03/11/16
25E52000 Market Entry Strategies
for Entrepreneurial Business
Introduction to the Course
Introduction
CONTENT, SCHEDULE AND TIPS & TRICKS
1
03/11/16
Learning Objectives
—  Economics-driven strategic analysis to evaluate
markets for successful entry and sustainable
competitive advantage
÷ Market
and competitive analysis
÷ Strategic positioning and dynamics
Examples of Questions We Will Study
—  What components of a product or service should be
produced in-house and which ones should be
bought from outside suppliers?
—  What economic forces influence industry profits?
—  How would competitors respond to a strategic
choice such as a price cut, or a new entrant?
—  What strategic positioning – cost, differentiation
or focus – creates a sustainable competitive
advantage under what circumstances?
2
03/11/16
The Five-Forces Framework
Study Material
Textbook
Cases
Besanko, David, Dranove, David, Shanley, Mark,
& Schaefer, Mark (2013). Economics of Strategy.
6th Edition International Student Version. Wiley.
Four cases will be available in
MyCourses after the first lecture.
It is essential to read the case
prior to the class where it is
discussed!
3
03/11/16
Timetable
Class Participation and Format
—  Participation is not mandatory but recommended
—  Format
¡ 
¡ 
First class is an introduction
Classes 2-6 follow the format
Case discussion
÷  Lecture
÷ 
—  If you attend classes, please
¡  Do so regularly
¡  Read the case in advance
¡  Think about the case assignment questions in advance
¡  Be prepared to discuss the case in class
¡  Sit in the front rows when in class
¡  Reading the textbook chapter before class is optional
4
03/11/16
How to Complete the Course
—  There are 100+10 points up for grabs: 50 or more are needed to pass
¡ 
Individual assignment: 0-50 points
÷ 
÷ 
÷ 
¡ 
Group assignment: 0-50 points
÷ 
÷ 
÷ 
÷ 
÷ 
¡ 
Short reports of 1000-1500 words on three cases: Slavic Treasures, Research in
Motion, and The Londoner
Focus on application of theory on the questions presented in the syllabus
Submit all three case reports as a single PDF document by 18 December
1-3 students per group; 4000 words
Full analysis of market and competitive environment including strategy
recommendations for sustainable competitive advantage
Flybaboo case or own business idea
Apply the whole breadth of material covered in the course – see the list of questions
in the syllabus for a guideline
One student per group submits the report as a PDF document by 18 December
Class participation: 0-10 points
Questions
—  Preferably post questions to the News forum in MyCourses so that
other students benefit from them too
—  Alternatively e-mail the lecturer
—  Before posting or sending e-mails remember to check the syllabus!
5
03/11/16
25E52000 Market Entry Strategies
for Entrepreneurial Business
Lecture 1
Horizontal Boundaries of the Firm:
Economies of Scale and Scope
Based on Chapter 2 in Besanko et al. (2013).
Economics of Strategy. Sixth Edition. Wiley.
Learning Objectives
—  Understand factors that create cost advantages
—  This is essential knowledge for the rest of the course
—  Principal concepts
¡  Fixed, variable, average and marginal costs
¡  Economies of scale
¡  Economies of scope
¡  Learning curve
¡  Minimum efficient scale (MES)
6
03/11/16
Horizontal Boundaries of the Firm
—  How big a market does the firm serve?
¡  What
quantities are produced?
¡  How many different products/services are produced?
Horizontal Boundaries of the Firm
—  In some industries a few large corporations
dominate the market
¡ 
e.g. airframe manufacturing (Boeing, Airbus)
—  In others small firms are typical
¡  e.g. website design, architecture
—  Many industries are characterised by a mix of
small and large firms
¡ 
e.g. beer, computer software, restaurants
7
03/11/16
Which Factors Define Horizontal Boundaries?
