Excuse me, but who are you? Research on strategic interaction, incentives and organizational economics Incentives for innovation exhibit tolerance for failure and rewards for longterm success (e.g., long vesting periods for stock options in pharmaceutical industry) Incentives to deter gaming may purposely introduce randomness to focus efforts on productive activities (e.g., gaming of law & business school rankings) Incentives for information acquisition in group settings need to provide motivation for information sharing (e.g., private equity partnerships) Social learning and social preferences among retail investors Teaching: Behavioral Economics, Competitive Strategy, I tweet about mildly interesting topics @florianederer What I love: Backcountry skiing, tennis, rock climbing, karaoke
Recurring Guest Speaker
Capabilities and Industry Analysis MGT 525 Competitive Strategy Florian Ederer
Agenda Review of Industry Analysis Some Unusual Examples Crown Cork & Seal Update
Where are the Opportunities? Why don t we just look at industry profits? 30% of profits due to industry 23% of profits due to position, history, structure 15% of profits due to CEO and management Rest is unexplained/luck! Foundation for answering questions How do I enter an attractive industry? How will this industry maintain profitability? How can I profit in an unattractive industry?
Industry Definition Industry boundaries are fuzzy Rule of thumb: Include close substitutes and exclude distant substitutes No right definition More expansive definitions turn producers of substitutes into rivals Industry/market definition is less important for strategy, but very important for antitrust market definition and the use of market shares are very crude tools of analysis (Carlton 2007) cross-price elasticity of demand
Industry Analysis & Competitive Strategy Industry Analysis Description of the economic structure of an industry Analyze long-run industry profits Building block of strategy formulation Essential to making effective decisions about entry, exit, expansion, product positioning, cost reduction, Ideally not just a checklist, but an analysis of what factors constrain industry profitability. Competitive Strategy Select a position in the industry that maximizes the firm s share of industry profits. Change industry characteristics to increase profits Measurement is crucial!
Five Forces THREAT OF NEW ENTRANTS BARGAINING POWER OF SUPPLIERS RIVALRY AMONG COMPETITORS BARGAINING POWER OF BUYERS COMPLEMENTS SUBSTITUTES 5 Forces Video: https://vimeo.com/39394749
Rivalry Among Competitors 3 basic questions How many firms are there? How do firms compete? price competition product competition technological innovations marketing competition for scarce inputs To what extent does price competition or non-price competition (e.g., advertising) erode the profitability of a typical firm in the industry? Intense rivalry erodes profitability by reducing price-cost margins (price competition) increasing programmed costs (e.g., advertising) (non-price competition)
Structure Structure vs. Conduct Top n firm concentration ratios, Herfindahl index Conduct Time between price responses, advertising spending, R&D investment, etc. but aren t two firms enough for Bertrand competition? Bresnahan & Reiss (JPE 1991) empirically show that 3 is enough!
Drivers of Pricing Rivalry Soft Pricing Rivalry Concentrated market Differentiated Products Strong capacity utilization Rapidly growing demand Significant brand loyalty Public sales terms; firms have good information about competitors small, frequent orders Key Questions How much pricing rivalry is there for a given number of competitors? Is the industry cartel-like? Bertrand-like?
Threat of Entry Key Question To what extent does the threat or incidence of entry erode the profitability of a typical firm in the industry? Factors that restrict entry into an industry: Economies of scale Large sunk capital expenditures for entry Large incumbent advantages learning curve effects patents and licenses pioneer brand advantages relationships with buyers and suppliers Substantial exit costs Force of Forces If rivalry will be very fierce, entry is unlikely to be the big issue. If entry is very easy, it can trump all of the other industry analysis factors.
Observed Entry Pitfalls Observed entry and exit rates do not define barriers to entry Lack of entry could mean that Entry barriers are high Industry profits are low Measures of entry barriers Time to recoup initial investment Time to enter and establish profitability
Bargaining Power in the Value Chain Identify other players in the value chain Key question To what extent do buyers/suppliers have the ability to extract profits from the value chain greater than what would prevail in perfectly competitive markets because of their bargaining power? For example, the power of suppliers increases if Input is a critical component of production Supplier industry more concentrated than the industry it sells to Firms in the analyzed industry purchase relatively small volumes relative to other customers of the supplier Suppliers can credibly threaten to forward integrate. Measurement: supply/demand elasticity
Substitutes Key question To what extent does competition from substitute products outside the defined boundaries of the industry erode the profitability of a typical firm in the industry? Identifying substitutes depends on how finely you draw the boundaries of the analyzed market Is Amtrak a competitor to Airlines or a substitute product? Substitutes limit the profits of an industry by placing a ceiling on industry prices. The more attractive the price-performance tradeoff offered by substitutes, the more important the substitute product Measurement cross-price elasticity: e AB =( q A / p B )(p B /q A ) diversion ratio: d AB = (e AB /e A )(q B /q A )
Complementary Products Key Questions To what extent does the availability and price of complementary products erode the profitability of a typical firm in the industry? Do complementors have bargaining power? Examples Intel/Microsoft Automobiles/Roads Facebook/Zynga Largely a statement about what the demand curve looks like Porter denies that complements are a force worthy of inclusion in his framework Mirror of substitutes so availability and price of substitutes/complements shift the demand curve in exactly opposite ways.
Agenda Review of Industry Analysis Some Unusual Examples Crown Cork & Seal Update
Budget for the F-35 is larger than Australia s GDP
Five Forces for Business Schools Rivalry No or little price competition among elites Barriers to entry Reputations are hard to build Supplier power Universities have huge leverage Buyer power Atomistic, little negotiating power Substitutes Cross-price elasticity among other professional schools is small
Agenda Review of Industry Analysis Some Unusual Examples Crown Cork & Seal Update
CC&S performance (1989-1996) relative to the S&P 500 was pretty good Crown Cork & Seal S&P 500
stunningly awful (1997-2001) S&P 500 Crown Cork & Seal Crown Cork & Seal S&P 500
and downright amazing (2002-2013)! Crown Cork & Seal S&P 500