Strategic Management Study Guide Final 3v3u4b

`Strategic Management Study Guide Questions For Professor 1) Uber and Lyft a. Do they have CA’s? b. Are they sustainable? c. Two sided market? i. It is not clear right now, but if one gets a monopoly through this subsidization, one could develop d. How is it a two sided market? i. Winner take all 1. What are positive network effects, and who is the side with the high multihoming costs? Marginal costs may decrease You gain value from more s, and then more drivers, like a two sided market, so benefit off growth of both s. They benefit Is WTP higher than cost? Uber is right now loosing money Today is just the starting point, as WTP may be much higher but they want a monopoly It is not clear that they are creating value But we do not know Taxi market is regulated, it fails at some points, and rate is fixed Supply is fixed Questions for Tatiana 1) Industry facts from professor for Bergerac 2) Graph for impediment of CA Lecture 14: Game Theory: We use game theory as a tool to predict outcomes in situations where agents interact and affect each other’s’ payoffs with their choices. Decision problems with no interactions (single-agent optimization): 1. Consumer maximizing utility 2. Firm choosing inputs to minimize production cost 3. Monopolist choosing a price 4. Firms choosing quantity in a Perfectly Competitive market Problems with strategic interactions: 1. Coke deciding price of a can 2. Apple choosing features to add to iPhone 6 3. Verizon deciding whether to enter the Canadian wireless market 4. OPEC deciding the annual quota for its 5. Automaker choosing product positioning in the quality/price space and 6. portfolio 7. Market entry decisions 8. Company deciding bid for FM broadcast auction by FCC Strategic Thinking: Never assume that your opponent’s behavior is fixed. Key is to predict their reaction to your behavior. Elements of A Game: 1. Players are the decision makers 2. Actions are the moves available to each player 3. Strategies are all possible contingent plans for each player 4. Payoffs 5. Information structures 6. Timing of moves a. Simultaneous moves

7.

b. Sequential moves Nature of conflict a. Repeated b. Single-Shot Game

Assumptions About Game: 1. Rationality 2. Common Knowledge Nash Equilibrium: It is the set of strategies such that, holding the strategies of all other players constant, no player can obtain a higher payoff by choosing a different strategy. Dominant Strategies: strategy that produces a higher payoff than any other strategy the player can use for every possible combination of its rivals. Best Responses: strategy that maximizes a player’s payoff given its beliefs about its rivals’ strategies Eliminate dominated strategies first 1. If you can find a single solution using dominant strategies, this is a Nash Equilibrium (NE). 2. Not all Nash Equilibria can be found using the dominant strategies method Other considerations: 1. Multiple or unique NE. 2. Pure and mixed strategies. For N class, that the key is player 1 is first column using each row, and then player 2 is second column, using each column Watch youtube for good example: https://www.youtube.com/watch?v=6rs_EQpxTI4&nohtml5=False Dynamic Games:  Players might move sequentially, or one goes, then the next. 

A simultaneous-move game can be repeated over time

Strategy is a contingent plan of actions Normal-Form simultanous representation (matrix) hides timing features Use Extensive Form (tree diagram) when moves are sequential: 1. n players 2. sequence in which players make moves 3. actions they can take at each move 4. information each player has about all players previous moves 5. payoff function over all possible strategies

The key with sequential moves is you first figure out best move for American which is 96, then figure out what best move is for United as they have the next move (or after pink moment). Subgame: All decisions that players make subsequently are made given the actions already taken and the corresponding playoffs. The whole game is a subgame (so Sequential (SPNE) or sub game NE is a subset of NE) SPNE: Players’ strategies are a NE in every subgame Solve by backward induction: Select best responses in each node for last player to move. Then the player making next-to-last move.... SPNE needs to include “off the equilibrium path” strategies: qA = 96 for American and (qU = 64 if qA = 48, qU = 64 if qA = 64, qU = 48 if qA = 96) for United (dark blue lines in previous slide) SPNE is about credible threats. Note that AA doesn’t get the same equilibrium by simply “announcing” qA = 96 in the simultaneous game Commitments (irreversible actions) make incredible threats credible Commitments: In some games, a player can improve her outcome by taking an action that makes it impossible for her to take what would be her best action in the corresponding simultaneous-move game. Such actions are referred to as commitments, and they can serve as alternatives to external enforcement in games which would otherwise settle on Pareto-inefficient equilibria. Suppose you own a piece of land adjacent to mine, and I'd like to buy it so as to expand my lot. Unfortunately, you don't want to sell at the price I'm willing to pay. If we move simultaneously—you post a selling price and I independently give my agent an asking price—there will be no sale. So I might try to change your incentives by playing an opening move in which I announce that I'll build a putrid-smelling sewage disposal plant on my land beside yours unless you sell, thereby inducing you to lower your price. I've now turned this into a sequential-move game. However, this move so far changes nothing. If you refuse to sell in the face of my threat, it is then not in my interest to carry it out, because in damaging you I also damage myself. Since you know this you should ignore my threat. My threat is incredible, a case of cheap talk. I could make my threat credible by committing myself. For example, I could sign a contract with some farmers promising to supply them with treated sewage (fertilizer) from my plant, but including an escape clause in the contract releasing me from my obligation only if I can double my lot size and so put it to some other use. Now my

threat is credible: if you don't sell, I'm committed to building the sewage plant. Since you know this, you now have an incentive to sell me your land in order to escape its ruination. First mover has advantage Commitment is: 1. Hard to revert 2. Long-term impact 3. Must be a. Visible b. understandable c. credible Sometimes, best when inflexible, or tying your hands Firms use commitments strategically all the time Price Matching guarentees Investment in new technology Explicit contracts Changing The Game: From Incredible To Credible The Problem:

In this case threat not credible: If we all deliver late, our payoff is $72 (9/10*80k) , if we deliver on time its only $27. All deliver late is best option Number suppliers from 1 to 10, and say I refuse delivery from lowest numbered supplier who is late All delivering late is not an equilibrium. Supplier 1 delivers on time, better than nothing no matter what. Then 2 must as he knows 1 will The credible commitment changed game so that deliver on time is now best.

Entry Deterring Strategies

Exclusion contract example with our profit being 10-b with b being cost for exclusive contract F is the entry cost for the rival in the mall If F is greater than 4, then cost is too high and will choose not to enter, no need for exclusion deal. If F is less than 4 and B is less than 6 then we prefer to exclude entry as they make profit entering, and will want to, and B being less than 6 we are still profitable. If B>6 then and F is less than 4 then we do not pay and compete.

We make the investment because first 8,0 or 4,4 based on entry choice (second column in profit), then we want 8,0 as 8 is best option. Building extra capacity, or investment leads entrant not to enter as best choice. Capacity is credible commitment because post entry competition will lead to lower market prices, and for entrant to get crushed potentially.

Cartels: Are a group of firms that explicitly agree to coordinate activities 1.

They do this in of quantities, quality, and price

The legality: Collusion is largely illegal in the United States, Canada and most of the EU due to competition/antitrust law, but implicit collusion in the form of price leadership and tacit understandings still takes place. Examples: OPEC, Canadian Potash Exporters Why Do Cartels Fail? Incentives to cheat, at collusive levels, Marginal benefit is greater than marginal costs Detection and punishment Punishment increases long run marginal cost of a cheater. These include price wars, and side payments Punishment can take many forms, ranging from other sellers targeting price discounts at the offender’s customers, to cutting the offender’s allocated sales quota, all the way to suspending the cartel’s activities for some period. In almost all instances, however, punishment will be costly not only to the offender but also to the sellers who mete out the penalties.

Tit for tat: Corporation in round 1, set high price then, and then you copy what opponent did in t-1 In other words adopt your opponent strategy from previous round. Grim triggers: Start off high price, and then if opponent ever goes low once, you go low forever High prices could occur if discount rate is very low and firms are patient in infinity periods In finite periods, it is key to think about last period, cheating incentives, and unraveling.

