Stanford University
Graduate School of Business
JUNE, 1997
For information, contact Janet Zich, [email protected], or
415/723-9193
Low-cost Production, High-tech Success
STANFORD - Innovation is always necessary if a firm is to become a leader
in the high-technology area, say Stanford Business School's Evan Porteus
and Glen Schmidt. But while the ability to innovate can get a firm to the
top, it alone is unlikely to keep it there as new technologies and the
generations of products that accompany them arise. While low-cost
production on the current product is always helpful, low-cost production
achievable in future generations of products can make a crucial difference
to the success of a company.
By investing in a powerful and efficient design, manufacturing, and supply
chain infrastructure, a company may be able to scare a would-be competitor
from jumping into the market at all, thereby preserving its own dominance
as an innovator. However, if a company fails to design efficiencies into a
new product, then another innovator may decide it is worthwhile to mount a
challenge.
A focus on cost may appear counterproductive when an existing product is
threatened by new technology. In the high-tech field especially,
aggressively pursuing cost reduction might suggest that a firm has resigned
itself to simply competing on price rather than to developing leading-edge
products. Indeed, a firm may strive to be the leader in innovation rather
than in low cost to avoid finding itself empty-handed when a competing
company introduces a widget with new bells and whistles.
But Porteus, the Sanwa Bank Professor of Management Science, and Schmidt, a
doctoral candidate, tested those ideas. They developed a theoretical
modelthat weighs the trade-offs between cost and innovation and discovered
that a firm working only on "innovative competence" (its ability to pursue
a new technology with a minimum of investment and a high likelihood of
mastering the product) is shortsighted. "Cost competence" (a firm's ability
to achieve cost advantage on a new product) can significantly mag-nify the
benefits of innovative prowess.
The researchers found that companies must look broadly to evaluate the
benefits of cost competence. Those that evaluate an investment based only
on currently projected sales volumes of the next-generation product may see
little benefit. However, once the cost advantage a company can achieve on
the next product passes a certain point, potential competitors are deterred
from entering the market. At that point, the company that has laid the
groundwork for low costs is likely to enjoy high profits. Firms that invest
in cost competence as well as maintain their ability to innovate are apt to
invest most in new technologies. Thus, cost competence leads to, and may
even be essential to, clinching a company's position of leadership in
innovation.
Porteus and Schmidt insist a firm needs to assess the impact of cost
reductions not only on the current product but on the next generation of
products. While investing in cost competence now could shrink the bottom
line a little bit, it could result in much higher profits later. If a cost
advantage the firm achieves today can carry over to the new product
generation, the advantage will continue as new technologies arise. That's
why a company has a strategic incentive to pursue cost leadership.
By Barbara Buell
-30-
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