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STR203 Midterm Study Guide

by: Danielle Katan

STR203 Midterm Study Guide STR203

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Study guide for the STR203 Midterm covering the first half of the course.
Economic Theory of Organizations
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This 23 page Study Guide was uploaded by Danielle Katan on Sunday February 28, 2016. The Study Guide belongs to STR203 at a university taught by Gilbert in Spring 2016. Since its upload, it has received 112 views.

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Date Created: 02/28/16
  Basic  Definitions     STR  203  –  Using  economic  concepts  to  solve  important  organizational  problems,   which  include  understanding  and  development  of  corporate  strategy,  execution,   performance  evaluation  and  compensation  systems   Organization  –  group  of  individuals  working  toward  common  purpose  to  create  and   deliver  benefits  to  its  constituents     • Set  goals,  allocate  resources     Business  –  a  discrete  collection  of  individuals  working  together  to  create  and   deliver  customer  benefits  via  products  and  services.   Strategy  –  about  crating  greater  value  for  a  customer;  iterative  process     Value  –  is  a  function  of  choices;  how  well  customers  needs  are  being  met   Core  Competencies  (set  of  activities)  –  something  the  company  does  especially  well   or  can  learn  to  especially  well  compared  to  rivals;  something  competitors  don’t   have/have  difficulty  matching       Firm  –  a  group  of  individuals  who  coordinate  activities  to  complete  a  project  or  task       Important  People/Ideas   Adam  Smith  (1700s)  –  Invisible  hand  (lack  of  market  power)     Ronald  Coase  (1930s)  –  Why  do  firms  exist?     Joseph  Schumpeter  (1940s)  –  Creative  destruction     Modern  Industrial  Study/Consulting  Groups  (1960s)  -­‐  GE/McKinsey     • GE/McKinsey  nine-­‐block         Williamson   Meckling/Jensen       Strategy  –  military  origins     Does  a  company  have  moat  protecting  from  comp?  “Secret  sauce”   • Ex.  Intel,  Qualcomm,  Sony  (had  a  moat  but  lost  to  LG/Samsung),  Coca-­‐Cola     • Wal-­‐Mart    (other  low  cost  competitors  but  no  one  has  replicated  their   formula  successfully)   o Started  in  small  (~5,000-­‐25,000  person)  towns,  “state  by  state”  –Sam   Walton   o Went  to  towns  that  didn’t  have  any  competition,  geographic   segmentation,  didn’t  have  any  big  stores,  put  small  businesses  out  of   business,  distribute  to  other  locations,  connect     o Capture  economies  of  scale     o Can  lower  prices  and  hold  out  longer  than  small  stores     o Fast  production  process-­‐  helps  them  stay  ahead     o Learning  curve  –  as  production  volume  doubles,  direct  cost  per  unit   decreases  substantially  (log  scale)     • Six  Flags  –  amusement  park     o In  competition?  With  theme  parks?     o Why  moat?   § Many  locations  (18  parks)     § Population  density     § Cost  $300+  million  to  start  a  new  park       Two  sides  to  every  market-­‐  buyers  and  seller     Meeting  needs  of  a  customer:     • Functionality  –  uniqueness     • Delivery     • After  market  support     • Price  of  the  product  or  service     • ^^  Package  that  makes  value  proposition       Opportunities  to  create  value:     • Novelty  of  design  or  style,  availability,  ruggedness,  after  market  care,  ease  of   use,  functionality,  price  (including  quantity  discounts)     • These  factors  combine  to  crate  value  for  a  customer       “Aim  [is]  to  locate  portions  of  the  market  [whose  needs]  are  unserved  or   underserved.”  -­‐Spark  innovation  through  empathic  design  1997  HBR,  Leonard  +   Jaworski   • 86%  of  businesses  deemed  “incremental”  or  “me  too”  improvements,  75%  of   those  fail     • If  a  firm  cannot  find  unserved/underserved  area  of  market  à  use  low  prices   to  attract  customers     Creating  Market  Opportunity  –  finding  a  new  company’s  “space”  in  marketplace   requires  analysis     • Current  needs  of  customer,  how  needs  are  being  met  à  whether  the   customer  receives  value     • Understand  cost  structure     • Understand  costs  of  competitors   o Visit  location  of  rival  (ex.  count  number  of  cars  in  parking  lot)   § Note  start  and  end  times,  labor  salary  ranges  based  on   position,  salary  ranges  for  managerial  positions,  local   unemployment  rates/salary  adjustments  in  past  year,  inflation   in  the  area     § Cost  of  factory  space  sqf.  –  real  estate  taxes,  utilities     • “The  essence  of  strategy  is  choosing  to  perform  activities  differently  than   rivals  do”     Charlie  Guth  –  accidentally  saved  Pepsi     • Changed  bottle  size,  increased  to  12  oz.  from  6  oz.,  and  increased  price  to  10   cents  rather  than  5  à  failed     • Chose  to  cut  price  of  large  bottle  to  5  cents,  same  as  6  oz.  