Stuck!Christopher Farrell and Zachary Schiller
Grandparents love them. So do parents. And kids do look awfully cute running around in their Oshkosh B'Gosh Inc. bib overalls. But in the past few years, the Wisconsin-based maker of high-quality children's clothing has faced increasing price resistance from consumers. To strengthen its ties to retailers, the company is working closely with department stores, helping to pay for new store fixtures and fancier displays. To lower costs, it's overhauling production processes and investing in worker training to become a highly flexible manufacturer. And in an unprecedented action to jump-start sales, Oshkosh will slash prices by 6% to 8% on its entire 1994 spring line of clothes.
It's not just Oshkosh, by gosh. All across the marketplace, companies are snipping away at their price tags. Mercedes-Benz is lowering prices on some luxury cars by almost 15%. Compaq Computer Corp. is slashing prices on its top-of-the-line personal computers by 23%. Borland International Inc. has chopped the list price on its latest Quattro Pro spreadsheet from $495 to $99. Boeing Co. is effectively freezing the prices of its commercial airplanes for the next five years. Says Ron Wood-ard, executive vice-president of Boeing Commercial Airplane Group: "Our airplanes cost too much."
RETHINK EVERYTHING. It's the Age of Disinflation--and it's creating a business landscape that few of the managers of these companies have seen in their professional lifetimes. The savvier among them aren't just whipping out the markdown pen, though. Like Oshkosh, a growing number of corporations are recognizing that ferocious pricing pressure means that they have to rethink virtually every aspect of how they do business. In this unfamiliar and treacherous terrain, they're having to abandon many of their old, inflation-inspired business habits. To preserve profits and eke out growth, companies are being forced to come up with radically different corporate strategies, manufacturing techniques, marketing tactics, compensation structures, and approaches to financing. Battered by worldwide overcapacity, brutal global competition, slow growth, and high unemployment, corporate pricing power has clearly been crumbling. Since 1990, consumer price inflation has fallen from a 5.4% annual rate to its current 2.7% yearly pace. At the same time, producer price inflation is down from 4.9% to 0.5%. It adds up to "a paradigm shift as profound in its significance for disinflation as the oil crisis of 1973 was for inflation," says Peter L. Bernstein, an economic consultant in New York City.
EXPOSED. In the new world of disinflation, cost-cutting is, of course, essential. But by freeing prices of the distortion of inflation, this challenging environment is also restoring prices to their traditional role as economic arbiter: They are the signals that tell companies and individuals how the marketplace truly values the goods they make and the services they sell. The price a company charges is, in turn, the culmination of every decision it has made along the line. Without the cloak of inflation, all those decisions are directly exposed to the ruthless pressures of the marketplace.
A number of companies are beginning to chart some imaginative paths across the new landscape of disinflation. They're redesigning products for ease and speed of manufacture or stripping away costly features that their customers don't value. Many are paring back expensive rebates and discounts in favor of stable, low, everyday prices. They're seeking to gain a bit of shelter from relentless pricing pressure by forging closer links with their customers or accelerating new-product development. They're working to improve productivity not just with layoffs but by tearing down bureaucratic barriers between departments and investing in high-tech hardware. Over the past 18 months, real equipment spending has increased by 24%, with about two-thirds of the increase concentrated in information technologies. "The management challenge of the 1990s is to reduce costs--and increase the perceived value of the product," observes Arthur L. Kelly, a private investor and director
of Deere, BMW, and Nalco Chemical.
Above all, the relentless pressure of disinflation means that companies must constantly review all aspects of their business to make sure they're doing whatever it takes to offer customers high-quality goods at low prices. "We are in a period of low to no inflation that we may live with till the year 2000," says Southwood J. "Woody" Morcott, chairman and chief executive of Toledo-based Dana Corp., a $4.9 billion producer of automotive parts and other industrial products. "That means you have to get productivity improvements forever."
