business strategy for lawyers chapter 3: the individual firm (strategic actions) prof. amitai aviram...

Business strategy for lawyersChapter 3:

The individual firm(strategic actions)

Prof. Amitai [email protected]

University of Illinois College of LawCopyright © Amitai Aviram. All Rights Reserved

S14D

The individual firm (strategic actions)Overview of Chapter 3

a) Strategic traits– Strategic competences– Strategic rigidities– Reform (modifying strategic traits)– From strategic traits to strategic actions

b) Differentiationc) Coordinationd) Confrontatione) Review (integrating the course’s components)

© Amitai Aviram. All rights reserved.2

Strategic traitsMoving beyond environment…

• Fighting over a slice of the Value Pool pie– Environment determines the portion of the VP that is allocated to

market participants (firm + rivals)– Strategic actions increase firm’s portion of VP by improving the

environment for the firm• If rivals could employ the same strategic

actions, firms would offset each other• Therefore, strategic actions rely on firm’s

strategic traits, which rivals don’t have

3 © Amitai Aviram. All rights reserved.

Strategic traitsWhat are strategic traits?

• A strategic trait has two aspects:– Positive aspect: strategic competence

• Often called “core competence” or “firm-specific resource”• This is the “strengths” part of the SWOT analysis

– Negative aspect: strategic rigidity• Possessing a strategic competence is always a trade-off: limits firm’s

ability or incentive to take certain strategic actions or to develop certain new strategic competences

• This is the “weaknesses” part of the SWOT analysis


Strategic competencesElements of a strategic competence (VRIO)

• Value [facilitates a strategic act that exploits an opportunity/neutralizes a threat]– A benefit that facilitates a strategic act

• For differentiation: value to customers (one of the bases of competition)• For confrontation: ability to impose costs on rivals• For coordination: low coordination costs• Value through benefitting others

– Competence that benefits another firm can facilitate coordination w/that firm– Competence that benefits politicians or their constituents can facilitate

regulation (for the purposes of confrontation, coordination or differentiation)– Benefit must be competitively superior (difficult for rivals to substitute)

• Rarity [unavailable to rivals]– Competence is scarce (currently available only to one/few competing firms)– Competence is difficult to imitate (rivals face cost/disadvantage to acquire/develop it)

• Organization [firm is able to capture the value of the competence]– Value must be appropriable (i.e., firm can capture the value)– Firm’s policies & procedures must support exploitation of the competence


Strategic competencesStrategic competence: organization

• Organization element involves support on the following dimensions– Skills/knowledge of individual employees– Technical systems (proprietary processes & information)– Managerial systems (firm policies on employee incentives)– Values/norms

• Example: supporting a competence in handling US-China M&A– Skills/knowledge: e.g., attorneys who can speak both English & Chinese and

who know both US & Chinese corporate law– Technical systems: e.g., timetables, procedures and templates for antitrust

review in both US & China– Managerial systems: policies that encourage temporary assignments in China;

policies that facilitate hiring foreign-trained lawyers– Values: e.g., foreign attorneys not disadvantaged in making partner


Strategic competencesExample: Elite M&A law firms

• Competence: lawyers w/exceptional M&A skills/expertise– Value: high

• Benefit: clients believe lawyer credentials indicate value of lawyer’s work (useful for differentiation, aiming at “bet the company” work)

• Competitively superior (difficult to substitute): somewhat– Other client benchmarks also indicate work quality (e.g., media visibility)

– Rarity: somewhat• Scarce: yes (in most markets, few rivals have highly-credentialed lawyers)• Difficult to imitate: yes

– Limited talent, limited capacity of credential-creating institutions such as law schools, big cases

– Elite firms provide their lawyers more opportunities to credential themselves– Organization: poor - lawyer can quit at any time, taking value with her

• This is a major weakness. What can firms do to mitigate it?


Strategic competencesExample: Best Buy goes green

• Competence: combining Best Buy’s existing business activities with selling “green” vehicles (electric bikes/scooters)

– Value: high• Benefit: economies of scope in demand (for differentiation); economies of

scope in supply (for confrontation: isolation)– In demand: if Best Buy’s customers are also interested in green vehicles, offering

them leverages Best Buy’s reputation & accessibility– In supply: this is a response to an increase in spare space in stores (flat screen

TVs replace bulkier TVs; CD & DVD sales declining)» Space is fixed cost, so more sales lower ATC, allowing lower prices» Also utilizes Best Buy’s existing logistics capacity

– Rarity: somewhat• Scarce: yes, at that point few mainstream stores offered green vehicles• Difficult to imitate: this is Best Buy’s weakness; other firms can imitate. But green

vehicles are bulky, so rivals will little available space can’t imitate.– Organization: good (assuming appropriate procedures are in place)• Lower ATC is captured by Best Buy (higher profit margins); higher value to

customers captured via higher prices8 © Amitai Aviram. All rights reserved.

Strategic competencesExample: Gyms with childcare

• Competence: bundling gym membership with childcare– Value: high benefit• Benefit: economies of scope (differentiation), switching costs (confrontation:

isolation). High cost for parents ascertaining that particular caregiver is “good” for child, and children get used to a particular caregiver

– Rarity: somewhat• Scarce: so-so (multiple gyms have childcare, but perhaps direct rivals don’t)• Difficult to imitate: somewhat

– Because trust takes time to build & is specific to the caregivers & gym, switching costs will remain even if other gyms also bundle childcare

– However, imitation by rivals can undo differentiation (copying popular toys & activities)– Organization: moderate appropriability• If parents & kids choose gym based on specific caregivers (as opposed to gym’s

caregiver selection & supervision process), caregivers should capture some of the value (through higher salaries). But caregiver skill set is very common & proving trustworthiness is a gym-specific investment.


