david bryce © 1996-2002 adapted from baye © 2002 the power of suppliers manec 387 economics of...

David Bryce © 1996-2002Adapted from Baye © 2002


The Power of SuppliersThe Power of Suppliers

MANEC 387Economics of Strategy

MANEC 387Economics of Strategy

David J. BryceDavid J. Bryce



The Structure of IndustriesThe Structure of Industries

Competitive Rivalry

Threat of newEntrants

BargainingPower of

Customers

Threat ofSubstitutes

BargainingPower of Suppliers

From M. Porter, 1979, “How Competitive Forces Shape Strategy”



Market Supply CurveMarket Supply Curve

• The supply curve shows the amount of a good that will be produced at alternative prices.

• Law of Supply – The supply curve is upward sloping

• The supply curve shows the amount of a good that will be produced at alternative prices.

• Law of Supply – The supply curve is upward sloping

Price

Quantity

S0



What Shifts Supply?What Shifts Supply?

• Input prices• Technology or government regulations• Number of firms• Substitutes in production• Taxes• Producer expectations

• Input prices• Technology or government regulations• Number of firms• Substitutes in production• Taxes• Producer expectations



The Supply FunctionThe Supply Function

• An equation representing the supply curve:

QxS = f(Px , PR ,W, H,)

– QxS = quantity supplied of good X.

– Px = price of good X.

– PR = price of a related good

– W = price of inputs (e.g., wages)– H = other variable affecting supply

• An equation representing the supply curve:

QxS = f(Px , PR ,W, H,)

– QxS = quantity supplied of good X.

– Px = price of good X.

– PR = price of a related good

– W = price of inputs (e.g., wages)– H = other variable affecting supply



Change in Quantity SuppliedChange in Quantity Supplied

Price

Quantity

S0

20

10

B

A

5 10

A to B: Increase in quantity supplied



Price

Quantity

S0

S1

8

5 7

S0 to S1: Increase in supply

Change in SupplyChange in Supply

6



Producer SurplusProducer Surplus

• The amount producers receive in excess of the amount necessary to induce them to produce the good.

• The amount producers receive in excess of the amount necessary to induce them to produce the good.

Price

Quantity

S0

Producer Surplus

Q*

P*



Market EquilibriumMarket Equilibrium

• Balancing supply and demand

QxS = Qx

d

• Steady-state

• Balancing supply and demand

QxS = Qx

d

• Steady-state



Price

Quantity

S

D

5

6 12

Shortage12 - 6 = 6

6

If price is too low…If price is too low…

7



Price

Quantity

S

D

9

14

Surplus14 - 6 = 8

6

8

8

If price is too high…If price is too high…

7



Applications of Demand and Supply AnalysisApplications of Demand and Supply Analysis

• Event: The WSJ reports that the prices of PC components are expected to fall by 5-8 percent over the next six months.

• Scenario 1: You manage a small firm that manufactures PCs.

• Scenario 2: You manage a small software company.



Scenario 1: Implications for a Small PC MakerScenario 1: Implications for a Small PC Maker

• What happens to your business? Do prices rise or fall? Are profits likely to rise or fall?

• What happens to your business? Do prices rise or fall? Are profits likely to rise or fall?



Priceof

PCs

Quantity of PC’s

S

D

S*

P0

P*

Q0 Q*

Big Picture: Impact of decline in component prices on PC marketBig Picture: Impact of decline in component prices on PC market



Scenario 2: Software MakerScenario 2: Software Maker• More complicated chain of reasoning to

arrive at the “Big Picture”• Step 1: Use analysis like that in

Scenario 1 to deduce that lower component prices will lead to– a lower equilibrium price for computers– a greater number of computers sold.

• Step 2: How will these changes affect the “Big Picture” in the software market?

• More complicated chain of reasoning to arrive at the “Big Picture”

• Step 1: Use analysis like that in Scenario 1 to deduce that lower component prices will lead to– a lower equilibrium price for computers– a greater number of computers sold.

• Step 2: How will these changes affect the “Big Picture” in the software market?



Priceof Software

Quantity ofSoftware

S

D

Q0

D*

P1

Q1

Big Picture: Impact of lower PC prices on the software marketBig Picture: Impact of lower PC prices on the software market

P0



Suppliers and PerformanceSuppliers and Performance

• Firms incur costs as they use inputs to produce outputs

• Suppliers are our sources of inputs– Materials– Technology/Equipment– Labor– Management

• Suppliers have power to raise our input costs through the strength of their bargaining power

• Firms incur costs as they use inputs to produce outputs

• Suppliers are our sources of inputs– Materials– Technology/Equipment– Labor– Management

• Suppliers have power to raise our input costs through the strength of their bargaining power



The Power of SuppliersThe Power of Suppliers

Suppliers have bargaining power over firms when:• Supplier’s products are highly differentiated• Suppliers are not threatened by substitutes• Suppliers threaten forward vertical integration• Supplier’s products are a large fraction of a

firm’s final costs• Firms in an industry are relatively unimportant

customers of the supplier – low purchasing volumes, high switching costs, supplier product important to quality of product

Suppliers have bargaining power over firms when:• Supplier’s products are highly differentiated• Suppliers are not threatened by substitutes• Suppliers threaten forward vertical integration• Supplier’s products are a large fraction of a

firm’s final costs• Firms in an industry are relatively unimportant

customers of the supplier – low purchasing volumes, high switching costs, supplier product important to quality of product



Manager’s RoleManager’s Role

• Procure inputs in the least cost manner

• Provide incentives for workers to put forth effort

• Failure to accomplish this results in a point like B

• Procure inputs in the least cost manner

• Provide incentives for workers to put forth effort

• Failure to accomplish this results in a point like B

$100$100

80 80

OutputOutput

CostsCosts

BB

AA

TC(Q)TC(Q)

QQ



Methods of Procuring InputsMethods of Procuring Inputs

• Spot Exchange– When the buyer and seller of an input meet,

exchange, and then go their separate ways.

