S1 Reading - What is Strategy?

Differentiating Operational Effectiveness and Strategy:

Operational Effectiveness (OE):
Operational effectiveness refers to a company's ability to perform similar activities more efficiently
and productively than its competitors. This involves implementing best practices, streamlining
processes, and optimizing resources. While OE is crucial for competitiveness, it is not a strategy
in itself. Companies often fall into the trap of assuming that continually improving operational
efficiency equates to having a strategic advantage.

Strategy:
In contrast, strategy involves creating a unique position that stands out in the market. It requires
making choices about the activities a company will perform and those it will not. A strategic
position is not easily replicable by competitors, providing a sustainable advantage. Strategy
demands discipline, continuity, and clear communication to guide the organization's actions and
decisions.

Understanding Activities and Systems

Activity Systems:
Competitive advantage arises from the interdependence and synergy of a company's activities.
Rather than focusing on individual activities, Porter emphasizes the importance of viewing
activities as systems. These systems, when mutually reinforcing, create a more robust and
sustainable source of competitive advantage.

Competitive Advantage Through Fit:

Fit among a company's activities enhances operational effectiveness and creates a barrier to
imitation. When all activities align cohesively, it becomes difficult for competitors to replicate the
same level of efficiency. Consistent fit contributes to winner-take-all scenarios, where the market
rewards the company with the best-fit activities.

Challenges to Strategy Implementation

Internal Threats:
Managers face internal challenges that can undermine strategy. These challenges include
misguided views of competition, organizational failures, and an overemphasis on the desire to
grow. The pressure to deliver tangible, measurable improvements often leads managers to
pursue operational effectiveness without a clear strategic focus.
Confusion About Necessity of Choices:
Companies operating away from the productivity frontier may perceive trade-offs as unnecessary.
This misconception arises when managers believe a well-run company should excel in all
dimensions simultaneously. The reluctance to make trade-offs can be driven by a perceived
weakness associated with such choices.

The Growth Trap

Perverse Effects of Growth:
While growth is a common objective, it can have detrimental effects on strategy. The desire to
expand can lead to compromises and a loss of strategic focus. Companies may succumb to the
temptation of incremental steps that blur their strategic position, eventually eroding their
competitive advantage.

Preserving Strategy Amid Growth:

To preserve strategy during periods of growth, Porter suggests concentrating on deepening a
strategic position rather than broadening and compromising it. Globalization is presented as an
avenue for growth that aligns with a company's strategy, particularly if expansion into larger
markets reinforces the unique position.

Role of Leadership in Strategy

Leadership's Broad Role:
Leadership plays a critical role in strategy beyond orchestrating operational improvements.
Leaders are tasked with defining and communicating the company's unique position. They guide
choices, maintain discipline, and, importantly, have the responsibility to say "no" to activities that
deviate from the strategic path.

Strategic Continuity and Change:

Strategic continuity doesn't imply a static view of competition. A company must continually
improve operational effectiveness while extending its uniqueness. Major industry changes may
necessitate a shift in strategy, and new entrants unencumbered by history may exploit these
changes more easily.

Conclusion:
In conclusion, Porter's article emphasizes the need for companies to distinguish between
operational effectiveness and strategy. The strategic focus involves making clear choices, trade-
offs, and maintaining a unique position over time. This comprehensive approach to strategy,
guided by effective leadership, is essential for long-term success in a competitive landscape.
1. Understanding Strategy:

1.1 Definition of Strategy:

Key Concept:
- Strategy is creating fit among a company’s activities.
- Porter emphasizes that strategy is not just about competing; it's about making choices and
creating a unique position.

Importance:
- Success depends on doing many things well and integrating them.
- The key is to align various activities so that they reinforce each other, creating a powerful,
difficult-to-imitate system.

2. Operational Effectiveness vs. Strategy:

2.1 Critical Distinction:

Operational effectiveness is not strategy.

- Danger:
- Many companies mistakenly focus on operational effectiveness, assuming it equates to
strategy.
- This confusion leads to the homogenization of industries and erodes competitive advantage.

3. Components of a Successful Strategy

3.1 Activity Systems:

Building Blocks:
- Activities form the basis of competitive advantage.
- Porter argues that strategic positions arise from the myriad activities a company performs.

Sustainability:
- Systems of interlocked activities are more sustainable than individual activities.
- It's the synergy among activities that creates a sustainable competitive advantage.
3.2 Strategic Fit:

Definition:
- Fit among a company’s activities creates pressure to improve operational effectiveness.
- A well-aligned system creates mutual reinforcement, compelling each activity to enhance the
overall effectiveness.

Incentives:
- Fit means that poor performance in one activity degrades performance in others.
- This mutual dependence incentivizes excellence across the entire spectrum of activities.

3.3 Trade-offs and Choices:

Essential:
- Strategic positioning involves clear trade-offs and choices.
- A company must decide what activities to perform and what not to, making explicit choices.

Consequences:
- Failure to make choices or frequent shifts lead to compromised strategies.
- Lack of discipline in making trade-offs can dilute a company's strategic focus.

4. Common Pitfalls:

4.1 Failure to Choose:

Internal Threats:
- Often, the greatest threat comes from within the company.
- Misguided views of competition and resistance to making choices internally can undermine
strategy.

Misguided Views:
- Managers may believe that trade-offs are unnecessary.
- The misconception that a company can excel in all dimensions simultaneously hampers
strategic clarity.
4.2 The Growth Trap:
Perils of Growth:
- Desire to grow can lead to compromises and blurred strategies.
- The pressure to grow often tempts companies to broaden their focus, eroding their distinctive
position.

Risk of Homogeneity:
- Attempting to serve all customer needs may erode competitive advantage.
- Companies may lose their uniqueness by trying to cater to every customer's needs.

4.3 Imitation and Hypercompetition:

Pitfall:
- Imitating competitors in all aspects increases hypercompetition.
- Blind imitation rather than thoughtful strategy can lead to a race where no one wins in the
end.

Result:
- Temporary profits but ultimate destruction of industry profitability.
- Copying competitors might yield short-term gains, but it erodes industry profitability over time.

5. Reconnecting with Strategy:

5.1 Rediscovering Unique Positioning:

Core Uniqueness:
- Companies often lose their uniqueness over time.
- Through incremental changes, companies compromise their core positioning, leading to
mediocrity.

Renewal:
- Reconnecting with strategy involves refocusing on the core and eliminating peripheral
elements.
- Identifying and reinforcing the unique aspects that contributed to initial success is crucial.
5.2 Globalization for Growth:
Leveraging Strategy:
- Global expansion can reinforce a company’s unique position.
- Going global should align with and strengthen the existing strategic position, avoiding
compromises.

Preserving Uniqueness:
- Growth strategies should align with and reinforce the existing strategic position.
- Expansion should enhance, not dilute, a company's uniqueness.

6. Leadership and Strategic Discipline:

6.1 Role of Leadership:

Leadership Responsibilities:
- Leaders must define and communicate the company’s unique position.
- Leaders play a pivotal role in providing clarity on strategy and making the necessary
trade-offs.

Guiding Choices:
- Leadership involves making and enforcing strategic choices.
- Leaders must guide the organization, saying no to distractions and maintaining a clear
strategic direction.

6.2 Strategic Continuity:

Dynamic View:
- Strategic continuity does not imply a static view of competition.
- Companies must evolve while maintaining a strategic core, adapting to changes without
compromising uniqueness.

Balance:
- Companies must balance ongoing improvement with efforts to extend uniqueness.
- Continual improvement and strategic extension must coexist for sustained success.
7. Practical Applications:

7.1 Customizing Strategy:

Approach to Growth:
- Concentrate on deepening a strategic position rather than broadening and compromising it.
- Growth should enhance and deepen the existing strategic position rather than diluting it.

Extension Strategies:
- Look for extensions that leverage existing activity systems.
- Extensions should build upon the strengths of current activities, creating synergies for
competitive advantage.

8. Conclusion:

8.1 Final Thoughts:

Strategic Discipline:
- Strategy requires discipline, continuity, and clear communication.
- Discipline in making choices, continuity in strategic vision, and effective communication are
paramount.

Ongoing Adaptation:
- A company may need to change its strategy due to major industry structural changes.
- While strategic continuity is crucial, adaptability is equally important in the face of industry
shifts.
S2 Reading - 2014 McKinsey Quarterly
1. Introduction: Strategy and Market Forces
The article emphasizes the importance of "beating the market" not only in the realm of finance but
also in the context of business strategy. It suggests that effectively navigating and overcoming
the profit-depleting effects of market forces is fundamental to achieving success.

2. Economic Profit (EP) Analysis

Economic profit, defined as what remains after subtracting the cost of capital from net operating
profit, serves as a critical indicator for market-beating strategies. The analysis involved a
comprehensive study of nearly 3,000 companies, shedding light on the factors that contribute to
sustained success.