Price leadership is an alternative cooperative method used to avoid tough competition. Under this method, usually one firm sets a price and the other firms follow. It is quite popular in industries like cigarette industry. Here any firm in the oligopolistic market can act as a price leader. The firm, which is highly efficient, and having low cost can be a price leader or the firm, which is dominant in the market acts as a leader. Whatever the case may be, the firm, which sets the price, is the price leader. We have two forms of price leadershipBarometric price leadership is said to be the simpler of the two. This normally occurs in the market where there is no dominant firm. The firm having a good reputation in the market usually sets the price. In dominant price leadership, the largest firm in the industry sets the price. If the small firms do not conform to the large firm, then the price war may take place due to which the small firms may not be able to survive in the market.

A Most-Favoured-Customer Clause (MFC) is a contractual arrangement between company and customer that guarantees the customer the best price the company gives to anyone. The MFC prevents a company from treating different customers differently in negotiations. If I go low as Firm 1 then I will have 30 more customers than firm 2, but owe 30 customers refunds from the last round making it not worth going low, as value is worse now compared to firm 2. It makes sure that you choose high high. As the next slide shows, MFCC is a promise to keep prices high. As next round, I will owe 30 customers refunds.

First example is not with MFCC, but second includes cost of refunds causing 60,60 to be optimal.

This exploits customer price awareness, sensitivity, and low switching costs which is what makes price competition so brutal.

Must be done by one party, you can match but not over-retaliated

Must keep competitive reactions private, and must have legit justification for price cuts, price increases, handling PR really well Clear pricing tactics with attorney.

LN 15 Sustaining Competitive Advantage Competitive advantage: Firm’s ability to outperform industry The CA is sustainable if it persists despite competitor’s efforts to duplicate it or neutralize it. Examples: Coca Cola, Walt Disney, BMW, Otis, Facebook Eroded ones: Apple (1997), Microsoft, Dell, and Sony

Reasons it is not easy to sustain CA: 1. 2. 3.

Market structure a. (Entry/internal rivalry can be problem) Imitation and innovation Changes to landscape

Perfectly Competitive Dynamic

The above lines are supply side. All firms move toward tangency with perfectly competitive market with costless imitation and free entry. Profits (ROA) will converge with cost of capital in this situation.

The line is supply side Dennis Muller Study found that low ROA and high ROA manufacturing firms, taking a study of 600, would move toward each other. Still high ROA and low ROA firms do not converge to a common mean.

Sustaining competitive advantages 1. 2.

Persistence in differences in resources/capabilities with competitors Isolating mechanisms a. Impediment to imitation b. Early mover advantage-ebay being the first auction process online

Sustaining requires some permanent entry barrier of some form. Entry deterring strategies: 1. 2. 3. 4. 5. 6.

Learning curve Advertising R&D patents Reputation Limit pricing Excess Capacity

Resource Based Theory Of The Firm The resource-based view (RBV) as a basis for the competitive advantage of a firm lies primarily in the application of a bundle of valuable tangible or intangible resources at the firm's disposal. To transform a short-run competitive advantage into a sustained competitive advantage requires that these resources are heterogeneous in nature and not perfectly mobile[ Example: Scarcity (in talented employees) Extra profits could go to resource owner unless… 1. 2.

Imperfect mobility (Customer loyalty to company not employees due to frequent flyer programs) Asset specificity (Landing slots in airline’s hub)

Rather, a competitive advantage is sustainable when the efforts by competitors to render the competitive advantage redundant have ceased (:[2] p102; Rumelt, 1984, p562). When the imitative actions have come to an end without disrupting the firm’s competitive advantage, the firm’s strategy can be called sustainable. This is in contrast to views of others (e.g., Porter) that a competitive advantage is sustained when it provides above-average returns in the long run. (1985).

A subsequent distinction, made by Amit & Schoemaker (1993), is that the encoming construct previously called "resources" can be divided into resources and capabilities.[4] In this respect, resources are tradable and non-specific to the firm, while capabilities are firm-specific and are used to engage the resources within the firm, such as implicit processes to transfer knowledge within the firm

Competitive forces can still neutralize CA based on special resources and capabilities Resource Based Theory of Barca

The players are these resources which serve as a CA. Even trying to imitate Barcelona, you won’t have similar players as these greats, and thus Barca can sustain winning, similar to Mickey Mouse

Imitating Dell Distinct Aspects include close integreation with suppliers, PC manufactured to order, direct sales, essentially no resellers. All of these lead to CA being sustained, even though distinct.

Isolating Mechanisms That Impede Loss of CA: 1) Impediments to imitation 1. 2. 3. 4.

Legal restrictions a. Airlines with regulations Superior access to inputs/customers Market size (less likely where markets are growing) and scale economies Intangible barriers (every company has different history, how operations are done

He made a graph, maybe Tatiana you have it 2) Early mover advantage 1. 2. 3. 4.

Learning curve Reputation Switching Costs Network Effects a. Gives advantage from demand side or from WTP not cost 1) Learning Curve Effects A firm that sells more in early periods moves farther down learning curve This leads to lower average cost than rivals and can undercut and sell more Think Pizza place lowering cost with efficiency like Dominos, or shipbuilders, leading to lower Average cost 2) Network Effects In economics and business, a network effect (also called network externality or demand-side economies of scale) is the effect that one of a good or service has on the value of that product to other people. When a network effect is present, the value of a product or service is dependent on the number of others using it.[1] The classic example is the telephone. The more people who own telephones, the more valuable the telephone is to each owner. This creates a positive externality because a may purchase a telephone without intending to create value for other s, but does so in any case. Online social networks work in the same way, with sites like Twitter and Facebook becoming more attractive as more s . Network goods offer opportunities to first movers WTP increases with installed base Actual network (physical link): meaning that actual connections (phone calls and messages) exist among s. Examples: Facebook, Telephone, Railroads Virtual Link:

Some goods make up a "virtual" network of s, meaning that although actual connections do not exist among s, virtual connections (eg, information and complementary goods shared among product s) do exist. Goods in virtual networks tend to experience indirect network effects. For example, consumers don't value the Microsoft operating system just because a great number of people use it. However, as more people use Windows®, more complementary goods become available (eg, software applications). Examples Computer OS, Video Game console, Keyboard No actual connection, but value added by more people using it Network goods evolve around standards Two key questions with this are: Should a firm compete for the market, or in the market? Is it possible to topple existing standard? Early mover disadvantages: Lack of complimentary assets (Apple Newton) Locked to inferior technologies (Wang with word processing earlier than others) Summary:  Resources and capabilities must be scarce and immobile to serve as basis of sustainable advantage  Isolating mechnaimsism prevent competitors duplicating or neutralizing CA  Barriers to imitation prevent competitors from matching firm’s value creation  Early mover advantages (learning curve, network effects, reputation) increase value creation spread in favor of firm with CA. Reading on CA: 1. Break a firm into discrete activities or processes 2. Step 1: Catalog Activities a. Breakdown value chain into primary activites that generate good servce, and i. included logisitics, sales, markets, etc. b. Then must be analyzed in of cost and WTP relative to competition 3. Step 2: Analyze Relative Costs a. Difference in cost lead to difference in profitability b. Figure out cost drivers: or what makes cost of activity rise and fall c. Allow managers to estimate competitors cost positions i. One can see competitors market share, portion of sales in certain areas, breath of product line d. Focus on difference in individual activities i. Focus on detail ii. Focus on areas where significant differences across competitors or strategic options iii. Large enough to effect cost position iv. Correspond to technically seperable activities v. Activiies with thicker slice of costs deserve deeprate attention vi. Should be modeled only if different than competitirs vii. Sensitivity analysis is crucial e. Pitfalls i. Financial ing overemphasizes manufacturing costs and poor job of allocating overhead and other indirect costs ii. Can confuse or mix one time and recurring costs 1. Look at comparables 4. Step 3: Willingness To Pay a. More for profitability than difference in cost levels b. Quality, performance, features, aesthetics affect WTP c. Most managers process

5.

