understand the competitive forces you currently face ..

1
Economic Strategy IssuesBig Picture Framework

• BUSI 7130/6 Strategic Analysis of the
  Competitive Environment

2
Economic Strategy

• Goal of economic strategy to thrive in a
  competitive marketplace
• understand the competitive forces you currently
  face
• understand the forces which shape your future
• understand your own competitive advantage

3
Porters Five Forces Model

• Initial task Define the Industry (not trivial!)
• product space
• geographic space (any Internet effects?)
• Evaluate the power of each of the forces
• can each force reduce our profits?
• can each force increase our profits?
• What are the net effects?

4
Porters Five Forces Model

• Porters model is a classic on which many have
  built - the core is microeconomic analysis
  applied to business management issues

5
Porters five forces, continued

• Internal rivalry - competition from other firms
  already in the industry how intense is this?
• Buyer power - can our buyers threaten our
  profitability? Are there large customers who can
  negotiate a better deal with us?
• Supplier power - can the suppliers of any of our
  inputs threaten our profitability?
• Complements or substitutes - are there related
  goods or services that can threaten our
  profitability if their prices or availability
  changes?
• New entrants - are there new firms possibly ready
  to enter our markets who pose a competitive
  threat?

6
Our additions to the five forces model

• Other strategic elements
• Evaluate the national and international economic
  scene - any macroeconomic issues that matter?
• Any political, legal or regulatory threats or
  opportunities?

7
Economic Strategy IssuesHorizontal and Vertical
Boundaries of the Firm

• BUSI 7130/6 Strategic Analysis of the
  Competitive Environment
• BDSS Chapters 2 3

8
The Boundaries of the Firm

• Why do firms exist at all? (See Coase.) why
  not market exchange for everything?
• Critical role of transactions costs and
  contracting issues
• within-firm production vs. market (outsourcing)
• Horizontal boundaries - role of production
  technology and economies of scale and scope in
  determining firm size and shape

9
Horizontal Boundaries of the Firm

• Role of economies of scale and scope and firm
  size and shape
• Economies of scale - declining LRATC
• implies MC lt AC, in range where Economies of
  scale exist
• cost advantages which favor larger firms

10
Some Sources of Economies of Scale

• Production technology
• Capital requirements
• Inventories
• advertising
• purchasing
• R D

11
Sources of diseconomies of scale

• Monitoring and transaction costs - coordination
  difficulties
• Managerial incentives and agency costs
• conflicts of interest, networks, and conflicting
  out

12
Economies of Scope

• Average cost reductions due to adding new or
  different product lines
• Sources
• specialized inputs, ex beef leather, banks
  information, exotic birds and hubcaps
• sharing fixed costs
• technology
• Conglomerate firms (will they last?)

13
Applications and estimation examples

• Financial Services Industry
• further reading for estimation examples
• Gropper, D. M. changes in scale economies for
  commercial banking firms 1979-1986, Journal of
  Money, Credit and Banking, 1991
• Gropper, D. M. Product-line deregulation and
  cost structure of U.S. savings and loan
  associations Applied Economics, 1995

14
Some examples to consider

• Dell Computer / Intel / Seagate
• Home Depot / Lowes / YellaWood
• Birds Eye Foods
• (See HBSP case)

15
Some questions to ponder for the Birds Eye case

• Why did Birds Eye develop as a vertically
  integrated producer?
• Should Birds Eye have bought their own fleet of
  fishing boats, and backward integrated into
  fishing? Why or why not?
• How about building cold storage facilities or
  farming? Are the answers similar to those for
  fishing? Why?
• What sort of advantage did Birds Eye build over
  other producers?
• Were there scale economies?
• If so, where were the scale economies, and what
  was their source?
• Why did the frozen food industry de-integrate?
• What do you see as a triggering event?
• What happened to asset-specificity?
• What could Birds Eye have done to stop the
  de-integration process?
• What are Birds Eyes problems at the end of the
  case? What are their main assets?

16
Economic Strategy Issues

• The Vertical Boundaries of the Firm
• BUSI 7130/7136

17
Basic questions to consider

• Should our firm be more (or less) vertically
  integrated than it is currently?
• Should we buy our inputs from another firm
  through a market transaction, or make it within
  our firm (perhaps buy a supplier)?
• Should we sell our outputs to another firm
  through a market transaction, or integrate more
  toward the final consumer?

18
Make-or-Buy Fallacies

• Buy, to Avoid the cost of production
• Make, to Avoid paying for another firms profit
  margin on an item
• Make, to Avoid price increases on an input.
  (ex electricity producers and natural gas in
  Summer 2000)
• Common theme above all fail to recognize
  opportunity cost concepts

19
Transactions Costsand Market Exchange

• Role of Contracts
• complete and incomplete contracts
• very difficult (e.g. costly) to write complete
  contingent contracts
• Bounded rationality issues
• Performance specification problems
• Asymmetric information

20
Relation-specific assets

• Specialized assets for a particular situation
• location
• design properties
• dedicated assets
• Human capital
• Asset specificity can lead to opportunistic
  behavior
• difference in best use and opportunity cost

21
Never contend with a man who has nothing to
lose.

• Baltasar Gracian, 1602-1658

22
The Holdup Problem

• Arise because of the wedge between first-best use
  and opportunity cost with relationship-specific
  assets
• Incomplete contracts make holdup more likely
• Renegotiation after decision points passed is
  likely
• How to deal with holdup problems?

23
Vertical Boundaries of the Firm

• Vertical integration - up and/or downstream
• Vertical integration avoids
• holdup problem
• underinvestment problem
• contracting problems
• Vertical integration considerations
• examine costs and benefits
• scale scope economies - technical efficiency
• agency costs - organizational efficiency

24
Examples to consider

• Telephone lines and end-use equipment production
• Frozen food processing and farming
• Food processing and grocery retailing
• Electric utilities and gas companies
• Electricity generation and transmission
• Paper companies and tree farms
• chips and computer firms

25
Alternatives to Vertical Integration

• Partial or tapered integration
• make some, buy some
• Strategic alliances and joint ventures
• soft contracts - based more on mutual trust and
  understanding
• Japanese Keiretsu
• Informal networks

26
Diversification

• Economies of Scope and Conglomerates
• Merger waves in U.S. history
• late 1800s, 1920s, 1960s, 1980s, 1990s
• Diversification vs. Integration
• Central notion of transaction costs and agency
  theory
• General skepticism about performance
• General concern about power and politics