Strategic Management and Competitive Advantage 6Th Edition Barney Solutions Manual Full Chapter PDF
Strategic Management and Competitive Advantage 6Th Edition Barney Solutions Manual Full Chapter PDF
Strategic Management and Competitive Advantage 6Th Edition Barney Solutions Manual Full Chapter PDF
INTRODUCTION
In this chapter, the focus is on firms working together with other firms to reduce
competition so as to generate profits. This strategy, called collusion, may lead to moves
such as:
Reducing industry supply below demand (so as to drive up prices)
Arranging to hold prices at a certain level so that industry profits can be protected
even when demand slows down
Slide 7-3
This slide introduces collusion by contrasting it with efficiency profits generated by the
generic strategies of cost leadership, product differentiation, and flexibility.
Just like how efficiency oriented strategies generate efficiency profits, collusion produces
collusion profits. The objective of this chapter is to show that there are a host of issues—
economic, strategic, legal, and ethical—associated with the decision to collude.
In the world of book publishing (fiction and non-fiction), six firms dominate
the market – Hachete, Harpercollins, Macmillan, Penguin, Simon & Schuster,
and Random House. Their business model called for selling hardcover titles
with a 30 percent commission to retailers. All this changed with the advent
of e-books and the entry of Amazon into this area. Amazon argued that it
should be allowed to set the final retail price of an e-book, even allowing it to
sell below cost (as a loss leader). Clearly, threatened by Amazon’s bargaining
power over them, the publishers had to act to protect their business.
According to a lawsuit filed by Amazon, the heads of these six publishers
brazenly met together to decide on a common price strategy. The court
Slide 7-4
Use this slide to summarize the e-book collusion vignette described above. It has some
additional details.
WHAT IS COLLUSION?
Learning Define Explicit and Tacit Collusion and Explain Why Collusion is Typically Inconsistent With Social
Objective Welfare in an Economy
7.1
Start with the examples of Coca-Cola, GE, and OPEC to illustrate collusion. Once these
examples are understood, it makes sense to provide a formal definition of the term.
Collusion exists when firms in an industry or market cooperate to reduce competition. In the
examples cited, the end result is the same: competition decreases, prices rise, and the
colluding firms gain economic profits.
Before getting into forms of illusion, it is important for students to know that not all
cooperation among firms is collusive. Firms, for example, engage in strategic alliances, not to
benefit from collusion, but from various kinds of economies.
Slide 7-5
Use this slide to reinforce the formal definition of collusion.
Explicit collusion
Tacit collusion
Explicit collusion happens when firms in an industry sit across from each other and directly
negotiate agreements to reduce competition. OPEC members met in a highly publicized
meeting in 1973 and negotiated a production level agreement. Explicit collusion is illegal in
most developed countries (such as the U.S.).
Slide 7-6
This slide identifies and explains both explicit and tacit collusion.
Slide 7-7
This slide looks at the ethics of collusion. It defines the term “dead weight loss” and its
impact on social welfare.
For tacit collusion to work, firms have to signal their intentions. The intention may be to
hold prices or increase production capacity. Whatever the intention is, sometimes signals are
lost in translation. When this happens, firms who stand to gain from cooperation may not
be able to realize these gains.
In the classic prisoner’s dilemma scenario (described in detail in Chapter 11), there is a huge
payoff to not cooperating (and the other prisoner is found guilty), but the risks are high.
Cooperation is the safer bet but it involves signaling and interpreting the signal!
In spite of the challenges involved in sending and receiving signals, there are examples of
both tacit and explicit collusion. Major League Baseball owners were found guilty of
colluding to depress the market for free agents in 1990. There are non-U.S. examples, too
(OPEC in 1973)
Important Point: Students must understand clearly that in the U.S. (and most
developed countries), explicit collusion is illegal. While tacit collusion is not always illegal,
there are ethical issues associated with any kind of illusion.
Teaching Points
• Use the examples given above to demonstrate that there are recognizable
examples both explicit and tacit collusion.
• Briefly explain that while explicit collusion is always illegal (in developing
countries), not all tacit collusion is deemed illegal.
• Stress the importance of signaling and interpreting signals in tacit collusion.
• Point out that ethical issues are associated with collusion, particularly the
concept of “dead weight loss.”
Strategic actions are aimed at creating value for the organization. Therefore, it is important
to look at the value creation rationale of collusion.
Slide 7-8
This slide shows that collusion can be aimed at any one of the five forces per the S-C-P
model
Colluding firms can cooperate to create entry barriers that would discourage or prevent new
entrants from entering the industry. Incumbents firms, for example, can increase the scale
of production that has an adverse effect on the newcomer’s pricing ability. Firms can
collude to develop and adopt common technology standards. This is an example of
increasing costs for new entrants that is scale independent. Promoting standardized industry-
wide product differentiation (“Made in the USA”) simply makes it difficult for new entrants
to succeed via their own product differentiation. Finally, incumbent firms can jointly lobby
to increase the cost of entry.
