Business Strategy involves analysis of how businesses and organizations behave in situations in which strategic decisions are interdependent, i.e. where my actions affect my competitors' profits and vice versa. Using the basic tools of game theory, it analyses how businesses choose strategies to attain competitive advantage.
- The Basics
- Cooperation
- Complementary Products
- Market Entry Strategy
- Research and Development
- Product Differentiation
- Customer Switching Costs
- Price Discrimination
- Competition Law
- Network Effects
- Economies of Scale
- Economies of Scope
- Mergers and Acquisitions
- Organic Growth
- Resources
Simultaneous Game - is a game where each player chooses his action without knowledge of the actions chosen by other players.
Sequential Game - a game where one player chooses their action before the others choose theirs. Importantly, the later players must have some information of the first's choice, otherwise the difference in time would have no strategic effect.
Dominant Strategy - a strategy that is always better than any other strategy, regardless of what the other player is doing.
Nash Equilibrium - a set of strategies, one for each player, such that no player has incentive to change his strategy given what the other players are doing.
Prisoner's Dilemma - a standard example of a game analyzed in game theory that shows why two completely rational agents might not cooperate, even if it appears that it is in their best interests to do so. It's a simultaneous game.
| Betray | Stay silent | |
|---|---|---|
| Betray | -2,-2 | 0,-3 |
| Stay silent | -3,0 | -1,-1 |
- If A and B each betray the other, each of them serves 2 years in prison
- If A betrays B but B remains silent, A will be set free and B will serve 3 years in prison (and vice versa)
- If A and B both remain silent, both of them will only serve 1 year in prison (on the lesser charge).
An example of a Prisoner's Dilemma is when Colgate and Sensodyne both advertise because it's a dominant strategy, share the market equally (the assumption here is that the size of the market stays the same regardless of whether any company advertises):
| Advertise | Don't advertise | |
|---|---|---|
| Advertise | $3M,$3M | $6M,$2M |
| Don't advertise | $2M,$6M | $5M,$5M |
- Total market size: $10M
- Advertisement cost: $2M
- Market split when both advertise or no one advertises: 50%/50%
- Market split when one advertises and another doesn't: 80%/20%
- Universal Studio charges $1.0mn for a product placement in the movie E.T. the Extra-Terrestrial
- Product placement by Mars
- Mars' gross profits increase by $0.8M
- Hershey's decrease by $0.1M
- Product placement by Hershey
- Hershey's gross profits increase by $1.2M
- Mars' decrease by $0.5M
- No product placement: "business as usual"
Mars decided to reject the deal and lost $0.5M. If the accepted the deal they would lose only $0.2M.
Price war is "commercial competition characterized by the repeated cutting of prices below those of competitors". One competitor will lower its price, then others will lower their prices to match. If one of them reduces their price again, a new round of reductions starts. In the short term, price wars are good for buyers, who can take advantage of lower prices. Often they are not good for the companies involved because the lower prices reduce profit margins and can threaten their survival.
In the medium to long term, price wars can be good for the dominant firms in the industry. Typically, the smaller, more marginal firms cannot compete and must close. The remaining firms absorb the market share of those that have closed. The real losers, then, are the marginal firms and their investors. In the long term, the consumer may lose too. With fewer firms in the industry, prices tend to increase, sometimes higher than before the price war started.
As can be seen from the Prisoner's Dilemma the outcome of the game can improve for both parties if they can cooperate.
Cooperation is the process of groups of organisms working or acting together for common, mutual, or some underlying benefit, as opposed to working in competition for selfish benefit.
Grim Trigger - a trigger strategy for a repeated game. Initially, a player using grim trigger will cooperate, but as soon as the opponent defects (thus satisfying the trigger condition), the player using grim trigger will defect for the remainder of the iterated game. Grim Trigger played by all players is a Subgame Perfect Equilibrium.
Discount Factor - a number between 0 and 1 that represents the time value of consumption and probability of continuation. A higher discount factor means more patience and higher chance of surviving into the next period.
What induces cooperation:
- Repeated games - if the game is played multiple times the payoffs are different. Assuming the Grim Trigger strategy for both players and that
| | 1st round | 2nd round | 3rd round | 4th round | | --- | --- | | --- | --- | | Betray | 0 | -2 | -2 | -2 | | Cooperate | -1 | -1 | -1 | -1 |
Cooperation will be chosen if the discount factor is sufficiently high.
