(FORTUNE Magazine) – XEROX LAST YEAR celebrated the 25th anniversary of the first commercial fax machine, which it introduced. The company controlled 7% of U.S. fax sales in 1989. Japanese companies had two-thirds. -- Raytheon in 1947 sold its first Radarange, a microwave oven marketed to restaurants. When the company introduced a household version 20 years later, sales boomed. Now four out of five American homes have microwaves. But three out of four microwaves sold here are made in the Far East. -- American-owned companies built 80% of the autos sold in the U.S. in 1979. Over the following decade U.S. carmakers shuttered 13 North American car and truck assembly plants, while 11 new plants opened under Japanese management. The Big Three's share of domestic sales fell to 67%. What is wrong? Maybe nothing is: America's economy is in its eighth straight year of growth, U.S. workers remain far more productive than Japanese, and the nation has regained the No. 1 share of world exports from West Germany. But still. It isn't easy to squander the enormous advantage of being the so-called first mover in an industry, let alone that of operating in the world's biggest market, yet time after time American corporations have managed the feat. In just ten years, in just two industries -- consumer electronics and computer chips -- imports have stolen market share that was worth $11.8 billion last year. These are among the great U.S. industrial blunders of our time, mistakes so massive that you've got to wonder what on earth could have caused them. No single factor explains them. A number of suspects have been fingered, including government policy, foreign conspiracies, feckless consumers, Wall Street buccaneers, even the Harvard business school. None is innocent. But, like a dousing rod indicating an underground stream, the finger of blame keeps pointing back to one place. If you want to see the villain up close, put down your (German-made) binoculars. He's sitting in your chair. Macroeconomics matters, but management means more, and in the histories of ''lost'' industries some management misconceptions appear time and again. American business has paid for them dearly. Here are some of the worst of these misconceptions -- which lead to blockbuster mistakes. -- ''Labor costs are killing us.'' The U.S. harbors a long tradition of thinking that costs, particularly labor costs, are all that matter. Recently Robert Hayes, a manufacturing expert at the Harvard business school, got an SOS from the head of a company making integrated circuits. The company had poured $250 million into a plant bejeweled with statistical process controls, computer-integrated manufacturing, the works. Though labor is less than 5% of the product's cost, labor was the problem: The workers, a quarter of them illiterate, couldn't handle the new machines. ''Why did you hire them?'' Hayes asked. Because, the executive explained, he needed several hundred workers and could not find enough literate ones in the new location. ''Then why put the plant there?'' Hayes asked. Came the reply: ''Because it has one of the cheapest labor costs in the country.'' Many managers overlook the fact that labor is less than 15% of the cost of most products. Says MIT President Paul Gray: ''By and large industry still has a Frederick Taylor-Henry Ford view that the worker is a cost to be minimized, not a resource to be maximized.'' Escaping that vision was one reason Ford's old company outmanaged GM and Chrysler in the 1980s. Ford runs eight of the nine most efficient auto factories in the U.S., according to a new study by Harbour Associates -- and that includes Japanese-owned plants. The secret? According to Philip Caldwell, Ford's CEO from 1979 to 1985, the company's quality and employee involvement program deserves much of the credit. It worked, he says, because Ford shared its problems with the union, focused on quality rather than costs, and had patience. For two years, he recalls, ''We couldn't see any improvement at all. Nothing. We looked at the numbers every month in detail. We kept asking, 'What's wrong? Why?' There were no answers, so we kept on doing it. Then all of a sudden, the results started coming in faster than we could count. It was like the tide in the Bay of Fundy.'' When the consulting firm A.T. Kearney surveyed U.S. companies planning new facilities, more than half said pursuing lower costs was their chief goal. American business has to learn that costs of any kind are only half the competitive equation: The customer wants value for money. Chrysler's Lee Iacocca says consumers fork over about $2,000 more for Japanese cars than for comparable American models because they believe they're getting a better machine. Says Harvard's Hayes: ''As we've been focusing on cost, the focus of competition has been shifting to quality and responsiveness.'' -- ''We'll get nibbled to death by ducks.'' A narrow focus on costs encourages another mistake: