Flexibility in Capability: Competitive Strategies and Market Dynamics

1. CompetinginCapabilities

2. The Final Element… • Since elements of know-how do not map one-to-one into products, it follows that any set of capabilities may imply a relative advantage in producing products other than those currently offered… • So the third and final element of capability is ‘flexibility’ • We can see this using the (simplest possible) example of the ABC model above

3. Investing in Capability We consider a model in which a firm can choose between mastering directly the know-how required to manufacture a specific product, or alternatively investing in the know-how of underlying technologies which will allow it to learn (at relatively low additional cost) how to produce certain specific products.

4. The Model: • Demand is concentrated in any period on a single product variety. Offering this variety yields payoff 1 in this period. • Only one firm is active (on each ‘island’ submarket). • Over successive periods, a switch may occur to the next product in the sequence X, Y …… • Whether such a switch occurs is determined by the indicator variable x (1 = switch, 0 = stay).

5. Strategies: Initially demand is for X. On entering, a firm can pay a setup cost C to produce X (the FIX strategy) or a setup cost 2c>C to acquire know-how elements A and B (the FLEX strategy). The firms payoff is the discounted sum of profits less costs.

6. FIX Strategy (investment cost c) Unit Cost Z X Y C c Z X Y C c A B C D FLEX Strategy (investment cost 2c > C)

7. Recall: X Y Trajectories Z W

8. If the firm chooses FIX and demand switches, it competes on equal terms with n potential entrants, and has probability 1/n of being the (sole) supplier of the new good. With probability 1 – (1/n) it exits.

9. If the firm chooses FLEX, the incremental cost of producing the next good is lower than the setup cost of a new entrant. The FLEX firm will remain as incumbent.

10. The market over time: Consider a set of independent (‘island’) submarkets, each with a single (FLEX or FIX) incumbent. A firms choice of FLEX or FIX depends on its belief as to whether (one or more) switch(es) will occur.

11. best for FIX best for FLEX

12. Model A: We assign beliefs over the hidden probability p Results: There is a zone where some firms play FLEX… and a zone where all firms play FIX

13. Model B: No expectations can be formed. No ex-ante expected profit can be defined. Instead we define a (series of) action(s) as ‘reasonable if they are ex-post undominated on some trajectory. We assume all reasonable (sequences of) action(s) will be chosen by some (subset) of potential entrants.

14. The Main Result In Model B: As T - FLEX dominates on almost all trajectories with probability p arbitrarily close to 1.

15. The Main Result In Model B: As T - FLEX dominates on almost all trajectories with probability p arbitrarily close to 1. - In the neighbourhood of the zone I/II boundary, FLEX is LESS profitable ex post on almost all trajectories.

16. Globalization Revisited: closer to home • Adjustment and survival in US manufacturing… the Schott-Bernard study

18. So who survives? • Key feature of survivor is switching across (5-digit SIC) industries

19. Policy Lessons: A Few Illustrative Points

20. Policy Lessons: A Few Illustrative Points • A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms.

21. Policy Lessons: A Few Illustrative Points • A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms. • ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly.

22. Policy Lessons: A Few Illustrative Points • A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms. • ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly. • A controversial issue: for big countries, ‘Domestic Content Requirement’ can tilt the speed of domestic capability building. (China and India in auto-components).

23. Policy Lessons: A Few Illustrative Points • A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms. • ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly. • A controversial issue: for big countries, ‘Domestic Content Requirement’ can tilt the speed of domestic capability building. (China and India in auto-components). • Governments’ role in capability building: the CII example; the USAID and IFC approach.

24. Policy Lessons: A Few Illustrative Points • A ‘basic’ lesson: improving the general ‘business climate’ reduces non-wage costs and is equivalent to a rise in the capability of all the country’s firms. • ‘Big push’ fallacies: governments are not good at picking winners. Capabilities grow slowly. • A controversial issue: for big countries, ‘Domestic Content Requirement’ can tilt the speed of domestic capability building. (China and India in auto-components). • Governments’ role in capability building: the CII example; the USAID and IFC approach. • The French Debate and ‘Social Europe’.

25. The Bigger Picture • The bottom billion… • Prospects for sub-Saharan Africa • Trade liberalization re-visited

26. Free Trade Free Trade II II III III b (i) b (ii) v/u v/u Case (a) Case (b)

27. From Globalisation to Global Recession • Will the pace of globalisation now slow down? • The big issue : the spectre of protectionism