—  Economies of scale
¡  When a firm produces more, the average cost of a unit of
production decreases
—  Economies of scope
¡  Producing different products/services in the same firm
leads to cost savings
—  Learning curve
¡  Cost advantage emerges from cumulative knowledge and
skills
Types of Costs
—  Fixed costs (FC)
¡  Do not vary with quantity produced
¡  e.g. administrative expenses, R&D, rents
¡  Semi-fixed costs vary with intervals of quantity
—  Variable costs (VC)
¡  Vary with production quantity
¡  e.g. raw materials, direct labour costs, commissions
—  Total cost (TC)
¡  TC(Q) = FC + VC(Q)
8
03/11/16
Example: Jane’s microbrewery
—  Fixed costs (FC)
¡  Rent (per month): €800
¡  Brewing equipment (5 years lifetime, per month): €200
¡  One employee’s salary: €3000
¡  Monthly FC = €800 + €200 + €3000 = €4000
—  Variable costs (VC)
¡  Ingredients and packaging per case of beer: €5
¡  Assume Jane can produce 1000 cases of beer per month
¡  Monthly VC(1000): €5*1000 = €5000
—  Total cost (TC)
¡  TC(Q) = FC + VC(Q) = €4000 + (€5*1000) = €9000
Types of Costs
—  Average cost (AC)
¡  How a firm’s average cost per unit produced varies at
different levels of output
¡  AC(Q) = TC(Q)/Q
—  Marginal cost (MC)
¡  How production quantity affects total cost
¡  Additional cost caused by producing one more unit of
output
¡  MC(∆Q) = [TC(Q+∆Q) – TC(Q)] / ∆Q
9
03/11/16
Example: Jane’s microbrewery
—  Jane can produce 1000 cases of beer per month
¡  FC = €4000
¡  VC(Q) = €5Q
¡  TC(1000) = €4000 + (€5*1000) = €9000
—  Average cost of a case (AC)
¡  AC(Q) = TC(Q)/Q
¡  AC(1000) = €9000/1000 = €9
—  What if Jane could produce an additional 500 cases per
month by increasing her own work effort (=same FC)?
¡ 
¡ 
TC (1500) = €4000 + (€5*1500) = €11,500
AC(1500) = €11,500/1500 = €7.67
Example: Jane’s microbrewery
—  What is the marginal cost of those additional 500 cases of beer?
¡ 
¡ 
¡ 
¡ 
¡ 
¡ 
MC(∆Q) = [TC(Q+∆Q) – TC(Q)] / ∆Q
TC(Q+∆Q) = TC(1500) = €11,500
TC(Q) = €9000
MC(500) = (€11,500 - €9000) / 500 = €5
Each additional unit produced in the range of 1000 to 1500 costs Jane €5
Why is MC=€5?
—  What if Jane had to hire an additional employee for the additional 500
cases?
¡ 
¡ 
¡ 
¡ 
FC = €4000 + €3000 = €7000
TC(1500) = €7000 + (€5*1500) = €14,500
AC(1500) = €14,500 / 1500 = €9.67
MC(500) = (€14,500 - €9000) / 500 = €11
10
03/11/16
Economies of Scale
—  When the marginal cost is less than average cost
(MC < AC), there are economies of scale
¡ 
Average cost declines with increasing output
—  If average cost increases with output (MC > AC) we
have diseconomies of scale
¡ 
Average cost increases with increasing output
—  Constant returns to scale (MC = AC)
¡  Increasing output neither increases nor decreases average
cost
Example: Jane’s microbrewery
—  Jane realised economies of scale in the original scenario where
¡ 
¡ 
¡ 
¡ 
¡ 
¡ 
FC = €4000
VC = €5(Q)
Q = 1000
AC(1000) = €9
MC(1000) = €5
MC < AC
—  By increasing her work effort, she also realised economies of scale when
producing an additional 500 cases of beer
¡ 
¡ 
¡ 
AC(1500) = €7.67
MC(500) = €5
MC < AC
—  But if she had to hire an additional employee for the 500 cases, she would incur
diseconomies of scale
¡ 
¡ 
¡ 
AC(1500) = €9.67
MC(500) = €11
MC > AC
11
03/11/16
U-Shaped Cost Curve
—  Average cost declines as fixed
costs are spread over larger
volumes
—  Average cost eventually starts
increasing as capacity
constraints kick in
—  This curve implies that small
and large firms are in a cost
disadvantage
L-Shaped Cost Curve
—  In reality, cost curves are closer to being L-shaped
than U-shaped
—  Large firms are rarely at a cost disadvantage
relative to smaller firms
—  A minimum efficient scale (MES) beyond which
average costs are identical across firms
12
03/11/16
L-Shaped Cost Curve
—  In reality, cost curves are closer
to being L-shaped in the long
run even if they can be Ushaped in the short run
—  Large firms are rarely at a cost
disadvantage relative to smaller
firms
—  A minimum efficient scale
(MES) beyond which average
costs are identical across firms
—  In order to be efficient in a
given market, the firm has to
reach the size where Q=MES.
