Survival of the Fittest (Cheapest?)


According to Wikipedia, survival of the fittest is a phrase that originated from Darwin’s evolutionary theory as a way of describing the mechanism of natural selection.

In the corporate world, perhaps an appropriate corollary would be, survival of the lowest costs, and the probable fate of high cost producers as an industry develops excess capacity.

In highly competitive industries, such as vehicle manufacturing, being a high cost producer can be manageable as long as supply and demand are substantially in balance.  However, as demand falls, or capacity increases, the high cost producer becomes increasingly less competitive.  In order to continue to compete, high cost producers have little alternative but to reduce prices, which puts pressure on margins and eventually leads to potentially overwhelming operating losses.

Investors should understand the relative costs when assessing opportunities.  While there is a general understanding that the low cost producer eventually wins, there is usually room for higher cost producers as long as demand stays strong.  However, during periods of economic stress, or other factors that reduce overall demand, the high cost producers tend to be the most vulnerable

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA

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