Night Thoughts of a Strategy Instructor

18 January 2007 at 7:38 pm 10 comments

| Steven Postrel |

1. Exactly what is accomplished by teaching (present or future) managers the five forces framework? It’s useful for investment and diversification decisions, but otherwise isn’t very actionable, unless you’re engaged in cartel management.

2. It’s a good bet that the term “barriers to entry” adds zero (or worse) to student understanding of when an incumbent has advantage over a new player (and when the anticipation of that advantage deters entry). Also, students are rightly confused about the distinction between entry and rivalry because realized entry contributes to future rivalry. At least in logical terms, I can avoid this confusion by stressing the “threat of entry” as a force separate from rivalry, but then we’re supposing individual firms coordinate their price and capacity decisions to keep out entrants, a view of industry collaboration and statesmanship that was musty in the 1980s (and often involves incredible threats). Maybe it would be better just to talk about the elasticity of long-run supply and not worry too much about whether new capacity comes from incumbents or from entrants.

3. Is it a good idea to teach positioning analysis using cost drivers without having a cost function that combines all the drivers together? Scale, learning, scope, product features, etc. — shouldn’t we worry a lot more about how they reinforce or conflict with one another in a given case?

4. Does it matter that it’s really hard to find good examples that fit the technical definition of economies of scope? Is it OK if I just keep passing off multiproduct scale as if it were scope since the students don’t know the difference?

5. Am I just getting old and curmudgeonly, or does it seem like the newer Harvard cases are more pre-digested than the classics? What’s up with constructing all the pro forma tables for the students instead of scattering the information around in the text and exhibits?

6. Will I be able to teach effectively tomorrow if I don’t fall asleep soon?

Entry filed under: Former Guest Bloggers, Strategic Management, Teaching. Tags: .

The Galileo Legend Ode to the RIAA

10 Comments Add your own

  • 1. Peter  |  18 January 2007 at 9:14 pm

    Thoughts on (1), though I am very much sharing concern (6):

    What do you think you are doing as a management professor? The 5 forces are indeed not actionable except under limited conditions (or at least severely fewer conditions than what managers clearly believe given the popularity of the 5 forces).

    Dare I suggest that there are …wait for it… institutional reasons for teaching Porter? Being a manager consists of two broad skills – actually knowing how to do stuff and knowing how to inhabit the identity of manager. That latter set of skills is actually valuable, and I suspect you’re doing a bang-up job of teaching them, acknowledging that you don’t for a minute believe that neo-institutional theory raises your hackles..

  • 2. Rob  |  19 January 2007 at 8:47 am

    Steven,
    I think you are right on with 1,3, and 4, but I’m not sure I understand your point in #2. I think “barriers to entry” explain much of the reason incumbents have an advantage – particularly in cases where a necessary asset for market entry has appreciated in price significantly.

  • 3. Joe Mahoney  |  19 January 2007 at 10:19 am

    Steve,

    In terms of points #1 and #2: For the past 20 years teaching undergraduates, MBAs and executives, I believe managers and managers to be benefit from thinking about the logic of the Structure-Conduct-Performance Paradigm: Increasing industry barriers to entry can lead to lower price rivalry in the industry and higher industry economic performance. Then, at the firm level when I discuss managers’ attempts to increase “isolating mechanisms” I find it useful that the economic logic of S-C-P has already been covered. Also, when all of these ideas are in place, I briefly discuss extant empirical work on “firm effects” and “industry effects.”

    In terms of point #3: The Baumol, Panzar and Willig book on CONTESTABLE MARKETS would cover cases where the economies of scope would outweigh diseconomies of scale in the concept of “trans-ray convexity” My judgment call is that it would be useful to mention that scale, learning and scope drivers may reinforce each other or be in conflict (I have not done so in the past, but I will for now on).

    4. The key idea for economies of scope is the cost savings derived from sharing an input to make multiple outputs.

    Examples:

    C (iron, steel)

  • 4. Joe Mahoney  |  19 January 2007 at 10:24 am

    To finish:

    4. The key idea for economies of scope is the cost savings derived from sharing an input to make multiple outputs.

    Examples:

    C (iron, steel)

  • 5. Joe Mahoney  |  19 January 2007 at 10:28 am

    .Hmmm

    it looks like equations are not allowed.

    In words: the key idea is shareable inputs. Thus, the cost of producing iron and steel together is less than the cost of producing them separately. The shareable input is the blast furnace achieving thermal economies. Another example would be the Ford Tauras Station Wagon and the Ford Minivan were produced at lower cost together. The shareable input here is the platform. Finally, might we not think of knowledge as a shareable input?

  • 6. spostrel  |  19 January 2007 at 5:13 pm

    Peter: Touche. (Although it’s a bit like saying that using correct English grammar is an example of institutionalism.) There is a lot of detritus students need to know about so they can communicate effectively with other managers–the BCG matrix, for example. The five-forces framework isn’t nearly as bad as that–it does have actual managerial value–but some of my motivation for teaching it is for similar reasons. That said, I have greatly reduced the time allocated to the subject over the last ten years, so I don’t think I’m all the way stuck in the iron cage.

