Topic 2: Value Creation

1
Topic 2 Value Creation

• How to identify opportunities forvalue creation
  and exploit them
• Paul Kerin Sam Wylie
• MBS Term 3, 2004

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Key economic skill

• Consider other players and put yourself in their
  shoes
• Two questions
• Do your actions affect their payoff?
• Do their actions affect your payoff?
• If the answer to either question is yes there
  is an opportunity to create value by cooperating

3
Neighbourhood blues

• Todd values a quiet neighbourhood
• Lisa enjoys playing the saxophone
• They live next to one another
• Do Lisas actions affect Todds payoff?
• Is there a gain from cooperation (if Lisa has the
  legal right to play the saxophone)?

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Answer depends on value

• Suppose that Lisa values playing the saxophone at
  100 while Todd values a quiet neighbourhood at
  150
• Then if Todd were to pay Lisa 100 or more, then
  Lisa would choose not to play
• What if Todd were legally entitled to silence?
  When would the outcome change?

5
The Coase Theorem

• The assignment of legal rights does not matter
  for the outcome. The efficient outcome will
  always be negotiated
• However, rights do matter for the distribution of
  value
• But what would happen if Lisa and Todd could not
  write an enforceable contract?

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Pizza videos

• A pizza store and video store are located next to
  one another
• The pizza store owner notes that many customers
  order a pizza then go next door to pick up a
  video before returning to pick up their order
• They wonder if many consumers are looking upon
  pizzas and videos as a joint product

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Pricing game

• The current price of a pizza is 10 and the
  current price of a video is 6. There are
  currently 100 customers who purchase both
• The pizza store owner reckons that by reducing
  the pizza price by 2, an additional 20 customers
  might be attracted
• Is this worth doing?

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Yes and no

• Current profits are 600 for the video store and
  1,000 for the pizza place
• After the price reduction, the video stores
  profits become 720 while the pizza places
  profits fall to 960. So for the pizza store, the
  discount is not worthwhile?
• But what if they could coordinate their pricing?

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Coordinating pricing

• What mechanisms could they use to coordinate
  pricing?
• What impediments do they face to reaching an
  outcome?

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Strategies for complements

• Provide the complements individually
• Too few units being produced
• Subsidise the provision of complements by others
• Be subsidised to produce complements
• Form a jointly funded complement provider

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Identifying Players

• Players differ in their roles in value creation

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The Value Net

SUPPLIERS
COMPANY
COMPLEMENTORS
COMPETITORS
CUSTOMERS
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Customers
Your Business
Production Flow
Monetary Flow
Your Customer

• Your customer may be another business, or a
  private consumer
• The production flow and the monetary flow go
  in opposite directions

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The Value Chain

• Business is engaged in multiple markets buying
  inputs and selling products.

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Complementors competitors The Customer Side

• A player is your complementor if customers value
  your product more when they have the other
  players product than when they have your product
  alone
• A player is your competitor if customers value
  your product less when they have the other
  players product than when they have your product
  alone

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Complementors and value

• (1) Creating value There may not be a pie
  without complementors
• (i.e. total value may otherwise be negative)
• Need to get complementors in the market
• Chicken-and-egg story who will invest first? Who
  will enter the market first?
• Division before creation Firms trying to gain
  too large a share of the pie can destroy it

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Complementors and value

• Bringing in complementors creating value (1)
• Example Common funds
• 1913 GM, Hudson, Packard created the Lincoln
  Highway Association to fund seeding miles
• 1999 Compaq, Sun, Netscape and Oracle provided a
  100m Java development fund

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Complementors and value

• (2) Dividing value Everyone would like cheap
  complements
• Example Vacation spots
• Hotels need airlines, airlines need hotels
• Allied or conflicting interests?
• Consumer cares about pa ph
• Each firm wants the other to be cheap

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Complementors and value

• (2) Dividing value
• Solutions
• price agreements
• one price for the two goods bundled together
• Vacation packages, Software applications, cinema
  and food at Jam Factory
• What about petrol and groceries?

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Do-it-yourself?

• Another solution Become your own complementor
  brings in the complement, and solves the pricing
  problem.
• Example What business is RACV in?
• roadside assistance
• insurance
• travel
• buying club
• financial products

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Complementors competitors The supplier side

• A player is your complementor if it is more
  attractive for a supplier to provide resources to
  you when it is also supplying the other player
  than when it is supplying you alone.
• A player is your competitor if it is less
  attractive for a supplier to provide resources to
  you when it is also supplying the other player
  than when it is supplying you alone.

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The supply sideExamples

• HP Dell
• compete with each other for the latest Intel chip
• complement each other in defraying Intels RD
  costs
• United American Airlines
• compete with each other for landing slots and
  gates
• complement each other in defraying Boeings RD
  costs

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Multiple rolesJekyll and Hyde

• Competitive threat or
• complementary opportunity?
• Movie theatres video rentals
• Traditional Internet booksellers
• Computers and paper paperless office
• ATM machines - the fate of Citibank

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Multiple rolesMaking markets

• Antique stores on High Street, Armadale
• Theater, music, dance on and off Broadway
• Supermarkets and hot bread stores
• Complementors in making
• the market
• Competitors in dividing
• the market

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Friend or foe?

• Traditionally
• Friends
• Customers, Suppliers, Complementors
• Foes
• Competitors
• Co-opetition points out that almost all players
  are both friends and foes (1) partners in
  creating surplus, (2) competitors in dividing the
  surplus

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Coming up

• Key area of value creation gains from trade
• Involves standing in shoes of customers and
  suppliers
• Willingness to pay
• Willingness to sell