© 2007 the mcgraw-hill companies, inc., all rights reserved. chapter 8: economics of strategy...
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© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Chapter 8: Economics of StrategyCreating and capturing value
Brickley, Smith, and Zimmerman, Managerial Economics and
Organizational Architecture, 4th ed.
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Creating and capturing valuelearning objectives
Students should be able to• Distinguish between value creation and
value capture and provide examples of each
• Define transactions costs and apply to strategic decision making
• Identify and provide meaningful examples of Porter’s “five factors”
• Differentiate between industry and firm effects on organizational success
© 2007 The McGraw-Hill Companies, Inc., All Rights Reserved.
Strategy
• General policies intended to generate profits– Choice of industry– Combination of products and services– Competitive and cooperative behaviors
• Strategies evolve as circumstances change
• Strategies must create and capture value
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Transaction costs• Consumer transaction costs
– product search– learning product characteristics and
quality– negotiating terms of sale– enforcing agreements
• Producer transaction costs– negotiating terms– legal expenses
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Ways to create valuereduction of transaction costs
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Value creation
• Reduce production costs or producer transaction costs– shift supply curve to the right
• Reduce consumer transaction costs– shift demand curve to the right
• Shift demand to the right by other means
• Devise new products and services
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Pricing complementsexample
• CompuInc produces personal computers• PrintCo produces complementary printer• Demand for each product is
Q=12-(Pc+Pp) when (Pc+Pp)12, 0 otherwise• Profit-maximization yields reaction curves
Q)P(P ji 12
ji P.P 56
• Each will view its demand curve as
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Noncooperative pricing CompuInc & PrintCo
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Advantage of coordination
• Failure to coordinate yields combined profits of 32
• Jointly setting MC = MR yields combined profits of 36– customers better off as product prices
fall, quantity purchased rises
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Capturing value
• Firms in competitive markets are price takers
• Market power and superior resources can lead to economic profit
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Market power comparison
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Market powerPorter’s five forces
• Potential rivals• Existing rivalry• Substitute products• Buyer power• Supplier power
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Porter’s Five Forces
Potential Rivals
Current Rivals
Substitute Products
BuyersSellers
Value/supply Chain
Competitive
Environment
Upstream Downstream
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Superior factors of production
• People– special talents or skills
• Physical assets– prime real estate– unique equipment
• But bidding for specialized assets may erode profits
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Producer surplus captured by superior assets
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Superior factors of production
again• Team production
– interdependencies among workers increase value beyond the “sum of the parts”
– luck or foresight may endow firms with unique team production capabilities
• Rivals may be unable to pinpoint source of advantage and unable to capture equivalent value
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Increasing demand
• Increase expected product quality– “value added” > cost increase
• Reduce price of complements
• Raise price of substitutes– limit entry of competitors
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Other value-enhancing strategies
• Introduce new products and services
• Cooperation with other firms
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Diversification
• Benefits– Economies of scope– Promoting complements
• Costs– Bureaucracy– Incompatible cultures
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Diversification and management
• Diversification for earnings volatility– may not increase value
• Related diversification– can increase value
• Capturing the gains– does the firm bring some special
resource to bear?
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Strategy formulation• Understanding resources and
capabilities– physical, human, and organizational capital
• Understanding the environment– markets, technology, regulation, economic
conditions• Combining environmental and internal
analyses• Strategy and organizational
architecture
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Framework for strategic planning
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To think about...
Can a firm capture value on a sustained basis?
Discuss.