The Technology-Strategy Nexus – Leveraging Market Imperfections

Ajit Prasad


he nexus between innovation, technology and strategy has been well established. However, a point hitherto ignored has been the dual role that technology can play in defining strategy. Technology can have two inputs: defining business strategy and defining corporate strategy. The roles, requirements and responsibilities of technology can thus be vastly different, depending on how we use technology.

The two roles of technology imply vastly different processes in both strategy formulation and implementation. Technology, in relation to business strategy, would look at generic strategies of product differentiation. Technology, in relation to corporate strategy on the other hand, would look at strategies of cost leadership and thereby of product development. Corporate technology would also most likely be more expensive than business technology, implying more stringent return on investment (ROI) decisions1. This paper however will look at using Porter’s framework2 in the context of single business firms. In our analysis, the role of technology needs to be understood in terms of three broad parameters: product differentiation, product development and cost leadership. The role of strategy too needs to be understood in a context beyond the Porterian assertion3 that strategy is about positioning: positioning in a market segment in which the balance of the forces would be more favourable to the firm. One of the little known uses of the Five Forces model4 is that it suggests guidelines for market entry decisions. In a producer’s utopia, all the five forces would be ‘low’, ie the bargaining power of buyers and suppliers both would be low, the threat of potential entrants and substitutes module would 365

Ajit Prasad is Professor, International Management Institute, New Delhi. IIMB Management Review, December 2006

Exhibit 1

The Strategy Clock

? (2)

Lufthansa KLM Virgin


BB, Aeroflot Royal Jordanian

? (1)


Source: G Johnson and K Scholes, 2003, Exploring Corporate Strategy, 6th Edition, Prentice Hall.

be low, and the jockeying for position would be also at a low intensity level. Thus questions of diversification and/or market entry decisions can be looked at from this rule: Improvement in competitive position implies moving towards a ‘low’ intensity of forces. However, the desired intensity of forces cannot be a fait accompli. Firms must actively work towards making sure that the intensity of forces is kept at a low level. The ability of a firm to keep the forces at a low level over a period of time would result in sustained competitive advantage. The point may be illustrated with an example from the aviation industry. In the standard ‘Strategy Clock’ diagram5 (Exhibit 1), given the value on the x-axis and price on the yaxis, it is clear that the following map can be constructed for existing players in the international civil aviation industry. At the high value-high price position we have players like Virgin, KLM and Lufthansa. At the low price-low value position we have Bangladesh Biman, Royal Jordanian, and Aeroflot. If we were to consider a hypothetical expansion of Aeroflot, entering into the ‘high-price, high-value’ proposition may not be advisable, therefore the two options are the other two corners represented by ?(1) and ?(2). The decision of which to enter would basically depend on the level of industry attractiveness. Porter’s model would suggest that the segment of the market in which the balance of forces6 is such that the intensity of each is low would be the most attractive. This would vary for different market structures, with all the forces being high under perfect competition and being zero or low in a monopoly7. 366

The Central Thesis
The central thesis of this paper will revolve around the fact that the purpose of strategy8 is to convert market perfections into market imperfections, and thus to leverage the imperfections to provide us with a sustainable source of competitive advantage. From the point of view of the consumer, utopian market conditions would consist of a large number of producers, undifferentiated products, the inability of individual producers or consumers to fix prices, the technology being constant returns to scale (an important factor in the managerial decision making process), and symmetric information flows. However, these constitute the worst market conditions from the viewpoint of the producer. The entire objective of the producer will be to find ways and means to corrupt this system, to introduce imperfections in the market that can be taken advantage of. The most effective way to introduce these imperfections is through the use of technology (Exhibit 2). The essence of strategy thus would be in the use of technology to convert market perfections into market imperfections.

