economics of strategy

1. Economics of Strategy @ RU 2013
04. Economics of Strategy

2. 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

3. 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

4. Economics of Strategy @ RU 2013
Profit maximization

5. Economics of Strategy @ RU 2013
Natural Monopoly
$
q
c1
q1 q2
c2
M
c3
q3
LRAC

6. Economics of Strategy @ RU 2013
•
Industry Structure

7. 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

8. Economics of Strategy @ RU 2013
Monopolistic vs. Perfect Competition

9. Economics of Strategy @ RU 2013
Monopoly vs. Perfect Competition

10. Economics of Strategy @ RU 2013
•
Competitive Advantage

11. Economics of Strategy @ RU 2013
The Ability to Create More Economic
Value Than Competitors
Competitive Advantage

12. Economics of Strategy @ RU 2013
Positional Advantage

13. Economics of Strategy @ RU 2013
Positional Advantage

14. Economics of Strategy @ RU 2013
TYPES OF ECONOMIES
• Economy of Scale
• Economy of Scope

15. Economics of Strategy @ RU 2013
Economy of Scale
C = F(1/q)
$
q
LRAC
c1
q1
c2
q2
c3
q3

16. 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.

17. Economics of Strategy @ RU 2013
•
Return to Scale

18. Economics of Strategy @ RU 2013
Return to scale

19. Economics of Strategy @ RU 2013
Long Run Average Cost Curve

20. Economics of Strategy @ RU 2013
Long Run Costs – Importance of Minimum Efficient Scale (MES)

21. Economics of Strategy @ RU 2013
Economy of Scale

22. Economics of Strategy @ RU 2013
Long-run costs - economies & diseconomies of scale

23. 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.

24. Economics of Strategy @ RU 2013
External economies of scale occur outside of a firm but within an industry.

25. 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

26. 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

27. 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”

28. Economics of Strategy @ RU 2013
•
Value Creation

29. Economics of Strategy @ RU 2013

30. Economics of Strategy @ RU 2013
Market power comparison

31. Economics of Strategy @ RU 2013
Producer surplus captured by superior assets

32. Economics of Strategy @ RU 2013
•
Value Innovation

33. Economics of Strategy @ RU 2013
◆Casio’s case

34. Economics of Strategy @ RU 2013

35. Economics of Strategy @ RU 2013
•
Network effect

36. Economics of Strategy @ RU 2013
Old and New Economy
• Industrial Economy
– Populated with oligopolies
– Economies of Scale
• Information Economy
– Temporary monopolies
– Economies of Networks

37. 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

38. Economics of Strategy @ RU 2013

39. Economics of Strategy @ RU 2013

40. Economics of Strategy @ RU 2013
Networks and Positive Feedback

41. 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.

42. Economics of Strategy @ RU 2013
42