Strategic competencesExample: Landline & mobile service

• Competence: operating in both landline phone service &wireless phone service

– Value: sometimes• Benefit: efficient cashflow management; land line phones produces a lot of

cash but market is dying; advanced wireless network demands high investment, but is growing

– So operating both land lines & wireless balances cashflow; increases VP by reducing financing costs

– Provides value only when capital markets overvalue capital (i.e., when it’s difficult to borrow)

– Rarity: perhaps• Scarce: originally, yes (few firms operated both land & wireless)

– Once most rivals already operate in both markets, benefit is no longer scarce• Difficult to imitate: only a few firms operate in each market; high barriers to

entry into each market– Organization: good appropriability


Strategic competencesIdentifying strategic competences

• Step 1: brainstorming– Write in unstructured form all strengths & weaknesses that come to mind– Check if each item you identified satisfied the three elements of strategic

competences (value, rarity & organization)• Step 2: examining each business activity

– Explained in the next slide• Step 3: inversion

– Look at the competences you identified to see what rigidities they create– Look at the rigidities you identified to see what competences they enable

• Rigidities often make value that’s otherwise easy to imitate inimitable• E.g., many elite lawyers could counsel corporate raiders on hostile takeovers, but

only those with the weakest reputation & fewest high-end clients (rigidity) would risk their reputation & existing relationships by representing raiders


Strategic competencesIdentifying strategic competences

• Examining each business activity– Apply Porter’s value chain to the

firm you are examining• Translate each segment of the value

chain into specific business activitiesthat involve your firm

• Does your firm engage in theseactivities or outsource them?

– For each activity the firm engages in (rather than outsources)• Is the firm better than, as good as, or worse than rivals?• If better, define what makes firm better in strategic competence terms (value,

rarity, organization)• If worse, define what makes firm worse in strategic rigidity terms: why doesn’t

firm change & what strategic acts does the rigidity preclude (or which strategic actions of rivals does the rigidity make the firm vulnerable to?)


Strategic rigiditiesThe dark side of strategic traits

• No “end of history” for corporate strategy– Strategic competences provide competitive advantages– So why hasn’t one firm acquired all relevant competences & then

held a permanent advantage over rivals?

– Reason: strategic competences create strategic rigidities (limits on firm’s ability or incentive to take certain strategic actions or to develop certain new strategic traits).


Strategic rigiditiesThe dark side of strategic traits

• Examples of competences creating rigidities– Kodak’s strength in film cameras limited incentive to develop digital cameras– Exceptional engineering-focused firm culture limits ability to attract

marketing/design talent, and limits ability of marketing/design executives to prioritize these aspects ofthe product’s value

– Gas refiner’s strong retail (gas station) brand reduces ability to coordinate with competing gas stations (e.g., sell them surplus gasoline)

– Giving local managers more discretion (less bureaucracy) means decisions are taken by less experienced managers, and there is less managerial slack (more harm from one bad or incapacitated manager)

– A firm that rents (rather than owns) its stores/factories has lower fixed costs (no need to buy real-estate), but higher variable costs (paying rent)


Strategic rigiditiesRigidities in a market analysis

• Strategic rigidities affect a market analysis in 2 ways:1. Prevents firm from exploiting a strategic action• This is an issue when a strategic action is desirable for the

firm & would be feasible but for the existence of the rigidity• E.g., firm’s luxury image makes it unable to lower prices (i.e., engage in

differentiation through cost leadership)2. Allows rivals to exploit a strategic action• This is an issue when a strategic action is desirable for a rival

& is made feasible for the rival because firm’s rigidity prevents firm from copying the action

• E.g., Kodak’s rivals differentiate by introducing digital cameras; Kodak can’t reciprocate

• So, in some cases it may be desirable to replace the strategic competence that is creating the strategic rigidity


Reform (modifying strategic traits)How are strategic traits created?

• Traits are usually created/modified by– Combining business activities; or– Using different inputs (e.g., a different technology)

• Not every new input or new combination of business activities creates a strategic trait– To be a strategic competence, need value, rarity & organization– Rarity can be a result of

• Limitations on access to an input or activity (e.g., patented technology, high BTE into an activity, etc.)

• Rivals’ strategic rigidities preventing them from mimicking your firm


Reform (modifying strategic traits)Using different inputs

• The Pereira-Zimmerman article provides an example of modifying strategic traits through use of different technology (temporary stores)– Replacing permanent stores with temporary stores replaces fixed costs

(ownership of real-estate or termination costs of long-term lease) with variable costs (short-term rent, daily wages rather than annual contracts for employees)

– Reducing FC lowers the MES, making it profitable to operate even if sales are smaller

– But increasing VC raises the MC, which is the lowest price the firm can profitably sell the product (making it harder to compete on prices)



Understanding toy sellers’ options• The strategic environment

– Threat (VP): toys are not to be recession-proof: sales decline by 5%– Opportunity (rivalry): weaker rivals have gone bankrupt (demand up for grabs)

• How can firms respond?– Go all out after the demand: open new stores where old ones closed. Problems

with this approach?– Avoid risks, minimize damage: reduce prices to increase sales, reduce

inventories to adjust to lower demand. Problems with this approach?– Increase underutilized capacity to capture sales from bankrupt rivals. Why is

Sears better equipped to do this than TRU?– Use temporary stores to soak up sales from bankrupt rivals (or from seasonal

increase) while maintaining ability to cut back when demand declines. What’s the trade-off of this response?



