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Strategy
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must be considered in an uncertain context. it's forward-looking. it's dynamic. firms do not operate in isolation but, rather, in competition. goals and strategies vary b/c firms pursue long-run profitability differently. competitive changes influence firms differently. no single performance metric is adequate for evaluating strategy/competitive position. Firms pursue long-run profitability differently; there isn't necessarily one "right" strategy
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Key Ideas from Porter
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1. Strategy > performing different activities or performing similar activities differently
2. Operational effectiveness (performing similar activities better) is NOT strategy. Advantages from processes, methods, techniques, etc. are often unsustainable due to ease of replication
3. Strategy sustainable bc it's difficult to replicate (i.e. entail costly tradeoffs on what not to do, what to give up and consists of systems of activities that fit).
2. Operational effectiveness (performing similar activities better) is NOT strategy. Advantages from processes, methods, techniques, etc. are often unsustainable due to ease of replication
3. Strategy sustainable bc it's difficult to replicate (i.e. entail costly tradeoffs on what not to do, what to give up and consists of systems of activities that fit).
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The "value stick"
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consumer surplus + producer surplus (profit) = economic surplus (total value created). operational effectiveness creates more value, but competition/replicability limit value capture.
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create more value
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increase consumer's WTP, without increasing cost. decrease product cost w/o decreasing WTP.
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claim more value
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increase sales price... holding cost and WTP constant or maintain price in light of falling costs.
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Tesla's Strategy
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innovation and economies of learning. then go through how it performs different activities, performs similar activities differently, and how its system of activities is difficult to replicate. tesla relies on secrecy to protect IP,
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Deliberate strategies
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Realized as intended
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Emergent Strategies
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Patterns or consistencies realized despite, or in the absence of, intentions
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What factors influence consumers' WTP for a product? (economics concepts)
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Demand, determinants of demand:
Tastes / Preferences
•Income
•Availability and cost of substitutes
•Availability and cost of complements •Expectations
Tastes / Preferences
•Income
•Availability and cost of substitutes
•Availability and cost of complements •Expectations
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How much more will the firm sell if it lowers its price? (economics concepts)
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Price elasticity of demand
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How many units should a firm produce? Should the firm enter or exit certain markets? (economics concepts)
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Costs (fixed, marginal, sunk, opportunity, accounting vs. economics/opportunity costs, economies of scale vs. economies of learning vs. scope)
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At what price should the company sell its products? (economics concepts)
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Supply & demand, nature of competition
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WTP > Consumer Demand > Market Demand
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Consumer Demand: A demand curve for a single buyer indicates WTP for different quantities of a product or service
Market Demand: The sum of all individual consumers' demand curve results in the market demand curve
Market Demand: The sum of all individual consumers' demand curve results in the market demand curve
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Law of demand
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The lower the price, the greater the quantity demanded
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Demand curve (shifts vs slides)
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Changes in factors that affect WTP SHIFT the Demand curve (e.g. a pandemic reduces disposable incomes).
Changes in price move/slide us along a demand curve (e.g. insulin manufacturer raises prices)
***not demand curve has quantity demanded on the x axis and price on the y axis
Changes in price move/slide us along a demand curve (e.g. insulin manufacturer raises prices)
***not demand curve has quantity demanded on the x axis and price on the y axis
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price elasticity of demand
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How responsive is quantity demanded to changes in price?
Percent change in quantity demanded for a percent change in price:
Ed = (% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅)/(% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆)
where percentage change is (New - Old)/Old
0 < absolute valued of Ed < 1 = Inelastic
absolute value of Ed > 1 = elastic
Ed is NOT the same as slope of the demand curve
Percent change in quantity demanded for a percent change in price:
Ed = (% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒒𝒖𝒂𝒏𝒕𝒊𝒕𝒚 𝒅𝒆𝒎𝒂𝒏𝒅𝒆𝒅)/(% 𝒄𝒉𝒂𝒏𝒈𝒆 𝒊𝒏 𝒑𝒓𝒊𝒄𝒆)
where percentage change is (New - Old)/Old
0 < absolute valued of Ed < 1 = Inelastic
absolute value of Ed > 1 = elastic
Ed is NOT the same as slope of the demand curve
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Factors that make demand for product MORE elastic
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Product lacks differentiation and competing products' prices/features are highly visible, buyers' expenditures on the product are a large fraction of their total expenditures, The product is an input that buyers use to produce a final good whose demand is itself sensitive to price
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Factors that make demand for product LESS elastic
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Comparisons among substitute products are difficult, Because of tax deductions or insurance, buyers pay only a fraction of the full price of the product, Buyer faces high switching costs, The product is used in conjunction with another product that buyers have committed themselves to
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Cross-price elasticity of demand
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How much does my demand change when another product's price changes
Substitutability of products
Will think about this more in Industry Analysis & Porter's 5 Forces
Substitutability of products
Will think about this more in Industry Analysis & Porter's 5 Forces
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Income elasticity of demand
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How much does my demand change when income changes?
