Discuss Porter's five forces model in the context of the four types of market structures.
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Chapter7WhenOtherFirmsDontRespond.pptPowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University
When Other Firms
Don’t Respond
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CHAPTER 7
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Figure 7.1
Standards of living are represented by the income per person. The standard of living in each nation is shown in this map.
Per Capita Income by Country
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Choices
- Strategy
Is all about making choices
- Production possibilities curve, PPC
Combinations of outputs
That can be produced/created
When existing resources and technology are fully and efficiently utilized
Trade-off curve
In order to have more of one item one must give up some of the other item
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Choices
- Points on the PPC
Resources are used fully and efficiently
- Points inside PPC
Resources are used inefficiently
- Points outside PPC
Impossible to attain
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Figure 7.2
Points B and D are fully and efficiently using available resources. At point A, resources are not being efficiently used. Point C illustrates a combination of output that is currently impossible to attain.
Production Possibilities Curve
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Short-term, Long-term
- Internal, and External Strategic Choice
- Short term strategy
Choice: which point on the PPC to select
Using resources fully and efficiently, on the PPC
Using resources inefficiently, inside PPC
- Long-term strategy
Choice: economic growth
Outward-shifting PPC
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Short-term, Long-term
- National strategy
Internal strategy
Bad internal strategy: nation producing inside PPC
Inefficient / corrupt government
External strategy
How to deal with other nations
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Short-term, Long-term
- Firm’s internal strategy
How to allocate resources internally
How to organize
How to structure compensation, and so on
- Firm’s external strategy
How to interact with other firms
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Short-term, Long-term
- The best practice frontier
The best that can be done with existing resources and technology
Strategic choice
Where to locate on the best practice frontier
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Figure 7.3
Points inside the curve, such as A, represent inefficiencies. Resources are not being used where their value is highest. Point C, is not possible given current technologies, and so on, that define the best practice frontier.
The Best Practice Frontier is a Production Possibilities Curve Illustrating the Choices a Firm has
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Business Insight
Best Practice Might Include Contesting
Frivolous Lawsuits
- Firm
How to allocate its resources
- 2005, Merck
Decision – allocate additional resources
To discovering medications
To defending itself against what it thought were frivolous lawsuits
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Business Insight
Best Practice Might Include Contesting
Frivolous Lawsuits
- 2005, Merck
Withdrew painkiller Vioxx
Studies linked it to heart attacks and strokes
Restoring reputation
Prove that the company had not misled investors and patients
- Choice between:
Settle the lawsuits, $20 billion
Fight the lawsuits
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Business Insight
Best Practice Might Include Contesting
Frivolous Lawsuits
- Strategy: fight the lawsuits
Merck began winning those cases
Compensations paid and settlements (2007): $4.85 billion
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Short-term, Long-term
- Comparative advantage, firm
Competitive advantage
Basis
Stock of assets
Structure
Governance, and other elements
One firm does relatively better than others
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Short-term, Long-term
- Opening a business
“What should my business do?”
Define those things that give the business a competitive advantage
Defining direction or strategy = defining competitive advantage
Strategy has to be driven by facts
Trade-offs: giving up something in order to get something else
There is no free lunch
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Porter’s Representation of External Strategy
- Industrial organization
The structure of an industry determines the conduct and performance of firms in that industry
The SCM or structure–conduct–performance model
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Porter’s Representation of External Strategy
- Michael Porter
Reworked the SCM into the five forces model
The ability to earn positive economic profit over long periods of time
Is related to industry structure
Whether the industry has “market power” with respect to customers and suppliers
Whether there are barriers to entry that keep the economic profits from being competed away
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Porter’s Representation of External Strategy
- Five forces model
Competition
Supplier Power
Buyer Power
Threat of Substitutes
Threat of Entry
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Figure 7.4
Strategy is seen as consisting of five elements: competition among rivals, the relationship of the firm with its suppliers, the threat of entry by new rivals, the threat that other firms will develop substitutes, and the relationship of the firm with its customers.
