Strategic Management/
Business Policy
Joe Mahoney
Competitive Dynamics
Competitive dynamics
results from a series of
competitive actions and
competitive responses among
firms competing within a
particular industry.
Competitive Dynamics
Mutual interdependence among firms
means that strategic competitiveness and
above-average returns result only when
companies recognize that their strategies are
not implemented in isolation from their
competitors’ actions and responses.
Eastman Kodak and Fuji Photo, for
example, continue to engage in a series of
competitive actions and responses in an
effort to establish competitive advantage.
Competitive Dynamics
Multi-point competition occurs when
firms compete against each other
simultaneously in several product or
geographic markets.
For example, the largest U.S. airlines have
substantial market overlap and such
overlap can reduce the likelihood of
competitive rivalry in the industry.
Competitive Dynamics
A first mover is a firm that takes an initial
competitive action.
Successful actions allow a firm to earn aboveaverage returns until other competitors are able
to respond effectively. In addition, first movers
have the opportunity to gain customer loyalty.
For instance, Harley-Davidson has been able to
maintain a competitive lead in large motorcycles
due to intense customer loyalty.
Competitive Dynamics
A first mover also faces
potential disadvantages:
High risk
High development costs
High demand uncertainty
Competitive Dynamics
A second mover is a firm that
responds to a first mover’s competitive
action often through imitation or a
move designed to counter the effects of
the initial action.
BankOne was a fast second mover in
Internet banking.
New Balance is a successful second mover
in the athletic shoe industry.
Competitive Dynamics
Second mover advantages include:
Reduction in demand uncertainty
Market research to improve satisfying
customer needs
Learn from the first mover’s successes and
shortcomings
Gaining time for R&D to develop a superior
product
Scenario Analysis -The Relationship
Between Finance & Strategy
Traditional Evaluation Of Financial
Projects
Net Present Value or Discounted Cash
Flow Analysis
CF
+
time
-
Scenario Analysis -The Relationship Between
Finance & Strategy
Differences Between Strategy and
Finance
Finance: Payoffs are determined
exogenously or by chance
Strategy: Our actions affect the
payoffs we are likely to experience
Decision-Theoretic Vs. GameTheoretic Analysis
Games against “Nature” Vs. Games
against other people
8- 6
How To Handle Uncertainty
Sensitivity Analysis - Analysis of the effects
of changes in sales, costs, etc. on a project.
Scenario Analysis - Project analysis given a
particular combination of assumptions.
Simulation Analysis - Estimation of the
probabilities of different possible outcomes.
Break Even Analysis - Analysis of the level of
sales (or other variable) at which the
company breaks even.
Irwin/McGraw-Hill
©The McGraw-Hill Companies, Inc.,2001
Commitment Versus Flexibility -The Value of Time
Cost to Build Plant = $1600
Cost of Capital = 10%
.5
Price(t=1) = $300
Price = $300
Price(t=0) = $200
.5
Price(t=1) = $100
Price = $100
Commitment Versus Flexibility The Value of Time
Time
Expected Cash Flow
(Traditional NPV)
Expected Cash Flow
(Scenario 1)
Expected Cash Flow
(Scenario 2)
0
1
2
3
4
5
6
7
8
Infinity
$
$
$
$
$
$
$
$
$
$
(1,400)
200
200
200
200
200
200
200
200
200
$
$
$
$
$
$
$
$
$
$
(1,300)
300
300
300
300
300
300
300
300
$
$
$
$
$
$
$
$
$
$
(1,500)
100
100
100
100
100
100
100
100
NPV
$
600
$
1,545
$
(455)
Competencies and Strategic Flexibility
In previous classes we have discussed
modular product and modular organizations.
A critical element in the design of modular
organizations is “quick connect” information
systems for scheduling, monitoring, and
documenting the interfacing activities across
linked firms.
E.g., associations of automobile assemblers,
grocery distributors, and chemical producers
have created industry-wide standard software for
quick connecting firms at different positions in
industry value chains.
Competencies and Strategic Flexibility
IKEA’s computer-based coordination of its
1,800 “loosely-coupled” suppliers of modular
ready-to-assemble furniture components in a
50-country global product creation and
production network illustrates strategic
flexibility and core competencies for
repositioning product offerings.
In dynamic markets, quick response capabilities
often increase the value of a firm’s strategic
options if the firm can devise ways to exercise
options faster than competitors.
Competencies and Strategic Flexibility
Thus, strategic flexibility is analogous to
“having options” and commitment is
analogous to the “exercise of an option.”
The greater the uncertainty the firm faces,
the more valuable are its strategic options.
The resolution of uncertainty over time is the
catalyst which induces a manager to make (sunk
cost) commitments.
Types of Strategic Options
Option to wait
Time-to-build option
staged, incremental investments
Option to abandon
Growth options
Example of Real Options
The SuperCom Project:
A large telecommunications company faces an opportunity to invest in an R&D project that
will revolutionize the way consumers use telephones, internet, and TV.
I1: Required investment in the
R&D project.
Real Options in the SuperCom Project
R&D Stage
0 (Years)
Commercialization Stage
3
5
7
T = 15
I2: Required investment in the
commercial-scale plant,
marketing, and distribution - if the
R&D effort is successful, and if
market conditions are favorable..
I1
Ic
I3: Final investment in the project;
can be decreased by Ic if the
market is weak.
Defer
( up to 1 year)
IE
I3
Expand
Switch Use
(Abandon for salvage)
Contract
( save Ic )
I2
Abandon
(forgo I2)
IE: Flexibility in the design of the
production process allows for
output expansion with an outlay of
IE.
V: Gross present value of the
completed project’s expected
operating cashflows.
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Option
Description
Examples
To wait before taking an action
until more is known or timing is
expected to be more favorable
When to introduce a new product, or
replace an existing piece of
equipment
Expand or
contract
To increase or decrease the
scale of an operation in
response to demand
Adding or subtracting to a service
offering, or adding memory to a
computer
Abandon
To discontinue an operation and
liquidate the assets
Discontinuation of a research
project, or product/service line
Stage
investment
To commit investment in stages
Staging of research and
giving rise to a series of valuations development projects or financial
and abandonment options
commitments to a new venture
Switch inputs
or outputs
To alter the mix of inputs or
outputs of a production process
in response to market prices
The output mix of
telephony/internet/cellular services
Grow
To expand the scope of
activities to capitalize on new
perceived opportunities
Extension of brand names to new
products or marketing through
existing distribution channels
Defer
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Sources
Baldwin, C., and L. Trigeorgis, 1995, “Real Options, Capabilities, TQM, and Competitiveness,”
Harvard Business School Working Paper.
Capozza, D., and Y. Li, 1994, “The Intensity and Timing of Investment: The Case of Land,”
American Economic Review.
Dixit, A., and R.S. Pindyck, 1994, Investment Under Uncertainty, Princeton University Press.
Kogut, B., and N. Kulatilaka, 1994, “Operating Flexibility, Global Manufacturing, and the Option
Value of a Multinational Network,” Management Science.
Kulatilaka, N., 1995, “The Value of Flexibility: A general model of Real Options,” Real Options
in Capital Investments, Praeger.
Trigeorgis, L., 1996, Real Options, MIT Press.
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