Practical Research 1: Lesson 8 Writing the Thesis Statement.pptx
Eco chapter 8
1. 1
Competition and Strategy
Chapter 8
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2. 2
• 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
opinion or government policy
• How a business can identify tangible and intangible competitive
resources and formulate strategies that make the best use of them.
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3. 3
The Supermarket
Supermarkets that dominated grocery retailing in the twentieth century are losing
their customers in the twenty-first. Managements of chains large and small are
searching for strategies to restore their former dominance. Individual stores and
brands have some market power, but competition rules at all levels of the industry.
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4. 4
What’s Next?
This chapter builds on earlier models to redirect our
thinking about competition and business decisions.
Rivalry among the grocers is nearly the polar opposite
of the passive price-taking we saw in perfect
competition. Each supplier is actively strategizing to
earn and protect profits above opportunity cost, and
each is subject to constant threats from innovators
and imitators.
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5. 5
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6. 6
Competition: A Quest to Be
Exceptional – Competitive Ideas
Competition starts with ideas. Asked how he had produced
so many good ideas over his career, Nobel Prize–winning
chemist Linus Pauling 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.
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7. 7
Competition: A Quest to Be
Exceptional - 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
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8. 8
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Competing to Acquire Market Power
part.
• The competition that now interests us is quite unlike
what we saw in the model of a perfectly competitive
market.
• In actual markets, businesses often compete by
discounting prices rather than taking the equilibrium
price as given and unalterable.
• Business try to bind customers to themselves using
techniques like frequent-flier miles or other loyalty
programs.
• In real markets advertising is valuable to offer
information
9. 9
Competition: A Quest to Be
Exceptional - 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.
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10. 10
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).
•
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11. 11
Pitfalls in Studying Competition -
Selection Bias, Again
In studying competitive strategies we are often given the
information that Company X used Strategy A and
prospered. Even if the author mentions several firms that
succeeded with Strategy A, the reader is likely to remain in
the dark about (1) those that used Strategy A and failed,
and (2) those that rejected Strategy A and succeeded.
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12. 12
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Selection Bias, Again
website, in whole or in
part.
• 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 Wal-Mart
13. 13
Pitfalls in Studying Competition –
What’s Wal-Mart’s Secret?
• Here is a partial list of explanations that have been offered for Wal-
Mart’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.
• Like it or not, no one really knows why Wal-Mart has attained its
stardom.
• Why have Sears and K-Mart been underperformers?
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14. 14
Pitfalls in Studying Competition – Self-
Serving Recommendations
• The structure of corporate business further complicates
the analysis of strategy.
• A corporation’s executives and board of directors might make
choices that are in their personal interests rather than those of their
shareholders, who would prefer decisions that maximize the values
of their stock.
• 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.
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15. 15
• 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.
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16. 16
The Basics: One Seller and One Buyer
Buyer and seller both benefit from exchanging some good
if the seller gets more than his opportunity cost (i.e., the
value of the best forgone alternative), and the buyer pays
less than her valuation (maximum willingness to pay for it
before going elsewhere). Economic value is the difference
between the cost and valuation that they share.
In this example there is $4 worth of value to be shared.
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17. 17
The Basics: One Seller and One Buyer –
Raising the Purchaser’s Valuation
Here, the seller chooses to incur a cost of $1 to alter his good’s
characteristics (possibly improving quality or making the good
available closer to the purchaser’s home). In so doing, he
raises the purchaser’s valuation by $2 to $13, increasing the
economic value from $4 to $5.
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18. 18
The Basics: One Seller and One Buyer –
Lowering the Seller’s Costs
Here the seller devises a way to lower costs by $2, from $7 to $5.
with the purchaser’s valuation constant at $11, this will
increase the economic value available from $4 to $6.
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19. 19
The Basics: One Seller and One Buyer –
Lowering Transaction Costs
Here is a situation that includes transaction costs. Seller’s
opportunity cost is $5 plus $2 in transaction costs. Purchaser’s
valuation is $16 plus $3 in transaction costs. Even after
transaction costs, there remains $6 in economic value available
to be shared.
