Overview
This lecture covers the fundamentals of organization and strategy, examining how firms structure themselves, make strategic decisions, achieve competitive advantage, and respond to competition and innovation.
Organization & Strategy Basics
- An organization is a social entity with defined boundaries and long-term goals.
- Strategy means deliberately choosing activities to reach a firm's objectives (Porter).
- Firms need strategies to achieve goals and compete effectively.
Porter's Five-Forces Model
- Internal rivalry occurs when firms compete for market share within a defined market.
- Entry barriers can be exogenous (e.g., regulations) or endogenous (e.g., brand loyalty).
- Substitutes lower industry profits; complements can raise demand.
- Supplier/buyer power affects profits through bargaining leverage and concentration.
Horizontal Boundaries and Economies of Scale & Scope
- Horizontal boundaries refer to the range of products and markets a firm operates in.
- Economies of scale: average costs fall as output increases up to the minimum efficient scale.
- Learning curves show cost reductions from experience over time.
- Economies of scope: cost savings from producing multiple related products together.
Make-or-Buy and Vertical Boundaries
- The vertical chain includes all activities from inputs to final sales.
- Firms "make" when they perform activities internally, and "buy" when they outsource.
- Reasons to "buy": suppliers have scale, learning, and specialization advantages; lower agency costs.
- Reasons to "make": better coordination, protection of private information, and reduced transaction costs with asset specificity.
Principal-Agent Problem & Incentives
- Principal-agent relationships arise when an agent acts on behalf of a principal, risking misaligned objectives.
- Solutions: bureaucracy, monitoring, and performance-based incentives.
- Performance incentives link agent rewards to principal outcomes but may induce risk aversion, neglect of unmonitored tasks, or free-rider problems in teams.
Organizational Structure
- Structures range from individuals, self-managing teams, to hierarchies.
- Departmentalization by product, function, or geography affects coordination and control.
- Main structures: unitary (U-form), multidivisional (M-form), matrix, and network.
- Structure should match strategy, technology, and environmental uncertainty.
Social Context
- Internal social context involves power (ability to influence without formal authority) and culture (shared norms and values).
- External social context includes institutions (laws, norms), and resource dependencies with other firms.
Competition & Market Structure
- Direct and indirect competition defined by strategic interdependence.
- Market structure measured by concentration ratios and Herfindahl index.
- Structure-Conduct-Performance (SCP) links market structure to firm strategy and performance.
- The Chicago School focuses on efficiency and firm decisions shaping industry structure.
Entry & Exit, Barriers and Strategies
- Entry: new firms entering markets; exit: firms leaving markets/products.
- Entry barriers: structural (resources, scale) or strategic (pricing, bundling).
- High entry/exit barriers affect industry dynamics and profitability.
Strategic Commitment & Flexibility
- Strategic commitments are long-term, irreversible moves affecting competition.
- Commitments must be visible, valuable, credible, and hard to reverse.
- Tough commitments hurt rivals; soft commitments benefit rivals.
- Real options preserve flexibility by enabling future strategic choices.
Strategic Positioning & Competitive Advantage
- Competitive advantage: generating higher economic profit than rivals.
- Cost-leadership: achieve lower costs than competitors.
- Benefit-leadership (differentiation): offer higher value or quality.
- Focus strategies specialize by client, product, or geography.
Sustaining Competitive Advantage
- The resource-based view stresses unique, valuable, and hard-to-imitate resources/capabilities.
- Isolating mechanisms deter imitation: legal protections, brand, scale, causal ambiguity.
- Early-mover advantages: learning, reputation, switching costs, network effects.
Innovation & Creative Destruction
- Innovation: introducing new products/processes, can be incremental or radical.
- Creative destruction: innovation disrupts market leaders and advantages shift over time.
- Sustained advantage requires dynamic capabilities and ongoing innovation.
Key Terms & Definitions
- Economies of Scale — Cost savings from increased production volume.
- Economies of Scope — Cost savings from producing a range of products together.
- Make-or-Buy — Decision to perform an activity internally or outsource it.
- Principal-Agent Problem — When managers (agents) have different incentives than owners (principals).
- Organizational Structure — The formal and informal ways a firm organizes tasks and authority.
- Entry Barrier — Advantage for incumbents deterring new competitors.
- Strategic Commitment — Irreversible choice affecting competitors’ actions.
- Resource-Based View — Theory focusing on firm-specific resources and capabilities for sustainable advantage.
- Isolating Mechanism — Factor preventing competitors from duplicating a firm’s advantage.
- Creative Destruction — Process where innovation reshapes and disrupts industries.
Action Items / Next Steps
- Review lecture slides for detailed examples and illustrations.
- Practice microeconomic exercises on duopolies and cartels.
- Prepare for potential mathematical exam questions on market structure and strategy.