A Most-Favoured-Customer Clause (MFC) is a contractual arrangement between vendor and customer that guarantees the customer the best price the vendor gives to anyone. The MFC prevents a company from treating different customers differently in negotiations. While it may appear that MFCs benefit consumers because prices are lowered, views have changed in recent years (since approximately 2012). Authorities increasingly argue that such clauses prevent the offer of lower prices elsewhere and make the market entry of competitive offers considerably more difficult because they prevent new entrants from offering products at lower prices. It thus violates competition.
Aggressive commitment: eliminate those moves which lead to unattractive equilibria:
- Boeing and Airbus both think about launching a new large scale passenger airplane (Airbus: A380, Boeing: 747X).
- There is not enough market for two different models
- Airbus moves first - builds production facilities in Hamburg and Toulouse, these can be used for the production of the A380 only.
Two products A and B are complementary if the demand for B increases when the price of A drops, and vice versa. Examples: Computers & Software, Skis & Skiing Sticks, Smartphones & Apps. This phenomenon is referred to as negative cross-price elasticity.
Cross-price elasticity of demand measures the responsiveness of the quantity demanded for a good to a change in the price of another good, ceteris paribus. It is measured as the percentage change in quantity demanded for the first good that occurs in response to a percentage change in price of the second good. For example, if, in response to a 10% increase in the price of fuel, the demand for new cars that are fuel inefficient decreased by 20%, the cross elasticity of demand would be: -2.
It may make sense to support the supplier of the complement - Better quality of complement and higher sales of complement is beneficial for own product.
Examples:
- Apple gave laptops to students writing software for Mac OS. More compatible software titles made Apple's laptops more attractive.
- Game console manufacturer 3DO made publishers pay a fee of 3 dollars to 3DO for every game copy sold.
- 3DO could sell consoles much cheaper and attract more customers.
- Publishers could sell more copies and increase net profits.
Producing the complement yourself:
- Pros:
- Market for complement may be unattractive
- Complement may require competencies the firm lacks (production, R&D, management,...)
- Prospective customers might be put off by firm’s dominant position
- Cons:
- Better tailoring of complement to own product
- Quality control for complement
- Internalisation of the positive effects of the complement on own product
Strategies related to complements
- Cross subsidies - charging higher prices to one type of consumers to artificially lower prices for another group.
- Razors and blades
- Mobile phones and operator contracts
- Printers and cartridges
- Espresso machines and espresso capsules
- Bundling - sell main product and complement as a bundle.
- Lock-in - complement can only be used with main product of certain producer. Users have switching costs when switching from A to a substitute. The more complements (B, C, ...) to A they buy, the higher the switching cost. Higher switching costs imply a higher value of the customer to the firm.
Sometimes two firms can be both competitors and complementors. For example, Sony and Apple. Both produce mp3 players. Sony uses iTunes store to sell music they produce.
Sometimes firms don't want to merge, because they want to maintain control or only part of business is complementary. In this case a strategic partnership can be used:
- Producers of complementary goods dependent on each other.
- Helping each other and coordinating each other's behaviour maximizes the positive effects of complementarity.
- In many cases, integration into one single company not feasible or not desired by involved firms.
- Forming a strategic partnership is a powerful way of institutionalizing coordination and formalising interests.
A strategic partnership is characterised by:
- Shared decision making
- Organizational integration
- Teams across firms
- Established reporting and decision routines across firms
- Heavy exchange of information
- Economic integration
- Joint equity ownership
- A new legal entity (joint venture)
- Threat of new entrants
- The existence of barriers to entry (patents, rights, etc.). The most attractive segment is one in which entry barriers are high and exit barriers are low.
- Government policy such as sanctioned monopolies or legal franchise requirements.
- Capital requirements - clearly the Internet has influenced this factor dramatically. Web sites and apps can be launched cheaply and easily as opposed to the brick and mortar industries of the past.
