Er 2016

Examiners’ commentaries 2016

MN 3119 Strategy
Important note
This commentary reflects the examination and assessment arrangements

for this course in the academic year 2015–16. The format and structure
of the examination may change in future years, and any such changes
will be publicised on the virtual learning environment (VLE).
Information about the subject guide and the Essential reading

references
Unless otherwise stated, all cross-references will be to the latest version
of the subject guide (2013). You should always attempt to use the most
recent edition of any Essential reading textbook, even if the commentary
and/or online reading list and/or subject guide refers to an earlier
edition. If different editions of Essential reading are listed, please check
the VLE for reading supplements – if none are available, please use the
contents list and index of the new edition to find the relevant section.
General remarks
Learning outcomes
At the end of this course, and having completed the Essential reading and
activities, you should be able to:
• use tools of strategic analysis and game theory to value and analyse
strategic options in real life.
In particular, you should be able to:
• anticipate the actions of a rational (that is, individually profit-
maximising) rival and act accordingly.
Planning your time in the examination

The examination is scheduled fairly generously (that is, time pressure is
typically not a major issue).
This should allow you to make use of your knowledge about the subject in
a broad fashion and select and prioritise your answers. In other words, this
generous time allowance of three hours is not meant to elicit long-winded
answers from you, but rather to let you have time to judge what is relevant
for answering a particular question.
Please note that questions should roughly be allocated time according to
their value. As candidates will answer eight questions (four compulsory
from the first part and four out of eight from the second part), candidates
should expect to spend between 20 and 25 minutes on each question. This
is plenty of time for each question.
You should also be courageous enough to move on to the next question if
you feel that you have said everything relevant about a question, even if
the answer is fairly short (i.e. even less than 300 words).
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MN 3119 Strategy
What are the Examiners looking for?

• Clear and systematic answers. A line of argument should be noticeable
in your answer.
• A real answer. That is, if the question ends in a question mark, the
candidate should provide an answer to this specific question. (A
surprising number of candidates do not do this.)
• Selectivity. Candidates should not look for keywords and then write
down everything they know about the keyword. Completeness of
knowledge or lengthy checklists are worth less than an intelligent
selection of the most relevant elements from such a list.
Key steps to improvement

Special care is taken in formulating the question to pose a concrete
question, implicitly or often explicitly ruling out peripheral concepts, to
make it easier for candidates to figure out what is needed to answer the
question well. The answers, however, are often quite generic, consisting
of lengthy explanations of the concept that was supposed to be applied,
not explained. This means that the ratio of useful content to length of the
answer is often disappointingly low. A 600-word answer containing two
sentences actually referring to the question at hand will be marked down
compared to just the two sentences.
The key areas of improvement are closely related to this point.
• Answer the question. The practice of trying to identify keywords in
the question and giving a long explanation of the keyword will lead
to failure. The questions ask something very concrete and often give
information that is needed to answer the question, so candidates
should make sure they read the question in detail and answer it
accordingly.
• Candidates should make sure the answers are sufficiently structured.
An essay, even if only 300 words, should have a discernible structure.
Candidates should use bullet points, numbering, etc. to make this
structure explicit. For example, if three aspects, examples etc. are
asked for, candidates should start a new paragraph for each example
and number it accordingly.
• Be more courageous and original. One aspect of Strategy is to come
up with ideas that others did not have. You are therefore strongly
encouraged to include original thoughts, examples and ideas. Most
of the questions in the exam will guide you towards this because it
defines a specific task.
• Link different topics and chapters. Some questions would benefit from
taking a broader view, and incorporating insights from different parts
of the course. This is lost if you compartmentalise your knowledge and
do not make links across topics.
2
Examination revision strategy
Many candidates are disappointed to find that their examination

