Strategic Management
An analysis with regard to a game theoretic perspective
©2000
Diplomarbeit
89 Seiten
Zusammenfassung
Inhaltsangabe:Abstract:
The growing or at least steady stream of literature that has been published in recent years on the variety of issues known as strategic management, both in the form of books and journal articles, some of them more, some less scientific, is ample evidence of the interest the management community takes in the subject. Likewise, game theory has experienced a surge in popularity, not only because the1994 Nobel-price was awarded to JOHN HARSANYI, JOHN NASH and REINHARD SELTEN for their contribution to the refinement of game theory but also with regard to the influence it has had on the social sciences during the last two decades, primarily on economics but also on other fields such as psychology or political science. Surprisingly, however, there is little, if any, literature available on the combination of game theory and strategic management, even though game theory is concerned with finding solutions to strategic problems, its terminology (bargaining, power, cooperation etc.) also being very suggestive of applications to business strategy. The consequent question then has to be: is there a need to investigate the subject further and why might it be beneficial?
Strategy is a wide field and so is game theory. Therefore the purpose of this essay cannot possibly be to explore the intricacies game theory has to offer nor can it be to investigate the depths of strategic management. Rather, it is to examine, whether game theory can be fruitfully applied to the problems faced within strategic management. In order to further narrow the topic down, there are various angles from which to approach strategic management and game theory. For instance, one way might be to assume that underlying strategic management as an academic discipline are various fundamental questions, which game theory is prepared to answer. One such question is How do firms behave?. Alternatively, one might view game theory as a set of tools assisting the strategist in finding practical solutions to specific problems within a strategic context. Here, one could think of Should we enter this particular market in order to challenge the incumbent firm? or How can we deter our competitors from starting a price war?, How should we organise the process of strategy formation? and the like.
In this paper my emphasis will be on the latter approach, in the style of Can game theory assist the general manager in coping with strategic issues arising from his daily […]
The growing or at least steady stream of literature that has been published in recent years on the variety of issues known as strategic management, both in the form of books and journal articles, some of them more, some less scientific, is ample evidence of the interest the management community takes in the subject. Likewise, game theory has experienced a surge in popularity, not only because the1994 Nobel-price was awarded to JOHN HARSANYI, JOHN NASH and REINHARD SELTEN for their contribution to the refinement of game theory but also with regard to the influence it has had on the social sciences during the last two decades, primarily on economics but also on other fields such as psychology or political science. Surprisingly, however, there is little, if any, literature available on the combination of game theory and strategic management, even though game theory is concerned with finding solutions to strategic problems, its terminology (bargaining, power, cooperation etc.) also being very suggestive of applications to business strategy. The consequent question then has to be: is there a need to investigate the subject further and why might it be beneficial?
Strategy is a wide field and so is game theory. Therefore the purpose of this essay cannot possibly be to explore the intricacies game theory has to offer nor can it be to investigate the depths of strategic management. Rather, it is to examine, whether game theory can be fruitfully applied to the problems faced within strategic management. In order to further narrow the topic down, there are various angles from which to approach strategic management and game theory. For instance, one way might be to assume that underlying strategic management as an academic discipline are various fundamental questions, which game theory is prepared to answer. One such question is How do firms behave?. Alternatively, one might view game theory as a set of tools assisting the strategist in finding practical solutions to specific problems within a strategic context. Here, one could think of Should we enter this particular market in order to challenge the incumbent firm? or How can we deter our competitors from starting a price war?, How should we organise the process of strategy formation? and the like.
In this paper my emphasis will be on the latter approach, in the style of Can game theory assist the general manager in coping with strategic issues arising from his daily […]
Leseprobe
Inhaltsverzeichnis
ID 5346
Deuster, Marc: Strategic Management - An analysis with regard to a game theoretic
perspective
Hamburg: Diplomica GmbH, 2002
Zugl.: Universität St. Gallen, Diplomarbeit, 2000
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Table of contents
i
Table of contents
Table of contents
...i
List of Illustrations ...
