Transcript Economics and Business Strategy

MANAGERIAL ECONOMICS
An Analysis of Business Issues
Howard Davies
and Pun-Lee Lam
Published by FT Prentice Hall
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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
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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 firm’s use of resources
and its environment
Strategy as an ongoing, unplanned and ‘unintended’
process of interaction between the firm’s internal
structures and its environment
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The Four Components
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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
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WHAT IS PERFORMANCE?
– Financial performance - ROI, ROS, ROE,
Tobin’s 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
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‘System performance’ - organisational
effectiveness
‘Goal performance’ - achievement of
specific lower level objectives
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SWOT Analysis as an Overall
Framework
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Normative and Prescriptive
Firms should begin with two kinds of
appraisal
– Internal Appraisal of Strengths and
Weaknesses
– External Appraisal of Opportunities and
Threats
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Both Internal and External Factors are
Important
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Strategy and the S-C-P Approach
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In the 1980s the strategy literature was heavily
influenced by economic thinking, especially Porter’s
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
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The Key Task of the Senior Executive?
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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.
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But Does Industry Matter?
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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
Schmalensee’s 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
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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
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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
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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?
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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
•
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•
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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
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What Characteristics Must a Resource Have
In Order to Earn Rents?
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Imperfectly mobile
– non-tradeable
• needs co-specialised assets
• high switching costs or transactions costs
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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?
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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?)
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Differentiation takes place on the basis
of the key resources
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Note the Central Influence of Economics
in the RBP
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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?
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BOTH Internal and External Factors MATTER
Industry matters - market attractiveness - O, T
Firm-level specifics matter - resources -S,W
Capon, Farley and Hoenig’s meta-analysis of 100’s 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
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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?
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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
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questionable relationship to empirical data. The case
study method is interesting but Ghemawat’s 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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