Coke     o Concluded  would  save  money  by  purchasing  less  glass     o Idea  took  off     • Coca  Cola  had  large  market  share,  didn’t  lower  prices,  sacrificing  margins     What  causes  D  curve  to  shift?     • International  markets     • Social  trends     • Emerging  shifts  (want  to  look  ahead)     Ex.  Toyota  hybrid  cars  –  Prius,  built  cars  around  changing  world     Ex.  BASF  –  plastic  manufacturers,  bought  oil  fields  to  reduce  costs     Elasticity  of  Demand  –  price  sensitivity,  increase  in  demand  due  to  change  in  price   (reduction)  that  causes  revenues  to  increase     • If  total  revenue  doesn’t  increase  why  lower  your  price?     Inelasticity  of  Demand  –  price  insensitivity     Factors  affecting  elasticity:  alternatives/substitutes,  commodity  like  attributes     Inelasticity  –  capture  more  consumer  surplus     Factors  affecting  elasticity  –  few  substitutes,  high  switching  costs     Willing  to  accept  some  of  customer  cost  –  make  supplier  more  attractive     Ex.  Wegmans/Tops  merchandiser  from  suppliers,  don’t  need  employee   stocking  –  trade  off     Eyeware  delivery  –  care  about  delivery;  price,  quantity     Understand  customers  real  cost  –  make  it  part  of  yours  then  work  it  out  of  the   system     Customers  will  pay  a  premium  for  what  they’re  looking  for;  lower  total  cost     Understand  customer  profile     • Budget  limitations/extra  income     Why  did  McDonalds  start  serving  breakfast?  Economies  of  scale     Costs     • Fixed  inputs   o Big  capitol  expenditures,  ex.  equipment     o Building  operating  costs  (insurance,  within  a  range  heat,  light)   o Costs  that  doesn’t  depend  on  quantity     • Variable  inputs     o Labor,  materials  (to  make  the  product),  supplies  (consumables)   o Costs  directly  related  to  quantity  produced     • All  costs  are  variable  in  the  long  run  (not  short  run)     Porter  –  What  is  Strategy?     • 3  primary  strategies:     o Perform  different  activities     o Perform  the  same  activities  in  different  ways     o Identify  undeserved  groups     • Perform  activities  differently  than  rivals  do;  maintaining  differences     • Difference  between  operational  efficiency  and  strategy;  operational   efficiency  is  a  type  of  strategy     • Do  enough  people  respect  your  business  that  you’ll  make  a  market?     o Ex.  Distinguishing  factors  that  make  a  customer  chose  one  product   over  another:     § Samsung  –  writing  notes  on  phone     § Blackberry  –  security     o Deliver  greater  value  or  comparable  value  at  a  lower  cost     o Similar  but  different     Why  not  every  customer?  Why  just  some  customers?     Functionality,  uniqueness,  quality,  delivery,  support,  price  >  value  proposition     Value  is  a  function  of  choices     • Somewhat  individualized,  do  better  job  meeting  needs     Look  for  opportunity,  ex.  novelty  of  design,  ruggedness,  many  factors   Locate  underserved/un-­‐served  markets     Reduce  price  à  reduce  revenue  further  rather  than  increase  –  Priceline     Price  is  not  strategic     Customer  profile  à  most  important;  underserved  market  segments     Create  more  value  during  periods  of  low  demand     Ex.  Happy  hour,  kids  eat  free     Capture  more  consumer  surplus     Accept  some  of  customer  costs  added  to  own     Understanding  business  landscape  –  world  around  us     Competition  à  encourage  companies  to  perform  at  higher  level       Porter  –  How  Competitive  Forces  Shape  Strategy     • Understand  business  landscape  and  competitive  advantage   • What’s  around  us       • Do  we  enter  the  market  or  not     o Some  industries  more  competitive     • Competition  encourages  a  company  to  perform  at  a  higher  level     • More  choices  for  consumers  à  better  value     • Competition  reduces  margins  for  suppliers     • Competitive  landscape  and  its  boundaries     o Geography,  customers  and  their  end  markets,  type  of  distribution,   functionality   • 5  constituents  in  any  market:  New  entrant,  customer,  substitute,  suppliers,   firm  &  rival     o Only  so  much  profit  can  be  created,  limited     • 5  constituents  –  all  profit  split  among  them     Porters  5  forces:             Mapping  market  attractiveness     • Gathering  information     o Important  to  best  understand  segment  being  considered     o Decide  whether  should  enter  market     Industry  definition     • How  interesting  is  the  industry?   o Is  it  growing?  At  what  rate?     o Who  are  current  direct/indirect  competitors     § Ex.    Indirect  Competition  -­‐  Wegmans,  sells  some  pet  food  but   isn’t  a  direct  competitor  with  pet  stores     o Substitutes  –  similar  and  identical     o Strong  buyers     o Strong  suppliers     • Horizontal  analysis:   o Does  the  industry  intersect  other  segments?     o Does  geography,  proximity,  to  possible  customers  matter?     • Vertical  analysis:     o Interlocking  supply     o Distribution  channels     Are  the  customers  the  right  one?   • Customer  profile?     • Customer  value  most?     • Customers  buying  pattern/habits?     • Is  the  firms  message  clear?     • Have  to  make  some  selections,  can’t  be  everything  for  everyone     • Understand  if  you  make  a  profile  with  certain  customers  and  not  others     Factors  that  determine  correct  customers:     • Speed  of  delivery     • Seamless  quality     • Breadth  of  choices     • Geographic  footprint     • Amount  of  inventory  carried     • Prices     • Material  management     • Test  systems   • Process  technology     Groups  with  unusual  power:     • Suppliers  that  have  a  large  portion  of  cost  structure,  usually  materials     • Supplier  capturing  majority  of  industry  value:   o Intel  chips  (semiconductors)     o Microsoft  (operating  system)   o Boeing  (aircraft)   o A  lot  of  buying  power     o Walmart-­‐  large  buying  capabilities     o Sam’s  club  –  owned  by  same  people,  coordination     o Costco     o General  Electric     o Disney     • Buyers  who  have  larger  market  share  (firms  as  buyers)   • Ex.  GE  both  supplier  and  buyer,  90%  of  freight  train  market  share     • Market  share  à  buying  power;  figure  out  how  to  close  gap  with  competition     Gap  analysis  à  closing  the  gap     • Dissection  of  competitor     o Focus  on:  operating  efficiency,  profit  margins,  cash  flow     • Developing  financial  models  to  estimate  rivals  production  and  overhead   costs   o Location/plant  cost     o Hourly  wages     o Exempt  wages/position     • Analytical  tools,  compare  firm  and  rivals  in  the  industry:   o ROA,  Asset  turnover,  Days  of  Inventory,  not  inventory  turn,  ROE,  DSO,   DPO,  Profit  Margin  %     Rivals     Most  observable:   • Historical  references  and  implications     • Quickest  way  for  value  dissipation  to  take  place     • Some  employee  swap   Many  rivals:     • More  competitive  and  commoditized     • Refrain  from  aggressive  behavior  to  manage  everyone  else’s  behavior,   similar  to  an  oligopoly     • Any  price  changes  will  be  felt  throughout,  cause  everyone  to  change  their   prices;  notice  and  react     Small  number  of  rivals:     • Behavioral  changes  will  go  unnoticed  by  rivals     o Failed  assumption  for  any  period     o Unnoticed  changes     o Equilibrium  and  balance     Dominant  rival  –  big  player  in  market,  controls  price,  “enforcer”   • Ex.  Saudi  nation  controls  gas  prices  -­‐  gas  prices  are  low  as  a  result  of   lowering  prices  to  hurt  smaller  rivals  trying  to  play  around/work  with   competitors   Two  categories  of  rivals:     • Similar  but  not  equal  (capability,  size,  customer  focus,  geographic  breadth)     • Similar  (lumber,  paint,  nails,  bolts)     o Truer  rivals,  fewer     Understanding  rivals     • Position  costly  to  exit/change,  they  view  portion  of  business  to  be  key   importance,  less  likely  to  change  or  exit     o Likely  to  be  more  aggressive     o Entrenched  behavior  à  opportunity     Southwest  Airlines     • How  does  the  airline  industry  compete?  (points  of  competition)     o Price     o Meals     o Seating  [class  and  choices]   o Entry  and  exit  process     o Lounges     o Hub  connectivity     o Friendly  service     o Speed  [time  to  destination]   • Point  to  point  vs.  spoke  and  hub     o Had  some  spoke  and  hub  because  of  acquisition     • Points  of  competition  –  price,  meals,  seating,  etc.;  end  up  being  investment   areas     • Decided  on  one  class  of  service,  eliminate  extras     o Improve  operating  margins     • They  value  –  friendly  service,  convenience  (storage),  more  departures,   increase  experience,  simple  and  cool     • Presented  attributes  differently  but  same  business,  convenience     • Picked  point  to  point,  fewer  locations     • Secondary  airports  –  lower  cost,  less  traffic/  hassle,  concentration  of  spare   parts  (only  use  one  kind  of  plane)     o Walmart  also  uses  secondary  locations  –  money  in  the  methodology     • Accountability  –  employees  on  flight  to  assure  service/audit     • Strategy  à  what’s  important  to  customer  is  also  important  to  staff     • Driven  by  speed,  arriving  at  destination  on  time     Messaging  has  to  match  delivery,  execution  tied  to  performances     Margins  –  study  and  understand  other  competitors     Analytics  are  very  important  for  decision-­‐making       Supplier  power  –  protected,  advantage     • Legal  –  copyright/patent  position     o Patents  are  publically  available  while  under  review,  companies  are   getting  smarter  about  releasing  method  patents,  keeping  more  things   internally     • Physical  –  location,  etc.     • Knowhow     o Ex.  