Colluding firms can cooperate to reduce the rivalry among themselves; the resulting reduced
rivalry can have a positive impact on profits. From a cost reduction perspective, incumbents
can agree to avoid (say) costly and periodic product upgrades and decide to reduce their
marketing spend. On the revenue side, firms can agree to raise prices without the fear of
one undercutting the other.
Colluding firms can cooperate to increase their profits by paying less for various inputs (thus
negating supplier threat) and/or by agreeing to sell only limited quantities to buyers (thus
negating buyer threat). It is important for students to understand that collusion cannot
address the threat of substitutes. Collusive action may actually increase the attractiveness of
substitutes (OPEC’s collusion led to the growth of alternative fuels).
Slide 7-9
Use this slide to summarize how collusion specifically addresses the forces in an industry.
Describe Different Ways That Collusive Agreements Can Fall Apart, and How it is Possible to Use the Learning
Attributes of an Industry to Anticipate How Sustainable These Agreements are Likely to Be Objective
7.3
Collusion is difficult to maintain over time. The reason is this: while parties to a collusive
agreement have strong incentives to cooperate (the profits that come from collaboration),
they also have strong incentives to cheat. In the prisoner’s dilemma example (Chapter 11),
the payoff is higher if the prisoner doesn’t cooperate and the other is found guilty. This is a
good segue to use to move to the topic of cheating.
Slide 7-10
This slide reproduces Table 7.1 that looks at ways firms cheat, and the assumptions and
performance implications of each. This is a good overview of cheating in collusion and
helps to understand the leading methods described below.
Per Joseph Bertrand, assuming little or no product differentiation among a small number of
firms, if one firm decides to cheat on a collusive agreement by reducing its prices, others will
as well and, in the long run, firms in this industry will earn no economic profits. In other
words, Bertrand’s conclusion is that, in the long run, collusion will lead to normal profits.
Bertrand made the key (and unrealistic) assumption that each time cheating firms adjust their
prices, they assume that other firms in the industry will continue cooperating.
Slide 7-11
This slide summarizes Bertrand cheating. While parts of it are covered in the previous slide,
this slide highlights the key aspects of Bertrand’s thesis.
Slide 7-12
This slide summarizes Cournot cheating by describing the key aspects of his thesis.
Slide 7-13
Use this slide to offer a succinct conclusion—takeaway—on collusion and cheating.
The discussion on cheating will enable students to understand that, to benefit from tacit
collusion, firms have to signal their intentions and others have to correctly interpret them.
Sometimes, signals of intent to collude are very ambiguous. This brings us to the idea of
“tough” and “soft” signals.
A tough signal indicates that the firm in question will aggressively respond to cheating. In
contrast, a soft signal indicates that the firm in question will not aggressively respond to
cheating. Before the instructor gets deep into these two kinds of signals, it is important to
reiterate the concept of conscious parallelism. This suggests that when firms consciously
make price and output decisions in order to reduce competition, the courts may regard this
as tacit collusion, even if they do not explicitly collude.
Slide 7-14
Use this slide to define both tough and soft signals. This will help in understanding the
various strategies identified in the “Research Made Relevant” box.
The intent of a tough signal is this: that if parties cheat on collusive agreements, the firm
sending the signal will decrease prices more or increase output more than would have
otherwise been the case. In other words, such a signal indicates punitive intent.
In contrast, a soft signal has a different intent: that if parties cheat on collusive agreements,
the firm sending the signal will decrease its prices less or increase its output less than would
have otherwise been the case. In short, the message is that the signaling firm will back off.
Slide 7-15
Use this slide to go over the four types of strategies associated with signaling.
Industry attributes play a key role in estimating the probability of cheating on collusive
agreements. These attributes are listed in Table 7.5.
Slide 7-16
Use this slide to go over the industry attributes that facilitate the development and
maintenance of tacit collusion. This slide reproduces Table 7.5.
Tacit collusion is more likely to be successful if there are a small number of firms in an
industry (or at least one in which a small number of firms dominate). Take the example of
book publishers confronting the threat of Amazon in e-books. The fact that the six firms
dominated the industry enabled them to send and interpret signals easily (of course, the
“cloak-and-dagger’ meetings in a New York restaurant didn’t hurt!). This would have been
much more difficult if a large number of firms were involved.
Tacit collusion is also more likely when firms produce and sell similar products or services,
i.e., when product homogeneity is high. This is because price changes (as signals) are easier
to send and interpret than product attribute changes.
A price leader is a firm that sets “acceptable” industry prices or “acceptable” profit margins
in an industry. In essence, price leaders (typically firms with the largest market share in the
industry) “police” the industry and ensure that there is order and discipline. The presence of
price leaders facilitates tacit collusion.
Industry social structure refers to accepted norms of behavior and competition that evolve
in industries (the “do’s” and “don’ts”). As the Major League Baseball collusion example
points out, industry social structure facilitates collusion. While each franchise is
independently owned, baseball owners cooperate to set schedules, rules of the game, and
other operating standards. It simply makes it easy in such a situation for owners to collude
on how much to pay for free agents.