- Economies of scale
- Product differentiation
- Brand equity
- Customer loyalty to established brands
- Industry profitability (the more profitable the industry, the more attractive it will be to new competitors)
- Network effect
- Threat of substitutes (products that use a different technology to try to solve the same economic need)
- Buyer propensity to substitute
- Relative price performance of substitute
- Buyer's switching costs
- Number of substitute products available in the market
- Availability of close substitute
- Bargaining power of customers
- Buyer concentration to firm concentration ratio
- Degree of dependency upon existing channels of distribution
- Buyer switching costs
- Buyer information availability
- Buyer price sensitivity
- Bargaining power of suppliers
- Supplier switching costs relative to firm switching costs
- Degree of differentiation of inputs
- Presence of substitute inputs
- Employee solidarity
- Competitive rivalry
- Sustainable competitive advantage through innovation
- Level of advertising expense
- Powerful competitive strategy which could potentially be realized by adhering to Porter's work on low cost versus differentiation
- Control of essential resources
- Natural resources: DeBeers / diamonds
- Supplier capacity: Minnetonka / liquid soap
- Patents: Sony and Philips / CD
- Distribution channel: Coca Cola / fast food chains
- Location: Supermarkets / top locations
- Timing: Airlines / Arrival slots at airports
- Rationing by governments: Cabs, mobile phone networks
- Economies of scale and scope
- Minimum efficient scale: Semiconductor production
- Cost advantages of incumbents through experience or economies of scope: Airframe production
- Marketing advantages of incumbents
- Brand loyalty: Frequent flyer programs
- Switching costs: Network markets such as mobile telephony
In business, strategic entry deterrence refers to any action taken by an existing business in a particular market that discourages potential entrants from entering into competition in that market. Such actions, or barriers to entry, can include hostile takeovers, product differentiation through heavy spending on new product development, capacity expansion to achieve lower unit costs, and predatory pricing. These actions are sometimes deemed anti-competitive and could be subject to various competition laws.
Commitment:
New entrant makes a commitment that makes him impossible to exit the market if incumbent retaliates.
Types of commitment
- High sunk cost investments
- Production capacity
- R&D
- Advertising
- Exit from other strategic market segments and focus on entry.
Judo Strategy:
Entrant:
- Sets a price lower than the incumbent's price
- Limits its capacity to serve a small proportion of the market
- Signals the incumbent that it does not increase its capacity drastically in the future
Incumbent:
- Loses some profits by giving market share to the incumbent
- Can exclude the entrant and fight back the whole market by setting itsown price marginally lower than the entrant's one
- Incurs (in the short run) losses through this price reduction
Example: Amazon vs. Barnes & Noble
- Amazon enters into the online book retail in 1994
- Barnes & Noble (leading US book retailer) does not respond with an own online store even though potential to exclude Amazon
- Fear that online store would trigger an online price war and cannibalizing sales through classical bookstores
- Amazon gradually dragging customers away from classical bookstores
Niche Market - a subset of the market on which a specific product is focused. The market niche defines the product features aimed at satisfying specific market needs, as well as the price range, production quality and the demographics that it is intended to target. It is also a small market segment.
- The entrant focuses on a niche market
- Across the board retaliation may not be feasible for incumbent
Limit Pricing:
A limit price is the price set by a monopolist to discourage economic entry into a market, and is illegal in many countries. The limit price is the price that the entrant would face upon entering as long as the incumbent firm did not decrease output. The limit price is often lower than the average cost of production or just low enough to make entering not profitable. The quantity produced by the incumbent firm to act as a deterrent to entry is usually larger than would be optimal for a monopolist, but might still produce higher economic profits than would be earned under perfect competition.
The problem with limit pricing as a strategy is that once the entrant has entered the market, the quantity used as a threat to deter entry is no longer the incumbent firm's best response. This means that for limit pricing to be an effective deterrent to entry, the threat must in some way be made credible. A way to achieve this is for the incumbent firm to constrain itself to produce a certain quantity whether entry occurs or not. An example of this would be if the firm signed a union contract to employ a certain (high) level of labor for a long period of time. In this strategy price of the product becomes the limit according to budget.
Predatory pricing:
Predatory pricing, also known as aggressive pricing (also known as "undercutting"), intended to drive out competitors from a market. It is illegal in some countries.
