1ei intro distributed 6apr09
TRANSCRIPT
8/8/2019 1EI Intro Distributed 6Apr09
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(Mrs) Chi Ching R.G.Lecturer
University of Bradford/MDIS (Singapore)
Email: [email protected]
ECONOMICS OF INDUSTRYECONOMICS OF INDUSTRY
Lecture ScheduleLecture Schedule
Lecture 1: Introduction & Horizontal ExpansionLecture 1: Introduction & Horizontal Expansion
Lecture 2: Vertical ExpansionLecture 2: Vertical Expansion
Lecture 3: Diversification & CompetitionLecture 3: Diversification & Competition
Lecture 4: Pricing, Entry & ExitLecture 4: Pricing, Entry & Exit
Lecture 5: Positioning & Sustaining CompetitiveLecture 5: Positioning & Sustaining Competitive
AdvantageAdvantage
Lecture 6: InnovationLecture 6: Innovation
Lecture 7: Industrial Structural ChangeLecture 7: Industrial Structural Change
L2Vertical
Expansion
Diversification
& Competition
L4 Pricing, and
Entry and Exit
Innovation
Industrial
Structural
Change
L1
Introduction
& Horizontal
Expansdion
Market &
Competitive
Analysis
L5
Positioning & Sustaining
Competitive
Advantage
••Economics of Economics of
IndustryIndustryCourse Outline
L3
L6
L7
ECONOMICS OF INDUSTRY
Lecture 1:
INTRODUCTION &
HORIZONTAL
EXPANSION
Mrs. Chi Ching R.G.
Sustaining
Competitive Advantage
Staying Competitive
FIRM
APPROACH TO UNDERSTANDING E.I.
ECONOMICS OF INDUSTRYEconomics of Strategy
Chapter 1
The Evolution of the Modern Firm
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Key Topics for L1 (Jul 09 exam)
• Economies of scale & scope
• Learning Curve
• Role of the government: regulation & deregulation
• Companies: automobile, supermarket, aircraft mfg
• Final exam: Answer 2 out of 5 questions
(minimum # of pages per question: 2 pages; toscore B & A, you must answer at least 3-4 pages per question); Exam questions are divided into parts a & b
• Strategy in the exam: memorize concepts & apply(make sure you THINK & EVALUATE); check MDIS blackboard everyday for further announcements, etc; Get/buy a textbook
• NOTE: You should have 2 sets of Study Guide (Part 1 & Part 2)
Groups (PT, 6 Apr 08)• Pls ensure you belong to a group. There should be 10 groups. I will email
info to group leaders.
• Tutorial1:• Max: 10 slides (no animation to be submitted to me; in presentation, you
can have your own laptop & animation)
• Q1 – G1
• Q2 – G2
• Q3 – G3 (MODIFIED QUESTION)
• Q4 – G4
• Q5 – G5
• Q6 – G6
• Q7 – G7
• Q8 – G8
• Q9 – G9
• Q10 – G10
Evolution of the Firm
•Smaller & flatter organizations
prevailed•More competition
•Well-developed financial
markets
•Improvements in transportation,
communication & financialinfrastructures
•Globalization
•Innovations in technology
minimized large-scale production
•Rise of professional managers
•Dominance of large hierarchical
firms
•Manufacturing firms vertically
integrated into raw materials
acquisition, distribution &
retailing
First Half of Century
Second Half of
Century
Present
Rapid Expansion in
Infrastructure
•Telegraph enabled business to
monitor & control suppliers,
distributors & factories
•Growth of financial institutions
led to more capital & transaction
on global scale
•New technologies led to higher
volume of standardized
production
•Expansion of rail system led to
wider distribution & factories
1910
Infrastructure
expanded
•Limited transportation &
infrastructures made it risky for
business to expand
•Owners ran their own business
•Dependent on market specialists
to match the products with needs
of the buyers
•Lack of production technology
•Lack of professional managers
•Lack of capital
•Lack of distribution networks
1840
Business were small &
Operated in Localized
Markets
1840, 1910 and Today
• The years 1840, 1910 and 2003 represent
widely disparate business conditions
• A historical analysis of business conditions
illustrates the durability of fundamental
economic principles behind business
strategy
Doing Business in 1840
• Numerous intermediaries
• Farmers to factors to brokers agents to
buyers
• Substantial price risk for participants
Infrastructure in 1840
• Infrastructure in transportation,
communication and finance were poorly
developed in 1840
• Poor infrastructure was behind the
dominance of small family firms in that
period
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Business in 1840
• Without communication infrastructure,
information on prices, sellers and buyers
were not readily available
• Given the tremendous risk, banks were
unwilling to finance business expansion
