Marchoud 1 Aida Marchoud April 16, 2008 Econ 442.001 Business (Managerial) Economics

Business/Managerial economics “applies economic theories, tools, and techniques to administrative and business decision making” (Managerial Economics.). The decision making process starts out with gathering economic data to make better managerial decisions. These decisions involve trying to make the company more efficient by seeing whether the company should hire and train more employees or fire employees, divesting or investing in departments, merging or acquiring companies, etc. Michael Porter and Clayton Christensen have influenced the business economy with their theories. This paper will introduce Porter and Christensen and their theories and its impact on business today. Michael Porter was born in Ann Arbor, Michigan in 1947. Went to Princeton and Harvard and trained as an economist. He was a lecturer at Harvard and then became a professor in 1982 (Michael Porter Biography). He has written various articles and books and has won prestigious awards. He has written 17 books and 125 articles on things pertaining to business, most of it dealing with competition and how to gain an upper hand in the market. Some of his awards include four time recipient of the McKinsey Award with three first place honors; the 1997 Adam Smith Award of the National Association of Business Economists; etc (Michael Porter). Two important concepts have interjected themselves in the business world Porter’s Five Forces Model and his thoughts on Competitive Advantage. Porters Five Forces model is way for a company to evaluate an industry, to see if the company will be able to gain a profit from the industry. Force number one is rivalry. In economics, rivalry states that all companies in the industry will gain a profit of zero in the long run. “Economists measure rivalry by indicators of industry concentration” (Strategic Management). Industry concentration means how many competitors are concentrated in the Industry, is the industry saturated or is there room for a new competitor/rival. Numerous factors influence the rivalry part of the model. The first factor is a large number of firms because more firms mean more competition for customers and resources. The second factor is slow market growth, which means firms will fight for more market share. The third factor is high fixed costs means that most of the costs are fixed and the firm must adopt economies of scale just to decrease unit costs, which increases rivalry. The fourth factor is high storage costs or highly perishable products adopt a just-in-time inventory, where the company sells their products as they get them. This causes competition for customers. The fifth factor is low switching costs pertains to a customer switching from one companies product to another companies product, both products being similar. The sixth factor is low levels of product differentiation factor five and six could be interchangeable because low levels of differentiation can cause low switching costs or vice versa. The seventh factor is strategic stakes are high this is when a firm loses their market position or has potential for great gains. The eighth factor is high exit barriers when the cost of exiting an industry is more than the loss a firm receives by staying in the industry. This usually happens with highly specialized manufacturing equipment that only belongs to the industry and becomes hard to sell these assets. The ninth factor is a diversity of rivals means that numerous firms with different cultures, philosophies, etc make the market of unstable because the firms that compete with each other use different strategies that one firm may find offensive and so on. The final factor is industry stakeout which means that the demand of the customers cannot support the competitors in the industry; this causes some firms to lose profits and cause them to go bankrupt. (Strategic Management) Force number two is threat of substitutes. The threat of substitutes is affected by price competition among other industries. Substitutes allow a product to become more price elastic. For example there are many different kinds of cereal to choose from the variety contributes to more price elasticity. An example of inelasticity is the gasoline industry; there are no substitutes to gasoline, which does not give customers options to a different type of fuel. The more you can differentiate a product, the less threat of substitutes that you have. Another contribution to the threat of substitution is new technology. For example I-Tunes are a substitute to CDs which were substitutes to tapes, so on and so on. Force number three is buyer power. This is self explanatory customers have power in an industry when there is competition. Customers create the demand and the money needed to allow the industry to survive. Firms have to be careful that the industry does not become a monopsony where there are many suppliers, but one buyer. Buyers are weak when there is a monopoly because they have no choice and have to pay for the product or service at whatever price is set. Force number four is Supplier power. Suppliers have control over the raw materials, labor, and other things necessary to produce a product. Suppliers provide these things to the firms, most likely producing firms, so the firms could make their products and sell them. Suppliers have immense power in an industry if there is more than one firm to buy from them. Switching suppliers can be high cost, and can outweigh the benefit of going with a new supplier. Force number five is Barriers to entry and/or threat of entry. The threat of entry in an industry is “easy to enter if there was common technology, little brand franchise, access to distribution channels, and low scale threshold” (Strategic Management). Firms do not like new entrants competing for the market share and customers. Barriers to entry in an industry are “patented or propriety know-how, difficulty in brand switching, restricted distribution channels, high scale threshold” (Strategic