3. Market-Beating Strategies and Inequality

The study reveals a significant imbalance in the distribution of economic profit, with a small
percentage of elite companies generating a disproportionate share. Market forces seem to act as
a powerful constraint, making it challenging for the majority of companies to create significant
value.

4. Components of Economic Profit

Economic profit is dissected into four components: revenues, margins, asset turns, and the
tangible-capital ratio (TCR). Size emerges as a key factor, with both the largest creators and
destroyers of economic profit being large companies.

5. Reversion to the Mean and Wealth Distribution

While markets typically exhibit mean reversion, economic profit tends to persist at the top. The
article highlights the dynamics of wealth distribution, emphasizing that top-quintile companies not
only experience convergence but also attract more investment, maintaining their advantage over
time.
6. Class Mobility and Industry Trends
Examining class mobility reveals that companies in the middle class face challenges, with a
significant majority remaining in their respective quintiles. Those rising to the top often benefit
from industry trends and improvements, showcasing the influence of external factors on corporate
success.

7. Industry's Impact on Economic Profit

The analysis underscores the substantial impact of industry on economic profit. A company's
performance is attributed to its industry to a significant extent, and riding on industry trends is
identified as a crucial factor for companies aiming to break out of the middle class.

8. Implications for CEOs and Strategists

The article provides strategic insights for CEOs and strategists based on their company's position:
- Elite Companies: Must be vigilant, understand the formula that led to their success, and adapt
to changes to avoid slipping down the ranks.
- Middle-Class Companies: Face challenges and need substantial strategic or operational shifts
for growth.
- Bottom-Tier Companies: Should focus on improving Return on Invested Capital (ROIC) and
seek new trends to escape the basement.

9. Conclusion: The Timeless Strategic Question

The article concludes by emphasizing the importance of companies measuring their ability to beat
the market and understanding the fundamental question of why they make money. This self-
assessment is presented as a timeless strategic endeavor for companies seeking sustained
success.
Study Guide
I. Introduction
- The concept of "beating the market" is crucial not only in investing but also in business
strategy.
- Overcoming market forces is the essence of good strategy, separating successful companies
from the rest.

II. Economic Profit (EP) Analysis

- EP, the profit after subtracting the cost of capital from net operating profit, is a key indicator of
market-beating strategies.
- A large-scale analysis of nearly 3,000 companies reveals insights into consistent winning
strategies.

III. Market Inequality in Economic Profit

- Economic profit distribution is highly imbalanced.
- The top quintile generates significantly more economic profit than the middle three quintiles
combined.
- Market forces pose a powerful constraint to creating value for the majority of companies.

IV. Components of Economic Profit

- Economic profit consists of revenues, margins, asset turns, and the tangible-capital ratio.
- Size matters, with both top creators and destroyers being large companies.
- High margins distinguish top performers, and weak performers surprisingly have the best
tangible-capital ratio.

V. Reversion to the Mean

- Markets typically show mean reversion, but economic profit exhibits persistence.
- Top-quintile companies attract more investment, maintaining their advantage over time.

VI. Class Mobility and Company Performance

- Companies in the middle class face challenges in moving to the top.
- Top-quintile companies, although staying ahead on average, can't rest on their laurels.

VII. Industry Trends and Upward Mobility

- Upward mobility often depends on riding industry trends.
- Companies in industries that improve economic profit rankings are more likely to move up.

VIII. Forces Affecting Company Performance

- 40% of a company's economic profit is explained by the industry in which it operates.
- The remaining 60% (company effect) is influenced by factors like market selection and unique
advantages.
IX. Implications for CEOs and Strategists
- Elite companies must vigilantly protect their privileged position.
- Middle-class companies face a tough battle, requiring significant strategic or operational shifts.
- Companies at the bottom need to focus on improving performance before seeking growth.

X. Conclusion
- The study emphasizes the empirical reality of strategy, urging companies to measure their
market performance and understand why they make money.
Formulas
1. Economic Profit (EP):
- Economic Profit = Net Operating Profit - (Cost of Capital * Invested Capital)

2. Tangible-Capital Ratio (TCR):

- TCR = Ratio of physical to total capital, including goodwill

3. Return on Invested Capital (ROIC):

- ROIC = Net Operating Profit / Invested Capital

4. Valuation Multiple:
- Valuation Multiple = Enterprise Value / Earnings

5. Growth Rate:
- Growth Rate = [(Ending Value / Beginning Value) ^ (1/n)] - 1, where n is the number of periods

6. Asset Turns:
- Asset Turns = Revenue / Average Total Assets
S3 Reading - Economies of Strategy
Overview
Professional sports leagues, such as the NFL, MLB, NBA, and NHL, operate in a landscape
characterized by high competition and revenue generation through various channels like ticket
sales, broadcasting rights, and merchandise.

Five Forces Analysis

1. Internal Rivalry
- Intense Competition: Teams within leagues fiercely compete for fan attention and success on
the field.
- Price Setting Challenges: While teams set prices above costs, negotiations with powerful
players' unions often erode potential profits.
- Market Differentiation: Loyal fan bases and league rules provide a unique product market
differentiation, setting the sports industry apart from others.

2. Entry Barriers
- Established Dominance: Major leagues have a stronghold, making it challenging for new
entrants to gain traction.
- Monopolistic Power: Dominance of established leagues creates significant barriers for new
competitors.
- Past Failures: Previous attempts by new leagues failed due to factors like poor quality or
unfavorable timing.

3. Substitutes and Complements

- Complements: The success of leagues, particularly the NFL, is closely tied to television
broadcasting and legal gambling.
- Gambling Risks: While gambling boosts fan interest, there's a constant fear of its influence on
players, potentially leading to scandals like the 1919 "Black Sox" incident.
4. Supplier Power
- Players' Unions: Players' unions hold considerable power in negotiations, impacting player
salaries and league dynamics.
- College Sports: The NCAA serves as a crucial supplier, providing trained players to the
professional sports leagues.
- Cities as Suppliers: Cities contribute by providing stadiums, but recent skepticism due to
economic downturns has changed the landscape.

5. Buyer Power
- Media Networks: Major television networks and sports cable systems compete for broadcasting
rights, impacting league revenues.
- Local Broadcasting: Leagues maintain some negotiation power in local broadcasting, but the
dynamics are influenced by the number of networks and their competitiveness.

Conclusion
- Market Dynamics: Loyalty of fans and the structure of league rules create a unique and
challenging market.
- Profit Challenges: Despite high revenues, many teams face operating losses due to factors
like high player salaries and owner motivations not solely driven by profits.
- Owner Motivations: Some owners prioritize winning over financial gains, contributing to the
industry's complex economic dynamics.
Study Guide
Industry Analysis: Professional Sports Leagues
Overview of the Professional Sports Industry
- Dominated by major leagues (NFL, NBA, MLB, NHL).
- High market concentration; few powerful players' unions.
- Teams enjoy loyal fan bases, strong product differentiation, and entry barriers.

Internal Rivalry:
- Fierce competition among teams for fan loyalty.
- Price wars driven by various factors.
- Teams set prices above marginal costs, but profits often bargained away by players' unions.

Entry:
- High barriers to entry; established leagues dominate.
- Attempted entries face challenges like limited differentiation and rule changes.
- Upstart leagues struggle due to player recruitment and fan engagement.

Substitutes and Complements:

- Leagues compete for entertainment dollars.
- Efforts to differentiate by time of year often fail.
- Complements like cheerleaders, mascots, and off-the-court entertainment crucial for fan
experience.

Buyer Power:
- TV networks and sports cable systems compete for broadcast rights.
- Networks view sports as a loss leader, paying large sums for association.
- Buyer power varies in negotiations over local broadcast rights.

Supplier Power:
- Players' unions hold significant power.
- Colleges critical suppliers; NCAA influences player drafts.
- Cities subsidize sports stadiums, but economic benefits are disputed.
Five-Forces Analysis of Search Consulting Industry
Overview of Professional Search Firms
- Search firms help businesses hire managers.
- $10 billion industry, highly fragmented with 4,000 firms.
- Top firms like Heidrick & Struggles, Korn/Ferry International, Spencer Stuart.

Internal Rivalry:
- Search firms set prices through retainer policies.
- Fierce competition despite a fragmented market.
- Price linked to quality; clients fear cut-rate firms may provide less effort.

Entry:
- Profit potential attracts entrants; barriers include relationship building.
- Search firms differentiate geographically and by industry.
- Advantage for established firms with global networks.

Substitutes and Complements:

- In-house HR departments are substitutes, but lack global knowledge.
- Management consulting firms can be substitutes, but often lack specialization.
- Globalization increases efficiency but challenges established firms.

Supplier Power:

- Star consultants pose a threat when leaving established firms.

- Legal restrictions and high wages used to retain star consultants.
- Prospects are also considered as suppliers; firms spend more time cultivating them.

