharply rising capi- change for each cost component. During the 1970s,the annual cost increases for British Steels key com-tal requirements, Ive seen the value of doing strate-

gic cost analysis to identify ways to defend against, ponents rose as little as 8% to as much as 24%, andthe year-to-year patterns from component to compo-and sometimes escape, a competitive pricing trap.

nent fluctuated markedly.2

This kind of cost differential helped reverse theinternational advantage U.S. steel producers oncehad. In 1956, they could produce a ton of cold-rolledStrategic cost analysissheet steel for $35 less than the Japanese. By 1976,Japanese companies were producing a ton for $35Because inflation affects each company in an in-

dustry differently, the first step is to diagnose your less than their American competitors.3

Because every company within an industry haschanging cost economics all the way from the rawmaterials stage to the final price paid by the ultimate a slightly different cost structure for manufacturing

HARVARD BUSINESS REVIEW JanuaryFebruary 1984 111


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inputs, varied inflation rates for these inputs can a result, steel companies must either refurbish theirinefficient mills or close them down.open up important cost differentials between com-

petitors. Take the case of energy fuels. Price patterns Capital costs can rise because of unforeseen diffi-culties with expanding operations. Southland Corpo-across fuel types have varied widely from fuel

source to fuel source and from year to year. In ration saw its costs for new 7Eleven conveniencefood stores rise because of the explosion in the indus-1976, the price of gas fuels went up 35.2%, while

that of crude petroleum increased only 8%. In 1981, try. When Southland first bought sites in the 1960s,few other companies were competing for the kind ofhowever, the price of crude shot up 44.4%, while

the rise in gas prices was only 23.5%. Such differ- location it needed. With the rise in the number offast retail operations, other fast food chains, serviceences in inflation rates for particular cost compo-

nents play a big long-term role in shifting the stations, and retail companies began to compete forthe same locations and thus drove up their prices.cost competitiveness of different fuel sources and

energy-intensive industrial companies. In the elec- Given the realistic probability that rising operatingand capital costs will affect each competing companytric utility industry, where fuel costs account for

40 to 60% of operating expenses, each power com- in a different way, it is important for each companyto probe the nature and size of the differences inpany has experienced a different net inflationary

impact, depending on the particular mix of coal, fuel order to understand the potential shift in competitiveadvantage. This is where a value chain comes in.oil, natural gas, nuclear power, and hydroelectric

generation. Variations in fuel costs, along withdifferences in capital construction needs, have

Using a value chaindriven big wedges between the rates charged forelectric power across the United States. A company can show the makeup of costs all the

Manufacturing companies in such energy-inten- way from the raw materials phase to the end pricesive industries as pulp and paper, chemicals, and pri- paid by the ultimate customer on a value chain (seemary metals feel the competitive impact of fuel cost Exhibit I).5 Strategic cost analysis cannot be re-differences. An aluminum producer with plant facili- stricted to ones own internal costs because econo-ties in the Pacific Northwest today can manufacture mywide inflation often affects suppliers andmore aluminum with fewer dollars than a producer distribution channels. By including the impact ofin the Midwest. costs both inside and outside the company, the value

Inflation, of course, raises the construction costs chain helps the manager understand the sum total ofof new facilities, the prices of new equipment, thecost of equity and debt capital, and the neededamount of working capital. Increasing capital costs

can push the incremental costs of fixed assets and Exhibit I The value chaincapacity far above the historic cost of existing plantand equipment. In turn, average costs rise sharply asnew capital investments are made and cause asqueeze on profit margins and a need to raise sellingprices. Moreover, the size of the increase in capitalrequirements can impose a severe financial burden.

Virginia Electric and Power Company, for example,will mothball a nuclear power plant, despite a $540million initial investment, because the estimatedfinal price tag has risen from $1.2 billion to $5.1billion. Long-term contracting for coal-fired generat-ing capacity from neighboring utilities is now more

economical.The capital costs for a new steel mill in the United

States have escalated to about nine times the costof the embedded technology. While production costsfor new plants have dropped $60 per ton (because theamount of labor and energy necessary to produce aton has dropped), the capital costs for a new mill are$130 per ton higher and push unit costs up a net $70,

Cost ofpurchasedinputs

Value addedby suppliers

Company'sownselling price

Company'sown valueadded

Selling priceto final user

Value addedin distribution

Forwardchannelcostelements

Profitmargin

Operatingcostelements

Capitalcostelements

Value

chain

or 10% above the market price per ton of steel. As

112 HARVARD BUSINESS REVIEW JanuaryFebruary 1984


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the shifting cost economies up and down the whole discover who has been most affected by operatingcost and capital cost changes. For example, if bothmarket spectrum.

