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Exercises on Besanko Strategy Book

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Individual Assignment 2

1)
If the company has already made the decision of going ahead with the musical and either if it will be a success or a flop they will still generate profits, there’s no sense in doing a market research.

2) A cartel is formed by a group of companies/countries which come together explicitly or tacitly to restrain supply of a certain good so that they can practice a monopolistic price or set specific prices for goods (price-setting). Eventually there’s more to description and detail which defines cartels but that won’t be taken in consideration in the following answer.
All markets have their ups and downs in demand and this something that cartels have to endure in order to stay cohesive. However, sometimes it is profitable to deviate from practices of these organizations. As a matter of fact, in times of high demand the attractiveness for collusion drops significantly to a point where the defection is inherently triggered (Shakkil Hassan 2006). The incentive for deserting comes from the short-term benefits companies can obtain by undercutting their competitors and therefore gain all the market share. It’s a common practice in cartels to limit outputs and capacity so that prices stay high but in times of high demand the market asks for more quantity of the same good which is tempting for firms to expand their output, by augmenting capacity and therefore reducing prices to reach all customers. This also brings along economies of scale because companies can now spread fixed costs over a larger production they have. This is especially tempting for small firms, because these are trying to penetrate the market and gain market share and therefore the punishment received for this deviation may not outweigh the actual defection. Ultimately (according Rotenberg and Saloner 1986), in times of high demand, the arrangement within a cartel will give place to a price war. In times of low demand (usally called “Busts”), companies in a cartel also have motives to deviate from former agreement. Usually, low demand is associated with less production and less sales and therefore, few consumers. If one is especially considering small firms, in these times, they have the incentive to defect since the profit they make in staying in the cartel now is reduced. By undercutting their rivals (and keeping the same level of production), these companies which deviate will start to gain more market share and consequently revamp sales on this particular market. Ultimately, these firms hope that this price decrease will get them new customers and if defection is not noticed in due time, they will gain loyal customers. In markets with low demand, delayed defection within a cartel is likely to be observed when there are high production costs and high concentration of customers and especially when benefits of new technologies are great. In a nutshell, one is left with the conclusion that, according to the study of Shakkil Hassan in 2006, there’s a positive relationship between the volatility of demand and defection and its timing within a cartel.

3) Times have evolved since the period of time analyzed by the three authors of the study and several aspects of industries have changed. Entry and exiting barriers have mutated and in some cases have increased depending on the industry and in other cases have decreased. To further analyze the change of these entry and exit patterns, one should look deeper into the transformations occurred in the world during these last 34 years. Since the 80’s, there have occurred some immense transformations in production processes which have become faster and more efficient. What really improved across all industries was the specific knowledge gained from the experience of operating in the already existing industries. With this in mind there were discovered new, more efficient materials in manufacturing industries not ignoring the fact that new methodologies like worldwide production segmentation have come into play. But not only in the secondary sector have changes been felt. In the tertiary sector as well, new technologies have improved services and made them available throughout the globe. Technologies like the Internet have allowed companies in both sectors to reach customers faster and to produce better products not to speak about the savings in money and time that enabled them to make better prices for customers. By controlling a production line miles away from site or to control a travel agency with a click of button are examples of changes that have come to revolutionize the world. Along with these transformations, all three sectors have changed, making new companies in them face new paradigms when considering entering in the business. For the primary sector, generally speaking, one could say that entering barriers for new companies are lower. Take the case of an agricultural or livestock where back in the days for entering such a business, a farmer would have to buy animals and wait for them to grow or reach maturity so that he could take advantage of their full potential, bearing with this process lots of costs to create the livestock and then to replace it. The same reasoning is valid for plants which crops used to take long and seeds used to be a great cost. Nowadays, with industry evolution and scientific breakthroughs, it’s much easier and affordable to grow animals or crops at a faster pace and cost efficiently. This makes entering the market a much easier task where fixed, sunk and methodology costs aren’t such a burden and where economies of scale are easier to attain. However, exit barriers haven’t become lower. For this kind of sector, bureaucracy as evolved heavily making life harder potential leavers to leave the business and potentially harming renters and financial institutions. Taking into consideration the secondary sector, an immense number of changes have occurred that made entry in this sector and its industries easier. In this case, the entry patterns changed because technological factors have evolved tremendously enabling constructors to produce at a faster pace without wasting as many resources. Going specifically into the automotive industry which is one of the most representative, one can see that materials have become much cheaper and computers have helped to make production lines more efficient. All this comes at a cost which is significantly lighter than before because machine and material providers can themselves sell their goods at a cheaper price. All these make entering barriers lower. But regarding this example there’s more to it. To enter the automotive market nowadays, new-comers must face a number of barriers that have evolved significantly. Car companies, more than ever rely on advertising to create barriers to entry following the market power theory of advertising, using advertisement to differentiate its brand from others to a degree that the consumers see the brand’s product as a slightly different one from the competitors. Experience from the learning curve has led car manufacturers to increase economies of scale and scope in such a way that is highly difficult for new-comers to replicate. Moreover, brands nowadays carry customer loyalty with them making it harder for new companies to gain market share. Aggravated by this last crisis, there has been a decreasing line for credit for the period studied which makes capital available for new-comers much more difficult to obtain making their entry harder. Finally, the cumulative R&D and patents done by existing companies in this industry lifts barriers to entry because has the future gets closer more research will be needed and more money will be required to invest in this kind of sunk cost because the energy world is changing bringing automobiles with it. All the aforementioned factors make the barriers to entry in this kind of industry and many others in the secondary sector tougher nowadays with companies having to leapfrog their way into new products or at least differentiated ones like TESLA Motors did in the USA. It goes without saying that many of these industries
Have higher exiting barriers because what works for leaving new-comers aside, works inversely to easily exit the industry with companies nowadays having more sunk costs than before mainly because of R&D and infrastructure costs. Last but not least, in the tertiary sector barriers to entry have seriously diminished. The technological breakthroughs in the service industry has given place to many small companies to rise and take over this market. Small start-ups used technologies like the internet and personal computers to better provide services for their customers at extremely low cost and cutting intermediaries in the value chain. Taking the case of online travel agencies, one can observe that this variation of the business wouldn’t have been possible hadn’t the internet arisen. They save money on the physical site, on processes that evolved with the years and the networking with hotels and airline carriers and all this behind a secretary, facts that make this business’ doors widely opened for newcomers. They also benefit from a strong advantage which is being now 24/7 available. Technology also brought great opportunities to companies in this industry but as it is easier to replicate business models, they have the obligation of being constantly innovating and therefore many of the new-comers leave the business at an early stage making exiting barriers lower. Quoting from Mckinsey’s website one can easily observe the kind of benefits companies enjoy with the internet and how they can diminish costs and improve relationships: “Web technologies can be a powerful lure for an organization; their interactivity promises to bring more employees into daily contact at lower cost. When used effectively, they also may encourage participation in projects and idea sharing, thus deepening a company’s pool of knowledge. They may bring greater scope and scale to organizations as well, strengthening bonds with customers and improving communications with suppliers and outside partners.”1
Lastly, the exiting barriers in this industry have never been so low because there are lower sunk costs and initial investment and less requisition of capital as well as not having great closure costs which might had prevented them from going out of the market before. Entering barriers because of the former arguments presented have decreased in my perspective since doing business in the service industry is now much cheaper, with a fast learning curve and knowledge acquisition readily available, all due to the internet.

1- (Jacques Bughin;Michael Chui;Andy Miller, 2009) at http://www.mckinsey.com/insights/business_technology/how_companies_are_benefiting_from_web_20_mckinsey_global_survey_results

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