MANAGERIAL ECONOMICS

An Analysis of Business Issues

Howard Davies and Pun-Lee Lam

Published by FT Prentice Hall

Chapter 18:

Economics and Business Strategy

Objectives:
To introduce some of the basic concepts used in the analysis of business strategy To examine the relationship between economic analysis and changing trends in the analysis of strategy

What Is Strategy?
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Strategy as purposive action the resource allocations that firms plan and implement in order to position themselves in markets and to compete with other Strategy as the fit between a firms use of resources and its environment Strategy as an ongoing, unplanned and unintended process of interaction between the firms internal structures and its environment

The Four Components

 

Strategy - in its various interpretations Structure the internal resources and organisation of the firm Environment the external circumstances in which the firm operates Performance the outcomes achieved
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Performance as the Central Focus



WHAT IS PERFORMANCE?
Financial performance - ROI, ROS, ROE, Tobins Q - the most common interpretation in strategy, almost the only interpretation in Economics Financial and Operational performance market share, new products, productivity increase Organisational Effectiveness - the ultimate criterion
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Two Approaches


System performance - organisational effectiveness Goal performance - achievement of specific lower level objectives

SWOT Analysis as an Overall Framework

 

Normative and Prescriptive Firms should begin with two kinds of appraisal
Internal Appraisal of Strengths and Weaknesses External Appraisal of Opportunities and Threats

Both Internal and External Factors are Important

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Strategy and the S-C-P Approach



In the 1980s the strategy literature was heavily influenced by economic thinking, especially Porters re-working of the Structure-Conduct-Performance approach The 5-forces analysis - the key to high performance lies in finding an attractive sector to operate in or taking action to improve the attractiveness of your current environment
high barriers to entry, low threat of substitutes, less intense rivalry, low power of buyers, low power of suppliers

The Key Task of the Senior Executive?



To find attractive new environments or take action to improve existing ones Market conditions and technology determine the 5-forces Emphasis placed almost entirely on the OT part of SWOT.

But Does Industry Matter?

 

Does performance vary most within industries or across industries? Studies differ somewhat
Schmalensee (1985) found industry effects important but no corporate effects Rumelt (1991) used longer term data and found major business unit effects, reversing Schmalensees finding McGahan (1999) much longer term data confirmed greater importance of firm effects BUT found stable and significant industry effects
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The Strategic Group Approach



At what level should industry be defined? Within industries some groups of firms seem to compete in similar ways while others are different -e.g. cost leaders or differentiators Strategic groups are groups within the same industry
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The Strategic Group Approach



In one sense, the strategic group approach simply re-defines industries into smaller groupings But the groups are determined by firms choice, not an exogenous factor From entry barriers to mobility barriers factors that prevent firms from copying the strategies of successful strategic groups

Emphasis shifts to what firms are able to do

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The Resource-Based Perspective



 

Edith Penrose (1959) - The Theory of the Growth of the Firm The firm is a collection of resources There are differences between firms in the same industry because they access different resources Superior performance - earning rents requires that a resource has certain characteristics
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What Characteristics Must a Resource Have In Order to Earn Rents?



Heterogeneity - it must differ from the resources owned by other firms - first-mover advantages commitments Ex post limits to competition - it must not be possible for others to access the same resource
imperfect imitability through isolating mechanisms
y y y y y property rights like patents and copyrighted brand names time lags and learning effects information asymmetries buyer search and switching costs reputation channel crowding economies of scale in specialized assets causal ambiguity 14

What Characteristics Must a Resource Have In Order to Earn Rents?



Imperfectly mobile non-tradeable

needs co-specialised assets high switching costs or transactions costs

Limited ex ante competition - before acquiring the resource, competition for it must have been limited. Otherwise the full value would have been paid, yielding no net benefit

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What Kind of Resources Have These Characteristics?

  

Knowledge - routines, cultures, structures The core competence of the corporation Prahalad and Hamel (1990) define the core competence of the corporation as the collective learning of the organisation, especially how to coordinate diverse production skills and integrate multiple streams of technology. Capabilities (Langlois) Combinative Capabilities (Kogut and Zander) BUT PHYSICAL FACILITIES MIGHT BE KEY IN SOME CASES
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Major Themes in RBP



Growth takes place around the key resources

economies of scope arise from being able to use the same competence in different sectors (but beware the hubris effect - the CEO may think he has a dominant logic which allows him to succeed everywhere - Jimmy Lai?)

Differentiation takes place on the basis of the key resources

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Note the Central Influence of Economics in the RBP

 

Penrose seminal influence Rents and equilibrium thinking - if there are no barriers then rents are competed away Entry barriers to mobility barriers to isolating mechanisms

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But Have We Forgotten the Lessons of SWOT?

   

BOTH Internal and External Factors MATTER Industry matters - market attractiveness - O, T Firm-level specifics matter - resources -S,W Capon, Farley and Hoenigs meta-analysis of 100s of performance studies confirms that internal and external factors both matter Child, Chung and Davies on Business and China managerially controllable factors and environmental factors both count NO REASON TO TAKE SIDES
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The NEWApproach to Industrial Organisation: Game Theory and Strategy



Ghemawat (1997) - there has been relatively little interest in the strategy literature surprisingly?
Entry deterrence Commitments giving advantage Reputation effects

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Why Has Game Theory Economics Not Had More Influence on Strategy?
  

Game theory piecemeal and detailed Not directly about performance The general weaknesses of game theory
too many equilibria,or no equilibria, even on quite narrow issues - high/low price commonsense solutions sometimes perform better than very complex explanations

questionable relationship to empirical data. The case study method is interesting but Ghemawats own book shows that for any case a dozen game-theoretic solutions may fit the facts, with no means of choosing
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