Chapter 2 --Market Imperfections Chapter 2 --Market Imperfections and Value: Strategy Mattersand Value: Strategy Matters

Wealth creation is impossible in a perfect market Porter’s five forces can be used to evaluate the industries

in which the firm operates or plans to to enter A strategy should be developed that allows the firm to

utilize market imperfections to establish a sustainable competitive and consequently an economic profit or positive net present value

Economic profit comes from competitive advantage in: Dealing with customers Dealing with financial markets

Conditions necessary for a perfectly competitive product market and resource market: No market power

no producer is large enough to influence prices Identical product Identical cost No restrictions on entry or exit Complete information

like information and expectations

Sustainable Competitive Sustainable Competitive AdvantageAdvantage

Sustainable competitive advantage is the elimination of perfect competition for a sustainable period of time so as to provide economic profit

Depends on: Industry characteristics Company actions

Product features or cost advantages

Assessing the Industry -- Assessing the Industry -- Porter’s Five ForcesPorter’s Five Forces

Threat of new entries Bargaining power of buyers Bargaining power of suppliers Threat of substitutes Rivalry among existing firms

Competitive Strategy. Free Press, 1980

Ways to Reduce the Threat of Ways to Reduce the Threat of New EntriesNew Entries

Economies of scale Patents, copyrights, & trade secrets Regulation Switching cost to customer Stability of demand Time needed to add capacity Customer loyalty

Ways to Decrease the Ways to Decrease the Bargaining Power of BuyersBargaining Power of Buyers

Product differentiation Information available to buyers Customer interest in features vs. price Price as a percent of buyer’s income Switching costs for buyer Difficulty of copying product advantages

Factors Influencing the Bargaining Factors Influencing the Bargaining Power of SuppliersPower of Suppliers

Five factors in the market for inputs Threat of new suppliers entering Bargaining power with regard to our suppliers Bargaining power of our suppliers Threat that we will switch to substitute inputs Rivalry among existing suppliers

Threat of vertical integration

Threat of SubstitutesThreat of Substitutes

Examples include: Drive vs. fly Oil vs. gas heat Chicken vs. beef Home equity loan vs. auto loan

The closer the substitutes, the more limited the power of the seller

Rivalry Among FirmsRivalry Among Firms

Goals of competitors Profit vs. size, for example

Strength of competitors Cost advantage or disadvantage Financial strength

Intelligence of competitors

Creating Competitive Creating Competitive Advantage on 3 FrontsAdvantage on 3 Fronts

Change or take advantage of some industry characteristics or market imperfection Create barriers to entry

Create some form of product advantage Distribution advantage

Create some form of cost advantage Pricing strategy Information management

Using Strategy to Create WealthUsing Strategy to Create Wealth

Steps to strategic planning Establish goals Assess the environment -- opportunities and threats Assess the organization -- strengths and weaknesses Develop a strategy Develop operating processes that support the strategy --

marketing, distribution, production, capital budgeting, financing

Implement, monitor and control Evaluate and reward