Valuing Limited Information in Decision Making Under Uncertainty

Fresh Juice Inc. (FJI) is in the process of determining whether they should launch a new fruit juice in a market that has been relatively stagnant for the last 15 years. Management of FJI is faced with uncertainty surrounding market share, market size, price, and competitor entry. In addition, FJI has the ability to chose between alternative production processes; this choice directly affects the likelihood the investment will return a positive Net Present Value. This case teaches students how to develop a stochastic simulation models given limited information to analyze risk investment decisions.: simulation, uncertainty, strategic management, flexibility, limited information, investment analysis

Protecting Your Turf: First-mover Advantages as a Barrier to Competitor Innovation

Product innovation for a juice company and its associated first-mover advantages are analyzed. Stochastic simulation is used to model market size, price, competitive intensity, and the likelihood of competitor entry. Results of moving first allow the firm to capture market share, realize first-mover advantages in excess of $2 million, and deter competitor innovation. In addition, the proposed model is flexible enough to be applied in other industries.Product innovation, first-mover advantages, barriers to entry, stochastic simulation, uncertainty, Research and Development/Tech Change/Emerging Technologies,

Law and economics of Microsoft vs. U.S. Department of Justice - New paradigm for antitrust in network markets or inefficient lock-in of antitrust policy?

This paper contains an economic and legal analysis of the lawsuit Microsoft vs. U.S. Department of Justice beginning with the District Court's decision on June 7, 2000 up to the Proposed Final Judgement on November 6, 2001. I found that the courts' underlying economic paradigm regarding the assessment of monopoly power in 'New Economy Network Markets' was strongly influenced by BRIAN W. ARTHUR's theory of path dependence claiming (1) that high-technology markets being subject to network effects generally involve a danger of being locked-in to an inferior technology since winning or losing in a technology race is determined by small early random historical events and not by economic efficiency and (2) that there is almost no possibility to overcome inferior lock-in positions since network (compatibility) effects create insurmountable switching costs protecting the lock-in monopolist. As to Microsoft, it was often claimed that Macintosh would have been the better solution than Windows. The U.S. courts are convinced that rivals such as Linux wouldn't have any chance to overcome Microsoft's lock-in position without any antitrust intervention. However, I argue in accordance with opponents of ARTHUR's work that path dependence theory is only a theoretical curiosity that lacks empirical evidence. The predominance of a certain technology and especially the predominance of Windows in the operating system market is determined by economic efficiency and dominant market positions can be eroded very quickly by providing better quality. There is no empirical indication that network effects protect Microsoft's monopoly as it was claimed by the courts within their 'applications barrier to entry' theory. I claim that current interpretations of the U.S. antitrust law don't meet the requirements of fair competition rules in the 'New Economy'. If plaintiffs and the U.S. Department of Justice are victorious over Microsoft and lock-in theories become generally accepted by courts and market participants, further antitrust lawsuits are going to follow since most markets in the 'New Economy' are subject to network effects and high seller concentration. Strict antitrust policy could dampen economic growth due to investor uncertainty and the impossibility to take advantage of scale-based productivity effects. --Microsoft,antitrust,network effects,path dependence

A Framework for Applied Dynamic Analysis in I.O.

This paper outlines a framework which computes and analyzes the equilibria from a class of dynamic games. The framework dates to Ericson and Pakes (1995), and allows for a finite number of heterogeneous firms, sequential investments with stochastic outcomes, and entry and exit. The equilibrium analyzed is a Markov Perfect equilibrium in the sense of Maskin and Tirole (1988). The simplest version of the framework is supported by a publically accessible computer program which computes equilibrium policies for user-specified primitives, and then analyzes the evolution of the industry from user-specified initial conditions. We begin by outlining the publically accessible framework. It allows for three types of competition in the spot market for current output (specified up to a set of parameter values set by the user), and has modules which allow the user to compare the industry structures generated by the Markov Perfect equilibrium to those that would be generated by a social planner and to those that would be generated by prefect collusion.' Next we review extensions that have been made to the simple framework. These were largely made by other authors who needed to enrich the framework so that it could be used to provide a realistic analysis of particular applied problems. The third section provides a simple way of evaluating the computational burden of the algorithm for a given set of primitives, and then shows that computational constraints are still binding in many applied situations. The last section reviews two computational algorithms designed to alleviate this computational constraint; one of which is based on functional form approximations and the other on learning techniques similar to those used in the artificial intelligence literature.

