Thinking About Strategy
Why do economists and cognitive scientists question the idea of
planning?
Because planning is combinatorially explosive.
If ten things can happen today and for each of those ten things ten
more things can happen tomorrow and so on—the possible
outcomes quickly get out of hand.
The Austrian view of the role of entrepreneurs—is to deal with the
unexpected.
But some economists allow that there may be a role for planning in
the following sense.
Determine a goal e.g. to develop a new product, technology, etc.
Planning is than used to determine the best way to achieve that goal.
And
Strategic interaction involves recognizing that your success depends
upon what others (your competitors) are doing and recognizing that
they will try to determine what you are doing.
So your actions, in part, depend upon your best guess about what
they are doing, and what they are doing is in part, dependent upon
what they think you are doing and so on—which is the essence of
strategic planning.
Cooperation Game
Consider the Prisoner’s dilemma:
Row
Cooperate
Player
Defect
Column Player
Cooperate
Defect
15,15
5,25
25,5
First sum is the payoff to the row player,
the second is the column player’s payoff
10,10
Coordination Game
Row
R
Player
L
Column Player
R
L
15,15
1,1
1,1
10,10
First sum is the payoff to the row player,
the second is the column player’s payoff
What is likely to happen if the players do not
know each other and play only one time in the
Cooperation game?
The Nash equilibrium: pick the best response to
your opponent’s strategy options.
What if the same players play the cooperation
game may times? Reciprocity, evolves in the
repeated PD game under some strategies—leads to
cooperation.
Ultimatum Game: randomly pick an
individual, called the proposer, give her $10,
to be divided with another called the
responder, if the responder rejects the offer
both get nothing—what is the Nash
equilibrium?
Beauty Contest Game: A relatively large
number of people each pick a number from the
interval 1 to 100. The winner is the individual
who’s number is closest to 2/3 times the
average of all numbers picked—what is the
Nash equilibrium?
What is the essence of strategy?
What do these games say about the limits of
strategy?
Porter’s Competitive Strategy
The Five Forces
Entry
Supplier
Power
Internal
Rivalry
Substitute
Products
Buyer
Power
Refers to Industries and the Forces that
Effect Firm Profit Within the Industry
• An industry refers to firms producing a
similar product
• Are industries or markets what is
important?—It depends
Why think about industries?
– View from the “outside” to guide investment.
– View from the “inside” to guide strategy.
Firms try to maximize expected
discounted of future profits
•
П = TR - TC
•
EPVП =  i /(1 r )i
i
•
Strategy refers thinking about and
planning for potential responses and
effects to the to various actions by your
firm to increase profits for example:
–
–
–
–
–
increase revenue by selling more
Increase revenue by raising your price
Increase quality
Reduce costs, e.g., reducing supply
price
Introduce new products
How customers affect revenue
• Tradeoff between higher price and more sales.
• Alternative opportunities for customer.
– Buy from someone else in the industry.
– Buy a substitute product
– Do it themselves.
– Do without.
Two terms for one idea
• Bargaining Power: ability of a buyer (seller) to
negotiate a lower (higher) price.
• Market Power: ability to raise your price without
losing all your customers.
• Depends on substitution opportunities (the
competitiveness of the market).
How suppliers affect cost
• Again, bargaining power (this time, the
competitiveness of the input market)
• Do they sell to many firms or just you?
• Are there other firms that you could buy
from?
Competitors
• Other firms try to get your customers to buy
from them instead of from you.
• New entry
• What does this do?
– Forces you to lower your price (bad for revenue).
– or make better products (bad for costs).
• Good for consumers!
Competition from other firms in the
industry
• Most noticeable type of competition
• Competition vs. Collusion.
• Some things that affect competition:
– Switching costs.
– Fixed costs.
– Legal restrictions.
Competition from potential entry of
new firms
• Not all competitors are seen!
• Barriers to entry:
–
–
–
–
–
Economies of scale.
Network externalities
Proprietary product technology.
Government use of coercive power
Customer loyalties and brand.
• Strategies to deter entry.
Competition from firms making
substitute products
• Opportunities for substitution reduce market
power.
• How big of an effect?
– How similar are the products?
– How much cheaper are they?
• Offering substitute products is a way of
competing.
Competition limits profits
• Firms would like to be free of competitors
so that they can have higher profits.
• But, higher profits attract more competitors
to the market.
Competitive strategies
• Get market power by developing a
differentiated product.
• Have lower cost and/or lower price.
• Have a “focused” or niche strategy
Competition as a dynamic process
• Firm develops new product - makes aboveaverage profits.
• Other firms follow with competitor products
and lower costs.
• Firm continues to innovate to develop new
products or to reduce costs.
Structural analysis of industries
• Think about sources of competition.
• Strategies for dealing with competitors.
• Overall strategy of the firm.
Examples
Errors (internal rivalry):
Let rivals get head start:
WordPerfect—slow to switch to Windows
Schwinn—slow to see the potential in
mountain bikes
Motorola—slow to embrace digital cell
technology
Music, Movies—digital format + computer +
internet = file sharing
Supplier Power:
California electricity market
Innovation as a strategy:
Why were Thomas Malthus, The Club of Rome
and Paul Ehrlich all wrong—resources are not the
key constraint, human material well being is
limited by ideas, not by stuff.
We don’t need coal, copper wire or paper, to heat
our homes, communicate with other or store
information. These can be satisfied by new
ideas—recipes, designs, or techniques—to
rearrange existing resources to yield more:
Petroleum replaces whale oil
Shipping containers
Margarine, Hippolyte Mege-Mourcez (1870)
The combinatorial nature of ideas allows
progress to be exponential—importantly ideas
are public goods