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ECONOMIC OF STRATEGY
HOIRUN NISA
Reflections and Home Work

1. Value Proposition

2. Jelaskan Tiga "Value Disciplines“

3. Mengapa Sebuah Perusahaan Harus Memilih Satu "Value Discipline" Untuk

Dikuasai, Dan Apa Implikasinya Terhadap Strategi Dan Operasional

Perusahaan?

4. Bagaimana Cara Menentukan "Value Discipline"

 Economics of Strategy
Seventh Edition
Besanko, Dranove, Shanley, and Schaefer

Chapter 5

Competitors and Competition

Copyright  2016 John Wiley  Sons, Inc.

 Competition

If one firm’s strategic choice adversely affects

the performance of another they are competitors

A firm may have competitors in several input

markets and output markets at the same time

Competition can be either direct or indirect

 Direct and Indirect Competitors

Direct competitors: Strategic choice of one firm

directly affects the performance of the other.
Contoh : Sturbucks , Dunkin Donuts, MCD

Indirect competitors: Strategic choice of one

firm affects the performance of the other because
of a strategic reaction by a third firm. (They
Compete for the same product)
 Identifying Competitors

In practice any one who produces a substitute

product is a competitor

Two products tend to be close substitutes when

 they have similar performance characteristics
 they have similar occasion for use and
 they are sold in the same geographic area
 Performance Characteristics

Performance characteristics describe what the

product does to the customer

Example from automobiles

 Seating capacity
 Curb appeal

 Power and handling

 Reliability
 Occasion for Use

Products may share characteristics but may

differ in the way they are used

Orange juice and cola are beverages but used in

different occasions

Another example: Hiking shoes versus court

shoes
Empirical Approaches to Competitor Identification

Cross price elasticity of demand

Pattern of price changes over time

Firms in the same Standard Industrial

Classification (SIC)
 Geographic Competitor Identification

When a firm sells in different geographical

areas, it is important to be able identify the
competitor in each area

Rather than rely on geographical demarcations,

the firm should look at the flow of goods and
services across geographic regions
 Identifying Competitors in the Area

Step 1: Locate the catchment area. (where the

customers come from)
Step 2: Find out where the residents of the
catchment area shop
With some products like books and drugs being
sold over the internet identifying geographic
competition becomes more difficult
 Market Structure

Markets are often described by the degree of

concentration

Monopoly is one extreme with the highest

concentration - one seller

Perfect competition is the other extreme with

innumerable sellers
 Measures of Market Structure

The N-firm concentration ratio

(the combined market share of the largest N
firms)
Herfindahl index (the sum of squared market
shares)
When the relative size of the largest firms is
important Herfindahl is likely to be more
informative
Harfindahl Index dan Concentration Ratio
HHI = Σ (Si)² , di mana Si adalah pangsa pasar perusahaan i
 Perfect Competition

Many sellers who sell a homogenous good

Many well informed buyers

Consumers can costlessly shop around

Sellers can enter and exit costlessly

Each firm faces infinitely elastic demand

 Zero Profit Condition

With perfect competition economic profits go to

zero
When profits are maximized percentage
contribution margin or PCM = 1/ where  is
the elasticity of demand
In perfect competition  is infinity and hence
PCM = 0
 Conditions for Fierce Price Competition

Even if the ideal conditions are not present, price

competition can be fierce when two or more of the
following conditions are met.
 There are many sellers
 Customers perceive the product to be homogenous

 There is excess capacity

 Many Sellers

Even when the industry is profitable, a low cost

producer may prefer to set a low price

With many sellers, cartels and collusive

agreements harder to create and sustain

Small players will be tempted to cheat and small

cheaters may go undetected
 Homogeneous Products

Three sources of increased revenue when price

is lowered
 Customers buying more

 New customers buying

 Customers switching from the competitors

 Excess Capacity

When a firm is operating below full capacity it

can price below average cost to cover the
variable cost
If industry has excess capacity, prices fall below
average cost and some firms may choose to exit
If exit is not an option (capacity is industry
specific) excess capacity and losses will persist
for a while
 Monopoly

A monopolist faces little or no competition in

the output market

Monopolist can act in an unconstrained way in

setting prices or quality, subject to demand

If some fringe firms exist, their decisions do not

materially affect the monopolist’s profits
 Monopoly

A monopolist faces a downward sloping

demand curve
Monopolist sets the price so that marginal
revenue equals marginal cost
Thus the monopolist’s price is above the
marginal cost and its output below the
competitive level
 Monopoly and Innovation

A monopolist often succeeds in becoming one

by either producing more efficiently than others
in the industry or meeting the consumers’ needs
better than others

Hence, consumers may be net beneficiaries in

situations where a firm succeeds in becoming a
monopolist
 Monopoly and Innovation

Monopolists are more likely to be innovative

(than firms facing perfect competition) since
they can capture some of the benefits of
successful innovation

Since consumers also benefit from these

innovations, they are hurt in the long run if the
monopolist’s profits are restricted
 Monopolistic Competition

There are many sellers and they believe that

their actions will not materially affect their
competitors
Each seller sells a differentiated product
Unlike under perfect competition, in
monopolistic competition each firm’s demand
curve is downward sloping rather than flat
 Vertical and Horizontal Differentiation

Vertically differentiated products

unambiguously differ in quality
Horizontally differentiated products vary in
certain product characteristics to appeal to
different consumer groups
An important source of horizontal
differentiation is geographical location
 Geography and Horizontal Differentiation

Grocery stores attract clientele based on their

location

Consumers choose the store based on

“transportation costs”

Transportation costs prevent switching for small

differences in price
 Idiosyncratic Preferences

Horizontal differentiation is possible with

idiosyncratic preferences

Location and Taste are important sources of

idiosyncratic preferences

Search costs discourage switching when prices

are raised
 Search Costs and Differentiation

Search cost: Cost of finding information about

alternatives

Low cost sellers try lower the search costs

(Example: Advertising)

Some markets have high search costs (Example:

Physicians)
 Monopolistic Competition and Entry

Since each firm’s demand curve is downward

sloping, the price will be set above marginal cost

If price exceeds average cost, the firm will earn

economic profit

Existence of economic profits will attract new

entrants until each firm’s economic profit is zero
 Monopolistic Competition and Entry

Even if entry does not lower prices (highly

differentiated products), new entrants will take
away market share from the incumbents
The drop in revenue caused by entry will reduce
the economic profit
If there is price competition (products that are
not well differentiated) the erosion of economic
profit will be quicker
 Monopolistic Competition and Entry

Customer loyalty allows prices to exceed

marginal cost and encourages entry
Entry considered excessive if fixed costs go up
due to entry without a reduction in prices
If entry increases variety valued by customers,
then entry cannot be considered excessive
 Oligopoly

Market has a small number of sellers

Pricing and output decisions by each firm

affects the price and output in the industry

Oligopoly models (Cournot, Bertrand) focus on

how firms react to each other’s moves
 Market Structure: Causes

Theory would predict that the larger the

minimum efficient scale (MES) of production
the greater will be the concentration.
If entry is not easy concentration will be the
result
Monopolistic competition would mean easier
entry and larger number of firms
 Endogenous Sunk Costs

Consumer goods markets seem to have a few

large firms and many small firms

The number of large firms and the total number

of firms depend more on advertising costs than
production costs (Sutton)

Advertising costs are endogenous sunk costs

 Endogenous Sunk Costs

Early in the industry’s life cycle many small

firms compete
The winners invest in their brand name capital
and grow large
The smaller firms can try to match the
investment and build their own brands or
differentiate their products and seek niches
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