Economics of Strategy

Citation

Besanko, D., Dranove, D., Shanley, M., & Schaefer, S. (2017). Economics of Strategy (7th ed.). Wiley.

Chapter Summary

The book has an introduction, an economics primer, and fourteen chapters in four parts: firm boundaries, market and competitive analysis, strategic position and dynamics, and internal organization. In the preface Dranove explains the aim: to give strategy a real economic foundation, with the breadth of Sharon Oster's Modern Competitive Analysis at a level of analysis approaching Milgrom and Roberts's Economics, Organization, and Management, illustrated by examples from around the world and from the eighteenth century to the present.

Introduction: Strategy and Economics, and Economics Primer: Basic Principles

The introduction asks why strategy needs economics and presents the four-part framework the book follows. The primer is a self-contained review of costs (fixed and variable, sunk and avoidable, economic versus accounting), demand and revenue (elasticity, marginal revenue), the theory of the firm's pricing and output decisions, perfect competition, and an introduction to game theory.

Part One: Firm Boundaries (Chapters 1–4)

Chapter 1: The Power of Principles: An Historical Perspective. Argues that the economic principles behind strategic decisions endure even as business environments change. Chapter 2: The Horizontal Boundaries of the Firm. Economies of scale and scope, sources of diseconomies, the learning curve, and diversification, including the reasons for and against it and its performance record. Chapter 3: The Vertical Boundaries of the Firm. The make-or-buy decision and the benefits and costs of vertical integration. Chapter 4: Integration and Its Alternatives. Integration decisions in terms of technical and agency efficiency and governance, with alternatives such as tapered integration, franchising, alliances and joint ventures, and implicit contracts.

Part Two: Market and Competitive Analysis (Chapters 5–8)

Chapter 5: Competitors and Competition. Competitor identification and market definition, measuring market structure, and the economics of perfect competition, monopoly, monopolistic competition and oligopoly. Chapter 6: Entry and Exit. Entry barriers, barriers to exit and entry-deterring strategies such as limit pricing, predation and capacity expansion. Chapter 7: Dynamics: Competing Across Time. Commitment and flexibility, tit-for-tat pricing and the conditions for cooperative pricing, facilitating practices, and the evolution of market structure. Chapter 8: Industry Analysis. A five-forces analysis, strategies for coping with the forces, and worked analyses of Chicago hospital markets, commercial airframe manufacturing, professional sports and professional search firms.

Part Three: Strategic Position and Dynamics (Chapters 9–11)

Chapter 9: Strategic Positioning for Competitive Advantage. Competitive advantage defined through willingness-to-pay and value creation, the logic of cost and benefit leadership, cost and benefit drivers, and the choice between broad coverage and focus. Chapter 10: Information and Value Creation. Disclosure and its alternatives, report cards, certifiers and matchmaking. Chapter 11: Sustaining Competitive Advantage. Threats to sustainability, the resource-based theory, impediments to imitation, early-mover advantages and disadvantages, creative destruction and disruption, and the environment of competitive advantage.

Part Four: Internal Organization (Chapters 12–14)

Chapter 12: Performance Measurement and Incentives. The principal–agent relationship, performance-based incentives, their problems, implicit incentive contracts, and incentives in teams. Chapter 13: Strategy and Structure. Individuals, teams and hierarchies, coordination, the functional, multidivisional, matrix and network forms, and the fit between strategy and environment. Chapter 14: Environment, Power, and Culture. The internal context of power and culture, and the external context of institutions, regulation, resource dependence and industry logics.

Key Concepts

Primer and Part One

• Economic versus accounting costs: the primer's distinction between costs and profits as an economist counts them and as an accountant does.
• Economies of scale and scope: the cost advantages of size and breadth, with the learning curve and diseconomies as counterweights.
• Transaction-cost reasoning for vertical boundaries: the technical-efficiency versus agency-efficiency trade-off in integration decisions.

Part Two

• Market structure and competitor identification: defining the market and measuring concentration.
• Entry deterrence and commitment: strategic benefits of commitment, and strategies such as limit pricing and predation.
• Five forces: the framework for industry analysis, applied to four industries.

Parts Three and Four

• Value creation and willingness-to-pay: the basis for defining competitive advantage.
• Sustainability of advantage: resource-based theory and isolating mechanisms.
• Principal–agent problems: why incentives and measurement matter inside the firm.
• Organizational forms: functional, multidivisional, matrix and network structures.

Critical Analysis

Strengths

• Economic foundation stated as the aim. The preface positions the book against general strategy texts that lack disciplinary grounding and against microeconomics texts, with transaction-cost economics, oligopoly theory, entry, commitment, incentives and agency treated seriously.
• Reading paths in the preface. The authors list which chapters suit a core MBA strategy course, a full semester, an organization-focused course and a one-quarter managerial economics course, and note that the strategy chapters (9–11) can be taught before the firm-boundaries chapters.
• Worked industry analyses. Chapter 8 applies the five forces to four industries, and each chapter is built around numbered real-world examples.
• Wider scope than a single framework. It covers boundaries, competition, positioning and internal organization within one book.

Limitations

• Demanding for readers without economics. The preface says Chapters 6 and 7 are the most game-theoretic and the most demanding for students with weaker economic backgrounds; the authors themselves defer them in their basic MBA course.
• Parts are separable, not cumulative. The preface notes that Chapter 12 and beyond do not depend on Chapters 9 to 11, and that placing the boundaries chapters before the strategy chapters is not essential, so the book is more a set of modules than a single continuous argument.
• Examples age. The preface acknowledges that references to organizations and individuals will become obsolete by the time the book is read.
• A weighty book. It runs to about 544 pages with many chapters; a single course normally uses a selection.

Where It Fits in the Course

This is the economics-based treatment in the strategy list. Grant's Contemporary Strategy Analysis is the broader strategy textbook that builds analysis on economics and the resource-based view and adds cases; Besanko goes further into boundaries of the firm, game theory and incentives. Porter's Competitive Strategy is the foundational statement on industry analysis, which the preface credits as the model for an economics-based approach to strategy, and Understanding Michael Porter is a concise guide to Porter's core ideas. Good Strategy Bad Strategy is a general-reader book on what a coherent strategy contains. Exploring Strategy is a European-rooted textbook with a large case collection.

Read Besanko when you want to understand why strategic advice works, not only what the frameworks are. It rewards readers who have already met the five forces and competitive advantage in a book like Grant's or Porter's.

How to Use This Book

Intermediate microeconomics is a helpful background; the primer reviews the tools used. The preface suggests several routes.

• Core MBA strategy course: the Primer, then Chapters 2, 3, 8, 9 and 11.
• Full semester: add Chapters 5, 10 and 12; an organization-focused course may swap in Chapters 13 and 14 for 5 and 10.
• Managerial economics, one quarter: the Primer, then Chapters 2, 3, 5, 6, 7, 8, 9 and 11; add Chapters 4 and 10 for a semester.

Work through the Primer first if microeconomics is rusty. Read the game-theoretic Chapters 6 and 7 after Chapter 5, and use the end-of-chapter questions to check your own application of the principles to a firm you know.