Spence (1984) - Cost Reduction Competition And Industry Performance

• This page is referenced in PHDBA602 (Innovation Models)

Reference(s)

• Spence, Michael (1984), "Cost Reduction, Competition, and Industry Performance', Econometrica, Vol. 52, No. 1 (Jan.), pp. 101-122 (pdf)

Abstract

In many markets, firms compete over time by expending resources with the purpose of reducing their costs. Sometimes the cost reducing investments operate directly on costs. In many instances, they take the form of developing new products that deliver what customers need more cheaply. Therefore product development can have the same ultimate effect as direct cost reduction. In fact if one thinks of the product as the services it delivers to the customer (in the way that Lancaster pioneered), then product development often is just cost reduction. There are at least three sorts of problems associated with industry performance. They occur simultaneously, making the problem of overall assessment of performance quite complicated. The problems are these. Cost reducing expenditures are largely fixed costs. In a market system, the criterion for determining the value of cost reducing R & D is profitability, or revenues. Since revenues may understate the social benefits both in the aggregate, and at the margin, there is no a priori reason to expect a market to result in optimal results. Second and related, because R & D represents a fixed cost, and depending upon the technological environment, sometimes a large one, market structures are likely to be concentrated and imperfectly competitive, with consequences for prices, margins, and allocative efficiency.