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20. 20
The Basics: One Seller and One Buyer –
Lowering Transaction Costs
If the seller cuts his transaction costs by $1, the economic value
available to be shared rises to $7. Similarly, the purchaser
could reduce her transaction costs and increase the economic
value available.
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21. 21
The Basics: One Seller and One Buyer –
Lowering Transaction Costs
Here, the seller spends $1 in order to lower the purchaser’s
transaction costs by $2. This will increase the economic value
available from $6 to $7.
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22. 22
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One Seller, Many Buyers
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part.
• Sellers can distinguish themselves in hopes that buyers
will pay a premium for their product.
• Distinguishing implies establishing market power and a
greater slope to the demand curve for their product.
• Depending on the substitutes available a seller may be
able to charge a higher price for his differentiated good.
23. 23
One Seller, Many Buyers - Raising Buyers’
Valuations – Altering Variable costs
Here the seller increases variable
cost to improve the product and
increase buyer valuation. Marginal
costs increases to MC’ and demand
shifts to D’. Price increases to $9.50
and profit rises.
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24. 24
One Seller, Many Buyers - Raising Buyers’
Valuations – Altering Fixed Costs
• Here the seller invests in fixed cost in
order to increase buyer valuation,
perhaps building a new plant that
produces fewer defective units of
output from the same variable inputs
as before.
• This will increase the seller’s present
and future profit but that increase in
the profit stream must be compared to
the cost of the new plant to determine
whether to build.
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25. 25
One Seller, Many Buyers – Lowering
Production Costs
Here, lowering production costs
from MC to MC’, increases annual
profit by $9 from $16 to $25. A
seller Be willing to invest up to $9
per year to achieve such a
reduction in production costs.
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26. 26
One Seller, Many Buyers – Lowering
Transaction Costs
• Here, buyers and sellers both face
transaction costs.
• Including transaction costs, demand is D’
(not D) and marginal cost is MC’ (not MC).
• Incurring additional cost (MC”), to reduce
buyer transaction costs shifts demand
curve to D and increases profit.
• If the seller can cheaply reduce buyers
transactions costs output and profit
increase as do benefits to buyers.
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27. 27
Many Buyers and Many Sellers
This shows what happens in a competitive market when a single firm initially
adopts a cost-saving innovation. Other firms will follow and a new long-run
equilibrium will be restored where firms once again earn zero
economic profit.
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28. 28
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.
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29. 29
Many Buyers and Many Sellers –
Upward Sloping Supply Curves
Supply curve S’ and demand curve
D’ include a $3 transaction cost
for sellers and a $2 transaction
cost for buyers. The market
equilibrium price is $10 with 75
units traded.
Suppose that all transaction costs
were costlessly eliminated. Market
price will fall to $9 with 110 units
traded.
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30. 30
Many Buyers and Many Sellers –
Outsider Reduces Transaction Costs
D1 would be the demand curve with
no transaction costs. With
transportation costs of $18 to buyers,
the demand curve is D2. Market
price will be $13 and 19 units will be
traded.
Imagine an intermediary reduces the
buyer transportation costs to $8,
making the demand curve D3. Market
price rises to $16.33 and the number
of units traded increases to 25.67.
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31. 31
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32. 32
Horizontal Mergers and Agreements -
Mergers
Mergers and acquisitions can be important elements of
strategy. A horizontal merger puts the assets of two
firms that operate in the same market under the same
ownership. The consequences depend on market
structure and on how the merger affects costs.
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33. 33
Horizontal Mergers and Agreements - Mergers
• Suppose the diagram to the right
depicts a perfectly competitive market in
equilibrium.
• If two of the firms merge to reduce
costs, nothing happens.
• But, if this sets off a merger wave we
may end up with an oligopoly whose
equilibrium looks like a monopoly (12,000
units at $10).
• This would create a deadweight
loss equal to the small red triangle.
• The net benefit of mergers is the algebraic
sum of cost savings and deadweight loss.
• Here it is positive but it could be negative.
• This is what anti-trust regulators assess.
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34. 34
Horizontal Mergers and Agreements - Agreements
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. Other
agreements among competitors can be both legal and economically
desirable.