Buyer Power:
- Larger employers have significant power, especially for senior executive searches.
- Buyers in senior positions have influence; may ask for quality service incentives.
- Repeat or referred business provides significant buyer power.
Conclusion:
- Professional Sports Leagues: Loyal fan base and entry barriers, but constant rule changes
and challenges from substitutes.
- Search Consulting Industry: High competition, with entry challenges and dependence on star
consultants and established networks.

Key Takeaways for Exam:

- Understand internal rivalry, entry barriers, substitutes, and buyer and supplier power.
- Recognize the specific challenges in the professional sports and search consulting industries.
- Relate industry analysis to economic principles and the five-forces framework.

Study Questions:
1. Explore the impact of pricing rivalry on industry profitability.
2. Discuss the role of star consultants in the search consulting industry.
3. Evaluate the factors influencing buyer and supplier power in both industries.
4. Examine the relationship between government influence and industry profitability.
5. Apply the five-forces framework to analyze the airline industry.
Appendix: Template for Five-Forces Analysis:
Factors Affecting Rivalry among Existing Competitors:
- Seller concentration, industry growth, cost differences, excess capacity, product differentiation,
brand loyalty, buyer switching costs, observable prices.

Factors Affecting the Threat of Entry:

- Economies of scale, reputation importance, access to distribution/technology, experience-based
advantages, network externalities, government protection.

Factors Affecting or Reflecting Pressure from Substitute Products:

- Availability and characteristics of substitutes, complements, price elasticity of demand.

Factors Affecting or Reflecting Power of Input Suppliers:

- Supplier concentration, firm's purchase volume, substitute availability, relationship-specific
investments, credible threat of forward integration.

Factors Affecting or Reflecting Power of Buyers:

- Buyer concentration, purchase volume, substitute availability, relationship-specific investments,

price elasticity of demand.

Exam Preparation Tips:

1. Master the five-forces framework and its application.
2. Understand the nuances and challenges of internal rivalry, entry, substitutes, and buyer and
supplier power.
3. Relate industry analysis to economic principles.
4. Utilize the provided template for comprehensive analysis.
5. Practice applying the framework to real-world industries for a deeper understanding.
S5 Reading - Economies of Strategy
1. Introduction to Competitive Advantage:
Sustaining competitive advantage is imperative in the business world. The notion that perfect
competition dynamics lead to profits converging to a competitive level over time suggests that
maintaining a competitive edge is challenging but essential for prolonged success.

2. Resource-Based Theory:
- Unique and Valuable Resources: The resource-based theory emphasizes that competitive
advantage arises from possessing resources that are both unique and valuable. These
resources could include tangible assets, intellectual property, or intangible capabilities.

- Scarce, Immobile Resources: For sustained advantage, these resources must be scarce and
immobile. Scarce resources are not easily replicable, and immobility ensures they cannot be
easily transferred to other firms.

- Isolating Mechanisms: Resources need protection through isolating mechanisms, which

prevent competitors from duplicating or neutralizing the source of the competitive advantage.
This protection can be legal restrictions, superior access to inputs, or brand reputation.

3. Barriers to Imitation:
- Legal Restrictions and Early-Mover Advantages: Barriers to imitation encompass legal
protections like patents and copyrights. Early-mover advantages, including brand reputation and
consumer switching costs, contribute significantly to a firm's ability to sustain its competitive
position.

- Economies of Scale: Achieving economies of scale coupled with a limited market size can
create a barrier. The cost advantages gained from producing at scale make it challenging for
new entrants to compete effectively.

4. Creative Destruction:
- Continuous Adaptation: Creative destruction, a concept by Joseph Schumpeter, highlights
the continual process of replacing old advantages with new ones. Entrepreneurship involves
seizing opportunities arising from these disruptions.
5. Dynamic Capabilities:
- Adaptation and Continuous Improvement: Dynamic capabilities refer to a firm's ability to
adapt and maintain the bases of its competitive advantage. This involves continuous
improvement, adapting to changing market conditions, and identifying new opportunities.

- Path Dependence and Learning: Evolutionary economics suggests that firms' decisions are
shaped by routines and incremental learning. Path dependence implies that a firm's current
trajectory influences its future choices, creating challenges in deviating from established
routines.

6. Evolutionary Economics:
- Routine-Based Decision Making: Firms make decisions based on well-practiced routines
rather than solely for profit maximization. The incremental nature of learning and the difficulty in
conceptualizing fundamentally new routines make the search for new sources of competitive
advantage path-dependent.

- Complementary Assets: The presence of complementary assets, which are valuable in

connection with a specific product or technology, can enhance or impede a firm's dynamic
capabilities.

7. The Environment and Competitive Advantage:

- Michael Porter's Diamond Framework: Competitive advantage is not solely an internal affair.
Michael Porter's diamond framework emphasizes the influence of the local environment on a
firm's ability to achieve and sustain competitive advantage.

- Factor Conditions, Demand Conditions, and Related Industries: Porter identifies four
attributes (Factor conditions, Demand conditions, Related supplier or support industries, and
Strategy, structure, and rivalry) in a firm's home market that contribute to or impede its
competitive advantage in global markets.

8. Factors Affecting Sustainability:

- Economies of Scale: The extent of economies of scale in an industry influences
sustainability. Achieving cost advantages through economies of scale can create barriers for
competitors.

- Product/Market Situations: Differences in product/market situations significantly impact

sustainability. Examining cases like Coke and Pepsi versus General Motors and Ford illustrates
how market dynamics play a role.
9. Case Example: Rise and Fall of the Swiss Watch
Industry:
- British Dominance and Decline: The case of the Swiss Watch Industry illustrates how British
dominance in the 18th century declined due to wars, lack of overseas marketing, and inability to
adapt.

- Geneva's Innovation and Marketing: Geneva's watchmakers innovated, marketed, and

adapted to new market conditions, ultimately dominating the industry.

10. Strategy, Structure, and Rivalry:

- Local Market Dynamics: Local management practices, organizational structure, and
competition influence a firm's ability to innovate and remain efficient.

11. Critical Questions:

- Sustainability Analysis: An analysis of sustainability is likened to a five-forces analysis,
exploring the forces that impact a firm's competitive position.

- Product/Market Differences: Exploring differences in product/market situations, like Coke

and Pepsi versus General Motors and Ford, sheds light on factors influencing sustainability.

- Co-specialization: Analyzing activities like Mercury's diagnostic skills of staff and buying
cooperative membership highlights potential co-specialization.

12. Auction Dynamics and Winner's Curse:

- Winner's Curse Challenges: The winner's curse poses challenges to optimal bidding in
auctions. Understanding this curse and implementing strategies is crucial for prospering in
auctions.

13. High-Resolution Audio Niche:

- Niche Product Dynamics: Despite offering high-quality products, high-resolution audio
remains a niche. Various factors, including consumer preferences and market dynamics,
contribute to its niche status.
14. Equilibrium in Uncertain Production Costs:
- Market Equilibrium: Exploring a market with uncertain production costs, the equilibrium price
is determined by trial and error. Firms produce as long as the price exceeds unit production
costs.

15. Incentives for R&D Investment:

- R&D Race Scenario: In a scenario involving an R&D race, the example illustrates which
company has a greater incentive to spend money to win. The effects shaping incentives, like
productivity and sunk costs, are discussed.
Study Guide
1. Resource-Based Theory:
a. Unique, Valuable, and Immobile Resources:
- Competitive advantage stems from resources that are distinct, add value, and are not easily
replicable by competitors.
- Examples include proprietary technology, brand reputation, and skilled workforce.

b. Isolating Mechanisms:
- Barriers to Imitation: Legal protections like patents, control over scarce resources, and
economies of scale limit competitors.
- Early-Mover Advantages: First movers benefit from learning curves, established brand
names, and consumer switching costs.

2. Barriers to Imitation:
a. Legal Restrictions:
- Patents and copyrights provide legal monopolies, hindering direct imitation.
- Laws safeguard against unauthorized use, promoting innovation.

b. Access to Scarce Inputs:

- Control over unique resources or suppliers creates a barrier.
- Examples include access to rare minerals or specialized talents.

c. Economies of Scale:
- Large-scale operations with limited market size pose a challenge for new entrants.
- Scale efficiency deters new competitors, enhancing sustainability.

d. Intangible Barriers:
- Causal ambiguity, dependence on historical circumstances, and social complexity.
- Uncertainty and complexity make it difficult for competitors to emulate.
3. Early-Mover Advantages:
a. Learning Curve:
- First movers benefit from experience and efficiency gains.
- Continuous improvement and cost reduction contribute to sustained advantage.

b. Brand Reputation:
- Brands with a strong reputation face less resistance from consumers.
- Trust and loyalty provide a protective shield against competitors.

c. Consumer Switching Costs:

- High switching costs make consumers less likely to shift to a competitor.
- Examples include proprietary software or unique features in products.

d. Network Effects:
- A phenomenon where the value of a product increases with the number of users.
- Early adopters gain a lasting advantage as the network grows.

