Page 5 - Portfolio Analysis

The strategic significance of the experience curve effect lies in the implication that increasing a company’s product volume and market share will also bring cost advantages over competition. This will, of course, depend upon each competitor’s position on the experience curve. Relative market share is a good surrogate for this, even taking account of the fact that some competitors may have entered the market by buying experience through licences or acquisitions. In any case, it follows that the competitor with the greatest accumulated experience will have the lowest relative costs and, if prices are similar between competitors, the lowest cost firm will also have the highest profits. Companies that fail to reduce costs and are not dominant will be at a competitive disadvantage. Figure 2 above, shows a price prevailing at one point in time. Over the long run, prices will decline at roughly the same rate as costs decline. The major exception to this rule occurs during the introduction and growth stage of the life cycle, when the innovator and/or dominant competitor is tempted to maintain prices at a high level to recoup its development costs. The high price umbrella usually achieves this immediate end because unit profits are high. The drawback is the incentive this provides to higher cost competitors to enter the market. In effect, the dominant competitor is trading future market share for current profits. This may be sensible if the early leader: 1) has a number of attractive new product opportunities requiring cash, 2) is faced with potential competitors whose basic business position will enable them eventually to enter the product category regardless of the pricing strategy, or 3) is confident that significant barriers to entry can be erected. Clearly, in determining corporate strategy a balance must be struck between those businesses which require cash injections and those which generate excess cash. The achievement of this balance is the art of portfolio management.