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International Business Professor Simon J. Evenett

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1 International Business Professor Simon J. Evenett

2 2 Plan for this afternoon ’ s session. Introduction.Objectives and rationale for this course.Course content and assessment. The point of departure: Porter’s Five Forces. Firm behaviour outside markets. Understanding corporate strategy.Main lessons learnt. Topic 2: Public Policies and Firms—Insights from Competitive Markets.

3 3 Objectives of this course. To better understand the factors that influence managerial decision- making, including economy-wide factors such as the "business environment" and regulatory and policy regimes. To understand how firms compete in both markets and the national and international political arena. To encourage non- business students to re- think their normative prescriptions in the light of how business might react.

4 4 Course content: Seven Topics An introduction to Corporate Strategy and its Adaption to Non-Market Environments. Firms’ Interests and Public Policy. Does Nationality Influence Firm Performance? Firm Strateges and the Business Environment in the Industrialised Economies. The Changing Business Climate in Emerging Markets and the BRICs.Financial Crises in Emerging Markets.The GE-Honeywell Debacle: An example of the multiple regulator problem. How Firms Use The WTO To Their Advantage: When Can Governments Be Good Agents For Business?

5 5 Course assessment. The rationale. For more details see course outline. Due dates: First assignment: 31 March 2011 Second assignment: 30 May 2011. Email assignments to "Sanna Maarala" Two individual analytical assignments (worth 50% each).

6 6 The 1 st Individual Analytical Assignment The Question: In what ways, if at all, will the potential reform of Europe’s “social model” affect the domestic and international competitiveness of firms located in Western Europe? Use corporate examples from selected industries to illustrate your argument. 1000-2000 words. Identifying the links between reforms of the European Social Model and corporate strategies and corporate performance. Use of examples.

7 7 The 1 st Individual Analytical Assignment Specific changes in legislation and regulations Change in options and trade-offs available to a firm Change in a firm’s performance The key challenge is to identify the relevant causal links: We seek explanations not assertions!

8 8 How to succeed in the written work for this course. Don’t look for a single correct answer—develop a coherent, intelligent, and creative answer of your own. Start by re-reading the essential articles and case studies on the reading list. Before writing, apply each tool taught in this class to see what each reveals about the range of choices available to firms, the consequences of those choices, and the other factors affecting managerial decision-making. Develop a paragraph by paragraph plan—each paragraph is a separate multi-faceted thought. Make sure the sequence of arguments is logically coherent.

9 9 How to succeed in the written work for this course (2) Start off with a strong introductory paragraph or two. Tell the reader why the questions you are answering are significant—therefore motivating and situating your answer effectively. Guide the reader throughout the assignment. Conclude with a strong paragraph that reminds the reader what was discussed, why it was important, and what you have found. Answer the question as tightly as possible—avoid irrelevant information. You'll find 2000 words is a small number.

10 Understanding Corporate Strategy

11 11 What is corporate strategy? It is the study of... firms should make critical decisions. firms do make critical decisions. Notice these are very different matters—and there is, of course, disagreements about what decisions are critical or not. We focus on 1. (above). Strategy as a deliberate, systematic, and enduring phenomenon. –Do remember that there are other ways of thinking about strategy—see the readings for topic 1.

12 12 What do we want from a good strategy tool? What are the features of an effective strategy tool in global business? Guides you to select the relevant factors/drivers. Provides explanations, not just recommendations. Is adaptable to many settings. Does not have excessive information requirements to implement. Detailed “Recipe books” are no good; chop sticks are better.Don’t expect too much from any one tool.

13 13 Porter on Strategy. What is the logic underlying Porter’s 5 forces? 1.Competition is the threat to industry profitability. 2.Competitive threats have systematic underlying causes— it is not a coincidence, bad luck, or necessarily inevitable. 3.Five forces shape those competitive threats. 4.The strongest of those forces determine the profitability of an industry—an example of “O-ring” thinking. 5.Recommendation: “the corporate strategist’s goal is to find a position in the industry where his or her company can best defend itself against these forces or can influence them its favor”. –Note the second “or” in the above statement.