4. Creative Destruction:
a. Entrepreneurial Innovation:
- Joseph Schumpeter's concept emphasizes entrepreneurs exploiting shocks or disruptions.
- Old sources of advantage are destroyed, making way for new, innovative ones.

b. Replacement Effect:
- The replacement of outdated products or processes with more innovative alternatives.
- Firms must innovate to replace existing sources of advantage.

5. Winner's Curse:
a. Optimal Bidding Strategy:
- Winning bidders may pay more than the item's value (winner's curse).
- Bidders must strategize to avoid overpaying while still securing the item.

b. Prosperity in Auctions:
- Bidders can prosper by carefully evaluating the item's value.
- Strategic bidding, considering the competition, and setting an upper limit can lead to
success.
6. Dynamic Capabilities:
a. Continuous Search for Improvement:
- Firms must engage in an ongoing search for ways to enhance routines.
- Adaptability and innovation are vital for maintaining a competitive edge.

b. Resource and Capability Adaptation:

- The ability to adjust resources and capabilities over time.
- Firms with strong dynamic capabilities seize new opportunities for competitive advantage.

7. Competitive Advantage and the Environment:

a. Michael Porter's Diamond Model:
- Factor conditions, demand conditions, related industries, and strategy/rivalry shape a firm's
home market.
- Competitive advantage originates from the local environment.

b. Home Nation Influence:

- The home nation plays a critical role in shaping managerial perceptions and supporting
resource accumulation.
- Local conditions influence a firm's ability to innovate, invest, and improve.

8. Case Study: Rise of Swiss Watch Industry:

a. Factors Leading to Decline (British Watchmakers):
- Lower wages in the British countryside, division of labor, and local demand.
- Crucible steel monopoly and specialization led to British dominance.

b. Rise of Swiss Watchmakers:

- Geneva's historical watchmaking, marketing strategies, and adaptability.
- Outsourcing, developing new markets, and targeting specific consumer needs.
S7 Reading - Distance Matters (Pankaj)
Introduction: The Significance of Distance
Global expansion for businesses is not just about physical distance but encompasses various
dimensions, including cultural, administrative, geographic, and economic factors. Understanding
and navigating these distances are crucial for successful international ventures.

Dimensions of Distance: CAGE Framework

1. Cultural Distance:
- Language and Ethnicity: Differences in language and ethnicity create communication
challenges.
- Religion and Social Norms: Variances in religious beliefs and social norms impact consumer
behavior and business practices.

2. Administrative Distance:
- Absence of Ties: Lack of historical or political connections increases administrative and
political barriers.
- Political Hostility: Hostile relations between countries contribute to trade restrictions.
- Government Policies: Varied regulatory environments pose challenges to cross-border
business.

3. Geographic Distance:
- Physical Remoteness: Physical distance affects transportation costs and logistical
challenges.
- Lack of Common Borders: Proximity or lack thereof influences ease of trade.
- Transportation Infrastructure: Well-developed infrastructure facilitates international business.

4. Economic Distance:
- Disparities in Consumer Incomes: Variances in income levels impact purchasing power.
- Cost and Quality Differences: Varied costs and quality of resources affect trade patterns.
- Economies of Scale: Importance of standardization and scale in certain industries.
Political and Administrative Barriers
1. Government Intervention:
- National Security: Industries vital to national security receive protection.
- Large Employers: Sectors with significant employment often garner state support.
- National Champions: Symbolic industries receive government backing.

2. Protective Measures:
- Tariffs and Quotas: Trade barriers in the form of tariffs and quotas protect domestic
industries.
- Foreign Investment Restrictions: Limits on foreign direct investment protect local businesses.
- Subsidies and Favoritism: Government support and preference for domestic companies.

China as a Challenge
1. Market Challenges:
- Cultural and Linguistic Barriers: Dialects and cultural nuances pose challenges for foreign
companies.
- Political and Administrative Hurdles: Market access restrictions, high taxes, and state
involvement hinder foreign businesses.
- Consumer Preferences: Chinese consumers' preference for domestic brands impacts foreign
companies.

2. Administrative Hurdles:
- Market Access Restrictions: Barriers to entry, regulatory complexities, and bureaucratic
hurdles.
- State Involvement: High levels of state intervention in the economy.

3. Political Risks:
- Corruption: Transparency and corruption challenges impact business operations.
- Political Risk Ranking: China's political risk is a significant consideration for international
businesses.
Industry Sensitivity to Distance
1. Cross-Country Complexity:
- Operational Challenges: Complexity and change favor locally focused businesses.
- Supply Chain Barriers: Disparities in supply chains pose significant challenges for global
replicators.

2. Supply Chain Barriers:

- Distribution Challenges: Domestic distribution costs play a significant role in trade barriers.
- Operational Complexity: Complexity favors locally focused businesses over globally spread
ones.

Case Study: Tricon Restaurants International (TRI)

1. Global Expansion Rationalization:
- Profitability Focus: Prioritizing markets based on profitability and revenue streams.
- Equity Investments: Rationalizing global operations by focusing equity investments in key
markets.

2. Country Portfolio Analysis:

- Adjusting for Distance: Recognizing the impact of distance on market assessments.
- Proximity Importance: Proximity to TRI's home base influenced market prioritization.

Conclusion: The CAGE Framework as a Tool

1. Managerial Awareness:
- Strategic Planning: The CAGE framework aids managers in strategic planning for global
expansion.
- Holistic Approach: Considering cultural, administrative, geographic, and economic factors is
essential for success.

2. Subjectivity and Costs:

- Persistent Costs: While technology connects the world, distance-related costs persist.
- Strategic Imperative: Strategic planning is imperative to overcome the challenges posed by
distance.
Study Guide
Cultural Distance:
Challenges and Impact on Trade:
Cultural distance involves differences in language, ethnicity, religion, and social norms.
Products with high linguistic content or those influencing cultural identity face challenges. For
instance, television programs with cultural significance may struggle to gain acceptance in
markets with different languages or social norms.

Administrative Distance:
Governmental Barriers:
Administrative distance is influenced by factors like political hostility, absence of colonial ties,
and government policies. Protectionist measures, including tariffs, trade quotas, and restrictions
on foreign direct investment, can be imposed. Industries vital to national security or considered
national champions often face more barriers, complicating cross-border competition.

Examples of Administrative Barriers:

The article highlights cases where domestic prohibitions on bribery, health and safety
regulations, and environmental policies in a company's home country affect its international
business. Additionally, state support for large employers or industries considered symbols of
national modernity further increases administrative distance.

Geographic Distance:
Transportation and Physical Factors:
Geographic distance involves physical remoteness, lack of common borders, and weak
transportation links. It affects industries with products having low value-to-weight ratios or those
requiring fragile or perishable transportation. The article emphasizes the impact of geographic
attributes on transportation costs and distribution channels.

Intangible Goods and Services:

Geographic distance also affects intangible goods and services. Cross-border equity flows can
decrease significantly as geographic distance increases, influenced by information infrastructure
rather than physical transportation costs. This complexity underscores the need for considering
information networks in assessing geographic influences.
Economic Distance:
Wealth Disparities and Economic Activity:
Economic distance is driven by differences in consumer incomes and the costs and quality of
resources. Wealthier countries engage in more cross-border economic activity. Industries vary
in sensitivity to economic differences; some rely on economies of experience, scale, and
standardization, while others exploit cost and price differentials.

Impact on Global Expansion:

The article provides a case study on China, emphasizing that economic challenges, such as
market-access restrictions, high taxes, state involvement, and corruption, significantly impact
global business performance. Transparency International's corruption ranking for China
underscores the economic challenges multinational companies face.

Factors Influencing Industries:

Government Intervention:
Industries deemed vital to national security, large employers, or producers of staple goods often
face government intervention. Protectionist measures, subsidies, and preferential treatment for
domestic competitors aim to shield these industries. The article discusses examples, such as
Europe's support for farmers and governments preventing foreign dominance in essential goods
markets.

High Sunk-Cost Commitments:

Industries requiring large, geography-specific investments, like oil refineries or infrastructure
projects, are vulnerable to local government interference. Irreversibility of investments increases
the risk of holdups, complicating the ability of foreign companies to establish a foothold.

Cultural Significance:
Industries or companies serving as symbols of a country's modernity and competitiveness, such
as the Boeing-Airbus competition, evoke strong feelings and may even lead to broader trade
wars. Cultural significance influences government protectionism, and the more a government
invests in an industry, the more protective it becomes.