The value chain is revealing but not simple. To your operating and your capital costs are higherthan those of competitors, youre about to be caughtuse it, a company must recast its own historical cost

accounting data into the principal cost categories in the pricing trap. You may find it hard to holdonto your share of the market and, more important,that eventually make up the value of its product.

Most difficult is the necessity of estimating the same you probably cant invest your way out of the costdisadvantage in the short run (because the newcost elements for its rivalsan advanced stage in the

art of competitive intelligence. capital requirements are unattractively high andleave no room for a return on investment at goingDespite the tediousness of this job, the value chain

pays off by exposing the cost competitiveness of your market prices for the product).At the other end of the spectrum, where your com-position and the attendant strategic alternatives. Ex-

hibit II shows a simplified value chain comparison pany is less affected by both relative operating andcapital cost increases, you are in an excellent posi-of the shifting costs and competitive advantage be-

tween U.S. and Japanese steel producers from 1956 tion to use your low-cost stance to win a highermarket share by offering a lower price. Companiesto 1976. The shifts in the several cost components

are dramatic. The major causes of the shift in cost in the middle (either more or less affected by twovariables) have less clear-cut strategies. Only a de-competitiveness involved differing inflation rates in

the prices for production inputs, but technological tailed analysis will reveal the trade-offs betweenhigher and lower capital costs and lower and higherchanges and higher Japanese labor productivity also

worked against the United States. operating costs and what to do about them.Plainly, the chains makeup will vary from com-

pany to company as well as from business segmentAssessing competitive shifts

to business segment (product line, customer type,geographic area, or distribution channel). Although In the next phase of strategic cost analysis, the

company has to assess how rising cost pressures willit makes sense to start with a value chain for a wholebusiness, searching for variations by segment can affect its growth objectives and market share poten-

tial. For the sake of simplicity, lets consider threereveal important differences in each products costcompetitiveness and the companys unwitting cross- basic strategic postures relating to growth: building

market share, defending the current market share,subsidy of unprofitable products.To illustrate the strategic payoff of constructing a or giving up market share (taking a shrink abandon

approach). Furthermore, lets focus the analysis onvalue chain, look again at Exhibit I. A relative costshift can occur in any one of three main areas the extremes, where inflation drives up either op-

erating costs or capital costs.suppliers, the companys own segment, or forwardchannels. After constructing a value chain, a com- If all competitors feel the same inflationary impacton operating costs but the fixed asset-capacity costpany may discover it can reestablish cost competi-

tiveness only if it goes outside in-house operations. increases that they suffer from differ greatly, then aninvest and grow strategy to build market share canFor example, if its losing out because of a competi-

tive disadvantage in the cost of purchased inputs, work to the advantage of a company, provided itinvests early in new capacity. Eventually it will enjoythe companys strategic options are to negotiate with

suppliers for more favorable prices, integrate back- lower fixed costs than competitors that add capacitylater, when investment costs are higher. It must alsoward to gain control over material costs, use lower-

priced substitute inputs, or make up the difference forecast future market volume accurately and targetits market share objectives to coincide with a rela-by initiating cost savings elsewhere in the total value

chain. tively lower-cost industry position.If the tables are turned and inflation hits operatingWhen the cost disadvantage is in distribution,

the company can push for more favorable terms, costs unevenly while capital costs remain equal, acompany can protect cost competitiveness if it: (1)change to more economical distribution, or make

up the difference by initiating cost savings earlier innovates around troublesome operating cost com-ponents as new investments are made in plant andin the total value chain. It is likely, of course, that

a substantial portion of any cost disadvantage a equipment, (2) translates the resulting cost advan-tage into a gain in market share, or (3) offsets anycompany has lies within its own in-house cost

structure. Here the strategy options are more com- increases in operating costs that do arise with newefficiencies associated with added sales volume andplex. One analytical approach is to compare your

own cost structure with that of your rivals to higher market share.



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Exhibit II Value chains for U.S. and Japanese steel companies: a comparison between 1956and 1976

Distributioncosts Shipping,import duties,etc.

