ECON 407 Study Guide: Chapters 8-10

Comprehensive vocabulary flashcards covering Michael Porter's Five Forces, Brandenburger and Nalebuff's Value Net, value creation equations, competitive positioning, signaling mechanisms, and quality certification from ECON 407 Chapters 8, 9, and 10.

Five Forces

Michael Porter's industry analysis framework consisting of internal rivalry, entry, substitutes and complements, supplier power, and buyer power, which collectively determine industry profitability.

Internal rivalry

Competition for market share among existing firms on price or non-price dimensions. Price competition erodes price-cost margins and is intensified by numerous sellers, undifferentiated products, excess capacity, and cost advantages that tempt price cutting.

Entry

A competitive force that harms incumbent firms by eroding market share and intensifying internal rivalry, thereby reducing the price-cost margin.

Exogenous barriers

Barriers to entry that are established by the intrinsic nature and characteristics of the industry itself.

Endogenous barriers

Barriers to entry that are deliberately created by the strategic choices and actions of incumbent firms.

Substitutes

Alternative goods or services that erode demand for an industry's output, exerting stronger downward pressure on profits when the price elasticity of demand is large.

Complements

Products that increase demand for an industry's output when used in conjunction with it.

Supplier power

The ability of upstream input providers to capture profits by charging higher prices. Operates indirectly in competitive markets and directly in less competitive markets.

Buyer power

The ability of downstream buyers to negotiate lower prices or better terms, operating indirectly in competitive markets and directly via buyer concentration or relationship-specific assets.

Tapered integration

A strategy where a firm partly produces an input in-house and partly buys it from external suppliers (or partly sells through internal vs. external channels) to reduce supplier or buyer leverage.

Value Net

A strategic map developed by Brandenburger and Nalebuff that includes suppliers, customers, competitors, and complementors, supplementing the Five Forces by identifying mutual opportunities rather than solely threats.

Coopetition

The simultaneous presence of cooperation and competition between firms, recognizing that inter-firm interactions can yield positive or negative outcomes.

Herfindahl index (HHI)

A measure of market concentration. In the Chicago hospitals case, consolidation caused the index to rise to $0.20$, yet price rivalry increased because managed care organizations simultaneously raised buyer power and price elasticity.

Value created

The total economic surplus generated by a transaction, represented by $\text{Value created} = B - C = (B - P) + (P - C)$, where $B$ is perceived benefit, $P$ is price, and $C$ is cost.

Maximum willingness to pay ($B$)

The perceived consumer benefit, defined as the exact monetary price at which a consumer is indifferent between purchasing a product and not purchasing it.

Consumer surplus

The net utility gained by a buyer from a transaction, calculated as $B - P$. It must be positive for a sale to occur, and consumers choose the product offering the largest consumer surplus.

Producer surplus

The economic profit earned by a seller on a unit of output, calculated as $P - C$.

Strategic positioning

The specific market approach a firm adopts relative to competitors in the same industry, resulting in differences in profitability and long-term survival odds.

Competitive advantage

The ability of a firm to earn higher economic profit than the industry average, determined jointly by overall market attractiveness and the firm's economic value created ($B - C$).

Value map

A graphical representation that plots competing products by consumer surplus to evaluate whether products are at surplus parity, offer superior surplus, or offer inferior surplus.

Viability

The economic feasibility of a product; if $B - C$ is negative, the product is economically unviable, whereas if $B - C$ is positive, a mutually beneficial transaction is possible.

Consonance analysis

A forward-looking strategic evaluation assessing whether a firm can sustain value creation in the face of changing consumer demand, emerging technologies, and potential moves from internal and external rivals.

Value chain

The conceptual model viewing a firm as a collection of distinct value-creating activities, each capable of raising perceived benefit ($B$) or reducing cost ($C$).

Resources

Specialized, durable firm-specific assets such as active patents or established brand reputations.

Capabilities

Organizational activities performed superiorly to rivals that are transferable across markets, embedded in organizational routines that survive employee turnover, and grounded in tacit knowledge.

