Chapter 2 --Market Imperfections and Value: Strategy Matters u Conditions necessary for a perfectly competitive product market and resource market: u No market power u no producer is large enough to influence prices u Identical product u Identical cost u No restrictions on entry or exit u Complete information u like information and expectations

Sustainable Competitive Advantage u Sustainable competitive advantage is the elimination of perfect competition for a sustainable period of time so as to provide economic profit u Depends on: u Industry characteristics u Company actions u Product features or cost advantages

Assessing the Industry -- Porter’s Five Forces u Threat of new entries u Bargaining power of buyers u Bargaining power of suppliers u Threat of substitutes u Rivalry among existing firms Competitive Strategy. Free Press, 1980

Ways to Reduce the Threat of New Entries u Economies of scale u Patents, copyrights, & trade secrets u Regulation u Switching cost to customer u Stability of demand u Time needed to add capacity u Customer loyalty

Ways to Decrease the Bargaining Power of Buyers u Product differentiation u Information available to buyers u Customer interest in features vs. price u Price as a percent of buyer’s income u Switching costs for buyer u Difficulty of copying product advantages

Factors Influencing the Bargaining Power of Suppliers u Five factors in the market for inputs u Threat of new suppliers entering u Bargaining power with regard to our suppliers u Bargaining power of our suppliers u Threat that we will switch to substitute inputs u Rivalry among existing suppliers u Threat of vertical integration

Threat of Substitutes u Examples include: u Drive vs. fly u Oil vs. gas heat u Chicken vs. beef u Home equity loan vs. auto loan u The closer the substitutes, the more limited the power of the seller

Rivalry Among Firms u Goals of competitors u Profit vs. size, for example u Strength of competitors u Cost advantage or disadvantage u Financial strength u Intelligence of competitors

Creating Competitive Advantage on 3 Fronts u Change or take advantage of some industry characteristics or market imperfection u Create barriers to entry u Create some form of product advantage u Distribution advantage u Create some form of cost advantage u Pricing strategy u Information management

Using Strategy to Create Wealth u Steps to strategic planning u Establish goals u Assess the environment -- opportunities and threats u Assess the organization -- strengths and weaknesses u Develop a strategy u Develop operating processes that support the strategy -- marketing, distribution, production, capital budgeting, financing u Implement, monitor and control u Evaluate and reward

Summary u Wealth creation is impossible in a perfect market u Porter’s five forces can be used to evaluate the industries in which the firm operates or plans to to enter u A strategy should be developed that allows the firm to utilize market imperfections to establish a sustainable competitive and consequently an economic profit or positive net present value u Economic profit comes from competitive advantage in: u Dealing with customers u Dealing with financial markets