Title: STR 421
1STR 421
- Economics of
- Competitive Strategy
- Course Wrap-up
- Michael Raith
- Spring 2007
2The key question
- Efficient markets successful strategies quickly
attract imitators - How, then, can companies achieve and maintain
above-normal returns? - Why do some companies consistently make more
profits than others?
3Part I Obtaining and sustaining a competitive
advantage
- Competition and markets
- 2. Value creation and competitive advantage
- 3. Horizontal and vertical scope of the firm
4The Bertrand trap
- A game you dont want to be in
- Assumptions
- Homogeneous goods
- No capacity constraints
- One-shot game
- Prediction competition drives prices toward MC
- With fixed costs, firms make losses
5Sellers offering goods of different quality
- Sellers compete by offering consumer surplus bids
B-P. - PS 2, FMA and network effects
- What matters for winning is not benefit or cost
but the difference Dell, RTE cereal brands vs.
private labels - Prices reflect costs, benefits, and competitive
bidding - Firms with a competitive advantage often have
some freedom in choosing prices Dell, Dupont
6Three ways out of the Bertrand trap
- Limit industry capacity Dupont
- Cooperate on prices American Airlines, RTE
cereal, Infant formula - Differentiate be different
- Differentiation relaxes price competition
- CCS, Dell, Enterprise, ValuJet
7Five forces analysis Taking a snapshot of an
industry
- Whats going on in the industry in general?
- Who appropriates value created? Firms in industry
or others? - Extreme cases Metal cans vs. RTE cereal
- Dont forget about complementors 6th force
e.g. Enterprise dealers - Dig deep Why does the industry look the way it
does? - Product differentiation, role of advertising/RD,
first-mover advantages, ability to collude, etc. - A useful analysis already requires considerable
knowledge of how markets work
8Limitations of Five Forces
- No conclusive answer to question Should we enter
this industry? - entry decision must focus on competitive
advantage - Only snapshot industry may look different in a
few years
9Industry dynamics What determines market
structure in the long run?
- Good strategic decisions must anticipate likely
changes in the market, and market structure, in
the future - Coors, Birds Eye, Dupont, RTE cereal, EMI
- Predictions about market growth and entry are
related Dupont - Forces towards a more concentrated market
- Economies of scale (look at MES/market size)
Dupont - Intense price competition Metal cans, PCs,
opposite PS 1, Restaurants - Escalation of spending on endogenous fixed or
sunk costs Beer, RTE cereal, CT scanners (as
market matures)
10Part I Obtaining and sustaining a competitive
advantage
- Industry analysis
- Value creation and competitive advantage
- Horizontal and vertical scope of the firm
11Positioning horizontal and vertical product
differentiation
- Firms are vertically differentiated when they
offer different quality/cost combinations. - Brands vs. private labels in frozen food and
cereal, Delta vs. ValuJet - Cost vs. benefit/differentiation strategy
- Firms are horizontally differentiated when they
- target particular groups of customers Dell,
Enterprise - offer products with attributes that appeal to
some customers but not others (light-bodied)
Coors, Honey Nut Cheerios
12Activities and strategic fit
- Check how a firms activities fit with the market
environment (external fit) and one another
(internal/strategic fit) - Same market can support different strategies and
sets of activities Dell vs. Compaq - A successful strategy is supported by all
activities of the firm - CCS e.g. one-month inventory
- Dell all activities tailored to particular
subset of business customers - Enterprise HR policies
- Most choices involve some tradeoff.
- Why arent other firms doing the same?
13The productivity frontier in practice
assessing competitive advantage
- To assess your or rivals competitive position,
look at - Cost drivers what factors determine costs?
- Beer transport costs
- Dupont scale and experience
- RTE cereal ingredients, packaging
- Benefit drivers what factors contribute to
buyers valuation? - Coors mystique, freshness
- CCS quick response
- EMI technology, service
14Quantitative cost/quality comparison
- Simple compare /unit, not of sales or costs
- Coors
- PS 3, ValuJet vs. Delta
- Fancier use own cost/quality position, and cost
and benefit drivers, to estimate rivals
cost/quality positions. - Dell
15Sources of a sustainable advantage1.
Impediments to imitation
- Regulatory restrictions
- Patents EMI?