Companies or firms that tend to get involved with the strategy of predatory pricing often have the goal to place restrictions or a barrier for other new businesses from entering the applicable market. It is an unethical act which contradicts anti–trust law, attempting to establish within the market a monopoly by the imposing Company. Predatory pricing mainly occurs during price competitions in the market as it is an easy way to obfuscate the unethical and illegal act. Using this strategy, in the short term consumers will benefit and be satisfied with lower cost products. In the long run, firms often will not benefit as this strategy will continue to be used by other businesses to undercut competitors margins, causing an increase in competition within the field and facilitating major losses. This strategy is dangerous as it could be destructive to a firm in terms of losses and even lead to complete business failure.
Price skimming:
Price skimming is a pricing strategy in which a marketer sets a relatively high initial price for a product or service at first, then lowers the price over time. It is a temporal version of price discrimination/yield management. It allows the firm to recover its sunk costs quickly before competition steps in and lowers the market price.
Penetration pricing:
Penetration pricing is a pricing strategy where the price of a product is initially set low to rapidly reach a wide fraction of the market and initiate word of mouth. The strategy works on the expectation that customers will switch to the new brand because of the lower price. Penetration pricing is most commonly associated with marketing objectives of enlarging market share and exploiting economies of scale or experience.
Other pricing strategies: https://en.wikipedia.org/wiki/Pricing_strategies#Models_of_pricing.
Preemption:
The incumbent can preempt an entry by
- (Over-) investing to reduce variable costs of production below the level that would be optimal without threat of entry
- Pursuing horizontal product differentiation with greater product variety than would be optimal without threat of entry
- Choosing locations of outlets more densely than would be optimal without threat of entry
Other strategies to deter new entrants: https://en.wikipedia.org/wiki/Strategic_entry_deterrence
- Basic Research - development of scientific knowledge that is applicable to wide range of potential uses.
- Applied Research - application of scientific knowledge to the solution of a specific problem, development of a new product or process.
- Product Development - identification of the relevant consumers, tailoring of the product / process to the needs of these consumers.
Results of Applied Research and Product development can be protected by patents or copyright.
- 100 consumers, 60 are willing to pay $500, 40 are willing to pay $400
- Production cost of 1 unit is $300
- Monopolist: Value of innovation $8,000 . Monopolist sets the price $500 and makes 60 * ($500 - $300) = $12,000, with innovation $400 is more profitable: 60 * ($400 - $200) = $12,000.
- Competitive market: Value of innovation $10,000. Everyone makes marginal profits, with innovation the innovator gets 100 * ~$100 = ~10,000.
- Monopolist with threat of entry:
- Value of innovation for monopolist $15,000. If new entrant innovates, the market will be split 50/50 and previous monopolist will be making 50 * ($400 - $300) = $5,000.
- Value of innovation for entrant $20,000. If new entrant innovates, the market will be split 50/50 and entrant will be making 50 * ($400 - $200) = $10,000.
From the above:
- Replacement Effect - for a given market structure, a monopolist has less incentive to innovate because of the higher level of pre-innovation profits.
- Efficiency Effect - under the threat of entry, a monopolist has higher incentives to innovate than a potential entrant into the market.
Sleeping patents - patents that prevent other firms to create similar products (example: Xerox).
Bertrand paradox describes a situation in which two firms reach a state of Nash equilibrium where both firms charge a price equal to marginal cost. The paradox is that in real life it doesn't happen i.e. firms make money. The explanation is that the assumptions used in the Bertrand model are not true in real life:
- Identical products: In reality, consumers have different taste and products are differentiated.
- Game played once: In reality, game has indefinite repetitions - cooperation is possible.
- Market transparency: In reality, imperfect market transparency.
- Infinite price elasticity: In reality, costs for consumers associated with switching seller (loyalty programs)
- No capacity constraints: In reality, companies have limited capacity (No incentive to induce a price war over the complete demand)
Vertical differentiation - given equal prices, every consumer would choose product A over product B (e.g. iPhones with different storage size).
Horizontal differentiation - given equal prices, some consumers would choose product A whereas others would choose product B (e.g. iPhones of different color).
Differentiation fixes Bertrand paradox - firms take different segments of the market and don't compete in prices.