• Under these conditions, businesses were
small and informally organized
Business Conditions in 1910
• Mass production technologies made possible high volume low cost manufacture
of goods• Railroads dominated transportation and
allowed mass distributors to reach widelyscattered customers
• Telegraph and telephones greatly improvedlong distance communications
Finance in 1910
• Securities markets traded shares of large
industrial firms
• Credit bureaus made credit information
easily accessible
• Public disclosure of accounting information
was in vogue
Government in 1910
• Government regulation extended to suchareas as corporate law, antitrust and worker safety
• Increased regulation forced managers tocollect a lot of data on internal operations
• Mandatory secondary schooling provided
the labor force needed by large bureaucraticorganizations
Business in 1910
• Expanded infrastructure allowed firms to
expand their markets, product lines and
production scale
• New technologies allowed high volume
standardized production
• Growth of financial infrastructure made
large scale firms viable
Transportation Infrastructure
Today• Air, rail and ground transportation have
become better coordinated
• Cities like Atlanta have grown relying on
air transport in spite of poor rail and water
connections
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Communications
• Telecommunication technology made
instantaneous transmission of data possible
and created global markets for some products and services
• Coordination of activities has become easier
with modern computer and communication
technologies
Finance
• Capital markets and financial institutions
have become more active in evaluating firm
performance
• Globalization of financial markets made
many mergers and acquisitions (such as
Daimler-Chrysler, Sony-Columbia) possible
Finance
• Financial accounting developed to cope
with the complexities of multi-divisional
firms
• Greater transparency in financial reporting
(Sarbanes-Oxley)
Production Technologies
• Modern technologies such as CAD/CAM
have made low cost tailor-made production
feasible
• Use of new technologies often means
reorganizing the firm around these
technologies
Government
• In some areas traditional regulation has
been relaxed (deregulation of airlines,
trucking, financial services)
• Regulation has increased in other areas
(health care, workplace safety,
discrimination, environmental protection)
Government
• Government support for basic research and
commercialization of R & D projects
• Intergovernmental treaties and agreements
create regional free trade zones
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Business Today
• Strategies that were effective whencompetition was essentially domestic do not
work well in globally competitive times• Internal structure of firms have been
changing, with firms focussing on their core businesses and leaving the rest to specialists
• Traditional hierarchies within organizationshave been weakening
Business Today
• Advantage of large scale productiondiminished in some areas
• Advances in computing and communicationlong with industry standards have enabledcomplex coordination over long distances
• The role of the general manager haschanged as the structure of the businessorganizations has changed
Infrastructure in Emerging
Markets
• The variation seen among 1840, 1910 and 2006
can be seen to exist today when we look at cross
section of countries
• Unlike the advanced nations, many developing
nations still lack transportation and finance
infrastructures
• Businesses are reluctant to invest in countries
where corruption, cronyism and conflicts are
rampant
Business Conditions and Strategy
• Vertical integration was not needed in 1840since scale of production was small
• Vertical integration trend is being reversedtoday since computer and communicationtechnologies make complex coordination of tasks possible
• In some instances “virtual corporation” begins to make sense
Business Conditions and Strategy
• Business conditions change over time and
so do the optimal strategies
• Principles needed to arrive at successful
strategies do not change
• Recipes change from period to period but
principles behind the recipes do not
Critical Thinking
• What do you think are the challenges
facing firms in this millennium?
– Globalisation?
– The rise of China …. and India?
– The role of USA? Japan? Europe?
• The future of manufacturing in Asia?
• The increasing importance of service-
oriented industries?
