Managerial

Managerial
Economics:Economics
Economics:Economics of
of
Strategy
Strategy
Economics of Strategy
Patrick McNutt
www.patrickmcnutt.com
Abridged ©
 Workshop Lesson plan….
• Day 1: Introduction and setting the scene using
McNutt’s E-book
• Focus: Type, signalling and strategy
• Plan is to follow Besanko’s Textbook ..
• Day 1 & 2: Progress into Ch 2 to Ch 4 and Ch 5
• Day 1 Workshop Study Groups & Case Analysis
• Day 2 & 3: Focus on Chs 6 to 9 and conclude with
Ch 10 and 11
• Advise Part III for post-Workshop reading
 At the frontier…..
• Understand management as ‘they are’ not as theory hitherto
‘assumed them’ to be
• Management can be ranked (by type) and are faced with
trade-offs => something must come ‘top of the menu’
• Firms are conduits of information flows (vertical chain)
• Reducing price does not necessarily lead to an increase in
revenues (elasticity)
• Prices are primarily signals (observed behavior)
• Companies understand the competitive threat as
interdependence (zero-sum)
 Players?
• Principal-agent relationship
• Shareholders as principals and
management as agents
• Who are decision makers?
Management ≈ firms ≈ companies
=
PLAYERS
Costs of not being a Player
• Agency costs across the
shareholders (esp institutional)
• Bounded rationality and opportunity
costs with trade-offs
• Make or Buy dilemma
• FMA
• Follower status ‘behind the curve’
 The competitive threat!
• Traditional Analysis is biased
towards answering:
what market are we in and how can we
do better?
• Economics of strategy (GEMS) asks:
what market should we be in?
 Bridging Unit 1 and Unit 3:
Strategic analysis
• Binary reaction; • Non-binary
Will Player B reaction: Player B
react? Yes or No? will react.
• If YES, decision Probability = x%
may be parked • Decision taking on
• If NO, decision conjecture of likely
proceeds on error reaction
• Surprise • No Surprise
 Lets’ begin! Unit 1: Why the
economics of strategy?
• The Firm as a nexus of contracts
• Vertical chains and agency
• Shareholders and management
• GHM Theory and incomplete
contracting
• Type of management
 Type of Management
• Maximise shareholder value, meet
the profit constraint
• McNutt E-book Ch 1
• Managerial discretion
• Managerial limitations and Penrose
effect
• Simon’s Bounded rationality
 Game type and signalling
• Decisions are interpreted as signals
• Observed patterns
• Recognition of market interdependence
(zero-sum)
• Price as a signal v Baumol model of TR max
• Scale and size: cost leadership
• Dividends as signals v Marris model
 Precis on a Marris model…
• McNutt Ch 4: Understand balanced
equation gc = gd to identify parameters of
profitability
• Supply of capital: debt v equity
• Demand for capital: R&D exp v dividends
• Instrumental variables influencing growth
– visit Diageo case in Kaelo v2.0
• KFIs: profits/output and output/capital
• Tobins q and Marris v ratio
Figure 5 Marris’ Trade-off
U1 U2 U3 U4
Valuation ratio Shareholders perference
x
V1
Best to management

V2 y Valuation curve

V(min)
0
G1 G2 Growth rate
 Unit 2: Cost leadership as a type
• Profitabiltiy v scale and (size and scope)
• Production as a Cost-volume constraint
• Understanding the economcis of
productivity as exemplar for incentives
• Normalisation equation
• Excess v reserve capacity [next slide]
• Cost leadership checklist
 Production has to determine demand
to attain cost leadership