6.

i. Who real buyer is ii. What does the buyer want iii. What are they willing to pay iv. How successful are competitos ar fulfilling customer needs v. Hard part: narrowing customers needs to small roster d. Horizontal differentiation: value products differently (I like non fiction you like novels) e. Vertical differentiation (customers agree on which product is better, buf dffer how much they will pay) i. Response is segmenetation of customers swho share preferences and analyze WTP of segmenet 1. Some even argue toward mass customization f. Limits: i. May be difficult to make precise 1. Market research tehchniques help quantify ii. Leary of those on new products or ones needs they do not even realize they have yet Step 4: Find ways to build wedge a. Consider competitor reactions, what drives competitors b. Most think about a product, but should think about full range of activities i. Draw not just ones value chain, but customers chain c. In rapid change, give bleeding ege customers special attention i. Yahoo giving sophisticated cs a test version d. One way to increase wedge is by increasing scope of operations either via vertical integration or horizontal Step 5: a. Finally go back to looking at the whole i. Many times must change activities in unision ii. Only so many choices, but a lot of interactaction of choices

LN 16 Husky Injection Molding Systems Husky’s Strategy: Ask Professor Husky Injection Molding Systems Ltd. is a supplier of machinery for injection moldingof plastics. The company was founded in 1953 by Robert Schad, a German immigrant toCanada. Husky was initially a small machine shop with no ties to the plastics industry.

Husky Strategy:

Differentiator as innovative products that operate more efficiently, leading to yearly cost savings. Furthermore fast, rugged, high performance, with total lifecycle costs rather than upfront acquisition cost (or for it) Price deserved due to 1) cost savings and 2) quality with lower variable bur pressure issues and blemishes.

Husky’s strategy is based on WTP wedge, as consumers save, leading to higher WTP.

Four areas they save are: 1) Purchasing expense 2) Resin per year 3) Electricity consumption per year 4) Factory rent per system per year

Consumers save over .14 million each year per machine. Plus you get few blemishes and less variable burst pressure so thus better quality This creates significant value compared to competitors.

Majority of savings are in the purchasing expense, as that is about .14 million per year. There was another $39,000 or so in savings from the other three.

You can perform a quantity relative WTP analysis for each. The cost savings make the injection molding systems worth the price they receive.

What caused Husky’s current crisis 1) Shortage of resin a.

PET resin makers underestimated demand by a wide margin leading prices to soar as not enough capacity i. Procesors simply could not obtain resin in some cases ii. Processors halted expansion and put equipment purchasing on hold

b.

58% of total cost (Exhibit 3)

c.

Demand for Husky products dropped

2) New entrants/competitors a.

Competitors entered, especially in PET business

b.

They have lower prices, even if lower expertise

3) Narrow range of products a.

70% of revenue from PET system business

4) Low production volume a.

Only 300 machines per year produced (unit costs fall at 500 machines or more

b.

Have not reached economies of scale to be able to go so cheap

How Could They Respond: 1.

Focus on Emerging markets/Asia a.

2.

3.

4.

Expanding economies and only 3.8% of revenue

Customer relationship management a.

Enhance sales team

b.

Convey the added value for why WTP should be higher

Cost side a.

Cost cutting such as relocation of all factories to Asia

b.

Buy out some of the parts companies supplied by few suppliers to lower cost

Diversify a.

What Happened

Go into new product lines so not as dependent on PET

They cust costs, cut 2 layers of hierarchy, decentralized decision making, and Asian expansion

Should have focused on WTP advantage due to cost savings by continuing to build R&D as well as conveying added value instead.

Questions to prep o

2.

1. What is Husky’s Strategy?



Incredible technology



Charge a price



Offer a full srvice

o

2. Are Husky injection molding systems worth the price the company charges? Can you perform a quantitative relative WTP analysis?

o

3. What has caused Husky’s current (1996) difficulties?



Misprediction of demand for resin



Entry of new player with similar technology at lower costs

Industry Structure Characteristics: 1.

Technologically progressive

2.

Cyclical industry

3.

Use of plastics is growing

4.

Large distribution of returns with industry

5.

But in general industry profits are low, though Husky has high ROE, which usually means high profits, and high CA.

6.

Are industry profits high? 1.

There is no representative producer

7.

2.

Mold - competitive

3.

Machine - less competitive

4.

In general, there are low profits

Is it possible to have CA in the industry?



Yes through differentiation in the form of efficiency, and talk about Husky ROE, elading to high profits, and WTP is higher. Though we do not know costs, we know WTP higher, and ROE high, which means WTP higher.



Or we could argue we do not know costs, as WTP is higher. We can make an inference or say we do not know.

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Processors (car makers, food packaging, cellphone – downstream manufacturers – are heterogeneous (some may care about quality, some may care about prices)) buy equipment from manufacturers like Husky to convert resin into products

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

Machine Business

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Consolidated

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Barriers to entry (reputation, dedicated factory, MES 500 machines/year)

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Buyers: processors (price sensitive, low switching costs, contract through bidding)

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Suppliers (Steel, hydraulic controls)

Mold Business

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Fragmented (small shops)

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No barriers to entry

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Suppliers (skilled labor – black art)

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Hot Runners

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Robotics

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Value added Services o

Processors buy equipment from manufacturers like Husky to convert resin into products



Machine business



Mold business



Hot Runners



Robotics



Value added services o

They have injection model systems

o

Industry characteristics

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Technologically progressive industry: many production processes, many product classes and heterogeneity in buyers



Cyclical industry – depends in the price of resin which depends in the price of oil 

Since they are not diversified, they are vulnerable to bankruptcy in the downturns



Use of plastic is growing



Large distribution of returns within the industry 

There is room for differentiation and some players can make a lot of profits like Husky o

Use resin that will become plastic inject into the mold, keep under pressure, cool down and make the product



Some companies only do this (need machines to work and have products at low cost and always available)



Machine to inject resin into the mold o

Husky does the machine and the mold



They help customers design the entire system

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Custom based solution



They have higher value added than competitors

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They are not the biggest player, but have good reputation and and make the best product



PET Packaging, containers and clusters

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They are not concerned about the current situation, but rather about the future



The profitability right now is high 

Husky Positioning o

Is Husky different from the competitors? What are the differences?

Yes as they have a product with faster cycle times, and more operating hours per day leading to savings over time for customer even with higher acquisition cost.

They have higher quality, with lower blemishes and variable burst pressure issues.



Husky serves customers that need unusually heavily engineered product and global



They have better products (faster cycle times, more hours operating per day)



Good reputation



Services that fix machines very quick

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Conscious about how clean their facilities have to be

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They have very important values

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They have a great sales force (internally run, they know the products and are more educated)





It is more decentralized, so regional managers have more control



Technical background, products are custom made

Production of molds

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Very mechanised

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Opposite of how they produce machines

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They are very efficient



Can enjoy economies of scale

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1. Operations - assembly of customized machines in job shop setting, mold operations are automated

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2. Sales and Services - employ representatives globally, same general managers that rotate between sales and services so they can learn the technical skills and really understand the product



3. Technology Development - investment leader at AMC



4. Procurement



WTP Calculation o

What is the most a company can charge and still make a sale?

o

Understand each consumer's economics: identify relevant customer costs

o

Calculate dollar value of savings associated with each category

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Capital Savings



Energy Savings

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Resin used per year



Plant Savings o

Does Husky have a cost advantage or disadvantage?

o

When there are more than 2 products, it is influenced by the second based alternative

o





WTP Calculations: PET preforms o

How many preforms a year can Husky and rival systems produce?

o

Cycle time is lower, you can make more units

o

You can save on electricity

o

You will save on space used for the factory

o

Less resin, hence it is less costly

o

Less blemishes, hence product is better and there are less variability

WTP Calculations Thinwall System o



*** The customer who wants to produce at max capacity should buy a Husky system

Variables: cost of resin, assumptions that you will produce at full capacity to take advantage of the capital savings, cost of capital and the time period for the NPV

Success in 1995 and challenges ahead o

Husky has carved an attractive niche in a competitive industry: selling to customer WTP for high performance injection molding systems, is in the PET industry which is the most profitable

o

Price s is ed by system of tailored activities

o

Husky is likely to create value (Husky’s products increase WTP more than the potential higher cost)

o

CRISIS



PET resin shortage



Entry by large players 

What happened? o

Large investment to become leader in the injection molding industry

o

New lines for small tonnage to large tonnage machines to expand customer and market scope

o

Exit mold business (except PET preform molds)

o

New campus in Vermont

o

Factory to produce components in Bolton

o

Drop in prices

o

IPO in 1998

Lecture 17: Scope of Corporation WTP for product X is cost of purchasing second best alternative+savings if X is used instead 1.

Overview a. The Strategy Statement i. Have a Long term strategy ii. Define the scope iii. Define which competitive advantages you will achieve and sustain iv. Present logic for 1, 2, 3 b.