Markets fo Heterogeneous Products: a Boundedly Rational Consumer Model

The paper is based on the acknowledgement that properties of markets stemming from features of demand are too frequently overlooked in the economic literature, and a re-balancing is necessary to properly account for theoretical and empirical phenomena. We sustain that one of the most relevant reasons for the neglect of the role of demand is the lack of an adequate representation of consumers. This claim is particu- larly relevant for evolutionary economics since its critique to the mainstream approach stopped at the representation of firms. The standard utility maximization approach to consumers? theory is even less defensible than the related assumption of producers? rationality, given the lack of competitive pressure on consumers. As a contribution to this theoretical gap, the paper presents a model for consumer based on the assumption of bounded rationality and inspired to the literature on experimental psychology. The proposed model can be applied to multi-dimensional products/services and relies on intuitive and potentially observable parameters, allow- ing for a wide range of theoretical and empirical applications. Moreover, the intrinsic structure of the model provides a clear definition of preferences, meant as ex-ante decisional criteria, distinguished from post-hoc justification of any decisional result. Though structurally simple, the proposed model is very flexible and allows for a clear exploration of the impact of specific demand features on the produced results. Several experiments show that the model can be successfully applied both to generate standard results and to implement complex configurations such as those of generated by large markets with heterogeneous products. Among the results presented, the most relevant concerns the identification of two classes of market segmentation, generated by the identical suppliers and demand?s ex- ogenous factors, but different consumers? decisional mechanisms. The results produced are observationally equivalent, but are shown to have radically different properties, and are proposed as initial elements of a taxonomy for the classification demand classes, likely to explain common properties across different markets.Evolutionary Economics, Consumer Theory, Bounded Rationality, Marketing and Preferences, Simulation Models, Market Structure

Modeling the Psychology of Consumer and Firm Behavior with Behavioral Economics

Marketing is an applied science that tries to explain and influence how firms and consumers actually behave in markets. Marketing models are usually applications of economic theories. These theories are general and produce precise predictions, but they rely on strong assumptions of rationality of consumers and firms. Theories based on rationality limits could prove similarly general and precise, while grounding theories in psychological plausibility and explaining facts which are puzzles for the standard approach. Behavioral economics explores the implications of limits of rationality. The goal is to make economic theories more plausible while maintaining formal power and accurate prediction of field data. This review focuses selectively on six types of models used in behavioral economics that can be applied to marketing. Three of the models generalize consumer preference to allow (1) sensitivity to reference points (and loss-aversion); (2) social preferences toward outcomes of others; and (3) preference for instant gratification (quasi-hyperbolic discounting). The three models are applied to industrial channel bargaining, salesforce compensation, and pricing of virtuous goods such as gym memberships. The other three models generalize the concept of gametheoretic equilibrium, allowing decision makers to make mistakes (quantal response equilibrium), encounter limits on the depth of strategic thinking (cognitive hierarchy), and equilibrate by learning from feedback (self-tuning EWA). These are applied to marketing strategy problems involving differentiated products, competitive entry into large and small markets, and low-price guarantees. The main goal of this selected review is to encourage marketing researchers of all kinds to apply these tools to marketing. Understanding the models and applying them is a technical challenge for marketing modelers, which also requires thoughtful input from psychologists studying details of consumer behavior. As a result, models like these could create a common language for modelers who prize formality and psychologists who prize realism