    Rob: Sorry I wasn’t clear. I was trying to distinguish between actual entry and the threat of entry as disciplines on industry pricing. Actual entry becomes rivalry, which is already one of the five forces and so is redundant–an expansion of capacity by new firms or by existing rivals is unlikely to be very different competitively if we already have two or more incumbents. The threat of entry, on the other hand, could restrain prices even without actual entry, but that requires incumbents to act in a collaborative fashion to hold their prices low enough to keep prospective entrant NPV negative. It also requires credible commitment to those prices post-entry even if higher prices would be the equilbirum of the post-entry game. All of that can be made to happen theoretically, but how relevant is it empirically?

    An additional point is that “barriers to entry” is not a useful technical term. It plays an instituitional role (like that, Peter?) because it shows up in the Justice Department’s merger guidelines and comes up in antitrust litigation, but modern industrial organization can dispense with it completely, and so should strategy.

    If you have a model with clear assumptions about sunk costs, information, and stage-game behavior then you can make a atatement about whether entry is likely to be profitable and hence whether it is likely to occur. Harvard school and Chicago school people will generally agree about these outcomes but disagree about what in the model ought to correspond to “barriers to entry.” Even without a formal model, the same logic applies. Thus, the term “entry barrier” adds litle or nothing to overall understanding of the desciptive or normative aspects of competition.

    Also, to your point about a scace asset needed for entry: If an asset needed for market entry has appreciated in value, neither school of thought would necessarily call that an entry barrier because the opportunity cost to the incumbent of employing the asset may be equal to that for the entrant. If you moved to LA in 1990, you paid less for land than a 2006 entrant, but the cost of getting a site is not an entry barrier because incumbents face a decision about selling their land each period they operate.

    Joe 1): I tell my students that having more competitors is theoretically correlated with greater price competition, but the ceteris paribus clause in that statement is very important. And I do the best I can with entry barriers. But in my opinion, entry barriers are a complicated special case of a first-mover isolating mechanism, so teaching them in that order (which I usually do) isn’t especially natural.

    And notice that even in your own comment the separation between entry and rivalry gets blurry–you have greater entry barriers leading to lower rivalry, while the five-forces framework assumes these are independent variables. My reading of exams and quizzes, as well as listening to class discussions, convinces me that these difficulties confuse students. We might actually be better off biting the bullet and rolling out some formal models and numerical examples instead of deploying fuzzy concepts, although I haven’t crossed that particular Rubicon myself.

    Joe 2): Yeah, I mention the interaction possibilities of scale, scope, etc., but unless one is doing the titanium dioxide case with the plant-level cost function data included (which I haven’t looked at in years), it’s not very easy to apply this wisdom to the case-specific cost driver analysis. I try, but it’s hard enough just getting through about scale, volume, learning, etc. and their differences. And what about the interaction with product attribute choices? Adding human provided service attributes to something like software, for example, normally reduces scale economies.

    Joe 3): Shared inputs across product varieties are the key to generating scope economies. You have to be careful that the sharing isn’t just a cost function of the form F + c1x + c2y, where a common fixed cost can be spread across multiple varieties. You need a fixed cost F!2

  • 7. spostrel  |  19 January 2007 at 5:20 pm

    Whoops. Some of it got dropped because I used a less-than sign.

    Joe 3): Shared inputs across product varieties are the key to generating scope economies. You have to be careful that the sharing isn’t just a cost function of the form F + c1x + c2y, where a common fixed cost can be spread across multiple varieties. You need a fixed cost F12 less than F1 + F2 to get scope economies.

    More importantly, though, scope economies are only relevant when the output vector (x, y) is held constant and you ask “Is it cheaper to produce x and y together than separately?” But frequently (usually?) in case discussions, scope economies are invoked when the question is “Should we add product line y to our existing production x?” Here any spreading of fixed costs, and hence reduction in average cost, is fundamentally a multiproduct scale phenomenon, not scope.

  • 8. Peter Klein  |  19 January 2007 at 6:20 pm

    A technical note to all: The server doesn’t accept the less-than and greater-than signs when typed from th keyboard (it thinks they are part of an HTML tag). You have to enter the text “&lt” and “&gt,” followed by a semicolon, to get them to display properly Then you see < and >. Sorry about that.

  • 9. Joe Mahoney  |  19 January 2007 at 6:20 pm

    Steve,

    Thank you, as always, for being a part of my education.

    Anyway back to the record 720 submission to the BPS Division for me to process as Program Chair (we beat the record by over 100 submissions). Lucky me :-)

    Take care,
    Joe Mahoney

  • 10. Peter Klein  |  19 January 2007 at 6:25 pm

    Joe, this rule may help: Any proposal for which author name ∈ {Foss, Klein, Grammich, Postrel} is automatically accepted. Now, doesn’t that make your job easier?

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