`Strategic Management Study Guide

Questions For Professor

1) Uber and Lyft
a. Do they have CAs?
b. Are they sustainable?
c. Two sided market?
i. It is not clear right now, but if one gets a monopoly through this subsidization, one could
develop
d. How is it a two sided market?
i. Winner take all
1. What are positive network effects, and who is the side with the high multihoming costs?
Marginal costs may decrease
You gain value from more users, and then more drivers, like a two sided market, so benefit off growth of both users.
They benefit
Is WTP higher than cost? Uber is right now loosing money
Today is just the starting point, as WTP may be much higher but they want a monopoly
It is not clear that they are creating value
But we do not know
Taxi market is regulated, it fails at some points, and rate is fixed
Supply is fixed
Questions for Tatiana
1) Industry facts from professor for Bergerac
2) Graph for impediment of CA
Lecture 14:
Game Theory: We use game theory as a tool to predict outcomes in situations where agents interact and affect each
others payoffs with their choices.
Decision problems with no interactions (single-agent optimization):
1. Consumer maximizing utility
2. Firm choosing inputs to minimize production cost
3. Monopolist choosing a price
4. Firms choosing quantity in a Perfectly Competitive market
Problems with strategic interactions:
1. Coke deciding price of a can
2. Apple choosing features to add to iPhone 6
3. Verizon deciding whether to enter the Canadian wireless market
4. OPEC deciding the annual quota for its members
5. Automaker choosing product positioning in the quality/price space and
6. portfolio
7. Market entry decisions
8. Company deciding bid for FM broadcast auction by FCC
Strategic Thinking: Never assume that your opponents behavior is fixed. Key is to predict their reaction to your
behavior.
Elements of A Game:
1. Players are the decision makers
2. Actions are the moves available to each player
3. Strategies are all possible contingent plans for each player
4. Payoffs
5. Information structures
6. Timing of moves
a. Simultaneous moves

7.

b. Sequential moves
Nature of conflict
a. Repeated
b. Single-Shot Game

Assumptions About Game:

1. Rationality
2. Common Knowledge
Nash Equilibrium: It is the set of strategies such that, holding the strategies of all other players constant, no player
can obtain a higher payoff by choosing a different strategy.
Dominant Strategies: strategy that produces a higher payoff than any other strategy the player can use for every
possible combination of its rivals.
Best Responses: strategy that maximizes a players payoff given its beliefs about its rivals strategies
Eliminate dominated strategies first
1. If you can find a single solution using dominant strategies, this is a Nash Equilibrium (NE).
2. Not all Nash Equilibria can be found using the dominant strategies method
Other considerations:
1. Multiple or unique NE.
2. Pure and mixed strategies.
For N class, remember that the key is player 1 is first column using each row, and then player 2 is second column,
using each column
Watch youtube for good example:
https://www.youtube.com/watch?v=6rs_EQpxTI4&nohtml5=False
Dynamic Games:
Players might move sequentially, or one goes, then the next.

A simultaneous-move game can be repeated over time

Strategy is a contingent plan of actions

Normal-Form simultanous representation (matrix) hides timing features
Use Extensive Form (tree diagram) when moves are sequential:
1. n players
2. sequence in which players make moves
3. actions they can take at each move
4. information each player has about all players previous moves
5. payoff function over all possible strategies

The key with sequential moves is you first figure out best move for American which is 96, then figure out what best
move is for United as they have the next move (or after pink moment).
Subgame: All decisions that players make subsequently are made given the actions already taken and the
corresponding playoffs.
The whole game is a subgame (so Sequential (SPNE) or sub game NE is a subset of NE)
SPNE: Players strategies are a NE in every subgame
Solve by backward induction: Select best responses in each node for last player to move. Then the player making
next-to-last move....
SPNE needs to include off the equilibrium path strategies:
qA = 96 for American and (qU = 64 if qA = 48, qU = 64 if qA = 64,
qU = 48 if qA = 96) for United (dark blue lines in previous slide)
SPNE is about credible threats. Note that AA doesnt get the same equilibrium by simply announcing qA = 96 in
the simultaneous game
Commitments (irreversible actions) make incredible threats credible
Commitments:
In some games, a player can improve her outcome by taking an action that makes it impossible for her to take what
would be her best action in the corresponding simultaneous-move game. Such actions are referred to as
commitments, and they can serve as alternatives to external enforcement in games which would otherwise settle on
Pareto-inefficient equilibria.
Suppose you own a piece of land adjacent to mine, and I'd like to buy it so as to expand my lot. Unfortunately, you
don't want to sell at the price I'm willing to pay. If we move simultaneouslyyou post a selling price and I
independently give my agent an asking pricethere will be no sale. So I might try to change your incentives by
playing an opening move in which I announce that I'll build a putrid-smelling sewage disposal plant on my land
beside yours unless you sell, thereby inducing you to lower your price. I've now turned this into a sequential-move
game. However, this move so far changes nothing. If you refuse to sell in the face of my threat, it is then not in my
interest to carry it out, because in damaging you I also damage myself. Since you know this you should ignore my
threat. My threat is incredible, a case of cheap talk.
I could make my threat credible by committing myself. For example, I could sign a contract with some farmers
promising to supply them with treated sewage (fertilizer) from my plant, but including an escape clause in the
contract releasing me from my obligation only if I can double my lot size and so put it to some other use. Now my

threat is credible: if you don't sell, I'm committed to building the sewage plant. Since you know this, you now have
an incentive to sell me your land in order to escape its ruination.
First mover has advantage
Commitment is:
1. Hard to revert
2. Long-term impact
3. Must be
a. Visible
b. understandable
c. credible
Sometimes, best when inflexible, or tying your hands
Firms use commitments strategically all the time
Price Matching guarentees
Investment in new technology
Explicit contracts
Changing The Game: From Incredible To Credible
The Problem:

In this case threat not credible:

If we all deliver late, our payoff is $72 (9/10*80k) , if we deliver on time its only $27.
All deliver late is best option
Number suppliers from 1 to 10, and say I refuse delivery from lowest numbered supplier who is late
All delivering late is not an equilibrium.
Supplier 1 delivers on time, better than nothing no matter what. Then 2 must as he knows 1 will
The credible commitment changed game so that deliver on time is now best.

Entry Deterring Strategies

Exclusion contract example with our profit being 10-b with b being cost for exclusive contract
F is the entry cost for the rival in the mall
If F is greater than 4, then cost is too high and will choose not to enter, no need for exclusion deal.
If F is less than 4 and B is less than 6 then we prefer to exclude entry as they make profit entering, and will want to,
and B being less than 6 we are still profitable.
If B>6 then and F is less than 4 then we do not pay and compete.

We make the investment because first 8,0 or 4,4 based on entry choice (second column in profit), then we want 8,0
as 8 is best option.
Building extra capacity, or investment leads entrant not to enter as best choice.
Capacity is credible commitment because post entry competition will lead to lower market prices, and for entrant to
get crushed potentially.

Cartels:
Are a group of firms that explicitly agree to coordinate activities
1.

They do this in terms of quantities, quality, and price

The legality:
Collusion is largely illegal in the United States, Canada and most of the EU due to competition/antitrust law, but
implicit collusion in the form of price leadership and tacit understandings still takes place.
Examples:
OPEC, Canadian Potash Exporters
Why Do Cartels Fail?
Incentives to cheat, at collusive levels, Marginal benefit is greater than marginal costs
Detection and punishment
Punishment increases long run marginal cost of a cheater.
These include price wars, and side payments
Punishment can take many forms, ranging from other sellers targeting price discounts at the offenders
customers, to cutting the offenders allocated sales quota, all the way to suspending the cartels activities for
some period. In almost all instances, however, punishment will be costly not only to the offender but also to the
sellers who mete out the penalties.

Tit for tat: Corporation in round 1, set high price then, and then you copy what opponent did in t-1
In other words adopt your opponent strategy from previous round.
Grim triggers:
Start off high price, and then if opponent ever goes low once, you go low forever
High prices could occur if discount rate is very low and firms are patient in infinity periods
In finite periods, it is key to think about last period, cheating incentives, and unraveling.

Price leadership is an alternative cooperative method used to avoid tough competition.

Under this method, usually one firm sets a price and the other firms follow. It is quite popular in industries like
cigarette industry. Here any firm in the oligopolistic market can act as a price leader. The firm, which is highly
efficient, and having low cost can be a price leader or the firm, which is dominant in the market acts as a leader.
Whatever the case may be, the firm, which sets the price, is the price leader. We have two forms of price leadershipBarometric price leadership is said to be the simpler of the two. This normally occurs in the market where there is
no dominant firm. The firm having a good reputation in the market usually sets the price.
In dominant price leadership, the largest firm in the industry sets the price. If the small firms do not conform to
the large firm, then the price war may take place due to which the small firms may not be able to survive in the
market.