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Total (TC)
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all costs associated with producing and selling total output Q
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Average (AC)
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TC ∕ Q
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Fixed
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do not vary with Q, but not sunk
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Sunk
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cannot be avoided/recuperated; may or may not vary with Q
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Variable
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vary with Q, but not sunk
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Marginal (MC)
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TC(Q+1) - TC(Q)
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opportunity cost
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Return of next best, often-implicit alternative foregone to engage in economic activity
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Accounting profit
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(P * Q) - (tc)
accountants focus on what HAPPENED
accountants focus on what HAPPENED
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Economic profit
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(P * Q) - (tc) - (opportunity cost)
Strategists focus on what happens next
Strategists focus on what happens next
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Economies vs Diseconomies of Scale
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Economies of scale for a firm involve reductions in the average cost (cost per unit) arising from increasing the scale of production for a single product type at a single point in time
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Economies of Learning
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Economies of learning involve lowering average cost through experiences which occur over time
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Economies of Scope
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Economies of scope involve lowering average cost by producing more types of products at the same time.
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Discounted cash flow analysis
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Value cash flow stream based on a specific discount rate.
•Compare strategic options in net present value terms.
NPV = -Co + (C1/1+r) + (c2/(1+r)^2)+...+Ct/(1+r)^t
-Co = initial investment
r = rate
t = time
•Compare strategic options in net present value terms.
NPV = -Co + (C1/1+r) + (c2/(1+r)^2)+...+Ct/(1+r)^t
-Co = initial investment
r = rate
t = time
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What is 5 forces analysis?
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A framework for analyzing industry profitability; used to systematically identify threats and opportunities, anticipate effects of industry change, and positioning the company.
The 5 forces are in the pic
The 5 forces are in the pic
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Industry
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Analysis of competitors, entry barriers, substitutes, buyers, and suppliers determined by industry definition.
• Start with basic customer need being fulfilled and think about where value generation & monetization come from
- "... a group of incumbent firms facing more or less the same set of suppliers and buyers."
• Start with basic customer need being fulfilled and think about where value generation & monetization come from
- "... a group of incumbent firms facing more or less the same set of suppliers and buyers."
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How does an economic recession influence supplier power?
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The recession decreases suppliers' power over retailers for at least two reasons (Delhaize v Unilever reading):
1. First, the recession makes price-sensitive consumers even more price sensitive (i.e., demand becomes more price elastic)
2. Second, greater price sensitivity makes retailers' private-label brands more attractive, relative to suppliers' premium brands, to consumers
1. First, the recession makes price-sensitive consumers even more price sensitive (i.e., demand becomes more price elastic)
2. Second, greater price sensitivity makes retailers' private-label brands more attractive, relative to suppliers' premium brands, to consumers
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Nature of Rivalry - "Smart" Competitors (Coke v Pepsi)
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Two dominant players with long history of interaction
Compete primarily on non-price dimensions
Price wars benefit neither Coke nor Pepsi. Any advantage short-lived
Compete primarily on non-price dimensions
Price wars benefit neither Coke nor Pepsi. Any advantage short-lived
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Industry Life Cycle
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A framework that describes a common pattern of industry evolution. S-shaped curve of industry growth driven by process of diffusion of new products. Note that industries do not NECESSARILY evolve through each of these stages. Duration of stages can vary widely across industries.