Thecompany'sown valueadded

Profit margin

Capitalcharges andother costs

Cost ofpurchased

inputsand basicmaterials

Labor

Iron ore

Scrap steel

Other energy

Coking coal

$ 35.69 $ 192.83Import priceto U.S.customers

TypicalJapanesecompany

TypicalU.S.company

TypicalJapanesecompany

TypicalU.S.company

Representativevalue chainsin 1956in dollarsper tonfor cold-rolledsheet steel

Representativevalue chainsin 1976in dollarsper tonfor cold-rolledsheet steel

$ 63.97 $ 157.14Producer'srealized price

$ 93.17

$ 56.17

$ 58.87 $ 125.05Producer'sprice

Shipping,import duties,etc.

$ 36.66

$ 119.63

$ 268.28Import priceto U.S.customers

$ 231.92Producer'srealized price

$ 112.29

$ 151.10

$ 203.78 $ 354.88Producer'sprice

Source: Compiled from data in the U.S. Federal Trade Commission, The United States Steel Industry and its International Rivals: Trends andFactors Determining International Competitiveness (Washington, D.C.: U.S. Government Printing Office, 1978) and in Robert W. Crandall, TheU.S. Steel Industry in Recurrent Crisis (Washington, D.C.: The Brookings Institution, 1981).



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If the source of rising unit costs in an industry ture a lucrative share of the market. When demandis expected to remain slack, the best position to de-comes mainly from the added costs of new invest-

ments in plant and equipment, a hold share growth fend is a hold-share strategy, in which long-term costcompetitiveness is protected by keeping new invest-objective can yield attractive profit margins. Compa-

nies that dont build new plants can gain a competi- ments in fixed assets to a minimum.Obviously, companies that expect high future op-tive advantage if they are able to use a higher

percentage of existing capacity to produce the extra erating and low capital cost increases and companiesthat anticipate low inflation in both types of costsvolume needed to maintain market share. This hold

share strategy can work under conditions of strong have a greater degree of strategic freedom. In neithercase do companies have to worry so much aboutor weak market demand. In a slack market, low-cost

companies are in the position to use a price-cutting the timing of decisions to add or replace productionfacilities. Their risk of falling into the pricing trapstrategy to protect their sales volume and preserve

capacity utilization. When market demand is strong, is lower, and they are more secure in raising priceswhen short-run cost changes squeeze profits. Athe company can go along with the price increases

that more growth-minded companies need to cover build-share growth strategy by one company can co-exist with a hold-share strategy by another.the incremental unit costs associated with new in-

vestments in plant and equipment. At IBM, top management decided that the eco-nomic impact of rising operating costs would out-Interestingly enough, a company with a long-term

shrink-abandon strategy may be able to benefit hand- weigh that of escalating capital costs. The companymade a big commitment to capital spending. Johnsomely from sharply rising costs for new plants and

equipment. Because it is committed to cost-con- R. Opel, IBMs CEO, once said, We want to be thelowest-cost producer of everything we make. Andtaining retrenchment and wont encounter capacity-

induced cost increases, a company can simply sell we now expect to begin realizing the productivitygains...made possible by our sizable investments. 6under the price umbrella of rivals and enjoy a long

cash harvest as competitors raise prices to com- The investment move allows IBM to take the offen-sive with its pricing strategy.pensate for the higher costs associated with capacity

expansion or capacity replacement.

Assessing future cost increases Factoring in cost economiesIn the final analytic step, a company turns to the

impact of future cost increases on both the operating Whether you expect your companys costs to beaffected more by operating cost changes or by capitaland the capital side of the production equation. For

example, if a company seems likely to suffer from cost changes also determines the success of yourcompetitive strategy. For example, if you want to beboth high operating and high capital costs, it willhave to increase prices at rates faster than inflation the low-cost producer in the market but you antici-

pate rising capital costs as a major problem, yourto hold its market, but it will soon invite customersto switch to substitutes. It will have to consider the companys best bet is either to build early (if demand

projections are bullish) or not to build new plants atoption to harvest or divest unless the industrysgrowth prospects are bullish despite inflation, or un- all (if the market is mature). Either way, you lock

into a low-cost position with fewer dollars of fixedless the industry has an immature technology andbreakthroughs can take away some sources of ris- asset investment. Then, given the capacity you have,

you try to produce at rates close to practical capacitying costs.If the inflationary combination results in a com- in order to enhance the revenue productivity of your

fixed investment.pany expecting higher relative capital costs but loweroperating costs and if its industry has good growth There are some constraints on this strategy. You

will have to adjust if, while pushing capacity to theprospects and a mature technology, then there is apotential first-mover advantage from adding new ca- limit, you find operating costs beginning to creep up.

