Download competitiveness

MGTECON 580:
Firms, Markets, and Policy
Strategies in Europe
Karl Aiginger
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Autumn 02/03
M/TH 8:00 – 9:45
First class: Sept. 26
Last class: Oct. 24
Professor Karl Aiginger
Office: Encina Hall E 105
Tel: 650.723.0249
[email protected]
Assistant: Jenny Smith
Office: Littlefield 216
Tel: 650.736.1634
[email protected]
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The content of the course
Objective
 diversity of business environment in Europe
 the interrelation of firm strategies, market characteristics and
business environment
 to analyze firm strategies in the framework of theoretical
concepts
Non-goals
 Another strategy or econ course
 Everything about Europe
 “the market solves all”
 “one model fits all”
To be achieved:
 Knowledge: Diversity of European business
 Ability: Strategy evaluation guided by theory
based framework
 Confidence: Diversity can be turned into an
advantage for persons, firms, countries
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The three core elements
The analytical framework:
•Industrial Organisation
•Strategy & Management
•Location, FDI, & Trade Theory
•Growth theory
Strategies of
European Firms
The relevant market:
•Industry growth
•Regional dynamics
•Technology & input structure
Industry structure
and
market dynamics
Policy Strategies and
Business Environment
Differences Across EU members:
•Innovation, industrial, regional policy
•Competition policy, Industrial Relations
•Welfare, taxes, openness
•Low cost, high-tech strategy
The ultimate reason:
Matching firm strategies with business
environment and economic policy increases
firm performance
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The analytical framework
Industrial Organization
Performance of markets and strategies
of firms to escape profit squeeze
Management and Strategy
How to gain and sustain a competitive
advantage
Location, International Production
(FDI), and Trade
Where to locate and what to trade
Growth theory, macroeconomic,
structural policy
What drives growth, limits, what policy
can do
The rationale:
Theory should provide the framework for
the analysis. There are four strands of
theories relevant as background for firm
strategies, market dynamics, and policy
strategies.
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Industrial organisation:
The “profit dissipation hypothesis”
The perennial threat for business is that
prices eventually decline to average costs, or
even worse, to marginal costs
If not, firms develop specifically successful strategies
Footnote 1:
Market perfection criteria in Welfare Theory:
• if markets work well, prices equal marginal costs
• this is good for consumers, good for society (short
run), however, bad for firms
Footnote 2:
• tension is less in the long run (see innovation theory)
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Profit dissipation in detail
For the competition model
p = MC: in the short run
p = AC: in the long run
For Bertrand competition, if there are two firms
p = MC
p= AC; PCM = 0
For Cournot competition, if n increases
PCM = 1 / (n*e)
And if entry p = AC; PCM = 0
For monopolistic competition
entry leads to zero profits;
and fragmented structures
Remark:
This is the “old” Industrial Organization
SCP Paradigm (S determines C, C determines P)
Critique 1: causalities can be reversed
Critique 2: firms are actors, strategic units (game theory)
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Strategies to escape profit dissipation
The tenfold path to entrepreneurial happiness
1. Monopoly
2. Collusion
3. Entry blockades
4. Shifting demand curve
5. Product differentiation
6. Costs advantage
7. Productivity lead
8. Quality upgrade
9. Size
10. Diversification
Conclusion:
Modern Industrial Organization indicates 10
active firm strategies to escape profit
squeeze
However:
In contrast to Nirvana and eternal happiness
profit dissipation will come back again
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Path to profitability 1 and 2
#1 Monopoly: allows p > MC
(more exactly (p-MC)/P = 1/ e; e = elasticity of demand)
But:
How to get a monopoly ?
