ECONOMICS 3200B
Lecture 2
Ch. 1, 2, 3
September 16, 2014
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Introduction
• Decision making
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Objectives
Information
Constraints
Trade-offs
Time horizons
• Role of self interest, aka “greed”
• Distributional issues – equity, fairness
– The 1%ers
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Introduction
• From here to there
– Defining here
– Choosing among all possible theres
– Choosing the path to get there
• Options created/foregone along each path
• How long to get there along each path
– What if “there” chosen proves to be the wrong one?
• How do you find out?
– Role of milestones and contingency planning
– Leadership
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Introduction
Decision making
– Forward looking: Information requirements,
uncertainty and risks
– Time horizon: short run vs. long run
– Adam Smith: individuals pursuing their own
self interest will collectively produce the
greatest good  Greed is good, Economics 101
• Importance of incentives: individuals motivated by
personal well-being
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Introduction
• Among 50 wealthiest: Bill Gates (1), Carlos Slim (2),
Amancio Oretga (4), Larry Ellison (5), Koch Brothers (6),
Christy Walton (8), Li Ka-shing (13), Michael Bloomberg
(14), Sheldon Adelosn (15), Mark Zuckerberg (16),
Bernard Arnault (17), Stefan Persson (18), Larry Page &
Sergey Brin (19 and 20), Jeff Bezos (21), Michele Ferraro
(22), Aliko Dangote (23), Carl Icahn (25), Mukesh
Ambani (27), Jorge Lemann (30), Steve Ballmer (31),
Dieter Schwarz (33), Leonardo del Vecchio (38), Phil
Knight (39), Michael Dell (40)
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Introduction
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Time horizon
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Longer the time horizon – fewer constraints,
more uncertainty
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Temporal interdependence among decisions made
at different points in time
Increasing complexity
Shorter time horizon
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Tradeoffs
Rash behavior
Susceptibility to herd mentality – safety in
numbers
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Introduction
Decision making
• Constrained optimization
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Constraints
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Character, history, skills, risk tolerance
Competitors’ strategies
Time
Resource constraints – short-run/long run (i.e. availability of
resources, quality)
Laws, regulations
Others – directors, investors, competitors, creditors (loan
covenants), contracts
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Introduction
• Economic paradigms:
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Perfect competition – many firms, homogeneous products
Monopoly – one firm (seller)
Contestable
Monopsony – one firm (buyer)
Oligopoly – small numbers
Monopolistic competition – many, heterogeneous products
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Introduction
• Problem: Competition
• Passive/active?
• Rivalry – “the goal of competition is to kill your competitors”
– Compare to concept of competition in perfect competition model
• Michael Porter: Determinants of rivalry
– Concentration and balance (Herfindahl-Hirschman index, concentration
ratios) – facilitate collusive behavior, deter entry, dominant firm
– Threat of entry, exit barriers
– Product differentiation – brand identity, switching costs, reputation
– Informational complexity
– Intermittent overcapacity – airlines, steel
– Bargaining power of buyers
– Industry growth
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Introduction
Competition
• Schumpeter
– “This process of creative destruction is the essential
fact about capitalism. Every piece of business strategy
must be seen in its role in the perennial gale of creative
destruction.”
• Bob Crandall
– “Kill your competitor”
• Porter
– Competitive advantage
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Competition
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In 513 B.C., Heraclites of Greece observed
“There is nothing permanent except change.”
Andrew Grove (a co-founder of Intel): “When
everybody knows that something is so, it
means that nobody knows nothing.’”
Organizations need to be change capable –
agile, innovative, nimble, and alert.
Leadership and teams
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Introduction
• Michael Porter: Competitive strategy
– Establish profitable and sustainable position factoring in
bargaining power of suppliers and buyers, threat of entry, threat of
substitutes, intensity of rivalry
• Strategies for achieving competitive advantage
– Cost leadership
– Differentiation
– Niche
• Role of management and luck
– Gamblers’ ruin and industry concentration
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Competition
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Competitive strategies
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Be cheaper
Be better – continued focus on quality
Be different – continued focus on product
innovation.
Cost, differentiation, niche
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Cost leadership cannot ignore differentiation
Differentiation cannot ignore costs
Niche cannot ignore costs and differentiation
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Competition
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Competitive strategies: gain competitive advantage in
order to generate superior financial performance (how
is this defined?)
