Beyond%20the%20Reach%20of%20the%20Invisible%20Hand:%20Impediments%20to%20Economic%20Activity,%20Market%20Failures,%20and%20Profitability

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Beyond the Reach of the Invisible Hand
Impediments to Economic Activity,Market
Failures, and Profitability

• Dennis A. Yao

Strategic Management Journal, Vol. 9, Special
Issue Strategy Content Research. (Summer, 1988),
pg. 59-70.
By Amit Jain
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MARKETS ARE EFFICENT
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Basic Relationships
Impediments to Econ Activities (IEAs)
Market Failure
Entry Barriers
1. Entry barriers as operational combinations of
IEAs 2. IEAs cause market failure 3. Absent IEAs,
entry barriers may not cause market failure
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Shortcomings of Economic Theory

• The Efficient Market
• Consumers and producers act as price takers
• Markets exist for all commodities
• Buyers and sellers have complete information
• Thus, all firms will make normal (average)
  profits
• Perfectly competitive markets lead to long-run
  profits that are average
• Good strategy leads to survival, not excess
  profits

• So why do we observe companies making excess
  profits?
• Market failure has created supra-normal
  profitability
• Strategists are interested in identifying factors
  that create an imperfect market (i.e. imperfect
  competition)

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Industrial Organization Barriers to Entry A
source of market failure

• Industrial Organization (IO) Literature
• Barriers to Entry (Bain 1956, Caves and Porter
  1977), such as product differentiation or capital
  requirements
• Example of product differentiation
• The perception of a product as being different
  works only if the buyer is uninformed about the
  products in the market
• Absence of cost-effective credible information
• Imperfect information
• Therefore, there is more to market failure (and
  more sources) than B2E

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Impediments Theory another source of market
failure

• Transaction Costs
• Production Economies
• Sunk Costs
• Imperfect Information

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Transaction Costs

• Two relevant types
• Free-rider problem Costs of excluding non-buyers
  from use of a product or service
• Excluding non-subscribers from benefits of
  product review
• Costs of communication and information
• Writing long-term contracts when all future
  contingencies cannot be predicted
• Strategies for dealing with transaction costs
• Vertical integration
• Culture change match employees goals with
  organizations goals
• Develop long-term relationships with outside
  organizations

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Production Economies, Sunk Costs, Imperfect
Information

• Production Economies
• Economies of Scale, Learning Curve, Economies of
  Scope
• Sunk Costs
• In absence of sunk costs, entry and exit become
  costless (contestible markets)
• Imperfect Information
• Absence of perfect buyer information leads to
  above average price-cost margins
• Ways to exploit provide information oriented
  strategies
• Reputations brand loyalty.
• Product differentiation through advertising
• Signaling quality through warranties
• Price reflects Quality high price, high
  quality.

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Concluding Thoughts and Comments

• The paper integrates B2E with IEA.
• However, the papers implications on transaction
  costs is limited.
• Heres an extended definition The firm exists by
  minimizing transaction costs, which includes
  costs associated with opportunism, complexity,
  and uncertainty.
• Can transaction costs theory encompass
  impediments theory?
• Since production economies (quasi-rents), sunk
  costs (sunk investments), and imperfect
  information (uncertainty) are handled within the
  boundaries of the firm, then transaction costs
  may be sufficient.

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