Challenges in Specific Markets:

Case Study: China:
The article delves into the challenges of doing business in China, highlighting cultural,
administrative, and economic barriers. The survey of multinational companies reveals the
difficulties faced in China, with many companies overestimating market potential. Administrative
barriers, market-access restrictions, and state involvement pose significant challenges.
Case Study: Tricon Restaurants International (TRI):
TRI's case study demonstrates how assessing markets solely through traditional methods like
Country Portfolio Analysis (CPA) can be flawed. The article emphasizes the importance of
adjusting assessments for distance attributes using the CAGE framework. TRI's decision to
focus on specific markets based on adjusted distance considerations exemplifies the practical
application of the framework.

Managing Distance:
Operational Complexity:
The article underscores the operational challenges arising from cross-country complexity and
change. It emphasizes the premium on responsiveness and agility, suggesting that companies
focusing on simplicity and profitability outperform those grappling with added operational
complexity. Examples from the home appliance industry highlight the impact of geographic
spread on returns for investors.

Full Analysis Considerations:

While the CAGE framework offers a comprehensive tool, a full analysis should consider
company-specific features. Factors like the cultural diversity of management or the company's
existing market presence influence how distance affects the business. In TRI's case, company-
specific features made Mexico even more attractive, showcasing the importance of considering
both industry and company characteristics.

Additional Readings:
Cross-Border Negotiations:
The article briefly references the hidden challenge of cross-border negotiations, emphasizing
the need to understand and navigate varying negotiation processes influenced by cultural
differences. Managing negotiations effectively requires mapping decision-making processes,
roles, and agreement-reaching mechanisms.

Clusters and Competitive Advantage:

The additional reading on clusters explores the concept of proximity, both geographical and
cultural, providing companies with a competitive edge. The formation of industry clusters, such
as Silicon Valley or Hollywood, highlights how local assets, knowledge, relationships, and
motivation contribute to unusual competitive success. Clusters impact competition by enhancing
productivity, driving innovation, and stimulating new business formation.
Conclusion:
Persistent Significance of Distance:
Despite technological advancements making the world more interconnected, the article
concludes that the costs of distance, in all its dimensions, remain high. The CAGE distance
framework serves as a subjective yet crucial tool for managers to navigate the challenges of
global expansion. It reinforces the idea that understanding and managing distance is essential
for successful international business operations.
S7 Reading - Friedman
1. The Ten Flatteners:
1.1. Fall of the Berlin Wall (11/9):
- Symbolic Importance: The fall of the Berlin Wall in 1989 marked a shift in global
perspective, eliminating physical and ideological barriers that had previously divided the world.
- Globalization Catalyst: Nobel Prize-winning economist Amartya Sen highlighted how the
wall prevented a global view of the future, and its fall allowed for a more interconnected world.

1.2. Netscape Goes Public (8/9, 1995):

- Internet Revolution: Netscape's initial public offering in 1995 had dual significance. It
brought the Internet to life by introducing a browser for displaying images and data stored on
websites.
- Dot-Com Boom: The event triggered the dot-com boom, leading to overinvestment in fiber-
optic telecommunications, ultimately fostering a global undersea-underground fiber network.

1.3. Workflows and Connectivity:

- People-to-People Connectivity: The Netscape revolution elevated people-to-people
connectivity to new levels, enabling individuals to connect globally.
- Workflow Revolution: The workflow revolution facilitated seamless connections between
software applications, standards, and electronic transmission, fostering collaboration worldwide.

1.4. Outsourcing and Offshoring:

- Digitization Impact: The ability to connect applications seamlessly led to the digitization and
outsourcing of various tasks, from accounting to software development.
- Global Work Distribution: Work could now be done anywhere in the world where it could
be done more efficiently and cost-effectively.

1.5. Open-sourcing and Insourcing:

- Collaborative Innovation: Open-sourcing, exemplified by Linux, showcased collaborative
online efforts in software development.
- Insourcing Dynamics: Companies like UPS could take over entire logistics operations,
emphasizing collaboration within and between companies.

1.6. Supply-chaining and Informing:

- Efficient Global Supply Chains: Companies like Wal-Mart perfected supply-chaining,
creating global supply chains for maximum efficiency.
- Information Accessibility: Informing, represented by search engines like Google, Yahoo,
and MSN, enabled individuals to access and mine unlimited data.

1.7. The "Steroids":

 - Wireless and VoIP: Wireless access and Voice over Internet Protocol (VoIP) acted as
"steroids," enhancing the speed and accessibility of global collaboration.
- Anywhere, Anytime Collaboration: Individuals could now collaborate from anywhere,
using any device, further flattening the world.

2. Impact on India and China:

2.1. India's Digital Leap:
- Resource Constraints Overcome: India, initially lacking resources and infrastructure,
benefited significantly from digital connectivity.
- Y2K Opportunity: India capitalized on the Y2K issue, demonstrating its capacity to provide
solutions for global challenges.

2.2. Global Collaboration Dynamics:

- Leveling the Playing Field: The connectivity allowed India and China to compete and
collaborate globally, breaking down geographical barriers.
- Innovation Hub: India, in particular, emerged as a hub for innovation, challenging traditional
Western multinationals.

2.3. Global Economic Shift:

- From "Sold in China" to "Designed in China": China and India aimed not only to
manufacture but also to design products, indicating a significant shift in global economic
dynamics.
- Education and Innovation: The emphasis was on leveraging educational heritage for
innovation and design.

3. Convergence of Players and Processes:

3.1. Inclusion of Three Billion People:
- Economic and Political Openness: The 1990s saw three billion people from various
regions gaining economic and political freedom.
- Global Collaboration Opportunities: The convergence of these new players with the
flattening world created opportunities for more equal collaboration.
3.2. Forces Shaping Global Economics:
- Horizontal Collaboration: The emphasis shifted from hierarchical structures to horizontal
collaboration within and between companies.
- Shift in Value Creation: Hierarchies gave way to collaborative models, with value
increasingly created through horizontal collaboration.

3.3. Challenges from Extreme Capitalism:

- New Economic Powers: The challenge to the United States came from countries practicing
extreme capitalism, such as China, India, and South Korea.
- Building Strong Individuals: The objective shifted from building strong states to fostering
strong individuals.

4. Challenges and Responses:

4.1. Comprehensive Response Required:
- Similarity to Cold War Challenges: Meeting the challenges of globalization requires a
response similar to that of the Cold War.
- Presidential Leadership: Leadership is crucial to summon the nation to work harder, get
smarter, and invest in infrastructure.

4.2. Ambition Gap and Numbers Gap:

- Need for Increased Effort: Friedman notes an "ambition gap" in the United States,
comparing the work ethic to that of young, energetic individuals in India and China.
- Shortage of Engineers and Scientists: The U.S. faces a significant shortage of engineers
and scientists, with a decline in the production of these professionals.

5. Urgent Actions Needed:

5.1. Quiet Crisis in Science and Engineering:
- Ambitious Response Needed: The quiet crisis in America's scientific and engineering base
demands an ambitious response.
- Innovation as a Driver: Innovation has been a consistent driver of America's prosperity and
must be nurtured.

5.2. Warning from Bill Gates:

- High School Education Obsolescence: Bill Gates warns of the obsolescence of American
high-school education.
- Comparison with Global Competitors: U.S. students' performance in math and science
declines compared to international peers.
5.3. Immediate Efforts Crucial:
- Long-Term Impact: Training engineers takes 15 years, emphasizing the need for immediate
efforts to address the crisis.
- Parental and Educational Responsibilities: Parents are urged to prioritize education and
guide children toward science and engineering.

6. Call to Action:
6.1. National Discussion and Adaptation:
- Need for Thoughtful Discussion: The United States needs a more thoughtful national
discussion on enhancing competitiveness.
- Adaptation to the Flattened World: Recognizing the need for a different approach,
Friedman emphasizes the importance of adaptation.

6.2. Recognition of Urgency:

- Time to Focus: Friedman urges Americans to recognize the urgency of the situation and
focus on necessary changes.
- Constant Innovation: In a flattened world, constant innovation is crucial for individual and
national advancement.

Conclusion:
"The World is Flat" serves as a wake-up call, urging the United States to adapt to the challenges
posed by a flattened world. The book emphasizes the importance of fostering innovation,
improving education, and responding energetically to the forces shaping global economics and
politics. It highlights the
Study Guide
Introduction
Thomas L. Friedman, in "The World Is Flat," explores the concept of globalization and its impact
on the world's economic, political, and technological landscape.

The 10 Flatteners
1. Fall of the Berlin Wall (11/9, 1989): Symbolized the end of divided ideologies and opened
up a global perspective.
2. Netscape's IPO (8/9, 1995): Revolutionized the Internet, connecting people globally and
triggering the dot-com boom.
3. Workflow Revolution: Enhanced people-to-people and application-to-application
connectivity, fostering collaboration.

Forms of Collaboration
1. Outsourcing: Enabled digital work to be sent anywhere in the world.
2. Offshoring: Shifting entire operations to other countries.
3. Open-sourcing: Collaborative software development.
4. Insourcing: External companies take over internal operations.
5. Supply-chaining: Efficient global supply chain management.
6. Informing: Search engines facilitating collaboration with unlimited data.

