Strategy Economics: Creating Value and Capturing Profits

1. Chapter 8: Economics of Strategy:Creating and capturing value Brickley, Smith, and Zimmerman, Managerial Economics and Organizational Architecture, 4th ed.

2. Creating and capturing valuelearning objectives Students should be able to • Explain methods to create and capture value • Define transactions costs and apply to strategic decision making • Identify and provide meaningful examples of Porter’s “five factors”

3. Strategy • General policies intended to generate profits • Choice of industry • Combination of products and services • Competitive and cooperative behaviors • Strategies evolve as circumstances change • Strategies must create and capture value

4. Transaction costs • Consumer transaction costs • product search • learning product characteristics and quality • negotiating terms of sale • enforcing agreements • Producer transaction costs • negotiating terms • legal expenses

5. Value creation • Reduce production costs or producer transaction costs • Reduce consumer transaction costs • Increase expected product quality • “value added” > cost increase

6. Value creation • Decrease price of complements • Raise price of substitutes • limit entry of competitors • Introduce new products and services • Cooperation with other firms

7. Capturing value • Firms in competitive markets are price takers • Market power and superior resources can lead to economic profit

8. Market powerPorter’s five forces • Potential rivals • Existing rivalry • Substitute products • Buyer power • Supplier power

9. Superior factors of production • People • special talents or skills • Physical assets • prime real estate • unique equipment • But bidding for specialized assets may erode profits

10. Superior factors of production • Team production • interdependencies among workers increase value beyond the “sum of the parts” • luck or foresight may endow firms with unique team production capabilities • Rivals may be unable to pinpoint source of advantage and unable to capture equivalent value

11. Diversification • Benefits • Economies of scope • Promoting complements • Costs • Bureaucracy • Incompatible cultures

12. Management Implications • Diversification to reduce earnings volatility • may not increase value • Related diversification • can increase value • Capturing the gains • does the firm bring some special resource into the transaction?

13. Strategy formulation • Understanding resources and capabilities • physical, human, and organizational capital • Understanding the environment • markets, technology, regulation, economic conditions • Combining environmental and internal analyses • Strategy and organizational architecture

14. Framework for strategic planning (Figure 8.5)