• Another example: technology often allows the opposite strategic trait modification: increasing FC to lower VC– For example, a steam powered weaving machine may do the work of a dozen

human weavers, with fuel and maintenance costing less than the weavers’ wages (lower VC, lowering the MC and therefore making it viable to lower prices), but the cost of the machine (higher FC) raises MES (see Section 1b4)


Reform (modifying strategic traits)Constraints on trait modification

1. New trait must have value, rarity & organization (like all competences)– E.g., an attempt to acquire a strategic competence by changing one aspect of

supporting organization (e.g., excellence in design by hiring top designers)can fail if other aspects are unsupported. For example, if product development process doesn’t leave room for design input; if firm HR policies are unattractive for creative people; or if firm’s norms don’t value design

2. Existing strategic rigidities may limit ability to acquire new strategic competences– E.g., firm known for engineering excellence may find it difficult to build

marketing excellence, because top marketing talent would prefer to be “top dog” in a marketing-focused firm

3. New strategic competences come with new strategic rigidities thatmay clash with existing & future competences/strategic actions– E.g., Google’s acquisition of a handset manufacturer (Motorola) threatens the

attractiveness of its open source operating system (Android) to rival handset manufacturers20 © Amitai Aviram. All rights reserved.

• Strategy: creating a fit between the strategic environment and the firm’s strategic traits– Environment determines how much value is captured by market participants

(firm & rivals), at expense of customers & suppliers

– Strategic actions apply a firm’s strategic competences to capture a larger part of the market’s portion of VP, at expense of rivals

Value pool The strategic environment (competition)Substitution Entry Rivalry Supply chain

Total value created by biz activity Allocates the value pool between markets

Strategic traits Strategic actions

Strategic competences (VRIO) Differentiation Coordination Confrontation

Strategic rigidities Does rigidity: (1) prevent firm from exploiting a strategy?(2) allow rivals to exploit a strategy?

Reform (modifying strategic traits)

From traits to actionsWhere do they fit in?


From traits to actionsMeans of acting strategically

• Unilateral actions: actions conducted within the firm (not with rivals or government)– E.g. (1): firm creates BTE by increasing it’s capacity & reaching MES– E.g. (2): firm reduces costs/increases value through proprietary R&D

• Coordinated actions: actions that synchronize between the firm & other players (rivals, suppliers, customers)– E.g. (1): firm agrees with rivals not to enter each other’s market segments– E.g. (2): firm agrees with rivals to have a joint venture for R&D

• Regulatory actions: actions that involve the government in the competitive environment– E.g., firm gets a patent or lobbies for regulation that creates BTE for rivals– E.g. (2): firm gets a grant for research (or has a government entity conduct and

share research) that increases firm’s VP


a) Strategic traitsb) Differentiationc) Coordinationd) Confrontatione) Review



DifferentiationWhat is it?

• Differentiation is a process that reduces substitution between your product and rivals’ products– Differentiation matches a market’s basis of competition with a firm’s strategic

competences• Sometimes differentiation is called “positioning”

– I don’t use this name because it may create confusion with Porter’s concept of “position”, which is a focus of a firm’s business activities – the result of a strategic analysis (which is then implemented by creating a fit)• Differentiation is an important part of creating a position, but other things may

dictate a position (e.g., market’s expected sales growth or margins, high BTE)• Porter calls this “generic strategies”

– For Porter, “differentiation” is one of three generic strategies (cost leadership & focus are the other two). But all generic strategies differentiate on some basis of competition (price is one of them) – so why distinguish?


DifferentiationHow to differentiate?

• Firm differentiates by using strategic competences to offer a better response than rivals to a basis of competition in a market– Identify bases of competition; your & rivals’ strategic traits– Market-wide scope

• Do your strategic competences (vs. rivals’ strategic rigidities) allow you to provide a better response to an important basis of competition?– E.g., lowest price; valued feature; best service; highest reliability

– Focused scope• Do market-wide leaders over-serve / under-serve particular segments?• Do your strategic competences (vs. rivals’ strategic rigidities) allow you to

better serve a particular segment?– Compare options by expected success & market attractiveness– Align activities with the chosen differentiation plan


DifferentiationViability

• Differentiation makes sense if– It gives significant advantage

• E.g., significant economies of scale, steep learning curve, market niche with promising VP (high margins, high growth)

– It is sustainable• Significant barriers to imitation (e.g., patents)

– Trade-offs help sustainability by making it less attractive for firms to trade-off existing advantages to imitate your firm

• Market has a high propensity for coordination, and it is feasible & legal to coordinate with rivals so that they don’t imitate your differentiation


DifferentiationCost leadership

• Murray: viability of cost leadership is driven by the supply-side (low cost production), not by the demand-side (price sensitivity)– Economies of scale– Preferential access to complements

• Preferential access to raw materials (high BTE & concentration in the upstream market)– Example 1: Control of oil reserves that are cheaper to extract– Example 2: Producing aluminum requires bauxite (low BTE, relatively cheap

to extract), and uses a lot of energy. Therefore, low-cost producers are those located next to cheap energy sources (Iceland: geothermal energy; Siberia: hydroelectric energy).

• Access to superior product or process technology• Access to superior distribution channels


DifferentiationCost leadership – Example (Uniqlo)

• Uniqlo is a cost leader is the Japanese “basic clothing”(T-shirts, socks & jeans) market

• Difficult market for cost leadership– Low BTE to raw materials markets (e.g., cotton, wool, labor)– Ubiquitous product technology– Low BTE to distribution channels

• How does Uniqlo achieve cost leadership?– Relatively small (1K) number of items (production economies of scale, lower

design costs, lower inventory management costs)– Longer shelf life for each item (tradeoff: doesn’t attempt to chase fashion)– Many colors (increases variety with minimal increase in costs)

• What are likely threats to Uniqlo’s strategic action?– I.e., what changes to the environment would cause Uniqlo’s differentiation to

be less profitable?