2.

3. 4. 5. 6. 7. 8.

Verticals scope (Bergerac): involve in activities further downstream or upstream in the product line i. How should we perform those activities? c. Horizontal Scope (Disney): firm expand into new products or services i. Products and services a firm chooses to offer ii. Diversification Organizing the vertical chain a. What should be the breath of the firm? b. What are some activities outsourced and others produced in house? c. Why do we observe different arrangements for firms that operate in the same industry? Fully integrated: Shell, Chevron, Exxon Upstream Only: PVSDA Refiner/Retailer: Tesoro, Valero Jobbers (wholesalers: Kiethco Retailers: Costco Make or Buy? a. Reasons to buy: Technical Efficiency i. Patents and Proprietary information ii. Demand aggregators iii. Agency cost and market discipline iv. Pay another firms v. More efficient vi. Diseconomies of scale vii. Our technical product costs are higher b. Reasons to make: Agency Efficiency i. Coordination Costs ii. Reluctance of partners to develop and share private information iii. Transaction costs iv. Other 1. Market development 2. Tax and regulators 3. VI might allow price discrimination

v. To expensive for us to acquire, the costs are less than the negotiating costs Virtual corporation: limit case in which each element in the vertical chain is produced independently Explain what this means Transaction costs and contracts a. Real life contracts are incomplete b. Incomplete contracts incite opportunistic behavior c. The hold up problem i. The hold-up problem is a situation where two parties may be able to work most efficiently by cooperating, but refrain from doing so due to concerns that they may give the other party increased bargaining power, and thereby reduce their own profits. 1. It is often argued that the possibility of a hold-up can lead Fisher Body had an exclusive contract with General Motors (GM) to supply car body parts and, therefore, Fisher Body was the only company to deliver the components according to GM’s specifications. In 1920, a sharp increase in demand occurred that was above expectations. It is claimed that Fisher Body used this unforeseen situation to hold up GM by increasing the price for the additional parts produced. It has been said that this hold up led to GM acquiring Fisher Body in 1926underinvestment in relation-specific investment, and, hence, inefficiency. a. Would be beneficial for Adobe to work with Apple, but inefficiency as slow to adept due to bargaining power concerns ii. Inefficient outcome iii. If the investment by one player is more important in value creation, vertical integration is preferred c.

9.

Coal Mine Example: 1. Long term contracts rather than vertical integration 2. Complex, and long term 3. Mine-mouths are more likely to vertically integrate 4. Even with changing conditions, breach, and renegotiation, contracts survived The Vertical Integration Trade off 1. Vertical integration is an arrangement in which the supply chain of a company is owned by that company. Usually each member of the supply chain produces a different product or (market-specific) service, and the products combine to satisfy a common need. a. A company exhibits backward vertical integration when it controlssubsidiaries that produce some of the inputs used in the production of its products. For example, an automobile company may own a tire company, aglass company, and a metal company. i. Apple has used the vertical integration strategy for 35 years and is one of the most successful companies in the smartphone and computer industries. Large companies such as Apple are more likely than smaller companies to employ vertical integration, as they have more resources to manage each stage of production (e.g. major expansion and funding). Implementing a vertically integrated strategy has helped Apple become a leading platform company; integrating their software (through APIs for third-party application developers) with their own hardware, ii. In order to increase profits and gain more market share, Alibaba, a Chinese-based company, full use of vertical integration makes it more than an e-commerce stage. Alibaba has built its leadership in the market by gradually acquiring complementary companies in a variety of industries including delivery and payments It is contrasted with horizontal integration, wherein a company produces several items which are related to oneanother.

d.

e. f.

Technical efficiency (buy): market minus hierarchy i. Always more efficient for someone to make it ii. The more specific the asset is to us, the stronger the incentive for is to make it but makes more sense to outsource due to economies of scale Agency efficiency (make): market minus hierarchy i. Cost of getting a good deal ii. Cost of finding a good supplier and negotiating K is the degree of asset specificity → to produce X, how refined and specific is it to produce? i. The more specific an asset, the lower its potential resale value or redeployability. Companies may be reluctant to invest in such assets in a poor or uncertain economy. When a company purchases a highly specific asset, this purchase is considered a sunk cost, since the asset will likely not be saleable or useable for purposes other than its intended purchase. ii. Asset specificity is usually defined as the extent to which the investments made to a particular transaction have a higher value to that transaction than they would have if they were redeployed for any other purpose. Williamson (1975, 1985, 1986) argued that transaction-specific assets are non-redeployable physical and human investments that are specialized and unique to a task. For example the production of a certain component may require investment in specialized equipment, the distribution of a certain product may necessitate unique physical facilities, or the delivery of a certain

service may be predicated on the existence of an uncommon set of professional knowhow and skills. g. The more asset specific, the lower the effect of demand aggregation a firm has i. In the absence of specific assets, there is no constraint on demand aggregation and this gives external production a considerable edge in achieving lower production costs. However, as technologies become more specific, the aggregation of demands from different firms generates fewer savings. 3 h. Defining AC as the unit production cost difference for a given demand by the downstream firm, i. Only looking at agency costs, there comes a point where it is more efficient to produce in house j. These change with the type of input that we are looking at k. This represents the make or buy decision l. Figure out why large firms are more vertically integrated than smaller firms i. Large companies such as Apple are more likely than smaller companies to employ vertical integration, as they have more resources to manage each stage of production (e.g. major expansion and funding). ii. Further asset specificity or k at larger firms is more likely leading C to increase and thus greater reason for VI 1. Think opposite in which asset specificity is lower, so commodity, better to go out to market, then asset is super specific with larger firm 10. Make or buy fallacies a. Firm should make rather than buy assets that provide CA b. Outsourcing an activity eliminates the cost of that activity c. Backward integration captures the profit margin of the supplier d. Backward integration insures against the risk of high input prices e. Tie up distribution channel to deny access to rivals 11. Alternatives to VI a. Control over specialized assets i. Can use independent body part suppliers but own a specific machines business b. Tapered integration (mix of vertical integration and market exhange) i. Major oil refiners have own service station, and sell through independent c. Implicit contracts d. t ventures and strategic alliances 12. Summary make or buy a. If outside has more expertise, relationship specific assets, or do not want private infor leakage, use market i. If above but detailed contract is feasible and common ownership needed to mitigate contracting problems 1. Vertical ii. If supplers not more expertise and intermediate arrangement doesn’t suffice, 1. Vertical iii. If supplers not more expertise but intermediate works 1. JV, alliance 13. Horizontal scope: Efficiency Based ON Diversification Horizontal integration is the process of a company increasing production of goods or services at the same part of the supply chain. A company may do this via internal expansion, acquisition or merger. a. Benefits of horizontal integration to both the firm and society may include economies of scale and economies of scope. Economies of scope are "efficiencies wrought by variety, not volume" (the latter concept is "economies of scale"). a. Economies of scope make product diversification efficient if they are based on the common and recurrent use of proprietary know-how or on an indivisible physical asset.[5] For example, as the number of products promoted is increased, more people can be reached per unit of money spent.

Increased economies of scope by sharing resources, economies of scale by selling more of same product, increased market power with suppliers or downstream channels, reduction in cost of international trade potentially One of the clearest examples of horizontal integration is Facebook's acquisition of Instagram in 2012 for a reported $1 billion. Both Facebook and Instagram operated in the same industry and were in similar production stages in regard to their photo-sharing services. Facebook, looking to strengthen its position in the social media and social sharing space, saw the acquisition of Instagram as an opportunity to grow its market share, increase its product line, reduce competition and access potential new markets. b. Expand into new business units only if the value under one roof is larger than independent c. Business units should be compatible with corporate structure, system and processes 14. Efficiency based diversification a. Economies of scale/scope i. Umbrella branding ii. Transfer of organizational capabilities iii. Benefits and bundling for buyers iv. Externalities in pricing complementary products: benefit of WTP of Mickey Mouse toy under Disney brand without cost increase b. Economizing transaction costs: c. Internalizing Capital Markets: Choose right businesses i. BCG Growth/share paradigm

15.

16.

17.

18.

