Title: ECON 308 Week 8-9
1ECON 308 Week 8-9
- Chapter 8 Economics of StrategyCreating and
capturing value
2Case 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
3Superior 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?
4Strategy
- 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
5Economic 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
6Transaction costs
- Consumer transaction costs
- product search
- learning product characteristics and quality
- negotiating terms of sale
- enforcing agreements
- Producer transaction costs
- negotiating terms
- legal expenses
7Creating Value
Price
Supply
Consumer Surplus
P
ProducerSurplus
ProducerSurplus
Demand
Q
Quantity/Time
8Creating 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
9Value 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
10Transaction 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
11Creating 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
12Creating 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.
13Creating 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
14Creating 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
15Technology 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
16Converting 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
17Capturing value
- Long Run Profitability in Competitive Markets
- Economic Profit
- Accounting Profit
- Firms with Market power
- With barriers to entry
- Without barriers to entry
18Market power comparison
19Market powerPorters five forces that affect
Market Power
- Potential rivals
- Existing rivalry
- Substitute products
- Buyer power
- Supplier power
20Porters Five Forces Affecting Market Power
Potential Rivals
Upstream
Downstream
Current Rivals
Buyers
Sellers
Substitute Products
Value/supply Chain
Competitive Environment
21Capturing 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
22Superior 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
23Producer surplus captured by superior assets
24Superior 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
25Sustainability?
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
26Increasing demand
- Increase expected product quality
- value added gt cost increase
- Reduce price of complements
- Raise price of substitutes
- limit entry of competitors
27Diversification
- 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
28Diversification
- 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
29Diversification
- Benefits
- Economies of scope
- Promoting complements
- Costs
- Bureaucracy
- Incompatible cultures
30Diversification 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?
31Diversification
- 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.
32Strategy 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
33Strategy Formulation
- Business Environment
- Markets
- Input
- Output
- Technology
- Production
- Information
- Communication
- Government Regulation
34Framework for strategic planning
35To think about...
- Can a firm capture value on a sustained basis?
- Discuss.
36Market 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.
37Specialized 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.
38Political 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.