The 10th Flattener: "The Steroids"

Wireless access and Voice over Internet Protocol (VoIP) turbocharged collaboration, making it
accessible from anywhere.

Convergence and New Players

- The convergence of collaborative tools sets the stage for a transformative information
revolution.
- Three billion people from China, India, Russia, and other regions entered the global market
just as collaboration tools were advancing.
Shift in Economic and Political Dynamics
- The convergence of new players, a new playing field, and horizontal collaboration shapes
global economics and politics.
- The challenge comes from countries practicing extreme capitalism, like China, India, and
South Korea.

Challenges and Responses

1. Ambition Gap: Americans must compete with the ambition of energetic individuals from
emerging economies.
2. Numbers Gap: Shortage of engineers and scientists, exacerbated by restrictive immigration
policies.
3. Education Gap: American education needs improvement to keep up with global standards.

Urgent Action Required

- Bill Gates warns of an "obsolete" American high-school education system.
- Immediate action is crucial to address the "quiet crisis" that threatens America's scientific and
engineering base.

Conclusion
- The era of flatism demands a comprehensive response, comparable to the challenge posed by
Communism during the Cold War.
- Individuals need to adapt to a world where competition and collaboration are direct and global.
- The crisis is an opportunity for transformative change.
S7 Reading - Ghemawat

1. Introduction: The Flat World Illusion

Globalization, often depicted as a flat world where barriers between nations diminish, is
challenged in this analysis. The perception of a seamlessly integrated world, popularized by
figures like Thomas L. Friedman, is examined critically.

2. The 10 Percent Presumption

Contrary to the belief in extensive global integration, data reveals that more than 90 percent of
phone calls, web traffic, and investments remain local. This challenges the notion that the world
is already operating at near-complete globalization.

3. Geographic Constraints on Globalization

Despite advancements in technology, national borders still significantly impact economic
activities. Examples from the Indian software industry illustrate that success is often tied to
geographical and political factors, such as U.S. capital investment.

4. Home Bias and Trade Intensity

Even in seemingly borderless industries like the internet, geographical boundaries persist. Web
traffic within countries exceeds that between them, indicating that people are more connected to
local communities than globally.

Trade intensity between neighboring regions, as observed in Canadian-U.S. trade, remains

significantly higher than international trade. This suggests a persistent "home bias" that
challenges the idea of a completely globalized world.

5. Trends in Integration: Past and Present

The analysis suggests that integration levels reached their peak in certain dimensions many
years ago. Despite recent policy changes and globalization trends, historical data indicate that
reversals and stagnation periods are not uncommon.
6. Challenges to Continued Globalization
Recent events, such as the suspension of the Doha round of trade talks and increased
protectionism in cross-border mergers, hint at challenges to sustained globalization. Public
sentiment, as expressed by GE's CEO Jeff Immelt, suggests that globalization may face
resistance in popular votes.

7. Conclusion: Rethinking the Flat World

The champions of globalization may be describing a world that doesn't align with current
realities. The potential for deep international economic integration may clash with national
sovereignty, and the road ahead may involve shocks, cycles, and periods of reversals.

8. Implications for Policymakers

Policymakers are urged to be cautious about basing decisions on the assumption of an already
fully integrated and "flat" world. The analysis underscores the need to consider the fragility of
globalization and its potential incompatibility with national sentiments.
Study Guide
1. Introduction
Globalization, often portrayed as a force breaking down borders and connecting nations, is
challenged by the author, Pankaj Ghemawat. Contrary to common belief, the world is not as
interconnected as presented in popular narratives.

2. The 10 Percent Presumption

Ghemawat introduces the concept of the "10 Percent Presumption," revealing that over 90
percent of phone calls, web traffic, and investment remain local. This challenges the widely held
notion of a highly globalized world.

3. Economic Activities and Borders

Despite claims that investment knows no boundaries, the data suggests that most economic
activities are still domestically concentrated. Geographical factors continue to significantly
influence economic interactions, challenging the idea that globalization has eliminated borders.

4. Impact on Trade
The concept of a "home bias" in trade is explored. Even with the implementation of international
trade agreements like NAFTA, domestic trade often surpasses international trade. This
challenges the assumption of a seamless, borderless economic landscape.

5. Challenges in Cyberspace
The author delves into the challenges faced in cyberspace, emphasizing that despite increased
internet connectivity, web traffic within countries and regions remains predominant. Google's
struggles to dominate markets in various countries underscore the continued importance of
geographical location.
6. Turning Back the Clock on Globalization
Ghemawat introduces the idea that globalization is not an irreversible trend. Historical trends
indicate periods of stagnation and even reversal in globalization. This challenges the notion that
the world is inevitably moving towards complete integration.

7. National Sovereignty and Global Integration

The tension between deep international economic integration and national sovereignty is
examined. Voter tendencies, particularly in advanced countries, suggest a proclivity towards
protectionism, posing a challenge to the continuation of cross-border integration.

8. Critique of Globalization Advocates

The author critiques the champions of globalization for presenting an overly optimistic view of a
fully integrated world. The danger of policymakers basing decisions on this idealized
perspective is emphasized, suggesting that such a worldview is not only unproductive but also
potentially dangerous.

9. Conclusion
Ghemawat concludes by cautioning governments against making policy decisions based on the
assumption of a fully integrated world. He highlights the potential reversibility of globalization
trends and encourages a more nuanced and realistic approach to policymaking.
Key Concepts for Exam Study:
- 10 Percent Presumption: The discrepancy between the perceived level of internationalization
and the reality that over 90 percent of certain activities remain local.

- Home Bias in Trade: Despite international trade agreements, domestic trade often exceeds
international trade, challenging the idea of a completely borderless economic environment.

- Challenges in Cyberspace: Despite increased internet connectivity, the challenges of

linguistic diversity and local competition persist, limiting true globalization in cyberspace.

- Turning Back the Clock: Historical trends suggest that globalization-friendly policies are
reversible, emphasizing the need for a nuanced understanding of global trends.

- National Sovereignty vs. Global Integration: The tension between deep international
economic integration and national sovereignty, influenced by voter sentiments, poses a
challenge to continued cross-border integration.

- Critique of Globalization Advocates: The danger of policymakers basing decisions on an

overly optimistic view of complete integration is emphasized, urging a more realistic approach to
policymaking.

- Caution in Policymaking: Governments are warned against making decisions based on the
assumption of a fully integrated world, considering the potential reversibility of globalization
trends.
S9 Reading - Economies of Strategy
1. Competitive Advantage and Consumer Surplus:
- Definition: Competitive advantage is achieved when a firm earns higher profitability than its
rivals.
- Consumer Surplus Importance: Consumer surplus (the difference between perceived
benefit - B and monetary price - P) is critical. A consumer purchases a product only if this surplus
is positive, emphasizing the role of perceived value.

2. Value Map and Competitive Implications:

- Value Map Significance: A value map illustrates the competitive implications of consumer
surplus. It shows the price–quality combinations that yield the same level of consumer surplus.
- Value-Created Formula: Value-created is calculated as the difference between perceived
benefit (B) and unit cost (C). It's equal to the sum of consumer surplus and economic profit.

3. Bases of Competitive Advantage:

- Resources and Organizational Capabilities: Competitive advantage relies on superior
resources (firm-specific assets) and organizational capabilities (clusters of activities that the firm
excels in compared to rivals).

4. Three Generic Strategies:

- Cost Leadership: A strategy focused on achieving a cost advantage by offering a product
with lower cost (C) for the same or lower benefit (B).
- Benefit Leadership: Aims to achieve a benefit advantage by offering products with higher B
for the same or higher C.
- Focus: Involves specialization in a narrow set of product varieties or serving a narrow set of
customers.
5. Focus Strategies:
- Customer Specialization: Involves offering related products to a limited class of customers
(e.g., industrial process control systems sold to petroleum refiners).
- Product Specialization: Focuses on producing a limited set of product varieties for a
potentially wide class of customers.
- Geographic Specialization: Offers related products within a narrowly defined geographic
market.

6. Advantages of Focus Strategies:

- Insulation from Competition: Focus strategies can insulate a firm from competition,
especially in small industry segments.
- Profitability in Low-Demand Segments: In segments with low demand, a focused seller may
be more profitable than one of several competitors in high-demand segments.

7. Questions on Competitive Strategy:

- Importance of B - C in Different Market Structures: Evaluates the significance of the
difference between perceived benefit and cost in various market environments.
- Effect of Economies of Scale on Positioning: Considers how economies of scale impact a
firm's strategic position.
- Role of Market Growth in Niche Strategy Viability: Examines how market growth affects
the viability of a focus (niche) strategy.
- Comparison of Brand and Generic Product Quality and Pricing: Explores whether
branded products are usually of higher quality than generic products.

