Foundations of international strategy
lecture 1, chapter 1, Standard Economic Theory:
Division of labour: (Adam Smith) the splitting of composite tasks into their component parts and
having these performed separately. This can lead to increasing the productivity (workmanship, save
time passing to other work, → invention of machines). Division of labour leads to specialization.
Specialization leads to a need for coordination. This coordination takes place in two places:
• Markets: the price system is the coordinating device. The ideal market is characterized by
the fact that prices act as sufficient statistics for individual decision making. Agents (both
buyers and sellers) are “price takers”: they use an externally fixed price : demand=supply.
Or
• Organizations/Firms: (Coase:) Coordination is not done by prices but using authority.
Organizations arise as solutions to information problems. Organizations are more suited to
dealing with certain information problems than are markets. (government, church etc.)
The decision between market or organization depends on the information requirement in the
situation.
Sufficient statistic: the price contains all the information you need to base your transaction on (e.g.
Information about quality, after sale, delivery conditions)
Standard Economic Theory (SET) has its roots in Adam Smith’s work: need for economic exchange,
Division of labor and specialization as optimal way of production, Economic transactions – need for
coordination between buyers and sellers. SET assumptions are:
Market is ideal under certain assumptions:
• Atomicity → many small buyers and sellers
– No one can influence the price
• Free entry/free exit of firms (costless)
– Anyone can enter/exit market without cost
• Perfect information
– Everyone in the market has the full information relevant to the decision on how
much to produce and how much to consume
• Product homogeneity → standardized products (perfect substitutes)
Market participants are “Homo Economicus”: Sellers & Buyers are rational, have COMPLETE
INFORMATION and are self-interested. Sellers and buyer have a unique goal: wealth maximization.
Decision making on markets
Sellers will only sell the product if the market price is bigger than their proposed price and buyers will
only buy if the market price is lower than their proposed price. The buyers and sellers can only
influence the quantities and not the price.
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,Ideal market, Firms
• Firm=Producer
“Black boxes” - holistic entities: single unified entity, no people inside the firm
Can be of any size: small firms, large MNCs
• Firm has a Single goal: profit maximization
• No strategy
Either firms adapt to the environment or they disappear
• Firms are efficient mechanisms to transform inputs into outputs
Firms’ actions are determined by the prices of the inputs/ outputs and not by
managers or employees
Firms cannot make any profit in the long-run: Paradox of Profits= abnormal profits
→ entries from new firms→ increased competition→lower market price→ lower
profits→ normal profits
Management within SET
• Firms cannot change
No need for strategic reasoning; they do not have to make any uncertain decisions
Either firms are adapted to the environment or they disappear
• No room for differentiation = Isomorphism
Same input & output prices = Same costs, same profits for all
Same optimal behaviors & decisions = Same structure
Same scope of activities= same products, presence on the same markets and
countries
• No room for competitive advantage
Innovations, key people,… are available to all firms via market transactions
Everything has a price and may be bought
So in this perfect world no managers are needed.
Standard Economic Theory does not explain:
• Firms’ profits in the long-run:
Why do firms differ in terms of profitability?
• The diversity of strategies / Organizational Behaviors:
E.g., why do some firms internationalize, and others not?
• The diversity of firms’ structures:
Small firms (SMEs) versus large multinational corporations
• The non-profit maximization behaviors (no full rationality)
Sponsorships, Corporate social responsibility (CSR), business ethics, employees
wellness
Are SET assumptions realistic?
• Fully rational behavior? In reality people are not fully rational, do not enjoy full information,
so cannot optimize
• What if the market transactions are not costless? E.g., to make and execute a contract costs
money; information collection costs money
• And most importantly for us, SET does not explain:
If there exists an efficient market for everything, why isn’t every transaction
conducted in the market ?
Why do FIRMS exist ? According to SET Firms provide additional cost economies,
which cannot be reached through market transactions. This is not enough to explain
why firms exist - we need a different view on a firm
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, ..The ideal market (according to SET) is characterized by the following:
• Market transactions use externally fixed market price
• Market prices are by nature fair for all buyers and sellers
• Counterparts always behave as agreed in the exchange contract. If not, they have to pay
costly penalties
• No need to control contracts (i.e. quality, delivery conditions, payment). No cheating
• Contracts are enforced by laws (anti trust laws, patent laws …) and regulation agencies
(governments, international institutions, EU, …)
Yet, SET is unable to explain firm diversity!
Isomorphism: same –optimal-decisions, same structure for all firms in a particular industry
Either firms survive or they disappear→ ADAPTATION IS NOT POSSIBLE
In this ideal world no managers are needed.
Six Organizational Mechanisms , (H. Mintzberg, 1983)
• Direct supervision:
One person (entrepreneur) gives orders or instructions to several others, one step at
a time
Owner directs production and allocation of resources
Inefficient as an organization grows
Entrepreneurial organization. E.g., any small firm with entrepreneur=CEO
• Standardization of work processes:
Specify work processes of people carrying out interrelated tasks - “How to work “
Production routines leading to standard inputs, e.g. packaging
Machine organization. E.g., McDonalds
• Standardization of outputs:
Specifies the results, but not the way they should be achieved.
Output expectations for divisions, but autonomy in how to attain these goals.
Diversified organization. E.g., GE, Unilever
• Standardization of skills (or knowledge):
Work is coordinated by virtue of related training (impossible to standardize work
process, as it requires creativity)
Well-trained individuals
Professional organization. E.g., lawyers, accounting firms, hospitals, school systems
• Standardization of norms:
Norms (ideology) and the same set of beliefs shared across organizational members.
Standardization of norms. Strong values and culture.
Missionary organization e.g., Church
• Mutual adjustment:
Informal communication, flexible structure, encourages creativity and innovation
Trust-based organizations
Innovative organizations. e.g., Google
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