iii
List of Abbreviations
...iv
1. Introduction
... 1
1.1. Purpose of this work
... 1
1.2. Approach to the subject
... 2
2. Strategic management and the strategist
... 5
2.1. Fundamental questions and problems
... 5
2.1.1. The nature of strategy
... 5
2.1.2. Aspects of strategic management
... 6
2.1.3. Economics and strategic management
... 11
2.2. The tasks and needs of the strategist
... 17
2.2.1. What is he supposed to do?
... 17
2.2.2. What does he actually do?
... 19
2.2.3. What does he need?
... 21
3. Game theory
... 27
3.1. Purpose and history
... 27
3.2. Basic concepts of game theory
... 29
3.2.1. Classification of games
... 30
3.2.2. Key terminology
... 31
3.2.3. Techniques
... 33
4. Game theory and strategic management: applications
... 36
4.1. The strategic decision process
... 36
4.2. Anticipation of changes and trends
... 40
4.2.1. Analysing past behaviour
... 41
4.2.2. Intuitive approach
... 45
Table of contents
ii
4.2.3. Literal application
... 48
4.2.4. Metaphorical application
... 65
a) Quantitative metaphorical application ... 66
b) Qualitative metaphorical application ... 68
4.3. Implementation and control
... 72
5. Conclusions
... 75
References
... 77
List of Illustrations
iii
List of Illustrations
Figure 1: Structure...3
Figure 2: Aspects of strategic management...8
Figure 3: The roles of the manager and the strategy process...20
Figure 4: Extensive form of sequential game...34
Figure 5: 2x2 matrix of simultaneous game...35
Figure 6: Strategic decision making...38
Figure 7: The literal approach...51
Figure 8: The value net...71
List of Abbreviations
iv
List of Abbreviations
e.g.
for example
etc.
et cetera
i.e.
that means
IO
Industrial Organisation
SCP
Structure Conduct Performance
SWOT
Strengths/Weaknesses Opportunities/Threats
TCE
Transaction cost economics
Introduction
1
1. Introduction
1.1. Purpose of this work
The growing or at least steady stream of literature that has been published in re-
cent years on the variety of issues known as `strategic management', both in the
form of books and journal articles, some of them more, some less scientific, is am-
ple evidence of the interest the management community takes in the subject.
Likewise, game theory has experienced a surge in popularity, not only because
the1994 Nobel-price was awarded to J
OHN
H
ARSANYI
, J
OHN
N
ASH
and R
EINHARD
S
ELTEN
for their contribution to the refinement of game theory but also with regard
to the influence it has had on the social sciences during the last two decades, pri-
marily on economics
1
but also on other fields such as psychology
2
or political sci-
ence
3
. Surprisingly, however, there is little, if any, literature available on the com-
bination of game theory and strategic management, even though game theory is
concerned with finding solutions to "strategic" problems, its terminology (bargain-
ing, power, cooperation etc.) also being very suggestive of applications to busi-
ness strategy
4
. The consequent question then has to be: is there a need to inves-
tigate the subject further and why might it be beneficial?
Strategy is a wide field and so is game theory. Therefore the purpose of this essay
cannot possibly be to explore the intricacies game theory has to offer nor can it be
to investigate the depths of strategic management. Rather, it is to examine,
whether game theory can be fruitfully applied to the problems faced within strate-
gic management. In order to further narrow the topic down, there are various an-
gles from which to approach ,,strategic management and game theory". For in-
stance, one way might be to assume that underlying strategic management as an
academic discipline are various fundamental questions, which game theory is
prepared to answer. One such question is ,,How do firms behave?". Alternatively,
one might view game theory as a set of tools assisting the strategist in finding
1 Camerer (1991), p.137.
2 Budescu, Erev & Zwick (1999).
3 Schelling (1960) ; Ordeshook (1986).
4 Brandenburger (1994), p.328-329.
Introduction
2
practical solutions to specific problems within a strategic context. Here, one could
think of ,,Should we enter this particular market in order to challenge the incumbent
firm?" or ,,How can we deter our competitors from starting a price war?", "How
should we organise the process of strategy formation?" and the like.
In this paper my emphasis will be on the latter approach, in the style of ,,Can game
theory assist the general manager in coping with strategic issues arising
from his daily work?" This focus seems rewarding and interesting to me for two
major reasons. One is, that the manager/executive himself has been the object of
research, particularly in the areas of strategic leadership and strategic decision
theory. The role of the chief executive has always been and still is a topic of par-
ticular interest in management literature and the question for the value added by a
firm´s headquarters unit continues to be one of the fundamental issues in strategic
management
5
. First and foremost, however, the focus on the individual decision
maker is valuable because "although strategic management has striven to attain
rigorous scientific standards, its study domain has to be relevant to actual busi-
ness operations" and it ,,exists because of the relevance of its subject and not be-
cause of the elegance of its theory"
6
.
