Economics of Strategy

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

The Power of Principles:
A Historical Perspective
Besanko, Dranove, Shanley and Schaefer
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.
Diversification yields to
deconglomeration.
Firms adopt complex matrix structures.
Transportation Infrastructure Today
Air, 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.