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• A rapid increase in international trade and investment in the last 20 years which is breaking down national borders
and creating a single global economy – often called the ‘global village’.
• Doing business beyond national boundaries.
•
Globalization
Economics of Strategy
Chapter 2
Horizontal Boundaries of the Firm
Horizontal Boundaries
• Horizontal boundaries: How big a market
does a firm serve?
• In some industries a few large firms
dominate the market (Commercial aircraft
manufacture)
• In others, smaller firms are the norm
(Apparel design, Universities)
Horizontal Boundaries
• There are several industries where large
firms and small firms co-exist (Software,
Beer, Banks, Insurance companies)
• What determines the horizontal boundaries
of firms?
• How should a firm optimally choose its
horizontal boundaries?
Determinants of Horizontal Boundaries
• Economies of scale
– Declining average cost with volume
• Economies of scope
– Cost savings when different goods/services are produced “under one roof”
• Learning curve
– Cost advantage from accumulated expertise andknowledge
Economies of Scale
• When the marginal cost is less than average
cost, there are economies of scale
• Example: Computer software. The
marginal cost of reproducing a CD is
negligible compared with the huge fixed
cost associated with software development
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U-shaped cost curve U-Shaped Cost Curve
• Average cost declines as fixed costs are
spread over larger volumes
• Average cost eventually start increasing as
capacity constraints kick in
• U-shape implies cost disadvantage for very
small and very large firms
• Unique optimum size for a firm
L-shaped Cost Curve L-shaped Cost Curve
• In reality, cost curves are closer to L-shaped
curves that to U-shaped curves
• A minimum efficient size (MES) beyond
which average costs are identical across
firms
Economies of Scope
• Firm 1 produces two products: A and B
• Firm 2 produces A only
• If the cost of producing A is smaller for
Firm 1 than Firm 2, there are economies of
scope
Economies of Scope
• Common expressions that describe
strategies that exploit the economies of
scope
– “Leveraging core competences”
– “Competing on capabilities”
– “Mobilizing invisible assets”
– Diversification into related products
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Economies of Scope
• The terms “Economies of Scale” and
“Economies of Scope” are sometimes used
interchangeably
• Managers may cite economies of scale and
scope (even when they do not exist) to
justify investment in growth
Some Sources of Economies of
Scale/Scope
• Spreading of fixed costs
• Increased productivity of variable inputs
• Saving on inventories
• The cube-square rule
Fixed Costs
• Certain inputs in the production process
may not fall below a minimum
• Increasing the volume of production yields
economies of scale in the short run
• In the long run, economies of scale are
obtained through choice of technology
Tradeoffs Among Technologies
Tradeoffs Among Technologies
• If output needs to be increased beyond a
point, capital intensive technology needs to
be substituted for labor intensive technology
• The “lower envelope” of the two cost
curves is the long run average cost curve
Long Run and Short Run
• Cost reduction through better capacity
utilization
– (short run economies of scale)
• Cost reduction by switching to high fixed
cost technology
– (long run economies of scale)
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Economies of Scale and
Specialization
• Economies of scale more likely when
production is capital intensive
• “The division of labor is limited to the
extent of the market”
• As markets increase in size, economies of
scale enables specialization
Economies of Scale and
Boundaries
• Larger markets lead to specialized firms
• As markets get even larger, the specialized
activity may become “in house” due to
economies of scale
Inventories
• Firms carry inventory to avoid stock outs
• In addition to lost sales, stock outs can
adversely affect customer loyalty
• Bigger firms can afford to keep smaller
inventories (relative to sales volume)
compared with smaller firms
Inventories
• Two firms may not experience stock outs atthe same time
• Merging the two firms will reduce the probability of stock out, given the level of inventory
• The combined firm can maintain a lower
level of inventory and have the same probability of stock out as before
Aircraft, Rolling Stock as
Inventories• The inventory model applies to aircraft,
rolling stock and road vehicles
• A larger bus company can keep a smaller
number of “spare buses” (relative to size of
operations) and still provide reliable
service, whereas smaller companies need
(proportionately) larger number of spares
Cube-Square Rule
• Double the diameter of a hollow sphere andthe volume will increase eightfold, whereasthe surface area will increase only fourfold
• The cost of the sphere is likely to increase by less than eight times
• If the hollow sphere is part of productionequipment in a chemical plant, cost savingsfollow from increased size
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Cube-Square Rule
• Examples of Scale Economies due to the
Cube-Square Rule
– Oil pipelines
– Warehousing
– Brewing tanks
Other Sources of Economies of
Scale/Scope
• Purchasing
• Advertising
• Research and development
Economies of Scale in Purchasing
• Large buyers can get volume discounts
– Reduced transaction costs
– More aggressive bargaining by large buyers
– Assured flow of business for the supplier
Economies of Scale in Purchasing
• Example: Group insurance is typically
cheaper than individual insurance.
