Beyond the Reach of the Invisible Hand:
Impediments to Economic Activity,
Market Failures, and Profitability
Dennis A. Yao
Strategic Management Journal, Vol. 9, Special Issue: Strategy Content Research. (Summer, 1988), pg. 59-70.
By Amit Jain
Production
Economies and
Sunk Costs
Transaction
Costs
Imperfect
Information
Product
Differentiation
Scale
Capital
MARKETS ARE EFFICENT
Switching
Costs
Distribution
Channels
Barriers to
Imitation
Govt
Policy
Basic Relationships
1. Entry barriers as operational combinations of IEAs
2. IEAs cause market failure
3. Absent IEAs, entry barriers may not cause market failure
Shortcomings of Economic Theory


The Efficient Market:
◦
◦
◦
◦
Consumers and producers act as price takers
Markets exist for all commodities
Buyers and sellers have complete information
Thus, all firms will make normal (average) profits
 Perfectly competitive markets lead to long-run profits
that are average
 Good strategy leads to survival, not excess profits
So why do we observe companies making excess
profits?
◦ Market failure has created ‘supra-normal’ profitability
◦ Strategists are interested in identifying factors that
create an imperfect market (i.e. imperfect competition)
Industrial Organization – Barriers
to Entry: A source of market failure

Industrial Organization (IO) Literature
◦ Barriers to Entry (Bain 1956, Caves and Porter
1977), such as product differentiation or capital
requirements

Example of product differentiation
◦ The perception of a product as being different
works only if the buyer is uninformed about the
products in the market
 Absence of cost-effective credible information
 Imperfect information

Therefore, there is more to market failure
(and more sources) than B2E
Impediments Theory – another
source of market failure
 Transaction
 Production
Economies
 Sunk
Costs
 Imperfect
Information
Costs
Transaction Costs

Two relevant types
◦ Free-rider problem: Costs of excluding non-buyers
from use of a product or service
 Excluding non-subscribers from benefits of product
review
◦ Costs of communication and information
 Writing long-term contracts when all future
contingencies cannot be predicted

Strategies for dealing with transaction costs
◦ Vertical integration
◦ Culture change: match employee’s goals with
organization’s goals
◦ Develop long-term relationships with outside
organizations
Production Economies, Sunk
Costs, Imperfect Information

Production Economies

Sunk Costs

Imperfect Information
◦ Economies of Scale, Learning Curve, Economies of Scope
◦ In absence of sunk costs, entry and exit become costless
(‘contestible’ markets)
◦ Absence of perfect buyer information leads to above
average price-cost margins
◦ Ways to exploit: provide information oriented strategies




Reputations: brand loyalty.
Product differentiation through advertising
Signaling quality through warranties
“Price reflects Quality” – high price, high quality.
Concluding Thoughts and
Comments


The paper integrates B2E with IEA.
However, the paper’s implications on transaction
costs is limited.
◦ Here’s an extended definition: The firm exists by
minimizing transaction costs, which includes costs
associated with opportunism, complexity, and
uncertainty.

Can transaction costs theory encompass
impediments theory?
◦ Since production economies (quasi-rents), sunk costs
(sunk investments), and imperfect information
(uncertainty) are handled within the boundaries of the
firm, then transaction costs may be sufficient.