A Most-Favoured-Customer Clause (MFC) is a contractual arrangement between company and customer that
guarantees the customer the best price the company gives to anyone. The MFC prevents a company from treating
different customers differently in negotiations.
If I go low as Firm 1 then I will have 30 more customers than firm 2, but owe 30 customers refunds from the last
round making it not worth going low, as value is worse now compared to firm 2.
It makes sure that you choose high high.
As the next slide shows, MFCC is a promise to keep prices high. As next round, I will owe 30 customers refunds.

First example is not with MFCC, but second includes cost of refunds causing 60,60 to be optimal.

This exploits customer price awareness, sensitivity, and low switching costs which is what makes price competition
so brutal.

Must be done by one party, you can match but not over-retaliated

Must keep competitive reactions private, and must have legit justification for price cuts, price increases, handling PR
really well
Clear pricing tactics with attorney.

LN 15 Sustaining Competitive Advantage

Competitive advantage: Firms ability to outperform industry
The CA is sustainable if it persists despite competitors efforts to duplicate it or neutralize it.
Examples: Coca Cola, Walt Disney, BMW, Otis, Facebook
Eroded ones: Apple (1997), Microsoft, Dell, and Sony

Reasons it is not easy to sustain CA:

1.
2.
3.

Market structure
a. (Entry/internal rivalry can be problem)
Imitation and innovation
Changes to landscape

Perfectly Competitive Dynamic

The above lines are supply side.

All firms move toward tangency with perfectly competitive market with costless imitation and free entry. Profits
(ROA) will converge with cost of capital in this situation.

The line is supply side

Dennis Muller Study
found that low ROA and high ROA manufacturing firms, taking a study of 600, would move toward each other. Still
high ROA and low ROA firms do not converge to a common mean.

Sustaining competitive advantages

1.
2.

Persistence in differences in resources/capabilities with competitors

Isolating mechanisms
a. Impediment to imitation
b. Early mover advantage-ebay being the first auction process online

Sustaining requires some permanent entry barrier of some form.

Entry deterring strategies:
1.
2.
3.
4.
5.
6.

Learning curve
Advertising
R&D patents
Reputation
Limit pricing
Excess Capacity

Resource Based Theory Of The Firm

The resource-based view (RBV) as a basis for the competitive advantage of a firm lies primarily in the application of
a bundle of valuable tangible or intangible resources at the firm's disposal.
To transform a short-run competitive advantage into a sustained competitive advantage requires that these resources
are heterogeneous in nature and not perfectly mobile[
Example: Scarcity (in talented employees)
Extra profits could go to resource owner unless
1.
2.

Imperfect mobility (Customer loyalty to company not employees due to frequent flyer programs)
Asset specificity (Landing slots in airlines hub)

Rather, a competitive advantage is sustainable when the efforts by competitors to render the competitive advantage
redundant have ceased (:[2] p102; Rumelt, 1984, p562). When the imitative actions have come to an end without
disrupting the firms competitive advantage, the firms strategy can be called sustainable. This is in contrast to views
of others (e.g., Porter) that a competitive advantage is sustained when it provides above-average returns in the long
run. (1985).

A subsequent distinction, made by Amit & Schoemaker (1993), is that the encompassing construct previously called
"resources" can be divided into resources and capabilities.[4] In this respect, resources are tradable and non-specific
to the firm, while capabilities are firm-specific and are used to engage the resources within the firm, such as implicit
processes to transfer knowledge within the firm

Competitive forces can still neutralize CA based on special resources and capabilities
Resource Based Theory of Barca

The players are these resources which serve as a CA. Even trying to imitate Barcelona, you wont have similar
players as these greats, and thus Barca can sustain winning, similar to Mickey Mouse

Imitating Dell Distinct Aspects include close integreation with suppliers, PC manufactured to order, direct sales,
essentially no resellers. All of these lead to CA being sustained, even though distinct.

Isolating Mechanisms That Impede Loss of CA:

1) Impediments to imitation
1.
2.
3.
4.

Legal restrictions
a. Airlines with regulations
Superior access to inputs/customers
Market size (less likely where markets are growing) and scale economies
Intangible barriers (every company has different history, how operations are done

He made a graph, maybe Tatiana you have it

2) Early mover advantage
1.
2.
3.
4.

Learning curve
Reputation
Switching Costs
Network Effects
a. Gives advantage from demand side or from WTP not cost
1) Learning Curve Effects
A firm that sells more in early periods moves farther down learning curve
This leads to lower average cost than rivals and can undercut and sell more
Think Pizza place lowering cost with efficiency like Dominos, or shipbuilders, leading to lower Average cost
2) Network Effects
In economics and business, a network effect (also called network externality or demand-side economies of
scale) is the effect that one user of a good or service has on the value of that product to other people. When a
network effect is present, the value of a product or service is dependent on the number of others using it.[1]
The classic example is the telephone. The more people who own telephones, the more valuable the telephone is to
each owner. This creates a positive externality because a user may purchase a telephone without intending to create
value for other users, but does so in any case. Online social networks work in the same way, with sites like Twitter
and Facebook becoming more attractive as more users join.
Network goods offer opportunities to first movers
WTP increases with installed base
Actual network (physical link):
meaning that actual connections (phone calls and messages) exist among users.
Examples:
Facebook, Telephone, Railroads
Virtual Link:

Some goods make up a "virtual" network of users, meaning that although actual connections do not exist among
users, virtual connections (eg, information and complementary goods shared among product users) do exist. Goods
in virtual networks tend to experience indirect network effects. For example, consumers don't value the Microsoft
operating system just because a great number of people use it. However, as more people use Windows, more
complementary goods become available (eg, software applications).
Examples
Computer OS, Video Game console, Keyboard
No actual connection, but value added by more people using it
Network goods evolve around standards
Two key questions with this are:
Should a firm compete for the market, or in the market?
Is it possible to topple existing standard?
Early mover disadvantages:
Lack of complimentary assets (Apple Newton)
Locked to inferior technologies (Wang with word processing earlier than others)
Summary:
Resources and capabilities must be scarce and immobile to serve as basis of sustainable advantage
Isolating mechnaimsism prevent competitors duplicating or neutralizing CA
Barriers to imitation prevent competitors from matching firms value creation
Early mover advantages (learning curve, network effects, reputation) increase value creation spread in
favor of firm with CA.
Reading on CA:
1. Break a firm into discrete activities or processes
2. Step 1: Catalog Activities
a. Breakdown value chain into primary activites that generate good servce, and support
i. Support included logisitics, sales, markets, etc.
b. Then must be analyzed in terms of cost and WTP relative to competition
3. Step 2: Analyze Relative Costs
a. Difference in cost lead to difference in profitability
b. Figure out cost drivers: or what makes cost of activity rise and fall
c. Allow managers to estimate competitors cost positions
i. One can see competitors market share, portion of sales in certain areas, breath of product
line
d. Focus on difference in individual activities
i. Focus on detail
ii. Focus on areas where significant differences across competitors or strategic options
iii. Large enough to effect cost position
iv. Correspond to technically seperable activities
v. Activiies with thicker slice of costs deserve deeprate attention
vi. Should be modeled only if different than competitirs
vii. Sensitivity analysis is crucial
e. Pitfalls
i. Financial accounting overemphasizes manufacturing costs and poor job of allocating
overhead and other indirect costs
ii. Can confuse or mix one time and recurring costs
1. Look at comparables
4. Step 3: Willingness To Pay
a. More account for profitability than difference in cost levels
b. Quality, performance, features, aesthetics affect WTP
c. Most managers process

5.