The Propositions
The interventions in Exhibit 2 would give rise to the following propositions. Proposition 1: Given the market characteristics of a large number of producers, imperfections are introduced by
The Technology-Strategy Nexus – Leveraging Market Imperfections

Exhibit 2

Market Perfections to Imperfections through the Use of Technology
Under Perfect Competition Large Utopian (desired) Small and few Lower the Average Cost curve Large Managing the tradeoff between communication and brand loyalty Differentiate, then segment through product development/ differentiation and then focus Nucor’s introduction of the Thin Slab Caster The US steel industry’s response to the EU quota imposition through VRAs (voluntary restraint agreements)9 Use of Technology Examples from the steel Industry

Market Attribute


Number of players


Number of buyers


Ability to fix prices



Using technology to convert cost leadership to price leadership

In 1992, SAIL and TISCO cartelised and were able to fund a price war that drove Lloyds Steel to financial bankruptcy


Information flow

Symmetric and full

Asymmetrical and limited

Open internally, restrict externally so as to allow consumers’ surplus to be minimised

The E-commerce initiatives by the steel majors, using the Vickrey Auction technique


Commodity attribute



Differentiate partially

The service element, offered by TISCO compared to SAIL


Presence of substitutes

Within the group

Totally absent

Differentiate extremely

The threat from plastics — use the bio degradability trump card


Rent-seeking behaviour


Substantial contribution to profits

Restrict supply, create barriers to entry, increase monopoly power

The industry practice of clubbing slow with fast moving items

lowering the average cost curves, and erecting entry barriers. A large number of producers implies the existence of competition among them. Technology can be used in two ways to reduce the level of competition. First, technology may be used to look at ways to lower the Average Cost (AC) curve. If this happens, the ability of the firm to either make super normal profits in the short run, or to depress the prices in the future will ensure that the bulk of the firms that cannot match the new average cost (AC ) curve will leave the market. With reference to Exhibit 3, in a profit maximising condition, equilibrium would be established at the point where marginal costs (MC) are equal to marginal revenue (MR). Since firms are price takers, average revenue (AR) will equal the marginal revenue (MR) giving us a perfectly elastic demand curve. It can be seen that any attempts by the firm to lower the AC curve through technical progress will result in the generation of supernormal profits. Thus there will be an increase in the concentration ratio and the monopoly power. Second, technology may also be used to prevent and to erect entry barriers. This may be done by resorting to (1) patents
IIMB Management Review, December 2006

and other legal means to prevent other firms from copying this technology, and (2) adopting technologies that have a ‘lumpiness’ effect10 and the associated impact on the increasing returns to scale. In the steel industry for example, . the adoption of the Blast Furnace-Basic Oxygen Furnace (BF-BOF) technology route as opposed to the Direct Reduction - Electric Arc Furnace (DR-EAF) route ensured that the increasing returns to scale (IRS) associated with the lumpy investment in the BF route was so strong that this itself intruded entry barriers in the industry. With a small number of firms, the rent seeking behaviour of existing firms became more pronounced. Proposition 2: Given the market characteristics of a large number of buyers, imperfections are introduced by segmenting the market through product differentiation. The homogeneity of the products introduced through the course of growing competition stands in the way of firms wanting to realise additional profit over and above the industry average. To do away with this homogeneity, firms use technology to differentiate the product. The advantage of 367

Exhibit 3

The Determination of Super Normal Profits
MC Super - Normal Profit AC AC'

P0 P1


Quantity Q1 Q0 AC : Average Cost; MC : Marginal Costs;

MR : Marginal Revenue; AR : Average Revenue

multiple differentiations is that it will eat into the consumers’ surplus that would have grown over a period of time. Thus the same product, differentiated in different ways, would attract different target segments, at different prices. The Marshallian concept of consumers’ surplus11 can be used effectively to explain the use of technology in not only product differentiation (physical or perceptual) but also in controlling information flows (Proposition 4 below). With reference to Exhibit 4, the traditional intersection of the downward sloping demand and upward sloping supply curve to determine Exhibit 4
Price Consumers' Surplus

quantity and price leaves out one very important management tool for managers: viz the group of people sitting on the upper section of the demand curve that were actually willing to pay much more, but because of market perfections, have benefited by paying a lower price. Marshall referred to this as ‘Consumers’ Surplus’, which is a good thing for consumers, but for producers represents a loss of revenue. To mop up this surplus, firms will introduce imperfections in the market through segmentation and product differentiation. The use of technology in product differentiation comes out