Cost leadership

A generic positioning strategy centered on achieving lower cost ($C$) while maintaining benefit parity (same $B$) or benefit proximity (slightly lower $B$ for a substantially lower $C$), earning higher margins at consumer surplus parity.

Benefit leadership

A generic positioning strategy centered on achieving higher perceived benefit ($B$) while maintaining cost parity (same $C$) or cost proximity (slightly higher $C$ for a much higher $B$), capturing profits via a price premium.

Stuck in the middle

Michael Porter's warning that attempting to pursue cost and benefit leadership concurrently leads to unfocused decision-making, compromise, and uninspired imitation, though some high-quality firms achieve both via scale and learning.

Broad coverage

A generic scope strategy that offers a full product line across multiple customer groups to exploit economies of scope across production, distribution, and marketing.

Focus strategies

Niche generic strategies based on specialization: customer specialization (broad product line to narrow customers), product specialization (narrow product line to broad customers), or geographic specialization.

Horizontal differentiation

Product differentiation where design changes cause only a subset of consumers to perceive an increase in benefit due to differing individual tastes (e.g., location, style, age preferences).

Vertical differentiation

Product differentiation that universally increases perceived benefit for all consumers, such that every buyer would choose it if price were held equal.

Sequential search

A consumer search pattern where a buyer sets a reservation threshold for consumer surplus ($B - P$) and stops to purchase from the very first seller that meets or exceeds that threshold.

Simultaneous search

A consumer search pattern where multiple sellers are evaluated concurrently before purchasing, an approach made standard by the internet's reduction of search costs.

Search good

A product whose attributes and quality can be easily inspected and verified prior to purchase, leading firms to compete primarily on price (e.g., gasoline, printer paper, batteries).

Experience good

A product whose true quality can only be assessed after purchase and during consumption (e.g., automobiles, consumer electronics, restaurants, movies).

Credence good

A good or service whose quality is difficult or impossible for consumers to accurately evaluate even after consumption (e.g., automobile repairs, medical procedures, higher education).

Unraveling (disclosure)

A voluntary market dynamic where the highest-quality seller discloses its quality first, compelling the next-highest to disclose to avoid being presumed the lowest, cascading all the way down provided self-assessment costs are negligible.

Warranty

A credible signal of product quality that is informative only when the cost structure makes offering it profitable for high-quality sellers but prohibitively expensive for low-quality sellers.

Report card

A standardized, codified quality assessment published by an independent certifier (e.g., Consumer Reports, Underwriters Bureau) designed to reduce information asymmetries, create consumer value, and capture profit.

Multitasking (teaching to the test)

A principal-agent distortion where monitored agents reallocate effort toward measured dimensions and neglect unmeasured quality dimensions when high-powered incentives are applied.

Outcome measures

Performance metrics that directly measure final results valued by consumers (e.g., student test scores), which are often noisy and subject to unrepresentative feedback.

Process measures

Performance metrics tracking specific executed actions or tasks (e.g., completing 180 days of an assigned protocol), favored when outcome measures are noisy, unavailable, or easily manipulated.

Input measures

Performance metrics evaluating the resources deployed in service delivery (e.g., using an approved textbook), useful when outcomes cannot be cleanly isolated or multitasking distortion is severe.

Risk adjustment

The statistical calibration of raw performance outcomes to control for exogenous factors outside the provider's direct control (e.g., controlling airline on-time arrival for weather conditions or route networks).

Gaming

Strategic behavior where low-quality sellers manipulate report card criteria because altering the score directly is cheaper than making genuine quality improvements.

Certification bias

A fundamental conflict of interest where a certifier's neutrality is compromised because the certified entity pays the rating fee or supplies the performance data directly.

Matchmaking

The process of certifying and recommending horizontally differentiated goods by aggregating preference data from consumers with similar demographic or personal profiles.

Shopping problem

consumer must find the seller offering the highest B - P.