6.

i. Who real buyer is

ii. What does the buyer want
iii. What are they willing to pay
iv. How successful are competitos ar fulfilling customer needs
v. Hard part: narrowing customers needs to small roster
d. Horizontal differentiation: value products differently (I like non fiction you like novels)
e. Vertical differentiation (customers agree on which product is better, buf dffer how much they will
pay)
i. Response is segmenetation of customers swho share preferences and analyze WTP of
segmenet
1. Some even argue toward mass customization
f. Limits:
i. May be difficult to make precise
1. Market research tehchniques help quantify
ii. Leary of those on new products or ones needs they do not even realize they have yet
Step 4: Find ways to build wedge
a. Consider competitor reactions, what drives competitors
b. Most think about a product, but should think about full range of activities
i. Draw not just ones value chain, but customers chain
c. In rapid change, give bleeding ege customers special attention
i. Yahoo giving sophisticated cusers a test version
d. One way to increase wedge is by increasing scope of operations either via vertical integration or
horizontal
Step 5:
a. Finally go back to looking at the whole
i. Many times must change activities in unision
ii. Only so many choices, but a lot of interactaction of choices

LN 16 Husky Injection Molding Systems

Huskys Strategy: Ask Professor
Husky Injection Molding Systems Ltd. is a supplier of machinery for injection moldingof plastics. The company
was founded in 1953 by Robert Schad, a German immigrant toCanada. Husky was initially a small machine shop
with no ties to the plastics industry.

Husky Strategy:

Differentiator as innovative products that operate more efficiently, leading to yearly cost savings.
Furthermore fast, rugged, high performance, with total lifecycle costs rather than upfront acquisition cost (or
premium for it)
Price premium deserved due to 1) cost savings and 2) quality with lower variable bur pressure issues and blemishes.

Huskys strategy is based on WTP wedge, as consumers save, leading to higher WTP.

Four areas they save are:

1) Purchasing expense
2) Resin per year
3) Electricity consumption per year
4) Factory rent per system per year

Consumers save over .14 million each year per machine.

Plus you get few blemishes and less variable burst pressure so thus better quality
This creates significant value compared to competitors.

Majority of savings are in the purchasing expense, as that is about .14 million per year.
There was another $39,000 or so in savings from the other three.

You can perform a quantity relative WTP analysis for each. The cost savings make the injection molding systems
worth the premium price they receive.

What caused Huskys current crisis

1) Shortage of resin
a.

PET resin makers underestimated demand by a wide margin leading prices to soar as not enough
capacity
i. Procesors simply could not obtain resin in some cases
ii. Processors halted expansion and put equipment purchasing on hold

b.

58% of total cost (Exhibit 3)

c.

Demand for Husky products dropped

2) New entrants/competitors
a.

Competitors entered, especially in PET business

b.

They have lower prices, even if lower expertise

3) Narrow range of products

a.

70% of revenue from PET system business

4) Low production volume

a.

Only 300 machines per year produced (unit costs fall at 500 machines or more

b.

Have not reached economies of scale to be able to go so cheap

How Could They Respond:

1.

Focus on Emerging markets/Asia

a.

2.

3.

4.

Expanding economies and only 3.8% of revenue

Customer relationship management

a.

Enhance sales team

b.

Convey the added value for why WTP should be higher

Cost side
a.

Cost cutting such as relocation of all factories to Asia

b.

Buy out some of the parts companies supplied by few suppliers to lower cost

Diversify
a.

What Happened

Go into new product lines so not as dependent on PET

They cust costs, cut 2 layers of hierarchy, decentralized decision making, and Asian expansion

Should have focused on WTP advantage due to cost savings by continuing to build R&D as well as conveying added
value instead.

Questions to prep
o

2.

1. What is Huskys Strategy?

Incredible technology

Charge a price premium

Offer a full srvice

2. Are Husky injection molding systems worth the premium price the company charges? Can you
perform a quantitative relative WTP analysis?

3. What has caused Huskys current (1996) difficulties?

Misprediction of demand for resin

Entry of new player with similar technology at lower costs

Industry Structure
Characteristics:
1.

Technologically progressive

2.

Cyclical industry

3.

Use of plastics is growing

4.

Large distribution of returns with industry

5.

But in general industry profits are low, though Husky has high ROE, which usually means high profits,
and high CA.

6.

Are industry profits high?

1.

There is no representative producer

7.

2.

Mold - competitive

3.

Machine - less competitive

4.

In general, there are low profits

Is it possible to have CA in the industry?

Yes through differentiation in the form of efficiency, and talk about Husky ROE,
elading to high profits, and WTP is higher. Though we do not know costs, we know
WTP higher, and ROE high, which means WTP higher.

Or we could argue we do not know costs, as WTP is higher. We can make an

inference or say we do not know.

Processors (car makers, food packaging, cellphone downstream manufacturers

are heterogeneous (some may care about quality, some may care about prices)) buy
equipment from manufacturers like Husky to convert resin into products

Machine Business

Consolidated

Barriers to entry (reputation, dedicated factory, MES 500

machines/year)

Buyers: processors (price sensitive, low switching costs, contract

through bidding)

Suppliers (Steel, hydraulic controls)

Mold Business

Fragmented (small shops)

No barriers to entry

Suppliers (skilled labor black art)

Hot Runners

Robotics

Value added Services

o

Processors buy equipment from manufacturers like Husky to convert

resin into products

Machine business

Mold business

Hot Runners

Robotics

Value added services

o

They have injection model systems

Industry characteristics

Technologically progressive industry: many production processes, many product classes

and heterogeneity in buyers

Cyclical industry depends in the price of resin which depends in the price of oil

Since they are not diversified, they are vulnerable to bankruptcy in the
downturns

Use of plastic is growing

Large distribution of returns within the industry

There is room for differentiation and some players can make a lot of profits like
Husky
o

Use resin that will become plastic inject into the mold, keep under
pressure, cool down and make the product

Some companies only do this (need machines to work and have products at low cost and
always available)

Machine to inject resin into the mold

o

Husky does the machine and the mold

They help customers design the entire system

Custom based solution

They have higher value added than competitors

They are not the biggest player, but have good reputation and and make the best product

PET Packaging, containers and clusters

They are not concerned about the current situation, but rather about the future

The profitability right now is high

Husky Positioning
o

Is Husky different from the competitors? What are the differences?

Yes as they have a premium product with faster cycle times, and more operating hours per day leading to
savings over time for customer even with higher acquisition cost.

They have higher quality, with lower blemishes and variable burst pressure issues.

Husky serves customers that need unusually heavily engineered product and global
support

They have better products (faster cycle times, more hours operating per day)

Good reputation

Services that fix machines very quick

Conscious about how clean their facilities have to be

They have very important values

They have a great sales force (internally run, they know the products and are more
educated)

It is more decentralized, so regional managers have more control

Technical background, products are custom made

Production of molds

Very mechanised

Opposite of how they produce machines

They are very efficient

Can enjoy economies of scale

1. Operations - assembly of customized machines in job shop setting, mold operations are
automated

2. Sales and Services - employ representatives globally, same general managers that
rotate between sales and services so they can learn the technical skills and really
understand the product

3. Technology Development - investment leader at AMC

4. Procurement

WTP Calculation
o

What is the most a company can charge and still make a sale?

Understand each consumer's economics: identify relevant customer

costs

Calculate dollar value of savings associated with each category

Capital Savings

Energy Savings

Resin used per year

Plant Savings
o

Does Husky have a cost advantage or disadvantage?

When there are more than 2 products, it is influenced by the second

based alternative

WTP Calculations: PET preforms

o

How many preforms a year can Husky and rival systems produce?

Cycle time is lower, you can make more units

You can save on electricity

You will save on space used for the factory

Less resin, hence it is less costly

Less blemishes, hence product is better and there are less variability

WTP Calculations Thinwall System

o

*** The customer who wants to produce at max capacity should buy a
Husky system

Variables: cost of resin, assumptions that you will produce at full

capacity to take advantage of the capital savings, cost of capital and the
time period for the NPV

Success in 1995 and challenges ahead

o

Husky has carved an attractive niche in a competitive industry: selling

to customer WTP for high performance injection molding systems, is in
the PET industry which is the most profitable

Price premiums is supported by system of tailored activities

Husky is likely to create value (Huskys products increase WTP more

than the potential higher cost)

CRISIS

PET resin shortage

Entry by large players

What happened?
o

Large investment to become leader in the injection molding industry

New lines for small tonnage to large tonnage machines to expand

customer and market scope

Exit mold business (except PET preform molds)

New campus in Vermont

Factory to produce components in Bolton

Drop in prices

IPO in 1998

Lecture 17: Scope of Corporation

WTP for product X is cost of purchasing second best alternative+savings if X is used instead
1.

Overview
a. The Strategy Statement
i. Have a Long term strategy
ii. Define the scope
iii. Define which competitive advantages you will achieve and sustain
iv. Present logic for 1, 2, 3
b.

2.

3.
4.
5.
6.
7.
8.