• Big buyers like CalPers (California Public
Employee Retirement Systems) drive hard
bargains with the insurers
Rationale for Volume Discounts
• Cost of service (per unit) is lower for large
buyers
• Large buyers may be more price sensitive
• Large buyers can disrupt operations of the
seller by refusing to buy
Economies of Scale in
Purchasing• Alternatives to bigness
– Small firms can join purchasing alliances
– Price sensitive firms may get better bargains
even when they are small
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Economies of Scale and Scope in
Advertising
• Cost per customer = (Cost per potential
customer) x (Proportion of potential
customers who become actual customers)
• Large firm have lower cost of reaching a
potential customer (First Term)
• Large firm also have a better reach (Second
Term)
Economies of Scale in Advertising
• Large national firms may experience lower
cost per potential customer when compared
with small regional firms
• Cost of production of the advertisement and
the cost of negotiations with the media can
be spread over different markets
Economies of Scale in
Advertising
• Large firms may have better reach than
small firms
– Example: The ubiquity of STARBUCKS
• Large firms convert a larger proportion of
potential customers into actual customers
Umbrella Branding and
Economies of Scope
• A well known brand like Samsung covers
different products
• There are economies of scope in developing
and maintaining these brands
• New products are easier to introduce when
there is an established brand with the
desired image.
Umbrella Branding - Limitations
• Umbrella branding may not always help
– Example: In the U.S. Lexus is a separate brand
from Toyota
• Conflicting brand images may cause
diseconomies of scope
Economies of Scale in R & D
• Minimum feasible size for R & D projects
and R & D departments
• Economies of scope in R & D; ideas from
one project can help another project
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Innovation and Size
• Are big firms better at innovating compared
to small firms?
• Size reduces the average cost of innovations
• Smallness may be more suitable for
motivated researchers
Other Sources of Economies of Scale
• Access to a distribution network
• Established governmental relations
Strategic Fit
• Strategic fit is complementarity that yields
economies of scope
• Strategic fit renders piece-meal copying of
corporate strategy by rivals unproductive
• Strategic fit is essential for long term
competitive advantage
Diseconomies of Scale
• Beyond a certain size, bigger may not
always be better
• The sources of such diseconomies are
– Increasing labor costs
– Bureaucracy effects
– Scarcity of specialized resources
– “Conflicting out”
Firm Size and Labor Cost
• Data indicate that workers in large firms get
paid more than workers in small firms
• Possible reasons
– Unionization is more likely in large firms
– Work may be more enjoyable in small firms
– Large firms may have to attract workers from
far away places
Firm Size and Labor Cost
• Large firms experience lower worker
turnover compared to small firms
• Savings in recruitment and training costs
due to lower turnover may partially offset
the higher labor cost
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Bureaucracy Effects and Firm Size
• When a firm gets large
– it is difficult to monitor and communicate with
workers
– it is difficult to evaluate and reward individual
performance
– detailed work rules may stifle the creativity of
the workers
Specialized Resources
• As the firm expands, certain resources may be limited in availability
• Example: As a restaurant expands, the chef may find himself/herself spread too thin
• Other limited resources may be
– desirable locations
– specialized workers
– talented managers
“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
The Learning Curve
• Learning economies are distinct from
economies of scale
• Learning economies depend on cumulative
output rather than the rate of output
• Learning leads to lower costs, higher quality
and more effective pricing and marketing
The Learning Curve
AC1
AC2
AC
Q 2QQuantity
Slope of the Learning Curve
• Slope of the learning curve is the relativesize of the average cost when cumulativeoutput doubles
• A slope of 0.9 indicates that the averagecost will decline by 10% when thecumulative output doubles
