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WEEK 2 The industrial organization perspective and the value-added view

Key concepts -Perfect competition -Monopoly -Oligopoly -Monopolistic competition -Monopolistic rents -The S-C-P model -Porters five-forces -Strategic groups -Porters value chain -Porters diamond -The cross-sectional problem -The longitudinal problem -Value creation and value appropriation -Willingness-to-pay -Opportunity costs -Zero-sum games vs. win-win games -Brandenburger & Nalebuffs PARTS model

Study questions 4. Consider Porters (1979a, 1979b) early view on strategy: (a) How does this view relate to the theories discussed by Conner (1991)? Bain mentions the S-C-P (structure-conduct-performance): performance differences due to industry structure (concentration, product differentiation, barriers to entry). This is the same view as Porter, who also state that performance differences depend on industry structure. (See answer 4b) b) How does Porters early view explain differences in performance among firms? Porter, M. (1979a), How competitive forces shape strategy Firms will realize superior performance if they enter industries with a large profit potential and position themselves well in these industries by choosing a generic strategy (cost leadership, differentiation, or focus). Goal: to limit one or more of the forces. Resources required follow from positioning choices. Weaker forces lead to superior performance. defend firm against forces through positioning.

5 forces model (=attractiveness of an industry)

Porter, M. (1979b), The structure within industries and companies performance. Strategic groups: industry consists out of groups of firms that follow similar strategies and are likely to respond the same. The structure within an industry consists of its configuration of strategic groups, including: different barriers to entry between groups = mobility barriers (e.g economies of scale) multiple strategic groups affect industry rivalry; numbers/size of the groups (more numerous and more equal in size), strategic distance (degree to which strategies differ), market interdependence (degree to which different SG are competing for the same customer) structure of the industry consists of its configurations of strategic groups. Firms will have higher profits in a group with the best combination of mobility barriers, insulation from inter-group rivalry, substitute products, bargaining power with adjacent industries, fewest other members and suitability to the firm's execution ability. Mobility barriers (=entry barriers); switch between strategic groups in one industry (airlines, low-cost versus full- service) 5. Compare Porters early view on strategy (Porter 1979a, 1979b) to his later view (Porter, 1991). What have been the changes in Porters view on strategy between 1979 and 1991? Porter (1991): value chain

Dynamic theory of strategy; link environmental circumstances and firm behavior to market outcomes. Firm: collection of discrete but interrelated economic activities which are performed at lower cost or in a different way Drivers of activities sources of the sources Cross-sectional problem: what underpins a desirable position? Longitudinal problem (historically): why do some firms have certain drivers that lead to that position? initial conditions (pre-existing reputation, skills, and in-place activities as a result of their history) managerial choices (define the firms concept for competing (positioning), its configuration of activities, supporting investments in assets and skills) Porter performance: industry firm strategic groups Porter's early work (eighties); translating Bain I/O into managerial frameworks, environment > firm, firm as a black box Changes in his work: from positioning to activities within the firm from cross-sectional to longitudinal problem (drivers) Value chain and Diamond (Schumpetarian) theoretically (underlying economics) weaker but opens up black box

Value chain (template for understanding cost position) very functional versus processes less theory to back it up Diamond (determinants of national competitive advantage) from firm-level to national systems addressing governments, which sectors could be more competitive and why? More competition makes to local industry stronger, opposed to 5 forces where competition is not good.

6 Consider the value-added view of strategy as developed by Brandenburger & Stuart (1996): (a) How does the value added view explain performance differences among firms? Brandenburger and Stuart explain performance differences through added value. Value created = willingness to pay opportunity costs Value added: value created by all players minus value created by all players except the one in question achieve through favorable asymmetries, four routes:

(1) Differentiation; raise w-t-p

(2) Reduce suppliers opportunity costs supplier relations HRM (3) Lowering w-t-p of other firms negative advertising high switching costs (4) Raising opportunity costs for suppliers; same mechanisms as number three Value created is given focus is on appropriation; bargaining between players Value created is given by the situation + value added by the players how to appropriate? bargaining

prices determine the share Determines where the price goes and what the share is Unrestricted bargaining: active deal-seeking aspect of the market place
Business model value (ceiling) willingness-to-pay revenue price*# costs price resources*# opportunity costs of suppliers is missing 1 buyer, 1 seller Price depends on non-economic arguments (formally indeterminate) Value added determines where the price goes (take out the other player) Monopoly bargaining positions change (two buyers, one seller) Price more towards willingness-to-pay Firms share > buyer share Perfect competition price will go down to opportunity costs of suppliers Monopolistic competition different willingness-to-pay for buyers for different products Amount of differentiation is what the firm can expect above opportunity costs (b) How does this explanation compare to the explanation given by Porter (what are similarities and differences)?

5-forces reconstructed by Brandenburger: substitutes shifted; sets a ceiling for the w-t-p alternative uses of resources for suppliers; new in framework and set the bottom for w-t-p competitors (potential and current rivalry) Porter's generic strategies are also about achieving positive added value and also shows the interdependence between firm and supplier/buyers --------------------------------------------------------------------------------------------------------------------Brandenburger (1995): use CGT to shape strategy

Strategy is about actively shaping the game Value created = win-win (cooperate with others) Value appropriation = zero -sum Value net compared to Porter's 5 forces and Brandenburger: complementors are new (e.g. complementor of inter Microsoft) competitors are called substitutors Interdependencies along players in the game: value net

Vertically; cooperation will increase value created and compete about value
appropriation Cooperate with competitors to create more value for the whole chain Complementors have another role than you, can never take your place, but substitutors can PARTS model: identify elements of the game and change one or more (1). Players (2). Added value; what each brings to the game, raise yours or lower others' (3). Rules; structure of the game (4). Tactics; reduce miss-perceptions or create uncertainty (5). Scope; boundaries of the game