Wednesday, January 26, 2011
Class #2 Key Takeaways
In class #2, we started talking about the fundamental rule of thinking strategically--look forward and reason back. We illustrated this in two ways. First, in durable goods industries, often competition comes from future "selves" of the firm. For instance, a firm selling a technology product can look forward and anticipate that it will want to cut prices in the future.
Reasoning back, this will affect the purchase decisions of today's consumers and hence optimal pricing policy. The result of this future competition is to erode today's margins. One solution to this problem is price protection. By "changing the game" for its future selves, it reduces the temptation to cut price in the future thereby maintaining margins today.
A second version of this idea occurred in the NBA free agency game. Absent the right of first refusal clause, the incumbent can look forward and anticipate strong competition from a rival. Reasoning back, this means that the incumbent must make an aggressive offer today. The competition between the incumbent and the rival allows the player to capture most of the value. The right of first refusal fundamentally changes this. Now, if the rival makes a counter-offer, the incumbent knows it can match this deal. Reasoning back, the rival now has little interest in making offers and hence the incumbent enjoys, effectively, no competition.