Chapter 7 Strategic Commitment Oleh : Deddi Wahyudi & Dian Eky 1

Strategic commitment are decisions that have long-term impacts and are difficult to reverse Strategic commitment should be distinguished from tactical decision Strategic commitment can significantly influence competition in an industry The detail of market rivalry can influence the commitments make 2

There are three essential characteristics to having a valuable strategic commitment: ◦It must be visible ◦It must be understandable ◦It must be credible  A key to credibility is irreversibility Public statement and contract can facilitate commitment 3

New Concept : 1. Capture how competitors react when one competitor changes a tactical variable a. Strategic complements b. Strategic subtitutes 2. Capture whether a commitment by one firm places its rivals at a advantage a. Tough commitment b. Soft commitment Strategic commitment and competition 4

Strategic Complements….. The more of the action one firm choose, the more of the action the other firm will also optimally choose Strategic Substitutes…. The more of the action one firm takes, the less of the action the other firm optimally choose Strategic Complements & Strategic Substitutes 5

The rule…. 1. Strategic complement a. Upward sloping reaction function (Bertrand Model) b. Component : price 2. Strategic substitute a. Downward sloping reaction ( Cournot Model) b. Component : quantity 6

Commitment have… 1. Direct effect  its impact on the present value of the firm’s profit 2. Strategic effect  competitive side effect of the commitment 7

Tough Commitment…. - bad for competitor - easier to visualize because they conform to the the conventional view of competition as an effort to outdo one’s rival - A tough commitment is a commitment that is going to have an adverse effect on the competitors of the firm. - We make a tough commitment when the positive strategic effect outweighs the potential negative direct effect Soft commitment - good for its competitor - A soft commitment is a commitment that is going to have a beneficial effect on the competitors of the firm. - We make a soft commitment when the positive direct effect outweighs the negative strategic effect. Tough and Soft Commitment 8

- Market with two firm… Stage 1  make commitment Stage 2  compete each other (Cournot or Bertrand analysis) - Market with two firm… Stage 1  make commitment Stage 2  compete each other (Cournot or Bertrand analysis) Tough and soft commitment in Cournot and Bertrand Equilibrium 9

Taxonomy of Commitment Strategies Nature of Stage 2Commitment Posture Commitment Action Strategy Strategic SubstitutesToughMakeTop-Dog Strategy FT Strategic SubstitutesToughRefrainSubmissive Underdog Strategic SubstitutesSoftMakeSuicidal Siberian Strategic SubstitutesSoftRefrainLean and Hungry Look FT Strategic ComplementsToughMakeMad Dog Strategic ComplementsToughRefrainPuppy-Dog Ploy FT Strategic ComplementsSoftMakeFat-Cat Effect FT Strategic ComplementsSoftRefrainWeak Kitten 10

- The strategic effect of commitment is positive when the commitment alter competitor’s behavior - Strategic commitments are almost always made under uncertainty condition - Some ways firm can preserve its flexibility when making strategic commitment : 1. Modify the commitment as future condition change 2. Delay making a commitment to future point until it has better idea of how profitable it is likely to be 3. Undertake unprofitable commitment today to preserve the option of making a follow-on commitment in the future Flexibility & Real Option 11

- Flexibility rises Real Option - Real option : a. exist when a decision maker has the opportunity to tailor decision to information that will be received in the future example : Firm wants to invest Rp 100M to enter new market, it creates 2 scenario with NPV : a. high-acceptance : Rp 300M b. low-acceptance : Rp 50M If firm invest today, expected NPV is( 0,5(300)+0,5(50)-100)=Rp 75M Flexibility & Real Option Cont… 12

If firm wait and the product tuns out to have high level market acceptance, firm should invest and obtain NPV Rp. 200M. But if the NPV = Rp. 50 M ( stop invest, we assume zero NPV investment) Assume annual discount rate = 10% Expected NPV = (0,5(200)+0,5(0))/1,10 = Rp 91M It’s better for the firm to delay the investment until they have as much as information of the new market 13

- A commitment-intensive decisions are durable, specialized, and untradable after the firm has moved forward with them - Pankaj Ghemawat developed a four-step framework for analyzing these decisions: 1. Positioning Analysis Analyze the direct effects of the commitment 2. Sustainability Analysis Analyze potential responses to the commitment by competitor and impact of those responses to the competition A Framework For Analyzing Commitment 14

3. Flexibility Analysis analyze uncertainty 4. Judgment Analysis analyze the distorting factors of the firm that affect the optimal choice of the strategy 2 types of error : Type I : rejecting an investment that should be made Type II : Accepting an investment that should be rejected A Framework For Analyzing Commitment… 15

Terima Kasih…. 16