walking away from low-margin commodity businesses, where savings are hard to get. Perhaps the most celebrated example centers on the transistor, invented at Bell Labs in 1948. The Japanese soon began using transistors in millions of cheap radios -- a commodity product if ever there was one. Why should anyone care who leads the world in cheap radios? Because the experience gave Japanese transistor producers valuable expertise that in time put them ahead of everyone else. That helped Sony, Matsushita, and the rest demolish most U.S. production of color TV sets -- RCA's most famous invention. The belief that the low end doesn't count because the profits are in the high end is myopic, says David Nadler, president of the Delta Consulting Group. Companies cushioned by high-end margins often lose touch with customers and ignore small but vital upgrades in products and processes. The surprise for many American executives is that in industry after industry, from motorcycles to mainframes, competition from below has been more formidable than competition from above. That's because last year's commodity business has a way of becoming next year's high-tech miracle. Liquid crystal displays began their commercial life in mass-produced watches. Two decades later they are a critical technology in high definition television and in Sony's new palmtop computer. Or take gallium arsenide, the metallic semiconductor used in powerful microchips. Because it's tricky to work with, one path to progress is to get the stuff out of the lab and into low-end uses, like those cheap radios. They will involve the high volume that will produce the experience that will yield knowledge of how to work with the material. But scarcely any U.S. companies are using gallium arsenide in high volume. Meanwhile, tens of millions of gallium arsenide laser diodes go into Japanese compact disc players each year. It's a long leap from diodes to integrated circuits -- but the market has helped the Japanese perfect the quality of gallium arsenide crystals, benefiting advanced applications. Gallium arsenide also can be used in telephones for cars and trucks; because it has six times the frequency range of silicon, it can carry far more phone traffic. Ford's aerospace division does gallium arsenide research, but the carmaker has not pursued the potential synergy, even though getting into the car phone business was one of Caldwell's pet projects. (When he retired, Ford's design executives gave him a model of a Lincoln Town Car wired with working phones.) Other accessories like radios and air conditioners are now designed into a car. But phones are not integrated yet, despite Caldwell's efforts. He's still trying: When McCaw Cellular went into play last year, Caldwell, now at Shearson Lehman Hutton, urged Ford to invest in the company -- unsuccessfully. So U.S. industry still has no high-volume uses for gallium arsenide. -- ''It's great, but we don't know how to sell it.'' Without customers, no products; without products, no customers. It is a familiar catch-22, pointing to another mistake: Americans are the world's greatest innovators and also its greatest mass marketers, but they often fail to link the two. Raytheon's microwave oven was a terrific innovation, and the company did a splendid job of commercializing it. But when America's big appliance makers entered the business they had the wrong vision of the market. They put their money on large ovens and combination microwave-conventional units sold next to refrigerators and washing machines in traditional appliance stores. The Japanese lacked easy access to these stores because they didn't export many appliances, so they went into the outlets they knew: consumer electronics stores. Partly as a result, the Japanese built portable countertop units -- which customers loved. Says Roger Schipke, former head of GE's appliance business: ''We finally woke up in 1980 to the fact that the microwave was a convenience oven entirely different from a conventional one.'' If the appliance companies misread the market, consumer electronics companies misread the whole industry. RCA scientists predicted in the early 1960s that the future of microwave technology was in industrial applications and that consumer appliances would be long shots. Fax machines reveal a different problem in fitting product to market. Xerox's fax philosophy came from the copier side of the company, where the highly successful strategy was, says CEO Kearns, ''to rent the machines and put meters on them'' by charging for use and service. But to make money that way in the fax business you'd have to own the telephone lines. As Kearns says, ''the meter is on the phone system.'' Nor could Xerox build a high-quality, $ low-cost machine and sell it at a profit. Its factories simply could not match the competition's. So instead the company planned to link faxes with copiers and computers in one giant metered network. By 1980, when Japanese