DifferentiationProduct differentiation

• Similar to cost leadership, except strategic competences supportanother basis of competition (rather than cost)

• Differentiation of easily ascertainable features (e.g., screen size) tends to be unsustainable because it is easily copied (unless something prevents copying; e.g., patents)– Such differentiation is more viable early in a product life cycle (when customers

don’t have info on any products & products vary widely)• Differentiation of difficult to ascertain features (e.g., quality,

reliability, service) is more sustainable because of customers’ learning costs– Takes time to convince a customer that a new product is reliable– Such differentiation is more viable later in a product life cycle


DifferentiationFocus

• Identify over-served / under-served segments– Overserved – cost focus; Underserved – differentiation focus

• Do your strategic competences (vs. rivals’ strategic rigidities) allow you to best serve segment?– No sense in focusing if, once market sees you found a profitable segment, other

firms can focus on it & outcompete you• Murray: consider positive/negative synergies between segments

– Negative synergies between segments (e.g., tarnishing premium brand by also having a value brand) increase odds that segments are over- or under-served

– Positive synergies (e.g., advantage of offering entire line of products) undercut odds of success despite identifying over-/under-service

– Sometimes, synergies may be positive among a group of segments but negative among others – then, focus on multiple segments• E.g., full-line of premium products, but not value products


DifferentiationFocus – Example (Independent films)

• Independent film makers squeezed from high & low end of market– High-end: blockbuster films become increasingly expensive

• E.g., advertising, special effects– Low end: cheap digital videocams, editing software & online distribution

• 5,500 films in Cannes festival; only about 600 shown in cinemas• Video on demand (VOD) to the rescue

– Distribution system more suited for niche movie preferences• “Not everybody lives near an art-house cinema, but almost everybody has a

remote control.”– Much larger movie capacity than cinemas– Cable companies help with advertising– Trade-off: much less likely to have a blockbuster

• “Famous actors and directors distrust a platform that carries only slightly less stigma than a straight-to-video release. Cinemas do not want to touch any film that has appeared on television.”


DifferentiationFocus – Example (Independent films)

• Using our analysis:– VOD segment overserved by blockbuster movies – cost focus

• Customers often don’t plan ahead of time– So, money spent on advertising (& resulting higher ticket price) is

unneeded• TV provides less auditory & visual experience than cinema

– So, special effects are wasted on VOD audience– But this is diminishing as more people have large-screen, HD TVs

– VOD underserved by blockbuster movies – differentiation focus• Customers experiment more when watching movies at home• Physical presence in cinemas mean in less densely-populated places only

very popular movies play in cinema• Differentiation: movies that have large but dispersed audience

– Assess the threat from lower end content (e.g., YouTube)


CoordinationWhat is it?

• Coordination is a strategic act that reduces (or eliminates) buyer/supplier power by directly involving the firm in the threatening upstream/downstream market– Example: a power plant relies on a supply of coal from a monopolist coal miner.

To reduce supplier power, the power plant can either:• Start its own coal mining company (integration via organic growth)• Buy the coal miner (integration via acquisition)• Sign a long-term contract to buy the coal it needs for 30 years• Have an informal agreement that the miner would sell coal to the power plant

• There’s a spectrum from complete integration to agreement– At one extreme, complete integration means the firm fully owns & controls the

coal miner (i.e., it has the right to control the coal mining activity)– At the other extreme, agreement means that the firm has an understanding

that it has rights to the coal• It creates incentives, such as the threat of a breach of contract lawsuit, for the

coal miner to comply with the power plant’s wishes


Vertical coordinationMake or buy?

• Which is better: integration or agreement?– This is sometimes called the “make or buy” decision

• Example: Firm A is active in a single market– Refines oil into gasoline

• For every complement (upstream or downstream link in the supply chain), the firm can choose between:– Make (integration): do this business activity yourself

• E.g., develop an operation that finds oil & extracts it, or develop a chain of gas stations

– Buy (agreement): let others handle this operation (outsource)• Firm A buys oil from firm B, and sells refined gasoline to firm C


Vertical coordinationSpecialization & outsourcing

• Specialization generally reduces costs/increases value– Economies of scale– Accumulated experience– Full managerial attention– Decisions requiring trade-offs favor specialized product

• The value of specialization suggests that “buy” (outsource all activities except those in which you specialize) is a betteroption than “make” (do it all inside the firm)

• So why don’t we always outsource? Buyer/supplier power– If we outsource to a firm that has buyer/supplier power over us, they will be

able to extract most of the value pool


Vertical coordinationA response to buyer/supplier power

• Recall the newspaper hypo in section 1b2: a newspaper can be exploited because of a $10M transaction-specific investment connecting its editorial computers to the printing press. To prevent exploitation, it hires Jane (an experienced printer) as an employee. Jane receives a fixed salary. At the extremes:– Jane can work diligently, saving the newspaper expenses and producing a

better product– Jane can shirk, resulting in a more expensive, lower quality product

• What is Jane likely to do?


Vertical coordinationReducing shirking

• This is bad for the newspaper. Is it bad for Jane?• How can the newspaper ensure Jane works hard?


Vertical coordinationMonitoring

• Monitor Jane’s inputs– Problems with this?

• Why aren’t punch clocksused to monitor professors?

• Monitor Jane’s outputs– Problems?