Over the course of the following four chapters I will argue that game theory can
certainly be of value in the conduct of strategic management, albeit on a some-
what lower or at least different level than euphoric proponents might expect. I will
also seek to show that although game theory does provide some help, it does so
in a limited fashion, since its logic is not applicable to the whole spectrum of con-
tent or process of strategic management.
1.2. Approach to the subject
Certainly it would be both helpful and desirable to support the discussion of
whether managers can benefit from the application of game theoretic concepts
5 Rumelt, Schendel, & Teece (1994), p.44.
6 Rumelt et al. (1994), p.9.
Introduction
3
with hard data. This essay, however, is not empirical in nature since it is difficult to
trace the outcome of projects, events, decisions etc. back to the usage of game
theoretic ideas, ignoring a multitude of other influences, such as general economic
conditions, chance and the like. While simple questionnaires would only lead to
vague estimates as to whether interviewees believe that game theory has helped
them or not, sophisticated statistical analysis is beyond the scope of this work. For
these reasons, I will rely exclusively on conceptual argumentation.
Also, the text is not of mathematical nature despite the considerable degree of
formalism of game theoretic models. Nevertheless, this doesn't pose a problem to
the forthcoming analysis, as the problems and limitations of game theoretic model-
ling as they will be mentioned, are not a result of insufficient mathematical sophis-
tication anyway. Quite to the contrary, my intention to look at game theory with
regard to its usefulness to the general manager implies that overly formal models
can probably neither be understood nor put into practice.
The figure illustrates that this essay is built upon three distinct components, i.e.
strategic management, the strategist and game theory.
Figure 1: Structure
Game Theory
Chapter 3
The Strategist
Chapter 2
Strategic Management
Chapter 2
Applications
Chapter 4
Introduction
4
Chapter two will be on the nature of strategic management and on the tasks of the
strategist. First, in order to pave the way for further analysis I intend to introduce
some basic concepts and contemporary problems of strategic management facing
the general manager, before I go on to describe past contributions of economics to
strategic management research. This sequence seems rather natural, as eco-
nomics is one of the most important disciplines if not the lead discipline within
strategic management. Furthermore, game theory itself is basically nothing but a
set of mathematical tools, possessing microeconomic trappings, so that one might
expect first insights as to the usefulness of game theory in strategic management.
Indeed, as we will see, certain biases typical of economic tools will reappear
throughout the analysis. Having thus revealed the object of the strategy process,
the remainder of chapter two will focus on the subject or architect of that process:
the manager. I will put strategy content into the context of managerial work, taking
note of both what the manager should do and what he actually does. From the
insights thus gained, certain requirements game theory as a managerial tool has
to fulfil will become obvious. At the end of chapter two we will be left with a set of
questions that are both relevant to strategy and the strategist, which will serve as a
thematic basis for the discussion in chapter four.
Chapter three will deal with the last building block, i.e. game theory. The purpose
of this chapter is a brief introduction to basic game theoretic concepts and jargon.
Chapter four will be a discussion of potential applications of game theory to strate-
gic management, always with regard to the needs of the manager. It is here that I
will bring all three strands together, discussing contributions and limitations of
game theoretic concepts within various contexts. In particular, I will discuss to
which degree game theory can be of use to the manager during individual phases
of the strategic decision making process.
Chapter five will conclude this essay with a summary.
Strategic management and the strategist
5
2.
Strategic management and the strategist
2.1. Fundamental questions and problems
2.1.1. The nature of strategy
To anyone only half literate in the field of strategic management, the attempt to
categorise the most pressing problems let alone characterise the nature of the
field must seem ludicrous. However, before one can attempt to consider a ques-
tion like "Can game theory assist the general manager in coping with strategic is-
sues", it is indispensable to clarify what these "strategic issues" could possibly be.
To begin with, I will therefore briefly comment on the roots and nature of strategy
and will then proceed to put this information into a context of contemporary strate-
gic thought. As a result, it should become clear what kinds of problems arise out of
this context for the general manager to deal with and to which game theory can
contribute.
The concept of strategy is rather old and its origins can be traced back to ancient
times and the Greek word "strategos", to be translated as "leader of an army"
7
.