Another problem may arise if you have to cut pricespacity early. To sustain the advantage, it must be ableto recoup the cost suffered from temporary excess to preserve volume; in that case, you wont be able

to use full capacity.capacity when rivals finally add or replace plant andequipment at inflated costs. The size of any first- Nonetheless, if your business has relatively high

and rising fixed costs per unit, successful cost leader-mover advantage depends on the speed of increasesin capital requirements, the extent of the industrys ship depends on the combinationand timingof

low capital investment and productive use of fixedneed to add capacity to meet new market demand,and the potential for lower-cost substitutes to cap- assets. The key cost drivers are the timing of capacity



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additions and investment and capacity use. Many around the components of operating costs most sus-ceptible to inflation. It can also try to restructure theelectric utility executives have begun to push the

use of this approach. whole value chain by substituting its own distribu-tion networks for dealers and franchises.

Petroleum refining provides an interesting exam-Differentiate with a twistple of how to defend against long-term price increases

Rising capital costs will hit your company hard if in a key resource input. Since 1975, U.S. oil compa-you rely on a differentiation strategy to win market nies have invested $15 billion to upgrade refineries

share. There are limits to how much more buyers so that they can use cheaper, more plentiful low-will pay for a product that is fancier than its rivals. quality crude oil. The investment is expected to payAt some point, the buyers may be attracted to a more a good return through the use of lower-cost crude oilgeneric product at a lower price. The key is to contain and improved refining technology to increase thenew spending commitments that are affected by ris- yields of higher-margin products.ing capital costs. You must try, insofar as you can, Ashland Oil figures it will reduce raw materialsto shift the basis of your differentiation to operating costs by 20% to 25% through a $240 millioncost variablesto advertising, service, inspection upgrading of its refineries. Making these kinds ofprocedures, and manufacturing workmanship. If that investments early can mean major savings inis impossible and you must continue to base the capital costs; Standard Oil of California, whichstrategy on the better performance of your product, spent $1.3 billion to upgrade its Pascagoula, Missis-then you must make certain that the costs to buy sippi refinery in 1981 and 1982, has estimated thatthe new plant and equipmentnecessary to make your the same improvement would have cost $2 billionproduct the better performer can be offset by perfor- in 1983.mance gains that will preserve your buyers prefer- In countering these strategies, the Sun Companyence for your product and forestall their natural decided not to upgrade its Pennsylvania refinerymotivation to switch to a lower-cost substitute. Oth- and gambled that the industrys shift to low-qualityerwise, a strategy to be the cost leader will beat a crude would leave Sun ample access to high-qualityperformance-based differentiation strategy. crude and that the price difference between high-

quality crude and low-quality crude would notFocus on a particular segment average the $6 to $7 per barrel that the other

companies had used to justify their investments.In an industry where new fixed assets or capacityThe success of differentiation strategies in an envi-additions are expensive, a company with relatively

ronment of rapidly rising operating costs varies ac-modern facilities and adequate capacity may wellcording to the basis for differentiation. The mostfind it competitively advantageous to use a focus

threatened are those quality and service typesstrategy and concentrate on selected groups of buy- of differentiation strategies that require skilleders. A narrow customer base helps limit the need forcraftsmanship, high labor content, customized de-capacity expansion and shields the company fromsign, elaborate marketing and distribution networks,the cost of escalating capital requirements. By nar-and personalized extrasthe costs of which rise atrowing the product line, the company can allocateabove-average rates. Less vulnerable are companiesexpensive production capacity to its most attractivethat (1) differentiate in parts of the value chain lessitems and market segments. Higher margins can beaffected by costs, (2) cater to price-insensitive buyers,expected both from having a favorable cost positionor (3) enhance the value of their differentiation fea-and from trading up the use of existing capacity.tures enough to outrun the effects of higher unitSuch focus directs corporate attention to the best usecosts.of existing capacity and has a tight strategic fit with

A differentiation strategy based on the intangiblesthe economic need to enhance the revenue produc-of image, buyer confidence, and brand recognitiontivity of expensive capital assets.