Strategies of taking share of the market:
- Cost Leadership - low-cost relative to competitors as strategic main theme:
- Efficient-scale facilities
- Rigorous cost reductions from experience
- Avoidance of marginal customer accounts
- Cost minimization in areas like R&D, service, sales force and advertising
- Differentiation - differentiating the product or service, offering something that is perceived industry-wide
as being unique. Dimensions:
- Design or brand image
- Technology
- Customer service
- Dealer networks
- Focus - focus on particular buyer group, segment of the product line or geographic market. Central rationale: Serving narrow strategic target group more effectively or efficiently than competitors.
Acquiring new customers is more expensive than keeping old customers. Firms can invest in loyalty programs to lock-in customers and make it less appealing for them to switch to a competitor.
New suppliers can give "goodies" (discounts, free flights) to their customers to give the incentive to switch. Switching costs for customers include:
-
Risk that the new supplier is not a reliable replacement, E.g. uncertainty about qualification of new car repair center
-
Costs of exchanging suppliers, e.g. cost of moving apartment, administrative costs if "supplier" is an employee
-
Learning costs with new supplier
-
Loyalty programs and accumulated quantity discounts
-
Psychological "costs" through change of contact person, e.g. missing the friendly welcome at your favorite restaurant
-
Replacement of complementary goods for the product
-
When will a customer switch to a new supplier?
C <= U + G, where C - customer switching costs, U - utility increase from switching, G - switching "goody" from new supplier.
- How much should a new supplier invest to make a customer switch?
S <= P - G, where S - supplier's switching costs, P - profit increase from new customer, G - switching "goody" given to the new customer.
-
How can a supplier increase customer switching costs?
- Loyalty programs
- Long-term contracts
- Sale of complementary products
- Specific software / data formats
- Specific interfaces
- Close personal customer service
-
How can customers decrease their switching costs?
- Use anticipated switching costs to negotiate a price reduction before supplier lock-in
- Use a second supplier / second sourcing (e.g. IBM purchases processors from Intel and AMD)
Price discrimination: is the practice of transacting the same product at different prices to capture more market segments, e.g. set lower prices for students. Can be combined with product differentiation when different product versions have different price.
- 1st degree discrimination - different price for each consumer.
- 2nd degree discrimination - firms construct prices so that consumers "self-select". Types:
- Nonlinear pricing
- Versioning
- Bundling
- 3rd degree discrimination - firms observe consumer characteristics that allow them to infer WTP (willingness to pay) and price accordingly. Consumer characteristics can include geography, timing, job.
Product differentiation vs price discrimination:
Why competition is better than Monopoly:
Monopoly:
Competition:
- Competition forces firms to innovate, differentiate, value customers, produce efficiently, exert effort to improve their products.
- Cartelization allows firms to earn high profits at the expense of customers, reduce risks, ignore customers, produce inefficiently, seek monopoly rents.
A cartel is a group of apparently independent producers whose goal is to increase their collective profits by means of price fixing, limiting supply, or other restrictive practices. Cartels typically control selling prices, but some are organized to control the prices of purchased inputs.
Competition policy (EU) / Anti-Trust Policy (USA)
- Protects consumers and firms from the negative effects of cartelization
- Prevents rent seeking, encourages competition and thus raises efficiency and innovation
Instruments of Competition Policy:
- Ban on Cartels - banning agreements between competitors or contracts between suppliers and customers that restrict
competition.
- Example: Otis, Kone, Schindler and ThyssenKrupp rig bids for procurement contracts, allocate projects to each other, fix prices and exchange commercially important / confidential information in four European countries (1995-2004). Total fine by the European Commission: €992mn (2007)
- Abuse Control - banning abusive exploitation of a dominant market position or anti-competitive practices
that tend to lead to such a dominant position.
- Exclusive Dealing: Firm signs procurement contracts which forbid the other party to sell to / buy from competitors. Example: Petrol stations and petroleum suppliers.
- Tying: Firm makes the purchase of one product over which it has market power ("tying good") conditional on the purchase of a second, competitively supplied, product / service ("tied good"). Example: Apple iPhone exclusively available with AT&T mobile contract. Example: Microsoft dominates markets for operating systems. The operating system comes with the Microsoft Media Player. Microsoft provides competitors with poor information about software interfaces necessary to engineer smoothly working applications for Windows. European Commission fines Microsoft €497mn and forces the company to offer a version of Windows without Media Player.
