Welcome To The Age Of Disinflation

A rare disinflationary expansion is coursing through America's economy. Falling prices are setting off a boom right where the economy needs it--in capital equipment. Capital spending, led by expenditures for high-tech gear, has been galloping ahead at a 15% annual rate for the past six quarters. At $185 billion, spending on high-tech equipment is up 45% since mid-1991 and is now larger than the total amount of money going into all nonresidential construction, including plants, offices, shopping centers, etc.

Disinflationary expansions are something of an economic oxymoron. Economic theory suggests that surging demand for products normally generates pressures for higher, not lower, prices and produces higher, not lower, inflation. This time, however, the opposite is happening. Fast-moving changes in digital technology are sending prices on computer-based equipment plummeting. Third-quarter prices for high-tech capital goods were an amazing 8.3% lower than a year earlier. These lower prices, in turn, generated enough demand to boost spending by an impressive 20.8%.

Welcome to the Age of Disinflation. Pricing power is dead. Price cutting is king. With stagnant income growth in the U.S., Europe, and Japan, price cutting is key to boosting consumer demand, sales, and profits.

The Age of Disinflation is being born of two connected global forces--vast technological change and the opening of international markets. While technology drives down the cost of computer chips, the spread of markets to formerly communist and statist economies pushes down the cost of labor, goods, and even services. In Detroit, auto workers compete against counterparts in Mexico. In Silicon Valley, software writers go head to head with programmers in Russia and India.

Many corporations are blazing trails into the new disinflationary wilderness. The mantra for the '90s is "price determines process." The game is to learn what customers are willing to pay for a product, then reverse-engineer the corporate process to hit that target. Instead of price being based on a company's costs, price now drives those costs.

The new world of disinflation demands a reorganization of corporate behavior to ensure speed, flexibility, and innovation. Companies that shed too many skills and competencies in search of the last penny may find themselves unable to reengineer themselves and unprepared to fight the pricing wars of the late 20th century.