• Benchmark• Proportionality to efforts


Vertical coordinationBonding

• Bonding – actions that align Jane’s incentives with those of the newspaper.– Successful bonding will result in Jane being worse off if she

doesn’t do what she promised (e.g., work hard).• E.g.:– Bonus (carrots)– Threat of getting fired (sticks)


Vertical coordinationAgency costs

• Agency costs are the sum of:– Monitoring costs

• Measuring the agent’s inputs/outputs• Identifying/calculating the benchmark• Risk allocation re effort-outcome relationship

– Inputs: Risk allocated to principal (proportionality to results)– Outputs: Risk allocated to agent (proportionality to efforts)

– Bonding costs• Cost of creating/maintaining the bonding mechanism• Cost of greater risk (e.g., income volatility) to agent

– Residual loss - the cost to the principal from the degree to which the agent shirks despite monitoring & bonding


Vertical coordinationThe transaction cost trade-off

• Risk of opportunism more significant with agreements– This risk tied to buyer/supplier power

• Buyer/supplier market power• Asset specificity (transaction-specific investment)

• Agency costs more significant with integration– Monitoring costs & bonding costs

• “Make vs. buy” depends on which cost is greater


Vertical coordinationOptimal form of combining activities

High Buyer/Supplier Power

LowAgency Costs

High Agency Costs

Leans toward integration(“make”)

Leans toward agreement

(“buy”)

Low Buyer/Supplier Power43 © Amitai Aviram. All rights reserved.

Vertical coordinationOptimal form of combining activities

Low B/SP

High B/SP

Low AC High AC

Spot Contract

Firm(Difficult to dissolve)

Long-term Contract

Relational Contract

Family(Relational Firm)

Leans toward integration

Leans toward agreement

Firm(Easy to dissolve)


CoordinationDeterrence

• Deterrence is a hostile form of coordination, in which a firm (F) sends a credible signal that a rival’s (R) unacceptable behavior (“trigger”) will bring a response from F that will cost R more than the benefit from the triggering event– Element 1: credibility – F must persuade R that F will respond even if the

response would be costly to it (e.g., losing money in a price war)• To maintain credibility, either the response must not be costly to F (rare), or F

must have “strategic inflexibility” (unable to avoid responding even if the response is costly)

– E.g., throwing steering wheel out of the window in a game of “chicken”– Element 2: force – response must cost R more than benefit from trigger• Tension with credibility (higher cost to R related to high cost to F)• Response may be any action that imposes a cost on R (foreclosure or attrition,

but likely attrition because F has to signal response, allowing R to better defend the target)

– Element 3: signal – trigger & response must be clearly communicated to R• Dr. Strangelove or: How I Learned to Stop Worrying and Love the Bomb (1964) (

http://www.youtube.com/watch?v=cmCKJi3CKGE) – US president discusses with Soviet ambassador the Doomsday machine45 © Amitai Aviram. All rights reserved.

http://www.youtube.com/watch?v=cmCKJi3CKGE


• Deterrence in business is often created by investing in production assets with high fixed costs & low variable costs– Element 1 – credibility: Once the asset (e.g., new production plant) is

purchased, firm has an incentive to operate it to full capacity, even if this lowers price below ATC, as long as it price is above VC

• Credibility is improved if the asset has no use in other lines of production & can’t be sold to others, so it can’t be sold or diverted to another market

– Element 2 – force: if F operates the productive asset in full capacity & lowers prices below ATC, firms operating in the market will lose money

• May not deter incumbent rivals (since exiting will cost them their investment in the market), but likely to deter potential rivals, since they lose nothing from not entering

– Element 3 – signal: F publicizes acquisition of new capacity



• R’s possible responses– Challenge credibility by

• Making small incremental provocations that just barely cross the trigger (each of which seems minor compared to cost of F’s action); or

• Counter-threatening (which increases the cost to F from confrontation)– Challenge force by reducing the harm from F’s response (e.g., reducing costs so

that R can profit even if F employs additional capacity)

• Failed deterrence results in costly confrontation; the commitment required for credible deterrence reduces F’s flexibility in such confrontations


ConfrontationDefinitions

• Players– Confronting firm (F)– Rival targeted for confrontation (R)– Another rival of F (R2)

• Terms– Actions: F’s actions or omissions that use F’s resources to impose costs on R

(e.g., cutting prices, “stealing” R’s customers, blocking R’s access to complements)– Resources: money and other assets that F’s actions require– Capitulation: R’s acceptance of F’s goals in return for stopping the confrontation

• Variables– Cost of confrontation to F (CF): this includes cost of resources plus harm to F’s

business activities as a result of the confrontation– Cost that F imposes on R if confrontation is successful (CR)– Benefit that F perceives it will receive from its goal (GF)– Cost that R perceives it will suffer if it capitulates to F’s goal (GR)– Probability that F’s confrontation is successful (GP)49 © Amitai Aviram. All rights reserved.

ConfrontationKey elements of confrontation plans

• Goal: purpose of the confrontation• Competitive advantage: F’s strategic competences exploited to impose CR

– Usually same as BTEs: restricting access to complements or to economies of scale/scope, or otherwise imposing disproportional costs

• Scope: extent of R’s activities that are targeted by F & extent of F’s resources devoted to confrontation– 3-way tradeoff between CR, GP & flexibility

• Example– F’s goal is to get R to raise its prices of widgets by 20%– F has competitive advantage of lower production costs– F decides to target only value (low-price) widgets (scope)– F cuts the prices of its value widgets (action), taking away sales from R and

reducing R’s economies of scale (market for premium widgets unaffected)– Due to F’s cost advantage, R does not expect to win a price war against F, so R

raises its prices by 20% and F ends the confrontation50 © Amitai Aviram. All rights reserved.