- Bundling: Firm offers two or more products (it has market power over one) separately, but gives a discount to customers who purchase these as a combined bundle. Example: Popular song only in an album together with other titles available.
- Predatory Pricing: Firm sets prices at a level that implies losses in the short run in order to eliminate competitors and realize monopoly profits in the long run. Example: The Times / UK Newspaper Industry.
- Refusal to Supply / Margin Squeeze: Company refuses to supply competitors with essential inputs / sells these inputs for a price that destroys the competitors' margin.
- Merger Control - supervising the mergers of large corporations. Prohibiting such transactions that substantially weaken competition and lead to a dominant market position.
Herfindahl-Hirschman index (HHI-score) - a measure of the size of firms in relation to the industry and an indicator of the amount of competition among them.
A network effect is the effect that an additional user of a good or service has on the value of that product to others. When a network effect is present, the value of a product or service increases according to the number of others using it.
There are 2 kinds of network effects:
- Direct network effects: An increase in usage leads to a direct increase in value for other users.
For example, telephone systems and social networks all imply direct contact among users. A direct network effect is
called a same-side network effect. An example is online gamers who benefit from participation of other gamers.
- Telephony
- Telegram
- Indirect network effects: Increases in usage of one product or network spawn increases in the value of a
complementary product or network, which can in turn increase the value of the original.
Examples of complementary goods include software (such as an Office suite for operating systems)
and DVDs (for DVD players). This is why Windows and Linux might compete not just for users, but for software developers.
This is also called a cross-side network effect. Most two-sided markets (or platform-mediated markets) are
characterized by indirect network effects.
- Google AdSense (advertisers and bloggers) - the more blogs Google AdSense can reach, the more advertisers it will attract, making it the most attractive option for more blogs, and so on, making the network more valuable for all participants.
- Airbnb (hosts and guests)
- Uber (drivers and passengers)
- iOS (app publishers and users)
- Credit Cards (shops and consumers)
Characteristics of network industries:
- Positive consumption externalities.
- Critical mass and network size.
- Complementarity, compatibility and standards.
- Switching costs and lock-in (not exclusive to network markets but frequently found in them).
- Often asymmetric and concentrated market structures.
- Often significant economies of scale in production.
Two forces determine market structure in network markets:
- Network effects:
- Strong - Monopoly
- Medium - Niche Survival
- Weak - Many Firms
- Consumer Heterogeneity
- Low - Monopoly
- Medium - Niche Survival
- High - Many Firms
Economies of scale are are the cost advantages that enterprises obtain due to their scale of operation (typically measured by amount of output produced), with cost per unit of output decreasing with increasing scale. (In economics, "economies" is synonym to cost savings and "scale" is synonymous with quantity or the scale of production.)
Sources of economies of scale:
- Fixed costs - Certain inputs in the production process may not fall below a minimum. Increasing the volume of production spreads the fixed costs over more units
- Inventories - Firms carry inventory to avoid stock out. Bigger firms can afford to keep smaller inventories (relative to sales volume) compared with smaller firms because demand is less variable.
- The possibility of purchasing inputs at a lower per-unit cost when they are purchased in large quantities.
Economies of Scope are "efficiencies formed by variety, not volume". (In economics, "scope" is synonymous with broadening production through diversified products.)
Sources of economies of scope:
- Umbrella branding - New products are easier to introduce when there is an established brand with the desired image. If a firm's reputation is at stake across a wide range of products, this helps establish trust.
- Combined purchasing - Different products may partially require the same inputs. With a higher purchasing volume the price per unit decreases.
- Labour costs - Larger firms generally pay higher wages. Unionization is more likely in large firms. Employees may require lower pay in small firms because of more enjoyable work. Large firms may have to attract workers from further away places.
- Incentive and bureaucracy effects - When a firm gets large it is difficult to monitor and communicate with workers. It is difficult to evaluate and reward individual performance.
- Coordination and control - it is more difficult to coordinate and control a bigger firm.
- Conflicting out - Professional services firms may find it difficult to sign up a client if a competitor is already a client of the firm. When sensitive information has to be shared, such conflicts may impose a limit to the growth of the firm.
