Topics 11-15 Flashcards
What are the five key traits of strategic commitment?
Long-term
Costly reversal
Changes rival’s strategy
Limiting
Simultaneous game to sequential w/ 1st mover advantage
What are strategic compliments?
Bertrand or Cournot?
When a firm’s action induces the rival to take the SAME action. Bertrand model.
Will announcing intentions alter rivals’ actions?
No. Need to make a commitment of some kind (i.e. put some $ down)
What are the two key traits of a tactical decision?
Short term
Easily reversible
What are strategic substitutes?
When a firm’s action induces the rival to take the OPPOSITE action.
Cournot model.
What is the Lean and Hungry strategy?
Strategic substitutes - Cournot
Negative impact
Stage 1: incumbent plays soft, lowers q.
Stage 2: Cournot competition, entrant plays aggressive, increases q.
What is the Top Dog strategy?
Strategic substitute - Cournot
Positive impact.
Overinvesting to be tough
Stage 1: Incumbent plays tough, increases production.
Stage 2: simultaneous quantity choice.
What is the Puppy Dog Ploy?
Compliments - Bertrand
Negative impact
Stage 1: Incumbent plays aggressive, charges lower price.
Stage 2: Entrant also plays aggressive.
What is the Fat-Cat Effect?
Compliments - Bertrand
Positive impact
Stage 1: Incumbent plays soft by charging a high price
Stage 2: Entrant also charges a high price
How do we get some flexibility out of a strategic commitment?
Break it into smaller portions.
How do we do the tit-for-tat problem?
- Q=q1+q2
- NPV = coupon + coupon/r
- First period the lower priced firm does Q(=q1+q2)
Why should firms choose tit-for-tat?
Does well in the long run against a variety of strategies.
What is the Grim Trigger Strategy?
Period 1: Firm 1 = Pmonopoly
Period 2+: If firm 2 = Pcompetitive, then firm 1 = P=MC FOREVER
What is the difference between Grim Trigger and Tit-for-Tat?
Tit-For-Tat = one period at a time
GT = Forever
What kind of returns to scale do we get when AC < MC?
Diseconomies of scale
What are the two determinants of the horizontal boundaries of the firm?
Economies of scale
Economies of scope
What is Minimum Efficient Scale?
The very first part of the flat bottom of the long run AC curve.
What are the four parts of the Long Run AC curve?
Economies of scale
Minimum efficient scale
Constant returns to scale
Diseconomies of scale
What kind of returns to scale do we get when MC < AC?
Economies of scale
What is the math for economies of scope?
What are two reasons to get economies of scope?
Leverage core competencies
Compete on capabilities
What are the three reasons economies of scale and scope occur?
Product-level economies
Plant-level economies
Firm-level economies
What are product-level economies of scale / scope?
Fixed costs setup
Specialization of inputs
Learning by doing
Cube square rule
What are plant-level economies of scale / scope?
inventories
meshing / indivisibilities
What are firm-level economies of scale / scope?
Multiple plant operations
Input procurement
Sales promotion
What is the cube square rule?
Output is proportional to volume of vessel
Costs are proportional to surface area of vessel
What are some sources of diseconomies of scale or scope?
Labour - lack of specialization
Spreading resources too thin
Bureaucracy
What are the 3 advantages of umbrella branding?
Transference
Brand recognition
New products easier to introduce
What are the 2 disadvantages of umbrella branding?
Transference
Dilution of brand
What is an indivisibility?
Certain inputs have a minimum level
= FC have economies of scale and scope
What are the levels of economies of scale and scope?
Product level
Plant level
Multi-plant level
What are the 7 sources of economies of scale and scope?
Product-specific FC
Trade-offs among alternative production technologies
Cube-square rule
Purchasing
Advertising
Inventories
R & D
Why diversify?
Slides:
- Increasing efficiency
- Economies of scale and scope
- Manager preferences to limit risk or increase social capital or - compensation
Class:
- Increased market = increased sales
- protection from market volatility
- Use excess capacity
Why should we not diversify?