Because of their importance within this military context, successful battle-
strategies were remembered, collected, analysed and distilled into maxims, to be a
source of reference in preparation of further engagements. The result of that proc-
ess were the works of much-cited authors such as S
UN
T
ZU
8
,
VON
C
LAUSEWITZ
9
or
Liddell-H
ART
10
to name but a few. With the power of an analogy stemming mainly
from the alleged similarity of the two concepts in question, the comparison be-
tween war and business has become somewhat unpopular, as the aims of the
latter are different and more peaceful than the goals of the former
11
. Nonetheless,
Q
UINN
has clearly demonstrated, citing the example of the battle of Chaeronea,
that many strategic problems bothering modern managers were of equal interest
7 Roger Evered (1983), p. 58.
8 Sun Tzu, in: Philips (1985).
9 Von Clausewitz (1973).
10 Hart (1954).
11 Grant (1995), p.10.
Strategic management and the strategist
6
to ancient generals
12
. Building on this insight, I would like to state four basic quali-
ties that I believe are common to all strategic actions/decisions and that will be
crucial in evaluating the impact of game theory on strategic management practice:
Firstly, strategic problems involve making decsions under uncertainty. Secondly, it
is not only the intentions of one party that matter. Rather, the plans of one side are
contingent on the other side's intentions, i.e. we are speaking of interaction. Then,
strategic reasoning involves considerations on the state and changing nature of
the environment. And finally, the evolution or changing capabilities of an entity
have to be taken into account.
2.1.2. Aspects of strategic management
Obviously, the nature of the field has changed over time, and in response to the
varying needs of strategists, researchers have taken care to address an ever in-
creasing diversity of subjects. Strategic management as an academic field can be
discussed along various dimensions. Before I address some of these dimensions
and hint at their implications for the general manager, it might prove helpful to take
a look at how leading scholars perceive strategy:
(1) "[Strategy means] the determination of long run goals and objectives of an en-
terprise, and the adoption of courses of action and the allocation of resources
necessary for carrying out these goals.
13
"
(2) "A strategy is a pattern or plan that integrates an organization´s major goals,
policies, and action sequences into a cohesive whole. A well-formulated strat-
egy helps to marshal and allocate an organization´s resources into a unique
and viable posture based upon its relative internal competencies and short-
12 Mintzberg & Quinn (1992), p. 6-10.
13 Chandler, (1962), p.13.
Strategic management and the strategist
7
comings, anticipating changes in the environment, and contingent moves by
intelligent opponents.
14
"
(3) "What business is all about is in a word, competitive advantage...The sole pur-
pose of strategic planning is to enable a company to gain, as efficiently as pos-
sible, a sustainable edge over its competitors. Corporate strategy thus implies
an attempt to alter a company's strength relative to that of its competitor in the
most efficient way.
15
"
(4) "The field of strategic management cannot afford to rely on a single definition of
strategy, indeed the word has long been used implicitly in different ways...-as
plan, ploy, pattern, position and perspective-...
16
"
(5) "Strategy is about winning.
17
"
14 Mintzberg & Quinn (1992), p. 5.
15 Ohmame (1982), p.36.
16 Mintzberg (1987), p.11.
17 Grant (1995), p.3.
Content
Process
Business
External
World
Corporate
Internal
World
Strategy
Figure 2: Aspects of strategic management
Strategic management and the strategist
8
While, judging on the basis of the above, one might justly argue that strategy is
about "everything a company does or consists of
18
", as it encompasses normative
and positive decisions on a corporate as well as on an operational level, employ-
ees, organisational arrangements and much more, there are certain recurring as-
pects which allow for a more appropriate categorisation. These polarisations are
depicted in Figure 2.
In the first three of the above quotations C
HANDLER
, Q
UINN
and O
HMAE
address an
issue that has been in the focus of managers' attention since the beginning of
strategic thought: achieving a fit between the company's internal strengths and
capabilities and its external threats and opportunities in order to ensure long-term
company growth and survival this so-called `contingency perspective' is at the
very heart of the famous SWOT-model. Over the course of time, like the swing of a
pendulum, attention given to either side of the concept has been moving to and
fro, at first stressing the importance of the external world, while neglecting the in-
side, then again concentrating on the inside of the firm. Starting in the 70's and
chiefly motivated by IO-based economics, scholars (notably P
ORTER
) have brought
the firm's immediate environment to the centre of attention. Under the notion of the
structure-conduct-performance-paradigm, industry structure was considered the
force determining the attractiveness of a market
19
rendering firm-internal capabili-
ties almost meaningless. IO-based economics is closely linked to the concept of
competitive strategy discussed below. P
ORTER
'
S
five forces-model being a rather
deterministic idea, with generic strategies (conduct) inevitably leading to certain
outcomes (performance), the more recent notion of the resource-based-view of the
firm has shifted the focus back to internal aspects of the firm, viewing the firm as a
bundle of competencies
20
and spawning thought on topics such as knowledge
generation, core competencies and culture.
