Lecture Managerial economics - Chapter 6: Competition and strategy

Lecture Managerial economics - Chapter 6 include the contents: How competition is rivalry to obtain a distinct advantage, categorizing and analyzing competitive strategies, how mergers and lawful agreements among competitors can sometimes increase economic value created in a market,... Inviting you to refer.

Week 6

COMPETITION & STRATEGY

• How competition is rivalry to obtain a distinct advantage

• Categorizing and analyzing competitive strategies

• How mergers and lawful agreements among competitors can

sometimes increase economic value created in a market

• How restrictive vertical agreements between manufacturers and dealers or parent companies and franchisees can increase

competition and benefit consumers

• Strategies for protecting profits

• costs and benefits of attempting to compete by influencing public

Competition: Exceptional – Competitive Ideas

• Competition starts with ideas.

• Asked how he had produced so many good ideas over his

career, Nobel Prize–winning chemist LinusPauling responded that “the best way to have a good idea is to have lots of ideas.” Even the most original ideas build on a foundation of other

ideas.

• A competitive idea is not necessarily a scientific one

• It may be as simple as opening a business in an underserved location, keeping it open all night, or outrightly imitating the success of a competitor.

Competition: The Paradox: Competing to Acquire

Market Power

• Businesses compete to distinguish themselves in the eyes of

customers, and by becoming distinctive they acquire some

market power

• A business implements a risky competitive idea in order to reap high returns

• The possibility of high returns induces risk-taking.

• But entry will erode profits

• In actual markets, businesses often compete by discounting

prices rather than taking the equilibrium price as given and

unalterable

Competition: The Risks of Competition

• Competition is risky, particularly for small startups

• Only about 40 percent of startups show accounting profits over their lifetimes, which may not cover their opportunity costs

• Thirty percent break even and 30 percent are losers

Competition and Deception

• Competitive conditions constrain the freedom of all producers, whether they face many competitors or

few

• In this chapter we continue to assume that buyers and sellers act rationally on information that is available

to them

• In particular we rule out strategies that only succeed

if one side can deceive the other (the sale of

loss-leaders e.g)

Selection Bias, Again

• People recall successes more easily than failures

• They give more weight to more recent events

• Our recall is biased and we often must use data that are not random samples of an underlying population

• Now to the success of Big-C

What’s Big-C’s Secret?

• Here is a partial list of explanations that have been offered for Big-C’s success:

• decentralized decision-making,

• centralized decision-making,

• decision-making between the center and the stores,

• regional relationships,

• relationships with employees

• using economics to determine strategy.

Pitfalls in Studying Competition –Self-Serving

• As will be seen later, managers whose firms produce

substantial free cash flows may prefer to spend them on

questionable acquisitions that often fail to benefit

shareholders.

• This tactic increases the size of the firm which usually means higher pay and prestige.

Creating Economic Value

• Both seller and buyer benefit from a transaction if the seller earns more than his opportunity cost and the buyer pays a

price below maximum willingness to pay.

• Economic value is the difference between cost and

valuation.

Many Buyers and Many Sellers

Four points emerge from this model:

1 as the innovation spreads among producers the earlier

adopters will see longer-lived streams of profit before the

market reaches its new long-run equilibrium.

2 the number of firms that survive after the innovation depends

on the direction in which the innovation shifts the minimum point of average costs.

3 as the percentage of sellers that use the innovation increases,

those who are slower to innovate will take losses if they

cannot shut down temporarily or leave the market quickly.

4 any newcomer to the market will only survive if it uses the

innovation.

MERGERS & AGREEMENTS

Horizontal Mergers and Agreements -Mergers

• Mergers and acquisitions can be important elements

• U.S antitrust law says that a “naked” agreement

whose only goal is to fix prices is per se illegal—its very existence is unlawful

Vertical Mergers and Agreements

• An industry’s output is often produced in stages

• For example, oil is first extracted from the ground, then refined, and finally the refined products are

retailed

• A firm is vertically integrated if it subsumes multiple stages

• Integration can produce savings if it improves

coordination among the stages

• But it also might raise costs if there are difficulties in

Vertical Mergers and Agreements (cont.)

• The degree of integration matters because costs and revenues can vary with the number of stages in which

Vertical Mergers and Agreements _ Restrictive

• Fast-food franchises often require the owner of an

outlet to buy all its food through the parent

organization, and the parent organization promises to

Vertical Mergers and Agreements _ Restrictive

Agreements (cont.)

• Manufacturers and retailers may have exclusive

dealing contracts.

• All these contracts contain vertical restrictions that

limit the parties choices.

• Often a parent will franchise outlets and hire

employees to run others

• McDonald’s only owns 15% of its stores

• Starbucks Coffee has no individual franchises

Sustaining & Extending Competitive

Advantage

Barriers to Entry-Size and Commitment

• Building barriers to entry that protect profits against existing and future competitors can be an important element of strategy

• Size and specificity may serve as barriers to entry

• A firm may need to be sufficiently large to achieve available economies of scale

• Firms may also need to invest in specific assets that are not easily redeployed to other uses and locations

A power plant for instance

Intangible Assets: Trademarks & Advertising

• A seller wants to inform customers about more than price—consistent quality, for instance,

may engender customer loyalty

• A producer can use a brand name or trademark

to assure buyers it will produce the quality

they expect

• Signalling

Influencing the Public and Government –Public

TV, which is beyond local control.

• Government can also make competition costly for foreigners

by imposing quotas or tariffs in return for support from the

domestic industry.

Choosing a competitive strategy

• How do businesses choose a competitive

strategy?

• Strategy is resource-based and market-based.

• Firms in the same market will have different

resources leading to different choices.

• Strategy is about more than price.

• It can range from product design, to mergers, to political activity

Resources and Strategies –Innovation Pro and Con

• Strategy need not entail innovation or entry into new markets—some firms have resources better suited to perfecting an established product

• Properly carried out, imitation can be as profitable as innovation and sometimes less risky

• Ampex invented the VCR and Xerox invented the

first office computer, but neither firm found

commercial success in those areas

• Success is surprisingly short-lived

Competence and Sustainability - Identification of

Resources and Feasible Strategies

• A firm’s strategy choice starts by identifying its

resources and the resources of its competitors, paying attention to those resources competitors have that it does not itself, and vice versa

• Discussions of strategy must go beyond simple

models that treat constraints as unalterable by the

decision makers

• The best choice depends on our resources and those

of our competitors

Competence and Sustainability -The Search for

Strategies

• The idea remains that no strategy that competitors can

easily duplicate will produce long-term profit

• The search for strategy must be a continuing one.

• Having a grand strategy may not be the road to success.

• Tactical moves are responses to idiosyncratic, short-lived developments

• If your competitors are flexible and unpredictable you

might do better by deemphasizing global strategy and

seeking to seize more immediate opportunities.

• Emphasize tactics rather than a strategic mission.

Competence and Sustainability -The Search for

Strategies (cont.)

• If competition is resource based, we will require a better understanding of the types, potential, and limitations of these and other intangible