Business economics and strategy

1. Business economics and strategy Petros Kavassalis petros@rpcp.mit.edu Unit 2: Markets, technologies and business

2. Markets and hierarchies • Business firms: Organizations that know how to do things • thinking • organizing resources • transacting • Markets: Institutions that succeed to coordinate the economic activity • transmitting information (through prices) • making convergent individual beliefs and plans • selecting (and rejecting) • Describe firms? • Describe markets? • Propose explanations, make predictions? THEORIES (appreciative theorizing and modeling) Univ. of Crete/Dpt of Econ./2001-2002

3. Theories we will make reference • Business firms: • Transaction costs and contract - based theories • Competences - based theories • Markets: • Supply and demand analysis • Evolutionary theories based on selection metaphors • Remind: • Microeconomics deal with the behavior of individual economic units (consumers, workers, investors, owners of land, business firms) • Individual economic units are divided in two large groups: buyers (individual and firms) and sellers (firms, workers, resource owners) • Markets are collections of buyers and sellers that interact, resulting in the possibility for exchange • Industry is a collection of firms that sell similar or closely related products (the supply side of the market) Univ. of Crete/Dpt of Econ./2001-2002

4. Markets as selection mechanisms • G. Dosi and L. Orsenigo, 1988: Coordination and transformation: an overview of structures, behaviors and change in evolutionary environments • G. Dosi, 1982: Technological paradigms and technological trajectories • Change = deviation: A process with micro and macro dimensions • Individuals and organizations “deviate”... and resulting behaviors are selected ex-ante on the basis of individual “visions of the world”, organizations norms etc. • They are also selected ex-post by the market which penalizes or rewards behaviors, products, techniques, organizational forms • Decentralized Markets are doing both: allocate resources and transmit impulses to change • Markets are Institutions not simple price-taking mechanisms • Markets co-ordinate the economic activity not only through prices but also by diffusing knowledge (market learning) Univ. of Crete/Dpt of Econ./2001-2002

5. Order and change • Technical and Institutional change: essential characteristics of the modern economies • Technologies develop along specific paths (technological paradigms and trajectories)... • shaped by the technical properties, the problem-solving heuristics and the cumulative expertise embodied in technological paradigms • Technologies ate not free good, they involve appropriable knowledge (request learning) • Technologies and Institutions (firms and markets) evolve together • Technical change and Markets: With positive technological opportunities, the economic agents react to (or anticipate) changes in prices and demand curves by searching for new techniques and new products within the boundaries of paradigms • Technologies and markets interact, thus giving coherence to the economic process and create order Univ. of Crete/Dpt of Econ./2001-2002

6. Change, uncertainty and behaviors • Uncertainty is a fundamental characteristic of Technical Change • Information gap • Competence gap • Facing such uncertainty, • markets may work efficiently, to deliver price information and discount contingencies about future states-of-the-world… • … but they are less efficient in defining common beliefs and optimal actions • What economic agents do in these environments? • Derive expectations from an an imagined future • Interpret complexities of existing (but under continuous transformation) environments • Develop “interpretative devices” to frame the “uncertain” world, discard among them those producing bad advice and improve those working well • So, Uncertainty implies institutions • behavior-shaping institutions (within firms) -- EX ANTE • markets with learning capacities (not only price takers) to efficiently organize interactions -- EX POST Univ. of Crete/Dpt of Econ./2001-2002

7. Market co-ordination in non-stationary environments • Economic environments where innovation is a pre-dominant feautures show • evolutionary characteristics • path-dependence • self-organization • That means, • multiple and non-stable equilibria (i.e states) • behavioral (more than price) equilibria • dynamic stability (technological trajectories, stable patterns of firms distribution (according to their organizational characteristics and technological asymmetries), stability in the distribution of firms’ performance variables) • So, structure matters: recurring patterns of social interaction bind agents together in networks • (While innovation and diversity guarantees dynamism, i.e. possibility for deviations), markets, selecting of the most successful agents, prevent the economy from departing “too much” from allocative, i.e. static, efficiency • Market selection: non-perfect (only phenotypic selection, various competitive regimes) Univ. of Crete/Dpt of Econ./2001-2002

