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ManagerialManagerial

Economics:Economics ofEconomics:Economics ofStrategyStrategy

ManagerialManagerial

Economics:Economics ofEconomics:Economics ofStrategyStrategyEconomics of StrategyEconomics of Strategy

Patrick McNuttPatrick McNutt

www.patrickmcnutt.comwww.patrickmcnutt.comAbridgedAbridged ©©



Workshop Lesson plan«. Day 1: Introduction and setting the scene using

McNutt·s E-book

Focus: Type, signalling and strategy Plan is to follow Besanko·s Textbook .. Day 1 & 2: Progress into Ch 2 to Ch 4 and Ch 5 Day 1Workshop Study Groups & Case Analysis Day 2 & 3: Focus on Chs 6 to 9 and conclude with

Ch 10 and 11 Advise Part III for post-Workshop reading



At the frontier«.. Understand management as ¶they are· not as theory hitherto

¶assumed them· to be Management can be ranked (by type) and are faced with

trad

e-offs => something must come ¶top of the menu·

Firms are conduits of information flows (vertical chain) Reducing price does not necessarily lead to an increase in

revenues (elasticity) Prices are primarily signals (observed behavior) Companies understand the competitive threat as

interdependence (zero-sum)



Players? Principal-agent relationship Shareholders as principals and

management as agents Who are decision makers?

Management § firms § companies

=PLAYERS



Costs of not being a Player Agency costs across the

shareholders (esp institutional)

Bounded rationality and opportunitycosts with trade-offs Make or Buy dilemma

FMA Follower status ¶behind the curve·



The competitive threat! Traditional Analysis is biased

towards answering:

what market are we in and how can wedo better?

Economics of strategy (GEMS) asks:

what market should we be in?



Bridging Unit 1 and Unit 3:

Strategic analysis Binary reaction;Will Player Breact? Yes or No?

If YES, decisionmay be parked

If NO, decisionproceeds on error

Surprise

Non-binaryreaction: Player Bwill react.Probability = x%

Decision taking onconjecture of likelyreaction

No Surprise



Type of Management Maximise shareholder value, meet

the profit constraint

McNutt E-book Ch 1 Managerial discretion Managerial limitations and Penrose

effect Simon·s Bounded rationality



Game type and signalling Decisions are interpreted as signals

Observed patterns

Recognition of market interdependence(zero-sum)

Price as a signal v Baumol model of TR max

Scale and size: cost leadership Dividends as signals v Marris model



Precis on a Marris model« McNutt Ch 4: Understand balanced

equation gc = gd to identify parameters ofprofitability

Supply of capital: debt v equity Demand for capital: R&D exp v dividends Instrumental variables influencing growth

² visit Diageo case in Kaelo v2.0

KFIs: profits/output and output/capital Tobins q and Marris v ratio



Figure 5 Marris¶ Trade-off

U 1 U 2 U 3 U 4

V aluation ratio Shareholders perference

x

Best to m anagem ent

V 2 V aluation curve

G 1 G 2 G row th rate

V 1

V (m in)

y

0



Unit 2: Cost leadership as a type Profitabiltiy v scale and (size and scope)

Production as a Cost-volume constraint

Understanding the economcis ofproductivity as exemplar for incentives

Normalisation equation

Excess v reserve capacity [next slide]

Cost leadership checklist



£

Q0,0

SAC1SAC

2 SAC3LAC

q1q2

Lower per unitcost for more units sold

qt

Current plan of plantclosures to lower costbase not completed

Av.Cost = marginal cost

Production has to determine demandto attain cost leadership



Bridge Unit 1 and Unit 2 Shareholder as principals expect max value

Management to minimise the agency costs

Positive Learning Transfer, PLT Nomenclature on type: Baumol type, Marris

type.

Cost leadership type (link into Ch 11 onstategic cost advantage)



Unit 3 Game Dimension What is a game ² loss of independence?

Action, Reaction and Reply

Non cooperative sequential games Introduce oligopoly and n < 5

Single shot price reduction: (i) fail TR testand revenues fall; (ii) near rival misreadsthe price as a signal



Describe game dimension Players and type of players Prices interpreted as signals

Patterns of observed behaviour Leader-follower as knowledge Accomodation v entry deterrence

Reaction, signalling and ¶best you cando, goven reaction of competitor·



Type of Players Incumbent type v entrant type Dominant type v monopoly incumbent

De novo entrant type and geographyof the market

Potential entrant type and the threat

of entry Newborn players



Limit Pricing Model Outline the game dimension: dominant

incumbents v camuflaged entrant

type Define strategy set for incumbents Allow entry and define the equilbrium

Preference - entry deterrentstrategy v accomodation [next slide]



1

2

Enter

0,10

-7,2

5,8

Do Not Enter

Agressive

Accommodating



Entry Deterrent Strategy Reputation of the incumbents

Entry function of the entrant

De novo and entry at time period t

Potential entrant and forces reactionfrom incumbent

Coogans bluff strategy



Continuing with Unit 4:

Define a price war Determine the Bertrand reaction

function

Signalling Compute a critical Time Line from

observed signals

Find a price point of intersection



Visit Kaelo v2.0 and

McNutt·s E-book Example: Critical Time Line in a Sony v

Microsoft, Apple v Nokia game dimension Play a PD game and investment game in

Kaelo v2.0 Altruism, fairness, selfish gene, dominant

strategy Understand the link across the extensive

decision-tree to the payoff matrices [nextslide]



Nash Equilibria Define the Nash equilibria [next

slide]

Analyse the Payoff matrix(B,Y) > (A, X)

Commitment and chat

Strategic ToolBox in terms ofcredible mechanisms



10,10

8,-50,0

-5,8

Strategy A

Strategy B

Strategy X Strategy Y

Player 1

Player 2



Prisoners· dilemma Introduce the Prisoners· Dilemma

[next slide]

Low price (compete) v high price(chat) Play mean p64 of e-Storybook and

Table 7.2 of textbook, p236 Punishment strategies



10,10

13,02,2

0,13

Low P

¡

¢ £ ¤

H¡

¥ h P

¡

¢ £ ¤

Low P

¡

¢ £ ¤

H¡

¥ h P

¡

¢ £ ¤

Player 1

Player 2



Games as Strategy Segmentation strategy to obtain FMA

Relevance of chain-store paradox

The Umbrella dilemma Value net and PARTS

Strategic ToolBox in terms ofsustainability

GEMS and Tx3 Framework [next slide]



Industry Analysis

Play-out GameScenario B

e.g. change the

game new

product

development

Strategic Options (Identify the G ames)

Play-out GameScenario A e.g. market

entry competitors

reactions

Play-out GameScenario C

e.g. change the

game

Consolidation

Strategic Decisions

y Porter·s 5 Forces

y BCG

y Value Net

y S.W.O.T.

y P.A.R.T.S.

y McKinsey

y Game theory

OrganizationalGoals

Game theory Insights



GEMS and Strategic Analysis Knowledge of the

identity of near rival:Action you -> Reactionrival

-> NashReply you



GEMS and Strategic Analysis Knowledge of likely reaction of near

rival

Binary reaction;Will Player B react?Yes or No?

Non-binary reaction: Player B will

react. Probability = x%



Final Scenarios«« The Rationale

Markets evolve

The RationaleType, Technology and

Time

The Rationale

Know your market

The Strategy

Non-binary

The StrategyGame metrics and

analytics

The Strategy

GEMS



Thank you for

participating«««

Sapere aude

¶That which one can know, one

should dare to know·

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