performance is poorer than they expected. This may be due to a number
of reasons. The Examiners’ commentaries suggest ways of addressing
common problems and improving your performance. One particular
failing is ‘question spotting’, that is, confining your examination
preparation to a few questions and/or topics which have come up in
past papers for the course. This can have serious consequences.
We recognise that candidates may not cover all topics in the syllabus in
the same depth, but you need to be aware that examiners are free to
set questions on any aspect of the syllabus. This means that you need
to study enough of the syllabus to enable you to answer the required
number of examination questions.
The syllabus can be found in the Course information sheet in the section
of the VLE dedicated to each course. You should read the syllabus
carefully and ensure that you cover sufficient material in preparation
for the examination. Examiners will vary the topics and questions from
year to year and may well set questions that have not appeared in past
papers. Examination papers may legitimately include questions on any
topic in the syllabus. So, although past papers can be helpful during
your revision, you cannot assume that topics or specific questions that
have come up in past examinations will occur again.
If you rely on a question-spotting strategy, it is likely
you will find yourself in difficulties when you sit the
examination. We strongly advise you not to adopt this
strategy.
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MN 3119 Strategy

MN3119 Strategy – Zone A
Important note

references
and/or online reading list and/or subject guide refer to an earlier
Comments on specific questions

Candidates should answer EIGHT of the following TWELVE questions: all
FOUR from Section A (12.5 marks each) and any FOUR from Section B
(12.5 marks each). The maximum length for the answer to each
question should be 300 words.
A calculator may be used when answering questions on this paper and
it must comply in all respects with the specification given with your
Admission Notice. The make and type of machine must be clearly stated
on the front cover of the answer book.
Section A
Answer all four questions from this section.
Question 1
The Herfindahl index (HHI) is a useful measure to describe the degree of
concentration in an industry. However, the HHI does not always provide an
accurate picture of the degree of competition in an industry. Give a concrete
numerical example to illustrate this phenomenon.
Reading for this question
See subject guide, Chapter 3, especially (esp.) 3.3.
Approaching the question
This question asks for a comparison of the Lerner index versus HHI.
Possible examples would be Bertrand versus Cournot competition, or
Duopoly versus Collusion, which would both produce the same HHI but
different Lerner indices.
The answers to this question were generally quite good, covering the
definition of the Herfindahl index and its motivation, but also making the
point that it measures concentration, not competition. Good answers went
on to discuss the Lerner index.
4
Question 2
Strategic entry barriers can only work if two conditions are met. Name and
explain the two conditions using a concrete example.
See subject guide, Chapter 14, esp. 14.1.
The two conditions are:
i. It is more profitable for the incumbent to deter than to accommodate
and
ii. entry deterrence changes the expectations of post-entry competition.
One possible example would be capacity expansion to deter entry: this
lowers profits as compared to an unthreatened monopoly, but may still
result in higher profits than duopoly (condition i). It also changes the
expectations of what would happen were an entrant to enter (condition ii).
Answers were generally good, pointing out that entry deterrence must be
profitable relative to the duopoly outcome, and that this entry deterrence
must also be credible (i.e. influence the potential entrant). Excellent
answers related this to the necessary presence of asymmetric information.
Question 3
The competitive outcome in oligopolistic markets depends on the degree of
product differentiation among competitors. Explain how the outcome is affected
by product differentiation and write down an example of a demand function
with differentiated products. (Hint: You may find it convenient to write down the
inverse demand function.)
Greater product differentiation leads to less intense competition, which
raises profits in the industry. An example of a demand function is as
follows:
p1 = 1 – q1 – ½ q2
The answers to this question were mixed. Most candidates intuitively
grasped that greater product differentiation affects the intensity of
competition. However, many candidates did not manage to write down
a function that adequately reflects differentiated products. Very good
answers gave an interpretation of the coefficient on the ‘other’ product,
indicating that the smaller the coefficient, the lower the degree of
competition.
Question 4
A group of firms have formed an R&D alliance. The alliance agreement states
that if a firm ever fails to contribute the agreed amount of resources, the
alliance will be dissolved immediately. The participating firms have now decided
to change their agreement to state that if a firm ever fails to contribute the
agreed amount of resources, all alliance members will stop contributing any
resources for six months. Do you think this makes the alliance more stable? Why
or why not?
See subject guide, Chapter 11, esp. 11.3.3.
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MN 3119 Strategy