Competition policy exists to prevent it
International competition
Threat of potential competitor sufficient
#2 Collusion: boosts profits
But:
Usually forbidden
Hard to sustain (cheating can be profitable)
Sometimes only marginally helpful (large n)
Eroded by international competition
Uncertainties and cost asymmetries makes it hard
Easy if government helps
If entry is blockaded
Interactions are repeated
Profits from colluding and punishment for defecting are
large
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Path to profitability 3
#3 Entry blockades: prevents dissipation
In competition, in oligopoly in monopolistic competition
Entry/ non-entry is important for firms
Legal blockades:
Patents
Early mover advantages
Size
Large upfront costs
Research, advertising, goodwill
Illegal:
Threats
Predation
Foreclosure
Refusal to supply
Refusal to connect
Strategic moves:
Early commitments
Reputation, skills
Economic policy (Competition policy) tries to prevent,
eliminate entry barriers
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Path to profitability 4 - 7
#4 Shifting demand curve
advertising: higher demand for given price
research: new products increase industry demand
#5 Product differentiation -even if horizontal- softens competition
Profit margin up to “distance costs”
Some sort of economies of scale or entry barriers must help
If profits are large, entry is attractive
Size and scope advantages can be combined
#6 Cost advantage
Profit margin up to cost differential
But:
how to get it
How to defend it
Persistent advantages imply persistent
improvements
Overtaking phenomena: stuck in, inertia
#7 Productivity lead
Higher productivity
Increasing output for given resources
Similar in result to #6
Different in perspective and means
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Path to profitability 8 - 10
#8 Quality upgrade (quality/cost relation)
Characteristics valued by consumer
Similar in result to #5 and #6 and #7
Different in perspective and means
#9 Size
If there are economies of scale
Cost advantage from size
But also higher risk of uncertainty
Market power (big three strategy)
But:
If crisis come threat of P = MC
Many firms try this strategy
No worth if n = 2 and market large & competitive
#10 Diversification – Global player
Production of different products
Presence on different local markets
If there are economies of scope
Diversifiable risks
Common headquarter, research resources
But:
Costs of diversification (loss of focus)
Adversity of financial markets to conglomerates
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Empirical facts
Industries do matter
Industries with high R&D grow faster
Industries with high R&D more productive
Country strategy matters
Countries with high R&D grow faster
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Management Science
Five “key forces determine industry performance”
Michael Porter: Competitive Strategy 1980
Entry
• Flat costs
• No patents
• No regulation
Supplier power
Internal Rivalry
• Large and few suppliers
• Number of firms
• Relation specific investment
• Excess capacities
• Threat of forward integration
• Exit barriers
• Price competition
Buyers power
• Large and few buyers
• Relation specific investment
• Threat of backward
integration
Substitutes and compliments
• Close substitutes
• No compliments
• Price elastic
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Porter’s five forces
in the perspective of 30 years
• These are threats to superior performance
• They are industry specific, not firm specific
• Behind these forces there are formal IO models
What is missing:
• Industry demand (low growth)
• Government (regulation)
Recall active strategies shaping the market,
synergies between firms (Brandenberry, Nalebuff)
Conclusion:
These forces are the “strategy analog” to
profit dissipation
They define the speed at which profit
dissipation occurs
And they indicate limits to escape strategies
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To escape the bad forces:
Getting a competitive advantage
What is a competitive advantage:
An advantage relative to other firms in the same industry
Two types of competitive advantage:
Cost advantage
Benefit advantage
How to create a competitive advantage:
Development of resources or capabilities
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Which resources and capabilities
Resources: firm specific assets
Patents
Trademarks
Brand name
Reputation
Organization
Specific natural resource
Coca Cola, Barbie, Toyota
Capabilities: activities in which firms excel
Marketing skills
Research skill/acquiring knowledge
Organizational routines
Skills multiple useable
