Three essays on strategic aspects in oligopoly with vertical structure

Thus, what is of supreme importance in war is to attack the enemy's strategy. (Sun Tzu, The Art of War (490 B.C.)) Capitalism, regardless of its advantages and disadvantages, relies on a significant pillar that is competitive markets. This economic system provides equal opportunities for all the potential players to enter the market, supply their products and services to the customers who passionate to maximize their utility. There, they may not be alone and should compete with some other rivals that have also found this market attractive. Nowadays it has transformed to a serious war, war of price, quality, quantity, innovation, wage and etc. Hence, firms must equip themselves with effective weapons, and one of the most significant tools is strategic thinking. Doing all the ordinary courses of business considering the analogous action and reaction of the competitors, and try to set its strategy based on this thinking model. Thus, firms’ strategy must be strategic. According to Michael Porter, strategy is making choices and trade-offs such as quantity choice, technology choice, capacity investment choice, R&D intensity choice and several other choices. The point is to consider that in the presence of competitors that are also strategic thinkers like us, rules of the competitive market determine the optimal amount of these choices and consequent profits. This dissertation contains of three independent papers which are approached to capture some strategic aspects in oligopoly with vertical structure. We focus on oligopolistic market structure in which few firms dominate. Firms are completely or partially aware of the actions of their rivals. Decisions of firms in this context affect, and are affected by decisions of other players. Offering homogeneous final products to the customers is the main assumption in our models. Cell phone, Film, Gas, Steel and several other examples can be mentioned as actual oligopolistic industries. To model our oligopolistic markets we choose Cournot, the model which assumes that there are two equally positioned firms; the firms compete on the basis of quantity rather than price and each firm makes an output decision assuming that the other firm’s behavior is fixed. (Kreps, 1990) To model demand, we employ linear inverse demand function. This demand model represents a consumer choice in which he maximizes a quadratic, strictly concave utility function. In chapter 2 and 3 our market characterized by demand uncertainty, that is occurs in the intercepts of the inverse demand function. In chapter 1, we face with deterministic demand. Game theoretic (static or dynamic – with complete or incomplete information) models are applied to formally plot the sequence of events in each essay. Incentives of players in each model are tried to capture interesting topics of industrial organization, from R&D, knowledge spillover and firm location in chapter 1 to capacity investment decision and technology choice of firms in chapter 2 and finally, information sharing and quantity ordering choice of corporations in chapter 3. All the players are assumed to be risk-neutral and try to maximize their own profit. The paper "The Effect of Vertical Knowledge Spillovers via the Supply Chain on Location Decision of Firms" which will be discussed in chapter 1 was published in the special issue of Journal of Business and Policy Research, April 2012 (JBPR, Vol. 7, No. 1). In this research a three-stage game of complete information is employed to model the incentives of two producers and two suppliers of two vertically-structured supply chains considering two different geographical regions, to investigate how the location decision of a producer is influenced by the location patterns of suppliers in the presence of vertical and horizontal knowledge spillovers. Strategic location choice of a producer between geographical concentration and isolation in equilibrium is the main interest of this essay. Numerical analysis expresses that both scenario (concentration and isolation) is possible depending on the range of model’s parameters. Moreover, the impact of different technological level of players on strategic location decisions will be explained. In chapter 2 the paper “The Effect of Salvage Market on Strategic Technology Choice and Capacity Investment Decision of Firm under Demand Uncertainty” is forthcoming in the Journal of Business Economics and Management in 2012. In this essay a multi-stage game with complete information is applied to model three strategic decisions of two competing producers in the presence of a secondary market (we call it salvage market). Technology choice (flexible and inflexible), capacity investment choice (general, specific and unified components) and quantity choice (Cournot competition) are three games which will be sequentially played by producers. Primary market of the model is characterized with demand uncertainty. Indeed this chapter deals with the choice of the flexibility of the production process of an oligopolistic producer facing uncertain demand. The trade-off studied is one between a flexible production process involving the production of generally usable components which are assembled after the size of the demand is known, and a less flexible but less costly production process, where specific products are produced and put on stock. The new feature of the paper compared to the literature is that the strategic effects on competitors in the market of these two choices are taken into account in the analysis. The paper “Supply Chain Configuration under Information Sharing” in chapter 3 is submitted to the Journal of Business Economics and Management. A dynamic multi-stage game with incomplete information (a signaling game) is employed to analytically model the incentives of firm’s to acquire, share and leak demand information, and their impact on order quantities and the configuration of supply chain(s). Private information about market demand is the source of asymmetry between two producers (the incumbent and the entrant), which could be leaked via a common supplier. Trade-off between operation management and information management defines the potential interaction of the players which could result in different supply chain scheme.