This move would make the alliance less stable, since it is a less severe
punishment. Such a move makes it less risky for firms to defect and
participants will thus be more prone to cheating.
Most answers came to the correct conclusion, differing in the extent to
which they explained and used the logic of collusion. Some also couched
this analysis in a more general view of R&D. Excellent answers would
examine if, in the R&D context, there is a special justification for why
punishments should be forgiving.
Section B
Answer four questions from this section.
Question 5
‘I would never enter a strategic partnership with someone who is not willing to
invest her own money in it.’ Explain the reasoning behind this statement.
Having an own equity stake in a partnership increases the likelihood that
interests are aligned and that, consequently, the partnership is successful.
Strategic partnerships will often also require organisational integration,
which frequently requires joint investments, and those are easier to
achieve with joint equity ownership.
Overall, answers to this question were good. Most candidates pointed
out the alignment of interests if equity stakes are at play. When it came
to more subtle points such as the fact that organisational integration is
helped by equity stakes, candidates did less well. However, traces of the
argument (especially referring to joint investment) were present in quite a
few answers.
Question 6
Café Cosmos introduced a new vegan menu last week. Despite being situated
right across the street and serving a largely similar clientele, Wright’s Bar has
not reacted to this competitive move. Give possible reasons why.
See subject guide, Chapter 13.
This question refers to competitive dynamics and the Awareness/
Motivation/Capability paradigm. Awareness is likely to be present as the
cafes are close by. However, Wright’s Bar may not be sufficiently motivated
to react (e.g. because they are much larger than Cosmos, or they have very
high brand loyalty among their customers) or capable of doing so (e.g.
because they cannot source vegan food products easily, or they cannot
prepare it in a kitchen with other food).
Very few candidates chose this question, probably due to the competitive
dynamics chapter being a newer addition to the subject guide. Those that
did gave good answers regarding the likely reasons for non-reaction and
the underlying drivers.
6
Question 7
MySpace has been losing market share to other social networks despite offering
significantly more functionality for uploading music than other networks like
Facebook. Give two possible reasons for this development, and what market
structure do you think the market for social networks will eventually settle on?
The social network market exhibits very strong network effects and very
low inherent preferences by consumers. Other networks like Facebook
have caught up to mimic MySpace’s functionalities.
The likely future market structure is one of niche survival: there will
be one dominant network, but several small, specialised networks for a
smaller clientele with special preferences.
Candidates picked up on the fact that network effects are important in
social network markets. Most candidates settled on niche survival as the
likely future market structure. However, the answers frequently remained
vague and mainly repeated commonsense.
Question 8
Pear, a consumer electronics manufacturer, currently makes a large share of its
revenues by selling a unique kind of telephone. They have now developed a new
product, a touchscreen mini-PC. They are now considering including telephony as
an additional function for the new product but they decided against it. Why do
you think they deliberately withheld functionality from a new product? What is
this effect called?
This is called the replacement effect. New products cannibalise profits
from old ones, and if there is a clear vertical improvement over the
existing product, that technology may disappear. In this case, there is
some degree of horizontal differentiation as well, so excluding phone
functionality reduces cannibalisation and renders the existing phone viable
in the long run.
Some candidates interpreted this as a case of sleeping patents. Most
candidates identified the replacement effect, but did not then go further
in their explanation (i.e. how exclusion of the telephony function creates
horizontal differentiation).
Question 9
Price competition is often said to generate surprising outcomes. Why is it that
quantity competition seems to lead to more realistic outcomes? Explain first why
the results seem more realistic and then give reasons why.
Price competition leads to very tough competition, to the point of zero
profits with two firms present. In the case of quantity competition, profits
are positive and competition less aggressive.
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MN 3119 Strategy
The reason for this is that prices are strategic complements, that is, an
aggressive move by one firm is countered by an aggressive move by the
other. Quantities, on the other hand, are strategic substitutes, so there is a
counteracting force to higher competition.
Many answers correctly identified the counterintuitive outcome of
Bertrand competition when products are homogeneous, firms are
symmetric and capacities are unlimited. Only good answers went on to
identify the root of this counterintuitive outcome in the assumption that
a firm which undercuts the competitor gains the whole market. Good
answers also made the connection between price and quantity competition
and the distinction between strategic complements and substitutes.
Question 10
Explain why owners and managers of a firm may not have identical objectives.
See subject guide, Chapters 9 and 10.
Owners want to maximise monetary profits, whereas managers want to
maximise their own utility. That may relate to monetary profits, but it also
includes tenure in the job, value of stock options at the maturity date,
career prospects, and depends on the effort the manager elects to make
too.
Unsatisfactory answers did not do much beyond re-state the question.
Good answers would specifically discuss the causes and dimensions of
the divergence of objectives (e.g. the size of the firm and the pursuit of
acquisitions, attitude towards risk and investment in risky projects, and
short-term vs long-term time horizons). Very good answers would couch
that in the language of principal-agent theory and explain how managers’
objectives depend on their incentive contracts.
Question 11
Describe why and how coordination costs can lead to firms choosing to integrate
vertically. Give one example from a manufacturing industry of coordination
costs.
If coordination across firm boundaries is difficult, for example due to a
divergence in incentives, aligning their incentives may reduce coordination
costs.
An example of this would be the quality of an interface that combines two
different parts. Independent firms want to minimise their effort by settling
on an interface, whereas an integrated firm will find it i) easier and ii)
more in line with their incentives to design a good interface.
Many answers explained the role of transaction costs in the logic of
vertical integration, but were rather generic. Good answers were specific
in their discussion of coordination costs, both in terms of what they are
and how they can influence the attractiveness of vertical integration.
8
Question 12
Organisation design is commonly considered an important determinant of firm
performance. Is there a ‘best’ organisation design? Why or why not?
There is no one ‘best’ organisation design (unlike when it comes to
contractual architecture for example). The best design depends on the
firm in question and the strategy it follows. Hence, the best design for any
particular firm is contingent on the rest of the firm’s activities.
Many answers correctly – but generically – referred to the need for fit
between strategy and organisation, concluding that there is no single best
organisation design. Good answers illustrated this point with the specific
organisational structures that are appropriate for different strategies (e.g.
Porter’s generic strategies of differentiation or cost leadership).
9
MN 3119 Strategy