Of course, it may be too early to say that disinflation is here to stay. Inflationary pressures usually ease during slack times, and both the Federal Reserve and bond traders are convinced that inflation will roar back to life as the economy picks up. Many executives see rising prices on the horizon, too, arguing that business costs are being propelled upward by higher taxes, government mandates, and President Clinton's health-care-reform package. No doubt, inflation scares will periodically roil the markets, and there will always be some companies or industries that are able to raise prices. Even now, the 14% decline in the value of the dollar against the Japanese yen is forcing Japanese companies to hike prices in the U.S. on everything from memory chips to cars, which could give domestic rivals in those markets some pricing room.
Still, certain industries, such as tires and energy, lived with lower prices through much of the 1980s. By the turn of the decade, gale winds of international competition and deregulation propelled disinflation into a broad array of manufacturing and consumer-goods businesses. What is most striking now is the spread of disinflation to previously immune sectors of the economy, such as legal services and health care. Even in the pharmaceutical industry, which enjoyed the luxury of raising prices at twice the rate of inflation through the 1980s, price-cutting is becoming rampant.
PLENTY OF GOODIES. To be sure, disinflation's spread is far from bad news. It means that consumers won't have to worry about sticker shock every time they pick up a box of detergent. And corporations can count on stable or falling prices for a host of raw materials, parts, services, and labor--not to mention capital costs, which are at their lowest levels in 25 years.
But inflation was the devil we knew--and the devil that companies had learned to live with. When prices were soaring, hiking revenues and reported profits was as simple as changing a price tag. Pay raises were easy, too. "When you have inflation, it covers up a lot of sins," says Eugene P. Beard, chief financial officer at Interpublic Group of Companies Inc., the advertising-agency holding company.
Disinflation, by contrast, is a much sterner taskmaster. A 1% drop in price will slash operating profits by 12.3% for the average Standard & Poor's 1000 company, assuming that costs and volume remain the same, figures Michael V. Marn, a consultant at McKinsey & Co. To avoid that kind of devastation, a growing number of companies know that they can no longer let their internal processes determine price. Rather, it's price that must determine process.
In the traditional approach to pricing, a company comes up with a selling price by adding up its costs, factoring in overruns, and putting an acceptable profit margin on top. These days, such cost-driven pricing is a recipe for too-high prices and a nice wide opening for lower-cost rivals.
That's why some companies are reversing the price equation. At General Motors Corp.'s Cadillac division, for example, marketers begin by setting a target price for a new model. "Then, you say your profit is so much, and you back down into the cost. We never used to do it that way," says Janet Eckhoff, Cadillac's director of marketing and product strategy. "We're backing into the [price] from the customer's perspective now." Her boss, GM Chief Executive Jack Smith, is a big believer in the target-pricing technique.
This seemingly simple shift in pricing philosophy has profound implications for product development, sourcing, manufacturing, and management. For example, target pricing won't work if it takes five to six years to develop and produce a car: Costs, competition, and consumer demand will have shifted too much in half a decade. To set a realistic sales price, the development cycle must be three years or less, as it was with the Neon, Chrysler Corp.'s new $9,000 subcompact. In turn, speeding up the development cycle requires stitching together teams from engineering, design, finance, marketing, and production. It means empowering workers and using lean manufacturing techniques. It means working with suppliers to deliver quality parts. Many of these efforts were already under way as companies strove to improve productivity, quality, and customer responsiveness. But disinflation has made them vastly more urgent.
TEAM EFFORT. Compaq is a case in point. After being battered for several years by low-cost personal-computer rivals, Compaq struck back in 1992. It now builds computers that cost up to 60% less through what it calls "design to price."
Here's how it works: A design team comes up with specifications for a new computer. It sits down with marketing, manufacturing, customer service, purchasing, and other departments. Based on a price target set by marketing and a profit-margin goal from management, the team determines what the costs will have to be. To achieve cost targets, engineers design products with fewer parts, and reuse parts from existing designs. Compaq's factories have been overhauled to crank out products more cheaply. And supplier contracts have been renegotiated, cutting material costs by $212 million in 1992 and $425 million this year.
The first products manufactured under the new pricing system, the Prolinea personal computer and the Contura notebook computer, came out in less than eight months. Since the third quarter of last year, Compaq's sales volume has skyrocketed 64%, and profits have nearly doubled.
