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A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Fleischer, Manfred Doctoral Thesis The inefficiency trap: strategy failure in the German machine tool industry Provided in Cooperation with: WZB Berlin Social Science Center Suggested Citation: Fleischer, Manfred (1997) : The inefficiency trap: strategy failure in the German machine tool industry, ISBN 3-89404-173-0, Edition Sigma, Berlin This Version is available at: http://hdl.handle.net/10419/122877 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. 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Weitere Informationen zum Projekt und eine Liste der ca. 1 500 digitalisierten Texte sind unter http://www.wzb.eu/de/bibliothek/serviceangebote/open-access/oa-1000 verfügbar. This text was digitizing and published online as part of the digitizing-project OA 1000+. More about the project as well as a list of all the digitized documents (ca. 1 500) can be found at http://www.wzb.eu/en/library/services/open-access/oa-1000. Fleischer: The Inefficiency Trap Herausgegeben vom Wissenschaftszentrum Berlin für Soziaiforschung Abteilung: Market Dynamics Direktor: Professor Dr, Dr. h.c. muit. Horst Albach Manfred Fleischer The Inefficiency Trap Strategy Failure in the German Machine Tool Industry Die Deutsche Bibliothek - CIP-Einheitsaufnahme Fleischer, Manfred: The inefficiency trap : strategy failure in the German machine tool industry / Manfred Fleischer. - Berlin : Ed. Sigma, 1997 Zugl.: Berlin, Humboldt-Univ., Diss., 1997 ISBN 3-89404-173-0 © Copyright 1997 by edition sigma® rainer bohn verlag, Berlin. All rights reserved. No part of this book may be reproduced or copied in any form or by any means - graphic, electronic, or mechanical, including photocopying, recording, taping, or information and retrieval systems — without prior written permission from the publisher. Design: Rother + Raddatz, Berlin. Cover printing: Grondsatz GmbH., Berlin. Typesetting: Nina Bonge, WZB Printing and binding: WZB Printed in Germany Contents Preface 9 Acknowledgments 13 1. Product Differentiation and Performance: An Introduction 15 1.1 The Problem 15 1.2 Previous Research 19 1.3 Central Hypothesis, Methodology, and Outline of the Study 20 2. The Case of the German Machine ToolIndustry 23 2.1 A Typical Example of a Medium-Sized Capital Goods Industry 23 2.2 Stylized Fact 1: Considerable Changes in Demand 25 2.2.1 The Product and the Structure of Demand 25 2.2.2 Demand by Users 26 2.2.3 Changes in Demand by Machine Tool Types 28 2.3 Stylized Fact 2: Significant Stability of Concentration 38 2.3.1 Concentration and the Size of the Industry 38 2.3.2 Development of Concentration over Time 41 2.4 Stylized Fact 3: Limited Economies of Scale 44 2.4.1 Static Economies of Scale 45 2.4.2 Dynamic Economies of Scale 50 2.4.3 Underlying Capital Requirements 52 5 2.5 Stylized Fact 4: Increasing Product Differentiation 54 2.5.1 Product Differentiation as Measured by Product Variety 54 2.5.2 Product Differentiation as Measured by Product Innovation 55 2.6 Stylized Fact 5: Increasing Foreign Competition 61 2.6.1 Import Shares 61 2.6.2 Structure of Imports 63 2.7 Stylized Fact 6: Decreasing Industry Profitability 64 2.7.1 Profit Margins by Firm Size 67 2.7.2 Accounting Rates of Return 68 3 . Theoretical and Empirical Foundation of the Inefficiency Trap Hypothesis 70 3.1 Introduction 70 3.2 A Preliminary Explanation of Structure 74 3.3 A Typical Market: The Market for Machining Centers 80 3.3.1 The Market 80 3.3.1.1 The Demand Function 80 3.3.1.2 The Cost Function 85 3.3.2 A Test of Market Structure 91 3.3.2.1 Introduction 91 3.3.2.2 Coumot-Nash Equilibrium 93 3.3.2.3 Bertrand-Nash Equilibrium 96 3.3.2.4 The Impact of Fixed Costs on Market Structure 97 3.3.2.5 Conclusion 102 3.4 Product Differentiation and Market Structure 103 3.4.1 Introduction 103 3.4.2 Product Differentiation in Spatial Models 104 3.4.3 Combining Horizontal and Vertical Product