Management). Firms use their resources to restrict entry into an industry by using the government laws and if there is specialty equipment, which can cost a lot of money that firms starting out, do not have. Another theory of Porter his version of how to achieve competitive advantage compared to competitive scope. According to Porter there are three strategies of competitive advantage. Strategy one is Cost leadership. A good example of a company who is a cost leader is Wal-Mart. Cost leadership means that a company in an industry is the only low cost company because if there were more than two then it is bad and could be disastrous. To be able to be a cost leader, using economies of scale becomes really important Marchoud 2 because it reduces per unit costs. This allows the company to pass what they save on costs to their prices. Strategy two is Differentiation. It is really important to have products that are different from other products in the same industry. Firms do not necessarily have to change their product to achieve differentiation. They can have the same product, but the way they advertise it can make a product different from another product from a different firm. The third strategy is focus; there are two type of focus; differentiation and cost. “Achieving focus means that a firm sets out to be best in a segment or a group of segments” (Competitive Advantage (Porter)). The last is the stuck in the middle. This may sound good because it may seem like taking the best of all the possible strategies, but without being concentrated on one strategy the firm becomes mediocre. As seen in the previous paragraphs Porter has contributed a lot in business economics. His ideas are used and taught. Porter’s five forces model and competitive strategy matrix have been taught to business majors as early as introductory management. Top business managers use Porter’s ideas to get further in the market and increase profits. Another important man is Clayton Christensen. He was born in Salt Lake City. He went on his mission in the Republic of Korea for his religion, The Church of Jesus Christ of Latter-Day Saints (Mormonism). He speaks fluent Korean. He received the highest honor in economics at Brigham Young University. He won the Mckinsey award in 1995 and 2001 (Biography). He currently teaches at Harvard Business School along with Michael Porter. His theory of disruptive technologies is well known. Disruptive Technologies are “innovations that result in worse product performance, at least in the near term” (The Innovator’s Dilemma). Christensen believes that bigger firms are more susceptible to disruptive technologies because they want to cut prices by using cheaper, easy to use, and used a lot. These products allow a firm to slip into inefficient territory. These technologies contribute to “The Innovator’s Dilemma”, which “describes a theory about how large, outstanding firms can fail ‘by doing everything right’” (The Innovator’s Dilemma). It happens less frequently than sustaining technologies. When big firms are used to these disruptive technologies, it hinders innovation allowing new and better technology to slip away. Those firms, who are prepared with sustaining technologies, get left in the dust because disruptive technologies will not allow sustaining technologies to work. An example of disruptive technology is Microsoft Office. Everybody uses Microsoft Office, by no means is Microsoft Office the best or has come out with new versions that are more innovative, but if you do not have this technology there is no way to function as a business because everybody has Microsoft Office. What most companies do use is sustaining technologies, which are technologies that improve a company’s performance. Most firms use sustaining technologies well and even improve upon these technologies. Christensen advises, “…firms need to provide experimental groups within the company a freer rein” (The Innovator’s Dilemma). What he means is that companies need to let the people in Research and Development do what they were hired to research test out their hypotheses with a certain technology. Give the researchers the space and time to develop a sustaining technology and decrease “The Innovator’s Dilemma”. The larger firms need to be careful of disruptive technologies and keep improving and expanding upon sustaining technologies. Business economics play an important role in business decisions, cycles, pricing, and etc. Michael Porter’s “Five Forces Model” and “Competitive Strategy Matrix” are the most well known to business students because it has been taught throughout many business courses. Christensen’s “Disruptive Technologies” not less important by no means, but not as well known. Both men have done many substantial things in the subjects of business and economics. Both men make very good points and have both contributed to current business practices and strategies. Business economics is too broad because it encompasses what makes businesses successful or how to achieve success in a firm’s current industry. As everyone can see these theories have forces in the real world. Wal-Mart is a cost leader, Apple is great in differentiating a product by design and marketing, Microsoft Office is a disruptive technology that businesses and people have to work with in order to be successful, and Cars are a sustaining technology because they are constantly improving and being innovative.

Works Cited

Biography. 6 April 2008. Clayton M. Christensen. 2003.

Competitive Advantage (Porter). 6 April. 2008. 12 Manage: The Executive Fast Track. 25 March 2008.

Managerial Economics. 6 April 2008. Encyclopedia of Business 2nd Edition. 2006.

Michael Porter. 6 April 2008. Global Leaders.

Michael Porter Biography. 6 April 2008. Online 1911 Encyclopedia Britannica. 2006.

Strategic Management. 6 April 2008. Strategic Management: Knowledge to Power Your Business. 1999-2007. < http://www. Strategic Management .com/strategy/porter.shtml>

The Innovator’s Dilemma. 6 April 2008. Teradyne’s Aurora Project.