Slides:
- Influence costs
- Need elaborate control and reward systems
- Reduced functioning of internal capital markets
Class:
- Additional tools needed
- Dilution of expertise
- Dilution of brand
- Opportunity cost
What do we consider when deciding to make vs buy?
Quality / process control
Cost
Reliability
Location
Patents
Why might it be cheaper to buy?
supplier has economies of scale
Why might it be cheaper to make?
supplier power is high
Why might it be more reliable to make?
unreliable suppliers
concentrated supply market
Why might it be just as reliable to buy?
Large number of backup suppliers
Why might a patent mean we need to buy?
Supplier owns the patent
Why might a patent mean we need to make?
We own the patent
Why might we buy when looking at quality?
Specialized supplier with high quality
Why might we make when looking at quality?
Process control
What is the make-or-buy continuum?
Buy: market transactions
Buy: long-term contracts
strategic alliances and joint ventures
Subsidiaries
Make
What are the benefits of buying?
Economies of scale
Market firms are more efficient and innovative
What are the costs of buying?
Coordination of production flows
IP
Transaction costs
What are the three reasons to buy?
IP for low-cost production held buy seller
Economies of scale of seller
Learning economies of seller
What are the three efficiency and incentive concerns with regards to making?
Transfer pricing between divisions
Agency costs are internalized
Influence costs
What are the two components of an effective contract?
Completeness
Body of contract law
What is a complete contract?
Thorough:
- Responsibilities
- Rights
What 3 things make a contract incomplete?
- ambiguities
- missing contingencies
- incomplete explanation of rights and responsibilities
What causes incomplete contracting?
Slides:
- Bounded rationality
- Difficulties specifying or measuring performance
- Asymmetric information
Class:
- Time
What are some limitations of contract law?
- broad language subject to interpretation
- uncertainty due to ^^ increases transaction costs
What are the reasons to make instead of buying?
Limitations of contracts
Coordination costs
Leakage of private information
Transaction costs
From class: flexibility
What is the assignment problem?
- issue with coordination
- getting the right people to do the right jobs
- easier to solve internally than with market
What are the sources of transaction costs?
- relationship-specific assets
- holdup problem
- quasi-rents
What are the four forms of relationship-specific assets?
Dedicated assets
Specificity of:
- Site
- Physical asset
- Humans
What is quasi-rent?
The excess economic profit (compared to alternative transactions)
Why do quasi-rents occur?
Relationship-specific assets
What can happen if there are quasi-rents?
- Partners can be induced to build a relationship-specific asset by the potential for them
- Other partners can exploit the quasi-rent through holdup. ***double check this with prof.
What does quasi-rent show us?
The magnitude of the holdup problem
What is the holdup problem?
One transactor takes advantage of another’s lack of comparably valued alternatives to insist on more favourable terms of trade.
What usually leads to holdup problems?
Relationship-specific assets
What is the principal-agent problem?
- divergence in interests
- Agent is acting simultaneously on the principal’s behalf and on their own behalf, which causes conflicts of interest.
When do we get the principal-agent problem?
- Objectives are different
- actions or info of agent hard for principal to observe
What are the main two ways of combatting the principal-agent problem?
Monitoring
Pay-for-performance
What are the 3 limitations of monitoring?
Expensive
Imperfect
Extra layer in relationship
What are the three things to consider when selecting performance measures?
Absolute vs Relative
Augment explicit incentive contracts with direct monitoring and subjective performance evaluations
Narrow vs broad measures
What are the three things that make a good performance measure?
- No random factors
- doesn’t divert attention from important tasks
- doesn’t motivate counterproductive actions
What is a Certainty Equivalent?
the smallest amount the decision maker would be willing to accept in exchange for the risky payoff.
What is a risk premium?
Risk premium = E-CE
(Expected - Certainty Equivalent)
Is CE higher or lower when the variability is higher?
CE drops as variability increases
What is risk sharing?
the cost of the consequence is distributed amongst parties
Why should we pool risk?
Pooling and sharing can reduce the variability without decreasing the expected value.
Does the CE increase or decrease when we pool risk?
Increases because we aren’t as scared.