8. Methods for Measuring Benefit Position:

- Reservation Price Method: Estimates perceived benefit (B) by asking consumers the highest
price they would pay.
- Attribute-Rating Method: Directly estimates benefit drivers from survey responses and
calculates overall benefits based on attribute scores.
- Hedonic Pricing Analysis: Determines the value of specific product attributes using data
about actual consumer purchases.
- Conjoint Analysis: Estimates relative benefits for hypothetical combinations of attributes,
especially useful for evaluating new features.
9. Notable Quotes and References:
- Michael Porter's Emphasis on Differentiation: Porter emphasizes the role of differentiation
in strategy.
- Consumer Tastes and Income Impact on Willingness-to-Pay: Acknowledges the role of
consumer tastes and income differences in willingness-to-pay.
- Examples of Successful Adaptation to Focus Strategies: Highlights examples of
successful companies starting with a focus strategy and later adapting.

10. Additional Insights:

- Distinction Between Experience and Search Goods: Explores the retailing differences
between experience goods and search goods.
- Impact of Market Growth on Focus Strategy Viability: Considers how market growth
influences the viability of a focus strategy.
- Profitability of Niche Strategies: Discusses the profitability of niche strategies, attributing it
to weaker price competition.
Study Guide

1. Competitive Advantage Essentials

Achieving competitive advantage is at the core of strategic positioning, where a firm seeks to
outperform rivals by earning higher rates of profitability. This hinges on a firm's ability to create
superior value compared to its competitors. This value is measured through consumer surplus,
the difference between the perceived benefit (B) and the monetary price (P) of a product.

2. The Value Map and Consumer Surplus

- Value Map: This tool visually represents the competitive implications of consumer surplus. It
helps firms understand the market positioning and competitive landscape based on the value they
provide.

- Consumer Surplus: Central to understanding value creation, consumer surplus is the surplus
benefit that consumers derive from a product beyond its monetary cost.

3. Bases of Competitive Advantage

- Resources: Firm-specific assets that are not easily replicable by competitors. These could
include patents, technology, or unique talent.

- Organizational Capabilities: These are clusters of activities that a firm excels in compared to
its rivals. It's the ability to execute strategies effectively.
4. Generic Strategies
- Cost Leadership: Aims to achieve a cost advantage over rivals by offering a product with a
lower cost (C) for the same or lower benefit (B). This is attractive in situations where economies
of scale or learning can be exploited.

- Benefit Leadership: Strives for a benefit advantage by offering products with a higher benefit
(B) for the same or slightly higher cost (C). This is appealing when consumers are willing to pay
a premium for enhanced quality or performance.

- Focus: Concentrates efforts on a narrow set of products, customer segments, or both. It's about
being excellent in a niche.

5. Focus Strategies: Customer, Product, Geographic

Specialization
Customer Specialization
- Example: MacKichan Software in word processing software.
- Approach: Offers an array of related products to a limited class of customers. Success depends
on identifying and satisfying the unique needs of this target customer group.

Product Specialization
- Example: Consulting firm ZS Associates.
- Approach: Produces a limited set of product varieties for a potentially wide class of customers.
This strategy relies on the ability to exploit economies of scale or learning economies within the
specialized product or service.

Geographic Specialization
- Example: Local breweries like Pittsburgh Brewing Company.
- Approach: Offers a variety of related products within a narrowly defined geographic market.
Success is often tied to the strength of local brands and promotional activities.
6. Advantages of Focus Strategies
- Economies of Scale: Focused firms can exploit economies of scale or learning, leading to cost
advantages.

- Better Serving Customers: By catering specifically to a niche, a focused firm can better meet
the needs of its target customer group.

- Insulation from Competition: In smaller market segments, where demand may only support a
few firms, focus strategies can insulate a firm from intense competition, leading to substantial
returns.

7. Competitive Advantage and Profitability

- Creating More Value: To achieve a competitive advantage, a firm must not only create positive
value but also more value than rival firms.

- Bases of Competitive Advantage: Superior resources and organizational capabilities are the
foundations of competitive advantage.

8. Selected Study Questions

Cost Leadership vs. Benefit Leadership
- Explanation: A firm can outperform rivals through cost or benefit leadership, not price
leadership. This distinction is crucial for understanding how firms can differentiate themselves in
the market.

Economies of Scale
- Explanation: The impact of economies of scale on strategic positioning is significant. When
firms can exploit scale, scope, or learning economies, cost leadership becomes an attractive
strategy.

Value Chain and Strategic Positioning

- Explanation: The value chain is a critical tool for firms to identify their strategic position.
Understanding how each activity in the value chain contributes to the firm's competitive advantage
is key.
Consumer Tastes
- Explanation: Recognizing whether consumer tastes differ is essential, as it can impact a firm's
ability to create value. This understanding is crucial for effective market positioning.

Focus Strategies and Market Growth

- Explanation: The viability of a focus strategy is influenced by market growth. Understanding
this relationship is key to making strategic decisions about focus and expansion.

9. Measurement Methods for Benefit Position

Reservation Price Method
- Explanation: Consumers' maximum willingness to pay is a crucial indicator of perceived benefit.
Asking consumers the highest price they would pay provides insights into their reservation price.

Attribute-Rating Method
- Explanation: Attribute rating directly gauges benefit drivers by having target consumers rate
products based on attributes. Calculating weighted scores helps determine the B/C ratio.

Hedonic Pricing Analysis

- Explanation: This method uses actual consumer purchases to determine the value of specific
product attributes. The hedonic pricing approach identifies how much consumers are willing to
pay for each attribute.

Conjoint Analysis
- Explanation: Particularly useful for new features, conjoint analysis estimates the relative
benefits of different product attributes for hypothetical combinations. It helps in understanding
consumer preferences and willingness to pay.

10. Key Concepts from Endnotes

Michael Porter
- Emphasis: Porter emphasizes differentiation as a critical strategy. His work, especially in
"Competitive Strategy," provides insights into generic strategies and their application.

“What Is Strategy?”
- Significance: Porter challenges the notion that operational effectiveness alone equates to a
strategic advantage. True strategy involves making unique choices that create value.
Activity Cost Analysis
- Example: Thompson and Strickland's "Strategic Management" provides a practical example of
activity cost analysis in the beer industry, highlighting the importance of understanding costs in
strategic decisions.

11. Conclusion: Strategic Positioning Essentials

- Creating Superior Value: At the heart of strategic positioning is the goal of creating superior
value for customers.

- Focus and Differentiation: Focus strategies, combined with differentiation, are critical elements
for success in a competitive landscape
S12 Reading - Besanko (Chapter 5)

I. Competitor Identification and Market Definition

1. Own and Cross-Price Elasticities
- Essential Concepts:
- Own-Price Elasticity: Measures how the quantity demanded of a good responds to a
change in its price.
- Cross-Price Elasticity: Indicates how the quantity demanded of one good responds to a
change in the price of another.

- Importance:
- Understanding elasticities helps firms identify substitutes and complementary products.
- Enables effective competitor identification and market definition.

2. Market Definition for Specialty Grocers

- Considerations:
- Product Differentiation: Assess the unique characteristics of natural and organic food
grocers.
- Consumer Preferences: Examine the degree of consumer loyalty and preferences for
specialty products.
- Competition Dynamics: Analyze the competitive landscape and entry barriers.

- Case Example:
- The Whole Foods/Wild Oats merger faced challenges as authorities questioned the distinct
market served by these grocers.

3. Nature of Competition in the Restaurant Industry

- Factors to Explore:
- Submarkets: Identify segments with unique competitive pressures (e.g., fast-food vs. fine
dining).
- Substitutes: Examine substitutes affecting pricing decisions.
- Profitability Strategies: Explore differentiation and customer loyalty strategies for
profitability.
II. Models of Competition
4. Revenue Destruction Effect in Cournot Competition
- Concepts:
- Cournot Equilibrium: Firms independently set quantities.
- Revenue Destruction Effect: Prices fall as more competitors enter the market.

- Illustration:
- Airlines in downturns experience excess capacity, leading to aggressive price competition
and substantial losses.

5. Bertrand Equilibrium in Differentiated Markets

- U.S. Cola Market Example:
- Model Type: Differentiated Bertrand model.
- Outcome: Equilibrium prices exceed marginal costs due to product differentiation.
- Real-World Validation: U.S. cola market prices align well with the differentiated Bertrand
model.

6. Price Elasticity and Profit Opportunities

- Insights:
- Homogeneous Products: Efficient production is crucial for success.
- Oligopoly and Monopoly: Differing profit opportunities and pricing strategies.

7. Monopolistically Competitive Markets

- Characteristics:
- Monopolistic Features: Differentiated products and many sellers.
- Competitive Features: Pricing influenced by consumer loyalty and willingness to switch.