- Superior access to inputs or customers or
complementors Enterprise, Dupont - Strategic fit CCS, Dell, Enterprise, ValuJet
- Experience/organizational learning Dupont
16Sources of a sustainable advantage 2.
First/early-mover advantages
- PS 2, First-mover advantage?
- PS 3, Capacity choice game
- Three conditions
- Being first/early mover
- First move (e.g. entry) is a credible commitment
- Second movers not deterred if first mover might
exit/ back down gt Sunk costs important - Entry unprofitable for second mover. Depends on
- Market size gt not too large!
- Intensity of competition
17Types of first-mover advantages
- Scale economies Look at MES/ size of relevant
market - Dupont
- Geographic or positional preemption
- CCS as last-resort canner, Coors in 70s
(location), - Enterprise, RTE cereal
- Reputation for quality
- CCS, Infant formula
- Building reputation/brand image through
advertising Are buyers responsive? Beer, RTE
cereal yes PCs not much, Frozen food
initially yes, later less so
18Types of first-mover advantages (contd)
- Switching costs how difficult is it for buyers
to switch? - Metal cans no Instant messaging yes
- What exactly is the nature of switching costs? CT
scanners - Network effects where do they come from? How
strong? - Direct Instant messaging
- Indirect Choice Hotels (guests and affiliated
hotels) - With new products, network effects often
difficult to predict - Learning effects are there any? How big?
- Dupont yes, Metal cans no
19Strategies are commitment-intensive
- Strategic decisions are often hard to reverse,
due to sunk costs, inertia etc. - Coors regional vs. national strategy
- Even firms with well-designed strategies can be
adversely affected by changes in market Compaq,
Birds Eye - Anticipate, dont react
- Monitor/anticipate developments in the market
- Dell, Enterprise luck or foresight?
- Try to anticipate others moves
- Extreme examples Coors vs. Dupont
20Part I Obtaining and sustaining a competitive
advantage
- 1. Industry analysis
- 2. Competitive positioning and competitive
advantage - 3. Horizontal and vertical scope of the firm
- How broadly should a firm choose its activities
beyond its core business?
21Good and bad reasons to expand scope
- Most expansion efforts fail! Two main reasons
- Agency problems growth objective
- Firms overestimate generality of their
capabilities - Think of narrow focus/ outsourcing as default
- Independent partners/suppliers have better
incentives, are - better able to realize economies of scale Birds
Eye - Two key questions
- What are the synergies/economies of scope?
- Can they be realized by contract, or is
integration only solution?
22Look for economies of scope
- Efficient use of resources
- Choice Hotels reservation system and umbrella
branding - GE in sales and service for CT scanners and other
products - Wal-Mart products with different seasonal
structures - Benefits of co-location soft-drink bottlers and
metal cans - Coordination/quality control Coors into
everything (!?), Birds Eye - Pricing of complementary products/double
marginalization Coors into cans in 1970s? - Benefits of bundling for buyers cross-selling at
Choice Hotels, Wal-Mart toys and clothes
23What about contractual solutions?
- No need for integration if contracting is easy
- Reservation systems in car rental, airlines
- Output-based contracts for pea farmers etc.
- Maybe integrate if contracting seems too
difficult - Holdup problems Soft drink bottlers and
can-making facilities Birds Eye and cold stores - How big are relationship-specific investments?
- How much uncertainty about future?
- Problems with performance measurement
cross-selling efforts at Choice Hotels
24Part II Strategic interaction
- Any major strategic decision you make will likely
provoke some kind of response from competitors - Use insights from game-theoretic models to
anticipate your competitors capabilities and
moves - American Airlines will competitors go along?
- Dupont how will others respond to expansion
plans? - Instant messaging what is logic of the game
being played? - ValuJet how will/should Delta respond to entry?
25Price dynamicsLogic of cooperative pricing
- Oligopoly pricing is a Prisoners Dilemma
situation - Cooperative pricing requires long enough time
horizon - Key questions
- How easy is it for firms to tacitly agree on
prices? - How tempting is it for a firm to cut price?
- How effectively can deviations be detected and
punished? - Industrys ability to cooperate on prices often
matters more than a firms relative performance
in industry - Shrimp game, airline vs. cereal industry
26Price dynamics industry factors and facilitating
practices
- Ability to cooperate depends on industry factors.