While managers cannot afford to neglect one view in favour of the other, implying
that game theory should ideally address them both, we will see in chapter four,
that game theory can be applied more effectively to questions of competitive strat-
egy, rather than issues concerning internal matters. But then this is hardly sur-
18 Mintzberg, Ahlstrand & Lampel (1998), p. 119.
19 Porter; in: Mintzberg & Quinn (1992), p. 60ff.
20 Hamel & Prahald (1990), p. 90.
Strategic management and the strategist
9
prising in view of the fact that game theory has been the major driving force behind
the transformation of the old IO into the new IO, which in turn is the source of con-
siderable research on competitive strategy.
Another dichotomy is that between corporate strategy on the one side and busi-
ness or competitive strategy on the other side. Basically, corporate strategy is
concerned with the firm's choice of businesses and markets, while competitive
strategy is about the firm's position relative to its adversaries in chosen markets.
Once more referring to the quotations mentioned above, it is obvious that different
authors emphasise different aspects of strategy. Whereas O
HMAE
views competi-
tive strategy as "what business is all about", Q
UINN
and C
HANDLER
speak of the
organisation's "major goals", thus stressing the importance of corporate strategy.
This differentiation has implications for the questions to be asked and answered.
As for corporate strategy, the question is "Which business should we be in?", with
answers most likely depending on industry attractiveness, economic and techno-
logical trends and ranging from topics such as vertical integration or acquisition to
diversification. In the case of business strategy, the question is "How should we
compete", implying maneuvering within a chosen domain and the quest for sus-
tainable competitive advantages over ones rivals. The term competitive advantage
refers to the implementation of a value-creating strategy that is not at the same
time being implemented by a firm's competitors and furthermore cannot be imi-
tated or replicated in the future. There is a certain relatedness between business
strategy and the external view and between corporate strategy and the internal
view, respectively. Still, the manager has to take both of them into account and
game theory will be measured against its contribution to solving the problem of
where to compete and how.
The final distinction I would like to make in this introduction to the issues of strate-
gic management is that between strategy content and strategy process. Most of
the literature on strategy and probably most practitioners are largely concerned
with pondering over what to do, i.e. about contents, rather than about how to arrive
at this what, i.e. about processes. The implicit assumption when thinking exclu-
sively about contents is that somebody (usually top management) is able to as-
sess the vast amount of information available on the situation, digest it, analyse it
and finally come up with a full-blown strategy ready for somebody else (usually
those working on operational and functional levels) to implement. The idea behind
this "rationalist approach" is that formulation and implementation of strategy are
Strategic management and the strategist
10
entirely different activities, which can safely be separated. Among the choices, a
firm has to make, those which are strategic and fall into the domain of content are
the selection of goals, choice of products and services, choice of an appropriate
level of scope and diversity, design of the organisation structure
21
, acquisitions
and mergers, strategic alliances, creation and diffusion of knowledge, building of
core competencies, generic strategies, i.e. anything that could possibly be the ob-
ject of corporate or business strategy. Since there is considerable doubt, however,
as to whether strategy formulation and implementation can actually be separated
or by necessity go hand in hand, another direction of thought within strategic man-
agement, strategy process, is concerned with how strategies come into existence.
The aim is to describe various models of strategy formulation, implementation and
control, dealing with questions such as "who is the strategist, really" (top manage-
ment, the whole of the organisation or some undefinable "it") or "how tightly can
implementation be related to formulation?" . M
INTZBERG
in particular has enlarged
on the distinction between "deliberate" and "emergent" strategies
22.
