Benefits of Intense Competition: Lower Prices and Better Products

No segment of our economy has been under more intense pressure than the manufacturing sector.  Lower labor costs in many parts of the international economy have forced manufactured product prices down and shifted manufacturing jobs out of the United States.  Competition has indeed been intense.

Over the years, we have done in depth studies of more than fifty industries who have faced intense competitive markets.  We found both what you might expect and, also, what you wouldn’t expect.  You would expect that costs in a difficult industry would fall as companies work to make a profit despite the falling prices that accompany intense competition.  What you might not expect is that product quality and supporting service levels increase at the same time as costs and prices fall.  Customers simply will not buy a poor product even if its pricing declines. 

The broad measures of the manufacturing sector illustrate these same conclusions.  Manufacturing in the U.S. is finally growing again.  In 2010, manufacturing jobs increased for the first time since 1997.  Today manufacturing is growing at three times the rate of the domestic economy.  Consider, as well, the following facts as noted by Jerry Jasinowski, a former President of the National Association of Manufacturers:

• American exports of goods rose 21% in 2010.  Conclusion: the quality of our goods is rising.

• Manufacturing output in the U.S. today is twice that of the rate of the 1970s, in real terms.  Conclusion: we are more cost competitive today than we were in the 1970s.

• Between 1987 and 2008, manufacturing productivity grew by more than 100%, while the rest of the business sector’s productivity increased by less than 60%.  Conclusion: we get far more out of our workforce today than we did in 1987 and than many businesses do today.

• Between 1995 and 2008, manufacturing prices decreased by 3%, while the overall price level in the economy increased by 33%.  Conclusion:  while product quality has improved, and costs have fallen, prices have also declined.

The overall picture the manufacturing sector portrays, over the last twenty-five years, is that hostile market conditions produce better products and lower prices for customers, both at the same time.

High Growth and Falling Profits

Recently, Europe passed legislation aimed at breaking long standing monopolies in Europe’s equity trading systems. As a result, a number of alternative trading systems poured into Europe’s equity markets.

The new market entrants are offering new technology and lower prices. They have succeeded in shifting significant market share away from the former industry leaders. In fact, four of the new entrants now control 16% of the trading in Europe’s equity markets. (See the Symptom and Implication, “Most share shifting in the industry seems to be coming from volume gained within existing customer relationships rather than from new customers” on StrategyStreet.com.) There is one problem, however, the margins are razor thin.

The problem is pricing. While all these new entrants poured into the market, the prices fell as they jousted with one another to gain their market shares. One of the companies has reduced its prices three times within the last four months. Industry prices are now down about 20%.

What are these new firms going to do about their poor profits? What any self-respecting low-end competitor would do if it has the opportunity. They are going to expand into other more complex markets and other asset classes that carry higher margins. This expansion will add relatively little cost because most of their trading systems costs are fixed. (See Video #6: Competition and Low-Cost Expansion on StrategyStreet.com.) In addition to improving margins, at least temporarily, this move into new asset classes and customer markets may help them in another way. These new trading systems will become more attractive because they become more of a one-stop shop for customers in the industry. The ability to offer one-stop shopping is usually a benefit offered by the industry’s leaders, whom we call Standard Leaders. This is one important reason that Standard Leaders dominate an industry.