The groups of individuals that make up a firm, or corporation, are responsible for determining its actions. Those decisions are made in the context of the markets in which the firm participates as manufacturer, seller, buyer, and competitor. By defining and categorizing strategies, firms can better understand their options and opportunities. Social scientists and policymakers can also investigate the reasons for firms’ success or failure and their contributions to society’s welfare.
To understand the motivations behind corporate strategies, one can think in terms of the individual members of the firm who make decisions or in terms of the firm acting as a single entity. In economics, the starting point is to think of the firm as indivisible—essentially as an extension of the owner-entrepreneur whose goal is to maximize profit. Expanding that assumption to encompass long-run profits can account for a large variety of observed behavior. Thus the profit motive helps one understand decisions not only concerning pricing or production in the firm’s current markets, but also investment to lower future costs and improve future quality, as well as decisions to enter markets that promise large future profits and exit markets that provide inferior profit opportunities. In this way many of the changes that occur in products and market structure over time can be described. Many business decisions that are not immediately recognized as profit maximization can be understood in these terms—generating growth, creating and maintaining competitive advantages over other firms, and improving the inputs available to the firm. Because the firm wishes to maintain profits today and in the future, it will take actions that are not immediately profitable but provide the firm with greater future profits, so that the project’s net present value of future profits exceeds the cost of implementation.
Milton Friedman’s (1953) assertion that firms behave “as if” they were profit maximizers, by arguing that firms that do not maximize profits will not survive, was intended to justify behavior that does not immediately appear to maximize profit. Although the literature has found this evolutionary argument difficult to support, improvements in modeling firms’ long-run goals have advanced understanding in the field.
Strategies can also be actions designed to make markets more amenable to the firm’s success by changing the attractiveness of rivals’ options (Bain 1956). For example, the firm can commit to large production by building additional manufacturing capacity or signing binding legal contracts. This in fact limits the firm’s options, but as a result is a credible commitment to substantial future production. Potential competitors can then observe that their entry will be less profitable, and as a result the incumbent firm can deter entry. As another example, firms that sell durable goods can benefit from committing to limit future sales (Bulow 1982). This causes the future resale value of present goods to increase, and customers are then willing to pay more for the goods today.
Of course, firms are made up of individuals whose goals and incentives are likely to differ from those of the owners. Thus “the firm” may take actions that are not those of a single profit-maximizing entity. Departures from the owner-entrepreneurs’ goals could be characterized as being caused by employees’ pursuit of their own self-interest. The principal (the owner or upper-level manager, for example) takes this constraint into account by appropriately adjusting the incentives of the agents (those that report to the principal). These internally motivated dimensions to strategy may affect the firm’s ability to pursue plans that would otherwise be optimal from the perspective of a single owner-entrepreneur.
As the firm interacts in markets, the description of its strategies can also be generalized with less precise foundations. In the business and management literatures, these generalized strategies serve as approximate heuristics for practicing managers. Corporate and business-level strategies may focus on growth (new or existing markets, new or existing products), portfolio analysis (each project’s market share, market growth rate, and resulting cash flow), matches between industry opportunities and the firm’s strengths and synergies, or fiscal properties such as the creation of shareholder value. These strategies are most successful when they are based on fundamentals from economics: the anticipation of costs, customers’ trade-offs, and rivals’ reactions. Michael Porter (1980) organizes the forces that affect the industry into these categories: buyers’ market power, suppliers’ market power, the threat of entry, linkages to substitutes and complements, and rivalry among firms in the industry. The implementation of these strategies in markets requires research in segmenting the market along demographic, geographic, or behavioral categories. Positioning products in chosen segments is particular to the firm’s marketing group. These strategies are usually framed in terms of the 4 P’s—product, price, promotion, and place (or distribution). An important ingredient for success is the recognition of linkages between these dimensions.
Bain, Joe. 1956. Barriers to New Competition: Their Character and Consequences in Manufacturing Industries. Cambridge, MA: Harvard University Press.
Bulow, Jeremy. 1982. Durable Goods Monopolies. Journal of Political Economy 90: 314–332.
Friedman, Milton. 1953. Essays in Positive Economics. Chicago: University of Chicago Press.
Porter, Michael E. 1980. Competitive Strategy: Techniques for Analyzing Industries and Competitors. New York: Free Press.
Schmalensee, Richard, and Robert D. Willig, eds. 1989. Handbook of Industrial Organization. 2 vols. Amsterdam: North-Holland.
Christopher S. Ruebeck