Lower per unit

cost for more units sold
SAC1
SAC
SAC
2
3 LAC
Av.Cost = marginal cost

0,0 Q
q1 qt q2
Current plan of plant
closures to lower cost
base not completed
 Bridge Unit 1 and Unit 2
• Shareholder as principals expect max value
• Management to minimise the agency costs
• Positive Learning Transfer, PLT
• Nomenclature on type: Baumol type, Marris
type.
• Cost leadership type (link into Ch 11 on
stategic cost advantage)
 Unit 3 Game Dimension
• What is a game – loss of independence?
• Action, Reaction and Reply
• Non cooperative sequential games
• Introduce oligopoly and n < 5
• Single shot price reduction: (i) fail TR test
and revenues fall; (ii) near rival misreads
the price as a signal
Describe game dimension
• Players and type of players
• Prices interpreted as signals
• Patterns of observed behaviour
• Leader-follower as knowledge
• Accomodation v entry deterrence
• Reaction, signalling and ‘best you can
do, goven reaction of competitor’
 Type of Players
• Incumbent type v entrant type
• Dominant type v monopoly incumbent
• De novo entrant type and geography
of the market
• Potential entrant type and the threat
of entry
• Newborn players
 Limit Pricing Model
• Outline the game dimension: dominant
incumbents v camuflaged entrant
type
• Define strategy set for incumbents
• Allow entry and define the equilbrium
• Preference - entry deterrent
strategy v accomodation [next slide]
 0,10
Do Not Enter

1
Agressive
-7,2
Enter

5,8
Accommodating
 Entry Deterrent Strategy
• Reputation of the incumbents
• Entry function of the entrant
• De novo and entry at time period t
• Potential entrant and forces reaction
from incumbent
• Coogans bluff strategy
 Continuing with Unit 4:
Define a price war
• Determine the Bertrand reaction
function
• Signalling
• Compute a critical Time Line from
observed signals
• Find a price point of intersection
 Visit Kaelo v2.0 and
McNutt’s E-book
• Example: Critical Time Line in a Sony v
Microsoft, Apple v Nokia game dimension
• Play a PD game and investment game in
Kaelo v2.0
• Altruism, fairness, selfish gene, dominant
strategy
• Understand the link across the extensive
decision-tree to the payoff matrices [next
slide]
 Nash Equilibria
• Define the Nash equilibria [next
slide]
• Analyse the Payoff matrix
(B,Y) > (A, X)
• Commitment and chat
• Strategic ToolBox in terms of
credible mechanisms
 Player 2
Strategy X Strategy Y

Strategy A 0,0 8,-5

Player 1

-5,8 10,10
Strategy B
 Prisoners’ dilemma
• Introduce the Prisoners’ Dilemma
[next slide]
• Low price (compete) v high price
(chat)
• Play mean p64 of e-Storybook and
Table 7.2 of textbook, p236
• Punishment strategies
 Player 2
Low Prices High Prices

Low Prices 2,2 13,0

Player 1

0,13 10,10
High Prices
 Games as Strategy
• Segmentation strategy to obtain FMA
• Relevance of chain-store paradox
• The Umbrella dilemma
• Value net and PARTS
• Strategic ToolBox in terms of
sustainability
• GEMS and Tx3 Framework [next slide]
 Organizational
Goals

 Porter’s 5 Forces Industry

 BCG Analysis
 Value Net

 S.W.O.T. Strategic Options (Identify the Games)

 P.A.R.T.S.
 McKinsey

Game theory Insights

 Game theory Play-out Game Play-out Game Play-out Game

Scenario A Scenario B Scenario C
e.g. market e.g. change the e.g. change the
entrycompetitors gamenew game
reactions product Consolidation
development

Strategic Decisions
GEMS and Strategic Analysis
• Knowledge of the
identity of near rival:
Actionyou -> Reactionrival
-> NashReplyyou
 GEMS and Strategic Analysis
• Knowledge of likely reaction of near
rival
• Binary reaction; Will Player B react?
Yes or No?
• Non-binary reaction: Player B will
react. Probability = x%
Game Embedded Strategy:
GEMS

What Market should we be in?

Competition Adaptation
& Cooperation & Technology

Games & Feedback

 Final Scenarios……
• The Rationale • The Strategy
Markets evolve Non-binary
• The Rationale • The Strategy
Type, Technology and Game metrics and
Time analytics
• The Rationale • The Strategy
Know your market GEMS
 Thank you for
participating………

Sapere aude

‘That which one can know, one

should dare to know’