• Contracts– A legal document that creates an extended

relationship between a buyer and a seller.

• Vertical Integration– When a firm shuns other suppliers and

chooses to produce an input internally.

• Spot Exchange– When the buyer and seller of an input meet,

exchange, and then go their separate ways.

• Contracts– A legal document that creates an extended

relationship between a buyer and a seller.

• Vertical Integration– When a firm shuns other suppliers and

chooses to produce an input internally.



Key Features of Procurement MethodsKey Features of Procurement Methods

• Spot Exchange– Specialization, avoids contracting costs,

avoids costs of vertical integration.– Possible “hold-up problem”

• Contracting– Specialization, reduces opportunism, avoids

skimping on specialized investments– Costly in complex environments

• Vertical Integration– Reduces opportunism, avoids contracting

costs– Lost specialization, organizational costs

• Spot Exchange– Specialization, avoids contracting costs,

avoids costs of vertical integration.– Possible “hold-up problem”

• Contracting– Specialization, reduces opportunism, avoids

skimping on specialized investments– Costly in complex environments

• Vertical Integration– Reduces opportunism, avoids contracting

costs– Lost specialization, organizational costs



Transaction CostsTransaction Costs

• Costs of acquiring an input over and above the amount paid to the input supplier – includes:– Search costs– Negotiation costs– Other required investments or expenditures

• Costs of acquiring an input over and above the amount paid to the input supplier – includes:– Search costs– Negotiation costs– Other required investments or expenditures



Specialized InvestmentsSpecialized Investments

• Investments in “specific assets” made to allow two parties to exchange

• Specific assets have little or no value outside of the exchange relationship– Site specificity– Physical-asset specificity – Dedicated assets– Human capital

• Lead to higher transaction costs and the problem of “holdup”

• Investments in “specific assets” made to allow two parties to exchange

• Specific assets have little or no value outside of the exchange relationship– Site specificity– Physical-asset specificity – Dedicated assets– Human capital

• Lead to higher transaction costs and the problem of “holdup”



The Problem of HoldupThe Problem of Holdup



Specialized Investments and Contract LengthSpecialized Investments and Contract Length

MCMC

L0L0

$$

Contract LengthContract LengthL

1

L1

MB1MB1

Longer ContractLonger Contract

Due to greater need for specialized

investments

Due to greater need for specialized

investmentsMB0MB0



Optimal Input ProcurementOptimal Input Procurement

Substantial specialized investments relative to contracting

costs?

Spot ExchangeNoNo

Complex contracting

environment relative to costs of

integration?

YesYes

Vertical Integration

Vertical Integration

YesYesNoNo

ContractContract



Suppliers of Labor & ManagementProblems of the Agency Relationship

Suppliers of Labor & ManagementProblems of the Agency Relationship

• Agency relations exist when a “principal” delegates binding decision-making authority to an “agent” – e.g., stockholders delegate to executives; managers delegate employees

• Agency problems arise when– Agent has different incentives than the principal– It is costly to monitor the agent’s behavior

• Agency theory designs governance mechanisms to align the incentives of the principal and the agent

• Agency relations exist when a “principal” delegates binding decision-making authority to an “agent” – e.g., stockholders delegate to executives; managers delegate employees

• Agency problems arise when– Agent has different incentives than the principal– It is costly to monitor the agent’s behavior

• Agency theory designs governance mechanisms to align the incentives of the principal and the agent



The Principal-Agent ProblemThe Principal-Agent Problem

• Occurs when the principal cannot observe the effort of the agent– Example: Shareholders (principal) cannot

observe the effort of the manager (agent)– Example: Manager (principal) cannot observe

the effort of workers (agents)

• Problem – principal cannot determine whether a bad outcome was the result of the agent’s low effort or due to bad luck

• Occurs when the principal cannot observe the effort of the agent– Example: Shareholders (principal) cannot

observe the effort of the manager (agent)– Example: Manager (principal) cannot observe

the effort of workers (agents)

• Problem – principal cannot determine whether a bad outcome was the result of the agent’s low effort or due to bad luck



Solving the Problem Between Managers and WorkersSolving the Problem Between Managers and Workers

• Profit sharing• Revenue sharing• Employee stock options• Piece rates• Commissions• Bonuses• Time clocks and spot checks

• Profit sharing• Revenue sharing• Employee stock options• Piece rates• Commissions• Bonuses• Time clocks and spot checks

david bryce © 1996-2002 adapted from baye © 2002 the power of suppliers manec 387 economics of...

Documents

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bryce slide

price of good

supply change

price quantity s d

supply function

market supply curve

demand q x s