1. ii. Shareholder diversification iii. Undervalued firms d. Efficiecny based diversification i. Berkshire with Sante Fe Railroad ii. Facebook with Instagram Diversification and long term performance a. Valuation studies i. It may destroy value given that they cannot be managed within the corporate structure b. Event studies Why to outsource a. Because the firm does not possess the resources to be a success in those businesses b. Virtual corporation c. Cost effectiveness d. Geographic proximity to main markets e. Risk diversification f. Resource management Why do companies off shore a. Gain a competitive advantage b. Lower labor reducing unit costs in the value chain c. To access highly skilled labor d. Leverage cost advantages Which activities should be performed and how? a. Multiple dimensions of scope

i. Graph with x as horizontal, y as vertical, linear line as geographic b. Given that is what we do, how should we do it? 19. Financial case a. istrative costs are less than the negotiating ones to get what you want b. Consider the opportunity cost 20. Strategic case a. Enhance the competitive advantage b. Is it sustainable? 21. Synergies a. Business to business linkage to produce a combined effect greater than the sum of their separate effects b. How do they create value? i. Cost reduction through enhanced manufacturing efficiencies consolidated of overhead and increased economies of scale ii. Improvement of mgmt decision making iii. Horizontal Scope 1. Corporation possesses a resources that contributed to competitive advantage in the new business 2.

Scope of Corporation Reading

When there are scope economies between the existing portfolio of businesses and the new business

The Scope of the Corporation Reading 1. Three dimensions a firm can expand on a. Geography, Vertical (value chain), and product/customer (horizontal) 2. Two questions to ask a. Economies of scope: value created by competing in that market b. Organizational scope: Why should it be done inside the firm and not through contractual arrangement 3. May need to vertically integrate in aspects it is not per se creating value but to ensure profits for original business a. Hotels for instance not franchising as it can lead to under investment and loss of brand 4. Horizontal integration a. Economic value can be created in this from two ways i. Company resource creates competitive advantage in new business 1. Pepsi’s marketing group or Apple marketing for Beats ii. Scope economies between portfolio business and new business 1. Economies of scope is an economic theory stating that the average total cost of production decreases as a result of increasing the number of different goods produced. iii. Another consideration 1. Whether or not it can be managed by corporate structures and systems b. Resources i. Need to look at specificity and disegration to be able to quantitatively demonstrate competitive superirority of company’s resource on new business ii. Will resource really be critical source of success for new business 1. Like toys, General Mills knows needs of people, but enough to be key to success of toy business iii. Can the corporation deply and mobilize resources in new business 1. Mark and Spencer good in UK, but bad in Europe, can they really deploy supply chain resources and reputational resource for new businesss then. iv. Third depends on chosen strategy

1.

5.

Frig business would not do well in low cost refrigerators if they are focused on high end products v. Reverse linkage of starting new business leading to resource upgrade c. Businesses i. Scope economies from business to business linkage, or exploiting synergy 1. Key is to ask whether better off in market A by being in market B a. Disney is better having theme parks, as it further cements people into characters, which help B i. Increases WTP of people for toys as well 2. Can be rational to expand scope into business it looses value in, if benefits overall corporation a. Example is Japanese firms willing to loose in U.S for decades, because competitive impact on US firms justified invesmtnet 3. Can only consider scope strategy as business as a whole across all markets 4. Mutual forbearance argument a. Though controversial company wont compete with another in one market in fear of rivalry in other markets d. Organizational Structure, System, and Proceses i. Does not imply have to be same systems for all businesses 1. Good corporate strategy can differentiate among businesses ii. There is a fit requirement in of control versus decentralization, how resources deployed, etc. 1. Saatchi and Saatchi imposed budging systems on ad agencies with enourmous detrimental results 2. Once corproration structures itself a certain way, it is difficult to control, and employ resources in another way iii. Managers accumulate knowledge and way to run one type of undustry and if asked to do one completely different can struggle or take a while to learn it Vertical Integration a. First figure out if the area is a source of rent i. Should not commit to business with no retun on capital 1. Why commit capital to trucking business as a concrete player, if trucking business does not have abnormal returns ii. Even with returns, only integrate if firm can be successful in that field b. Thus should only direcly involve resources that provide firm competitive advantage for their strategy i. Sulzer differentiation was design, not manufacturing 1. So it focused on that area of differentiation and though 10% of cost of engine was them, they got nearly all profits c. Virtual corporation is the epitome of this i. Nearly all the profits, with few costs d. Issue is when valuable resources at multiple stages of value chain i. Example is biotech have technolocial resource and pharmacy have marketing channel resource ii. Each has resource whose value is only realized when the two are combined iii. Thus you see many pharma buying biotech, or establishing JV/contracts e. Transaction costs i. Costs such as monitering, bonding, and enforcement of of contracts 1. When risk one firm will hold up another, or demanding incease/decrease of price ii. Classic example is GM and Fischer which I went through already iii. TC conditions 1. Durability a. Requires continuity of transaction, auction would not have high transaction costs 2. Assset specifcicty a. If asset specific then there is high transaction costs

3.

6.

7. 8.

Uncertainty a. Uncertainty in industry can cause transaction costs 4. Frequency iv. All of this leads that when transaction costs are too high internalization VI makes sense f. Agency Costs i. Person acts in his bet interest, rather than principal (or business) ii. Most costly when employee critical to firm’s performance Start from scratch or buy a. Starting from scratch i. All profits to firm ii. Integrated to firm with corporate culture iii. Bad 1. Can be slow 2. Can fail b. Acquisition i. Loose some money from acquisition paid ii. Pros is it is fast, and immediate access to resources Divest businesses a. Few willing b. Few show ability to restructure portfolio of business without pressure Figure 6 in the case a. With business scope, internal organization costs go up, resource value goes down i. Finally transaction costs indenepdent b. As coordination intensity increases, more internal governance costs occur, and thus a more narrow scope

Lecture 18 Bergerac Case Need notes for industry facts 1. Bergerac's net income/sales in 2007 = 9% 2. Growing market demand 3. Competitive and fragmented upstream market of plastic suppliers (p.5) 4. Volatility in petrochemical industry affected supply of cartridge omponents by GenieTech and Elsinore [ Husky case?] 5. Razor-blades pricing model Company had choice to buy Genietch for $5.75 million or to build in house Industry facts: 1. Vet spending grown at 78% er year over the last decase 2. Increased WTP by pet owner due to pet humanization 3. Supply side growth of sophisticated vet care 4. In-house lab equipment adoption o No longer needed days for test results on many things o Especially helpful for critical care o Only 40% have adopted in house allowing for huge growth pipeline 5. Projecting 8-10% annual growth Competitor Facts 1. Four main players o Idexx  Industry leader  Largest installed base of diagnostic equipment  Sticky customer relationships  Famous for one product that is good for high volume practices

o o o

Abaxis  Comparable to Idexx but slightly more cost effective and easier to use Heska  Lower end in quality and less innovative Bergerac  friendly, required no training  Price point below Abaxis, giving a lower cost per use choice  Gained traction among vets

CA? 1. 2. 3.

Cost are lower than competitor causing potential wedge But you do not know WTP of the business I would say do not know

Based on the business challenges described in the case, should Bergerac integrate backward into the manufacture of plastic cartridge components? If so, then how? What is the economic and strategic case for the recommendation? Economics Build a model based on: 1. Cartridge demand grows at 10% per year 2. Labor and overhead costs increase proportionatally with machinery 3. Labor cost also increase at 3% per year 4. GenieTech price of $2.96 would not increase, and price charged to other customers 5. How much is sold does not affect labor and overhead Model Annual demand Production capacity Machines required Excess capacity Sale price per unit Revenue Expenses Incremental profits with selling NPV is positive and better off which means economically a good purchase. Lesser model is the same without selling off excess capacity Qualitatively Does not make sense 1. Diseconomies of scale o Can they maintain economies of scale with the aquisitioon 2. Diseconomies of scope o Managing the new business distracts sources from core business 3. Development of capabilities o Will they be able to retain employees post acquisition 4. Lack of flexibility o How quickly can Bergerac adjust to product design changes? 5. Incentive problems o Without implicit threat of losing a contract, will fabricators still maintain effort 6. Counpounded risk o Transition difficulties could cause even more delays? 7. Integration risk

o Will integration of Genietech employees to Bergerac systems be smooth Pros: Genietech has a core competence in plastic injection molding Flexibility to experiment with producing new diagnostics technologies Cons: Distract management from core business/product development Redundancy in overhead Opportunity cost of $5.75 million Strategic Recommendation Cartridge sales depend on analyzer sales, so invest $5 million in core business Specifically 1. New product development 2. More sales/service employees 3. Financial hedging against oil price shocks Develop comprehensive sourcing strategy 1. Increase leaverage with suppliers for better quality and or price by expanding supplier base o new entrants 2. Experiement with one in house machines press o Make backward integregation issues o Produce more accurate in house estimates More from case: Lecture 19 Disney Case Lecture 20: Two Sided Markets Two-sided markets Two-sided markets, also called two-sided networks, are economic platforms having two distinct groups that provide each other with network benefits. The organization that creates value primarily by enabling direct interactions between two (or more) distinct types of d customers is called a multi-sided platform (MSP).[1]

