RSM1201 - Day 4 - Silverman Exercises

Value Creation and Value Capture: Added Value
Added value = total value created with the firm in the game
minus total value created without the firm in the game
l Key point 1: A firm cannot expect to capture more than its added value
– If a firm were to capture more than its added value, its buyers and suppliers could strike a deal
with another firm in which they were all better off
l Implication: A firm that creates no value typically captures no value
l Key point 2: A firm does not necessarily capture its entire added value
– A firm’s ability to capture value depends both on its added value and the added value of others.
In general, the value that it captures is higher the lower is the added value of its buyers and
suppliers
l Implication: Moves that reduce the added value of others can help a firm capture value
(but they may also reduce the total value created)
© 2020 Brian S. Silverman, University of Toronto , inspired by Mara Lederman & Michael Ryall 2019 1
Let’s test our understanding: Example 1
Charlie just moved to Toronto to start an MBA at Rotman. Charlie owns a car.
Charlie has moved close to campus and therefore does not expect to drive
much. Charlie values the car at $1,000.
Charlie’s classmate Jamie is looking to buy a car. Jamie lives further from the
Rotman School and will drive to school every day. The car is worth $7,500 to
Jamie.
There are no other potential buyers of the car.
How much value is created if Charlie sells the car to Jamie?
What is Charlie’s added value to this transaction?

What is Jamie’s added value to this transaction?
What will happen? Will they transact? If so, then at what price?
Just as before, Charlie values the car at $1,000 and the car is worth $7,500 to
Jamie.
But now:
Alex is also a Rotman student. Alex would like to drive to school a lot, but
could also share a ride with a friend. Alex values the car at $5,500.
Now what will happen? Who will transact? At what price?

What is Alex’s added value to this transaction?
Just as before, Charlie values the car at $1,000, the car is worth $7,500 to
Jamie, and Alex values the car at $5,500.
But now:
Ryan is also a Rotman student. Ryan will drive to school, and also plans to
drive for Uber occasionally. Ryan values the car at $10,000.

What is Alex’s added value to this transaction?
What is Ryan’s added value to this transaction?
Just as before, Charlie values the car at $1,000, and the car is worth $7,500
to Jamie. But now Alex and Ryan both win cars in a contest, so they no longer
value Charlie’s car.
But now:
Austen joins the Rotman MBA program, and values the car at $800.

What is Austen’s added value to this transaction.
Just as before, Charlie values the car at $1,000, the car is worth $7,500 to
Jamie, and Austen values the car at $800.
But now:
Jamie finds a great deal on an apartment right by school, and no longer

values the car at all.

What is Austen’s added value to this transaction.
Example 6: Two transactions (two “value networks”)
• Two pharmaceutical companies: Pfizer and Eli Lilly

• Each of them seeks an exclusive product-development alliance for a drug
• Two biotech firms: Biogen and Sage, each of which has one promising drug
• If a firm doesn’t form an alliance, then it earns zero
• From the standpoint of each biotech firm, the pharma companies are interchangeable
• In other words, Biogen will have an equally successful outcome whether it
partners with Pfizer or with Eli Lilly, and the same for Sage
• Biogen does better research than Sage. So the value created by the biotech firms in
alliance with a pharma company are:
• Biogen + either pharma = $75B
• Sage + either pharma = $50B
(see next page for continuation of example 6)
Example 6: Two transactions (two “value networks”)
• We know that two alliances will occur
• One will be between Biogen + either Pfizer or Eli Lilly and will create $75B
• One will be between Sage + either Pfizer or Eli Lilly and will create $50B
• Let’s assume that Biogen & Pfizer start to negotiate, and Sage & Eli Lilly start to
negotiate
• In the Biogen-Pfizer transaction, what is Biogen’s added value?

• In the Biogen-Pfizer transaction, what is Pfizer’s added value?
• What is the maximum that Biogen will get? What is the minimum?
• What is the maximum that Pfizer will get? What is the minimum?
• In the Sage-Eli Lilly transaction, what is Sage’s added value?

• In the Sage-Eli Lilly transaction, what is Eli Lilly’s added value?
• What happens if Biogen leaves the ”Pfizer” table and walks over to the table
where Sage and Eli Lilly are negotiating?
• If Biogen, Sage, and Eli Lilly are at the same table, what is Biogen’s added
value?
suppliers
l Key point 3: A firm will capture at least its added value in its next-best deal
– If a firm captures less than this in its current deal, then it would leave to engage in the other deal
l Implication: A firm should cultivate outside options in which it has high added value
Example 7
l Same as in the previous example. Biogen and Sage each has one promising drug;
Pfizer and Eli Lilly each wants an alliance; a Biogen partnership will create $75B in
value and a Sage partnership will create $50B in value.
l Assume that Biogen works with Pfizer and Sage works with Eli Lilly.
– Reminder: What is the range of value that Biogen will capture?
l Now suppose that Biogen realizes that it is a higher-value firm than Sage. The VP of
R&D proposes investing in a second drug project to be able to partner with both Pfizer
and Eli Lilly. There is zero cost to doing this.
l If Biogen has two drug projects, each of which can support a partnership that will create
$75B in value, then:
– What is Biogen’s added value to the market?
– What transactions will be formed?
– What happens to Sage?
– If Pfizer were to negotiate with Sage, what would Pfizer’s added value be to a Sage-
Pfizer deal?
– What is the minimum that Pfizer will capture in its deal with Biogen?
– Is it a good decision for Biogen to add the second drug project?
suppliers
l Key point 3: A firm will capture at least its added value in its next-best deal
– If a firm captures less than this in its current deal, then it would leave to engage in the other deal
l Implication: A firm should cultivate outside options in which it has high added
value…and consider moves that reduce the outside options of others

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Value Creation and Value Capture: Added Value

l Implication: A firm that creates no value typically captures no value

There are no other potential buyers of the car.

How much value is created if Charlie sells the car to Jamie?

What is Charlie’s added value to this transaction?

Now what will happen? Who will transact? At what price?

Now what will happen? Who will transact? At what price?

Now what will happen? Who will transact? At what price?

Jamie finds a great deal on an apartment right by school, and no longer

Now what will happen? Who will transact? At what price?

• Two pharmaceutical companies: Pfizer and Eli Lilly

• If a firm doesn’t form an alliance, then it earns zero

(see next page for continuation of example 6)

• We know that two alliances will occur

• In the Biogen-Pfizer transaction, what is Biogen’s added value?

• In the Sage-Eli Lilly transaction, what is Sage’s added value?

l Implication: A firm that creates no value typically captures no value

l Implication: A firm that creates no value typically captures no value

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