The Dynamics of Consumers’ Surplus




Quantity Q1


The Technology-Strategy Nexus – Leveraging Market Imperfections

clearly in the case of the steel industry. In the 1980s, Tata Iron and Steel Company (TISCO)’s introduction of high carb chromium metals in its TS423 series, took out the products from the Joint Plant Committee12 net, which attracted independent pricing. TISCO was therefore able to (a) distort the market, and (b) extract consumers’ surplus. This for a long time gave TISCO its competitive advantage. Proposition 3: Given the market characteristic of the inability of either producers or consumers to influence prices, imperfections are introduced by allowing cost leadership to be translated into price leadership through the back-up of reserves and surpluses. While Porter is very clear about the generic strategies13 to be followed by firms, the three strategies of cost leadership, , product differentiation and focus represent different levels of inferior choice. It may be argued that cost leadership may not always be looked upon as strategy, as it ultimately depends on how cost leadership is used. While it is clear that cost leadership will result in an increased accrual to the reserves and surpluses (R&S) account of the balance sheet through the increased margins, it may be prudent to look into what the firm is expected to do with these increased accruals. To our mind the increased accruals can be used in two ways: one, it can be used to fund a price war, a case of cost leadership being converted into price leadership (resulting in a depletion of the R&S), or it can be used to fund R&D activity to support product differentiation, resulting in higher margins, again a return to price leadership (resulting in a further accrual to the R&S). Proposition 4: Given market characteristics of symmetric information flows, imperfections are introduced by allowing asymmetric information flows to develop through the use of technology (Internet). An important way of introducing imperfections in the market is to attack the symmetry of information flows. As pointed out above in Proposition 2, the basis of the consumers’ surplus rests on the fact that in the market every one knows what price is being paid. Perfect information thus leads to consumers concealing their preference orderings. Sameulson’s work on Revealed Preference is a case in point14. The Vickrey Auction15 is another way in which exact consumer valuations can be ascertained by distorting information flows. Because the consumer is exceedingly intelligent, he must be tricked into revealing his preference and thus his true valuation of the product. The consumer may be ‘tricked’ through product differentiation, a point that has been discussed earlier. Technology can also induce
IIMB Management Review, December 2006

An important way of introducing imperfections in the market is to attack the symmetry of information flows. The basis of the consumers’ surplus rests on the fact that in the market every one knows what price is being paid. Because the consumer is exceedingly intelligent, he must be tricked into revealing his preference and thus his true valuation of the product.
‘consumer alienation’ to prevent information from being symmetric. The Internet is a good example. Any one who has gone through the process of booking a hotel room knows that there is no standard price. You eventually land up ‘bidding’ for the room, and if the hotel finds your bid acceptable, you get the product. This is asymmetric information at its best; you have no idea of how much the next door neighbour has paid for the same room16. The role of technology thus gets established in terms of its ability to disrupt information flows, and to introduce ‘noise’ into the system. Proposition 5: Given the market characteristics of homogeneous goods, imperfections are introduced by differentiating the product, either physically or perceptually. In a seminal work, Levitt introduced the concept of the core17 and the augmented product. The definition of the core product envisaged the generic need that has to be fulfilled. In the augmented product, the characteristics by which one firm competes with another get emphasised. In terms of Porter’s Five Forces model18, the ‘jockeying for position’ would be determined by the augmented product., while the threat of substitutes would be defined more on the basis of the core product. We have discussed earlier that in the case of homogeneous goods, the bargaining power of the buyers would be high. To curtail and reduce this bargaining power, commodities must be converted into products, either physically or perceptually. Once we are in the domain of the ‘product’, then the firm can rely on brand loyalty to introduce irrationality in the market, leading to sustainable advantage. Here again technology can play an important role in achieving this transition. R&D and other activities can mould the product 369