Cincinnati Milacron Inc. is another manufacturer that is paying renewed attention to manufacturing during the design process. It now builds machine tools with 30% to 40% fewer parts. On the new Maxim 500, a machining center it introduced last year to replace its T-10, design streamlining reduced the number of fasteners from 2,542 to 709 and cut assembly time from 1,800 hours to 700 hours. Altogether, the approach cut production costs by 36%--and the selling price for the Maxim 500 is the same as it was for the machine it replaced. Plus, the Maxim takes up 60% less floor space, can be installed and started up in two days instead of two weeks, and makes much more rapid changeovers, which sharply increases productivity.
Similar tactics paid off in lower production costs for Milacron's plastic injection-molding machines, which now typically sell at 7% to 9% below list price. "Five years ago, we couldn't be profitable with that [discount]," says Milacron CEO Daniel J. Meyer. "Now, we can not only be profitable, we're gaining market share."
Other companies are seeking to escape pricing pressure by embracing a "value-added" strategy--introducing a new or improved product that can still be sold at a premium price. Intel Corp. has its Pentium microchip, Gillette Co. has its Sensor razor system, and Goodyear Tire & Rubber Co. has its Aquatred, an all-season radial designed to provide better traction on wet roads. The Aquatred costs an average of $90, about 10% more than Goodyear's previous top-of-the-line mass-market tire. Yet the company has sold more than 2 million Aquatreds since its introduction two years ago. Goodyear concentrates on speeding new products to market and backing them with strong merchandising and advertising campaigns once they get there. "If you can have a richer mix, that's as good as a price increase on the lower end," says Chief Executive Stanley C. Gault.
QUALITY GENERICS. But selling value may be the toughest marketing job around these days. For one thing, the quality of many generic products, from diapers to cigarettes to drugs, has dramatically improved in recent years. The inroads of generics forced Philip Morris Cos., for example, to slash prices on its flagship Marlboro brand by 40 a pack. With brand loyalty on the wane, it's a challenge for marketers to find the right price gap between a name brand and a low-cost rival. "A brand will carry a premium, but the question is, how much of a premium?" says George J. Bull, Grand Metropolitan PLC's CEO for food operations.
Moreover, consumers now expect low prices even on many value-added products. Emerson Electric Co., an $8.2 billion instruments-and-electronics maker, finds it increasingly difficult to raise prices even on innovative products. "In general," says Emerson CEO Charles F. Knight, "customers see little reason for price increases." Emerson and most other manufacturers, he adds, are sharing whatever cost reductions they get with their customers, putting even more downward pressure on prices.
That has some companies taking virtually the opposite tack from premium pricing: They're stripping down, selling a product at a cheaper price by offering less. It's a tactic Southwest Airlines Co. has exploited to become the most profitable carrier in its industry, and United Airlines Inc. may emulate it by setting up a new low-cost subsidiary to compete against short-haul rivals. Says Robert L. Crandall, chief executive of AMR Corp., parent of American Airlines Inc.: "The market is telling all the traditional airlines that they must compete in a low-cost, low-price world."
Even such a flashy brand marketer as Reebok International Ltd. is stripping down. Its best-known sneaker is the $135 Shaq Attaq, named after Shaquille O'Neal, the popular center for the Orlando Magic basketball team. But sales of such top-of-the-line sport shoes, after surging for much of the 1980s, have been slowing sharply industrywide. So Reebok plans to launch four different versions of the Shaq Attaq next year, with prices ranging from $60 for a stripped-down sneaker to $130 for a gadget-laden one. It expects to sell most of its shoes in the $50 to $80 range in 1994--about $10 to $15 less than last year's best-selling range.
Another costly tactic that some companies are stripping away is the frenzied rebate and discount strategy they once relied on to lure customers. They're using the savings from eliminating such costly promotional gimmicks to pay for everyday low prices. Consumer giant Procter & Gamble Co., for example, has slashed its promotional spending to help pay for 10% to 25% price cuts on several of its products, including Pampers and Luvs diapers, Liquid Tide detergent, and Folger's coffee.