Two-sided networks can be found in many industries, sharing the space with traditional product and service offerings. Example markets include credit cards (composed of cardholders and merchants);HMOs (patients and doctors); operating systems (end-s and developers); yellow pages (rs and consumers); video-game consoles (gamers and game developers); recruitment sites (job seekers and recruiters); search engines (rs and s); and communication networks, such as the Internet. Examples of well known companies employing two-sided markets include such organizations as American Express (credit cards), eBay (marketplace), Taobao (marketplace in China), Facebook(social medium), Mall of America (shopping mall), Match.com (dating platform), Monster.com(recruitment platform), Sony (game consoles), Google (search engine) and others. Benefits to each group exhibit demand economies of scale. Consumers, for example, prefer credit cards honored by more merchants, while merchants prefer cards carried by more consumers. Two-sided markets are particularly useful for analyzing the chicken-and-egg problem of standards battles, such as the competition between VHS and Beta.

1. Differences with traditional markets 2. Strategies for platforms 3. Sustainability of competitive advantage

New Lingo: Cross-sided network effects A two-sided network typically has two distinct groups. of at least one group exhibit a preference regarding the number of s in the other group; these are called cross-side network effects. Each group’s may also have preferences regarding the number of s in their own group; these are called same-side network effects. Cross-side network effects are usually positive, but can be negative (as with consumer reactions to advertising). Same-side network effects may be either positive (e.g., the benefit from swapping video games with more peers) or negative (e.g., the desire to exclude direct rivals from an online business-to-business marketplace). For example, in marketplaces such as eBay or Taobao,[8] buyers and sellers are the two groups. Buyers prefer a large number of sellers, and, meanwhile, sellers prefer a large number of buyers, such that the in one group can easily find their trading partners from the other group. Therefore, the cross-side network effect is positive. On the other hand, a large number of sellers mean severe competition among sellers. Therefore, the same-side network effect is negative.

Subsidy side vs. Money side Typically platforms end up charging one side (the Money side) and subsidizing the other. WTA dynamics Envelopment Platform envelopment refers to one platform provider moving into another one's market, combining its own functionality with the target's, to form a multi-platform bundle.[1] The markets which evolve rapidly are rich in enveloping opportunities and the companies in these markets are under the continuous threat of becoming obsolete. Mobile phones used to be a separate market but the boundaries between them and music players are beginning to blur. Envelopment of Complements A network market consists of several players operating in various adjacent layers. In this kind of attack a player tries to gain a dominant position in the adjacent layer by bundling the services the adjacent layer player provides in its own offerings. Envelopment of Weak Substitutes[

Price a person is willing to pay for a bundle consisting of two perfect substitutes will be the one which he uses either of them and hence there would be no value for a firm to envelope a platform which acts as a perfect substitute for its own offering. However, there is a value to be created when we have in question a set of weak substitutes. Envelopment of Unrelated Platforms The platforms previously meant for a different usage begin to converge as the common set of s begin to rise. Such is the case with mobile phones and video game devices which were used for distinct purposes but the digital platforms available today have converged all such usages into one.

Some networks derive most of their value from a single class of s. An example of this kind of network is instant messaging (IM). While there might be some add-ons for the most popular IM tools, they don’t influence most s’ choice of an IM system. But some markets are comprised of two distinct categories of network participant. Consider video games. People buy a video game console largely based on the number of really great games available for the system. Software developers write games based on their ability to reach the greatest number of paying customers, and so they’re most likely to write for the most popular consoles, first. Economists would call this kind of network a two-sided market (network markets comprised of two distinct categories of participant, both of which that are needed to deliver value for the network to work). When an increase in the number of s on one side of the market (say console owners) creates a rise in the other side (software developers), that’s called a cross-side exchange benefit.

Cross sideded network effects , WTP, and dynamics A two sided market or mult-sided Value of platform to from one side is a function of a number of s on the other side Different from one sided network effect (network goods) Examples of two sided platforms Architecture+Rules Architecture: product design and infrastructure Rules: of engagement and pricing DVD Consumers and Studios Online recruitment Job seekers and employers We search: Side 1: Searchers Side 2: rs DVD Side 1: Consumers Side 2: Studios

WTP increased as platform size increases (both sides with architecture+platform)

Revenue can come from any side Installed based and tilting There may be tilting between Pricing is key to generate key dynamic

Pricing Subsidy side vs. Money Side Not so relevant in shared platforms (less competition for the market) Who should be subsidized more? 1. 2. 3.

Price sensitivity side Side that demands high quality Side with no variable cost of serving

Negative same side effects A negative same-side network effect appears when there is competition between suppliers in an online auction market or competition for dates on Match.com. Marquee s: Exceptionally big buyers or high profile suppliers Especially important for attracting participants to the other side of the network. A platform provider can accelerate its growth if it can secure the exclusive participation of marquee s in the form of a commitment from them not to rival platforms. However, it can be expensive, especially for small platforms, to convince marquee s to forfeit opportunities in other networks. Also, when the participation of a few large s is crucial for mobilizing a network, conflict over the division of value between platform providers and large s is common. Winner Take All Battles Is the market a “natural monopoly” (Multi-homing costs)* (strong cross-side and positive network effects) Cost of s to adopt more than one platform, so Uber and Lyft, or two credit credit cards, costs are very low The higher the cost of the network the more likely only one will survive Same side positive network effects Relatiely similar preferences Examples: DVD High multi-homing costs and strong cross side and positive network effects Bet the company decision Fight for proprietary control

Or being willing to share platform

The threat of envelopment Good pricing and WTA management are needed but not sufficient Envelopment by adjacent platform Envelopment Platform envelopment refers to one platform provider moving into another one's market, combining its own functionality with the target's, to form a multi-platform bundle.[1] Microsoft, for example, launched an envelopment attack against RealNetworks (Real), the dominant streaming media platform with more than 90% market share in1998. Real had invented the technology and successfully harnessed "two-sided" network effects (Rochet & Tirole, 2003; Parker & Van Alstyne, 2005) by giving away free versions of its media player to end s and charging audio/video content providers for server software. Like Real, Microsoft freely supplied its Windows Media player (WMP) to consumers, bundling WMP into its Windows operating system for personal computers. Microsoft also bundled WMP server software, at no additional cost, as a standard feature of Windows NT server, an operating system for enterprise customers, including contentproviders. WMP offered no major functional improvements over Real’s software yet bases heavily overlapped (see Figure 1). Consumers and content providers foundMicrosoft’s operating system bundles appealing and Real rapidly lost market share. Focused platform are at risk Multi-platform bundle can hurt stand-alone platforms Reaction of stand alone platform: Sell, change, find a big brother, or exit

Uber and Lyft How is the value created? Marginal costs may decrease You gain value from more s, and then more drivers, like a two sided market, so benefit off growth of both s. They benefit Is WTP higher than cost? Uber is right now loosing money Today is just the starting point, as WTP may be much higher but they want a monopoly It is not clear that they are creating value But we do not know Taxi market is regulated, it fails at some points, and rate is fixed Supply is fixed Strategies For Two-Sided Networks 1.