Difficult to reduce to algorithm and guides
Resources:
What a firm has – “nouns”
Capabilities:
Activities in which a firm excels – “verbs”
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Factors explaining profitability:
The share of competitive
advantage
19%
Industry effect
Business unit effect
43%
Corporate parent
Year effect
32%
Unexplained
2%4%
Conclusion:
Competitive advantage is larger than
industry effect
Source: Porter McGahan, in Strategic Management Journal 1997 pp
15–30. BDS p 390
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Sustaining competitive advantage
The threat:
- all markets (with entry, without collusion) tend to zero profits
- competitive advantages can be copied
The strategy:
1. Develop resources and capabilities that are
a) Specific
Patents, brand names, human assets
b) Scarce
Non-reproducible
c) Immobile
Not tradable on well-functional markets
2. Develop isolating mechanism with
a) Early mover advantage
Learning
Network economies
Reputation
Buyer switching costs
b) Impediments to imitation
Legal
Superior access to inputs
Scale economies in market of limited size
Intangible barriers
3. The instrument needed: Innovation
4. Look for a great help: the best business
environment (cluster)
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The best business environment:
Porter’s diamond
Attributes of the local environment
create/sustain Competitive Advantage worldwide
Factor conditions
• Specialized inputs
• Human Resources
• Physical infrastructure
• Administrative, scientific
infrastructure
Demand conditions
Related and
supporting industries
• Size of sophistication of local
demand
• Skillful suppliers
• Customer needs anticipate those
elsewhere
• Clusters of industries
• Character (specific demand J for
small, quiet, energy efficient air
conditioners)
Competitive rivalry
• Management practice
• Governance
• Efficiency encouraging
environment
• Local capital markets
Source: Porter McGahan, Competitive Advantage of Nations, 1990,
p.72
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The Holy Trinity of Regional
Optimization
Economic geography
• where to locate business
• specific core or periphery
Theory of Foreign Direct Investment
• the decision to become an MNE
• why to produce abroad
Trade Theory
• who sells/buys what?
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Economic geography:
where to locate business
The dichotomy of core and periphery
• there is a constant battle between centrifugal and
centripetal forces
• firms are optimizing production costs and transport costs
The attractiveness of the core
• big market (center of demand)
• specialized inputs:
- trainees of many professions
- capital goods or capital good production
on order
• backward linkages
• forward linkages
• skills spillovers (from universities and other firms)
• accelerating force: economies of scale
The remote chances of the periphery
• low wages
• absence of congestion costs
• all non-mobile factors cheaper
The policy issue
• The common belief (threat) that integration favors the
core
• Model: lowering “transport costs” i.w.s.
• Outcome: inverted U
• Decreasing t boost size and spillover effect
• If t becomes very small cost difference effect becomes
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dominant
The Theory of Direct Investment:
at home or abroad
How can foreign firms be successful?
• Domestic firms have “natural” advantages
• Firms specific assets compensate them
-Knowledge, patent, organizing principle, goodwill
• Size effects in research, marketing, finance may add, but not
plant size economies
• Trade barriers (tariff jumping) ironically attract investments
Why do firms go multinational?
• Market extension
• Cost reduction
• Uncertainty reduction
• Asset utilization
The problem with the theory is that there are usually alternatives such
as patenting, licensing, and long-term contracts.
Modern version: vertical split of production chain
The make or buy decision.
All come back to the hidden treasure:
• There is something, the firm has, it is privately owned, and better
used.
• If it stays within the boundary of the firm (widely used, closely
hidden)
Some predictions:
• Cheap countries are good locations for mature, competitive
industries AND for labor intensive industries
• Core/rich locations offer research input as well as research
spillovers
• And have an advantage of test markets (early relative large
demand for sophisticated products)
• Headquarter in sophisticated location allows optimal recruiting
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and saves in door education
Trade theory:
from resources to chance
Who (which country) sells (buy) what?