Verticals scope (Bergerac): involve in activities further downstream or upstream in the product
line
i. How should we perform those activities?
c. Horizontal Scope (Disney): firm expand into new products or services
i. Products and services a firm chooses to offer
ii. Diversification
Organizing the vertical chain
a. What should be the breath of the firm?
b. What are some activities outsourced and others produced in house?
c. Why do we observe different arrangements for firms that operate in the same industry?
Fully integrated: Shell, Chevron, Exxon
Upstream Only: PVSDA
Refiner/Retailer: Tesoro, Valero
Jobbers (wholesalers: Kiethco
Retailers: Costco
Make or Buy?
a. Reasons to buy: Technical Efficiency
i. Patents and Proprietary information
ii. Demand aggregators
iii. Agency cost and market discipline
iv. Pay another firms
v. More efficient
vi. Diseconomies of scale
vii. Our technical product costs are higher
b. Reasons to make: Agency Efficiency
i. Coordination Costs
ii. Reluctance of partners to develop and share private information
iii. Transaction costs
iv. Other
1. Market development
2. Tax and regulators
3. VI might allow price discrimination

v. To expensive for us to acquire, the admin costs are less than the negotiating costs
Virtual corporation: limit case in which each element in the vertical chain is produced
independently Explain what this means
Transaction costs and contracts
a. Real life contracts are incomplete
b. Incomplete contracts incite opportunistic behavior
c. The hold up problem
i. The hold-up problem is a situation where two parties may be able to work most
efficiently by cooperating, but refrain from doing so due to concerns that they may give
the other party increased bargaining power, and thereby reduce their own profits.
1. It is often argued that the possibility of a hold-up can lead Fisher Body had an
exclusive contract with General Motors (GM) to supply car body parts and,
therefore, Fisher Body was the only company to deliver the components
according to GMs specifications. In 1920, a sharp increase in demand occurred
that was above expectations. It is claimed that Fisher Body used this unforeseen
situation to hold up GM by increasing the price for the additional parts
produced. It has been said that this hold up led to GM acquiring Fisher Body in
1926underinvestment in relation-specific investment, and, hence, inefficiency.
a. Would be beneficial for Adobe to work with Apple, but inefficiency as
slow to adept due to bargaining power concerns
ii. Inefficient outcome
iii. If the investment by one player is more important in value creation, vertical integration is
preferred
c.

9.

Coal Mine Example:

1. Long term contracts rather than vertical integration
2. Complex, and long term
3. Mine-mouths are more likely to vertically integrate
4. Even with changing conditions, breach, and renegotiation, contracts survived
The Vertical Integration Trade off
1. Vertical integration is an arrangement in which the supply chain of a company is owned by that
company. Usually each member of the supply chain produces a different product or (market-specific)
service, and the products combine to satisfy a common need.
a. A company exhibits backward vertical integration when it controlssubsidiaries that produce
some of the inputs used in the production of its products. For example, an automobile company
may own a tire company, aglass company, and a metal company.
i. Apple has used the vertical integration strategy for 35 years and is one of the most
successful companies in the smartphone and computer industries. Large companies such
as Apple are more likely than smaller companies to employ vertical integration, as they
have more resources to manage each stage of production (e.g. major expansion and
funding). Implementing a vertically integrated strategy has helped Apple become a
leading platform company; integrating their software (through APIs for third-party
application developers) with their own hardware,
ii. In order to increase profits and gain more market share, Alibaba, a Chinese-based
company, full use of vertical integration makes it more than an e-commerce stage.
Alibaba has built its leadership in the market by gradually acquiring complementary
companies in a variety of industries including delivery and payments
It is contrasted with horizontal integration, wherein a company produces several items which are related to oneanother.

d.

e.
f.

Technical efficiency (buy): market minus hierarchy

i. Always more efficient for someone to make it
ii. The more specific the asset is to us, the stronger the incentive for is to make it but makes
more sense to outsource due to economies of scale
Agency efficiency (make): market minus hierarchy
i. Cost of getting a good deal
ii. Cost of finding a good supplier and negotiating
K is the degree of asset specificity to produce X, how refined and specific is it to produce?
i. The more specific an asset, the lower its potential resale value or redeployability.
Companies may be reluctant to invest in such assets in a poor or uncertain economy.
When a company purchases a highly specific asset, this purchase is considered a sunk
cost, since the asset will likely not be saleable or useable for purposes other than its
intended purchase.
ii. Asset specificity is usually defined as the extent to which the investments made to
support a particular transaction have a higher value to that transaction than they would
have if they were redeployed for any other purpose. Williamson (1975, 1985, 1986)
argued that transaction-specific assets are non-redeployable physical and human
investments that are specialized and unique to a task. For example the production of a
certain component may require investment in specialized equipment, the distribution of a
certain product may necessitate unique physical facilities, or the delivery of a certain

service may be predicated on the existence of an uncommon set of professional knowhow and skills.
g. The more asset specific, the lower the effect of demand aggregation a firm has
i. In the absence of specific assets, there is no constraint on demand aggregation and this
gives external production a considerable edge in achieving lower production costs.
However, as technologies become more specific, the aggregation of demands from
different firms generates fewer savings. 3
h. Defining AC as the unit production cost difference for a given demand by the downstream firm,
i. Only looking at agency costs, there comes a point where it is more efficient to produce in
house
j. These change with the type of input that we are looking at
k. This represents the make or buy decision
l. Figure out why large firms are more vertically integrated than smaller firms
i. Large companies such as Apple are more likely than smaller companies to employ
vertical integration, as they have more resources to manage each stage of production (e.g.
major expansion and funding).
ii. Further asset specificity or k at larger firms is more likely leading C to increase and thus
greater reason for VI
1. Think opposite in which asset specificity is lower, so commodity, better to go
out to market, then asset is super specific with larger firm
10. Make or buy fallacies
a. Firm should make rather than buy assets that provide CA
b. Outsourcing an activity eliminates the cost of that activity
c. Backward integration captures the profit margin of the supplier
d. Backward integration insures against the risk of high input prices
e. Tie up distribution channel to deny access to rivals
11. Alternatives to VI
a. Control over specialized assets
i. Can use independent body part suppliers but own a specific machines business
b. Tapered integration (mix of vertical integration and market exhange)
i. Major oil refiners have own service station, and sell through independent
c. Implicit contracts
d. Joint ventures and strategic alliances
12. Summary make or buy
a. If outside has more expertise, relationship specific assets, or do not want private infor leakage, use
market
i. If above but detailed contract is feasible and common ownership needed to mitigate
contracting problems
1. Vertical
ii. If supplers not more expertise and intermediate arrangement doesnt suffice,
1. Vertical
iii. If supplers not more expertise but intermediate works
1. JV, alliance
13. Horizontal scope: Efficiency Based ON Diversification
Horizontal integration is the process of a company increasing production of goods or services at the same
part of the supply chain. A company may do this via internal expansion, acquisition or merger.
a. Benefits of horizontal integration to both the firm and society may include economies of
scale and economies of scope.
Economies of scope are "efficiencies wrought by variety, not volume" (the latter concept is
"economies of scale").
a. Economies of scope make product diversification efficient if they are based on the common and
recurrent use of proprietary know-how or on an indivisible physical asset.[5] For example, as the
number of products promoted is increased, more people can be reached per unit of money spent.

Increased economies of scope by sharing resources, economies of scale by selling more of same product,
increased market power with suppliers or downstream channels, reduction in cost of international trade
potentially
One of the clearest examples of horizontal integration is Facebook's acquisition of Instagram in 2012 for a reported
$1 billion. Both Facebook and Instagram operated in the same industry and were in similar production stages in
regard to their photo-sharing services. Facebook, looking to strengthen its position in the social media and social
sharing space, saw the acquisition of Instagram as an opportunity to grow its market share, increase its product line,
reduce competition and access potential new markets.
b. Expand into new business units only if the value under one roof is larger than independent
c. Business units should be compatible with corporate structure, system and processes
14. Efficiency based diversification
a. Economies of scale/scope
i. Umbrella branding
ii. Transfer of organizational capabilities
iii. Benefits and bundling for buyers
iv. Externalities in pricing complementary products: benefit of WTP of Mickey Mouse toy
under Disney brand without cost increase
b. Economizing transaction costs:
c. Internalizing Capital Markets: Choose right businesses
i. BCG Growth/share paradigm

15.

16.

17.

18.