14 14 Porter on Strategy (2). What advice follows from this perspective? Knowledge of the underlying causes of competitive threats is necessary for strategy making. “The strategist...must learn what makes that environment tick.” Firm strategy is about conscious decisions to develop distinctive means to attaining the chosen goals/ends. Plans of action draw on three types of strategic decision: 1.“Positioning the company.” 2.“Influencing the balance” of competitive threats. 3.“Exploiting industry change.” Strategy making is a multi-step process.

15 Adapting Porter’s Five Forces to take account of governments, courts, and NGOs

16 16 Why Porter’s approach must be adapted Porter urges us to analyse the causes of the five forces yet emphasises a limited set of actors (principally firms, their actual or potential rivals, customers, and suppliers.) Incomplete characterisation of relevant fora. International dimension is not well developed—are we to take on trust that this approach to strategy works in all capitalist countries? Baron extended Porter’s framework to include the non- market environment and so- called Integrated Strategies—but at some cost in terms of prescriptive power.

17 17 Businesses operate in two environments simultaneously (Baron). 4 I’sNon-market environment Market environment Issues: threats to profits or opportunities. Regulations, proposed laws, court judgments. Porter’s 5 forces. Institutions: relevant decision-maker and their processes. Regulators, legislatures, courts, etc. Collective or non-unanimous decisions. Arms length market transactions. Voluntary decision- making. Interests: identity and goals of those with a stake in the issue. Goals can include “fairness”, “harmony”, and inclusion. Firms seek to maximize profits. Information: beliefs, knowledge of actors, and what is persuasive. Prejudices, rumor, state reports, press coverage, etc. Market research, reputation, advertizing.

18 18 Baron on non-market strategies Lets think more systematically about the implications for strategic analysis and firm strategies. Analysis: “Nonmarket forces and the institutional arenas in which they are manifested are sufficiently different from market forces that they require a nonmarket strategy system for effectively managing interactions with the nonmarket environment.” Strategy formation: “A nonmarket the concerted action of an interested party directed at a non-market issues that is a subject of competition in the cognizant institutions where information typically plays an important role.”

19 19 Examples of non-market strategies. Two main objectives: creating and exploiting opportunities and countering threats. 1.Create opportunities for self—opening foreign markets. 2.Alter rival’s current opportunities—raising rivals costs through impact of differential regulation. 3.Block rival’s opportunities altogether—opposing rival’s M&A plans. 4.Reducing threats from rivals—blocking entry by imports, patents. 5.Reducing threats from the state—self regulation in financial services. 6.Mitigating threats—state bail outs and insurance. 7.Creating threats and uncertainty—threatening legal action.

20 20 Important characteristics of trade- related non-market strategies. Appropriability: Are the gains from pursuing non-market strategy only appropriated by those firms pursuing such strategies? If not, what are the implications for the desirability of a non-market strategy? –Collective versus individual action: Would collective action be preferable to individual approaches? Credibility and Reversibility: Does precedent matter? Can a particular strategy be reversed? If not, does it matter? Sustainability and Retaliation. What are the sources of distinctive—that is, hard to copy yet effective—non-market strategy? Can the strategy be copied abroad, leading to possible retaliation? Can non-market strategy be a source of long term competitive advantage?

21 21 A multi-step approach to creating Integrated Strategies Need not involve a change in the objectives of the firm. Identifying the relevant 4I’s and 5 forces. Identifying a set of strategic options which may have market and non-market components. Anticipating strategies of actors in market and non-market environment. Given 1-4, evaluating strategic options: decision, implementation needs, and coherence in both spheres. Mitigation of risks associated with chosen strategy. Implementation. Evaluation of prior decision. Start of feedback loop. Effective strategy formation involves:

22 Case Study: Taking The Cake. Should Peter tell CEO Ed Malanga that Southland needs to recast its product lines?

23 23 Working through the case study. What are the 4 I’s here?Which of the Five Forces threatens Southland’s profits the most? What are the critical pieces of information you need to formulate and evaluate strategic options? What are the options available to this firm?What is your evaluation of these options? At present, how effective do you think this firm would be in implementing your recommendations? How could the firm do better in this respect? In what way would you conduct an ex-post review of your decision?

