It's Not Luck - Eliyahu M. Goldratt [52]
“First year course in economics,” Jim says cynically.
“No, it is not,” Brandon beats me by a hair’s breadth, “and stop being such a smart aleck. Don’t you realize what Alex wrote here? The pendulum is swinging to the market side, unrelated to the relation between supply and demand.”
“What do you mean?” Jim is surprised by Brandon’s fierce reaction.
“Let me explain,” I try to cool them down. “What we said is when competition becomes very fierce, like the situation when it’s also fueled by a technological race, when companies throw new products into the market every few months, in such cases prices will continue to go down, even when demand is higher than supply.”
“But that can’t be,” Jim protests.
“If it cannot be, then you must point out to us where we went astray; where exactly the mistake is in our logic.”
Jim bends over the table to reexamine our tree, but Brandon says to him, “Don’t bother. Alex is right. Look, for example, at the electronic wafer industry. Demand is much greater than supply. All the wafer plants everywhere are huge bottlenecks. The backlog, right now, is well over a year. Nevertheless prices continue to dive.”
“I guess you’re right. I’ll have to think it over. Brandon, if that’s the case, then in many relatively high-tech companies we are invested in, we shouldn’t expect that the recovery will lead to increases in their product prices. That is awful.”
“Jim, didn’t you suspect it? The recovery has been going on for almost a year now. Haven’t you started to scale down the profit forecast of those companies?”
“Not enough,” he admits.
“Can we continue?” I ask them. “We are about to connect to some more UDEs.”
It doesn’t help. Brandon continues to mutter, “First year economics . . . ” Jim is probably trying to reevaluate the future of some of his investments. Who said that practical results don’t come directly from the analysis stage?
Eventually I am able to continue to read. “If ‘Supplier perception of value is product cost plus reasonable margin,’ and ‘Prices and quantities sold are determined more and more by the markets’ perception of value and less and less by the suppliers’ perception of value,’ then, ‘In more and more cases the price that the market is willing to pay doesn’t leave enough margin,’ which is our UDE number three.”
“Simple, isn’t it?” Brandon teases Jim.
I don’t think that they’ll continue to smile after the next few derivatives. “Let’s view this branch,” I suggest. “If, as we said before, ‘Most managers believe that product cost is something real that quantifies the efforts absorbed by the product,’ then, ‘Most managers believe that selling below product cost leads (at least in the long run) to losses.’ ”
I examine them. They look at me. They look at each other thoughtfully. “Alex, don’t you believe it?” Brandon asks.
“If I don’t believe in product cost how can I believe it! I believe in the bottom line. But that’s beside the point. Do you agree with this derivative?”
“We believe that most managers believe in it,” Jim says. “As for us, for now, we would like to reserve our judgment.”
So far, so good, I think to myself, and calmly continue to read, “If ‘Most managers believe that selling below product cost leads (in the long run) to losses,’ then ‘Most companies are reluctant to accept orders with low margins and even go so far as dropping low-margin products.’ ”
“Alex,” Brandon says slowly, “are you telling us it is a mistake when we tell the management of our companies to strategically prune low-margin products?”
“It depends,” I keep a poker face. “When you ‘prune’ low-margin product you lose the money that you get from the clients who were buying that product. The question is do your resulting savings come to more than that amount.”
“We cut the variable cost, but we don’t always cut much of the fixed cost,” he admits.
“Brandon, stop fooling yourself,” Jim comes out strong. “Many times we don’t cut even the entire variable