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Chapter 8: Economics of Strategy: Creating and Capturing Value
INVESTING IN A NEW RESTAURANT CONCEPT
Discussion Question Answer:
You have worked in the health food industry for ten years. You have relatively good information
about the demand for this type of restaurant, and you have met a variety of people who are likely
to try your restaurant should you open it. You have skills and knowledge about health and food
Your friends are right that there are relatively low entry barriers to the restaurant business. You
also have to worry about existing restaurants quickly copying your concept if it is successful.
With increased competition it may be difficult to maintain the $50 price point. If your success is
based on a talented chef or staff you can anticipate that other employers will try to hire them and
The restaurant business, however, is not perfectly competitive. The product is not homogenous
and consumers differentiate among restaurants on a variety of dimensions (food, service, status,
etc.). You might create some competitive advantages by a successful early entrance (see Chapter
6). For example, you might establish a reputation for good food and service that new entrants can
The statement that “you can’t make profits in a competitive industry” is not entirely correct. It is
true that in a long-run competitive equilibrium firms do not make economic profits. However,
economic profits are possible in the short run. Indeed it is these profits that induce entry. You can
The bottom line is that you can expect intense competition if you are successful. In the long run
it is probably true that you will not continue to earn economic profits. However, it is important to
note that zero economic profits still implies that you are making a competitive return on your
Without more details about your financial analysis it is impossible to tell whether you should
invest in the business. A good analysis would anticipate that you will face competition relatively
quickly if your idea is a success. Nevertheless, it might be a good investment. One important
LEAVING NEW YORK CITY FOR THE FARMLANDS OF ILLINOIS
Discussion Question Answer:
Be careful when someone tells you that an investment will yield huge profits with little risk. Low
risk opportunities for huge profits rarely occur in competitive markets.
Your friends are correct that good farm land is limited in supply and that the government actions
are likely to increase the demand for corn and thus the demand and price of farmland. The
information on the government’s actions, however, is widely known. You should expect that this
This example is based on a real world example.1 Consistent with the economic analysis in the
previous paragraph, the price of farmland has increased significantly in Illinois in anticipation of
future increased ethanol production. The current owner of the 80 acres originally purchased the
land at a price of $400/acre. Local real estate consultants attribute the dramatic increase in
The investment is risky and the price of farmland might decrease or increase in the future
depending on how the “ethanol experiment” works out. Thus if you purchase the land your
wealth might increase or decrease as land prices change. In either case, however, you would not
1See Monica Davey (2007), “Ethanol is Feeding Hot Market for Farmland,” nytimes.com
(August 8).
relative to experienced farmers. You might be smart, but do you really think you can quickly
learn the farm business?
Your desire to leave big cities might motivate you to enter the farming business even if you
expect to lose money. However, it is wrong to consider this as a great business opportunity for
WALMART.COM
Discussion Question Answers:
1. Introducing Walmart.com should lower customer-borne transaction costs by giving them an
additional channel to purchase products — via the web. For those customers using this channel,
their search and information costs about products are lower. They also save time and expense of
2. Walmart.com creates value by reducing customers’ costs of a physical shopping experience
and the information and search costs incurred when deciding which products to buy.
Walmart.com also creates value by capturing economies of scope by more intensively using its
3. Walmart captures the value created by Walmart.com if other firms cannot emulate the
Walmart strategy. If existing e-tailers, such as Amazon.com, can do it cheaper than Walmart,
Walmart will capture little, if any, of the value. One potential problem faced by traditional
bricks-and-mortar retailers such as Walmart and Sears involves local sales taxes. Some states are
claiming that on-line sales in that state must be charged sales tax if the on-line company has a
retail store in the state (especially if the consumer has the right to return merchandise to the retail
store). If these states are successful at collecting sales taxes from Walmart.com customers,
Another way Walmart can capture value is through economies of scale and/or scope created by
the Site-to-Store option where consumers order on line and have free delivery to their local store
where they pick it up. Using Walmart’s highly efficient logistic system, presumably, Walmart can
offer faster and cheaper delivery to their stores than other e-retailers without stores who must
4. It is not obvious that Walmart should have pursued e-commerce vigorously prior to 1999.
Few consumers were on-line prior to 1999, and those that were on-line tended to be more
affluent (not the typical Walmart customer). Note that a potential disconnect exists between
Walmart’s traditional customer base (mid to lower income families) and the higher income
5. On-line, e-commerce businesses jump international borders very quickly. An e-commerce
strategy might give Walmart the ability to enter international markets more quickly and less
In November 2007, Walmart.com announced that it wants to be “the most visited, most valued
online retail site.” Suppose you were hired by an outside consulting firm to evaluate
Factors working in Walmart.com’s favor:
Walmart stores have the reputation for “everyday low prices.” Consumers have come to expect
Walmart to offer low prices, so they will naturally think that Walmart.com follows a similar
Walmart’s purchasing power and logistic system. Given economies of scale and scope, Walmart
Having numerous local stores where internet customers can pick up and return web purchases
with “free” shipping lowers customers’ transaction costs. Whether the shipping is really “free”
depends on how much time consumers must spend driving to their local Walmart, parking, and
Factors working against Walmart.com:
To the extent that online retailers do not have to charge sales tax to consumers if the retailer does
not have a store in that state places Walmart.com at a disadvantage. Since Walmart has stores in
Walmart.com tends to offer the same product mix as its stores. Amazon.com offers a broader
array of products and actually operates as a clearing house whereby other online sellers are able
to list their products and sell through Amazon.com. For example, the music CD “Jazz Icons:
Dave Brubeck Live in '64 & '66” is available as both new and used disks and there are 46
vendors on Amazon selling the used disk. Walmart.com does not offer this CD either new or
used. Likewise, Amazon sells a $700 Nikon camera lens while Walmart.com does not. Walmart’s
ability to offer low prices depends on economies of scale and scope, which may not exist for low
volume products, such as the Nikon lens. A logistic system that is based on high volume products
may not be the low cost system for handling low volume products. Also having many unique
products online might make it costly for the company to continue allowing returns at a store
Can an organization such as Walmart that does one thing superbly, such as selling physical
products through retail stores at low prices, be successful in a new distribution channel such as
online retailing, where this new channel faces focused, highly efficient competitors? The same
