The probability has increased significantly in the last few months that we are entering a deflationary period in the US.  Whether it will be mild deflation or severe deflation is what the debate will soon become.  How long will it last is anyone’s guess, but deflationary periods in the US in the late 1800’s and 1930s and in Japan and Switzerland in the 1990’s indicate that they do not dissipate quickly.

Although a few economists have written about deflation, I have not seen anyone yet deal with the issues of what a deflationary environment does to corporate strategies.  Given that the probability of deflation is increasing, it would seem prudent to start to think through how business and investment strategies would be affected.  So that will be my theme for the next few daily columns.

Those of us in the computer business are used to deflation – most of us have a hard time remembering when prices were not eroding for our products.  In fact, it may well be that price erosion of the computer industry has caused deflationary forces to spread into the rest of the economy.  Regardless, the computer industry is one industry that knows how to manage its business in an environment of falling prices.  Unfortunately, one cannot say the same thing about the telecom industry, where we were protected up until a few years ago from uncontrolled price erosion by regulatory bodies.  Telecom executives could learn a lot from their computer industry counterparts on this issue.

What is new for all of us is the fact that our customers are also experiencing deflation for the first time in their lives. Businesses have responded with cost reduction programs and cuts in capital equipment budgets.  Consumers have responded with a spending spree for durable goods, taking advantage of what they view as unusually good prices and terms. The most recent statistics indicate that the spree may soon be over, though, with consumer confidence waning, unemployment rising and defaults increasing.

The trillion dollar question is “What happens next?”  It seems clear that once established, deflation will not abate very soon – Japan, China, and Europe will make sure of that with their deflated exports.  I participated in a slew of IT industry 3Q conference calls in the last few weeks, which yielded some instructive conclusions.  Not one of you reported any up-tick in demand.  All of you are attempting to increase your earnings by cutting costs.  Nobody is increasing capital expenditures.  Everyone is digging in for a tough 2003.  Debt, liquidity, restructuring charges, and pension obligations occupied an unusual proportion of your presentations and discussion.

Despite all of these similarities, it seemed clear to me that some of you have figured out a strategy for winning in this environment, while others are continuing to hope the things will change soon while losing share.  In the former category I include you guys at IBM, Dell, Microsoft, and Cisco.  I fear that the rest of you (at least, the rest of you big IT vendors) may be in the second category.

The economy has turned a growth environment into a zero sum game or even a negative sum game (in telecom), and those companies with the right strategies and execution will survive and win at the expense of the others.  I’ll go further into these differences of strategy in an upcoming column.