Southwest  airlines  method  –  did  actions  that  all  airlines  do   differently     • Contracts     Security  –  intranet  within  companies,  difficulties  for  cloud  computing     Buyers  –  care  about  whether  product  meets  requirements/distribution  capabilities,   different  than  a  consumer  who  may  care  about  brands     Threat  of  new  entrant  –  barriers  restricting  entry,  ex.  Legal,  physical,  knowhow,   capital  intensity     Threat  of  a  New  Entrant     • Industry  profitability  is  not  stable     o Can  be  influenced  by  new/existing  rivals     o Whenever  profits  adjusted  for  WACC  (weighted  average  cost  of   capital)  are  >  0  new  entrants  are  possible     • Barriers  to  entry  –  factors  that  prevent/delay  new  companies  from  entering   the  market     o Legal     o Physical     o Knowhow     o Capital  intensity     o Brand  identity     o Economies  of  scale     o Distribution  presence     o Product/service  offering     o Limited  number  of  key  customers       Schumpeter  and  creative  destruction  –  The  Theory  of  Economic  Development   (1912)   • Focused  on  growth  of  the  economy     o Economic  recessions/depressions  as  cleansing  –  remove  inefficient   firms     o Prepare  economy  for  growth  with  only  sustainable  firms     o Most  growth  from  new  firms     • Entrepreneurial  innovation  =  growth  engine     • Importance  of  new  entrants     • Schumpeter  –  entrepreneurs  create  value;  new  capability,  delivery  system  or   ease  of  use     o Thought  recessions  were  good,  force  certain  underperforming  firms   out  of  system     o Reshaping  attributes  delivered  to  a  customer     o Inventions  –  high  risk  factor  vs.  innovation  –  new  feature     o Different  configuration  creates  opportunity     o Didn’t  use  the  word  “entrepreneur,”  rather  individual  risk  takers     o Encourage  competition  à  drives  innovation     Schumpeter  x  Porter     • (S)  New  capability,  new  delivery  system  or  ease  of  use     • (P)  Reshaping  attributes  delivered  to  a  customer.  The  attributes  are  the  same   as  rivals  –  configuration  creates  opportunity     Clayton  Christensen  –  Disruptive  technology     Used  to  take  108  men  5  days  to  fill  a  ship  with  timber,  now  it  takes  8  men  1  day   (introduction  of  machinery  and  containers)  –  creative  destruction     Kodak  –  new  market  (slightly  digitized  products)  wasn’t  growing  as  quickly  as  the   older  film  market  had     • Saw  digital  camera  being  a  future  force,  invested  in  R&D,  developed  first   million  pixel  sensor   o Were  trapped,  didn’t  see  how  quickly  the  market  would  grow     o Had  the  technology  but  didn’t  move  fast  enough,  didn’t  view  the   market  to  grow  as  rapidly     • Took  huge  revenue  cuts,  needed  cash,  took  blows  to  cash  flow     o Decrease  dividends,  corporate  spending   • “When  you  come  to  a  fork  in  the  road,  take  it!”  –Yogi  Berra     • Should  have  promoted  digitized  products  as  a  separate  brand,  or  license  out   technology  to  other  photo  giants     Organizations  don’t  have  smooth  paths,  “lurching  forward”     Not  everything  that  changes  is  creative  destruction  –  first  isn’t  necessarily  best     Many  early  tech  developments  not  successful       Ex.  Apple  early  table,  the  “Newton”  or  video  chat  phones   Important  how  you  shape  product  in  marketplace,  ex.  Corporate  vs.  personal   intended  use/price  range     Gerber-­‐  population  births  going  down,  developed  new  product  “Gerber  Singles”     Everything  developed  is  not  necessarily  an  advance     Economic  perspective:     • Buyer  power  –  buyer  size  vs.  industry  as  a  whole,  and  buyer’s  margins     • Seller  –  similar  substitutes,  cost  of  switching     • Rivals  –  growth  rate  of  industry,  intensity     o High  fixed  costs?  Struggle  if  revenue  decreases     • New  entrants  –  unrecoverable  capital  from  startup,  prices  lowered?  How   similar  are  alternatives?     • Value/price  –  trying  to  capture  consumer  surplus     Who  gets  the  surplus?   • Buyers  and  sellers  –  haggling  determines  who  gets  surplus     o If  buyer  understands  sellers  cost  structure  or  company,  can  put  up  a   better  argument     • More  buyers  (2  buyers  1  seller)  –  seller  is  the  monopolist  and  likely  to  retain   much  of  the  value    *correction*   o 2  buyers  compete  for  price   o Buyer  power  –  depends  on  market  share;  strength  if  large  part  of   market  or  they  have  info  that  can  capture  greater  reward     § Buyers  have  greater  strength  if  they  are  large  part  of  the   market  or  if  they  have  info/knowledge  that  can  capture  greater   reward     • More  sellers  (1  buyer  2  sellers)  –  buyer  gets  surplus,  sellers  compete  and   drive  prices  down         Shumpeter  –  concept  of  innovation   • New  delivery  system  or  ease  of  use     • Reshape  rivals,  “reconfiguration  creates  opportunity”   Seller  is  a  monopolist  à  captures  most  of  the  value     Chapter  3  –  economic  profits  for  Airline  and  Pharmaceutical     • Airline  –  big  guy  losers,  little  guys  relative  winners     o Highly  elastic,  consumers  won’t  buy  tickets  if  the  price  goes  up   slightly;  not  a  necessity     • Pharmaceutical  –  big  guy  winners,  little  guy  relative  losers       o Inelastic,  actual  need  for  products,  few/bad  substitutes     o High  R&D  costs,  patents  (not  key  point  but  additional  factor)   • Second  important  consideration:  contract/fixed  determined  relationship   with  pharmaceuticals     • Airlines  have  a  different  contract  relationship   Must  understand  firms/rivals’  competitive  advantage  as  they  see  them     • Create  competitive  advantage  à  start  with  economic  profit  of  the  industry     o Industry  EP  may  be  more  or  less  than  average  across  all  industries     § Each  industry  has  own  characteristics     • Firm  can  perform  relatively  higher  than  average  of  other  industries     o Company’s  comparative  advantage  influences  outcome  within  the   industry   o Ex.  Southwest  Airlines  vs.  the  valance  of  the  U.S.  industry,  didn’t  play   by  others  rules       Competitive  Position   Assessing  competitive  position:     • Cost  analysis     • Differentiation  appreciation     • Added  value     • Cost  benefit  trade-­‐offs,  experience     Economic  profit  might  be  out  of  phase  with  other  industries     • Ex.  Oil  &  Gas  industries  being  crushed,  used  to  be  hugely  lucrative,  within  any   industry  there  are  times  that  are  more/less  attractive  or  earn  higher  or  lower   profits;  firms  act  in  their  own  best  interest     • Ex.  Southwest  didn’t  play  by  certain  rules;  other  airlines  would  reschedule   their  passengers  on  other  airlines’  flights  if  they  had  delays,  Southwest  didn’t   abide;  operated  differently;  invested  in  different  activities     Little  Debbie  –  effort  to  automate,  understood  competitive  position     • Defined  self  for  price  à  value;  stole  large  amount  of  market  share     • Understood  attributes  that  customers  need/want  through  multi-­‐step   analytical  process     o Step  1:  Find  variables     o Step  2:  Rate  yourself  and  competition  against  variables     • Have  to  lower  costs  to  offer  lower  prices     Look  at  a  company  and  costs  (centers  per  unit)       Try  to  minimize  costs,  ex.  transportation  &  preservation  to  increase  shelf  life     McKinsey  consulting  –  helped  struggling  large  companies,  focus  on  costs     • Focused  on  cost  drivers  (what  incurred  additional  costs)   o Disaggregated  a  businesses  cost  structure  across  business  units  or   product  lines     o Assessed  how  costs  were  developed  (drivers)   § Costs  divided  into  raw  materials  cost  and  ‘cost  added’   • Costs  added  =  ‘activiites’   § Looked  for  opportunities  to  capture  ‘scale’  effect  and   simplification   § Allocation  methods  –  especially  services  used  by  more  than   one  product  line     • Separate  raw  materials  from  everything  else  –  is  there  a  way  to  buy  cheaper   or  outsource?     • Capture  “scale”  effect  and  simplification     • Allocation  methods  (accounting)   • Benefit  -­‐  more  information  for  managerial  decisions,  more  accountability  and   more  coordination  from  various  parts  of  the  organization     • Risks  –  long  process;  delays;  customer  decision  made  by  numbers,  not   relationship     There  is  give  and  take  with  customers  &  company/buyers  &  suppliers     Bain  –  economies  of  scope     • Thought  about  problem  of  assessing  competitive  position  and  advantage   from  a  market  perspective     • Emphasis  of  economies  of  scope  vs.  scale     • Recognized  it  costs  more  to  attract  a  new  customer  than  to  retain  an  existing   one   • Economies  of  scope  –  value  in  representing  multiple  products  to  a  single   customer;  one  person  to  many  items     o Costs  more  to  attract  new  customers     • (Versus)  Economies  of  scale  –  cost  advantages  due  to  size  of  the  operation;   one  item  to  many  people     • Bottom  line  –  get  some  of  consumer  surplus     Differentiation  –  analyze  competitive  position  by  looking  at  customer     • Segment  of  the  served  market  vs.  the  defined  customer  profile,  who  should   be  the  customer     • Product  differentiation  –  what  products  were  attractive  in  the  market  and   did  the  firm’s  products  have  any  of  the  attributes     o Pricing  tactic,  design,  functionality     Porter  –  competitive  advantage  à  value  chain,  system  to  break  it  down     • Distinction  between  cost  and  benefits     o Regrouped  cost  by  categories  within  a  value  chain  by  activity     o Value  chain  =  systematic  way  to  deconstruct  activities  and  related   firm  costs  and  customer  benefits   § Producing,  marketing,  delivery,  after  market  support       • Cannot  look  at  firm  as  a  whole  –  understand  linkage  between  activities     • Divided  activities  into  primary  