Porter’s Five Forces
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Porter’s Representation of External Strategy
- Competition
How competition occurs
Number of rivals
- Supplier Power
Ability of a firm to pass along cost increases to the suppliers
- Buyer Power
Firm’s ability to pass cost increases along to the customers
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Porter’s Representation of External Strategy
- Threat of Substitutes
Possibilities that substitutes to your firm’s products might be introduced
- Threat of Entry
Whether a positive economic profit will attract competitors
How difficult it would be for them to open up a business
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Porter’s Representation of External Strategy
- Market Structures
Selling environment in which a firm produces and sells its product
Number of firms
Ease of entry and exit
Degree to which products are differentiated
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Table 7.1
Characteristics of Market Structures
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Porter’s Representation of External Strategy
- Perfect Competition
A very large number of firms
Whatever any one firm does has no effect on the market
Firms that produce an identical product
Perfect substitutes
Easy entry
Consumers – perfectly elastic demand
A firm’s demand curve: horizontal line
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Porter’s Representation of External Strategy
- Monopoly
There is just one firm
Entry by other firms is not possible
There are no close substitutes
Faces the market demand
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Porter’s Representation of External Strategy
- Monopolistic Competition
A large number of firms
Easy entry
Differentiated products
A firm’s demand curve: downward sloping
The greater the differentiation among products
The less price-elastic the demand
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Porter’s Representation of External Strategy
- Oligopoly
There are few firms
Each firm alone can affect the market
Product can be either differentiated or identical
Entry is difficult, but it can occur
Firms are interdependent
Downward-sloping demand curve
Shape of the curve - behavior of competitors
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Figure 7.5
The demand curve for an individual firm in perfect competition is a horizontal line as shown in Figure 7.5(a). Figure 7.5(b) shows the market demand, which is the demand curve faced by a monopoly firm. The firm is the only supplier and thus faces the entire market demand. Figure 7.5(c) shows the downward-sloping demand curve faced by a firm in monopolistic competition. The curve slopes downward because of the differentiated nature of the products in the industry.
The Demand Curve Facing an Individual Firm
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Resource-Based Model
- Resource-based model
The fit between the external market context in which a company operates and its internal capabilities
Firm’s internal environment
More critical to the determination of strategic action than is its external environment
Basis of strategy: firm’s unique resources and capabilities
Not the industry
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Resource-Based Model
- Core competencies
Firm’s competitive advantage
- Sustainable competitive advantage
Core competency yields a long-term advantage to the company
- Strategy
Create sustainable competitive advantage
Earn positive economic profit
For a significant period of time
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Resource-Based Model
- Distinctive capabilities
Characteristics that cannot be replicated by competitors
Or can only be replicated with great difficulty
Patents, exclusive licenses
Strong brands, effective leadership
Teamwork, knowledge
Employees
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Resource-Based Model
- Reproducible capabilities
Can be bought or created by competitors
Cannot be a source of competitive advantage by themselves
- Resource-based view
Firms can earn positive economic profits
If and only if they have superior resources
And those resources provide distinctive capabilities
Resources: VRIN framework
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Resource-Based Model
- VRIN framework
Positive economic profits can be earned from resources
Only if they are valuable, rare, imperfectly imitable, and non-substitutable
- VRIO framework
Valuable, rare, imperfectly imitable, and organization
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Restricting Entry
- Barriers to entry
Anything that deters competitors from entering the market
Internal capabilities, government regulations, intellectual property rights, economic and market conditions, difficulties related to new product development, high start-up costs, the firm’s culture, market share, strategic alliances market leadership, consumer loyalty, branded products, large expenditures on research and development
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Brand Name
- Brand Name
To increase consumer loyalty
To reduce the likelihood that customers will purchase a different product
If price increases
- Price elasticity of demand
Customer’s response to a price change
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Brand Name
- Value of reputation
Likelihood of repeat purchase
Long run - providing high quality
Takes a long time to establish
Rent an established reputation in one market to use in a new market
Endorsement by famous personalities
Use their established reputation in one market to enter a new market
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Brand Name
- Brand names
Costly to create
Take a long time to establish
- Incumbent firms
Reluctant to alter products or enter new markets
For fear of damaging their brand name
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Warranties and Guarantees
- Warranties and Guarantees
Barriers to entry
Guarantees - difficult to fake
The higher the quality of the product, the better the guarantee offered by the firm
Warranty policy – better
Other firms – follow or admit having a lower-quality product
New entrants – better warranty
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Economies of Scale
- Economies of scale
Barriers to entry
Firm’s cost per unit of output declines as the size of the firm grows
Larger firm can produce a product at a lower per-unit cost than can a smaller firm
New entrant - enter as a large firm
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Sunk Costs
- Sunk Costs
Barriers to entry
Expenditure on an asset that has no liquidation value
Advertising
New entrant – has to spend similar amounts on sunk expenditures
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Business Insight
Sunk Costs and Ancient Societies
- Collapse of ancient societies
The Mesa Verde-region pre-Hispanic Pueblos
Puzzled generations of scientists
- Explanations
Social, political, and economic to climatic factors
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Business Insight
Sunk Costs and Ancient Societies
- Sunk cost effect
Ancient societies - tendency to hold on to previous investments
Even if this was a rationally bad choice
Not abandon settlements once they had invested time and resources to establishing them
Even if resources become scarce
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Unique Resources
- Unique Resources
Barrier to entry
Advantage over competitors
Strategy for earning economic profit for one firm with unique resources
Not available for other firms
Established distribution channel
Product that is not easily imitated
Limiting supply
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Pricing to Deter Entry
- Limit price
Price that discourages or prevents entry
Keeps potential entrants from entering
Allows incumbent firm some profits
Could be very costly
Revenue lost - never recouped
Low price – become standard
Threatens to lower price – effective if credible
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Predatory Pricing
- Predatory pricing
Setting a very low price
Below average variable cost
In order to drive competitors out of business
Then increasing price to recoup the lost revenue
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