so as to have a greater appeal to one dominant market segment. Technology can also play a role in altering the perceptual map, by making the same product available to different market segments (the Internet, once again), with supporting advertising, which can realise the same advantage. Proposition 6: Given the market characteristics of cross elasticity of substitution (CES) equal to infinite (perfect substitutability), imperfections are introduced by making the CES equal to zero (zero substitutability) through product development (differentiation). One of the key tenets of perfect competition is the fact that as the goods in question are of a homogenous nature, consumers are willing to pick up as much as is available of the good supplied at a price that is fixed. Changes in price will not change the quantity of goods demanded by the market. The demand curve thus will be perfectly elastic. This is also because of the assumption of perfect substitutability, in the sense that if the producer tries to increase prices, the consumer will go to some other producer who while not having the same commodity, is able to satisfy the consumer’s generic need perfectly. It can be argued that strategy based distortions must include how to convert the perfectly elastic demand curve into a relatively elastic demand curve and so on. As can be seen from Exhibit 5, the key to the transition from perfect competition to monopolistic competition lies in the clockwise swing from AR to AR’. This swing while leading to

a fall in the output from Q0 to Q1 will lead to an increase in the market price from P0 to P1. The increase in the price realisation will definitely lead to a drop in total revenue19, as the monopolist will tend to operate on the inelastic segment of the demand curve: this however gets compensated with the trade off between revenue and profits20. Technology thus facilitates the market manager’s dream of converting commodities into products and allowing brand loyalty to emerge through enabling differentiation of the product and the creation of brand loyalty. Proposition 7: Proposition 7: Given the market characteristics of the total absence of super normal profits, imperfections are introduced to result in super normal profits not only in the short run, but also in the long run through rent seeking behaviour. Under the normal assumptions relating to the prefect market, super normal profits cannot exist in the long run. The assumptions about free exit and entry take care of this. With one firm making super normal profits, the industry attractiveness will increase, and more and more firms will enter the market. This will lead to oversupply and thus a fall in the AR=MR curve. Super normal profits will thus be wiped out. There are different ways in which firms can retain the ability to make super normal profits. Growth Dynamics21 suggest a sequential process by which firms move from exploiting strategies of product development to market development and vice versa. Diversification would be last on the list of

Exhibit 5

Converting Commodities to Products

P1 P0


MR' Q1 AC : Average Cost; Q0


MC : Marginal Costs;

MR : Marginal Revenue; AR : Average Revenue


The Technology-Strategy Nexus – Leveraging Market Imperfections

growth options, unless of course the product life cycle (PLC) for the existing product has been wiped out totally. It is clear that the strategy of product (differentiation) and market development will lead to the extension of the PLC, a feature akin to firms getting into rent seeking behaviour. In the long run, every firm will try to exploit the limited elasticity of supply in a relatively inelastic demand oriented market, leading to the establishment of economic rent, or firms trying to establish rent seeking behaviour. It is this situation that is at the pinnacle of the firm’s ability to generate profits over and above the firm average. Technology again plays an interesting role here. Starting from the patent issues of product development to controlling the flow of information, we find technology increasingly being used to support the existence of super normal profits. In the steel industry, there exists ample evidence of product development22, technology development to establish and exploit increasing returns to scale, and monopolistic behaviour in limiting the supply schedule: all ultimately aimed at establishing rent seeking behaviour23.