Two sided markets

Companies that make money by linking markets from different sides of the customer network  Uber: People and Drivers  Newspaper: Readers and rs  Online recruitment: Job seekers and employees  Video games; Players developers  Wifi: Latop and access points Platforms o Products and services that bring together groups of s Two sided vs. traditional o Traditional you have revenue on left and costs on right  Think grocery store o In two sided  Revenue and costs on both left and right  Driver has costs and revenue  has costs  They are linked together through Uber Platform value comes from value given to on the other side Sucessful platforms enjoy increasing returns to scale o Margins improve as bases grow o In traditional businesses, growth beyond a certain point leads to diminishing returns o Sucessful platforms can use leverage for RD, lower prices, and drive out weaker rivals Usually dominated by a large players like credit card companies Yet they have struggled to sustain two sided networks o Even if vanquish their peers, there may be threat from adjasent market business Pricing and Platform o Normal pricing is determined largely by MC of production  WTP is ceiling, for those with barriers to entry, and margins fat o In this case there is the subsidy and money side  Money side (think video game designers) pay more than it would in independent market  Subsidy side (think players) pay less for console and games  Challenge is how much of each for each player o Not always obvious who should be the money or subsidty side o Should look at following factors  Ability to capture cross-side network effects  Your giveaway will be useless if subsidy side can transact on rival platform providers money side  Example is Netscape subsidized to s 1. However web site operators didn’t need to buy their servers for data, could buy rival’s web service instead  sensitivity to price  Should subsidize price sensitive side  Example is Adobe subsidizes reader, charges writer a good amount  If readers charged, probably dead business  sensitive to quality  Should charge the side that must supply quality (video game maker) not the demander  Royalty in gaming helps weed out crappy games  Output costs  Easy when each new does not cost platform company essentially anything  Hard when giveaway from platform has costs  Free PC got killed giving away PC’s in return for ads  Same side network effects o

2. 3.

4. 5.

6. 7. 8.

Sometimes worth not including certain s In face of negative same side network effects, too much of one  Should consider granting exclusive right to a singer in each transaction category 1. Like online car buying service attached to one single dealer  ’s brand value  Sometimes marque s can help attract important partcipants  Like big buyers like U.S government  Or maybe high profile suppliers, like anchor stores in malls  Can accelerate growth by getting exclusive participation  Can be expensive to do so Winner Take All Dynamics 1. Increasing returns to scale can lead to WTA dynamic  Question is whether to fight or share platform 2. Networked market is likely to be served by a single platform occurs when the following:  Multi-Home costs are high for at least one side  Homing costs comprise all expenses network suers incur, from opportunity cost to adoption, in order to establish platform affiliation 1. Uber apps have low network costs 2. Other side is windows for operating system as it is expensive, difficult to have multiple operating systems  When high cost, s need good reason to have multi-platform 3. Single platform increases when same side network effects are high (s share video games or software files), or cross side network effects are high and strong 4. Neither sides s have a strong preference for special features  If special features wanted, may be differentiated platforms  DVD has high multi-homing costs, high cross sie network effects for both consumers and studios, and technical differentiation is moderate 5. Winning the battle  Need differentiation  First movers advantage can be significant but not always deciders  Later movers could win as they acoide positioning errors of previous players like Google  Still want to get s as quickly as possible, urgency is appropriate  Key is only done if businesses is scalable, and funding will be forthcoming should capital markets turn negative 1. Prone to boom and bust valuation cycles The threat of envelopment 1. Platforms frequently have overallped s  Can make it attractive for one platform to swallow network of other  Especially damaging if rival platform is part of a multiplatform bundle 2. In fast changing technology world, envelopment can blur market boundaries  Mobile phones include video, music, PCs, and even credit cards 3. Business facing envelopment has many times little choice but to exit or be sold 4. Real Example  Originally content companies money side, s subsidy side  Then Microsoft came in with Windows Media Player which bundled  Real had to switch with consumers the money side, like Spotify  Killed by other bundlers again 5. What to do  Change business models  Find a big friend like partnerships  Sue  

o

o

 

 Anti trust still in dispute for how you deal with it Vigilence is crucial Must coordinate strategies through firm  Sony has had trouble with this with its video games, movies, and music business for many years

LN 19 Disney Questions How has Disney sustained its success? 1.

Through their brand equity → Mickey Mouse a.

2.

Image of the brand: family, universal, honest, harmless - overall a consistent brand

Innovation and risk takers a.

Entering into new markets like theme parks, and innovating how movies are made

Businesses: 

1. Theme parks



2. Cruises, hotels (travel agencies)



3. Store (toys, books)



4. Disney Studios (TV and Movies)

Economies of Scope: There’s synergy between all of them, which creates more value. It creates savings (or costs down across products) and increases the WTP. Furthemore production cots decrease Synergies 1.

Between businesses creates more value or willingness to pay

2.

Synergy group, reported directly to Eisner a.

Monthly operating reports expected to disucss new cross divisional projects i. Awarded large bonuses to those most committed to synergy

3.

Cross promotion

4.

a.

In movies, made presentation to home video, consumer product, and theme park group

b.

Each new movie became a mini-industry between licensing and all these groups

Cost savings a.

Lower costs in theme parks and merging divisions lowered costs

5.

Geographically 1.

Looked to integrate internationally where there was higher spending per capita, and Disney generated only 21% of sales

2.

Created Disney theme parks in Tokyo, Hong Kong, Paris

Horizontally 1.

Enter new types of entertainment a.

Grown up movies

b.

Music and publishing

c.

ESPN Zones were made

d.

Disney Cruse ships

e.

Disney Institute focused on fitness and adventures in learning i. Had courses in culinary arts, animation

Vertically 1. Control of TV through ABC 2. Internet as well through websites like ESPN 3. Own cruise lines and Broadway theater

Diversification

Epxanding horizontal boundaries is sometimes called diversification. It sounds as venturing into unrelated businesses.

Financial Hedging Value not added as shareholders can do it on their own

Source of all Competative Advantage: Mickey, and arguably other Disney Characters

Unlike Messi 1. Owned by the company 2. does not grow to meet expectations 3. company has full control of asset 4. company captures 100% of value as there is no salary

Furthermore, even though target is both parents and kids, parents grew up with Mickey, and not Nickelodeon random characters, so you only need to convince kids.

Economies of scope: increases in WTP across products (mickey) decreases production costs 

Through diversification

Magical Turnaround 1.

Budget conscious a.

(even though their core capability is creativity and innovation)

2.

3.

Exploit synergies a.

8 day, one day meetings

b.

Disney dimensions

c.

Synergy group

Theme parks a.

Increase prices

b.

Mondays are open

c.

Increase number of people that can enter park

d.

Add more hotels

Long term want to focus on increased synergies

Disney Boundaries 1995-2000 1.

Max shareholder wealth (20% growth target)

2.

Keep values of quality, creativity, teamwork

3.

Corporate skill: Manage creativity a.

4.

5.

All businesses need potential though for long term profitability

Rebuild TV and movies a.

Expanded animation staff

b.

Increased budgets

c.

Sell independent TV stations (not that synergistic)

Theme park profitability a.

Continued to increase # of people in park

b.

Rapid revenue profit growth

c.

Raised ticket prices

6.

7.

d.

Opened Mondays

e.

Diseny development company

Coordination of businesses a.

Synergies to build on each other

b.

Media purchasing together

Other parks a.

Euro Disney

b.

Hotels

Misc. Notes 1.

History a.

1927 Walt changes Oswald to Mickey who is international sensation

b.

1937 Snow White is made which full color animated and highest grossing animated movie of all time

c.

After WWII you had Cinderalla, Mary Poppins, and other hits

d.

Expanded into TV with Mickey Mouse club in 1954

e.

Park was a huge risk opening in 1971 i. Tokyo park in 76

2.

Eisner Turnaround-1984-1993 a.

Focused on ROE being about 20% as well as revenue growth i. He wanted this through quality, creativity, entrepenuership, and teamwork

b.

Disneys movie share was 4% i. Made 27 of next 33 movies profitable which was much above 40% average 1.

Market leader in movies by 1988

c.

Katzenberg i. Focused on people who were in career slumps or less known ii. Made moderately budgeted filsms with financial box where still could be creative

d.

Theme parks i. Focused on attendance building and revenue/profit growth ii. Used national television ad iii. Expansion of hotle rooms and convention center

e.

Employeed internal transfer prices and quick to settle disputes i. Corporate marketing function was made ii. tly corrdinated big events like Micky’s 60th birthday

f.