When maintaining a collusive agreement precludes a firm from doing something else
(opportunity costs), the incentive to cheat is high. Industries characterized by infrequent and
large orders are more prone to cheating in collusive agreements.
In the same spirit, the ability of firms to produce for inventory and to create order backlogs
helps facilitate tacit collusion. Inventory buffers help firms maintain consistency in output
and prices, resulting in creating conditions for tacit collusion.
Of all the factors, though, the most important industry characteristic facilitating tacit
collusion is the presence of entry barriers. Low entry barriers mean a constant flow of new
entrants that makes it difficult to signal and facilitate tacit collusion.
Important Point: Industry factors play an important role in not only enabling
tacit collusion but also in maintaining it. The key factor, though, is the presence of entry
barriers.
Rarity implies selectivity or exclusivity. This runs counter to the concept of collusion which
requires a number of firms to agree to something. Rarity in this context refers to the small
numbers issue discussed as one of the industry characteristic that facilitates collusion. By the
same token, the idea of imitation also seems to run counter to cooperation. What is
important here though, is this: imitation here has to be looked as equivalent to entry barriers
for the industry.
Important Point: The small-numbers industry attribute is equivalent to the
rarity requirement; the barrier-to-entry industry attribute is equal to the costly-to-duplicate
requirement.
Slide 7-17
This slide reiterates the important point described above, that rarity and costly-to-duplicate
concepts have to be looked at in terms of industry factors when it comes to collusion.
In the same vein, organizational self-discipline become an issue when a firm is engaged in
collusion. Because tacitly colluding firms will almost certainly be tested in their resolve to
maintain price and output stability, the ability to implement this strategy successfully
depends on an unusual level of organizational self-discipline.
Slide 7-18
This slide lists the two unique organizational requirements necessary to implement and
maintain a strategy of tacit collusion.
Teaching Points
SUMMARY OF COLLUSION
Slide 7-19
This slide can be used to summarize the key points in this chapter.
This chapter runs counter to the ideas described in the other chapters in the book,
particularly Chapters 4, 5, and 6, all of which talk about strategies to effectively compete
against other firms in the industry. In this chapter, an alternative notion is introduced – one
that involves colluding with and not competing against other firms in the industry.
CHALLENGE QUESTIONS
7.1. Firms that engage in Cournot cheating will achieve higher levels of performance than
will firms that engage in Bertrand cheating. Why, then, would firms ever engage in
Bertrand cheating?
7.2. Both cost homogeneity and product homogeneity enhance the ability of firms in an
industry to implement tacit collusion strategies. Under what conditions, if any,
would a firm be able to pursue a cost leadership strategy or product differentiation
strategy while simultaneously trying to implement a tacit collusion strategy? Are
these strategies mutually exclusive?
7.3. At one level, the requirement that all firms in an industry be involved in a tacit
collusion strategy in order for that strategy to be viable seems to contradict the
rareness and imitability requirements for sustained competitive advantage, first
discussed in Chapter 5. Is it possible to rationalize this apparent contradiction? If
yes, how? If no, why not?
The rareness part comes from the small numbers requirement. Collusion
passes the rareness test if an industry has a small number of firms that
facilitates collusion. The costly-to-imitate requirement cannot be
rationalized, though, simply by looking at incumbents. If it is very costly for
non-colluding firms to begin colluding, then collusion will break down.
Therefore, this test has to be looked at by also including potential entrants.
Collusion creates entry barriers for potential entrants because it is costly for
them to duplicate the colluders’ resources.
7.4. Some have argued that the implementation of a tacit collusion strategy will lead a
firm to be relatively inefficient. Others have argued that the implementation of a
tacit collusion strategy requires firms to be very efficient at implementing this
strategy. Which is it? Do firms implementing a tacit collusion strategy become less
efficient or more efficient? Justify your answer.
Collusion takes away competition because the colluding firms are essentially
competing the same way. Because competitive intensity is lacking, if
collusion continues for a long time, it will make the colluders less efficient.
However, the exception to this is if collectively, the cheaters decide to
become more efficient, perhaps because of the possibility of a powerful new
entrant entering the industry, then all the colluding firms become more
efficient.
Problem Set
7.5 The opening case of this chapter poses a specific strategic question. If you owned the
established gas station, would you raise your gasoline prices or not? Why?
Answer 7.5
5. There are only weak incentives to defect from this collusion. Defection would only
yield short-term advantage and trigger Bertand competition, which would drive
prices down unnecessarily.
6. The increase is relatively small, and likely within the normal range. As long as the
price does not become excessive, such that it would drive consumers away, following
the signal would be profitable and harmless. However, if the other manager begins
raising the price excessively, refusal to follow future signals will signal to the other
manager that the price is too high. However, flat refusal to follow the signal now will
indicate a lack of cooperation or misunderstanding of the signals. Thus, following
the signal now enables communication in the future.
7. I can still compete on the prices of convenience store goods. These are much more
difficult to cooperate on and allow for differentiation without reducing gasoline
revenues.
8. There’s always time to compete on price later, but triggering competition now will be
difficult to undo without.
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