Economies of Scope
—  It is cheaper for one firm to produce both X and Y than for two different
firms to specialize in X and Y each
¡ 
TC(QX, QY) < TC(QX, 0) + TC(0, QY)
—  Example
¡ 
¡ 
¡ 
¡ 
¡ 
Emma produces beer and cider
Jane produces only beer
Martin produces only cider
If Emma can produce both beer and cider more cheaply than Jane and
Martin only beer or cider, Emma enjoys economies of scope
Emma could realise cost advatage for example by
÷ 
÷ 
÷ 
÷ 
÷ 
Leveraging her beverage production knowledge for both beer and cider
Using the same production facilities
Purchasing e.g. bottles in larger volumes
Using the same distribution channels
Advertising both products in the same media
13
03/11/16
Some Sources of Economies of Scale/Scope
—  Spreading of fixed costs
—  Saving on inventories
—  The cube-square rule
—  Advertising
—  R&D
—  Purchasing power
—  Umbrella branding
Diseconomies of Scale
—  Beyond a certain size, bigger may not always
be better
—  Some sources of such diseconomies
¡  Increasing
labour costs
¡  Spreading specialized resources too thin
¡  Bureaucracy: incentive and coordination effects
14
03/11/16
QUIZ TIME!
The Learning Curve
—  Learning economies are distinct from economies of scale &
scope
¡ 
¡ 
Economies of scale and scope are based on rate of output at a certain
time
Learning economies depend on cumulative output (know-how,
experience)
—  Learning leads to lower costs, higher quality and more
effective pricing and marketing
—  Complex labour intensive processes can offer learning
economies without economies of scale or scope
15
03/11/16
The Learning Curve
—  Learning benefits can be
expressed with the slope of the
learning curve
—  The slope of a process is the
relative size of the average cost
when cumulative output
doubles
—  A slope of 0.8 indicates that the
average cost will decline by
20% when the cumulative
output doubles
—  Learning flattens out over time
and the slope eventually
becomes 1.0
Example: Learning Strategy
—  Manufacturer of computer memory chips
—  Current situation
¡ 
¡ 
¡ 
¡ 
The firm’s cumulative production to date is 10,000 chips
MC = €2.50
The firm believes that its AC will reduce to €2 once they have
manufactured 20,000 chips; AC will not decrease further than that
The firm has orders for 200,000 chips
16
03/11/16
Example: Learning Strategy
—  The firm receives an opportunity to fill an immediate additional order
of 10,000 chips
—  What is the lowest price the firm can accept?
¡ 
¡ 
Generally, accept if P > MC
So accept of P > €2.50?
—  But - €2,50 is not the real MC even if it holds for the next 10,000 units
¡ 
¡ 
¡ 
¡ 
AC decreases by 20% from €2.50 to €2 when the firm produces the next
10,000 units
The slope of the learning curve between 10,000 and 20,000 units is 0.8
No further learning economies after 20,000 units
The additional order would therefore realise the possible learning economy
Example: Learning Strategy
—  Scenario 1: the firm rejects the additional order
¡ 
¡ 
¡ 
The first 10,000 chips cost €2.50 each
The remaining 190,000 costs €2 each
TC(200,000) = €405.000
—  Scenario 2: the firm accepts the additional order
¡ 
¡ 
¡ 
¡ 
TC of the additional order (€2.50*10,000) = €25.000
Original order of 200,000 chips at AC=€2 = €400.000
So TC of 210,000 chips is €425,000
The real cost of the additional order is €20.000 because it generates a
saving of €5,000 for the original order
—  The firm should accept the additional order if P > €2
¡ 
Because the real MC of producing additional 10,000 units is €2
17