and  secondary     o Primary  activities  =  actual  making  of  product/service     o Secondary  activities  =  support  activities     • Perform  similar  activities  in  a  different  way     Primary  activities  à  actual  making  of  product  “hands  in  a  box”   Secondary  activities  à  support  making  of  product     Companies  will  go  to  lengths  to  satisfy  an  unhappy  customer     Return  à  can’t  sell  as  new,  “refurbished”   Pick  up  and  return  at  store  system  –  reduce  transaction  costs  for  business  and  wait   time  for  customer     • Incentive  to  keep  shopping,  customer  might  see  something  else  they  like     • Bonuses  for  customer  that  come  out  of  cost  saved     Create  competitive  advantage     Only  motivated  to  change  if  sales  decrease/profits  drop   Added  value  –  spread  between  willing  to  pay  and  opportunity  cost     • Understand  the  spread  between  the  customer’s  willingness  to  pay  and   supplier’s  opportunity  cost     • At  best,  estimates  of  opportunity  cost     • Estimate  spread  and  close  gap  on  who  has  the  power     Low  cost  strategy  can  be  more  materially  rigorous     • Organization  structure     • Remuneration  and  reward  system     • Corporate  culture,  decision  making,  latitude  of  responsibility,  accountability     • Leadership  style     • Capabilities     When  analyzing  competitive  advantage     • Identify  discrete  activities  or  processes  believed  to  be  advantageous,  why   they  create  value  –  for  the  firm  and  its  rivals     o Relative  cost  position     o Comparative  willingness  to  pay     • Linking  competitive  positioning  concepts  to  strategic  planning  and  action     o Ex.  Dell  computers  –  saw  emerging  shift  in  computer  literacy  market     • Performed  the  same  activity  differently  than  rivals     o Analysis  and  observation  shapes  insight     Using  activities  to  analyze  relative  willingness  to  pay     • Differences  in  activities  account  for  differences  in  customer  value     • Any  activity  in  value  chain  can  affect  customers’  willingness  to  pay     Value  à  customer  loyalty     Within  organizational  structures  –  reward  system     Identify  advantageous  discrete  activities,  why  they  add  value     Ex.  Dell  à  saw  shift  in  market:  increased  computer  literacy   • Changed  distribution  to  direct  mail/catalog/phone     Ex.  Liz  Claiborne  –  made  work  close  for  women,  which  previously  didn’t  exist     Little  Debbies  –  model  defined  by  price,  not  freshness     • Use  more  additive  à  longer  shelf  life,  fewer  returns/transportation,   reduction  of  costs     Everything  that  money  is  spent  on  not  necessarily  adding  value  for  customers     Have  to  break  up:  producing,  marketing,  delivery,  after  market  support     • Strategic  deconstruction     • Varying  levels  of  value  added     Understand  value  of  cost:  inspection  vs.  late  delivery     • Inspection  –  value  added     • Late  delivery  –  cost  incurred     • Can  redirect  value     o Ex.  put  in  an  extra  $10  to  make  sure  it  gets  there  on  time   Points  of  competition  become  areas  to  invest  in     Ex.  Southwest  identified  items  not  valued  by  flyers:  meals,  lounges,  classes  of   service,  hub  connectivity     • Cut  costs  to  improve  operating  efficiency     Add  building  blocks  –  understanding  of  competitive  position     Internal  analysis:  organization  structure,  remuneration  &  reward  system,  corporate   culture,  leadership  style,  decision-­‐making,  accountability,  capabilities     Customers  don’t  get  care  internal  factors  when  trying  to  get  a  product  (coat   example)     Ex.  Wegmans  –  good  at  conducting  focus  groups     Ex.  Dollar  store  –  focus  on  households  <  $30,000/yr,  small  towns,  most  things  for  $1,   nothing  more  than  $5   • Intense  focus  on  core  customer  base     • Small  town,  low-­‐income  urban  areas   • Performance  based  culture     • Deliver  promise  by  supplying  off  brands  that  are  high  quality   • Cut  overhead     • “Cut”  trick  –  if  sales  increase  and  costs  are  flat,  cost  will  comparatively   decrease  as  a  percentage  of  sales     • Cut  200  SKUs  every  year  (out  of  3500+/-­‐),  get  rid  of  slow  movers  and  have   new  merchandise  in  store     • Manage  scarce  resource  à  cash     • Purchasing  people,  “customer  representatives”     o Have  to  negotiate/cut  costs     • Invest  in  community  development,  help  employees  get  GEDs  à  business  is   better  with  more  educated  employees     o Incentive  system,  make  sure  employees  stay;  offer  managers  stock   options  and  other  perks     Ex.  K-­‐Mart  and  Sears  failing?     • Appeal  to  lower/middle  and  upper/middle  classes  –  some  disconnect,   wouldn’t  want  to  shop  in  same  places     • Value  proposition:  low  price  on  housewares,  pull  in  shoppers  then  offer   higher  priced  apparel     • Tried  to  offer  blue  light  specials  to  go  after  bargain  hunting  moms,  new   moms  didn’t  identify  with  older  program     • Walmart  beat  their  advertised  low  prices     • Would  be  out  of  stock  of  advertised  item     • Invested  in  companies  that  were  outside  of  their  core  business  à  failing     • End  result:  lack  performance,  bad  culture,  failing/downsize  of  additional   businesses         Ex.  Target  –  smaller  selection  but  more  upscale  than  Walmart     • 40%  name  brand,  60%  private  label     • Not  competing  with  Walmart’s  buying  power     • Focused  on  middle  income  households  and  middle  upper  incomes,  that  want   a  bargain;  offer  lower  but  not  low  prices     o Merchandising  directed  at  market  segments     o Shopping  ease,  style,  bright  stores       Successful  companies  focus  on  creating  value  for  customers  by  performing  similar   activities  differently   Fast  foods  –  different  specialty  items,  change  with  time  –  force  by  customer   (healthier  market);  fast  food  market  well  saturated     Ex.  In-­‐n-­‐Out     • Simple  menu,  don’t  look  for  more;  fewer  buyers,  less  labor,  less  waste     • SoCal  geographic  cluster     Is  the  distribution  of  customers  large  enough  to  create  a  business?     • A  good  idea  with  worthless  without  buyers     Look  at  market  and  realize  its  saturated,  doesn’t  make  sense  to  compete  in  same   way,  use  it  to  establish  differences     Game  Theory   Game  theory  –  economic  perspective  of  competitive  behavior     • Understand  incentives  under  conditions  of  competitions     • Think  through  competitor’s  routines  à  behavior  may  not  represent  true   goals  and  beliefs   • Profiling  to  identify  competitor’s  predispositions       • Rivals  incentive  –  what  they  really  want  and  payoffs  under  certain  conditions     • Advantages  and  disadvantages  of  Game  theory     • Choices     o Empty  threats  (credibility  of  rival),  bargaining,  entry  deterrence,   advantage  of  moving  first,  asset  allocation  (Walmart  153  stores  à   1009  in  1986),  auction  (English,  Dutch,  sealed  bids)     Life  is  more  complicated  with  many  competitors     Companies  react  to  behavior  of  other  companies  à  unexpected  events     We  expect  uniformity,  doesn’t  normally  accompany  strategy     Markets  are  decentralized     • Price  =  primary  unifying  mechanism     • Price  for  demand  and  supply  of  goods     Trying  to  reach  an  entire  market  can  be  costly;  you  can’t  supply  everything  to   everyone     Ex.  buying  meals  for  the  next  3  months  –  wouldn’t  be  practical,  difficult  to   store,  cost  of  storing,  food  expiring     Asymmetric  warfare  –  have  to  think  in  counterintuitive  way       Ex.  take  away  key  customers  to  eventually  take  over  the  business     Understand  other  companies’  routines/actions  à  understand  decision-­‐making     Pros/cons  (+/-­‐)  to  game  theory  –  wrong  assumptions  à  wrong  results     Look  at  behavior,  can  result  in  a  range  of  outcomes,  interacting  economic   events     Threats  can  be  empty  –  consider  credibility     Strategic  plans  –  waste  of  time  or  planning  process  is  invaluable     Asset  allocation  –  Wal-­‐Mart  did  in  a  way  that  others  couldn’t  copy     • Did  whatever  was  necessary  for  growth     • Only  so  much  money  to  be  spent     • Borrow  limit     • Growth  (huge)   • Assets  are  necessary  to  expand,  consider  tradeoffs   Dutch  auction  –  start  high,  come  down;  good  way  to  see  what  people  are  willing  to   pay     Charlie  Brown  –  kick  or  don’t  kick;  from  past  experience  pulled  away,  understand   rival’s  experience     Guessing  game  –  thinking  systematically/symmetrically     Companies  react  to  other  companies     We  expect  uniformity     Firms  vs.  rivals  –  study  of  econ     • Doesn’t  consider  emotion/rationality   Price  is  unifying  mechanism  in  the  marketplace  –  provides  information     • Price  is  a  sponge     o Gives/takes  info     • Info  about  marginal  value  of  a  product  and  opportunity  costs  for  the  use  of   funds     • Price  is  impacted  by  information  –  react  to  news  or  other  price  changes     Purely  competitive  markets  efficient  when:     • Information  freely  exchanged  and  buyers  and  sellers  have  same  data     • No  buyer  or  seller  can  influence  the  market  by  actions  of  one  buyer  or  seller   • The  products  are  essentially  the  same     • Resources  are  free  to  move  in  and  out  of  the  market     Knowhow  –  knowing  how  to  do  something  well/efficiently  is  an  invaluable  asset     • If  you  don’t  know  how  to  assemble  something  it  doesn’t  matter  whether  you   have  the  necessary  parts     • Getting  information  is  a  cost   o Uncertainty,  negotiation,  recourse     • Contracts  have  to  include  what  they’re  not  supposed  to  do  also  –  not  costless     • Search  costs  –  capturing  info     Contracting  –  important  to  maintain  