fax machines first invaded the U.S. in force, the astonishingly creative researchers at Xerox's Palo Alto Research Center were already working to tie the three machines into a complete document processing system. That vision may become reality in the next few years as the technology becomes better and cheaper. Back in 1980, Xerox had run so far ahead of the market that it couldn't have seen it with a telescope. Does hindsight provide any lessons on how companies can avoid mismatches between innovation and market? McKinsey consultant Michael Nevens has studied that problem for the Council on Competitiveness, the private-sector successor to President Reagan's Commission on Competitiveness. He concludes that companies should set goals for commercializing innovation, measure development time, and set targets to shorten it. They should closely link R&D, design, manufacturing, and marketing. At most companies these operate in separate worlds, and manufacturing, in particular, is a second-class citizen. Rarer still: a company with the institutional memory and flexibility to transfer innovation from one business unit to another -- which means lots of interdivisional teamwork and gabfests at all levels of management. Says A.T. Kearney's Detlef Koska: ''Most executives have seen more factories on Mr. Rogers than they have on the job.'' -- ''It's cheaper to buy it than grow it.'' U.S. business spends too much money buying and selling operations and not enough building them. That's a relatively new phenomenon, says Alfred Chandler, the dean of business historians: ''I haven't found a bank that had a mergers and acquisitions department before the late Sixties.'' The conglomerate movement of the 1960s and the divestitures of the next decade created a fundamentally new business: buying and selling companies. Many acquisitions and divestitures are beneficial. But a steady diet of them gets top managers thinking about strategy without knowing the nitty-gritty of operations. A generation of B-school-trained executives was brought up on the theory of ''portfolio management,'' and as manufacturing expert Robert Hayes points out, its very nature is to focus on ''restructuring and rearranging the boxes'' on the diagram of corporate holdings ''rather than getting inside them'' to manage each operation better. For companies that would rather acquire and divest businesses than grow their own, ''If it ain't broke, don't fix it'' has a new corollary: ''If it is broke -- sell it.'' Portfolio management is fertile soil for two kinds of mistakes. First, as operating units are treated as ever salable, stand-alone businesses, walls arise between them that inhibit sharing technology, sales forces, and wisdom. Second, a company spread across many enterprises will eventually have to match the investments of less diversified rivals in each one or get out. Remember that GE was once a major player in mobile telephones, consumer electronics, computers, and semiconductors. But these were only a few of GE's businesses, and specialized competitors, mostly foreign, drove them out of each one.

Hayes's Harvard business school colleague Michael Porter is studying why U.S. companies shuffle too much and build not enough, or, as he explains it, ''why companies underinvest in certain areas -- why they spend billions on acquisitions but not enough on plant and equipment, R&D, and human resources.'' Among the reasons he sees: a capital market that loves startups while shying away from the large investments they may need later to become big league. Another is the use of management techniques, such as discounted cash-flow analysis, that treat life-or-death business decisions no differently from more prosaic investment choices. Years ago U.S. consumer electronics companies needed to invest huge sums in efficient factories just to survive -- and hang the rate of return. Instead their managers calculated that the expected return wouldn't beat their cost of capital, so they dropped out of one business after another, eventually losing almost the whole industry. If IBM had demanded as high a rate of return on its early computers as it earned on other products, it might still be making adding machines. Harried by raiders and battered by competitors, American business has grown cautious. Its greatest mistake now may be that it tries too hard to avoid mistakes, hesitates to admit them, and therefore cannot learn from them. U.S. companies today are perhaps most likely to fail because they lack grand visions and the courage to follow them. ''It sounds off the wall,'' says Lester Thurow, dean of MIT's Sloan School of Management, ''but I'd argue that there is a crucial difference between the entrepreneurs of a hundred years ago and those of today. People in the first period wanted to be empire builders. That was even James J. Hill's nickname -- the Empire Builder. But would any American businessman today stand up and say, 'I'm building an empire'?''