ConfrontationGoal: general purpose

• Usually: compel R to coordinate with F, on terms desirable to F– The conflict signals to R and/or other rivals F’s ability to retaliate for

undesirable behavior, which makes rivals conform to F’s wishes– This is usually the most sensible goal: renegotiating the balance of power

between F & R, or denying R’s attempt to renegotiate the balance of power• In rare circumstances, confrontation has other goals:

– Eliminate R• F causes R to exit the market• Risky & often wrong goal: extremely costly & eliminating R often strengthens

other rivals or opens way for new entrant– Reduce R’s ability to compete

• F denies R strategic competences (e.g., sufficient scale of operations)• Also risky goal: effect is often temporary (R finds ways to recover) & weakening

R often strengthens other rivals or opens way for new entrant


ConfrontationGoal: requirements for the specific goal

• Valuable: only if F can recoup CF after goal was achieved– Recoupment (GF) depends on market structure after confrontation ends– E.g., low BTEs prevent recoupment because once F tries to raise prices to

recoup confrontation costs, new entrants capture sales & lower prices– E.g., other rivals’ relative position – if R was a threat to R2, then R2 may become

a bigger threat to F after R is eliminated• Achievable: only if F is successful

– Ability to inflict CR > GR

– Tolerance for attrition (ability to sustain confrontation long enough to win)• Better access to capital• Management is able to ignore SHs’ desires (corporate governance)• SHs have goals other than profits (or have longer-term horizons for achieving profitability)

• If CR is insufficient to make the goal achievable, need to:– Define a more modest goal (reduces GR, but also reduces GF)– Increase confrontation scope (increases CR, but also increases CF and/or reduces GP)– Develop greater competitive advantage (increases CR, but hard to do & temporary)


ConfrontationGoal: common misperception

• Knee-jerk confrontation plans (in business & war)– Trigger for confrontation: R intentionally acts unfairly/immorally– Goal of confrontation: destruction of R’s fighting capability (unconditional

surrender)• This makes no strategic sense

– Utility of confrontation not limited to addressing intentional or immoral acts– No connection to ability to win the confrontation– Destroying R may hurt you (e.g., strengthen R2)

• So why is this approach so common?– Confrontation requires sacrifices; easier to justify sacrifices for

a total war– Day-to-day interactions require normative constraints on confrontation; need

justification to shake off constraints; justifications become the triggers of confrontation

– Facilitating deterrence: deterrence is made credible by a social norm that mandates confrontation in response to a norm violation, regardless of the expected outcome• But this can also backfire (e.g., confrontation with R reduces resources available to

deter R2)• Also limits F’s freedom to pick the best action when circumstances change


ConfrontationCompetitive advantage

• A competitive advantage is a strategic competence used by F’s actions to impose CR

– Impose CR > CF (either directly or by allowing F to “steal” R’s customers)– Increase F’s (or reduce R’s) tolerance for attrition

• Typically, competitive advantages raise BTEs for R but not for F (in antitrust terminology, this action is called foreclosure)– Limit R’s access to complements– Limit R’s ability to exploit economies of scale/scope– Otherwise impose disproportional costs on R– E.g., capturing the only, the main, or the early customers of a products (e.g.,

lobbying the government to be their supplier of fighter jets)• One way that competitive advantage negatively affects R but not F is

for F to use a different business model than R (so that it’s profitable for F to compete in a way that clashes with R’s business model)– E.g., Amazon enters the tablet market with business models that expects to profit

from a complement (online purchases), so tablets can be sold at cost. This clashes with Apple’s business model, which relies on profits from the tablets.54 © Amitai Aviram. All rights reserved.


• Example 1 (bottleneck): F controls a unique & necessary complement to the product F & R compete over– Without the complement, R can’t compete– Modified example 1 (“real foreclosure” – restriction but not elimination of

access to complement): F has exclusive access to the lowest cost/highest quality complements

• Example 2 (cartel ringmaster): F arranges a quid pro quo with the complement producers– F orchestrates a cartel between the complement producers, allowing them to

charge higher prices/avoid price cutting– In return, cartel members charge R higher prices than they charge F

• F is in good position to monitor cartel & punish deviation if it has a large market share, so cartel has interest in supporting F against R

– Modified example 2 (Frankenstein monster): instead of an inferior complement R faces an inferior market for complement• Example: Firm A & B manufacture widgets. There are only 3 retailers through

which they can sell the widgets. If Firm A signs an exclusivity agreement with two of them, Firm B can only work with one retailer, who will charge B as a monopolist (more than A has to pay)



• Sometimes foreclosure can be exercised through F’s “negative control” (e.g., blocking R from accessing the complement)

• Example: First railroad bridge over Mississippi River– Government Bridge: Rock Island, IL to Davenport, IA (1856)– Connected the Chicago & Rock Island Railroad (1854) with the

Mississippi and Missouri Railroad (1855)



• Who is attempting to foreclose whom? (a bit of trivia)– Fort Armstrong was built on Rock Island in 1816 as a frontier defense;

closed in 1836• Nonetheless, U.S. Secretaries of War claimed jurisdiction

over Rock Island– Jefferson Davis (Secretary of War under Franklin Pierce) tried to use his

jurisdiction to stop construction of the bridge• He sued for an injunction, but lost• Why would Davis oppose the bridge?

(Consider where commerce could go ifthere’s no bridge at Rock Island, IL)



• Who is attempting to foreclose whom? (a bit of trivia)– Two weeks after the bridge opens, a steamboat collides

with the bridge– Steamboat companies sue to have the bridge dismantled– Railroads hire lawyer Abraham Lincoln to defend them• In 1862, S.Ct. rules for the railroads

– What is plaintiff’s motivation in litigating this?


