(FORTUNE Magazine) – Hormel Foods is facing a marketer's nightmare. (No, we're not talking about the fact that one of its best-known brands, Spam, is synonymous with unwanted e-mail.) Prices for one of Hormel's core products--fresh pork--are dropping because of an oversupply of hogs. And consumers are losing their appetite for slow-cooking homemade braises and roasts.

You'll find similar scenarios playing out at companies all across the country. Just substitute televisions, cellular-phone service, or hotel rooms for pork. Call it selective deflation. While the overall U.S. economy has stubbornly deflected deflation--the consumer price index rose 0.3% in March--many industries have been suffering from sustained falling prices. Women's clothing, for example, is about 3% cheaper than it was last year. Audio equipment costs some 6% less.

That's good for thrifty consumers. But unchecked, deflation can cause havoc for a corporation, not to mention its employees and shareholders. It's no coincidence that some of the biggest bankruptcies in history (United Airlines, Kmart, WorldCom) have occurred in industries facing massive pricing pressure. If companies don't cut costs quickly enough or find new revenue sources--or both--they may find themselves unable to pay their bills or their workers. But rather than treat deflation as a life-threatening emergency, many companies fail to take dramatic action, simply because they've grown used to it. "Deflation is sort of like a headache that you've had for a long time," says William Rochelle, a bankruptcy attorney with Fulbright & Jaworski in New York City. "If you've had it long enough, you don't even realize you've got a headache."

Deflation doesn't have to be a pain for companies, though. In fact, it can be a much-needed kickstart to innovation. Consider Dell Computer, which has been living with deflation since its inception and which constantly reinvents itself to survive. Other big companies have gotten the message too, though their approaches are often very different. Here's how three--Hormel, AT&T, and General Motors--are coping with falling prices.

HORMEL'S IDEA: CRANK OUT HIGHER-MARGIN PRODUCTS. Thanks to big productivity gains and limits on exports, the meat industry faces a classic imbalance of supply and demand: Prices for fresh and frozen pork fell a whopping 13% last year, according to the Labor Department. Yet Hormel managed a slight revenue increase, to $3.9 billion, and improved its operating margins.

How? By creating a whole new class of products. Hormel is increasingly turning its low-margin fresh pork--slabs that groceries and restaurants butcher themselves--into highly profitable heat-and-serve meals. These precut, value-added products, such as teriyaki-flavored loins, are easier for consumers to cook. "We had all these pounds of meat coming at us," says CEO Joel Johnson. "There's a bit of desperate creativity that kicks in."

Turns out that Hormel's frantic move was no pig in a poke. Busy families were avoiding pork because they were not sure how to cook the stuff properly. Grocers, eager to win business back from takeout restaurants, cleared refrigerator space eagerly. In 1996, Hormel introduced its line of Always Tender pork products, which arrive at the grocery store marinated in a patented "secret sauce" of salt, water, phosphate, and sodium diacetate (yum!) to keep the meat from drying out while cooking.

So far the strategy is working. The company today sells more than 162 million pounds of value-added pork; back in 1995 it sold none. Not only do these prepared meat products offset top-line deflation in Hormel's commodity pork operation, but they also yield juicier profits. The company says margins on its top-rung pork products--such as precooked entrees--are, on average, five times greater than the profits on a plain old pork loin. The most processed poultry, such as marinated-turkey entrees, makes 15 times the profits of a whole bird. As a result Hormel eked out an 8.3% operating margin last year, up from 7.9% in fiscal 2001, while analysts say some pork-producing peers, such as Smithfield Foods, struggled.

Hormel keeps looking for ways to add value. In its roughly $1-billion-a-year food-service business the company is offering bulk quantities of presliced, pre-marinated products to restaurants and cafeterias. Next up: specially packed entrees that can go straight from the fridge to the microwave to the table without additional cookware. A lazy cook's dream!

AT&T'S IDEA: STREAMLINE OPERATIONS. Massive discounting in the telecommunications sector (see charts) has clobbered Ma Bell. Last year its top line shrank 10%. Many analysts predict that the situation will only worsen when WorldCom emerges from bankruptcy with restructured debt and more pricing flexibility. To cope, the former telephone monopoly is finally doing something its critics have been urging it to do for years: consolidating and cutting costs in its core network and business operations. "We call it the 'concept of one,'" says Hossein Eslambolchi, AT&T's chief information and chief technology officer. "It means do it once, do it right, and do it everywhere."

Sounds simple. But simplicity is exactly what AT&T was lacking. Just a few years ago the company had a slew of processes to cope with just one kind of outage in its massive phone network. In many cases basic information was reentered in a database each time a new repairman looked at the problem. Eslambolchi figured out which processes worked best (do it once) and most cheaply (do it right), and deployed them throughout AT&T's operations (do it everywhere). He automated tasks that used to be done by hand--certain kinds of order entry, for example--and let computers rather than human beings pass information from one part of the network to another. The result: In four years AT&T has eliminated some 21,000 jobs in its network and customer-care operations, saving about $2 billion in payroll.

At the end of 2001, AT&T's management asked Eslambolchi to apply his methodology throughout the company. Today he is collapsing AT&T's 70 billing systems into one platform. He hopes to move most of AT&T's billing functions to 11 platforms starting this year, and onto a single system by 2005. He's also mothballing some of the software systems AT&T uses to sign up customers for service. The transformation he's undertaking isn't just about applying new technology, Eslambolchi insists: "It's a cultural shift." To execute his plans he must cajole AT&T's rank and file to change; it helps that he has CEO David Dorman's blessing.

Investors haven't yet reaped the benefits of Eslambolchi's efforts. Last year AT&T's operating margin slipped to 11.5%, from 18.6%, partly because of one-time restructuring costs. But the company improved margins to 13% in the first quarter, and analysts think AT&T at last is moving in the right direction. To fight falling prices, "AT&T has to figure out a way to get its margins up--they can't just keep cutting people," says Glen Macdonald, a vice president with Adventis, a technology consulting company in Boston.

The concept of one is catching on with an important constituency. Eslambolchi says he has shared AT&T's plans with hundreds of big customers. "The first question I get is, 'Can you come and help us implement it?'" he says.

GENERAL MOTORS' IDEA: CREATE UNLIKELY ALLIANCES. Auto prices are careering downhill, and the pace seems to be only accelerating. The world's largest automaker has told analysts that it expects 1% to 2% deflation annually. The first quarter of 2003 was worse than that: Net pricing in North America declined 3.2%. In response, GM has made a creative move to drive costs out of the components it uses to build cars. It's pairing up the engineers who design car parts with the people who buy them.

Last year the company assigned a purchasing manager to work with each of its six engineering teams. The leaders of the engineering groups and their partners in purchasing were given a target for reducing parts costs and told that they shared the responsibility for reaching it. "We have an opportunity to impact the design of a product to eliminate waste," says Jim Bovenzi, executive director of worldwide purchasing for GM.

Example: car stereos. Working together, an engineering/purchasing team realized it could buy one kind of cassette player--basically a commodity--for all its sound systems. The engineers figured out the best technology, and purchasing worked with its suppliers to command a big discount for buying one model in bulk. Thanks to efforts like those, GM says it reduced its material costs by about 3% last year. It hopes to keep doing so every year to help offset pricing pressure.

If deflation has a silver lining, it's that those who master it can master just about anything. "There's that old line: If it doesn't kill you, it makes you stronger," says Paul Ballew, GM's executive director of industry sales and analysis. "We are a company today that is far more competitive than it was five years ago." If prices rise again? Watch out.

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