The purpose of strategy is to introduce a competitive advantage, and this can be done by the pro-active approach of a firm which wants to move away from perfect competition to monopoly. The deliberate distortion of market conditions does not favour the consumer, but it definitely favours the producer, who uses this to increase his profits in the short term and initiate rent seeking behaviour in the long term.
reflex reactions by using technology adversely to alter the competitiveness of the industry structure may not be the long term solution. Despite the fact that there may be a ‘Nash equilibrium’24 preference for the short term solution, firms need to realise that strategies dealing with the different constituents of the markets (buyers, suppliers etc) cannot be uniform and must change according to the market distress signal that is sent. Firms cannot and should not have uniform strategies (or tactical) responses across the industry. In the context of the ever changing technology, the role of information (a)symmetry is going to be critical. The Internet has already addressed this in terms of breaking down the bargaining power of buyers and suppliers by geographical isolation. Among the generic strategies specified by Porter, it is probably only product differentiation that will be sustainable in the long run (unless of course cost leadership is made synonymous and sequential with price leadership). Finally, it is very easy for firms to sink into the luxury of rent seeking behaviour. But its impact on creativity will limit the firm’s ability to redefine itself in the long run. The importance of technology in supporting strategy thus cannot be underestimated. Especially with the shortening of the PLC, technology will play an increasing role in defining the strategic basis of competitive advantage. Firms that have been able to harness the use of technology will be the firms that will emerge as survivors in the next shakeout. Technology strategy, or strategic technology, whichever interpretation that may appeal to the firm, will be the imperative for tomorrow’s market place. 371

In this paper an attempt has been made to look at the strategytechnology nexus. We have asserted that the purpose of strategy is to introduce a sense of competitive advantage, and this can be done by the pro-active approach of a firm, which wants to move away from the market characteristics of perfect competition to the market characteristics of monopoly. The deliberate distortion of market conditions does not naturally favour the consumer, but it definitely favours the producer, who uses this as an opportunity to increase his profits in the short term and initiate his process of rent seeking behaviour in the long term. It can be argued that this also may not be conducive to the long term interests of the firm, as rent seeking behaviour will obviously encourage complacency in the organisation. This then is the classic dilemma between short term tactical response, which is basically in the nature of a reflex reaction, and the long term strategic positioning, which the manager will have to resolve. The paper then looks at the role of technology in supporting the firm’s efforts in introducing distortions across various parameters, be it in buyer behaviour, supplier behaviour, or growth patterns followed by companies or even facilitating the firm’s unending quest for rent seeking behaviour. Managers must understand that acceptance of short run
IIMB Management Review, December 2006

References and Notes
1 Liebenstein, H,1966, ‘Allocative Efficiency vs X-efficiency’, American Economic Review, Vol 56, No 3, pp 392-415. 2 Porter, M E, 1979, ‘How Competitive Forces Shape Strategy’, Harvard Business Review, March-April, Vol 57, No 2, pp 137-145. 3 Porter, M E, 1996, ‘What is Strategy?’, Harvard Business Review, Vol 74, No 6, Nov-Dec, pp 61-78. 4 Porter, M E, 1980, Competitive Strategy, The Free Press. 5 Johnson, G, and K Scholes, 2003, Exploring Corporate Strategy, 6th Edition, Prentice Hall, pp 319-21. 6 As such the literature has not been able to come up with cardinal measures for the intensity of forces. Decision of market entry thus must be heuristic. 7 Duopoly is the only market structure form in which the 5Forces model may not be applicable. Because of the presence of relational expectations (output of x will be determined by price of y and vice versa), the linearity assumption relating to bargaining power may not necessarily lead the system into convergence (a’ la the ‘Cobweb Theorem’ — Kaldor, N, 1934, ‘A Classificatory Note on the Determination of Equilibrium’, Review of Economic Studies, Vol I, February, pp 122-36. 8 This is in essence the difference between the study of economics and the study of strategy: economics teaches you how to live with imperfections; strategy teaches you how to take advantage of imperfections. 9 In the 80s, following a glut in the steel industry (this was the same period that Nippon Steel scrapped over 30 mt of steel capacity) the EU imposed quotas on the import of American steel. The US responded by adopting Voluntary Restraint Agreements on the import of certain special steels from Europe. Steel producers in Europe, in order to beat the system started to differentiate the ‘garden’ varieties of steel, so as to escape out of the VRA/ Quota regime, and much of the differentiation was cosmetic. In India, TISCO followed the same strategy to escape out of the JPC net (in the pre 1991 period steel production, pricing and distribution came under the administered régime through a Joint Plant Committee). 10 Cooper, R, J Haltiwanger, and L Power, 1999, ‘Machine Replacement and the Business Cycle: Lumps and Bumps’, American Economic Review , Vol 89, pp 921-46. The ‘lumpiness of capital’ refers to the attribute of perfect indivisibility. Thus while it may be possible to set up a million tonne steel plan for US$ 500 million, it may not be possible (or even desirable) to set up a one tonne steel plan for US$ 500! The lumpiness of capital would also depend on the minimum economic size of investment. 11 Marshall, A, Principles of Economics, English Language Book Society, London, 1969 (8th Edition 1920: 1st edition 1890). 12 It may be recalled that during the 1980s, most of the integrated steel producers, came under the Joint Plant Committee (JPC) net, wherein, not only the prices of the (homogenous) products were controlled by the Ministry of Steel, but also their supply: a strict rationing system was