has a stronger chance of being successful when thecosts of creating or maintaining the intangibles arenot greatly affected by the forces of rising operatingcosts. The key is to find cost-competitive ways toThe operating sidepreserve the value of differentiation for the buyerand to contain customer switching by offering lowerWhen rising costs hit the operating-cost side of the

value chain harder than the capital side, a company prices. Another strategic option is to try to shiftmore of the basis for differentiation to aspects ofcan still be successful in pursuing a strategy of being

the low-cost producer if it can find ways to innovate product performance that can be added by invest-



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ments in technology and fixed assets. Such a movemay produce a durable competitive edge, especially

Inflation: who gets hurt?if it catches competitors by surprise.When operating costs spiral upward faster than the

Like theweather, inflationis a loteasierto talk aboutcosts of plant and equipment, a focus strategy can

than to do something about. . . .succeed if the company either concentrates on buyer

In my judgment, the impact of inflation on balancegroups that are less price sensitive or tries to build sheets is considerably more serious than that on in-its product line around items that are least affected come statements. In thefirstplace, inflationdeprivesby cost changes. people of the opportunity to save in a form that gives

them a predictable command over future consump-tion goods. In a noninflationary environment, peoplecan acquire various liquid assets, earn a reasonableStrategic realignmentreturn on them, and count on them as the means toacquire a basket of consumer goods in the event of

The major lesson in strategy formulation thatespecially large needs or declines in income. To be

emerges from this analysis is that a company must sure, they can never get a guarantee of future tuitionclosely gear its strategy to the long-term changes in costs, or the prospective price tag on their retirementthe industrys cost economics. Managers must think home, or charges for large medical needs. But thesestrategically about the long-run implications of risks are much less serious than those associated

with general inflation.short-run cost increases and be creative in findingWhen over-all prices are rising rapidly, their exactways to capture a competitive advantageby minimiz-

course is bound to be unpredictable. If we all knewing the effects of inflationary cost pressures on the that 4 per cent a year inflation would lastthrough thecompanys strategy.

next decade, nominal interest rates would probablyWhile there is nothing inherently wrong in makingbecome adjusted to levels offering a reasonable real

a series of short-run pricing changes to cover chroni-return, and people would know how much of a con-

cally rising costs, the fatal mistake is to fail to recog-sumer market basket their savings accounts could

nize why and how strategy must deal with almost command in 1980. But there simply cant be greatcertainly uneven cost changes among rival compa- confidence that the price level will rise steadily atnies. Though small at first, the cost disparities that any substantial rate, such as 4 per cent. Only if theemerge can over time create big shifts in cost compet- Government is committed to limit the rise to a creep

of not much above 2 per cent can there be reasonableitiveness and competitive advantage.predictability.Avoiding pricing traps requires a strategic view

The opportunity for safe saving is lost in a periodof the present cost structure, of how the structureof sizable and unpredictable price increases. Somechanges, and of the implications for gaining a sus-assets offer a degree of protection against inflation

tainable competitive advantage. Success comes to a in the sense that their values are likely to move upcompany that accentuates long-term strategic posi-

as consumer prices rise. But no asset shows a goodtioning.

year-by-year correlation with prices; even corporateequities and real estate are not good anti-inflationaryhedges by this test. They may actually tend to out-pace the price level on the average in the long run,Referencesbut only with wide swings and great uncertainty.

1. Pulp and Paper, August 1982, p. 133.From2. See R.A. Bryer, T.I. Brignall, and A.R. Maunders, AccountingEconomics for Policymaking, Selected Essays of Arthur M.for British Steel (Aldershot, England, Gower, 1982), p. 124.Okun, ed. Joseph A. Pechman (Cambridge, Mass.: The MIT3. Robert W. Crandall, TheU.S. Steel Industry in Recurrent CrisisPress, 1983), pp. 3, 1213; 1970 by New York University(Washington, D.C. The Brookings Institution, 1981), p. 173.Press. Reprinted with the permission of the publisher.4. Ibid., pp. 73 and 86.

5. The concept of value chains is discussed and analyzed in Mi-

chael E. Porter and John R. Wells, Strategic Cost Analysis,unpublished working paper, Harvard Business School, 1982.

6. IBM: The Giant Puts It All Together, Duns Business Month.December 1982, p. 56.


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Strategies for Staying Cost-Competitive