III. Empirical Evidence and Market Structure

8. Price and Concentration Relationship
- Observations:
- Higher Concentration: Often linked to higher prices.
- Industry Studies: Confirm relationship across various sectors.

9. Factors Affecting Margins Besides Market Structure

- Considerations:
- Accounting Practices: Influence reported margins.
- Regulation: Impacts pricing dynamics.
- Product Differentiation: Affects competition strategies.
10. Herfindahl Index and Market Definition
- Analysis:
- Soft Drink Market Example: Computing Herfindahl for market shares.
- Implications: Explore effects of potential mergers on market concentration.

IV. Industry-Specific Models

11. Cournot Competition in Turbine Generator Industry
- Duopoly Dynamics:
- Demand Curve: P = 100 − Q.
- Equilibrium: Price = $60, firms produce 20 machines, and profits are $400.

12. Bertrand Competition in Dancing Machine Industry

- Duopoly with Technology Investment:
- Sunk Cost: Chuckie B Corp. considers technology investment.
- Strategic Decision: Evaluate impact on equilibrium and profit maximization.

V. Tools and Concepts

13. Elasticities of Demand and Market Dynamics
- Foundational Tools:
- Elasticities: Essential for understanding consumer behavior and market responses.
- Insights: Guide firms in making strategic decisions.

14. Capacity Constraints in Bertrand Competition

- Electricity Market Example:
- Capacity Constraints: Explain price spikes.
- Real-World Scenario: High demand and capacity limitations contribute to deviations from
Bertrand equilibrium.
VI. Conclusion
15. Relationship Between Market Structure and Conduct
- Key Takeaways:
- Market Structure Influence: Pricing, conduct, and profitability.
- Dynamic Factors: Competitive pressures, differentiation, and external influences shape
industry dynamics.
Study Guide
Competitor Identification and Market Definition
Own and Cross-Price Elasticities:
- Own-Price Elasticity: Measures how sensitive the quantity demanded of a good is to changes
in its own price.
% #$%&'( )& *+%&,),- .(/%&0(0
- Formula: !"# %&'() *+,-.'('./ =
% #$%&'( )& 12)3(
- Cross-Price Elasticity: Measures how sensitive the quantity demanded of one good is to
changes in the price of another.
% #ℎ%&'( )& *+%&,),- .(/%&0(0 12 3110 4
- Formula: !"#$$ %&'() *+,-.'('./ =
% #ℎ%&'( )& 56)7( 12 3110 8

Market Structure Measurement:

- N-Firm Concentration Ratio: Measures the combined market share of the top N firms.
- Herfindahl Index (HHI): Sum of the squared market shares of all firms in the market.
- Interpretation: Higher concentration (higher ratio or index) suggests less competitive
markets.

Types of Market Structures

Competitive Markets:
- Homogeneous Products: Products are identical.
- Many Sellers: Numerous firms competing.
- Outcome: Prices tend to be close to marginal costs.

Monopoly:
- Single Seller: One dominant firm.
- Outcome: Can set prices above marginal cost without losing much business.

Monopolistic Competition:
- Many Sellers: Several firms with some brand loyalty.
- Outcome: Prices set based on consumer loyalty; entry erodes profits.

Oligopoly:
- Few Firms: Small number of influential firms.
- Outcome: Pricing dynamics influenced by interaction among oligopolists and product
differentiation.
Cournot and Bertrand Models
Cournot Competition:
- Assumption: Firms set quantities simultaneously.
- Outcome: Price falls as the number of Cournot competitors increases.
- Revenue Destruction Effect: Smaller firms have greater incentive to cut prices.

Bertrand Competition:
- Assumption: Firms set prices simultaneously.
- Outcome: Prices can be driven to marginal cost if products are perfect substitutes.
- Homogeneous Products: Lead to aggressive price competition.

Real-World Examples and Applications

Electricity Markets:
- Bertrand Competition:
- Prices driven to marginal cost in competitive markets.
- Capacity constraints can lead to price spikes.

Cola Market:
- Differentiated Bertrand Model:
- Pricing based on product differentiation.
- Empirical evidence supporting the model.

Antitrust and Market Performance

Price and Concentration:
- Studies: Show prices tend to be higher in concentrated markets.
- Relationship: Observed in various industries.

Factors Affecting Margins:

- Concentration: Not the sole factor; other elements like regulation, product differentiation, and
market dynamics play a role.
Study Questions
Elasticities of Demand:
- Own and Cross-Price Elasticities: Essential for competitor identification.

Antitrust Case:
- Market Identification: Determining the market served by grocers specializing in natural and
organic foods.

Nature of Competition in the Restaurant Industry:

- Submarkets: Identifying distinct competitive pressures and important substitutes.

Price Elasticity at Industry and Firm Levels:

- Impact on Profit Opportunities: Understanding the role of elasticity in shaping profit
opportunities.

Revenue Destruction Effect:

- Understanding the Concept: Exploring the implications of increasing Cournot competitors.

Demand Responsiveness in Different Markets:

- Customer Behavior: Considering how customer behavior affects price competition in various
markets.

Relationship Between Concentration and Price:

- Correlation: Exploring the systematic relationship between concentration and prices.

Factors Beyond Concentration Affecting Margins:

- Influencing Factors: Considering other influences on pricing beyond the number of firms.

Herfindahl Index and Market Definition:

- Calculation: Understanding how to compute the Herfindahl Index and its implications for
antitrust concerns.

Efficiency in Markets with Homogeneous Products:

- Role of Efficiency: Exploring the importance of efficiency in competitive versus
oligopoly/monopoly markets.

Monopolistically Competitive Markets:

- Analyzing Characteristics: Understanding how monopolistically competitive markets exhibit
both monopolistic and competitive aspects.
Case Study: Frosty's Pricing Strategy:
- Profit Maximization: Assessing Frosty's pricing strategy based on location, fixed costs, and
consumer willingness to pay.

Duopoly in the Turbine Generator Industry:

- Cournot Equilibrium Calculations: Examining the equilibrium pricing and profits in the
turbine generator industry.

Investment Decision in the Dancing Machine Industry:

- Sunk Cost Impact: Assessing the impact of a one-time sunk cost on Cournot equilibrium.

Bertrand Equilibrium in Horizontally Differentiated Markets:

- Calculating Equilibrium Prices: Understanding how to calculate Bertrand equilibrium in
markets with horizontally differentiated products.

Conclusion
- Understanding market structures and competitor behavior is crucial for predicting market
outcomes.
- Real-world applications demonstrate the relevance of economic models in various industries.
- Consideration of elasticities, concentration, and pricing dynamics provides a comprehensive
view of market competition.
Formulas
1. Demand Functions:
!1 = %! − '!! (! + '!" ("
!2 = %" − '"! (" + '"" ("

Explanation:
- These demand functions represent the quantity demanded for Coke (!1) and Pepsi (!2)
based on their respective prices ((1, (2).
- The coefficients indicate how changes in the prices of both Coke and Pepsi affect the quantity
demanded for each.

2. Cournot Reaction Functions:

% − . + '!2
!1 =
2'
% − . + '!1
!2 =
2'

Explanation:
- In the Cournot model, firms simultaneously choose quantities to maximize profit.
- These reaction functions show each firm's optimal quantity given its expectations about the
competitor's quantity.
-%, ' %/0 . are parameters reflecting demand and cost conditions.

3. Differentiated Bertrand Reaction Functions:

(1 = .! + 0!! ("#
!2 = .2 + 021 (1&

Explanation:
- In a differentiated Bertrand model, firms choose prices, considering the rival's price as a
strategic variable.
- These reaction functions show each firm's optimal price given its expectation of the
competitor's price (%22, %12).
4. Herfindahl Index:
'

112 = 3 8"(
()!

Explanation:
- The Herfindahl Index measures market concentration.
-5( represents the market share of firm 6, and the formula squares and sums these shares.
- A higher HHI indicates higher concentration.

5. Cournot Equilibrium Price and Quantity:

!
!=#−
2
%−.
! =
3

Explanation:
- In Cournot competition, equilibrium quantities and prices are derived based on cost (.) and
demand (%) parameters.
- The equilibrium reflects the point where both firms are maximizing profits simultaneously.

6. Bertrand Equilibrium Prices (for Coke and Pepsi):

%1 = *56'+'7&'68 %&'() 9:& ;'&8 1
%2 = *56'+'7&'68 %&'() 9:& ;'&8 2

Explanation:
- In a differentiated Bertrand model, equilibrium prices are found where firms set prices
considering the competitor's price.
- These prices are determined through simultaneous solution of the reaction functions.

7. Herfindahl Index Calculation for Soft Drinks:

'

112 = 3 (8%9:;< =ℎ%9; ?@ A9%/0 6)"

()!

Explanation:
- Applied to calculate Herfindahl Index for the soft drink market.
- Evaluates concentration and helps assess potential market power.