1.
ii. Shareholder diversification
iii. Undervalued firms
d. Efficiecny based diversification
i. Berkshire with Sante Fe Railroad
ii. Facebook with Instagram
Diversification and long term performance
a. Valuation studies
i. It may destroy value given that they cannot be managed within the corporate structure
b. Event studies
Why to outsource
a. Because the firm does not possess the resources to be a success in those businesses
b. Virtual corporation
c. Cost effectiveness
d. Geographic proximity to main markets
e. Risk diversification
f. Resource management
Why do companies off shore
a. Gain a competitive advantage
b. Lower labor reducing unit costs in the value chain
c. To access highly skilled labor
d. Leverage cost advantages
Which activities should be performed and how?
a. Multiple dimensions of scope

i. Graph with x as horizontal, y as vertical, linear line as geographic

b. Given that is what we do, how should we do it?
19. Financial case
a. Administrative costs are less than the negotiating ones to get what you want
b. Consider the opportunity cost
20. Strategic case
a. Enhance the competitive advantage
b. Is it sustainable?
21. Synergies
a. Business to business linkage to produce a combined effect greater than the sum of their separate
effects
b. How do they create value?
i. Cost reduction through enhanced manufacturing efficiencies consolidated of overhead
and increased economies of scale
ii. Improvement of mgmt decision making
iii. Horizontal Scope
1. Corporation possesses a resources that contributed to competitive advantage in
the new business
2.

Scope of Corporation Reading

When there are scope economies between the existing portfolio of businesses
and the new business

The Scope of the Corporation Reading

1. Three dimensions a firm can expand on
a. Geography, Vertical (value chain), and product/customer (horizontal)
2. Two questions to ask
a. Economies of scope: value created by competing in that market
b. Organizational scope: Why should it be done inside the firm and not through contractual
arrangement
3. May need to vertically integrate in aspects it is not per se creating value but to ensure profits for original
business
a. Hotels for instance not franchising as it can lead to under investment and loss of brand
4. Horizontal integration
a. Economic value can be created in this from two ways
i. Company resource creates competitive advantage in new business
1. Pepsis marketing group or Apple marketing for Beats
ii. Scope economies between portfolio business and new business
1. Economies of scope is an economic theory stating that the average total cost of
production decreases as a result of increasing the number of different goods
produced.
iii. Another consideration
1. Whether or not it can be managed by corporate structures and systems
b. Resources
i. Need to look at specificity and disegration to be able to quantitatively demonstrate
competitive superirority of companys resource on new business
ii. Will resource really be critical source of success for new business
1. Like toys, General Mills knows needs of people, but enough to be key to success
of toy business
iii. Can the corporation deply and mobilize resources in new business
1. Mark and Spencer good in UK, but bad in Europe, can they really deploy supply
chain resources and reputational resource for new businesss then.
iv. Third depends on chosen strategy

1.

5.

Frig business would not do well in low cost refrigerators if they are focused on
high end premium products
v. Reverse linkage of starting new business leading to resource upgrade
c. Businesses
i. Scope economies from business to business linkage, or exploiting synergy
1. Key is to ask whether better off in market A by being in market B
a. Disney is better having theme parks, as it further cements people into
characters, which help B
i. Increases WTP of people for toys as well
2. Can be rational to expand scope into business it looses value in, if benefits
overall corporation
a. Example is Japanese firms willing to loose in U.S for decades, because
competitive impact on US firms justified invesmtnet
3. Can only consider scope strategy as business as a whole across all markets
4. Mutual forbearance argument
a. Though controversial company wont compete with another in one
market in fear of rivalry in other markets
d. Organizational Structure, System, and Proceses
i. Does not imply have to be same systems for all businesses
1. Good corporate strategy can differentiate among businesses
ii. There is a fit requirement in terms of control versus decentralization, how resources
deployed, etc.
1. Saatchi and Saatchi imposed budging systems on ad agencies with enourmous
detrimental results
2. Once corproration structures itself a certain way, it is difficult to control, and
employ resources in another way
iii. Managers accumulate knowledge and way to run one type of undustry and if asked to do
one completely different can struggle or take a while to learn it
Vertical Integration
a. First figure out if the area is a source of rent
i. Should not commit to business with no retun on capital
1. Why commit capital to trucking business as a concrete player, if trucking
business does not have abnormal returns
ii. Even with returns, only integrate if firm can be successful in that field
b. Thus should only direcly involve resources that provide firm competitive advantage for their
strategy
i. Sulzer differentiation was design, not manufacturing
1. So it focused on that area of differentiation and though 10% of cost of engine
was them, they got nearly all profits
c. Virtual corporation is the epitome of this
i. Nearly all the profits, with few costs
d. Issue is when valuable resources at multiple stages of value chain
i. Example is biotech have technolocial resource and pharmacy have marketing channel
resource
ii. Each has resource whose value is only realized when the two are combined
iii. Thus you see many pharma buying biotech, or establishing JV/contracts
e. Transaction costs
i. Costs such as monitering, bonding, and enforcement of terms of contracts
1. When risk one firm will hold up another, or demanding incease/decrease of price
ii. Classic example is GM and Fischer which I went through already
iii. TC conditions
1. Durability
a. Requires continuity of transaction, auction would not have high
transaction costs
2. Assset specifcicty
a. If asset specific then there is high transaction costs

3.

6.

7.
8.

Uncertainty
a. Uncertainty in industry can cause transaction costs
4. Frequency
iv. All of this leads that when transaction costs are too high internalization VI makes sense
f. Agency Costs
i. Person acts in his bet interest, rather than principal (or business)
ii. Most costly when employee critical to firms performance
Start from scratch or buy
a. Starting from scratch
i. All profits to firm
ii. Integrated to firm with corporate culture
iii. Bad
1. Can be slow
2. Can fail
b. Acquisition
i. Loose some money from acquisition premium paid
ii. Pros is it is fast, and immediate access to resources
Divest businesses
a. Few willing
b. Few show ability to restructure portfolio of business without pressure
Figure 6 in the case
a. With business scope, internal organization costs go up, resource value goes down
i. Finally transaction costs indenepdent
b. As coordination intensity increases, more internal governance costs occur, and thus support a more
narrow scope

Lecture 18 Bergerac Case

Need notes for industry facts
1. Bergerac's net income/sales in 2007 = 9%
2. Growing market demand
3. Competitive and fragmented upstream market of plastic suppliers (p.5)
4. Volatility in petrochemical industry affected supply of cartridge omponents by GenieTech and Elsinore
[remember Husky case?]
5. Razor-blades pricing model
Company had choice to buy Genietch for $5.75 million or to build in house
Industry facts:
1. Vet spending grown at 78% er year over the last decase
2. Increased WTP by pet owner due to pet humanization
3. Supply side growth of sophisticated vet care
4. In-house lab equipment adoption
o No longer needed days for test results on many things
o Especially helpful for critical care
o Only 40% have adopted in house allowing for huge growth pipeline
5. Projecting 8-10% annual growth
Competitor Facts
1. Four main players
o Idexx
Industry leader
Largest installed base of diagnostic equipment
Sticky customer relationships
Famous for one product that is good for high volume practices

o
o
o

Abaxis
Comparable to Idexx but slightly more cost effective and easier to use
Heska
Lower end in quality and less innovative
Bergerac
User friendly, required no training
Price point below Abaxis, giving a lower cost per use choice
Gained traction among vets

CA?
1.
2.
3.

Cost are lower than competitor causing potential wedge

But you do not know WTP of the business
I would say do not know

Based on the business challenges described in the case, should Bergerac integrate backward into the manufacture of
plastic cartridge components? If so, then how?
What is the economic and strategic case for the recommendation?
Economics
Build a model based on:
1. Cartridge demand grows at 10% per year
2. Labor and overhead costs increase proportionatally with machinery
3. Labor cost also increase at 3% per year
4. GenieTech price of $2.96 would not increase, and price charged to other customers
5. How much is sold does not affect labor and overhead
Model
Annual demand
Production capacity
Machines required
Excess capacity
Sale price per unit
Revenue
Expenses
Incremental profits with selling
NPV is positive and better off which means economically a good purchase.
Lesser model is the same without selling off excess capacity
Qualitatively
Does not make sense
1. Diseconomies of scale
o Can they maintain economies of scale with the aquisitioon
2. Diseconomies of scope
o Managing the new business distracts sources from core business
3. Development of capabilities
o Will they be able to retain employees post acquisition
4. Lack of flexibility
o How quickly can Bergerac adjust to product design changes?
5. Incentive problems
o Without implicit threat of losing a contract, will fabricators still maintain effort
6. Counpounded risk
o Transition difficulties could cause even more delays?
7. Integration risk

o Will integration of Genietech employees to Bergerac systems be smooth

Pros:
Genietech has a core competence in plastic injection molding
Flexibility to experiment with producing new diagnostics technologies
Cons:
Distract management from core business/product development
Redundancy in overhead
Opportunity cost of $5.75 million
Strategic Recommendation
Cartridge sales depend on analyzer sales, so invest $5 million in core business
Specifically
1. New product development
2. More sales/service employees
3. Financial hedging against oil price shocks
Develop comprehensive sourcing strategy
1. Increase leaverage with suppliers for better quality and or price by expanding supplier base
o Support new entrants
2. Experiement with one in house machines press
o Make backward integregation issues
o Produce more accurate in house estimates
More from case:
Lecture 19 Disney Case
Lecture 20: Two Sided Markets
Two-sided markets
Two-sided markets, also called two-sided networks, are economic platforms having two distinct user groups that
provide each other with network benefits. The organization that creates value primarily by enabling direct
interactions between two (or more) distinct types of affiliated customers is called a multi-sided platform (MSP).[1]