•The specialization pattern
• Production takes place
-Where the most important input is cheapest
-Where productivity is highest
-Specifically partial productivity of important
factor
Rich countries engage in exchange of similar
products
-First mover advantages
-Economies of scale
-Commitments, oligopolistic structures
-Specialization by chance
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Taking together: Location/FDI/Trade
Starting from hard facts
•Natural resources
•Manmade resources
•Size, low cost of labor, and physical capital
Dematerialization of the determinants
•Getting hold of linkages and spillovers
•Utilizing firm specific effects: FDI
•Making use of quality, product differentiation
•First mover advantages and commitments
Towards specifically rewarding activities
•In parallel to active strategies
•And activities defining competitive advantages
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Growth Theory: determinants of the
growth of an economy
Research
(to produce
technical progress)
Human capital
(to innovate and use
technologies)
Technical progress
(falling down like manna from heaven)
Physical investment
(share of output used for investment)
Population growth (including migration)
Natural resources
Remark: The missing factors
•Cost of inputs
•Business environment: red tape, flexibility
•Tension between Competitiveness Studies
and Growth Analysis
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Macroeconomic environment:
A Macro-Web
Growth factors
•(Physical) infrastructure
•R&D
•Education
•ICT - technology
Competition indicators (competitiveness)
•Openness/Market access
•Toughness of competition
•System costs (taxes, bureaucracy, governance, law,
incentives)
•Factor cost advantages (wages, other inputs, finance)
Forward orientation
•Sophisticated industries
•High level income, dynamic countries
•High quality segments
•Environmental content
Innovativeness
•Risk capital
•Diffusion speed
•Implementation, absorption speed
Stability
•Maximal use of resources
•Lack of imbalances (trade, finance, goals/achievements
•Cyclical amplitude
•Income inequality, poverty
•Energy resources
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The framework in a nutshell
Industrial Organization
•Describe structure, conduct, performance
•Discuss profit dissipation
•Ten escape strategies for firms
Management and Strategy
•Industry specific limits to profitability (5+)
•Strategies to gain a competitive advantage
•How to sustain a competitive advantage
Location, FDI, Trade
•Where to locate, whether to go international
•What to trade, to produce, to buy
Growth Theory, Policy
•What drives and limits country growth
•Link between country growth and market dynamics
Conclusion:
Using this framework for firm strategy
analysis makes this analysis theory-based,
less arbitrary; open to stimulating, scientific
discussion
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The comparison with Industrial
Organization (A1)
Threats are the same as in profitability dissipation hypothesis
Difference IO vs. Strategy
IO-Models are more specific
•Specify conditions and quantitative predictions
•Entry, competitive mode
The formal model in IO
•Who are the players
•What are the goals
•What are the choices
•Relationship between choices and outcome
•Game theory (non-cooperative class)
The perspective of Welfare Theory
All these threats are welfare maximizing (total surplus)
•More 1-3 leads MC pricing, lower PS higher TS
•4 and 5 if they are; this is “countervailing” market power
Preventing these threats does not increase GNP or generate
labor
This is the old focus: threats
•Go to active strategies:
•Shaping the market (via sunk costs, quality upgrade, innovation)
•Changing the position in markets
•R&D, advertising product differentiation
The last two are also surplus increasing
Conclusion:
Both IO and strategy first define the threats
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then the opportunities
Core decisions about best route to
Competitive Advantage (A2)
Decision 1: Cost advantage or Benefit advantage
Porter’s warning: If you try both, you may get “stuck
in the middle”
Decision 2: Share or margin strategy
Decision 3: Targeting (focus) or full line
Decision 4: Make or buy
Conclusion:
Each course, book suggest important
decisions. The most important thing is to
develop a competitive advantage.
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Which route to take: CA or BA (A3)
When to go for a cost advantage
Scale economics and high growth
Commodities
Price elastic industries
Search goods (quality is observable)
When to go for a benefit advantage
People value quality (steep indifference curve pricequality)
Scale economies exist but are exploited
Experience goods
Porter:
Firms should try either of these, but not both.