As is apparent
from quotation (4), strategies are partly plan, partly pattern, becoming recognis-
able only in hindsight but not by anticipation. M
INZTBERG
, A
HLSTRAND
and L
AMPEL
have then, in an attempt to appreciate the contributions of various social sciences
to the explanation of phenomena within the strategy process, categorised existing
opinions and approaches into ten "schools" of strategy formation, each highlighting
a different aspect of the process
23
. It then becomes obvious that various stages of
the process are subject to all sorts of influences the strategist has to take into con-
sideration if he is to successfully implement his strategy. For instance, the decision
making process is dominated by cognitive concerns derived from psychology
("how does the strategist perceive the world")
24
, while the implementation process
is influenced by corporate culture, questions of power
25
and organisational behav-
iour derived from sociology. Resulting from this final polarisation are two more ba-
sic questions for the manager. Firstly, "How do I choose among the various con-
tents at my disposal?". Secondly, "How do I develope deliberate strategies without
suppressing emergent ones?".
21 Rumelt et al. (1991) , p.6.
22 Mintzberg (1987), p. 14.
23 Mintzberg et al. (1998), p. 5.
24 Mintzberg et al. (1998), p.149-176.
25 Mintzberg et al. (1998), p. 233-262.
Strategic management and the strategist
11
All of the distinctions made above are purely artificial and result from the tendency
of the human mind (at least of most occidental people) to analyse and divide any-
thing under scrutiny into its (alleged) components. My intention in following this
procedure is not so much to prove(claim) any approach right or wrong, appropriate
or inappropriate, nor is it to give a detailed overview of the current trends or the
historical development in the field of strategic management. Rather, it is to dem-
onstrate that strategy is highly eclectic by nature and I think it has become clear,
that this eclecticism is inevitably mirrored in the tasks of the general manager.
To sum up what we have so far: strategic management is a complex task that de-
mands of the manager to make important, far-ranging decisions under uncertainty,
often involving considerable and irreversible commitment of resources
26
. In doing
so, he will try to achieve "a fit" between the firm's inherent capabilities and an un-
stable environment. At the same time he has to anticipate the moves of competi-
tors and crucial changes in trends, technologies etc. Neither must he neglect so-
cial processes within and without the firm, paying heed to notions such as power,
culture and hierarchy. And finally he has to integrate all these aspects into a co-
herent meaningful whole. If game theory were to provide a general theory of strat-
egy, it follows that it would have to address all of the above and provide the man-
ager with answers or reliable mechanisms to arrive at those answers.
2.1.3. Economics and strategic management
Before turning my attention to the strategist, I would like to very briefly address the
contribution of economics to the field of strategic management. Even though this
essay is not on economics and strategy, there are two reasons why such an ex-
cursion might be interesting nonetheless. First of all, among those social sciences
that have contributed to the advancement of strategic management, economics is
the single most important. Furthermore, although game theory itself is not so much
a branch of economic theory but rather a collection of mathematical tools, it does
display certain microeconomic trappings, insofar as it presumes "rational-decision
26 Grant (1995), p.11.
Strategic management and the strategist
12
makers with well-defined objective functions and possible actions"
27
. Therefore,
further discussion of game theory and strategy might benefit from reviewing the
contribution of economics to strategy, as the closeness of game theory to eco-
nomics could imply a similarity of problems the two fields share with regard to their
application to strategic management.
Although I noted that economics is probably the leading discipline within strategic
management, there is still some dispute in the relevant literature over its useful
contributions to strategy research. While Kay suggests these have been negligi-
ble
28
, R
UMELT
, T
EECE
and S
CHENDEL
assert they have been substantial
29
. The rea-
son for this difference is, I believe, twofold. First, it stems from an unstated differ-
entiation between neoclassical microeconommics and "new" microeconomics. In
fact, neoclassical microeconomics, as it was perceived by scholars like Marshall,
not only contributed nothing to strategic management research or practice, it
would even deny the necessity of any investigation into the reasons why firms
succeed or fail, a question which is at the very heart of strategic management. It is
easy to see why this is true. In the neoclassical world, firms are price takers, they
act as monolithic decision makers, all the relevant information is known to every-
body, a given technology determining a specific production function with in- and
output being bought from and sold to anonymous markets. All that is left to do is to
compute the optimal amount of input such that marginal revenue equals marginal
cost, yielding zero profits for all economic agents in competitive equilibrium a
task, which does certainly not require the attention of a highly-paid manager, let
alone that of a strategist. And, should there ever be some external shock to the
economy, the new equilibrium is quickly determined by means of comparative
statics analysis. A situation R
UMELT
et al. quite fittingly call "a truly amazing victory
of doctrine over reality"
30
. But R
UMELT
et al. also note five forces that have found
their way into economic reasoning during the last three decades and profoundly
changed the face of microeconomics. They are: uncertainty, information asymme-
try, bounded rationality, opportunism and asset specificity
31
. Before that reorienta-
tion towards (partially) more realistic assumptions, economics already started to
