Managerial Economics and Organizational Architecture, 5e Copyright © 2009 by The McGraw-Hill...

Managerial Economics and Organizational Architecture, 5e

Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.


Chapter 8: Economics of Strategy: Creating and

Capturing Value

McGraw-Hill/Irwin


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

8-2


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

8-3


Ways to Create Valuereduction of transaction costs

Pric

e (

in d

olla

rs)

Quantity

Consumer-borne transaction costsConsumer surplus

Producer surplus

Producer-borne transaction costs

Effective supply given transaction costs

Potential supply if noTransaction costs

Potential demand if noTransaction costs

Effective demand afterTransaction costs

Q

8-4


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

8-5


Other Ways to Increase Demand• Improve product quality • Price complements so consumers will buy

more– printers and ink cartridges, razors and razor

blades

• Change the price of substitutes– Theaters ban patrons from bringing food into

the theater, no liquids are allowed past the security gates at airports

8-6


Pricing Complements Example• CompuInc produces computers• PrintCo produces complementary printers• 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

8-7


Noncooperative Pricing CompuInc & PrintCo

Pric

e of

Prin

tCo

pri

nte

rs

Price of personal computers

Compulnc’s reaction curvein choosing PC

PrintCo’s reaction curvein choosing Pp

6

6 12

Pp

PcPc = 4

Pp = 4

12

8-8


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

8-9


Converting Organizational Knowledge into Value

• Hardware – physical assets

• Wetware – employee brainpower

• Software – formulas or recipes for creating value

• Implications - allow employees to experiment and innovate

8-10


Capturing Value

• Firms in competitive markets are price takers

• Firms with market power choose price and quantity– They can capture value if they exploit their

market power

8-11


Market Power Comparison

Producer surplusS

D

$ $$

Pric

e (in

dol

lars

)

Di

P* Dj

QiQj Q

Q*Quantity: Firmi Quantity: Firmj Quantity: Industry

P*

MARKET POWER COMPETITIVE INDUSTRY

8-12


Market Power Rests In

• Entry barriers– Economies of scale, patents, brand

names, high exit costs

• Degree of rivalry– Number and size of competitors

• Threat of substitutes– Outside products (satellite dish vs. cable)

• Buyer and supplier power– Number and size matters 8-13


Other Value-Enhancing Strategies

• Introduce new products and services

• Cooperation with other firms

8-14


Superior Factors of Production

• People– special talents or skills

• Physical assets– prime real estate– unique equipment

8-15


Superior Factors of Production• Bidding for specialized assets may erode

profits

• If a resource is adding value to a firm, other firms will attempt to bid this resource away

• The price of this resource will rise, raising costs

• Initial profits will fall8-16



profits





Producer Surplus Captured by Superior Assets

Cos

t pe

r un

it (in

dol

lars

)

P*1

P*0

Q*0 Q*1

Quantity: Firm i

LRMC

LRAC1

LRAC0

Qi

$ $

Quantity: Market

Q*0 Q*1

D0

Q

D1

S

8-20


Superior Factors of Production• 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

8-21


Diversification• Benefits

– Economies of scope– Promoting complements

• Costs– Bureaucracy– Incompatible cultures

8-22


Diversification and Management• Diversification for earnings volatility

– may not increase value

• Investors can diversify on their own

• Related diversification– can increase value

• Capturing the gains– Target firms often obtain the largest gains in a

takeover8-23


Strategy Formulation

• Understanding internal resources and capabilities– physical, human, and organizational capital

• Understanding the environment– markets, technology, and government

regulation

• Combining environmental and internal analyses

• Strategy and organizational architecture8-24


Framework for Strategic Planning

STRATEGY

INTERNAL RESOURCES AND CAPABILITIES

Physical Capital

Human Capital

Organizational Capital

BUSINESS ENVIRONMENT

Markets

•Input

•Output

Technology

•Production

•Information

•Communication

Government Regulation

8-25


Capturing Value• Can a firm capture value on a sustained

basis?

• Market will bid prices of resources up

• Environments change

• Normal rates of return will be earned in the long run

8-26

Managerial Economics and Organizational Architecture, 5e Copyright © 2009 by The McGraw-Hill...

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