Reasons to buy:
- Exploit economies of scale
- Supplier can exploit economies of scale and learning curve effects by serving several downstream firms.
- Input good can be produced at lower unit costs.
- Example: Bosch produces brakes for BMW, Audi, etc. and has a higher volume than a BMW internal brake production unit would have.
- Transfer of fixed costs into variable costs
- With in-house production unit costs vary with output needed, with outside purchasing unit costs are always equal to the agreed price (independent of volume).
- Better risk allocation
- Supplier can spread the risk of change in production between several downstream firms (if their production is imperfectly correlated)
- Less bureaucracy and influence costs
- Disproportionately high costs of coordination, internal communication and enforcement of control in larger organizations
- High-powered incentives
- Independent suppliers have greater incentives to lower costs and be innovative because they appropriate the profits from these activities.
Reasons to make:
- Avoiding transaction costs (finding appropriate partners, specifying, monitoring and renegotiating contract)
- Coordination advantages - If strategic decisions at different stages of the value chain are highly interdependent, coordinating decisions across firm boundaries may become very costly.
- Smoother ex-post adjustment - When there is high uncertainty and contracts need to be adapted, this is less costly within a single firm.
- Avoid Hold-up - If relationship-specific investments are required, transaction costs are high due to "quasi-rents" from the investment.
Mergers and acquisitions (M&A) are transactions in which the ownership of companies, other business organizations, or their operating units are transferred or consolidated with other entities. As an aspect of strategic management, M&A can allow enterprises to grow or downsize, and change the nature of their business or competitive position.
From a legal point of view, a merger is a legal consolidation of two entities into one entity, whereas an acquisition occurs when one entity takes ownership of another entity's stock, equity interests or assets. From a commercial and economic point of view, both types of transactions generally result in the consolidation of assets and liabilities under one entity, and the distinction between a "merger" and an "acquisition" is less clear. A transaction legally structured as an acquisition may have the effect of placing one party's business under the indirect ownership of the other party's shareholders, while a transaction legally structured as a merger may give each party's shareholders partial ownership and control of the combined enterprise. A deal may be euphemistically called a merger of equals if both CEOs agree that joining together is in the best interest of both of their companies, while when the deal is unfriendly (that is, when the management of the target company opposes the deal) it may be regarded as an "acquisition".
Advantages of horizontal mergers for partners and buyers:
- Lowering competition
- Reducing the risk of becoming a target
- Gaining bargaining power
- Production advantages
- Realizing economies of scale and / or scope
- Securing access to new technologies
- Entering into new products
- Accessing new markets / customer groups
- Acquiring brand name / image
Advantages of vertical mergers for partners and buyers:
- Reduction of transaction costs
- Gaining control over upstream or downstream resources
- Raising barriers to entry
Advantages for the target:
- Solving financial problems
- Producing funds for investments
- Initiating company restructuring
- Securing exit (cash-out)
- Organizing succession (ownership / management)
- Solving disagreements among shareholders
Organic growth can be achieved by:
- Acquiring new customers and increasing the sales of existing products and services
- Introducing new products and services
- Moving into new (geographic) markets
- Diversification
In market penetration strategy, the organization tries to grow using its existing offerings (products and services) in existing markets. In other words, it tries to increase its market share in current market scenario.
In market development strategy, a firm tries to expand into new markets (geographies, countries etc.) using its existing offerings and also, with minimal product/services development.
In product development strategy, a company tries to create new products and services targeted at its existing markets to achieve growth. This involves extending the product range available to the firm's existing markets.
In diversification an organization tries to grow its market share by introducing new offerings in new markets. It is the most risky strategy because both product and market development is required.
- Lack of resources (product or factor markets)
- Capital
- Labor
- Natural resources
- Technologies and know-how (patents or non-disclosure agreements)
- Lack of opportunities / demand
- Fierce competition may be deterring entry
- Successful growth and expansion oftentimes requires a high degree of managerial skill, delicacy of feeling and imagination
- Limits to managerial ability
- Managerial diseconomies
- Structural misfit
- Uncertainty and risk
- Competitive Strategy: course on Coursera https://www.coursera.org/learn/competitive-strategy
- Advanced Competitive Strategy: course on Coursera https://www.coursera.org/learn/advanced-competitive-strategy