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Beyond the Reach of the Invisible Hand: Impediments to Economic Activity, Market Failures, and Profitability Dennis A. Yao Strategic Management Journal,

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Presentation on theme: "Beyond the Reach of the Invisible Hand: Impediments to Economic Activity, Market Failures, and Profitability Dennis A. Yao Strategic Management Journal,"— Presentation transcript:

1 Beyond the Reach of the Invisible Hand: Impediments to Economic Activity, Market Failures, and Profitability Dennis A. Yao Strategic Management Journal, Vol. 9, Special Issue: Strategy Content Research. (Summer, 1988), pg By Amit Jain

2 MARKETS ARE EFFICENT Product Differentiation Capital Barriers to Imitation Govt Policy Distribution Channels Switching Costs Scale Transaction Costs Production Economies and Sunk Costs Imperfect Information

3 Basic Relationships 1. Entry barriers as operational combinations of IEAs 2. IEAs cause market failure 3. Absent IEAs, entry barriers may not cause market failure

4 Shortcomings of Economic Theory The Efficient Market: ◦Consumers and producers act as price takers ◦Markets exist for all commodities ◦Buyers and sellers have complete information ◦Thus, all firms will make normal (average) profits  Perfectly competitive markets lead to long-run profits that are average  Good strategy leads to survival, not excess profits So why do we observe companies making excess profits? ◦Market failure has created ‘supra-normal’ profitability ◦Strategists are interested in identifying factors that create an imperfect market (i.e. imperfect competition)

5 Industrial Organization – Barriers to Entry: A source of market failure Industrial Organization (IO) Literature ◦Barriers to Entry (Bain 1956, Caves and Porter 1977), such as product differentiation or capital requirements Example of product differentiation ◦The perception of a product as being different works only if the buyer is uninformed about the products in the market  Absence of cost-effective credible information  Imperfect information Therefore, there is more to market failure (and more sources) than B2E

6 Impediments Theory – another source of market failure  Transaction Costs  Production Economies  Sunk Costs  Imperfect Information

7 Transaction Costs Two relevant types ◦Free-rider problem: Costs of excluding non-buyers from use of a product or service  Excluding non-subscribers from benefits of product review ◦Costs of communication and information  Writing long-term contracts when all future contingencies cannot be predicted Strategies for dealing with transaction costs ◦Vertical integration ◦Culture change: match employee’s goals with organization’s goals ◦Develop long-term relationships with outside organizations

8 Production Economies, Sunk Costs, Imperfect Information Production Economies ◦Economies of Scale, Learning Curve, Economies of Scope Sunk Costs ◦In absence of sunk costs, entry and exit become costless (‘contestible’ markets) Imperfect Information ◦Absence of perfect buyer information leads to above average price-cost margins ◦Ways to exploit: provide information oriented strategies  Reputations: brand loyalty.  Product differentiation through advertising  Signaling quality through warranties  “Price reflects Quality” – high price, high quality.

9 Concluding Thoughts and Comments The paper integrates B2E with IEA. However, the paper’s implications on transaction costs is limited. ◦Here’s an extended definition: The firm exists by minimizing transaction costs, which includes costs associated with opportunism, complexity, and uncertainty. Can transaction costs theory encompass impediments theory? ◦Since production economies (quasi-rents), sunk costs (sunk investments), and imperfect information (uncertainty) are handled within the boundaries of the firm, then transaction costs may be sufficient.

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