Economics of Strategy

University of Victoria
Summer 2011
Pascal Courty
Economics of Strategy
Objectives for today

Discuss course outline
Introduction to economics of strategy
Academic influences
Course objectives: learn how market environment and firms
strategy influence firm performance
Learning approach: mix of formal lectures (1/2), discussion of
research articles (1/4), and class discussion(1/4)
Material: book, slides, weekly emails, research articles
Pre-requisites: Micro, IO, game theory
Expectations: read book chapters, read research articles,
follow instructions in weekly emails
Grading: pb sets (40%), midterm (30%), essay (30%)
Course outline
Part I. Incentives, Firms, and Markets
Chapters 3, 5, 6, 16, 17
Performance measurement and incentives within firms
Vertical boundaries of the firm
Part II. Markets and Competitive Analysis
Chapters 9, 10, 11, 12
Thinking strategically and strategic commitment
Pricing rivalry
Entry
Industry analysis
Part III. Competitive Advantage and Industry Dynamics
Chapters 13, 14, 15
Competitive advantage
Innovation and industry dynamics
Course Contents
Economics of Strategy
Academic Influences

Industrial organization (analysis of market
competition)
Game theory (strategic interactions)
Economics of organization (transaction cost
economics, contract theory)
Incentive theory (personnel economics,
information theory)

Focus can be on managerial ability to change firm
position (organizational behaviour) or market
environment (competition economics)
Research articles
Part I. Incentives, Firms, and Markets
The Dynamics of Franchise Contracting: Evidence from Panel Data. Francine Lafontaine and Kathryn L. Shaw. The Journal of Political Economy. Vol.
107, No. 5 (October 1999) (pp. 1041-1080)
Peers at Work. Alexandre Mas and Enrico Moretti. American Economic Review 2009, 99:1, 112145.
Competition and Business Strategy in Historical Perspective. Pankaj Ghemawat. The Business History Review, Vol. 76, No. 1 (Spring, 2002), pp. 37-
74
Performance Pay and Top-Management Incentives. Michael C. Jensen and Kevin J. Murphy. Journal of Political Economy, 98. Page 225 of 225-
264
Part II. Markets and Competitive Analysis
How Much Does Industry Matter, Really? by Anita M McGAHAN, Michael E Porter. Strategic Management Journal (1997) Volume: 18, Issue: S1,
Publisher: John Wiley \& Sons, Pages: 15-30
Commitment to a Process Innovation: Nucor, USX, and Thin-Slab Casting. Pankaj Ghemawat. Journal of Economics & Management Strategy
Volume 2, Issue 1, pages 135161, March 1993.
Entry, Exit, Growth, and Innovation over the Product Life Cycle. Steven Klepper. American Economic Review. 1996, vol 86, 562-58.
Klepper, S., and K. Simons, "The Making of an Oligopoly: Survival and Technological Change in the Evolution of the U.S. Tire Industry," Journal of
Political Economy 108 (2000), 728-760.
What do we know about entry? P. A. Geroski International Journal of Industrial Organization. Volume 13, Issue 4, December 1995, Pages 421-440
Part III. Competitive Advantage and Industry Dynamics
Managing with Style: The Effect of Managers on Firm Policies. Marianne Bertrand and Antoinette Schoar. Quarrterly Journal of Economics, Nov
2003, vol 143. Page 1169 of 1169-1208
Does management matter? Evidence from India. Nicholas Bloom, Benn Eifert, Aprajit Mahajan, David McKenzie and John Roberts. Mimeo 2011.
Measuring and Explaining Management Practices Across Firms and Countries. Nick Bloom and John Van Reenen. Quarterly Journal of Economics,
November 2007.
Architectural innovation: The reconfiguration of existing product technologies and the failure of established firms. Rebecca M. Henderson and Kim
B. Clark. Administrative science quarterly, 1990, 35, 9-30.
Measuring Competence? Exploring Firm Effects in Pharmaceutical Research. Rebecca Henderson and Iain Cockburn. Strategic Management
Journal. 1994, vol 15, 63-84.
Exploiting a Cost Advantage and Coping with a Cost Disadvantage. David Besanko, David Dranove, Mark Shanley. Management Science, Vol. 47,
No. 2 (Feb., 2001), pp. 221-235
On the evolution of the firm size distribution: Facts and theory. Luis Cabral and Jose Mata. American Economic Review, 2003. 93, 1075-90.


