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Innovation is always necessary if a firm is to become a leader in the high-technology area, say the GSB'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 model that 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 magnify 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.
"Does Technology Leadership Require the Ability to Produce at Lower Cost?" Glen M. Schmidt and Evan L. Porteus, GSB Research Paper #1431, March 1997.
By Barbara Buell