24 24 Evaluating the expert advice. McClain: Unnevehr: Martaugh:Berman:

25 25 Main lessons. Integrated Strategy is about systematic, informed, decision-making using multiple-steps to analyze the global business situation confronting a manager. This approach can be usefully applied to non-market as well as market environments, both of which affect the performance of the firm. The non-market environment differs across countries and is likely to be even more significant in markets with lots of government intervention and important non-firm actors. The characteristics of many non-market strategies are different from market strategies. Implementation and evaluation of non-market strategies often requires different resources and approaches than market strategies.

26 Public Policies and Firms: Insights from Competitive Markets Simon J. Evenett

27 27 Purpose of this presentation To show how straightforward economics tools can be used to provide useful rules of thumb when analysing the impact of certain government policies. These tools also provide insights into why some firms pursue certain non- market strategies. To show how these tools underlie some of the fundamental ideas in corporate strategy. This is not meant to be a review of microeconomics— here we will use the tools for very different purposes.

28 28 Supplemental reading If you need to review any of this material, take a look at Pindyck and Rubinfeld’s textbook Microeconomics (especially Chapters 2-4, 6-9.) This accessible book has plenty of good examples to illustrate the key points.

29 29 What is a competitive market? It is an institution where a large number of potential purchasers and a large number of suppliers buy and sell a given good. Each agent is said to have their own individual objectives, not collective goals. No one coordinates the trade between buyers and sellers.

30 30 Determining sales and revenues in the short run P Q MS MD P1 Q1

31 31 Producer surplus is directly related to profits in the short run. P Q MS MD P1 Q1

32 32 What happens to the industry if production costs fall? P Q MS MD P1 Q1 P2

33 33 Some of the producer surplus increase is lost due to the price fall P Q MS MD P1 Q1 P2

34 Now for some counterintuitive findings…

35 35 The farmers’ dilemma: does productivity growth always pay? P Q MS MD P1 Q1 P2 Q2 - +

36 36 The farmers’ dilemma: does productivity growth always pay? P Q MS MD P1 Q1 P2 Q2 - +

37 37 Does the polluter always pay for pollution taxes? P Q MS MD P2 Q2 P1 Q1 P1+t

38 38 Turning fixed costs into variable costs— outsourcing, relaxing employment laws etc P Q MS: low variable costs MD P2 Q1 P1 Q2 MS: high variable costs

39 39 Turning fixed costs into variable costs—the effects of liberalising rigid employment laws P Q MC: low variable costs MD P1 Q1 MC: high variable costs Old MS

40 40 Turning fixed costs into variable costs—the effects of liberalising rigid employment laws P Q MC: low variable costs MD P1 Q1 P2 Q2 MC: high variable costs Old MS New MS

41 The Ultimate Application: Rationalising Porter’s Five Forces Approach

42 42 Porter’s Five Forces Model Did you ever wonder where Porter got the conceptual ideas for his Five Forces Model? The simple answer is that the supply-and- demand framework that you have been using can rationalise Porter’s approach. You just have to make one change: don’t think of the factors that determine equilibrium price— think instead of the factors that determine the producer surplus in an industry. Porter’s five forces all reduce the producer surplus in an industry—let’s take one example.

43 43 Threat of new entrants: Before…and After P Q MS MD P1 Q1 P2

44 44 New entrants erode incumbents producer surplus. P Q MS MD P1 Q1 P2

45 45 What about the other four forces? Let’s discuss each in turn Bargaining power of suppliers. Bargaining power of customers. Threat of substitute products or services. Rivalry among current producers. The straightforward supply-and-demand framework, when used to explain producer surplus, shows why four of the five forces are indeed threats to industry profitability.

46 46 Summary: Understanding a lot out from a straightforward framework. The own price elasticity of demand is a critical determinant of how industry sales respond to most changes. This analysis can be used to analyse the impact of government policies and reforms—essential for understanding a firm’s interests and incentive to engage in non- market strategies. This analysis also helps rationalise much of Porter’s approach to industry performance and strategy. Remember that supply-and-demand analysis tells you have a competitive industry would respond, not how an individual firm would respond to new circumstances.

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