MN3119 Strategy – Zone B
Important note

references
and/or online reading list and/or subject guide refer to an earlier
Comments on specific questions

Candidates should answer EIGHT of the following TWELVE questions: all
FOUR from Section A (12.5 marks each) and any FOUR from Section B
(12.5 marks each). The maximum length for the answer to each
question should be 300 words.
A calculator may be used when answering questions on this paper and
it must comply in all respects with the specification given with your
Admission Notice. The make and type of machine must be clearly stated
on the front cover of the answer book.
Section A
Question 1
Give a definition of corporate relatedness and describe two prototypical
organisations with high and low corporate relatedness, respectively.
See subject guide, Chapter 8, especially (esp.) 8.2.
Corporate relatedness (CR) describes the transfer of corporate core
competencies from the headquarter to different businesses. Low CR would
be a conglomerate with a portfolio of independent firms, whereas high
CR would be a firm that tries to leverage core competencies across their
businesses, like Procter and Gamble.
Overall, the answers to this question were not satisfactory. Very few
candidates distinguished clearly between operational and corporate
relatedness and then correctly described the two extreme organisational
forms the question asked for. Many answers also mistakenly identified
Strategic Business Units as one of the extreme forms.
10
Question 2
Firm asymmetries are often short-lived. Give three strategies that firms can
choose to turn (advantageous) short-term asymmetries into long-run ones.
Three strategies are:
• intellectual property protection
• building complementary capabilities
• vertical foreclosure of an essential input.
The answers to this question were mixed. Weak answers often limited the
asymmetries to informational asymmetries, or started with ones that were
already long-term to begin with, or were unclear whether the asymmetry
they referred to was short-term or long-term (e.g. economies of scale).
Good answers, on the other hand, were explicit and clear about the
challenge of turning a short-term advantage into a long-term one.
Generic discussions of economies of scale, scope and learning were
frequently not at all specific here. Good answers discussed patenting, R&D
and umbrella branding, among other strategies. Some examples given
by candidates were quite unsuitable (e.g. engaging in mergers or tacit
collusion).
Question 3
Stackelberg leaders are more profitable than followers in the same market under
certain circumstances. First, outline in which industries we expect Stackelberg
leaders to be more profitable than followers, and second, give two strategies
that firms can use in these markets to become Stackelberg leaders.
In industries with strategic substitutes (e.g. quantity competition),
Stackelberg leaders are more profitable than followers. Promising
strategies in such industries are to commit to output early or invest in
inflexible production technologies which signal commitment to high
production in the market.
This question was answered surprisingly badly. Many candidates did
not draw a distinction between strategic complements and strategic
substitutes, and many of those that did so confused it with complements
and substitutes.
Question 4
Café Cosmos introduced a new vegan menu last week. Despite being situated
right across the street and serving largely similar clientele, Wright’s Bar has not
reacted to this competitive move. Give possible reasons why.
This question refers to competitive dynamics and the Awareness/
Motivation/Capability paradigm. Awareness is likely to be present as the
cafes are close by. However, Wright’s Bar may not be sufficiently motivated
11
MN 3119 Strategy
to react (e.g. because they are much larger than Cosmos, or they have very
high brand loyalty among their customers) or capable of doing so (e.g.
because they cannot source vegan food products easily, or they cannot
prepare it in a kitchen with also other food).
Very few candidates chose this question, probably due to the competitive
dynamics chapter being a newer addition to the subject guide. Those that
did gave good answers regarding the likely reasons for non-reaction and
the underlying drivers.
Section B
Question 5
Strategic entry barriers can only work if two conditions are met. Name and