Differentiation 109 3.4.4 Product Differentiation and Cost Reduction 110 3.4.5 Product Differentiation and Customer Reactions 113 3.4.5.1 The Doubly Kinked Demand Function 113 34.5.2 Albach’s Nonlinear Duopoly 116 34.5.3 Conclusion 119 3.5 An Explanation; The Inefficiency Trap Hypothesis 119 6 Hypothesis Test I: Analysis of Survey Data from the NIFA Panel 123 Introduction 123 Measurement Issues 128 The NIFA Panel 128 Product Differentiation 129 Productive Performance 134 Capacity Utilization 134 Value Added 135 Technical Efficiency 135 Market Performance 138 Intensity of Competition 139 Variation of Product Differentiation in the NIFA Panel 141 Development of a Simultaneous Equation Model 143 The Product Differentiation Equation 144 The Efficiency Equation 146 The Profitability Equation 147 Estimation Results 148 Conclusion 150 Hypothesis Test II: Analysis of Published Accounts from the Bonn Databank 152 Methodological Issues 152 Product Differentiation in Strategy Research 152 Introduction 152 Prior Strategy Measurement Studies in the Machine Tool Industry 154 An Index of Product Group Specialization 159 Choice of Performance Criteria 164 Limitations of Unidimensional Criteria 164 The Hexagon Criterion of Albach 164 The Z Value of Altman 167 Efficiency Measures 168 Implications for the Test of the Inefficiency Trap Hypothesis 170 7 5.2 Sample and Data 171 5.2.1 Structure of the International Machine Tool Industry 171 5.2.2 The Sample: German Machine Tool Firms with Published Accounts 172 5.2.3 The Data 173 5.3 Empirical Results 175 5.3.1 Profitability 175 5.3.2 Technical Efficiency 179 5.3.3 Strategy Analysis: Cost Leadership versus Product Differentiation 181 5.3.4 A Second Test of the Inefficiency Trap Hypothesis 184 6. Conclusions 185 7. Appendix 189 8. References 214 List of Figures 230 List of Tables 231 8 Preface The author of this book has taken up the challenging task of explaining the considerable loss of employment in the German machine tool industry in recent years. The central question is: Is this loss of employment a structural phe nomenon or one related to the business cycle? The answer presented here is very clear and convincing: It is a structural phenomenon. Firms of the German machine tool industry are plagued with their strategy of product differentiation, a strategy which created success in the past, it is true, but is shown to be counter productive today. Firms which now pursue a strategy of product differentiation without a matching strategy of cost leadership are showing losses and risking their competitiveness. This clear-cut result is derived convincingly with the use of different methodological approaches; the most interesting among these are the strategy map and the strategy portfolio. These results of these methods (and a number of others) provide convincing evidence for Fleischer’s proposition that the German machine tool industry evolved in a way which led itself into an inefficiency trap. The book is clear and concise. In the second chapter, six “stylized facts” are derived, which describe the major characteristics of the German machine tool industry. Statistics in this section show a significant stability of the firm size distribution, although considerable changes in demand are observed. Foreign competition increases, firms do not meet intensified competition by exploiting economies of scale. Instead, they increase product differentiation which cannot prevent further decreases in profitability. These six facts outline the thesis which Fleischer develops. The German machine tool builders have placed their bets on the wrong horse. As Fleischer proves, greater cost efficiency rather than stronger product differentiation would have been be the more appropriate strategy. Only cost competitiveness has the desired impact on the customers of the machine tool industry, since only the supply of cost efficient equipment keeps them alive in a situation of increasing international competition.