8. Design and markets in technical change • K. Clark, 1985: The interaction of design hierarchies and market concepts in technological evolution • J. Utterback, 1994:Dominant Designs and the Survival of Firms • Technology develops in an evolutionary fashion: Conceptual framework • Technological paradigms and technological trajectories: uncertainty, search and progressive, i.e, cumulative on the trajectory, learning • Evolution in two stages: from an early, “fluid” state (with a lot of design variety) to a highly “specific”, rigid state • The transition to a “specific stage” of development entails a change in the nature of innovation: i) only a small aspect of the basic product changes and, ii) introduced modifications serve to refine the established design, iii) industrial structure stabilizes and entry in the industry is not easy anymore • The logic of problem solving in design and the formation of concepts that underlie markets’ choices impose a HIERARCHICAL STRUCTURE in the evolution of technologies(key point: dominant design; IBM PC, WAP and GPRS in mobile networks) Univ. of Crete/Dpt of Econ./2001-2002

9. Dominant Design_I • How dominant design occurs? • by exclusion and synthesis • nor in a pre-determined way, neither optimal • How looks like? • As a new product • or as a set of features • please give computer software and hardware examples! • How emerges? (I) • interaction between problem-solving in the design and formation of concepts that underly customer choices • product/functional domains or components/core concepts • a core concept establishes a “narrowing” agenda for a product’s technical development within a particular functional domain (examples: automotive/internal combustion, television/on-the-air transmission) • dominant design: • a set of core concepts plus, • architecture (i.e., a platform organizing relationships between functional domains or components) Univ. of Crete/Dpt of Econ./2001-2002

10. Dominant Design_II • How dominant emerges? (II) • interaction between problem-solving in the design and formation of concepts that underly customer choices • customer choice: uncertainty again... • customers do not have certainties, either… • customers learn about what they want to need (and producers learn to innovate) • model: first grouping - then distinguishing • communication channels between customers (e.g. word of mouth) along with experimenting (especially, in Internet times!) • … And then? • automotive: Model T -- then, stability • television: PAL, SECAM, NTSC -- then, stability • networks interconnection: TCP/IP -- then, stability • Mobile networks: GSM – then stability • What stability does mean? • possibility only for incremental change (different from radical change) • a dominant design incorporates a range of basic choices about the design that are not revisited in every subsequent design (once the dominant automobile design has been accepted, engineers did not reevaluate the decision to use a gasoline engine each time they developed a new design) Univ. of Crete/Dpt of Econ./2001-2002

11. Re-open the agenda • Moving down the hierarchy: add marginal characteristics • Moving up the hierarchy: it is possible! • Innovation affects skills and resources… • both COMPETENCES, • those linked to product and process technology (competence-enhancing or competence-destroying innovation?) and, • those linked to customers and markets (“mass” or “niche” strategies?) Architectural innovation Radical innovation Modular innovation Incremental innovation Univ. of Crete/Dpt of Econ./2001-2002

12. Broadening the concept of dominant design Factors other than technology and customer choices influencing the dominant design Co-specialized assets Regulation and government Strategic maneuvering Producers-users links Univ. of Crete/Dpt of Econ./2001-2002

13. Dominant Design and Industry Structure • (again) Technological trajectories illustrate two phases • a period of rapid learning • a period of slower progress • The emergence of a dominant design, shifts the competitive emphasisin favor of those firms -- large or small -- that are able to achieve better technical andengineering skills • Among the (new) firms linked to a particular innovation, • those that are not able to develop process engineering skills, are unable to compete effectively and die • those possessing special resources may successfully merge with (old) dominant firms • those developing good and not easily appropriable competencies, prosper (Cisco)… • Change requires at the same time technical and organizational adaptativity • The peak of the total population curve for competition will occur within a year or two of the time when a dominant design emerges Univ. of Crete/Dpt of Econ./2001-2002

14. The pattern • The emergence of a dominant design also coexists with: • Standards definition • Competition based on cost and scale and product performance • The peak of the life-cycle of an industry Univ. of Crete/Dpt of Econ./2001-2002

15. Entries and exits: an example • Disk Drive Industry • Five generations of drives • Nobody led all five • Small drives won Univ. of Crete/Dpt of Econ./2001-2002

16. Lessons from technology markets • Invest in understanding the process of emergence of a dominant design • Go process… immediately • Develop products within the “constraints” of dominant design • Monitoring new firm formation • Big risk: “hidden” architectural innovations Univ. of Crete/Dpt of Econ./2001-2002