Page 6 - 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.