Strategies depend upon history of company, core
competencies of company, possible competitor
reactions (market structure within which company
competes)
Success depends upon skills, abilities of senior
management; execution of strategies (organization
structure, incentives/ motivation); luck (timing, bad
decisions by competitors, right location,
macroeconomic environment)
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Competition
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Continually develop new strategies and new basis for
competitive advantage
Don’t stand still
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Blackberry/Apple
Barnes & Noble/Amazon
Blockbuster/Netflix
Microsoft/Google
Nokia/Google, Apple
Kodak and digital
Cable companies/Netflix
Stelco/ArcelorMittal
Groupon/?
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Strategic Behavior
• Competitive strategy to be successful
– Act before rivals or learn from mistakes of
rivals
– Deter entry
– Difficult to imitate – time lags
– Commitment to strategy, as long as it appears
to be correct
• Contingency plans – Blackberry and Playbook;
Tokyo Electric, AIG, GM
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Competition
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Compete on strength
Shift rivalry to difficult to detect, timeconsuming to respond strategies
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Product innovations/introductions
Marketing
Lobbying
Production technology innovations
Exclusive contracts – suppliers, distributors
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Introduction
• Sustainability of competitive advantage
– Barriers to imitation not insurmountable, thus firm must
create moving target by investing to continually
improve position
– Well executed offensive strategy best defense against
attack by challenger
– Role remains for defensive strategy – increase
structural barriers to entry, increase probability of
retaliation; retaliate when entry attempted
– Deeper pockets
– Risk-taking vs. risk aversion – role of regulations, fear
of liabilities
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Competitive Success
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Financial performance: management
talent, incentives, strategy, luck
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Interaction will lead to small number of
dominant firms in each industry
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Successful firms able to attract “best and
brightest” – Goldman Sachs, Google
Leaders will change over time
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Competitive Success
Execution: Moving the company from here to
there
• Leadership that can communicate clearly the essence of the strategy
and its goals, inspire employees and gain their confidence and their
cooperation (buy-ins to what the leaders are trying to accomplish);
• Accountability so that everyone knows what is expected of her/him,
and clear-cut rewards and penalties;
• Breaking down the “grand” strategy into a number of clear and
manageable projects, each with specific milestones, and each assigned
to a team with a designated leader;
• Consistency among the projects and in the timing of the projects.
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Introduction
• Problem: Market definition
• Identification of buyers, sellers – potential entrants,
potential sources of supply
• Geographic scope
– Local, regional, national, international
– Trade barriers, information
• What constitutes a substitute product?
– Cross-price elasticities – measurement, critical values
– MR>0: elastic range of demand curve, thus high degree of
substitutability with products that are not included in market
– Substitutability over time – alternative energy sources
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Introduction
• Entry barriers – ease, speed of entry
– Entry by outsiders (who are they?); entry by insiders
– Height, perception of entry barriers – reputation,
economies of scale/scope, learning curves, access to
distribution networks, switching costs, firm specific
capital (patents, trade secrets, management skills,
location)
– Strategic behavior of incumbents – entry
accommodation or deterrence
• Time period for defining markets – time required
for adjustments in buyer/seller behavior in
response to certain size price change
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Introduction
• Problem: Information
• What do buyers know about availabilities, prices, quality?
– Search costs
– Uncertainties re. quality – signals by firms for quality (advertising,
warranties, investments in creating brand names)
– Limited search enhances market power of each firm
– Impact of Internet – search sites
• What do suppliers know about technologies (product, production),
consumer tastes, price elasticity, number and location of buyers,
number and competencies of rivals, cost structures of rivals, strategies
of rivals
– Role of B2B – impact on relative bargaining advantages
• What do potential entrants know?
– Impact of Internet
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Introduction
• Theory: If, then
– If perfect competition, then P=MC
– If monopoly, then, P>AC
– If no entry barriers and zero exit costs, then markets contestable
and P=AC
– If economies of scale to Q0 and diseconomies of scale beyond Q0 ,
then AC curve is U-shaped
– If oligopoly, then ???
– If heterogeneous product, then monopolistic competition
– If economic profits, then entry occurs
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Introduction
• Common shortcomings
– Time: short run vs. long run
– Market/industry boundaries
– Competitive behavior – competitive strategies, competitive
advantage
– First entrant
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Learning curves
Economies of scale
Tipping point
Networks
– Evolution of technology
• Disruptive technologies
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Introduction
• Problem: Many paths to the “if”, thus many paths for
“then”
• Example: Monopoly
– How was monopoly created?
• Government, natural monopoly, successful strategies, superior
management, luck
– Entry barriers created as part of process?
• Depends on how monopoly created
– Strategies to sustain monopoly?
• Rent seeking – public vs. private sector
• Sustainability
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