Theories of Economics, Management and Strategy

1. Theories of Economics, Management and Strategy Learning Objectives: To develop a working knowledge of important theories at the intersection of economics, management and strategy.

2. What These Theories Attempt to Explain • Transaction cost – vertical integration or the organizational boundary of a firm • Agency theory – how to align the interests of principals (owners) and agents (employees) • Resource-based View – the nature of competitive advantage • Organizational Population Ecology – the birth and demise of organizational forms

3. Transaction Cost Economics …why would markets, as a method for managing economic exchanges, ever be replaced by firms …? Ronal Coase • What are transaction costs ? • Search • Bargaining • Contract and enforcement • What determines the level of these costs ? • Frequency of exchange • Asset specificity • Technological uncertainty • Limited rationality • Opportunistic behavior

4. Transaction Costs:Oil and Gas Industry Value Chain

5. Agency Theory and the Principal-agent Problem … the problem of motivating the agent to act on behalf of the principal when performance is costly to observe … Why is it costly to observe performance ? What about computer monitoring ? … environment characterized by incomplete and asymmetric information ...... What does this mean ?

6. Principal-agent Problem – cont’d. • Types of financial compensation: - Hourly - Salary - Piece rates - Bonuses - Promotions - Profit sharing - Stock options • Non-financial compensation Which of these types do you receive ? Pros and cons of promotions (tournaments) as means of compensation ?

7. Principal-agent Problem – cont’d. Problem often solved by effective contract design. Four principals: - Informativeness - Incentive-intensity - Monitoring-Intensity - Equal compensation What do these principals suggest ? Objective vs. Subjective performance evaluation • Simple vs. complex jobs • “rating compression” due to centrality and leniency biases How are you evaluated in your job ?

8. Resource Based View of the Firm • Dominant theoretical perspective in strategy • Resources / capabilities • Financial • Physical • Human • Organizational

9. Resource Based View of the Firm:Critical Assumptions • Assumptions • Resource heterogeneity • Resource immobility Reasonable ? Compare to economic assumptions of perfect competition ?

10. Resource Based View of the Firm:Model / Theory RBV Model: Value Rare Imitability Organization Sustained Competitive advantage Heterogeneity Immobility

11. Discovering Sustained Competitive Advantage:The VRIO Framework • Value – when resources and capabilities enable the firm to respond to threats and opportunities • Rarity – when resource is controlled by a small number of competing firms • Imitability – the degree that the resource can be duplicated or substituted • ‘unique history’ • ‘causal ambiguity’ (numerous small decisions) • ‘social complexity’ • Organization – how the firm is structured, organized and managed to exploit valuable, rare and costly to imitate resources.

12. Applying the VRIO Framework • Assumes firm is organized to exploit resource • Some Examples…

13. Applying the VRIO Framework:Some Examples Telephone systems ? Frequent flyer programs ? 3145 S. Las Vegas Blvd ? Information processing systems ? Firm reputation ? Firm culture ?

14. Strategy Implications of the Resource-based View • Broader responsibility for competitive advantage • Better to exploit firm’s existing valuable, rare and costly to imitate resources, rather than mimic other successful firms • Relative cost of difficult to implement strategy should be compared to its value • Socially complex resources can be source of competitive advantage • Firm’s structure, control systems and compensation policies should change if they conflict with firm’ resources or capabilities