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Product innovation
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The development of new or substantially improved products & services
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Process innovation
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New ways to produce existing products or services
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Key Takeaways from Product Lifecycle
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Various characteristics (customers, # competitors, growth, priorities) can help us recognize the stage a particular industry / product occupies at a given time.
Knowing where an industry is in its life cycle can help companies clarify strategic priorities and anticipate future developments.
Also, can help companies strategize how they can implement policies to extend the life of a stage or re-set the industry cycle.
Knowing where an industry is in its life cycle can help companies clarify strategic priorities and anticipate future developments.
Also, can help companies strategize how they can implement policies to extend the life of a stage or re-set the industry cycle.
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The need for a "Theory of the firm"
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Economcis: Duality of the firm
Inputs go into the firm > Black Box (this is the firm, but there are unknowns) > output produced (might be differences in efficiency or inventiveness)
Strategic management asks what's in the black box?
resources and capabilities feed into core competencies which leads to activities and then a variety of heterogenous final products
Inputs go into the firm > Black Box (this is the firm, but there are unknowns) > output produced (might be differences in efficiency or inventiveness)
Strategic management asks what's in the black box?
resources and capabilities feed into core competencies which leads to activities and then a variety of heterogenous final products
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Resources
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any tangible and intangible assets the firm can draw on when crafting and executing strategy•
Tangible: e.g., Cash, buildings, machinery, supplies, labor, land• I
Intangible: e.g., Managerial skill, vision, knowledge, culture, brand equity, reputation
2 assumptions about resources:
• Heterogenous
• Relatively immobile, tied to the firm, "sticky"
Tangible: e.g., Cash, buildings, machinery, supplies, labor, land• I
Intangible: e.g., Managerial skill, vision, knowledge, culture, brand equity, reputation
2 assumptions about resources:
• Heterogenous
• Relatively immobile, tied to the firm, "sticky"
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The VRIN+DA Test
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Competitive advantage likely to result from resources if they are:
Valuable (E.g. it can increase WTP, reduce cost to create value)
Rare: Few rivals have the resource
Inimitable: Rivals can't easily develop or acquire the resource
Non-substitutable: Can't easily be substituted for
Durable: Depreciates slowly
Appropriable:
Company can capture the returns from the resource
Valuable (E.g. it can increase WTP, reduce cost to create value)
Rare: Few rivals have the resource
Inimitable: Rivals can't easily develop or acquire the resource
Non-substitutable: Can't easily be substituted for
Durable: Depreciates slowly
Appropriable:
Company can capture the returns from the resource
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What things are hard to imitate? what things are inimitable?
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Customer loyalty, know-how, and culture are hard to imitate.
Patents, system "fit" are INIMITABLE
Patents, system "fit" are INIMITABLE
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What resources are easily imitated or plausibly imitated (but may not be)
answer
Capital and commodities are easily imitated.
Capacity, scale, and prime location are plausibly imitated.
Capacity, scale, and prime location are plausibly imitated.
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How do firms obtain valuable resource
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Buy and sell on strategic factor markets
Many resources can't be bought and sold
Many resources can't be bought and sold
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Capabilities
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Capability: A process or competency embedded into the company's routines, procedures, and processes
vs.
Dynamic capabilities: Organizational and managerial skills necessary to create, deploy, modify, upgrade and leverage resources over time in constantly changing environment
vs.
Dynamic capabilities: Organizational and managerial skills necessary to create, deploy, modify, upgrade and leverage resources over time in constantly changing environment
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Core competencies
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Unique strengths embedded deep within the firm.
The firm's resources and capabilities reinforce core competencies
The firm's resources and capabilities reinforce core competencies
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What are some of Zara's unique resources?
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Tangible: Highly centralized headquarters, large distribution center, more than 2,000 stores globally, high tech equipment
Intangible: Fully integrated and efficient design, manufacturing, distribution system, unconventional idea, location in region with history of garment production, centralized decision-making/coordination
Intangible: Fully integrated and efficient design, manufacturing, distribution system, unconventional idea, location in region with history of garment production, centralized decision-making/coordination
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Zara's core competencies
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Speed in supply chain, responsiveness of inventory
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Game theory
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Formal analysis of interdependence among outcomes of informed, logical decision makers.
