Transcript Managerial Economics and Organizational Architecture

Managerial Economics and Organizational Architecture, 5e
Managerial Economics and Organizational
Architecture, 5e
Chapter 8: Economics
of Strategy: Creating and
Capturing Value
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
Ways to Create Value
reduction of transaction costs
Price (in dollars)
Effective supply given
transaction costs
Potential supply if no
Transaction costs
Consumer surplus
Producer surplus
Potential demand if no
Transaction costs
Effective demand after
Transaction costs
Q
Quantity
8-4
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
Pricing Complements Example
• CompuInc produces computers
• PrintCo produces complementary
printers
• Demand for each product is
Pi  ( 12  Pj )  Q
• Each will view its demand curve as
Pi  6  .5Pj
• Q=12-(Pc+Pp) when (Pc+Pp)12, 0 otherwise
Profit-maximization yields reaction curves
8-7
Managerial Economics and Organizational Architecture, 5e
Noncooperative Pricing
CompuInc & PrintCo
Pp
Price of PrintCo printers
12
Compulnc’s reaction curve
in choosing PC
6
Pp = 4
PrintCo’s reaction curve
in choosing Pp
Pc = 4
6
Price of personal computers
12
Pc
8-8
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
Market Power Comparison
$
$
Price (in dollars)
$
Dj
P*
Producer surplus
S
P*
Di
D
Qj
Qi
Quantity: Firmi
MARKET POWER
Q*
Quantity: Firmj
Q
Quantity: Industry
COMPETITIVE INDUSTRY
8-12
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
Other Value-Enhancing Strategies
• Introduce new products and services
• Cooperation with other firms
8-14
Managerial Economics and Organizational Architecture, 5e
Superior Factors of Production
• People
– special talents or skills
• Physical assets
– prime real estate
– unique equipment
8-15
Managerial Economics and Organizational Architecture, 5e
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 fall
8-16
Managerial Economics and Organizational Architecture, 5e
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 fall
8-17
Managerial Economics and Organizational Architecture, 5e
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 fall
8-18
Managerial Economics and Organizational Architecture, 5e
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 fall
8-19
Managerial Economics and Organizational Architecture, 5e
Producer Surplus Captured by
Superior Assets
LRAC1
$
$
LRMC
S
Cost per unit (in dollars)
LRAC0
P*1
P*0
D0
Q*0 Q*1
Quantity: Firm i
D1
Qi
Q*0
Q*1
Quantity: Market
Q
8-20
Managerial Economics and Organizational Architecture, 5e
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
Managerial Economics and Organizational Architecture, 5e
Diversification
• Benefits
– Economies of scope
– Promoting complements
• Costs
– Bureaucracy
– Incompatible cultures
8-22
Managerial Economics and Organizational Architecture, 5e
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
takeover
8-23
Managerial Economics and Organizational Architecture, 5e
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 architecture
8-24
Managerial Economics and Organizational Architecture, 5e
Framework for Strategic Planning
INTERNAL RESOURCES
AND CAPABILITIES
BUSINESS ENVIRONMENT
Markets
•Input
Physical Capital
•Output
Human Capital
Technology
Organizational Capital
•Production
•Information
•Communication
Government Regulation
STRATEGY
8-25
Managerial Economics and Organizational Architecture, 5e
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