- Airlines transparency vs. asymmetries and excess
capacity - Infant formula, RTE cereal several conducive
factors - Firms can also facilitate cooperative pricing in
a variety of ways. - American Airlines establish price leadership,
increase transparency, standardize products,
spatial pricing rules - PS 3, HMOs
- Keep antitrust restrictions in mind! Price-fixing
agreements prohibited for good reasons.
27Strategic commitments
- Key idea limit your own options in the future to
influence your rivals behavior to your advantage - Basic ingredient of any first-mover advantage
- Commitment is simple in theory, but hard in
practice - Moving first is not a commitment
- How costly is it to change your mind later? If
not much, youre not committed
28Commitment tactics
- Sunk costs sinking costs in a useful way
credibly increases incentives to stay in the game - Dupont actual construction of a new plant
- PS 3, Capacity choice game
- Short of true commitment, rely on reputation, or
engage in tactics to influence rivals and
buyers perceptions - Crandalls claims about commitment to Value
pricing - Duponts announcements of expansion plans
- MSNs claims about bug in AIM
29Strategic effects anticipate competitors
responses to strategic commitments
- E.g. if I invest in lowering costs and want to
lower my price, how will you respond, and how
will that affect my price profit? - With strategic complements (e.g. prices),
- tough commitments have a negative strategic
effect PS 3, export subsidy for railroad
engines - soft commitments have a positive strategic
effect ValuJet - With strategic substitutes (e.g. capacity), tough
commitments have a positive strategic effect
Dupont - Short-run competition is normally in price,
long-run competition may be about capacities
apply Cournot model
30Entry deterrence
- Ways to deter entry
- Preemption Incumbent has incentive to preempt
entry if otherwise entry is certain (efficiency
effect) - CCS in plastics, Dupont, PS 3 capacity choice
game - Preemption strategies are investments in a
first-mover advantage (or dont invest EMI) - Any other investments that reduce entrants
potential profits Pricing strategies to
deter/fight entrants limit pricing, predatory
pricing Delta vs. ValuJet - Antitrust law prohibits attempts to monopolize.
31Entry games
- For small entrants reduce incumbents incentive
to respond aggressively - Judo economics stay small, differentiate
- ValuJet
- (Groups of) Firms may get caught up in a war of
attrition if they fight for market in which only
one fits - Another game you dont want to be in
- Like 20 auction
32Innovation management
- Company that makes innovation is not necessarily
best positioned to produce/market final product
EMI - Need capabilities in production, marketing etc.
as well - Options go alone, JV, license, sell
- Normally sell innovation if its worth more to
others than to you - Value of innovation is irrelevant!
- Basic problem if I want to sell you my idea, I
have to tell you first what it is, but then you
already have the idea - Contracting may be difficult if intellectual
property protection is weak
33Standards
- How strong are forces towards standardization?
- Can competing technologies exist? Instant
messaging yes - Go alone or alliance/licensing/open standard?
- Go alone good if you (1) have a great product,
(2) are the first mover, (3) can produce
complementary product (if relevant) - AOL
- Alliance etc good to increase chance of
establishing own technology as standard JVC in
VCRs, supporters of open standard in instant
messaging - But how will you make money?
34Fact-based strategy Use/collect data to inform
strategic decisions
- Quick dirty investment analysis Coors
- Cost benefit comparisons
- (Simple) How is Coors positioned?
- (Better) How large is Dells cost advantage?
- Can Big 3 in cereal squeeze private labels by
cutting price? - (Fancy) Is Duponts cost advantage big enough to
pull off growth strategy? - Entry decisions
- Is Delta pricing like a monopolist?
- What does it take to enter the cereal industry as
a small player? - Market forecasts When will CT scanner market be
saturated, and how does that affect EMIs options?
35Concluding remarks
- Principles of good strategy are enduring and do
not change with management fashions. - But companies are unique and must apply those
principles to discover the optimal strategy for
them. - Cookie-cutter recommendations rarely helpful
- Economics is useful for strategy.
- How can companies make profits in the long run?
- Unique resources and capabilities dont come out
of the blue - Ultimately, understanding how firms interact in
markets is essential for answering the question