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ECON 308 Week 8-9

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ECON 308 Week 8-9 Chapter 8: Economics of Strategy Creating and capturing value * Framework for strategic planning * To think about... Can a firm capture value on a ... – PowerPoint PPT presentation

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Title: ECON 308 Week 8-9


1
ECON 308 Week 8-9
  • Chapter 8 Economics of StrategyCreating and
    capturing value

2
Case Wal-Mart
  • Wall Mart
  • Most profitable retailer in the world, 5,170
    stores,1.6 million emp.
  • 1962 First store opens rural Arkansas, small
    towns
  • 1993 q2 1997 stock value dropped
  • Slow growth in value till 1997.
  • 2005 220 billion in sales, 10.3 billion net
    income
  • Responses to problems in mid 1990s
  • New international super-centers
  • E-commerce sites
  • Experimented with traditional sized grocery
    stores in Arkansas
  • By 1998 the stock was performing well again

3
Superior Performance?
  • Beating the market over a long period
  • What accounts for the success of these firms?
  • Should all properly managed firms expect superior
    performance?
  • What actions can managers take to generate
    superior performance?
  • Can managers enhance financial returns by
    diversification?
  • Do all firms eventually drop back to the pack?

4
Strategy
  • General policies intended to generate profits
  • Choice of industry
  • Combination of products and services
  • Competitive and cooperative behaviors
  • Strategies evolve as circumstances change
  • Strategies must create and capture value

5
Economic Strategy Maximizing long-run
profitability
  • Economic Profit Total Revenue Total Cost
  • Increase Total Revenue ( Price x Quantity)
  • How to Increase Price?
  • Price is Demand determined
  • Increase Value of the product to customer
  • How to increase Quantity?
  • Decrease Total Economic Cost
  • Efficiency in purchase
  • Efficiency in production

6
Transaction costs
  • Consumer transaction costs
  • product search
  • learning product characteristics and quality
  • negotiating terms of sale
  • enforcing agreements
  • Producer transaction costs
  • negotiating terms
  • legal expenses

7
Creating Value
Price
Supply
Consumer Surplus
P
ProducerSurplus
ProducerSurplus
Demand
Q
Quantity/Time
8
Creating Value Reduce Transaction Costs
Price
Supply with Producer Transaction Costs
Producer-borne transaction costs
Consumer Surplus
P
ProducerSurplus
Consumer-borne transaction costs
Demand with Consumer Transaction costs
Q
Quantity/Time
9
Value creation
  • Reduce production costs or producer transaction
    costs
  • shift supply curve to the right
  • Reduce consumer transaction costs
  • shift demand curve to the right
  • Shift demand to the right by other means
  • Devise new products and services

10
Transaction Cost Creating Value
  • Consumer Transaction Costs
  • Costs of search
  • Costs of learning about product quality
  • Costs of Negotiation
  • Producer Transaction Costs
  • Costs of negotiation
  • Attorney fees to draft sales agreements
  • Examples
  • Dell eliminates the middle man in direct web-site
    PC sales and splits the gain between themselves
    and the buyer
  • Early Wall Marts were in rural areas reducing
    transportation costs by opening stores closer to
    customers.
  • Kraft Lunchables
  • Terrorist Attacks and the Airline Industry

11
Creating Value Advertising
  • Major economic function Provide information
    about the product.
  • Lowers Search Cost
  • Lowers Quality Identification Costs
  • Second Function Create value in the minds of
    consumers
  • Lowenbrau
  • Perfumes

12
Creating Value Reducing Consumer Waiting Time
  • Cable Installation4 hour window
  • Doctors Office Patients Waiting
  • How to value your time
  • Salary 50,000
  • Employee Cost to firm 50,000
  • 100,000 / 2000 hours 50 per hour.

13
Creating Value Alternative Product Pricing
  • Pricing Complements
  • Cut the price of the complement and increase the
    sales of both products
  • Applications
  • Printers and Personal Computers
  • Razors Blades
  • Pepsi Frito, and Lays Potato Chips
  • Pricing Substitutes
  • Raise the price of a substitute
  • Applications
  • Dont allow people to bring food into a theater
  • Airlines restrict the use of cell phones

14
Creating Value Product Quality
  • Product Quality
  • Profit is increased if MR gt MC
  • Marginal Revenue depends on value created for
    Customer
  • Product Quality Examples
  • Titanium Golf Clubs
  • Parabolic Skis

15
Technology and Value
  • Rapidly falling cost of information processing
  • Streamline Order processing, shipments,
    payables, receivables
  • Create custom products for smaller groups of
    customers
  • Reduce transaction costs with suppliers and
    customers

16
Converting Organizational Knowledge into Value
  • Hardware physical Assets
  • Software Soft Assets, formulas, recipes for
    creating value (can be replicated)
  • Wetware Employees brainpower (biological
    computer)
  • Firm owns 1,2 but only rents Wetware.
  • Must convert 3 into 1,2
  • Macdonalds Fillet of Fish

