Strategic Frameworks

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Strategic Frameworks

• Ian Larkin Evan Rawley
• MBA 299 Strategy
• April 14th, 2006

2
Update

• Case write-ups will be handed back in section
  next week (4/21), and we will discuss common
  problems and suggestions for improvement at that
  time
• Round 4 CSG results will be posted this evening
• Round 5 CSG strategies due Tuesday 4/18 by noon
  Round 6 CSG strategies due Friday 4/21 by noon
• 2nd CSG memo due in section next Friday, 4/21

3
Agenda for today

• Round 5 of the CSG
• Alternative strategy frameworks
• Brief intro to game theory

4
Am I on a path to make money?

• If you had done nothing, by end of Round 5 you
  would have had in the bank 1,000,000(1.02)4
  1,0825,000
• Youll have to re-spend your capacity costs to
  play in the remaining rounds, so in order to be
  on track to make money, you should have MORE
  THAN
• 1,0825,000 .5(total EC spent)
• in the bank by the end of Round 5
• Question Why is this calculation simplistic?

5
You should do better in Rounds 6-9

• Its not unexpected that few teams will have the
  break even amount of money in the bank at the
  end of Round 5. Rounds 6-9 are the chance to
  take advantage of what you gained in the earlier
  rounds
• Have better information
• Sent signals to competitors,
• Reinvested along the way
• Hopefully wont make as many mistakes
• Most teams do STILL have the chance to beat
  break even which is 1,000,000(1.02)8
• 1,172,000

6
Thinking about Round 6-9 strategy

• If you DIDNT make money in a market, why would
  you choose to rebuild your factory?
• You expect fewer entrants in Round 6 (Why?)
• You expect better pricing in Rounds 6-9, even
  with the same number of entrants (Why?)
• You expect the Magic CSG Fairy to bless your team
• Staying in a market because youre committed to
  it is NOT a valid reason
• Assuming you lost money in your initial market in
  Rounds 1-5, a big part of your CSG memo needs to
  be why you did (or didnt) choose to rebuild
  capacity for Rounds 6-9
• You also should consider whether there are any
  profitable markets for you to enter in the second
  half of the game dont be too constrained by
  previous decisions!

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A note on the CSG memos

• Most of the CSG memos for round 1 looked good
• Some typical problems
• Over-use of bullet points (these are meant to be
  memos, not power point presentations)
• Overly descriptive, without talking about
  expected market/competitive dynamics
• Little if any discussion of alternative scenarios
  or contingency plans if game doesnt develop as
  expected
• Round 5 memo should cover what your initial
  strategy was (very brief), what you saw and
  learned in rounds 2-5, and what your strategy is
  going forward, along with how you expect the game
  to play out

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Agenda for today

• Round 5 of the CSG
• Alternative strategy frameworks
• Brief intro to game theory

9
Going beyond Porters Five Forces

• Cost/differentiation
• Core competencies
• Value-net
• Transaction cost economics (most useful for
  discussions of vertical integration)
• Game theory

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Two generic sources of competitive advantage
3rd dimension is degree of focus

• Low cost focus on operations
• Essential in a commodity business but can work in
  almost every business
• Ruthlessly efficient/lean Dell, Ryanair (after
  initial strategy failed)
• High scale/utilization Beer giants
• Highly differentiated focus on unique quality
• Strong brand Coke
• Constant product innovation Husky
• Target profitable niche with very high quality
  product
• IP protected product - Pharmaceuticals

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Generic risks to generic strategies

• Can you defend your low cost position?
• Technological or preference changes can erase
  scale advantages
• Fords 1st assembly line was down for years to
  install paint lines
• Hard to be lean and mean forever
• Often advantage lies in one stage in the value
  chain (more on this later) is it vulnerable?
• Can you defend your highly differentiated
  position?
• Brand is not always a sufficient BTE imitators
  can get close
• Preferences change, new brands can outflank old
  tired ones

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What are core competencies?

• Core competencies lie at the heart of a firms
  source of competitive advantage
• Some special ability to control costs or produce
  differentiated products
• Huskys engineering strength allowed relatively
  small improvements to machines dramatically
  increase customer willingness-to-pay
• Dells supply chain management
• Supposed to be a combination of hard to imitate
  processes and knowledge

13
Identifying core competencies

• Value chains are a good place to start
• Then benchmark cost and capabilities against
  competitors
• If you are the best in a segment of the value
  chain you probably have a core competency in that
  activity
• The deeper/more specific you can be the better

Sales
Mark eting
Manu facturing
Develop- ment
Research
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Core competencies often take advantage of
competitors weaknesses

• What is Dells core competency? Why did it work?
  Why couldnt IBM/HP replicate it?
• What is Wal-Marts core competency? Why did it
  work? Why couldnt Kmart replicate it?

15
Core competencies and corporate strategy

• Can be a very useful tool for thinking about the
  boundary of the firm
• At the business unit level think about what
  activities in the value chain are best performed
  internally and which can be outsourced
• At the corporate level think about which business
  units are central to the firm and which can be
  spun off
• Note the close relationship between synergies and
  core competencies in this set-up

16
Core competencies as a model

• Very intuitive mental model of a firm
• Create profit by focusing on what you are good at
• Not always clear what is a core competency and/or
  how the concept differs from sources of
  competitive advantage
• Can be tautological (were good at what were
  good at)
• Not a dynamic model
• Sony was supposed to have a core competency in
  miniaturization but they missed the iPod market

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The value net

• The value net holds that the amount of value a
  company can capture is both defined and
  constrained by other players in the net

Customers
Company
Complementors
Competitors
Suppliers
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Complementor vs. Competitor axis looks at your
ability to sustain value capture

• A player is a complementor if customers value
  your product more when they have the other
  players product than when they have your product
  alone.
• Oscar Mayer and Colemans mustard
• A player is a competitor if customers value your
  product less when they have the other players
  product than when they have your product alone.
• Pepsi and Coke

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Who are the complementors?