LEAN TAB, FAT MARGINS. And on Oct. 4, Burger King Corp. abandoned coupons, discounts, and direct mail as key weapons in the fast-food wars. Instead, it's using everyday low "value pricing" and "combo meal" bargains, much like McDonald's Corp. and Taco Bell before it.
In most markets, Burger King is cutting the price of its croissant-sandwich breakfast combo to $1.99 from $2.47, and its Whopper hamburger with french fries and a drink is down to $2.99 from $3.72. The savings from getting rid of promotions means that the new strategy won't have much of an impact on profit margins in the near term, and higher volumes will eventually show up in better margins, says Sidney J. Feltenstein, Burger King's senior vice-president for marketing.
New information technologies are also helping some companies price better. Data bases and computer networks allow managements to move away from traditional average- pricing techniques. Instead, the new information technologies let companies closely track customer preferences and finely target prices, says McKinsey's Marn. Similarly, new accounting systems, such as activity-based cost accounting, allow managers at Hewlett-Packard, General Electric, and Dana to quantify in depth the costs of production inefficiencies. And having a better handle on production costs encourages smarter pricing.
In industries such as health care, the pressure of disinflation is also driving companies into mergers and alliances that would once have been unthinkable. Consider Merck & Co.'s $6 billion purchase of Medco Containment Services Inc., the country's largest drug discounter. Then there's Columbia Healthcare Corp.'s $5.7 billion acquisition of HCA-Hospital Corp. of America, which will create the nation's largest hospital chain. The purchase fits with Columbia's push to add volume and cut costs in response to price pressures. "Our strategy is focused on believing that prices will come down," says Columbia CEO Richard L. Scott.
Nevertheless, considering the inflation experience of the past three decades or so, does it make sense for companies to go through the turmoil of adapting to a disinflationary world? It certainly seems so, especially as price wars rack industry after industry, from airlines to cigarettes. "We've found the U.S. to be the most price-competitive market in the world," says David de Pury, co-chairman of the board at ABB Asea Brown Boveri Inc., the Swiss-Swedish maker of capital equipment.
The pricing pressures are global, though. Japan is flirting with deflation, as is most of Europe. Worldwide, overcapacity plagues machine tools, chemicals, consumer electronics, and computers. Zenith Electronics Corp. figures its prices for VCRs and TVs have dropped more than 3% a year since 1984. Its lost revenue from falling prices tops $2 billion over the past 10 years, says CEO Jerry K. Pearlman.
Continued corporate bloodletting also means that disinflation is likely to be a fact of life for some time. In just the past few weeks alone, Woolworth Corp. said it plans to eliminate 13,000 jobs, four major drug companies reported a total of 11,000 layoffs, and Anheuser-Busch Cos. announced a 1,200 person cut. Overall, employment is about 3.5 million workers below what the job count would be if the U.S. were in a typical post-World War II recovery, according to Stephen S. Roach, economist at Morgan Stanley & Co.
Disinflation, like inflation before it, is taking on a momentum of its own. Pricing pressure leads to more restructurings, and restructurings lead to more disinflation. Every twist in pricing strategies for a low-inflation world ends up reinforcing the disinflation trend.
Today, prices are signaling companies to move beyond the slash-and-burn strategies of cost-cutting and reinvent their organizations to thrive in a world of low inflation. Low everyday prices--with vast everyday implications--are here to stay.
Stragegies For Thriving In Disinflationary Times Target Pricing Forget traditional cost-plus pricing. Instead reverse the equation for price-driven costing. Meeting corporation to speed up new-product development, simplify design, and reorganize the work flow. Value Pricing Coupons discounts, and rebates have gotten out of hand. Cut back on expensive promotions and instead offer stable, low, everyday prices. Stripping Down Offer cost-conscious customers quality products with fewer bells and whistles at a cheaper price. Adding Value Introduce innovative products sold at a modest premium. Back advertising campaigns. Getting Close To Customers Find out what customers really want and give it to them. Use the new information technologies to closely track their needs and your costs. Going Global The future is now. It's mature markets offer more pricing flexibility.
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