Could be stuck in the middle (Competitive Strategy, ch2, 1980)
Empirically often both
Price (cost) quality frontier p. 426
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Cost and Benefit Drivers in detail (A4)
Cost drivers (determinants)
Size scope, utilization
Experience
Input prices, density, location, efficiency, focus/complexity,
policies
Organizational, agency efficiency
Benefit drivers
Product performance, quality, aesthetics, durability,
easy installment, operation
Services and complementary products, repair
Delivery characteristics
Consumer perceptions, anticipations, fears
Image, advertising, packages, labeling
More details in BDS p. 420 (table 12.4 or appendix p. 432 ff)
PHD idea: regressing empirically revealed price and quality
intensive industries on these indicators for CA vs. BA
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An important second decision: Share or
margin strategy (A5)
If you get a CA or a BA it depends how large demand elasticity
And/or how divergent preferences are
In extreme, it is possible to get the whole market by
either technique
If horizontally differentiated and low price elasticity: margin
strategy (enjoy p>c)
If price elasticity is high: gain market shares (share
strategy)
For both CA and BA
An important third decision: Targeting or full line
Choosing the market (within industry)
Broad coverage strategies vs. focus strategies
Serve all segment, full line
Gilette: cartridges and disposable, men,
woman, complementary products
Focus strategies
Only one product and/or only one market
Cray Research only supercomputers, but universities
and business
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A successful strategy consists of four
classes of issues (BDS pp. 6-8) (A6)
Boundaries of firm: What should a firm do, how large
Horizontal how big: share of markets
Vertical: Integration, make or buy
Corporate portfolio of businesses
Market and competitive analyses: Nature of market and
interactions
Which type of market
Dynamics
Competitive rivalry
Position and dynamics
How to position firm in the market
Defining competitive advantage
Developing capabilities and resources
Internal organization
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Cost advantage vs. benefit advantage
on national level (A8)
Cost advantage
Keeping costs (input prices) low
Wages, working time, capital prices, interest
rates, import prices, system costs
Pushing productivity up: lower unit costs
Benefit advantage
Quality
Prices
Service
Cost strategy
Leads to lower wage and lower GDP (1st order)
If not positive, competition effect (2nd order)
Share strategy successful if price elasticity is high
If growth, wages will grow again
- competitive advantage not sustainable
Productivity strategy
Leads to unemployment (1st order)
If not positive competition effect (2nd order)
Margin strategy acceptable, since rents for
innovation
If growth, self-enforcing strategy
- spillovers, experience curve
High cost country going for cost advantage fights an uphill
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battle
Porter today on his homepage (A7)
Industry Structure and Structural Change
A company’s profitability depends in part on the structure of the
industry in which it competes
Industry structure resides in five basic forces of competing:
Intensity of rivalry among existing competitors
Threat of new entrants
Threat of substitute products or services
Bargaining power of suppliers
Bargaining power of buyers
Industry structure is relatively stable, but industries
are sometimes transformed by changes in buyer
needs, regulation, or technology.
Companies can shape industry structure rather than
passively react to it.
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Distribution of tasks
•
•
•
•
Framework: me, help appreciated
Country profiles: me, list of open questions
Policy issues: jointly
Firm strategies: you
Homework
•
•
•
Issue paper: overview on issue defining business
environment
Firm strategy paper: interpretation of firm strategies using
framework
Evaluation paper: short summary about country for CEO
Upcoming problem overview may substitute 3 or
Rescue option for absentees, improvement requests
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Homework: content, length, timing
Homework 1: The strategy of large European firms
Objective: To analyze the strategy of a firm against the
background of the framework
Not: short run, stock market (crash) related
Not: when did the firm what
Not: history of management or founders
But: relative to framework (profit dissipation, competitive
strength, etc.)
But: relative to other companies in the industry
But: encouraged by the business environment/policy in
country of origin
• 1-3 firms in groups of 1-3 students
• 5-10 pages per firm
• References required; must be public and accessible.
- If not original, clearly indicate.
• Be prepared to present and defend it in class and to put it
on internet
- Must be sent 3 days in advance to me and assistant, Jenny
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Homework 2: Report on a policy issue important for
business environment
Objective: To analyze an issue, cross European differences
and difference to US and Japan
List of issues to be discussed (starting literature
refers to authors in reference list):
Competition policy
Corporatism
FDI (Foreign Direct Investment)
Regional policy, Clusters
Integration, Specialization
Welfare & Labor Reforms
Innovation, telecommunication policy
The task is to present a short paper (one issue per person)
•To define the question in a tractable and sensible way
•To find literature (beyond indicated here)
•To relate the topic to the country of the session
•To condense the information to a 15 page paper / 15 minute
presentation
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Homework 3: A three-page evaluation report
Business opportunities evaluation
Page 1: A short briefing on a specific EU country
Page 2: A recommendation: I would invest in this
country, if .. (type of investment, caveats)
Page 3: What can be learned from this country for my
firm, for my government
The evaluation report can be substituted only
IF an interesting question comes up during the course
IF there are specific interests well-fitting to the course
objective
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