Chapter 7Chapter 7

Strategic CommitmentOleh : Deddi Wahyudi & Dian Eky

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Strategic commitment are decisions that have long-term impacts and are difficult to reverse

Strategic commitment should be distinguished from tactical decision

Strategic commitment can significantly influence competition in an industry

The detail of market rivalry can influence the commitments make

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There are three essential characteristics to having a valuable strategic commitment:◦It must be visible◦It must be understandable◦It must be credible

A key to credibility is irreversibility

Public statement and contract can facilitate commitment

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New Concept :New Concept :1. Capture how competitors react when one 1. Capture how competitors react when one competitor changes a tactical variable competitor changes a tactical variable

a. Strategic complementsa. Strategic complementsb. Strategic subtitutesb. Strategic subtitutes

2. Capture whether a commitment by one2. Capture whether a commitment by one firm places its rivals at a advantage firm places its rivals at a advantage

a. Tough commitmenta. Tough commitmentb. Soft commitmentb. Soft commitment

Strategic commitment and competition

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Strategic Complements…..Strategic Complements…..The more of the action one firm choose, the more The more of the action one firm choose, the more of the action the other firm will also optimally of the action the other firm will also optimally choosechoose

Strategic Substitutes….Strategic Substitutes….The more of the action one firm takes, the less of The more of the action one firm takes, the less of the action the other firm optimally choosethe action the other firm optimally choose

Strategic Complements & Strategic Substitutes

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The rule….1.Strategic complement

a. Upward sloping reaction function (Bertrand Model)b. Component : price

2. Strategic substitutea. Downward sloping reaction ( Cournot Model)b. Component : quantity

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Commitment have…1. Direct effect its impact on the present value of the firm’s profit2. Strategic effect competitive side effect of the commitment

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Tough Commitment….Tough Commitment….- bad for competitor- bad for competitor- easier to visualize because they conform to the the - easier to visualize because they conform to the the conventional view of competition as an effort to outdo one’s rivalconventional view of competition as an effort to outdo one’s rival- - A tough commitment is a commitment that is going to have an A tough commitment is a commitment that is going to have an adverse effect on the competitors of the firm.adverse effect on the competitors of the firm.- We - We make a tough commitment when the positive strategic effect make a tough commitment when the positive strategic effect outweighs the potential negative direct effectoutweighs the potential negative direct effect

Soft commitmentSoft commitment- good for its competitor- good for its competitor- - A soft commitment is a commitment that is going to have a A soft commitment is a commitment that is going to have a beneficial effect on the competitors of the firm.beneficial effect on the competitors of the firm.- We make a soft commitment when the positive direct effect - We make a soft commitment when the positive direct effect outweighs the negative strategic effect.outweighs the negative strategic effect.

Tough and Soft Commitment

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- Market with two firm…- Market with two firm…Stage 1 Stage 1 make commitment make commitmentStage 2 Stage 2 compete each other (Cournot or compete each other (Cournot or

Bertrand analysis)Bertrand analysis)

Tough and soft commitment in Cournot and Bertrand Equilibrium

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Taxonomy of Commitment StrategiesTaxonomy of Commitment Strategies

Nature of Stage 2 Commitment Posture

Commitment Action

Strategy

Strategic Substitutes Tough Make Top-Dog StrategyFT

Strategic Substitutes Tough Refrain Submissive Underdog

Strategic Substitutes Soft Make Suicidal Siberian

Strategic Substitutes Soft Refrain Lean and Hungry LookFT

Strategic Complements

Tough Make Mad Dog

Strategic Complements

Tough Refrain Puppy-Dog PloyFT

Strategic Complements

Soft Make Fat-Cat EffectFT

Strategic Complements

Soft Refrain Weak Kitten

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- The strategic effect of commitment is positive when the - The strategic effect of commitment is positive when the commitment alter competitor’s behaviorcommitment alter competitor’s behavior

- Strategic commitments are almost always made under - Strategic commitments are almost always made under uncertainty conditionuncertainty condition

- Some ways firm can preserve its flexibility when making - Some ways firm can preserve its flexibility when making strategic commitment : strategic commitment : 1. Modify the commitment as future condition change1. Modify the commitment as future condition change2. Delay making a commitment to future point until it has 2. Delay making a commitment to future point until it has better idea of how profitable it is likely to bebetter idea of how profitable it is likely to be3. Undertake unprofitable commitment today to preserve the 3. Undertake unprofitable commitment today to preserve the option of making a follow-on commitment in the futureoption of making a follow-on commitment in the future

Flexibility & Real Option

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- Flexibility rises Real Option- Flexibility rises Real Option

- Real option :- Real option : a. exist when a decision maker has the opportunity to tailor a. exist when a decision maker has the opportunity to tailor decision to information that will be received in the futuredecision to information that will be received in the futureexample :example :

Firm wants to invest Rp 100M to enter new market, it Firm wants to invest Rp 100M to enter new market, it creates 2 scenario with NPV :creates 2 scenario with NPV :a. high-acceptance : Rp 300Ma. high-acceptance : Rp 300Mb. low-acceptance : Rp 50Mb. low-acceptance : Rp 50MIf firm invest today, expected NPV If firm invest today, expected NPV

is( 0,5(300)+0,5(50)-100)=Rp 75Mis( 0,5(300)+0,5(50)-100)=Rp 75M

Flexibility & Real Option Cont…

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If firm wait and the product tuns out to have high level market acceptance, firm should invest and obtain NPV Rp. 200M. But if the NPV = Rp. 50 M ( stop invest, we assume zero NPV investment)Assume annual discount rate = 10%Expected NPV = (0,5(200)+0,5(0))/1,10 = Rp 91M

It’s better for the firm to delay the investment until they have as much as information of the new market

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- A commitment-intensive decisions are durable, - A commitment-intensive decisions are durable, specialized, and untradable after the firm has moved specialized, and untradable after the firm has moved forward with themforward with them

- Pankaj Ghemawat developed a four-step framework for - Pankaj Ghemawat developed a four-step framework for analyzing these decisions:analyzing these decisions:1. Positioning Analysis1. Positioning Analysis

Analyze the direct effects of the commitmentAnalyze the direct effects of the commitment

2. Sustainability Analysis2. Sustainability AnalysisAnalyze potential responses to the Analyze potential responses to the

commitment by competitor and impact of commitment by competitor and impact of those those responses to the competitionresponses to the competition

A Framework For Analyzing Commitment

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3. Flexibility Analysis3. Flexibility Analysisanalyze uncertaintyanalyze uncertainty

4. Judgment Analysis4. Judgment Analysisanalyze the distorting factors of the firm that analyze the distorting factors of the firm that

affect the optimal choice of the strategyaffect the optimal choice of the strategy 2 types of error :2 types of error :Type I : rejecting an investment that should be Type I : rejecting an investment that should be mademadeType II : Accepting an investment that should be Type II : Accepting an investment that should be rejectedrejected

A Framework For Analyzing Commitment…

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Terima Kasih….

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