Strategic Management

Competitive Strategy

Week 1: Strategy

• Def: the choice of what goals to pursue and how pursue it given the resources and potential responses of rivals/ other organizations.
• Cost/operational advantage =/ strategic advantage
• Strategic advantage: choose your product mix, org structure in a way overcomes whatever inherent disadvantages you may face
• Strategic advantage=/ Sustainable strategic advantage
• Sustainable strategic advantage: retained even after rivals see what you are doing and attempt to respond
• Tradeoffs make it difficult for rivals to replicate what you’re doing, and hence can make strategic advantages sustainable= a source of long run profits
• Example: The fast fashion from Zara is acquired through their high cost production in Spain.
• Many strategies involve components that fit together. If you replicate only a few, it is worse than not replicating at all.

Week 2: Industry Analysis

• Industry differences explain roughly 10-20% of differences in firm profits (fixed) ; rest of the differences be explained by strategic choice of actions of the firms themselves.
• Industry structure includes competitive and complementary actors.

• Rivalry among firms, buyer power, supplier power, the available of substitutes for your product, and the easy of entry for new competitors.
• Complementor= any organization who sees it in their interest to take actions which increase your profitability (e.g., governments, non profits, R&D)

• The behavior - the conduct - of firms in an industry determines the industry’s structure
• Potential value captured is affected by value added and outside options

• =WTP of your buyers- your cost
• you cannot earn more than the added value - must be the case, since otherwise other firms could simply reorganize the industry, cutting you out, and each be better off.

• 3 ways you want to affect industry structure: 1. increase your added value to the entire group (i.e. making a product for which consumers have higher willingness to pay), or 2. increase your outside option (by having, say, a second-best product you can quickly redeploy your firm’s resources to), 3.  increase your ability to bargain your way to better outcomes within those two bounds. (advertising, government tax)

Week 3: Differentiation

• Value added=Profit=WTP-Cost

• Cost depends on how much power you have over your suppliers
• WTP depends on what your rivalry’s are doing-> differentiate
• When your product is not identical (differentiation) to other close competitors, some buyers who particularly like those changes will have a higher WTP for your good than the price your competitors sell their good at.

• Horiz. Or Vert. differentiation can increase WTP by lessening competition

• Horiz. Diff: same price, some prefer A, others prefer B (Pepsi &Coke)
• Vert. Diff: same price, all prefer higher quality product (luxury hotel & Hostel) 

• Firms differentiate on quality solely to lessen price competition from rival

• If diff, I can keep my price higher than my rival if he locates besides me

• Tradeoff: diff moves you away from fiercely price competition, also move your product away from the mass of demand

• Whether you want to differentiation depends on the benefits from less price competition is greater or smaller than the cost of not having the “optimal” product (locate at center of demand) from the view of consumers.

• Benefits of avoiding competition/ Differentiation tradeoff depends on market structure

• market structure characterized by “firms can price discriminate” is

one in which differentiation is less useful.

• differences in supplier power, or barriers to entry, or certain types of complementors, affect the incentive to differentiate.

Week 4: Pricing Strategies

• When firms sell similar products, and have free capacity, firms have incentive to continually cut prices to take their customers

• Air travel “surprise sales”, pizza
• How to avoid?
• Extra capacity

• For variable demand
• Strategic reasons: to expand production and punish rivals and deter entry (can keep price low)

• Price match guarantees and related strategies help avoid pricing dilemma

• reduce the incentives of your rivals -> to reduce prices to undercut you, and commit you to not undercutting your rival

• Price math guarantees: rival will not undercut me because he will not get additional sales
• Loyalty programs-decrease the # of customers your rival can steal if they try to undercut you on price; can price higher w/o losing all my customers if my rivalry undercut me
• Obfuscated prices- make it hard to figure out prices for customers to compare-> hard to switch firms for customers
• Bundling: allowing customers who prefer interoperability to buy components separately decreases incentive of rival to lower price to steal from your strong and weak market

• Predatory pricing is effective only in very specific situations

• Me: reason for PP is because I know my prices will go up (gain) in the LR
• Rivalry: as long as I have enough money to fight off the predatory price
• Smart firms understand the rare conditions when predatory pricing can be profitably used, and position themselves to fight it.

• To avoid trigger price war, make your price structure bad for some customers, good for other customers to enter the incumbents’ weak market.

• Make the incumbent’s most profitable customers will not switch over to you
• E.g. Virgin target young people instead of business users (the most popular);

Week 5: The Product Life Cycle

• With lots of entry early followed by a shakeout, is common

• how your firm should act, how it should experiment, how big it should be will depend heavily on precisely what point of the industry life cycle your firm finds itself in.

• Shakeout tends to occur after dominant design solidifies 

• E.g., Once suppliers to the industry get very good at producing cheap gas engines, though, it is no longer cost-effective to build a car using anything else.
• Not just physical product, or suppliers’ techniques, legal systems that lock in Dominant design

• During mature stage, few firms settle on dominant design (all firms make fairly standardized/similar product), lots of firms exit, shakeout happens
• Firms that are big before shakeout tend to dominate after shakeout

•  First mover adv: firms with the greatest share of the mkt/ earn greatest return tend to be those entered earliest

• Reason: process R&D leads incumbents to become very good at producing a certain type of product cheaply

• Who finds worthwhile? Large firms who can spread this R&D cost out over many units
• Even in the early stages of the industry when products are not standardized, you need to ensure you grow big enough to be able to afford the process R&D that will become important once a dominant design starts to solidify, else you will quickly find yourself unable to compete on costs.

• Life Cycle less common in industries without process R&D by manufacturers

• High end restaurant
• Process R&D done by contract firms (send production to 3rd party manufactures)  Nike/Under Armour.
• The mechanism of PLC doesn’t depend solely on process R&D

• cost of advertising generates brand equity that accumulates over time and can have it cost spread over all units sold, hence industries where brands are very important may also show an industry life cycle

Week 6: Theories of the firm

• Def: organizations in a market economy that centralize decisions = make decisions by fiat
• Economy of scope: AC for multiple products falls when all are made by same firm
• Many interactions exist within a firm rather than between firms
• Modern firms do not arise until the late 1800s because of the technologies where MES could be the entire world
• Transaction cost theory: the cost of operating is higher in the market > within the firm. –one reason for the existence of the firm
• AQRs: the value we create working together – value of our next-best options if we stop working together (e.g.:  me and a contractor)

• Why have AQR?  relationship-specific interests and worth renegotiating

• Incomplete contract matters: cannot conceive some states of the world

• Unprogrammed adaption: hit events where any contract we previously had

doesn’t cover that event, and we want to renegotiate

• Holdup problem: once sunk cost is paid by A, B has the incentive to seek renegotiation of the contract that would receive a higher price.

• Negotiation are costly

• ***If contracts are highly incomplete, and AQRs are high, and haggling or transaction costs of renegotiating the contract are high, we may simply be better off integrating into one firm.
• Residual control rights theory/ Property rights theory:
•  when we renegotiate, owning the assets improve our bargaining power over the joint surplus. (exclude transaction cost)
• *** assets in a joint relationship should be owned by the agent whose investment decision is most sensitive to the bargaining power change that results.
• Resource-based view:  Some firms, for some reason, are good at certain tasks. They have tangible or intangible resources which make them better than any other firm at performing some task; sometimes these are called “core competencies”.

• Not replicable/  imitable

•  Resource developed over times
• Historical benefit  (unique relationships)

• Immobile

• ***If you are claiming a merger is a good idea on the basis of the resource view, you need to not only know what the special resource you claim you firm has is, but also need to explain why other firms can’t simply acquire the same resource or skill.