• Learning flattens out over time and theslope eventually becomes 1.0
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Learning Curve Strategy
• Expand output rapidly to benefit from the
learning curve and achieve a cost advantage
• May lead to losses in the short term but
ensure long term profitability
BCG’s Growth/Share Paradigm
• Product life cycle model combined with an
internal capital market, with the firm
serving as a banker
• Use the cash generated by “cash cows” to
exploit the learning economies of “rising
stars” and “problem children”
BCG’s Growth/Share MatrixIndividual Learning and
Organizational Learning
• Learning resides with individuals
• Organizational learning includes expertisethat individuals have and the way theycomplement each other
• Worker mobility can lead to loss of expertise in the organization
• On the other hand, reducing job turnover may stifle creativity
Learning Curve and Scale
Economies• Learning reduces unit cost through
experience
• Capital intensive technologies can offer
scale economies even if there is no learning
• Complex labor intensive processes may
offer learning economies without scale
economies
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Critical Thinking
• What are the challenges facing financialinstitutions due to the global financialturmoil which started in 2008 (collapse of
Lehman Brothers & bailing out of manybanks)??
• What is the role of the government inindustries that enhance and/or prohibitcompetition? Cite industry examples.
• Should there be more government regulationor less government regulation. Justify.
Role of the Government
• Providing the legal structure
– It sets the legal status of business, rights of privateownership, making & enforcement of contracts
• Maintaining competition
– Control monopoly through regulation & antitrust
– Deregulation, Nationalisation
• Redistributing income
– Transfer payments, market intervention (price control),taxation
• Reallocating Resources
– Market failure (due to positive & negative externalities)
• Promoting stability
– Fiscal & monetary policy to correct macroeconomic problems
Role of the Government
• Antitrust laws
– Legislation that prohibits anticompetitive businessactivities such as price fixing, bid rigging,monopolisation, & tying contracts
• Deregulation
– The opening of the industry to more competition
– When the governmetn removes official bharriers tocompetition such as licences and minimum quality
standards, etc• Nationalisation or Nationalised industries
– State-owned industries that produce goods or servicesthat are sold in the market
Role of the Government
• Government enhances the operation of the marketsystem by providing an appropriate legalfoundation and promoting competition.
• Government can correct for the overallocation of resources associated with negative externalitiesthrough legislation or taxes; it can offset theunderallocation of resources associated with positive externalities by granting governmentsubsidies
• A nation’s government and central bank promoteeconomic stability by engaging in prudent fiscaland monetary policies
Role of the Government:
Regulation• Government enhances the operation of the market
system by providing an appropriate legalfoundation and promoting competition.
• Government can correct for the overallocation of resources associated with negative externalitiesthrough legislation or taxes; it can offset theunderallocation of resources associated with positive externalities by granting governmentsubsidies
• A nation’s government and central bank promoteeconomic stability by engaging in prudent fiscaland monetary policies
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What is EI?
• A combination of various modules:
– Economics
– Marketing – Organization Behavior
– Strategic Management
What is EI?
• There should be two books:
– Part 1 – PPT slides
– Part 2 – Readings & articles on EI (I will request
Lucas to print this)• Companies we can discuss:
– Apple, Airbus, Lenovo, Daiso, Toyota
• FINAL EXAM:
– Answer 2 out of 5 questions (comprehensiveessay, each question is worth 100 marks)
– Per essay question, you have to answer aminimum of two pages (to score high marks (B &above), you have to write about 3-4 pages
Top 10 Innovative Companies
www.businessweek.com
• 1. Apple
• 2. Google
• 3. 3M
• 4. Toyota
• 5. Microsoft
• 6. General Electric
• 7. P&G
• 8. Nokia• 9. Starbucks
• 10. IBM