Lecture Unit 6: Dynamic competition (2/3)

Question 1

What is the best time to make a strategic investment when faced with uncertain conditions?

Answer 1

–>Answer is given by the study of real options

Question 2

What are the key aspects of the commitment-flexibility tradeoff?

Answer 2

• Waiting preserves a firm’s option values.
• Waiting may allow competitors to make preemptive investments
• Example: Philips delayed its CD manufacturing plant in the U.S., allowing Sony to build its plant first.

Question 3

Flexibility and Real options:

How can one get better information about demand?

Answer 3

by delaying the implementation of projects

Question 4

Flexibility and real options:

When does a real option exist?

Answer 4

• A real option exists when a decision maker has the opportunity to tailor a decision to information that is unknown today but will be revealed in the future

–>Real option analysis can be mathmatically complex, because the formula for valuing an option often involves differential equations

Question 5

With what can the value of real options be limited?

Answer 5

value of real options may be limited by the risk of preemption (Risk der Vorrangstellung)

Question 6

Which investment is more valuable a investment with option to delay or a now or never investment?

Answer 6

• An investment project with an option to delay is more valuable than
• one where** the firm faces a “now-or-never” choice of investing or not investing in the project

Question 7

What is the benefit of delay in investment projects?

Answer 7

• allows the firm to avoid the money-losing outcome of investing when market acceptance is low

Question 8

What is a key managerial skill related to real options?

Answer 8

Spotting valuable real options.

Question 9

Real options:

On what should the timing of a firm´s investment depend upon?

Answer 9

The timing of a firm’s investments should depend on the degree of uncertainty about future business conditions.

Question 10

What are the implications/consequences of delaying investment decisions for firms?

Answer 10

• By delaying investment decisions, firms postpone any of the benefits of the investment,
• but they also learn valuable information that can be used to modify the investment.

Question 11

What shoould a firm do when conditions are volatile regardin real options?

Answer 11

• When conditions are volatile, there is more to learn,
• suggesting that firms should postpone investments when business conditions become more uncertain

Question 12

What do major strategic decisions involve in terms of investment factors?

Answer 12

• Major strategic decisions involve investments in “sticky factors,”
• which cannot be easily transformed or redeployed elsewhere

Question 13

How is the choice of a strategy manifested?

Answer 13

• Is manifested in a few commitment-intensive investments
• The essence of strategy is getting these commitments right.

Question 14

What is the 4-step process for analyzing commitment intensive decisions?

Answer 14

Panjay Ghemawat developed this four step process for analyzing commitment intensive decisions:

• Positioning analysis
• Sustainability analysis
• Flexibility analysis
• Judgment analysis

Question 15

4-step process for analyizing commitment intensive decisions?

What does Positioning Analysis determine and analyse?

Answer 15

• Determines the direct effects of commitment and
• analyzes whether the firm´s commitment results in a profitable product market position

Question 16

What is positioning analysis the bases for?

Answer 16

= provides a basis for determining revenues and costs associated with each alternative.

Question 17

4-step process for analyizing commitment intensive decisions?

What does Sustainability Analysis determine and analyse?

Answer 17

• Determines the strategic effects of commitment
• Analyzes market imperfections that make resources scarce and market conditions that protect the firm´s competitive advantage

Question 18

4-step process for analyizing commitment intensive decisions?
What does Sustainability Analysis provide a basis for?

Answer 18

= provides a basis for determining the time horizon beyond which the economic profits are zero.

Question 19

How can Positioning and Sustainability Analysis be used together?

Answer 19

together can be used as a formal analysis of the NPV of alternative strategic commitments

Question 20

4-step process for analyizing commitment intensive decisions?

What does flexibility analysis incorporate?

Answer 20

• Flexibility analysis incorporates uncertainty and option value

Question 21

What is a key determinant of the option value in flexibility analysis?

Answer 21

is the ratio of the “learn rate” to the “burn rate” of the firm

Question 22

Flexibility analysis: What is the learn rate and the burn rate?

Answer 22

• Learn rate: The rate at which a firm receives new information that allows it to adjust its strategy
• Burn rate: The rate at which the firm makes irreversible investments in support of its strategy

Question 23

What is the implication of a high lern to burn ratio?

Answer 23

• indicates that the option value of delay is low

Question 24

How can firms increase their learn to burn ratios?

Answer 24

increase learn to burn ratios through experimentation and pilot programs

Question 25

4-step process for analyizing commitment intensive decisions?

What does judgment analysis involve?

Answer 25

• involves looking at the organizational and managerial factors to ensure that incentives exist to support the optimal strategy

Question 26

What bias may hierarchical and decentralized decision making create?

Answer 26

Hierarchical decision making:

• may create a bias towards type I errors (rejecting good projects)

Decentralized decision making:

• may result in higher incidence of type II errors (accepting unprofitable projects)

Question 27

What should managers be cognizant of in judgment analysis?

Answer 27

• Managers should be cognizant of the biases imparted by the structure of the organization and its politics and culture.

Question 28

What is the tit for tat pricing?

Answer 28

• is a competitive strategy in which a company adjusts its prices primarily in response to price changes made by its competitors

Question 29

What can a tit-for-tat strategy make possible when two firms compete over several periods?

Answer 29

• A tit-for-tat strategy may make cooperative pricing possible.
• when two frims compete over several periods

Question 30

Why do firms have no incentive to engage in price cutting under a tit-for-tat strategy?

Answer 30

Because each firm knows that its rival will match any price cut.

Question 31

What is another reason for firms to choose a tit-for-tat strategy?

Answer 31

• Firms probably do well over the long run against a variety of different strategies
• also, because, here neither firm has a incentive for price cuts

Question 32

What is the grim trigger strategy?

Answer 32

= is to lower the price to marginal cost indefinitely in response to rival’s price cutting in one period

–>In tit-for-tat, the response lasts for only one period and future responses depend on future actions of the rival

–>Both grim trigger and tit-for-tat are capable of sustaining cooperative pricing

Question 33

What is the grim trigger strategy in response to a rival’s price cutting?

Answer 33

• is to lower the price to marginal cost indefinitely
• in response to a rival’s price cutting in one period.

Question 34

What is the time horizon of the tit for that strategy? On what do future response depend upon?

Answer 34

• In tit-for-tat, the response lasts for only one period
• and future responses depend on the future actions of the rival.

Question 35

hat do both grim trigger and tit-for-tat strategies have in common?

Answer 35

Both grim trigger and tit-for-tat strategies are capable of sustaining cooperative pricing.

Question 36

Why is tit-for-tat considered superior over the grim trigger strategy

Answer 36

• because it is easy to communicate, easy to describe, and easy to understand.
• Tit-for-tat combines “niceness,” “provocability,” and “forgiveness.”

Question 37

What does mircodynamics refer to??

Answer 37

Refers to the unfolding of competition among a small number of firms

Question 38

Firms engaged in oligopolistic competition can increase profits through competitive discipline what is one of such strategy?

Answer 38

• strategies such as tit for tat pricing can facilitate coordination but are difficult to implement

Question 39

Why is coordination on the right price difficult?

Answer 39

• coordination must be tacit
• firms may disagree as to what constitutes the „right price“ and
• may disagree on how to „divided the market“
• misreads and misjudgments can trigger price wars