ConfrontationCompetitive advantage: foreclosure & attrition

• When F does not have the ability to foreclose R (make R’s business model unsustainable), F might still hope to win through attrition: actions that impose on R unacceptable losses (compared to GR)– One common situation involves F entering R’s most profitable market in order

to deflate R’s profits, so R is unable to threaten F’s key markets• E.g., Microsoft, threatened by Netscape’s potential to undermine Windows, creates Explorer

– Common attrition actions: price competition, litigation• Attrition is usually used when either:– F has greater tolerance for attrition (F is able to sustain losses better than R)– F has a favorable rate of attrition (inflicts greater loss on R than it costs F)• CR > CF (e.g., price war when F has lower costs than R)• F has lower sales than R, yet can drive down the price R receives

• R may respond by reducing confrontation to reduce attrition (e.g., reduce market share), increasing R’s tolerance for attrition or reducing F’s tolerance for attrition (e.g., get F SHs to rebel); counter-attacking where F is vulnerable

• Attrition is a risky plan (because it imposes high CF and strengthens R2), and is often the unintended result of a failed foreclosure plan


ConfrontationScope

• Scope is the extent of R’s activities that are targeted by F & extent of F’s resources devoted to confrontation

• Total war: why not 100% of resources against all of R’s activities?1. Uncertainty: F can’t be sure about CR, GP & GR (affecting success) or about CF ,

GF (affecting the value to F from success)2. Escalation: R could respond with a counter-attack on F, or R2 could attack F (to

exploit F’s commitment or to contain F)• Optimal scope (economy of effort) involves a 3-way tradeoff

between CR, GP & flexibility– To maximize CR target more of R’s activities– To maximize GP concentrate more resources on fewer targets (concentration of force)

– To maximize flexibility maintain a reserve of resources that aren’t committed to confrontation. Flexibility allows F to:• adjust plans that fail or become too costly• deter R/other rivals from escalating (since F can retaliate)• protect F’s activities from R/R2 (security)


a) Strategic traitsb) Differentiationc) Coordinationd) Confrontatione) Review (integrating the course’s components)



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Integrating course componentsThe analytical framework

• Strategy: creating a fit between the strategic environment and the firm’s strategic traits– Environment determines how much value is captured by market participants

(firm & rivals), at expense of customers & suppliers

– Strategic actions apply a firm’s strategic competences to capture a larger part of the market’s portion of VP, at expense of rivals


Value pool The strategic environment (competition)Substitution Entry Rivalry Supply chain

Total value created by biz activity Allocates the value pool between markets

Strategic traits Strategic actions

Strategic competences Differentiation Coordination Confrontation

Strategic rigidities Does rigidity: (1) prevent firm from exploiting a strategy?(2) allow rivals to exploit a strategy?

Reform (modifying strategic traits)

Integrating course componentsThe analytical framework

• The market analysis evaluates:– The strategic environment– Strategic traits (of either the “starting point” firm or all major players)– Strategic actions that exploit the traits to improve the environment

• Strategic actions (except modifying strategic traits) must rely on existing strategic competences

• Strategic actions cannot conflict with existing strategic rigidities

Value pool

[1d]

The strategic environment (competition)

Substitution [2c] Entry [2d] Rivalry [2e] Supply chain [2b]

MarginVolume

Market definition Economies of scale/scopeAccess to complementsImposing disproportional costs

Propensity for coordinationPropensity for differentiationPropensity for confrontation

Buyer/supplier MPAsset specificityPrice discrimination

Competences [3a] Differentiation [3b] Coordination [3c]/Confrontation [3d]

Rigidities [3a] Does rigidity: (1) prevent firm from exploiting a strategy? (2) allow rivals to exploit a strategy?

Reform [3a]


Integrating course componentsGeneric structure of the report

Part 1: Environmenta. Substitution

– Starting point product (SPP) [very specific]– Customer needs: why would a customer want the SPP? [very specific]– Customer benchmarks: how would customer tell if SPP adequately addresses needs?– Market definition (what products rate similar to SPP on customer benchmarks?)– Substitution directness: identify main rival products (closest substitutes within defined market)

b. Entry– Identify BTEs in your market (what prevents new firms from entering?)

c. Rivalry – Propensity for coordination (how likely is coordination within your market?)• One of the factors is concentration (market share/concentration calculations)

– Propensity for differentiation• Bases of competition other than price?

– Propensity for confrontation (examine firm-by-firm, discuss only if relevant)• Barriers to expansion, ability to impose BTEs on rivals, lower cost structure, near MES• Look for mavericks: firms that have an interest in confrontation• Consider potential competition: firms outside the market that can quickly & at low cost

produce a product in your market



Part 1: Environmentd. Supply chain

1. What is the supply chain in which your market is a segment?2. Supplier/buyer power• Market power: substitution, entry & rivalry in upstream/downstream markets

– Customer price sensitivity (if relevant)• Asset specificity (relationship-specific assets vulnerable to suppliers/buyers; if relevant)• Ability to price discriminate (if relevant)

e. Value pool (discuss only if relevant)– Do any segments of the market have significantly different (higher/lower)

margins or volume growth?f. Summary– Current constraints on profitability– Threats/opportunities (elements of the environment that are likely to change

or can be changed by the firm or its rivals) (if relevant & backed with evidence)



Part 2: Competitive dynamics (individual firms)a. Strategic traits: for the firm producing the SPP & each of the firms

producing the main rival products, identify -– Strategic competences (show they satisfy VRIO: value, rarity & organization)– Strategic rigidities

b. Strategic actions– Looking at the behavior of the firm & rivals in the recent past, identify events that

demonstrate strategic actions by them• I.e., how does firm/rival use its strategic traits to modify the business environment in its

favor (examples of differentiation, coordination or confrontation)– Discuss actions that actually occurred, not hypothetical actions– This section should take, in terms of space, more than each of the other sections