Mathematical analysis (esp. set theory & topology) to analyze how strategic choices are optimized by one agent and influence another's "optimization problem" and vice versa (we will not go nearly this far!)
Mathematical analysis (esp. set theory & topology) to analyze how strategic choices are optimized by one agent and influence another's "optimization problem" and vice versa (we will not go nearly this far!)
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Two types of games in strategy
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Simultaneous move games (Matrix-form/the boxes with one firm on the side and one on top) and then sequential move games (Extensive form/those lines branching off from one another).
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Nash equilibrium
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each player's strategy yields a payoff at least as good as the payoff from any other available strategy, given the strategy of the other players
Each player is playing the best response to the other players' strategies
In Nash equilibrium, each player has no incentive to deviate
Not necessarily the best outcome in terms of payoffs
Each player is playing the best response to the other players' strategies
In Nash equilibrium, each player has no incentive to deviate
Not necessarily the best outcome in terms of payoffs
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How to solve basic extensive form games?
answer
The difference here is that Firm A moves first. Firm B can observe action, then decide.
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Dominant strategy in Prisoner's Dilemma vs. dominated strategy
answer
Prisoner's Dilemma is like a Price War; nash equilibrium is a sub-optimal outomce even though dominant strategies are played; committing to a dominated strategy is rarely credible (requires a lot of trust or repeated interaction).
DOMINANT = to confess bc it is optimal regardless of rival's actions
DOMINATED strategy = to not confess which will result in sub-optimal outcome regardless of rival's actions
DOMINANT = to confess bc it is optimal regardless of rival's actions
DOMINATED strategy = to not confess which will result in sub-optimal outcome regardless of rival's actions
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The entrant game
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sequential move game where the problem is that commitment to fight is not credible. To make it more credible you want to change your payoffs (change cost of fighting) and/or change the entrant's payoffs (make entry more expensive)
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Predatory pricing likely to succeed? (what questions do you have to ask yourself?)
answer
Am I growing the market? (If demand inelastic, price decreases don't not grow total demand; just shift customers between competitors)
How is my competitor likely to react? (KL unlikely to exit. Established player; preferred by customers; can bleed cash — has other sources of funding)
How important is market share? (Is market share key to profitability? How relevant fixed costs, network effects?; would it be sustainable? or would price increases cause customers to switch?)
How is my competitor likely to react? (KL unlikely to exit. Established player; preferred by customers; can bleed cash — has other sources of funding)
How important is market share? (Is market share key to profitability? How relevant fixed costs, network effects?; would it be sustainable? or would price increases cause customers to switch?)
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Perfect competition
answer
Many small firms
• Undifferentiated product
• Low entry barriers
• Firms are price takers
• Undifferentiated product
• Low entry barriers
• Firms are price takers
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Monopolistic competition
answer
Many firms
• Differentiated product
• Medium entry barriers
• Firms have some pricing power
• Differentiated product
• Medium entry barriers
• Firms have some pricing power
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Monopoly
answer
one firm
• Unique product
• Firms have considerable pricing power
• Unique product
• Firms have considerable pricing power
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What is Strategy?
answer
Strategy, operational effectiveness, tradeoffs, value stick, value creation & capture, economic surplus, consumer surplus, producer surplus
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Economic foundations
answer
WTP & its determinants, demand, price elasticity of demand and its determinants, sunk cost, fixed cost, variable cost, marginal cost, ATC, opportunity cost, NPV, economies of scale, scope, & learning, economic profit, accounting profit
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Industry Analysis
answer
Firm vs. industry effects, 5 Forces Framework, determinants of buyer & supplier power, threat of substitutes, barriers to entry, and threat from rivalry
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Company Analysis
answer
Tangible & intangible resources, VRINDA, more or less imitable resources, capabilities, core competence, value chain activities
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Competitive interactions
answer
Extensive & matrix form games, backward induction, Nash equilibrium, changing payoffs, making commitments, best response / reaction curves
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Economies of scale
answer
Economies of scale for a firm involve reductions in the average cost (cost per unit) arising from increasing the scale of production for a single product type at a single point in time
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Economies of learning
answer
involve lowering average cost through experiences which occur over time
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