17
Capturing value
  • Long Run Profitability in Competitive Markets
  • Economic Profit
  • Accounting Profit
  • Firms with Market power
  • With barriers to entry
  • Without barriers to entry

18
Market power comparison
19
Market powerPorters five forces that affect
Market Power
  • Potential rivals
  • Existing rivalry
  • Substitute products
  • Buyer power
  • Supplier power

20
Porters Five Forces Affecting Market Power
Potential Rivals
Upstream
Downstream
Current Rivals
Buyers
Sellers
Substitute Products
Value/supply Chain
Competitive Environment
21
Capturing Value What Works?
  • Barriers to entry
  • Degree of rivalry
  • Number of competitors
  • Relative size of competitors
  • Threat of substitutes
  • Example Email and fax pose serious threats to
    profits for Federal Express and UPS
  • Buyer and Supplier Power
  • Example Microsoft and Intel in Personal
    Computers

22
Superior factors of production
  • People
  • special talents or skills
  • Physical assets
  • prime real estate
  • unique equipment
  • But bidding for specialized assets may erode
    profits
  • Some things are hard to copy
  • Flexible Technology
  • Team Production

23
Producer surplus captured by superior assets
24
Superior factors of productionagain
  • Team production
  • interdependencies among workers increase value
    beyond the sum of the parts
  • luck or foresight may endow firms with unique
    team production capabilities
  • Rivals may be unable to pinpoint source of
    advantage and unable to capture equivalent value

25
Sustainability?
Rank 1970 2004
1 IBM Wal-Mart
2 ATT Exxon-Mobil
3 General Motors General Motors
4 Standard Oil of NJ Ford Motor
5 Eastman Kodak General Electric
6 Sears Roebuck Chevron-Texaco
7 Texaco Conoco-Phillips
8 General Electric Citigroup
9 Xerox IBM
10 Gulf Oil American International Group
26
Increasing demand
  • Increase expected product quality
  • value added gt cost increase
  • Reduce price of complements
  • Raise price of substitutes
  • limit entry of competitors

27
Diversification
  • Benefits
  • Economies of Scope
  • Example When one input is used in several
    products you may get a better price when ordering
    it.
  • Promoting Complements
  • Example Ford can advertise its auto-financing
    when advertising its cars

28
Diversification
  • Costs
  • With larger firms it gets increasingly difficult
    to get lower level managers to act in the
    interests of the owners.
  • Success in management of one area may not apply
    in other products

29
Diversification
  • Benefits
  • Economies of scope
  • Promoting complements
  • Costs
  • Bureaucracy
  • Incompatible cultures

30
Diversification and management
  • Diversification for earnings volatility
  • may not increase value
  • Related diversification
  • can increase value
  • Capturing the gains
  • does the firm bring some special resource to bear?

31
Diversification
  • When does diversification create value?
  • Related Diversification
  • Businesses serve common markets or use common
    technologies
  • Example Disney operates theme parks, hotels,
    retail shops and TV stations. All are family
    oriented products. This can reduce consumer
    transactions costs for people searching for safe
    products for children.

32
Strategy formulation
  • Understanding resources and capabilities
  • physical, human, and organizational capital
  • Understanding the environment
  • markets, technology, regulation, economic
    conditions
  • Combining environmental and internal analyses
  • Strategy and organizational architecture

33
Strategy Formulation
  • Business Environment
  • Markets
  • Input
  • Output
  • Technology
  • Production
  • Information
  • Communication
  • Government Regulation

34
Framework for strategic planning
35
To think about...
  • Can a firm capture value on a sustained basis?
  • Discuss.

36
Market Power Profits
  • Airbus and Boeing are two major producers of
    jumbo jets. Are these firms guaranteed to make
    high profits since there are only two large firms
    in the industry? Explain.
  • No. Even if there are only two firms in the
    industry, they may compete vigorously to reduce
    prices and profits.

37
Specialized Resource Economic Profits
  • The Watts Brewing Company owns valuable water
    rights that allow it to produce better beer than
    competitors. The company sells its beer at a
    premium and reports a large profit each year. Is
    this firm necessarily making economic profits?
  • No. Its advantage is that it owns a valuable but
    marketable asset. The firm may be only making
    normal profits given the opportunity cost of
    keeping the water rights itself rather than
    selling them to others in the marketplace. The
    company is more valuable because it owns the
    water rights. However, selling the rights to
    others might be the best way to capture this
    value.

38
Political Competition
  • Sun Resorts has a hotel on a Caribbean Island. It
    recently spent money to lobby the government to
    build a better airport and expand air service.
    Why did they do this? Do you think that Sun
    Resorts cares about how many airlines will serve
    the island?
  • Airline service is a complement for Sun Resorts.
    Cheaper air service to the island increases the
    demand for Sun Resorts. Thus, Sun Resorts wants
    better airport service and lower airfares. Lower
    fares are more likely to result if there are
    several airlines that compete in serving the
    island.
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