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Pricing power eludes U.S. firms, weighs on profits

By Eric Burroughs

NEW YORK, Aug 29 (Reuters) - After two rough years, business is finally turning around at Yellow Corp.

But like many U.S. companies struggling to boost profits in a halting U.S. economic recovery, the trucking carrier is still finding it all but impossible to push up prices.

For vast swaths of U.S. business -- retailers, airlines, auto makers, software firms and telecommunications companies -- prices have been on a relentless slide due to a hangover of capacity from the 1990s boom as well as brutal competition.

"It's still pretty dismal," said Bill Zollars, Yellow's chief executive, of the current pricing environment.

As the economic environment has soured, customers and shoppers became increasingly reluctant to pay regular prices. To entice them, companies have resorted to rampant discounting in a game of chicken that has forced margin-conscious firms to cut costs and focus on productivity.

Even higher raw material costs, on steel or energy, are tough to pass on.

"It's great when you're a buyer, but it's a drag when you're a seller," said Paul Kasriel, chief U.S. economist at Northern Trust in Chicago.

For now, the power to hike prices and give profits a shot in the arm seems a long way off, economists said. And weak profits, in turn, are likely to weigh on economic growth by discouraging companies from spending or hiring workers, something vital to put the bumpy recovery on a smoother road.

The price declines have also raised worries the United States could fall into a deflationary spiral like that which ensnared Japan's economy in the late 1990s -- where consumers delay purchases in anticipation of lower and lower prices.

But while there is reason for hope, the outlook remains murky.

In the latest data on U.S. economic activity in the April-to-June quarter, profits edged higher. But by some measures that account for inventory valuation and other factors profits fell 1.7 percent for a second straight quarter.

"What's it going to take to get profits increasing at a faster rate? You need faster increases in prices, which a sluggish economy may not deliver," said Kevin Logan, senior economist at Dresdner Kleinwort Wasserstein.

Consumer price data show that the trend has improved only a little this year. In July the Consumer Price Index was up 1.5 percent compared with a year earlier, up from June's 1.1 percent gain but still at a very weak pace seen only once since the early 1960s.

GETTING PAST THE GLUT

In many industries, particularly technology and telecommunications, massive amounts of unused production capacity is expected to keep downward pressure on prices.

Even after having recovered from the lowest levels since the recession in the early 1980s, the Federal Reserve's measure of capacity utilization remains nearly 7 percentage points below its 25-year average.

The evidence of eroding prices is everywhere. After business software maker PeopleSoft Inc. reported its second-quarter earnings, chief executive Craig Conway described competitive discounting tactics as "desperate" and "suicidal."

In the past year, software prices are down 13.6 percent. Personal computer prices have fallen 24 percent. Prices on new and used autos have fallen 11 straight months and now stand where they did in 1995.

At Cook Technologies Inc., a specialty metal fabricator outside Philadelphia, the pricing environment is described as "not good" by its president, Tom Panazarella. He said the firm is buried under 60 percent excess capacity.

For Yellow, Zollars says the situation has improved but the company still has about 25 percent excess capacity, an improvement from 30 percent at the worst point of the slump.

Bankruptcies may put more downward pressure on prices in many industries. Instead of being liquidated, companies like U.S. Airways , WorldCom Inc. and Kmart seeking court protection from creditors could reemerge as competitors and slash prices to revive business.

"The hope is that some of these companies that are in bankruptcy don't make it out, they get liquidated, the industries are rationalized and there is better pricing power for the companies that remain," said Mark Zandi, chief economist at Economy.com.

PRODUCTIVITY TO THE RESCUE

Unable to push up prices, companies rely on better worker productivity as a key route to better margins -- although such productivity and cost-cutting perversely can hurt the economy by making new hiring unnecessary or even lead to more layoffs.

Fed Chairman Alan Greenspan summed this up in his recent testimony on monetary policy before Congress. "Those businesses where heightened competition has engendered a loss of pricing power have sought ways to raise profit margins by employing technology to lower costs and improve efficiency."

For Zollars, that has meant keeping the company's $80 million technology investment budget steady throughout the downturn rather than cutting back.

"We really believe that longer-term, that's a sustainable competitive advantage," he said.

About 20 percent of Yellow's 400,000 customers do business through the company's Web site now, compared with just under 1,000 three years ago. Meanwhile, information technology allows Yellow to effectively track its 70,000 shipments a day.

"We're constantly looking at two new kinds of technology: things that make it easier to let our customers do business with us and that make our internal business and network run more efficiently," he said.

While Yellow Corp.'s profits fell slightly in the second quarter compared with a year earlier, Zollars said profits should double in the third quarter if current trends continue.