27 Saloner (1991), p. 120.
28 Kay (1993), p.362.
29 Rumelt et al. (1991), p. 5.
30 Rumelt et al. (1991), p. 13.
31 Rumelt et al. (1991), p. 13.
Strategic management and the strategist
13
have a significant impact on strategic management in the 70's and 80's, when
Porter, building on the insights of Mason and Bain, introduced his five forces
framework and enabled practitioners to transfer the knowledge of IO to problems
of corporate and business strategy. The acknowledgement of the "imperfections"
of the market, however, as I mentioned them, brought about completely new
branches of economics, enabling researchers to leave the predominant domain of
IO, i.e. the external world, and start analysing the inside of the firm. Most notable
are transaction cost economics (TCE) and agency theory, which together are also
referred to as organisational economics or managerial economics.
Put simply, TCE seeks to explain, why organisations exist. TCE views hierarchies
as organisational alternatives to markets, the attractiveness of either depending on
the amount of transaction costs incurred. It is premised on a set of assumptions,
particularly on bounded rationality, opportunism, uncertainty and asset specificity.
TCE has been brought to bear on a number of substantial issues in strategic man-
agement, such as the analysis of the M (multidivisional)-form as well as on "hybrid"
forms of organisation (joint ventures, franchising, licensing etc.).
Agency theory, on the other hand, resting primarily on the assumptions of oppor-
tunism and asymmetric information, states that there is a conflict of interest be-
tween principals (shareholders) and managers (agents), due to the separation of
ownership and control. According to theory, managers will pursue their own inter-
ests, even at the expense of shareholders. Agency theory has been applied to
topics such as innovation, corporate governance, diversification and executive
compensation.
Also, the extensive use of game theory has marked the transition of what is now
known as "classical" IO to"new" IO. Classical IO was mainly concerned with a de-
scription of the market by referring to its structure, the behaviour of economic
agents and the resulting performance (SCP)
32
. As B
AIN
put it, IO is about the
"economywide complex of business enterprises ... in their function as suppliers,
sellers, or buyers, of goods and services of every sort produced by enterprises"
and "the environmental settings within which enterprises operate and in how they
behave in these settings as producers, sellers, and buyers". That approach was
32 Jacquemin (1987), p. 1.
Strategic management and the strategist
14
mainly "external", while the "primary unit of analysis was the industry or competing
groups of firms, rather than either the individual firm or the economywide aggre-
gate of enterprises"
33
. J
ACQUEMIN
notes that classical IO was suffering from two
basic shortcomings, one being theoretical, the other empirical. On the theoretical
side, the theory neglected economic behaviour of agents, assuming passive ad-
justment to the industrial environment. Performance could thus be directly related
to structure, overriding conduct. Besides, the old model was devoid of any interac-
tion between agents, lacking any concepts of dynamic competition. Empirically,
classical IO relied heavily on econometrics, especially cross-sectional industry
studies, which sought to discover statistical links between chosen indicators, e.g.
profit rate and degree of concentration. J
ACQUEMIN
speaks of a "weak" approach,
as the choice of explanatory variables was not based on an underlying general
model but was instead of an "ad hoc" fashion
34
. Game theory and the new IO have
sought remedies for the above mentioned drawbacks by explicitly modelling com-
petitive behaviour and oligopolistic interdependence by means of cooperative and
noncooperative games. Empirically, the inter-industry analysis has been comple-
mented by time series analyses of the same industry and intra-industrial compari-
sons.
Other fields, such as evolutionary economics, might also merit inclusion at this
point, but this is not an essay on economics as such. Before I go on to the short-
comings of economic models, however, I would like to summarise the major bene-
fits to strategic management that can be credited to the application of the "new"
economics:
1. In addition to any advancement of strategy theory economics has produced, it
has brought about a general shift in research style within strategic manage-
ment. While during the early stage of strategic management as an academic
discipline, emphasis has been placed on case study analysis and generalisa-
tion via induction
35
, the increasing need to interpret a wide array of industry
data
36
led to the use of econometric tools and subsequent deductive reasoning
33 Bain (1968), p. vii.
34 Jacquemin (1987), p.4.
35 Chandler (1969), p. 5.
36 e.g. Hatten, Schendel ,& Cooper (1978).