Two-sided networks can be found in many industries, sharing the space with traditional product and service
offerings. Example markets include credit cards (composed of cardholders and merchants);HMOs (patients and
doctors); operating systems (end-users and developers); yellow pages (advertisers and consumers); video-game
consoles (gamers and game developers); recruitment sites (job seekers and recruiters); search engines (advertisers
and users); and communication networks, such as the Internet.
Examples of well known companies employing two-sided markets include such organizations as American
Express (credit cards), eBay (marketplace), Taobao (marketplace in China), Facebook(social medium), Mall of
America (shopping mall), Match.com (dating platform), Monster.com(recruitment platform), Sony (game
consoles), Google (search engine) and others.
Benefits to each group exhibit demand economies of scale.
Consumers, for example, prefer credit cards honored by more merchants, while merchants prefer cards carried by
more consumers. Two-sided markets are particularly useful for analyzing the chicken-and-egg problem of standards
battles, such as the competition between VHS and Beta.

1. Differences with traditional markets

2. Strategies for platforms
3. Sustainability of competitive advantage

New Lingo:
Cross-sided network effects
A two-sided network typically has two distinct user groups. Members of at least one group exhibit a preference
regarding the number of users in the other group; these are called cross-side network effects.
Each groups members may also have preferences regarding the number of users in their own group; these are called
same-side network effects. Cross-side network effects are usually positive, but can be negative (as with consumer
reactions to advertising).
Same-side network effects may be either positive (e.g., the benefit from swapping video games with more peers) or
negative (e.g., the desire to exclude direct rivals from an online business-to-business marketplace).
For example, in marketplaces such as eBay or Taobao,[8] buyers and sellers are the two groups. Buyers prefer a large
number of sellers, and, meanwhile, sellers prefer a large number of buyers, such that the members in one group can
easily find their trading partners from the other group. Therefore, the cross-side network effect is positive. On the
other hand, a large number of sellers mean severe competition among sellers. Therefore, the same-side network
effect is negative.

Subsidy side vs. Money side

Typically platforms end up charging one side (the Money side) and subsidizing the other.
WTA dynamics
Envelopment
Platform envelopment refers to one platform provider moving into another one's market, combining its
own functionality with the target's, to form a multi-platform bundle.[1]
The markets which evolve rapidly are rich in enveloping opportunities and the companies in these markets are under
the continuous threat of becoming obsolete. Mobile phones used to be a separate market but the boundaries between
them and music players are beginning to blur.
Envelopment of Complements
A network market consists of several players operating in various adjacent layers. In this kind of attack a player tries
to gain a dominant position in the adjacent layer by bundling the services the adjacent layer player provides in its
own offerings.
Envelopment of Weak Substitutes[

Price a person is willing to pay for a bundle consisting of two perfect substitutes will be the one which he uses either
of them and hence there would be no value for a firm to envelope a platform which acts as a perfect substitute for its
own offering. However, there is a value to be created when we have in question a set of weak substitutes.
Envelopment of Unrelated Platforms
The platforms previously meant for a different usage begin to converge as the common set of users begin to rise.
Such is the case with mobile phones and video game devices which were used for distinct purposes but the digital
platforms available today have converged all such usages into one.

Some networks derive most of their value from a single class of users. An example of this kind of network is instant
messaging (IM). While there might be some add-ons for the most popular IM tools, they dont influence most users
choice of an IM system.
But some markets are comprised of two distinct categories of network participant. Consider video games. People
buy a video game console largely based on the number of really great games available for the system. Software
developers write games based on their ability to reach the greatest number of paying customers, and so theyre most
likely to write for the most popular consoles, first. Economists would call this kind of network a two-sided
market (network markets comprised of two distinct categories of participant, both of which that are needed to
deliver value for the network to work). When an increase in the number of users on one side of the market (say
console owners) creates a rise in the other side (software developers), thats called a cross-side exchange benefit.

Cross sideded network effects , WTP, and dynamics

A two sided market or mult-sided
Value of platform to user from one side is a function of a number of users on the other side
Different from one sided network effect (network goods)
Examples of two sided platforms
Architecture+Rules
Architecture: product design and infrastructure
Rules: terms of engagement and pricing
DVD Consumers and Studios
Online recruitment Job seekers and employers
We search: Side 1: Searchers Side 2: Advertisers
DVD Side 1: Consumers Side 2: Studios

WTP increased as platform size increases (both sides with architecture+platform)

Revenue can come from any side

Installed based and tilting
There may be tilting between
Pricing is key to generate key dynamic

Pricing
Subsidy side vs. Money Side
Not so relevant in shared platforms (less competition for the market)
Who should be subsidized more?
1.
2.
3.

Price sensitivity side

Side that demands high quality
Side with no variable cost of serving

Negative same side effects

A negative same-side network effect appears when there is competition between suppliers in an online auction
market or competition for dates on Match.com.
Marquee users: Exceptionally big buyers or high profile suppliers
Especially important for attracting participants to the other side of the network.
A platform provider can accelerate its growth if it can secure the exclusive participation of marquee users in the
form of a commitment from them not to join rival platforms.
However, it can be expensive, especially for small platforms, to convince marquee users to forfeit opportunities in
other networks.
Also, when the participation of a few large users is crucial for mobilizing a network, conflict over the division of
value between platform providers and large users is common.
Winner Take All Battles
Is the market a natural monopoly
(Multi-homing costs)* (strong cross-side and positive network effects)
Cost of users to adopt more than one platform, so Uber and Lyft, or two credit credit cards, costs are very low
The higher the cost of the network the more likely only one will survive
Same side positive network effects
Relatiely similar preferences
Examples: DVD
High multi-homing costs and strong cross side and positive network effects
Bet the company decision
Fight for proprietary control

Or being willing to share platform

The threat of envelopment

Good pricing and WTA management are needed but not sufficient
Envelopment by adjacent platform
Envelopment
Platform envelopment refers to one platform provider moving into another one's market, combining its
own functionality with the target's, to form a multi-platform bundle.[1]
Microsoft, for example, launched an envelopment attack against RealNetworks (Real), the dominant streaming
media platform with more than 90% market share in1998. Real had invented the technology and successfully
harnessed "two-sided" network effects (Rochet & Tirole, 2003; Parker & Van Alstyne, 2005) by giving away free
versions of its media player to end users and charging audio/video content providers for server software. Like Real,
Microsoft freely supplied its Windows Media player (WMP) to consumers, bundling WMP into its Windows
operating system for personal computers. Microsoft also bundled WMP server software, at no additional cost, as a
standard feature of Windows NT server, an operating system for enterprise customers, including contentproviders.
WMP offered no major functional improvements over Reals software yet userbases heavily overlapped (see Figure
1). Consumers and content providers foundMicrosofts operating system bundles appealing and Real rapidly lost
market share.
Focused platform are at risk
Multi-platform bundle can hurt stand-alone platforms
Reaction of stand alone platform:
Sell, change, find a big brother, or exit

Uber and Lyft

How is the value created?
Marginal costs may decrease
You gain value from more users, and then more drivers, like a two sided market, so benefit off growth of both users.
They benefit
Is WTP higher than cost? Uber is right now loosing money
Today is just the starting point, as WTP may be much higher but they want a monopoly
It is not clear that they are creating value
But we do not know
Taxi market is regulated, it fails at some points, and rate is fixed
Supply is fixed
Strategies For Two-Sided Networks
1.