explain the two conditions using a concrete example.
The two conditions are:
i. It is more profitable for the incumbent to deter than to accommodate
and
ii. entry deterrence changes the expectations of post-entry competition.
One possible example would be capacity expansion to deter entry: this
lowers profits as compared to an unthreatened monopoly, but may still
result in higher profits than duopoly (condition i). It also changes the
expectations of what would happen were an entrant to enter (condition ii).
Answers were generally good, pointing out that entry deterrence must be
profitable relative to the duopoly outcome, and that this entry deterrence
must also be credible (i.e. influence the potential entrant). Excellent
answers related this to the necessary presence of asymmetric information.
Question 6
It is often claimed that competition in research and development (R&D) has two
negative side effects: redundancy of efforts and excessive risk taking. Pick one of
the two and explain how they work, i.e. why competition generates this effect.
If two firms compete but only one receives a patent, the other firm has
invested in R&D in vain (i.e. without making any profits). This effort will
have likely been spent on similar things as the firm that did receive the
patent, such that it is duplicated without any side benefit.
If firms race towards a patent only the first to get there will be awarded
that patent. This incentivises the taking of excessive risks to overtake the
rival, even if it would have been optimal to play it safe. In extreme cases,
all firms competing take excessive risks, thus implying that an innovation
can fail completely because all individual efforts failed.
This question was not chosen by many candidates, possibly because they
had not seen it discussed in detail in the subject guide. However, those
candidates that did select the question answered it quite well, especially
when it came to the duplication effect.
12
Question 7
Adoption of the King Disk, a storage medium that had twice the storage
capacity of its predecessor, the Prince Drive, fell some way short of expected
sales. Two years after King Disk’s release, the Emperor Card is announced. The
Emperor Card has twenty times the capacity as the King Disk and is expected to
be released about one year after the announcement. What will happen to the
adoption of the King Disk and why?
Adoption of the King Disk is likely to slow down because not only is it
competing with the old technology (Prince Drive), but also with the
already announced new technology (Emperor Card). In short, the option
value of waiting goes up.
Answers to this question were generally good. Many candidates mentioned
the option value, and excellent answers also explained the economic forces
leading to such an increase in option value.
Question 8
In technologies with network effects, we often see early versions of the
technology given away for free and later versions being sold at a fairly high
price. Why does this happen? Give an analytical answer.
Consumers’ willingness to pay depends on the number of other adopters.
Hence, if the installed base increases, the willingness to pay also increases
and the firm can charge higher prices. Moreover, technological progress
is likely to reinforce this trend because technologies improve across
generations.
The answers to this question were generally quite strong. A significant
portion of candidates explained the effect by using a utility function to
illustrate network effects. Excellent answers gave a numerical example and
even examined the prices that firms can charge.
Question 9
Price competition is often said to generate surprising outcomes. Why is it that
quantity competition seems to lead to more realistic outcomes? Explain first why
the results seem more realistic and then give reasons why.
Price competition leads to very tough competition, to the point of zero
profits with two firms present. In the case of quantity competition, profits
are positive and competition less aggressive.
The reason for this is that prices are strategic complements, that is, an
aggressive move by one firm is countered by an aggressive move by the
other. Quantities, on the other hand, are strategic substitutes, so there is a
counteracting force to higher competition.
13
MN 3119 Strategy
Many answers correctly identified the counterintuitive outcome of

