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Economics of Strategy @ RU 2013
04. Economics of Strategy
Economics of Strategy @ RU 2013
Economics of Strategy
• Overarching Goal: Maximize Profits – Returns to Scale – Demand and competition – Value Creation and Innovation – Network Effect : Understanding Network Effects
Economics of Strategy @ RU 2013
Q
P
D
MR
D
ATC MC
Q
P
(D=MR=Price)
Imperfect Competition Perfect Competition
Competitive Advantage
ATC MC
Economic Models Competitive Advantage
Economics of Strategy @ RU 2013
Profit maximization
Economics of Strategy @ RU 2013
Natural Monopoly
$
q
c1
q1 q2
c2
M c3
q3
LRAC
Economics of Strategy @ RU 2013
• Industry Structure
Economics of Strategy @ RU 2013
Concentration
Entry and Exit Barriers
Product Differentiation
Information
Perfect Competition Oligopoly Duopoly Monopoly
Many firms A few firms Two firms One firm
No/Low barriers Significant barriers High barriers
Homogeneous Product Potential for product differentiation
Perfect Information flow Imperfect availability of information
Industry structure
Economics of Strategy @ RU 2013
Monopolistic vs. Perfect Competition
Economics of Strategy @ RU 2013
Monopoly vs. Perfect Competition
Economics of Strategy @ RU 2013
• Competitive Advantage
Economics of Strategy @ RU 2013
The Ability to Create More Economic Value Than Competitors
Competitive Advantage
Economics of Strategy @ RU 2013
Positional Advantage
Economics of Strategy @ RU 2013
Positional Advantage
Economics of Strategy @ RU 2013
TYPES OF ECONOMIES
• Economy of Scale
• Economy of Scope
Economics of Strategy @ RU 2013
Economy of Scale
C = F(1/q)
$
q LRAC
c1
q1
c2
q2
c3
q3
Economics of Strategy @ RU 2013
Economy of Scope
C( x1 + x2 ) C( x1 ) + C( x2 ) <
Economies of scope occur where it is cheaper to produce a range of products rather than specialize in just a handful of products.
Economics of Strategy @ RU 2013
• Return to Scale
Economics of Strategy @ RU 2013
Return to scale
Economics of Strategy @ RU 2013
Long Run Average Cost Curve
Economics of Strategy @ RU 2013
Long Run Costs – Importance of Minimum Efficient Scale (MES)
Economics of Strategy @ RU 2013
Economy of Scale
Economics of Strategy @ RU 2013
Long-run costs - economies & diseconomies of scale
Economics of Strategy @ RU 2013
Internal economies of scale come from the long-term growth of the firm.
• Technical economies of scale: Expensive (indivisible) capital inputs, Specialization of the workforce, The law of increased dimensions, Learning by doing
• Managerial economies of scale: division of labour • Financial economies of scale ‘credit worthy’ • Network economies of scale: network economy.
Economics of Strategy @ RU 2013
External economies of scale occur outside of a firm but within an industry.
Economics of Strategy @ RU 2013
Diseconomies of scale
• Nokia, diseconomies of scale and lost competitive advantage • Diseconomies of scale a business may experience relate to:
– Control – Co-ordination – Co-operation
• Avoiding diseconomies of scale – Human resource management – Performance related pay schemes (PRP) – out-sourcing
Economics of Strategy @ RU 2013
Economies of Scope
Common expressions that describe strategies that exploit the economies of scope – “Leveraging core competences” – “Competing on capabilities” – “Mobilizing in visible assets” – Diversification into related products
Besanko, Dranove, Shanley and Schaefer
Economics of Strategy @ RU 2013
Diseconomies of Scale
l Beyond a certain size, bigger may not always be better l The sources of such diseconomies are – Increasing labor costs – Bureaucracy effects – Scarcity of specialized resources – “Conflicting out”
Economics of Strategy @ RU 2013
• Value Creation
Economics of Strategy @ RU 2013
Economics of Strategy @ RU 2013
Market power comparison
Economics of Strategy @ RU 2013
Producer surplus captured by superior assets
Economics of Strategy @ RU 2013
• Value Innovation
Economics of Strategy @ RU 2013
◆Casio’s case
Economics of Strategy @ RU 2013
Economics of Strategy @ RU 2013
• Network effect
Economics of Strategy @ RU 2013
Old and New Economy
• Industrial Economy – Populated with oligopolies – Economies of Scale
• Information Economy – Temporary monopolies – Economies of Networks
Economics of Strategy @ RU 2013
Salient structural features of high technology industries
• Product and price differentiation
• Bundling
• Switching costs and lock-in
• Supply-side economies of scale
• Demand-side economies of scale
• Standards
Economics of Strategy @ RU 2013
Economics of Strategy @ RU 2013
Economics of Strategy @ RU 2013
Networks and Positive Feedback
Economics of Strategy @ RU 2013
Size of network
Willingness to pay
Demand curve
Supply curve
Network Effects and Demand
0
“Critical mass” area
N*
Willingness to pay begins to diminish at network size N* due to “network congestion” effects.
Economics of Strategy @ RU 2013
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