Slides by: Richard Ponarul, California State University, Chico
Copyright 2010 John Wiley Sons, Inc.
Chapter 4

The Power of Principles:
A Historical Perspective

1840, 1910, and Today
The years 1840, 1910 and 2009 represent
widely disparate business conditions.
The general economic principles behind
business strategy are enduring.
Business practices evolve with changing
environment.
Doing Business in 1840
Numerous intermediaries - Farmers to factors to
brokers agents to buyers
Substantial price risk for participants
Infrequent transactions
Scarcity of information regarding sales and
prices of comparable goods
Infrastructure in 1840
Infrastructure in transportation, communication
and finance were poorly developed in 1840.
Poor infrastructure meant the dominance of
small family run firms.
Markets were local.
Transportation in 1840
Railroads, in their infancy, were fragmented.
National railway network had not yet arrived.
Waterways were used for long distance
transportation. Yet routes were limited.
With poor transportation, producers were
limited to local markets
Communication in 1840
Postal service was the dominant mode of long
distance communication.
Postal service relied on the horse and
stagecoach.
Telegraph was expensive and was used only for
important time-sensitive information.
Finance in 1840
Most businesses were sole proprietorships or
partnerships which made long term debt difficult to
obtain.
Shares of stock were not easily traded and cost of
capital was high.
No institutional mechanism existed for handling
business risk.
Futures trading to manage price risk was yet to come
about.
Production Technology in 1840
Most factories used century old methods of
production.
Textile manufacture was mechanized.
Use of standardized parts (prevalent in clocks
and guns then) was just beginning.
Scale intensive industries and high volume
production were non existent.
Government in 1840
Government was involved in large infrastructure
investments such as canals and railroads.
Later in the century government regulation of
the business environment was emerging.
Prime Meridian Conference led to the system of
standard time.

Business in 1840
Technology limited production to traditional
modes.
Production served local markets.
Without transportation infrastructure and
access to large markets, mass production
technologies would not have been useful.
Business in 1840
Without communication infrastructure,
information on prices, sellers and buyers was
not readily available.
Credit was available based on personal
relationships.
As a result businesses were small and informally
organized.
Business Conditions in 1910
Mass-production technologies made possible
high volume low cost manufacture of goods.
Railroads dominated transportation and
allowed mass distributors to reach widely
scattered customers.
Telegraph and telephones greatly improved long
distance communications.
Business Conditions in 1910
Manufacturing became more vertically
integrated.
Multidivisional firms emerged in response to
the size and complexity of operations.
Industries were becoming concentrated.
As standardization increased so did labor
related conflicts.
Finance in 1910
Securities markets traded shares of large
industrial firms.
Credit bureaus made credit related information
easily accessible.
Innovations appeared in monitoring and
reporting business activities.
Public disclosure of accounting information was
in vogue.
Government in 1910
Government regulation extended to such areas
as corporate law, antitrust and worker safety.
Increased regulation forced managers to collect
a lot of data on internal operations.
Mandatory secondary schooling provided the
labor force needed by large bureaucratic
organizations.
Business in 1910
Expanded infrastructure allowed firms to
expand their markets, product lines and
production scale.
New technologies allowed high volume
standardized production.
Growth of financial infrastructure made large
scale firms viable.
Doing Business Today
Large vertically integrated firms have been
declining.
Alliances and joint ventures could work better
than mergers and acquisitions.
Firms adopt complex matrix structures.
Transportation Infrastructure Today
Air, water, rail and ground transportation have
become better coordinated.
Sophisticated communication and data
processing technologies enable container
shipping.
Cities like Atlanta have grown relying on air
transport in spite of poor rail and water
connections.
Communications Technology Today
Capacity for instantaneous transmission of
complex information makes possible global
markets for products and services.
Technology has enhanced worker productivity.
Coordination of activities has become easier
with modern computer and communication
technologies.
Finance
Regulation of banking and securities markets
resulted in a stable financial services sector.
Capital markets and financial institutions
became more active in evaluating firm
performance.
Globalization of financial markets made many
mergers and acquisitions possible.
Liquidity crisis of 2008 has slowed economic
and entrepreneurial activity.
Production Technology
Modern technologies such as CAD/CAM have
made low cost tailor-made production feasible.
Use of new technologies often means
reorganizing the firm around these
technologies.
Government
In some areas (airlines, trucking and financial
services) traditional regulation has been
relaxed.
Regulation has increased in other areas
(workplace safety, discrimination and
environmental protection).
Government
Intergovernmental treaties and agreements
create regional free trade zones.
Governments anti trust policy encourages in-
house development of capabilities.
Government policy supports basic research and
the commercialization of R & D projects.
Business Today
With rising demand from developing nations
the market size has increased.
Firms focus on a narrow range of activities and
enjoy the economies of scale.
Financial innovation enables faster growth of
firms and the ability of new entrants to
challenge the incumbents.
Infrastructure in Emerging Markets
Unlike the advanced nations, many developing
nations still lack transportation and finance
infrastructures.
Businesses are reluctant to invest in countries
where corruption, cronyism and conflicts are
rampant.
Business Conditions and Strategy
Business conditions change over time and so do
the optimal strategies.
Principles needed to arrive at successful
strategies do not change.
Recipes change from period to period but
principles behind the recipes do not.