Analyzing Productivity, Sunk Cost, Replacement and Efficiency Effects

Posted: February 3rd, 2022

Chapter 11 • Sustaining Competitive Advantage
7. In light of the winner’s curse, must winning bidders in auctions necessarily “lose” in the sense of paying more than the item is worth? What steps can bidders take to prosper in auctions?
8. Two incompatible high-resolution audio formats, Super Audio CD (SACD) and DVD Audio (DVDA), were introduced in 2000. Both offered surround-sound music at a qual- ity that approaches the original studio master recordings from which they are made. Both formats could be added to new DVD players for an additional $25 to $250 per format, depending on the quality. SACD was originally supported by Sony. While Sony has abandoned the format, it has since won support from numerous classical music and jazz labels that sell in small numbers to audiophiles. DVDA has been abandoned by its backers. Why do you think high-resolution audio remained a niche product?
9. Consider an industry in which firms can expect to sell 1,000 units annually at a market price of P. Before firms enter, they do not know their production costs with certainty. Instead, they believe that unit costs can be $2, $4, $6, or $8 with equal probability. Annualized sunk production costs are $1,500—firms cannot recover this expense should they choose to exit. What is the equilibrium price at which firms are indifferent about entering? What is the average profit of firms that are producing? (Hint: Firms will produce as long as the price equals or exceeds unit production costs.)
10. Is the extent of creative destruction likely to differ across industries? Can the risk of creative destruction be incorporated into a five-forces analysis of an industry?
11. Is patent racing a zero-sum game? A negative-sum game? Explain. 12. What are a firm’s dynamic capabilities? To what extent can managers create or “man-
age into existence” a firm’s dynamic capabilities?
13. “Industrial or antitrust policies that result in the creation of domestic monopolies rarely result in global competitive advantage.” Comment.
14. IQ, Inc., currently monopolizes the market for a certain type of microprocessor: the 666. The present value of the stream of monopoly profits from this design is thought to be $500 million. Enginola (which is currently in a completely different segment of the microprocessor market from this one) and IQ are contemplating spending money to develop a superior design that will make the 666 completely obsolete. Whoever develops the design first gets the entire market. The present value of the stream of monopoly profit from the superior design is expected to be $150 million greater than the present value of the profit from the 666.
Success in developing the design is not certain, but the probability of a firm’s success is directly linked to the amount of money it spends on the project (more spending on this project, greater probability of success). Moreover, the productiv- ity of Enginola’s spending on this project and IQ’s spending are exactly the same: Starting from any given level of spending, an additional $1 spent by Enginola has exactly the same impact on its probability of winning. The following table illus- trates this. It shows the probability of winning the race if each firm’s spending equals 0, $100 million, and $200 million. The first number represents Enginola’s probability of winning the race, the second is IQ’s probability of winning, and the third is the probability that neither succeeds. Note: This is not a payoff table.
(i) each firm makes its spending decision simultaneously and noncooperatively; (ii) each seeks to maximize its expected profit; and (iii) neither firm faces any financial constraints,
which company, if any, has the greater incentive to spend money to win this “R

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