Two sided markets

Companies that make money by linking markets from different sides of the customer network
Uber: People and Drivers
Newspaper: Readers and advertisers
Online recruitment: Job seekers and employees
Video games; Players developers
Wifi: Latop user and access points
Platforms
o Products and services that bring together groups of users
Two sided vs. traditional
o Traditional you have revenue on left and costs on right
Think grocery store
o In two sided
Revenue and costs on both left and right
Driver has costs and revenue
User has costs
They are linked together through Uber
Platform value comes from value given to user on the other side
Sucessful platforms enjoy increasing returns to scale
o Margins improve as user bases grow
o In traditional businesses, growth beyond a certain point leads to diminishing returns
o Sucessful platforms can use leverage for RD, lower prices, and drive out weaker rivals
Usually dominated by a large players like credit card companies
Yet they have struggled to sustain two sided networks
o Even if vanquish their peers, there may be threat from adjasent market business
Pricing and Platform
o Normal pricing is determined largely by MC of production
WTP is ceiling, for those with barriers to entry, and margins fat
o In this case there is the subsidy and money side
Money side (think video game designers) pay more than it would in independent market
Subsidy side (think players) pay less for console and games
Challenge is how much of each for each player
o Not always obvious who should be the money or subsidty side
o Should look at following factors
Ability to capture cross-side network effects
Your giveaway will be useless if subsidy side can transact on rival platform
providers money side
Example is Netscape subsidized to users
1. However web site operators didnt need to buy their servers for
user data, could buy rivals web service instead
User sensitivity to price
Should subsidize price sensitive side
Example is Adobe subsidizes reader, charges writer a good amount
If readers charged, probably dead business
User sensitive to quality
Should charge the side that must supply quality (video game maker) not the
demander
Royalty in gaming helps weed out crappy games
Output costs
Easy when each new user does not cost platform company essentially anything
Hard when giveaway from platform has costs
Free PC got killed giving away PCs in return for ads
Same side network effects
o

2.
3.

4.
5.

6.
7.
8.

Sometimes worth not including certain users

In face of negative same side network effects, too much of one user
Should consider granting exclusive right to a singer user in each transaction
category
1. Like online car buying service attached to one single dealer
Users brand value
Sometimes marque users can help attract important partcipants
Like big buyers like U.S government
Or maybe high profile suppliers, like anchor stores in malls
Can accelerate growth by getting exclusive participation
Can be expensive to do so
Winner Take All Dynamics
1. Increasing returns to scale can lead to WTA dynamic
Question is whether to fight or share platform
2. Networked market is likely to be served by a single platform occurs when the following:
Multi-Home costs are high for at least one user side
Homing costs comprise all expenses network suers incur, from opportunity
cost to adoption, in order to establish platform affiliation
1. Uber apps have low network costs
2. Other side is windows for operating system as it is expensive,
difficult to have multiple operating systems
When high cost, users need good reason to have multi-platform
3. Single platform increases when same side network effects are high (users share video
games or software files), or cross side network effects are high and strong
4. Neither sides users have a strong preference for special features
If special features wanted, may be differentiated platforms
DVD has high multi-homing costs, high cross sie network effects for both
consumers and studios, and technical differentiation is moderate
5. Winning the battle
Need differentiation
First movers advantage can be significant but not always deciders
Later movers could win as they acoide positioning errors of previous
players like Google
Still want to get users as quickly as possible, urgency is appropriate
Key is only done if businesses is scalable, and funding will be
forthcoming should capital markets turn negative
1. Prone to boom and bust valuation cycles
The threat of envelopment
1. Platforms frequently have overallped users
Can make it attractive for one platform to swallow network of other
Especially damaging if rival platform is part of a multiplatform bundle
2. In fast changing technology world, envelopment can blur market boundaries
Mobile phones include video, music, PCs, and even credit cards
3. Business facing envelopment has many times little choice but to exit or be sold
4. Real Example
Originally content companies money side, users subsidy side
Then Microsoft came in with Windows Media Player which bundled
Real had to switch with consumers the money side, like Spotify
Killed by other bundlers again
5. What to do
Change business models
Find a big friend like partnerships
Sue

Anti trust still in dispute for how you deal with it

Vigilence is crucial
Must coordinate strategies through firm
Sony has had trouble with this with its video games, movies, and music
business for many years

LN 19 Disney
Questions
How has Disney sustained its success?
1.

Through their brand equity Mickey Mouse

a.

2.

Image of the brand: family, universal, honest, harmless - overall a consistent brand

Innovation and risk takers

a.

Entering into new markets like theme parks, and innovating how movies are made

Businesses:

1. Theme parks

2. Cruises, hotels (travel agencies)

3. Store (toys, books)

4. Disney Studios (TV and Movies)

Economies of Scope: Theres synergy between all of them, which creates more value. It creates savings (or costs
down across products) and increases the WTP. Furthemore production cots decrease
Synergies
1.

Between businesses creates more value or willingness to pay

2.

Synergy group, reported directly to Eisner

a.

Monthly operating reports expected to disucss new cross divisional projects

i. Awarded large bonuses to those most committed to synergy

3.

Cross promotion

4.

a.

In movies, made presentation to home video, consumer product, and theme park group

b.

Each new movie became a mini-industry between licensing and all these groups

Cost savings
a.

Lower costs in theme parks and merging divisions lowered costs

5.

Geographically
1.

Looked to integrate internationally where there was higher spending per capita, and Disney generated only
21% of sales

2.

Created Disney theme parks in Tokyo, Hong Kong, Paris

Horizontally
1.

Enter new types of entertainment

a.

Grown up movies

b.

Music and publishing

c.

ESPN Zones were made

d.

Disney Cruse ships

e.

Disney Institute focused on fitness and adventures in learning

i. Had courses in culinary arts, animation

Vertically
1. Control of TV through ABC
2. Internet as well through websites like ESPN
3. Own cruise lines and Broadway theater

Diversification

Epxanding horizontal boundaries is sometimes called diversification. It sounds as venturing into unrelated
businesses.

Financial Hedging
Value not added as shareholders can do it on their own

Source of all Competative Advantage:

Mickey, and arguably other Disney Characters

Unlike Messi
1. Owned by the company
2. does not grow to meet expectations
3. company has full control of asset
4. company captures 100% of value as there is no salary

Furthermore, even though target is both parents and kids, parents grew up with Mickey, and not Nickelodeon
random characters, so you only need to convince kids.

Economies of scope:
increases in WTP across products (mickey) decreases production costs

Through diversification

Magical Turnaround
1.

Budget conscious
a.

(even though their core capability is creativity and innovation)

2.

3.

Exploit synergies
a.

8 day, one day meetings

b.

Disney dimensions

c.

Synergy group

Theme parks
a.

Increase prices

b.

Mondays are open

c.

Increase number of people that can enter park

d.

Add more hotels

Long term want to focus on increased synergies

Disney Boundaries 1995-2000

1.

Max shareholder wealth (20% growth target)

2.

Keep values of quality, creativity, teamwork

3.

Corporate skill: Manage creativity

a.

4.

5.

All businesses need potential though for long term profitability

Rebuild TV and movies

a.

Expanded animation staff

b.

Increased budgets

c.

Sell independent TV stations (not that synergistic)

Theme park profitability

a.

Continued to increase # of people in park

b.

Rapid revenue profit growth

c.

Raised ticket prices

6.

7.

d.

Opened Mondays

e.

Diseny development company

Coordination of businesses
a.

Synergies to build on each other

b.

Media purchasing together

Other parks
a.

Euro Disney

b.

Hotels

Misc. Notes
1.

History
a.

1927 Walt changes Oswald to Mickey who is international sensation

b.

1937 Snow White is made which full color animated and highest grossing animated movie of
all time

c.

After WWII you had Cinderalla, Mary Poppins, and other hits

d.

Expanded into TV with Mickey Mouse club in 1954

e.

Park was a huge risk opening in 1971

i. Tokyo park in 76

2.

Eisner Turnaround-1984-1993
a.

Focused on ROE being about 20% as well as revenue growth

i. He wanted this through quality, creativity, entrepenuership, and teamwork

b.

Disneys movie share was 4%

i. Made 27 of next 33 movies profitable which was much above 40% average
1.

Market leader in movies by 1988

c.

Katzenberg
i. Focused on people who were in career slumps or less known
ii. Made moderately budgeted filsms with financial box where still could be creative

d.

Theme parks
i. Focused on attendance building and revenue/profit growth
ii. Used national television ad
iii. Expansion of hotle rooms and convention center

e.

Employeed internal transfer prices and quick to settle disputes

i. Corporate marketing function was made
ii. Jointly corrdinated big events like Mickys 60th birthday

f.