• Cars Auto loans, insurance, roads
• Televisions VCRs, satellite TV
• TV shows TV guide
• Fax machines Phone lines
• Catalogs Delivery services
• Hardware Software
• GameCube Game titles
• Complementors are critical to business success!

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However, complementors can steal value!

• Computer industry example
• Microsoft and Intel are complementors of computer
  hardware companies, yet they constrain the value
  hardware players can capture
• How is Dell a complementor rather than a computer
  manufacturer?
• Value net is also complementary to core
  competencies you may figure out non-central
  activities allow most value capture
• These dynamics mean you may have uneasy
  relationships with complementors, even though
  they are necessary to increase total value of an
  industry

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Changing the players can increase your value
capture

• Bring in customers - Increase industry demand.
  This helps competitors, but may be worthwhile for
  you. To do this
• Educate consumers about your product (Diapers in
  Asia)
• Pay customers (esp. early adopters) to play
• Subsidize some customers, other full paying
  customers will follow (Initial discount to lower
  risk)
• Bring in suppliers
• Compaq / AMD / Intel
• Bring in complementors
• Do it yourself. Nintendo - both h/w s/w. Intel
• Pay complementors to play (at least initially)
• Bring in competitors does this ever make sense?
• Sometimes!

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Two major rationales for vertical integration

• Rationale 1 Increase market power
• Ability to charge higher prices or price
  discriminate
• Foreclose competitors from suppliers or customers
• Rationale 2 Improve economic efficiency
• Improve technical or productive efficiency
• Lower costs by joining parts of value chain
• Improve transaction efficiency
• Reduce hold-up when suppliers have power
• Increase investments which may be risky due to
  hold-up
• Improve incentives (agency efficiency)
• Reduce incentive conflicts or allow better
  monitoring

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However, vertical integration has costs

• Costs of vertically integrating
• Can add layers of bureaucracy or management
• Outside core competencies, can we get it cheaper
  from the market?
• Are market incentives better in motivating
  managers?
• Can raise intra-organization influence costs
  (lobbying, decisions that are inefficient but
  benefit one part of the firm)
• Can turn previous suppliers or customers into
  competitors, increasing costs or decreasing
  market size

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Transaction cost economics focuses on
relationship-specific investments

• A relationship-specific investment is one that
  isnt very valuable for another trading partner
  except the one who benefits from it
• Site specificity you locate your plant right
  next to a customers factory
• Technical specificity you build expensive metal
  molding equipment for a specific car
• Dedicated asset specificity you undertake a
  major specific investment with a specific
  customer in mind, and a very thin market
• Human capital specificity you train all of your
  employees on the specialized equipment of a
  certain supplier

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Why horizontally integrate?

• Scale
• Market power, exploit economies of scale,
  increase power with suppliers
• Leverage know-how across new customers, channels,
  products and/or technologies
• Access a growing market

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Agenda for today

• Round 5 of the CSG
• Alternative strategy frameworks
• Brief intro to game theory

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What is game theory?

• Game theory is about how individual decisions are
  made strategically by taking into consideration
  the actions and interests of competitors
• What isnt game theory
• Much of traditional operations management
• Neo-classical micro-economics
• Game theory is usually most applicable when there
  are limited numbers of players

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Some Examples

• Areas where game theory can (has) been fruitfully
  applied
• Price competition between oligopolists
• Entry decisions
• Areas that are not game theory
• Optimizing factory line performance
• Monopoly pricing (maybe)

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Why is game theory useful?

• Provides predictions for what should happen
• This means using estimates of payoffs to deduce
  behavior in advance
• Moves away from the world of post-modern strategy
• Provides an underlying structure to compare
  across different environments
• Enables thinking through analogies

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What is a game?

• Three elements
• Players
• Payoffs
• Rules
• Given all of this information players try to
  determine what their best course of action should
  be given
• The possible actions they can take
• What they think other players will do
• What their payoffs are
• Nash equilibrium occurs when all players have
  taken the previous factors into account and take
  their actions

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A Simple Game The Prisoners Dilemma
B
Confess Dont Confess
0,0
4,-3
Confess Dont Confess
A
1,1
-3,4
Three Key Components Players Outcomes Choices
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Nash Equilibrium of the Prisoners Dilemma (AKA
what should everyone do)
B
Confess Dont Confess
0,0
4,-3
Confess Dont Confess
A
1,1
-3,4

• Nash Equilibrium Given what the other guy doing,
  you cant do better

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Application of Prisoners Dilemma Price War
B
Fight Accommodate
0,0
4,-3
Fight Accommodate
A
1,1
-3,4
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A simple variation
B
Fight Accommodate
-5,-5
-3,4
Fight Accommodate
A
1,1
4,-3
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A few comments caveats

• Equilibria are not necessarily socially
  efficient they are just in some sense stable
• Do we ever see inefficient equilibria in real
  life?
• Better outcomes for the players could be achieved
  through coordination and commitment
• Mergers
• Collusion

36
Coordination Games Divide the Market
B
Segment A Segment B
-1,-1
1,3
Segment A Segment B
A
-1,-1
3,1
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Some examples of the coordination games
prisoners dilemmas

• Prisoner's dilemma
• Pricing decisions when there are only a few firms
• Coordination games
• Timing of advertisements on TV/radio
• Entry into (CSG) markets
• These games differ in the amount of commitment
  required and what communication can get you in
  terms of outcomes

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Next time

• Go over feedback from the case write-ups
• Go into more depth into game theory
• Backwards induction
• Imperfect information games and signaling/sorting
• Application of games to real-life business
  situations