being followed. Obviously, by adding a few alloys, the chemical composition of the steel could be changed, and this would land it outside the JPC net. Scope of using technology to map not only physical differences but perceptual differences (most of the time, the added alloys contributed little to the physical strength of the product), increased profits. 13 Cost Leadership, Product Differentiation, and Focus — Porter, M E, 1985, Competitive Advantage, Free Press. 14 Samuelson, Paul A, 1948, ‘Consumption Theory in Terms of Revealed Preference’, Econometrica, Vol 15, pp 243-253. 15 Vickrey, W, 1961, ‘Counterspeculation and Competitive Sealed Tenders’, Journal of Finance, Vol 16, No 1, pp 8-37. 16 We also see ample evidence of this in the airline industry 17 Levitt, T, 1980, ‘Marketing Success through Differentiation — of Anything’, Harvard Business Review, Vol 58, No 1, JanFeb, pp 83-91. This is not to be confused with the ‘core product’ as introduced by Prahalad and Hamel. 18 Porter, ‘How Competitive Forces Shape Strategy’. 19 This also links up to the concept of strategy as inferior choice (Prasad, A, 2002, Issues in Strategy — Some Debates of Irreverence, Global Business Review, Sage, Vol 3, No 1, pp 2538). By converting the product (elastic demand curve) into a commodity (relatively elastic demand curve), the producer has actually reduced his market. This action obviously has associated risks. The newly segmented market may not value the basis of the segmentation, and more important, the very basis of segmentation can itself vanish through technological change. These are risks upfront, but the payoff is that if this segment can be isolated, the resulting brand loyalty will yield additional profits. Communication costs too would be lower. 20 This is the classic assumption that the monopolist’s aim is not to maximise sales but to maximise per unit profit. Also, the more he is able to restrict the sales, the greater is the per unit profit that he will make. 21 Ansoff, I A, 1965, Corporate Strategy, McGraw-Hill. It is interesting to note that the sequencing for the four quadrants would be different for consumer goods vs industrial goods. For the former, the sequencing would be: product development – penetration - market development diversification. For industrial goods the sequencing would be: market development – penetration - product development and then diversification. This would be essentially due to the fact that product development in industrial goods would be more R&D and capital-intensive process than that in consumer goods. 22 It would be interesting to search for empirical evidence of Xefficiency (Liebenstein, ‘Allocative Efficiency vs X-efficiency’), wherein we could possibly correlate the pace of product development to the extent of competition there in the market. The causal relationship would also yield interesting results. 23 This of course may not always be a good thing. Rent seeking behaviour would introduce complacency, never a good thing in industry. The collapse, if market conditions change, would come much faster.
The Technology-Strategy Nexus – Leveraging Market Imperfections


24 Nash, John F, 1950, ‘Equilibrium Points in N-Person Games’, Proceedings of National Academy of Sciences.

Collis, D J, and C A Montgomery, 1998, ‘Creating Corporate Advantage’, Harvard Business Review, Vol 76, No 3, May-June, pp 70-83. Grove, A., 1996, Only the Paranoid Survive , Currency Doubleday, Robins, Lionel, 1931, An Essay on the State and Nature of Economic Science, Cambridge,

Other Works
Brian Arthur, W, 1996, ‘Increasing Returns and the New World of Business’, Harvard Business Review, Vol 74, No 4, July-Aug, pp 100-109.

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