Expanded into new businesses

i. Disney stores
ii. Disney press
iii. Tokyo Disneyland

g.

Released a series of high profit films

i. Little Mermaid and Beauty and the Beasty

h.

Sell through of VHS instead of just video rentals

i.

Broadway theater
i. Proftiable and further brand building

3.

Turmoil
a.

President Wells killed in helicopter crash

b.

Katzenberg leaves

c.

ABC merger somewhat diworsification

i. Too big
ii. Difficult to create synergies

d.

Went big budget which did not go well

e.

Revenues in videos were dropping

f.

Internet results were uneven

i. Had to shut down Go.com and subscription service was failure

g.
4.

Cost cutting a lot and selling non strategic assets like Fairchild

Eisner Challenges
a.

Managed synergies
i. 300 people in synergy boot camp
ii. Synerg group focused on maximizing synergy through cross divisional projects and
bonuses

b.

Managing the brand

i. Ellen sparks controversy
ii. Catholic groups against movie with gay cleric
iii. Some felt Disney hamstrung by wholesome image in new era of video games and
such

c.

Managing Creativity
i. Michael Ovitz is hired and then left after just over year
ii. 75 high level executives left
1.

Not as fun as it used to be

iii. Combative culture and Eisner becoming autocratic

1.

What can they do?

How did Eisner improve Disneys competitive position?

Maximize shareholder wealth

Kepp values: quality, creativity, teamwork

All businesses with potential of long term profitability

Budget Conscious

Transfer pricing for economic incentives

Identify the weakest link in the system

Identify resources in big companies

Magical Turnaround:
1. Exploit synergies
1.

8 day 1 year meeting

2.

Disney Dimensions Synergic Group (observe opportunities across activities)

Disney Boundaries

Vertical Forward Integration

Own cruise lines

Broadway theater

Geographic

Disney theme parks in tokyo, hong kong, paris

Horizontal

Grown up movies

Music and publishing

Revitalized TV and Movies:

Created TV shows for network television

Created a syndicated operation to sell to independent TV stations

Maximized theme park profitability

Updated and expanded attractions at the parks

Raised ticket prices

Opened parks on Mondays

Created retail tie-ins

Added more hotels next to theme parks

Coordination among businesses

Negotiated internal transfer prices for any activity performed by one division for
another

Created an in-house media group established to coordinate media buying for the
entire company

Corporate Marketing Function

Built on each other for synergies

New Businesses

Euro Disney

Retail as an entertainment concept

These were all one time changes: His focus was on exploiting the synergies even more
while being budget conscious at the same time

What limits the diversification strategy?

Cut throat environment

Too centralized

Stock stall in 2000 and 2011

High FC

Licensing

How can they sustain success?

Continued brand equity power, and a focus on increased synergies

Review Session
For sequential, not simultaneous, you need a tree diagram.
First you make the second mover the right column at end, and first mover as first column
First do backward moving and find second movers best three moves, then find best move, based on those three, for
the first mover. That is the optimal move.
It is a contingent plan when sequential
In cartel want to maximize industry profits by taking highest payment.

Uber Lyft views:

Uber and Lyft do not currently have a CA, but if they gain monopoly, then WTP is higher
Additional Readings
Micro Stars, Macro Effects
1.
2.

3.
4.
5.

6.

Macro economist have dreadful task with failure predicting economy and interest rates
However, those at Google and Microsoft are changing how business decisions are made
o Preston McAfee hired by Yahoo in 2007, and now Google
1. He showed two part tariff (or higher prices when demand peaks) could shift time-sensitive
taks to night-time, allowing bandwitch cost to be more efficient
Economist with cars: More information better
o Found prices went up and more sales when told all transparency of car including how paintwork was
Sometimes less information better
o Ebay sellers, less info, just list, increased auction
MsAthey from Stanfrod
o She toughened ads so less show/fewer times, lose out in shor term
1. But other forces in play like more relevant ads improve user experience, and user number rise
Led to more clicks of ads
Microeconomists are looking at problems through tech as well
o Like using googel search engine and key words like jobs offer daily charts, even better than monthly
for policymakers on employment

Gaming the System

1.

Students all took 0, which gave them all As in John Hopkins class
o One equilibrium is no one takes test, and other is everyone take si
1. First one is unlikely due to trembling hand perfect
The idea is that a mistake occurs one person plays different
If one mistake made for first, 99% fail, while second only one person fails
o Professor kept score but made changes later

First mover disadvantage

1.
2.

There is a benefit to being first

o Users get lasting impression, earning strong brand recoignition
Early entry on costs not fully understood
o One hand get patents, gain control of scarce inputs
o However, later movers can avoid mistakes and costs of predecessors

1.
3.

Can also adopt new and more efficient processes and tech, while other player may be
entanched

Finding was:
o Signficant sales advantage for first mover, but also cost disadvantages
o Pioneers were also less profitable by multiple ROI percentage points
1. Big thing is executives should be careful to say first mover leads to long run profit advantage

Companies More Prone To Go Vertical

1.
2.
3.
4.

5.
6.
7.
8.
9.

Ellison and Oracle plan to buy Sun Microsystems so that it is maker of software, compuers, and components
o Revive vertical integration
Pepsi doing it to get more authority over distribution
Pendulum shift from disintegration to integration
Departure from past half-century moves
o More specialized, shifting fucntions
o Steelmarkers selling mines in 1980s
o Tech companies stopped making every piece of computer system
Used to be that you had complete control of supply chain and that you could manage it best
o Now it is more aspects of supply chain
Boeing made the move to buy factory as supplier assembly problem knocked plane off schedule
GM bough Delphi to ensure non-interruption of supply
Oracle
o Flourshed being usable for multiple types of compuers
Apple bough semicounder chip maker
o Appl hopes to tighten control of key technology from rivals

Article On Uber vs. Lyft

1.

Very strong rivalry between the two brands

a. Undercutting each others prices, poaching drivers, and co-opting innovations, increasing blur
between two services
b. Loudest opposition is taxis and regualtrod
2. People are betting on Uber being a logistics and network for other services
3. Uber in 3 times the cities
4. Lyft has created new arenas of competition
5. Uber offers referrels to build driver base
6. Carpools
a. Cheaper at first, but could entce and boost usage
i. Two sided network this is great
ii. Still multi-costing is very real
7. Could buy Lyft
8. Lyft uses commissions to get user growth
9. Essentially matchmaking or two sided market businesses
a. Link is between consumer and driver with both receiving subsidy, though one could make the
argument, based on reports released from MS, that consumers are now the majority of subsidy,
with driver the money side
b. Low barriers to entry business
i. Not unlike Facebook, or market place businesses
ii. The key is number of users on each side and building CA sustainability by becoming only
platform
10. But Uber strategy is to have more users in terms of drivers and consumers
a. Uber wants to be lowest cost provider according to VC firm Benchmark, who was an early player
in both.
b. The idea is it is 15 times bigger, and No.18 on app store
i. From this perspective returns are increasing, and they can get huge capital to continue
subsidy on both sides

1.

c.

Furthermore it has billions in financing, and lured some 50 engineers from CM

to launch rpbot business
2. It used money to also further subsidize as it takes over space
3. One day with monopoly could increase WTP
4. Very clear winner take all mentality where once the dominant and only platform
they can have all the power: similar to Amazon
On the other side, for students the multi-homing costs are very low as they have 2,3,4 of these
apps, and adults are following
i. Because of this it is easy, like credit cards, to have multiple platforms
ii. Still, if Uber becomes so dominant that there is just so much greater ease, then they will
choose this return model

Husky Math
Purchasing Expense
Daily Cycle Number: Average operating cycle hours per day/cycle time
Daily Production Capacity=Number of preforms per cycle*number of cycles
Do it for husky and competitors
WTP=Then husky/competitors get you ratio* competitor purchase price=1.34
Savings=1.34 million-1.2 million (Husky cost)=.14 million of value add or savings
Savings of raw material
Weigt of preform for each
Husky 24.39
Major Competitor 24.42
.03 saved from Husky
Daily production capacity (from before)*365 for yearly
Then multiply by .03 gm difference*.70 center per kiko
Gets you $2840
Electricity
Weight of preform per year
Quantity (capcity)*weight* 365=3,2 million gm
3.2 million gm*(how much less husky uses per gm .137)8.08 cost
Savings
36,000
Husky can save 8.7 feet
Assume $5 per square foot
Annual savings $5*12*8.7
$522 per year
Add them all up to get cost savings of a machine
Consumers save over .14 million on each machine and better quality