For example, members of the Recording Industry Association of America
(RIAA) long ago agreed on common technical specifications for music CDs.
Such a standard allows CDs from any RIAA member (or nonmember who
uses the format) to work on many different players and computers.
Antitrust law treats agreements like these under a rule
of reason standard that balances their favorable and unfavorable effects on
competition.
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35. 35
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
managing dissimilar activities.
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36. 36
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Vertical Mergers and Agreements
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• The degree of integration matters because costs and
revenues can vary with the number of stages in which a
firm operates.
• Costs may increase if there are problems managing
dissimilar operations.
• Vertical mergers are hardly ever strongly scrutinized by
anti-trust regulators.
• A firm will merge vertically to improve its
competitiveness.
37. 37
Vertical Mergers and Agreements -
Mergers
• D is the market demand for
diamonds.
• A is DeBeers’ MC for mining and B is
the MC for independent retailers.
• C would be the sum of A & B which
means 9 diamond rings would be sold at
$15 each.
Should DeBeers extend into the Retail
business?
Only if it can retail rings at lower cost
than jewelry stores.
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38. 38
Vertical Mergers and Agreements -
Agreements
• Two firms in different stages of a vertical chain might reach an agreement
that makes them a better competitor when they act as a team.
• An agreement will be preferable to a merger if a single management
cannot monitor both stages as well as separate managements can.
• Independent retail store managers searching for profit might have better
incentives than salaried employees of an integrated firm.
• Vertical agreements in apparel and textiles – integrated firms in this
industry are rare.
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39. 39
Vertical Mergers and Agreements –
Restrictive Agreements
• Many vertical agreements greatly restrict the future
choices of both parties.
• A franchise contract between a carmaker and a dealer
often prohibits the manufacturer from opening another
outlet close by, that is, it specifies an exclusive territory.
• 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 always have food on hand
to fulfill its side of the requirements contract.
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40. 40
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Restrictive Agreements
• 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.
41. 41
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42. 42
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.
• New competitors do not miraculously appear especially where
economies of scale are important.
• Inexperienced competitors rarely appear except in new markets.
• The automobile market – incumbent disadvantages
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43. 43
Intangible Assets: Trademarks and
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
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44. 44
Influencing the Public and Government
– Public Relations
• Public recognition and approval of a firm’s practices can also be a
competitive tool.
• In 2005, two hurricanes destroyed much of the New Orleans and
Beaumont–Port Arthur areas.
• While the relief efforts of local and national governments faltered,
companies like Wal-Mart, Home Depot, and Lowe’s had stockpiled and
shipped necessities to the area before the storms hit, and the firms
bypassed profits by keeping prices at pre-disaster levels.
• Actions can be both charitable and competitive.
• Similarly, energy and auto producers advertise their environmental
concerns.
• Campaigns for Toyota’s and Honda’s hybrid cars stress their ecological
impact rather than their performance.
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45. 45
Influencing the Public and Government
– Influencing Government
• Government can also help a business to advantage itself or
disadvantage competitors.
• Among possible strategies, a firm might seek legislation that makes
competition illegal, as cable TV operators have done in many cities.
Cable, however, has failed to suppress satellite 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.
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46. 46
• 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.
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47. 47
Resources and Strategies - What Are
Resources?
The originator of the resource-based model, Birger
Wernerfelt of MIT, writes:
By a resource is meant anything which could be
thought of as a strength or weakness of a given
firm. More formally, a firm’s resources at a given time
could be defined as those (tangible and intangible)
assets which are tied semi-permanently to the firm.
Examples of resources are: brand names, in-house
knowledge of technology, employment of skilled
personnel, trade contacts, machinery, efficient
procedures, capital, etc.
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48. 48
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.
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49. 49
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.
• We will often wish to use or acquire resources that make our strategy
more resistant to their attacks.
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50. 50
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.
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51. 51
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Competence and Sustainability - The
duplicated, or posted to a
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Search for Strategies
• If competition is resource based, we will require
a better understanding of the types, potential,
and limitations of these and other intangible
resources.
• To do so, we must proceed beyond transactions
in markets.
• Contracts with enforceable commitments.