Lecture Unit 6: Dynamic competition (2/3) Flashcards
What is the best time to make a strategic investment when faced with uncertain conditions?
–>Answer is given by the study of real options
What are the key aspects of the commitment-flexibility tradeoff?
- 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.
Flexibility and Real options:
How can one get better information about demand?
by delaying the implementation of projects
Flexibility and real options:
When does a real option exist?
- 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
With what can the value of real options be limited?
value of real options may be limited by the risk of preemption (Risk der Vorrangstellung)
Which investment is more valuable a investment with option to delay or a now or never investment?
- 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
What is the benefit of delay in investment projects?
- allows the firm to avoid the money-losing outcome of investing when market acceptance is low
What is a key managerial skill related to real options?
Spotting valuable real options.
Real options:
On what should the timing of a firm´s investment depend upon?
The timing of a firm’s investments should depend on the degree of uncertainty about future business conditions.
What are the implications/consequences of delaying investment decisions for firms?
- 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.
What shoould a firm do when conditions are volatile regardin real options?
- When conditions are volatile, there is more to learn,
- suggesting that firms should postpone investments when business conditions become more uncertain
What do major strategic decisions involve in terms of investment factors?
- Major strategic decisions involve investments in “sticky factors,”
- which cannot be easily transformed or redeployed elsewhere
How is the choice of a strategy manifested?
- Is manifested in a few commitment-intensive investments
- The essence of strategy is getting these commitments right.
What is the 4-step process for analyzing commitment intensive decisions?
Panjay Ghemawat developed this four step process for analyzing commitment intensive decisions:
- Positioning analysis
- Sustainability analysis
- Flexibility analysis
- Judgment analysis
4-step process for analyizing commitment intensive decisions?
What does Positioning Analysis determine and analyse?
- Determines the direct effects of commitment and
- analyzes whether the firm´s commitment results in a profitable product market position
What is positioning analysis the bases for?
= provides a basis for determining revenues and costs associated with each alternative.
4-step process for analyizing commitment intensive decisions?
What does Sustainability Analysis determine and analyse?
- Determines the strategic effects of commitment
- Analyzes market imperfections that make resources scarce and market conditions that protect the firm´s competitive advantage
4-step process for analyizing commitment intensive decisions?
What does Sustainability Analysis provide a basis for?
= provides a basis for determining the time horizon beyond which the economic profits are zero.
How can Positioning and Sustainability Analysis be used together?
together can be used as a formal analysis of the NPV of alternative strategic commitments
4-step process for analyizing commitment intensive decisions?
What does flexibility analysis incorporate?
- Flexibility analysis incorporates uncertainty and option value
What is a key determinant of the option value in flexibility analysis?
is the ratio of the “learn rate” to the “burn rate” of the firm
Flexibility analysis: What is the learn rate and the burn rate?
- 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
What is the implication of a high lern to burn ratio?
- indicates that the option value of delay is low
How can firms increase their learn to burn ratios?
increase learn to burn ratios through experimentation and pilot programs
4-step process for analyizing commitment intensive decisions?
What does judgment analysis involve?
- involves looking at the organizational and managerial factors to ensure that incentives exist to support the optimal strategy
What bias may hierarchical and decentralized decision making create?
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)
What should managers be cognizant of in judgment analysis?
- Managers should be cognizant of the biases imparted by the structure of the organization and its politics and culture.
What is the tit for tat pricing?
- is a competitive strategy in which a company adjusts its prices primarily in response to price changes made by its competitors
What can a tit-for-tat strategy make possible when two firms compete over several periods?
- A tit-for-tat strategy may make cooperative pricing possible.
- when two frims compete over several periods
Why do firms have no incentive to engage in price cutting under a tit-for-tat strategy?
Because each firm knows that its rival will match any price cut.
What is another reason for firms to choose a tit-for-tat strategy?
- 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
What is the grim trigger strategy?
= 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
What is the grim trigger strategy in response to a rival’s price cutting?
- is to lower the price to marginal cost indefinitely
- in response to a rival’s price cutting in one period.
What is the time horizon of the tit for that strategy? On what do future response depend upon?
- In tit-for-tat, the response lasts for only one period
- and future responses depend on the future actions of the rival.
hat do both grim trigger and tit-for-tat strategies have in common?
Both grim trigger and tit-for-tat strategies are capable of sustaining cooperative pricing.
Why is tit-for-tat considered superior over the grim trigger strategy
- because it is easy to communicate, easy to describe, and easy to understand.
- Tit-for-tat combines “niceness,” “provocability,” and “forgiveness.”
What does mircodynamics refer to??
Refers to the unfolding of competition among a small number of firms
Firms engaged in oligopolistic competition can increase profits through competitive discipline what is one of such strategy?
- strategies such as tit for tat pricing can facilitate coordination but are difficult to implement
Why is coordination on the right price difficult?
- 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