relationships  à  better  prices       Game  Theory  –  economic  perspective  to  behavior     • Best  you  get  is  a  range,  right  within  a  certain  tolerance     • Profiling  à  identify  rivals  behavior     • Assumes  rationality,  however  people  don’t  think  systematically     • Creates  a  payoff  matrix  under  various  conditions     • Cons:     o If  assumptions  are  incorrect,  results  will  be  incorrect     o Assumes  rationality     • Pros:     o Forces  a  discipline  of  looking  at  all  aspects  of  behavior  related  to  a   transaction     o Range  of  outcomes  given  different  circumstances  and  interacting   economic  events   • Games:     o Rival  past  behavior     o Asymmetric  thinking     o Analytics       Price  is  revealing,  it  provides/absorbs  information  like  a  sponge     • Info  about  product  and  opportunity  cost     • Price  doesn’t  reflect  all  costs     • Determined  by  marginal  value     • Doesn’t  reflect  all  costs     o Ex.  having  to  do  an  extra  step     Transaction  costs  associated  with  capturing  information   • Search  costs     • Cost  of  asymmetry  –  if  one  person  knows  what  another  doesn’t  it’s  a  cost  to   them   Contracting  costs,  reaching  an  agreement     • Bargain,  enforcement,  write/document,  policing  each  other/  enforcement     Firms  contracting  costs  aren’t  equal  to  individuals,  advantages:     • Frequency,  repetitive     • Bulk  material  &  return  customers,  relationships  vs.  one  time  purchases     • Ask  the  right  questions     • Employees  –  paid  less  but  have  less  risk;  ex.  Average  employees  don’t  have   agreements     Coase  –  the  nature  of  a  firm  –  use  a  firm  when  it  costs  less  than  going  into  the   market  to  complete  a  project     • There  are  transaction  costs  –  costs  associated  with  capturing  information     • Contracting  costs,  reaching  an  agreement     • Firms  do  not  have  the  same  contracting  costs     • Individuals  work  for  someone  else  than  work  for  themselves  à  paid  less  but   less  risk     • Transactions  come  with  costs  beyond  price     • Help  is  a  firm     • Firm  utilized  when  project  cost  <  what  an  individual  can  complete  the  project   for  in  the  marketplace     • Costs  beyond  price  mechanism  in  market     Decision-­‐making  –  has  various  levels  of  complexity     • If  not  made  in  timely  manner,  organization  is  paralyzed,  can’t  go  forward     Volume  of  decision-­‐making  increases  à  complexity  &  time  increase     • Can’t  run  a  business  as  efficiently  if  the  pace  is  slow     Firms  stop  growing  when:   • Too  large/diversified  to  manage  business     o Too  many  internal  costs,  ex.  Management     o Could  no  longer  coordinate/organize  actions     o Can’t  focus  on  necessary  activities     o Need  additional  management,  sometimes  in  pieces     • Transaction  costs  =  marketplace  costs     • Entrepreneur  can’t  efficiently  coordinate  all  activities     Ex.  Few  firms  that  have  divided  into  smaller  businesses:  Xerox,  Conoco  Phillips,   Apple/Alphabet     Firms  –  central  planning  systems,  no  free  trade  within   • Managers  control  asset  allocation  –  don’t  always  direct  to  the  most  efficient   uses     • Employees  have  no  real  incentive  to  participate  in  better  solution  –  no  direct   gain     • Firms  succeed  through  knowhow,  knowledge  and  market  economics     Firms  has  benefits  –  ease     Knowledge  is  property  à  has  rights  à  value  à  income     Purchase  of  land  based  on  buyers’  specific  knowledge  à  better  use  of  the  property  =   more  value     Specific  knowledge  creates  economic  consequences     • Creates  property  rights     • Difficult  to  transfer  to  someone  else     Oliver  Williamson  –  there  are  costs  to  our  relationships     • Putting  value  on  it,  give  and  take     • Relationships  develop  between  entities  and  groups       • Asset  specificity  –  assets  have  a  use  but  not  many  alternative  uses     o Ex.  putting  a  factory  in  a  region  for  a  special  customer     o Ex.  modifications  to  packaging  –  equipment  just  for  triangle  milk   cartons     • Investments  can  be  difficult  to  maximize   o Geographic,  unique  equipment,  technology,  human  skills   o Ex.  Manufacturer  of  chem  equipment  that  was  difficult  to  use;   dedicate  a  business  day  to  explaining  equipment  to  university   students     • Conflicts  can  develop     o  Party  feels  taken  advantage  of     • Relationship  difficult  to  monetize  and/or  have  complete  information     • “Information  impactedness”  –  difficult  to  ascertain  costs  of  information   pertaining  to  a  relationship     o May  pay  higher  price  due  to  uncertainty  and  opportunism     o Can’t  access  all  of  the  information,  don’t  know  what  they  don’t  have   access  to     Boundaries     • Resolving  conflict  encourages  continued  investment,  renews  


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