 Wall Mart Most profitable retailer in the world Most profitable retailer in the world 1999: $165 billion in sales1999: $165 billion in sales 1962: First store opens1962: First store opens 1993 q2 – 1997: stock value dropped1993 q2 – 1997: stock value dropped Responses to problems in mid 1990’s Responses to problems in mid 1990’s New international super-centersNew international super-centers E-commerce sitesE-commerce sites Experimented with traditional sized grocery stores in ArkansasExperimented with traditional sized grocery stores in Arkansas By 1998 the stock was performing well againBy 1998 the stock was performing well again The Economics of Strategy: Creating & Capturing Value

Superior Performance  All managers want to consistently beat the market over an extended period of time What accounts for the success of these firms? What accounts for the success of these firms? Should all properly managed firms expect superior performance? Should all properly managed firms expect superior performance? What actions can managers take to generate superior performance? What actions can managers take to generate superior performance? Can managers enhance performance by diversification? Can managers enhance performance by diversification? Do all firms eventually drop back to the pack? Do all firms eventually drop back to the pack?

Strategy  Strategy: Management definition A general description of all of the policies that managers adopt to increase profit A general description of all of the policies that managers adopt to increase profit  Wall Mart’s strategy Low prices every day Low prices every day Assortment of products Assortment of products

Creating Value Quantity Price In $ Q*Q* P*P* Demand Supply

Creating Value Quantity Price In $ Q*Q* P*P* Consumer Surplus Producer Surplus

Creating Value Quantity Price In $ Q*Q* P*P* Consumer Surplus Producer Surplus Producer-borne transaction costs Consumer-borne transaction costs

Creating Value Quantity Price In $ Consumer-Borne Trans. Costs Producer-Borne Trans.Costs Q*Q* P*P* Consumer Surplus Producer Surplus

Transaction Cost Examples  Consumer Transaction Costs Costs of search Costs of search Costs of learning about product quality Costs of learning about product quality Costs of Negotiation Costs of Negotiation  Producer Transaction Costs Costs of negotiation Costs of negotiation Attorney fees to draft sales agreements Attorney fees to draft sales agreements  Examples Dell eliminates the middle man in direct web-site PC sales and splits the gain between themselves and the buyer Dell eliminates the middle man in direct web-site PC sales and splits the gain between themselves and the buyer Early Wall Marts were in rural areas reducing transportation costs by opening stores closer to customers. Early Wall Marts were in rural areas reducing transportation costs by opening stores closer to customers.

Other Ways to Increase Demand  Product Quality Titanium Golf Clubs Titanium Golf Clubs Parabolic Skis Parabolic Skis  Pricing Complements Cut the price of the complement and increase the sales of both products Cut the price of the complement and increase the sales of both products Application: Printers and Personal Computers Application: Printers and Personal Computers  Pricing Substitutes Raise the price of a substitute Raise the price of a substitute Application: Don’t allow people to bring food into a theater Application: Don’t allow people to bring food into a theater Application: Airlines restrict the use of cell phones Application: Airlines restrict the use of cell phones

Capturing Value  Competitive firms make normal accounting profit (zero economic profit) in the long run Accounting profit may be higher than normal in the short run, but other firms enter the industry and drive the price down in the long run until accounting profit is at normal levels Accounting profit may be higher than normal in the short run, but other firms enter the industry and drive the price down in the long run until accounting profit is at normal levels  Firms with Market Power may get better than normal accounting profit (positive economic profit)

Capturing Value  Barriers to entry  Degree of rivalry Number of competitors Number of competitors Relative size of competitors Relative size of competitors  Threat of substitutes Example: and fax pose serious threats to profits for Federal Express and UPS Example: and fax pose serious threats to profits for Federal Express and UPS  Buyer and Supplier Power Example: Microsoft and Intel in Personal Computers Example: Microsoft and Intel in Personal Computers  Superior Factors of Production Better inputs tend to cost more Better inputs tend to cost more May be hard for other firms to copy if their structure is inappropriate. May be hard for other firms to copy if their structure is inappropriate. Example: A new flexible technology is hard to copy for firms that can’t rapidly reassign workers to new tasksExample: A new flexible technology is hard to copy for firms that can’t rapidly reassign workers to new tasks

All good things come to an end Rank IBMWal-Mart 2AT&TExxon-Mobil 3General Motors 4Standard Oil of NJFord Motor 5Eastman KodakEnron 6Sears RoebuckGeneral Electric 7TexacoCitigroup 8General ElectricChevron-Texaco 9XeroxIBM 10Gulf OilPhilip Morris

Diversification  Benefits Economies of Scope Economies of Scope Example: When one input is used in several products you may get a better price when ordering it.Example: When one input is used in several products you may get a better price when ordering it. Promoting Complements Promoting Complements Example: Ford can advertise its auto-financing when advertising its carsExample: Ford can advertise its auto-financing when advertising its cars

Diversification  Costs With larger firms it gets increasingly difficult to get lower level managers to act in the interests of the owners. With larger firms it gets increasingly difficult to get lower level managers to act in the interests of the owners.

Diversification  Faulty reason to diversify: Reducing Earnings Volatility Example: Good year tire went into oil. When gas prices are low people drive more and need more tires even though they buy less gas. Example: Good year tire went into oil. When gas prices are low people drive more and need more tires even though they buy less gas. This does reduce earnings volatilityThis does reduce earnings volatility Owners can get the same effect by buying stock in both tire and gasoline companies. Why pay a premium for that?Owners can get the same effect by buying stock in both tire and gasoline companies. Why pay a premium for that?

Diversification  When does diversification create value? Related Diversification Related Diversification Businesses serve common markets or use common technologiesBusinesses serve common markets or use common technologies Example: Disney operates theme parks, hotels, retail shops and TV stations. All are family oriented products. This can reduce consumer transactions costs for people searching for safe products for children.Example: Disney operates theme parks, hotels, retail shops and TV stations. All are family oriented products. This can reduce consumer transactions costs for people searching for safe products for children.

Strategy Formulation  Understanding Resources and Capabilities Capital Capital Physical CapitalPhysical Capital Human CapitalHuman Capital Organizational CapitalOrganizational Capital Opportunity Costs Opportunity Costs How much would assets be worth if sold to another firm?How much would assets be worth if sold to another firm?

Strategy Formulation  Business Environment Markets Markets InputInput OutputOutput Technology Technology ProductionProduction InformationInformation CommunicationCommunication Government Regulation Government Regulation

Strategy at Microsoft  Assets Lock-in Lock-in Since most people have Microsoft already, Microsoft products offer greater compatibilitySince most people have Microsoft already, Microsoft products offer greater compatibility Buying software from other firms would require learning new softwareBuying software from other firms would require learning new software  Strategy Produce regular upgrades for system software Produce regular upgrades for system software Operating system upgrades encourage the purchase of new softwareOperating system upgrades encourage the purchase of new software Operating system upgrades run better on faster computers so they encourage new hardware salesOperating system upgrades run better on faster computers so they encourage new hardware sales New hardware sales encourage purchases of new software New hardware sales encourage purchases of new software