Expanded into new businesses i. Disney stores ii. Disney press iii. Tokyo Disneyland

g.

Released a series of high profit films i. Little Mermaid and Beauty and the Beasty

h.

Sell through of VHS instead of just video rentals

i.

Broadway theater i. Proftiable and further brand building

3.

Turmoil a.

President Wells killed in helicopter crash

b.

Katzenberg leaves

c.

ABC merger somewhat diworsification i. Too big ii. Difficult to create synergies

d.

Went big budget which did not go well

e.

Revenues in videos were dropping

f.

Internet results were uneven i. Had to shut down Go.com and subscription service was failure

g. 4.

Cost cutting a lot and selling non strategic assets like Fairchild

Eisner Challenges a.

Managed synergies i. 300 people in synergy boot camp ii. Synerg group focused on maximizing synergy through cross divisional projects and bonuses

b.

Managing the brand i. Ellen sparks controversy ii. Catholic groups against movie with gay cleric iii. Some felt Disney hamstrung by wholesome image in new era of video games and such

c.

Managing Creativity i. Michael Ovitz is hired and then left after just over year ii. 75 high level executives left 1.

Not as fun as it used to be

iii. Combative culture and Eisner becoming autocratic 1.

What can they do?

How did Eisner improve Disney’s competitive position?



Maximize shareholder wealth



Kepp values: quality, creativity, teamwork



All businesses with potential of long term profitability



Budget Conscious



Transfer pricing for economic incentives 

Identify the weakest link in the system



Identify resources in big companies

Magical Turnaround: 1. Exploit synergies 1.

8 day 1 year meeting

2.

Disney Dimensions → Synergic Group (observe opportunities across activities)

Disney Boundaries 



Vertical → Forward Integration 

Own cruise lines



Broadway theater

Geographic 







Disney theme parks in tokyo, hong kong, paris

Horizontal 

Grown up movies



Music and publishing

Revitalized TV and Movies:



Created TV shows for network television



Created a syndicated operation to sell to independent TV stations

Maximized theme park profitability



Updated and expanded attractions at the parks



Raised ticket prices









Opened parks on Mondays



Created retail tie-ins



Added more hotels next to theme parks

Coordination among businesses



Negotiated internal transfer prices for any activity performed by one division for another



Created an in-house media group established to coordinate media buying for the entire company



Corporate Marketing Function



Built on each other for synergies

New Businesses



Euro Disney



Retail as an entertainment concept

These were all one time changes: His focus was on exploiting the synergies even more while being budget conscious at the same time

What limits the diversification strategy? 

Cut throat environment



Too centralized



Stock stall in 2000 and 2011 

High FC



Licensing

How can they sustain success? Continued brand equity power, and a focus on increased synergies

Review Session For sequential, not simultaneous, you need a tree diagram. First you make the second mover the right column at end, and first mover as first column First do backward moving and find second movers best three moves, then find best move, based on those three, for the first mover. That is the optimal move. It is a contingent plan when sequential In cartel want to maximize industry profits by taking highest payment.

Uber Lyft views: Uber and Lyft do not currently have a CA, but if they gain monopoly, then WTP is higher Additional Readings Micro Stars, Macro Effects 1. 2.

3. 4. 5.

6.

Macro economist have dreadful task with failure predicting economy and interest rates However, those at Google and Microsoft are changing how business decisions are made o Preston McAfee hired by Yahoo in 2007, and now Google 1. He showed two part tariff (or higher prices when demand peaks) could shift time-sensitive taks to night-time, allowing bandwitch cost to be more efficient Economist with cars: More information better o Found prices went up and more sales when told all transparency of car including how paintwork was Sometimes less information better o Ebay sellers, less info, just list, increased auction MsAthey from Stanfrod o She toughened ads so less show/fewer times, lose out in shor term 1. But other forces in play like more relevant ads improve experience, and number rise  Led to more clicks of ads Microeconomists are looking at problems through tech as well o Like using googel search engine and key words like jobs offer daily charts, even better than monthly for policymakers on employment

Gaming the System 1.

Students all took 0, which gave them all A’s in John Hopkins class o One equilibrium is no one takes test, and other is everyone take si 1. First one is unlikely due to trembling hand perfect  The idea is that a mistake occurs one person plays different  If one mistake made for first, 99% fail, while second only one person fails o Professor kept score but made changes later

First mover disadvantage 1. 2.

There is a benefit to being first o s get lasting impression, earning strong brand recoignition Early entry on costs not fully understood o One hand get patents, gain control of scarce inputs o However, later movers can avoid mistakes and costs of predecessors

1. 3.

Can also adopt new and more efficient processes and tech, while other player may be entanched

Finding was: o Signficant sales advantage for first mover, but also cost disadvantages o Pioneers were also less profitable by multiple ROI percentage points 1. Big thing is executives should be careful to say first mover leads to long run profit advantage

Companies More Prone To Go Vertical 1. 2. 3. 4.

5. 6. 7. 8. 9.

Ellison and Oracle plan to buy Sun Microsystems so that it is maker of software, compuers, and components o Revive vertical integration Pepsi doing it to get more authority over distribution Pendulum shift from disintegration to integration Departure from past half-century moves o More specialized, shifting fucntions o Steelmarkers selling mines in 1980’s o Tech companies stopped making every piece of computer system Used to be that you had complete control of supply chain and that you could manage it best o Now it is more aspects of supply chain Boeing made the move to buy factory as supplier assembly problem knocked plane off schedule GM bough Delphi to ensure non-interruption of supply Oracle o Flourshed being usable for multiple types of compuers Apple bough semicounder chip maker o Appl hopes to tighten control of key technology from rivals

Article On Uber vs. Lyft 1.

Very strong rivalry between the two brands a. Undercutting each others prices, poaching drivers, and co-opting innovations, increasing blur between two services b. Loudest opposition is taxis and regualtrod 2. People are betting on Uber being a logistics and network for other services 3. Uber in 3 times the cities 4. Lyft has created new arenas of competition 5. Uber offers referrels to build driver base 6. Carpools a. Cheaper at first, but could entce and boost usage i. Two sided network this is great ii. Still multi-costing is very real 7. Could buy Lyft 8. Lyft uses commissions to get growth 9. Essentially matchmaking or two sided market businesses a. Link is between consumer and driver with both receiving subsidy, though one could make the argument, based on reports released from MS, that consumers are now the majority of subsidy, with driver the money side b. Low barriers to entry business i. Not unlike Facebook, or market place businesses ii. The key is number of s on each side and building CA sustainability by becoming only platform 10. But Uber strategy is to have more s in of drivers and consumers a. Uber wants to be lowest cost provider according to VC firm Benchmark, who was an early player in both. b. The idea is it is 15 times bigger, and No.18 on app store i. From this perspective returns are increasing, and they can get huge capital to continue subsidy on both sides

1.

c.

Furthermore it has billions in financing, and lured some 50 engineers from CM to launch rpbot business 2. It used money to also further subsidize as it takes over space 3. One day with monopoly could increase WTP 4. Very clear winner take all mentality where once the dominant and only platform they can have all the power: similar to Amazon On the other side, for students the multi-homing costs are very low as they have 2,3,4 of these apps, and adults are following i. Because of this it is easy, like credit cards, to have multiple platforms ii. Still, if Uber becomes so dominant that there is just so much greater ease, then they will choose this return model

Husky Math Purchasing Expense Daily Cycle Number: Average operating cycle hours per day/cycle time Daily Production Capacity=Number of preforms per cycle*number of cycles Do it for husky and competitors WTP=Then husky/competitors get you ratio* competitor purchase price=1.34 Savings=1.34 million-1.2 million (Husky cost)=.14 million of value add or savings Savings of raw material Weigt of preform for each Husky 24.39 Major Competitor 24.42 .03 saved from Husky Daily production capacity (from before)*365 for yearly Then multiply by .03 gm difference*.70 center per kiko Gets you $2840 Electricity Weight of preform per year Quantity (capcity)*weight* 365=3,2 million gm 3.2 million gm*(how much less husky uses per gm .137)8.08 cost Savings 36,000 Husky can save 8.7 feet Assume $5 per square foot Annual savings $5*12*8.7 $522 per year Add them all up to get cost savings of a machine Consumers save over .14 million on each machine and better quality