IMPORT TENDERS AND BIDDING STRATEGIES IN WHEAT

Bidding competition plays an important role in price discovery and the determination of suppliers in international grains. In this paper we analyze international bidding competition for wheat for a specific importer. Tender data over the period 1993-1999 were analyzed and bid functions estimated by class of wheat (hard red spring, hard amber durum, and hard red winter denoted as HRS, HAD, and HRW, respectively) and by selling firm. A stochastic simulation model was developed to determine the optimal bid and to analyze factors affecting bidding behavior and competition. The tender data indicated there was a surprisingly wide range of bids. Variation of bids across firms submitted for individual HRS tenders had standard deviations that ranged from $5/mt or less in a number of tenders to as high as$22/mt. Tenders for HAD show similar variability. Tenders for HRW showed higher variability yet with standard deviations of bids between $30 and$40/mt. These results show much greater variability than is normally ascribed to competition among international grain sellers. The spread between participants' bids and cost indicators ranged widely across firms. Optimal bids and expected payoffs were derived for a prototypical bidder competing against the existing incumbents. Using this as a base case, we analyzed the impacts of the number of competitors, information, and cost differentials. In each case, we quantified the likely impact on optimal bids and expected payoffs. In addition, there were three particularly interesting extensions from conventional auction models that were examined. One was the impact of the option to the seller of supplying wheat from Canadian origins. Effects of Canadian offers in bid functions were not statistically different from U.S. origins. The effect however, was interpreted as an increase in the number of random bidders within a tender. The effect of this was to reduce optimal bids for HRS by $0.50/mt. This suggests that the effect of Canadian origin as an option is minimal when the Canadian Wheat Board (CWB) sells through accredited exporters. The second interesting effect was that of correlated bids. Results indicated a high degree of correlation among bidders which had the effect of increasing the probability of winning, optimal bids, and expected profits. Finally, we explored the prospective impacts of the winner's curse on optimal bids. Results suggest that in light of the winner's curse, bidders should raise their bids; in the case of HRS, from a high of 1.9% to 7.7% to correct for bias in value estimation, to a low of 0.2% to 3.1% when considering money left on the table. These results have a number of implications. The simulations improve our understanding of a very important mechanism of procurement and competition in international grain trading. For buyers, tendering is useful particularly if there is temporal variability in costs and they vary across supply firms, if the number of bidders is large, and if information about bidders is transparent and bidders' offers are less correlated. Finally, for sellers, auctions can result in intense competition among participants. Being low cost is essential to success in this form of competition. Sellers that are not low cost should avoid auctions to be successful, and bidders should make adjustments to their bids to account for the winner's curse.auction, bidding, wheat tenders, optimal bid, U.S., Canada, Marketing,

Overseas Entry Decision and Ownership Strategy of Japanese Companies: Institution and Corporate Governance

Using 20-year panel data, this paper tests Japanese companies' sequential decisions: (1) to invest abroad or not and (2) if so, what ownership strategy for that local company to be employed. In addition to transaction advantage emphasized by traditional studies on FDI, the focus is the role of corporate governance of the parent companies and institutional environment of the host countries. Through Heckman's two-step estimation, corporate governance is found to play an important role for entry decision but not for ownership strategy. Transaction cost approach has been well supported for entry decision. Most importantly, an institutional environment favorable to MNEs leads to higher level of ownership of local companies. Firm size plays a significant role for FDI decision as well as for ownership decisionSample selection bias; Entry decision; Ownership strategy; Corporate governance; Institution

Searching the eBay Marketplace

This paper proposes a framework for demand estimation with data on bids, bidders' identities, and auction covariates from a sequence of eBay auctions. First the aspect of bidding in a marketplace environment is developed. Form the simple dynamic auction model with IPV and private bidding costs it follows that if participation is optimal the bidder searches with a "reservation bid" for low-price auctions. Extending results from the empirical auction literature and employing a similar two-stage procedure as has recently been used when estimating dynamic games it is shown that bidding costs are non-parametrically identified. The procedure is tried on a new data set. The median cost is estimated at less than 2% of transaction prices.

I Like The Way You Move: An Empirical Investigation into the Mechanisms Behind First Mover and Follower Strategies

There appears to be an ambivalent dimension in innovation strategies: timing. When is an innovation ready for the market or when is the market ready for the innovation? This paper empirically investigates the determinants of a firm?s decision to become a first mover or a follower in innovation strategies. Much of theoretical and empirical work has focused on whether first mover strategies pay off or not. Here we take a different approach by analysing the determinants that lead companies to opt for either a first mover or a follower strategy. One of this paper?s major goals is to distinguish between firm and industry specific effects on this particular strategic choice. We estimate our model using the most recent data from the German innovation survey of 2003. This dataset allows us to identify deliberate followers rather than outstripped first movers. One of our main findings is that firms choosing a first mover strategy operate in industries with intensive knowledge exchange and further leverage this advantage through excellent internal absorptive capacities. Followers, though, compete by way of their operational excellence for streamlining processes and cutting costs. Hence, we argue that neither of these two innovation strategies is per se superior to the other. --innovation strategy,first mover,bivariate probit