Integrating course componentsWriting a market analysis

• The business intelligence component (acquiring information)is integrated into each part of the report

• Support all elements of your analysis with evidence– Reference all evidence in footnotes– Where direct evidence is not available, use proxies & explain:

• Why it is a good proxy• When is the proxy biased & in which direction

• If the way you collected the data is not obvious from the reference, describe it in detail– Method is obvious from reference: book, article, webpage– Method is not obvious: survey (attach copy of survey, provide

data on who answered it); interview (attach notes, questions asked, etc.); self-examination (attach notes)


Integrating course componentsWriting a market analysis

• The big biz strategy questions rely on common sense– What makes this product good? (bases of competition; substitution)– If Acme’s product is profitable, why aren’t others copying Acme? (entry)– Will firms find it profitable to “play nice”? (rivalry)– Balance of power between firm, suppliers & customers? (supply chain)– How to exploit a firm’s strengths & weaknesses? (strategic actions)– How do we add value, cut costs, increase sales? (value pool)

• Implications– Detailed framework in this course helps you recognize common patterns, but

shouldn’t be a straightjacket– You can do a good job without a business background– Qualitative data can be just as good as quantitative data– Figure out what factors are most important in your industry and focus on them

(e.g., Standard Oil case: BTE for refiners & FC/VC for railroads)


Integrating course componentsCase study: Standard Oil


Case study: Standard OilMarket definition

• Starting point: Standard Oil’s kerosene• Kerosene is a high-quality illuminating product, mostly exported to Europe via

U.S. East Coast• Bases of competition: price only– Customer needs: lighting fuel, price as low as possible– Customer benchmarks• Lighting fuel: kerosene is a commodity; no quality variations• Price: location of rival products doesn’t affect their pricing by much– Oil produced mostly near Pennsylvania/Ohio border; refiners mostly in Cleveland

& Pittsburgh; major port cities are New York & Philadelphia– Refinery are close to oil wells & competition among railroads keeps

transportation cheap• Market definition: refining of crude oil into kerosene


Case study: Standard OilEnvironment

• Substitution: somewhat benign– Kerosene can be substituted with other illuminators, but has quality

advantages• Entry: threat

– Known & unpatented technology– Relatively low economies of scale & low capital requirements– Supply chain opportunities benefit entrants as well as incumbents

• Rivalry: threat– Participating firms: numerous– Low propensity to coordinate (fragmented industry & low BTE)– Lack of differentiation between products makes price competition fierce


Case study: Standard OilEnvironment

– Supply chain: benign

– Crude production• Competition: high– Substitution: low– Entry – low BTE– Rivalry – low concentration

• Asset specificity: not much (pipelines to oil fields)– Crude/kerosene transportation• Competition: high– Substitution: low until pipelines (transportation by horse impractical, by ship long

& requires land transport to Miss. River or Lake Erie)– Entry: high BTE (acquiring right of way & laying tracks is expensive)– Rivalry: high (high ratio FC/VC; very little differentiation – price almost only factor,

distance/time differences bw/railroads not significant for freight)• Asset specificity: not much (only when destination doesn’t have a union station)

Crude oil production

Crude transport Refining Kerosene

transportKerosene

export/wholesaleKerosene

retail


Case study: Standard OilFirm’s traits

• Strategic competence: Standard Oil is larger than rival refiners– Value• Benefit: normally size matters in exploiting economies of scale, but here it also

places Standard in superior position to police a railroad cartel– Detection: since it buys much of the oil & ships much of the kerosene, it can track

each railroad’s market share & prices to ensure compliance w/cartel– Punishment: if one of the railroads cheats, Standard Oil can punish by stopping to

ship its oil & kerosene via that railroad• Competitive superiority: rivals don’t have alternative trait making them superior

in policing cartels– Rarity• Imitability: right now no refiner is big enough to rival Standard Oil. Normally,

when BTE is low, rivals can quickly expand and become equally large, but here Standard Oil, as first mover, can get railroads to hinder rivals from expanding

– Organization: all value is captured by railroads, not by Standard Oil,so competence can only be used as part of quid pro quo with railroads


Case study: Standard OilStrategic actions

• Differentiation: not feasible (price is only basis of competition)– Strategic competences don’t provide Standard Oil much advantage on price– Branding the kerosene to make quality a basis of competition? (3rd best

option) [compare to GoDaddy.com]• Coordination: not desirable– Upstream/downstream markets not a threat

• Confrontation: cartel ringmaster is feasible– Foreclosure (cartel ringmaster) – this is what Standard Oil did (1st best option)

• Reform: bring in & capture government regulation of oil refining & transportation (2nd best option)


Case study: Standard OilStrategic action: cartel ringmaster

• Standard Oil– Environment threats: low BTE; high rivalry (price competition)– Strategic action: confrontation (foreclosure via cartel ringmaster plan)

• Railroads– Environment threats: high rivalry (price competition), otherwise benign

conditions (high BTE, low substitution)– Bring in an outside firm (Standard Oil) as cartel policeman to overcome high

rivalry• The deal– Standard Oil uses its competence (advantage in coordinating a railroad cartel)– In return, railroads charge Standard Oil’s rivals higher rates (allowing Standard

Oil to win the price competition & making entry unattractive)• Railroads have incentive to allow Standard Oil a large market share, because it

enhances its detection & punishment capabilities


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strategic rigidity

firms strategic traits

certain strategic actions

strategic competences

competence value

firms competence

organization firm

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