Bertrand competition when products are homogeneous, firms are
symmetric, and capacities are unlimited. Only good answers went on to
identify the root of this counterintuitive outcome in the assumption that
a firm which undercuts the competitor gains the whole market. Good
answers also made the connection between price and quantity competition
and the distinction between strategic complements and substitutes.
Question 10
A group of firms have formed an R&D alliance. The alliance agreement states
that if a firm ever fails to contribute the agreed amount of resources, the
alliance will be dissolved immediately. The participating firms have now decided
to change their agreement to state that if a firm ever fails to contribute the
agreed amount of resources, all alliance members will stop contributing any
resources for six months.
Do you think this makes the alliance more stable? Why or why not?
This move would make the alliance less stable, since it is a less severe
punishment. Such a move makes it less risky for firms to defect and
participants will thus be more prone to cheating.
Most answers came to the correct conclusion, differing in the extent to
which they explained and used the logic of collusion. Some also couched
this analysis in a more general view of R&D. Excellent answers would
examine if, in the R&D context, there is a special justification for why
punishments should be forgiving.
Question 11
Many firms will organise their research and development activities in-house and
outsource their distribution activities. Why might this be the case? Under which
circumstances would you expect the opposite outcome?
R&D is more likely to involve confidential proprietary knowledge, while
distribution is often rather generic and benefits from the economies of
scale of a large distributor.
The opposite outcome is possible if distribution is a key source of
competitive advantage, while R&D is not very beneficial in the industry.
Outsourcing R&D may also be preferable if it needs multiple inputs and
large economies of scale.
Almost all answers correctly referred to the crucial role of proprietary
knowledge and potential spillovers. However, answers were less clear and
precise on distribution, some ignoring it altogether. Good answers also
distinguished between basic and applied research.
14
Question 12
Most automobile manufacturers design exclusive territories for their dealers, i.e.
dealers will be allocated an area in which they can operate. Explain how this can
be profitable for the manufacturer and the dealer.
This saves the manufacturer advertising costs because it creates incentives
for the dealer to invest in their own advertising (due to low spillovers). It
benefits the dealer because it will have a monopoly over local consumers.
Many answers, but by no means all, considered the competition between
the retailers, both in price and advertising, and realised the crucial role
of externalities. The answers often did not follow up on that point (i.e.
they did not spell out in detail the consequences for the manufacturer,
or place the topic within the context of vertical foreclosure). Some
answers were confused as to the impact of exclusive territories on double
marginalisation: without competition (due to exclusive territories) the
retailers’ margins will go up, increasing double marginalisation and thus
reducing demand, which itself is bad for the monopolist.
15

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Examiners’ commentaries 2016

Examiners’ commentaries 2016

This commentary reflects the examination and assessment arrangements

Information about the subject guide and the Essential reading

Planning your time in the examination

What are the Examiners looking for?

Key steps to improvement

Examination revision strategy

Many candidates are disappointed to find that their examination

Examiners’ commentaries 2016

Information about the subject guide and the Essential reading

Comments on specific questions

Approaching the question

Examiners’ commentaries 2016

Information about the subject guide and the Essential reading

Comments on specific questions

Many answers correctly identified the counterintuitive outcome of

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