Economic approach to strategic decisions

Abstract

After the 1980s, due to financialization and penetration of technology, business landscape has changed dramatically. These changes have created an extremely competitive business environment. In this business landscape, firms face so many challenges but at the same time, they are equipped with a large number of “strategic instruments” to deal with these obstacles. Key strategic instruments that are at the disposal of top managers to achieve competitive advantage include, among others: pricing, advertising, quality differentials, R&D, integration, acquisition, financial leverage, brand, and customer loyalty. The central premise of theories in microeconomic literature addresses the fundamental questions of why strategic decisions work differently for different firms and how firms achieve and sustain competitive advantage. Industrial organization which is a subfield in economics concentrates on addressing these research questions. Scholars in industrial organization have developed three distinct theories that investigate possible causative linkages between the performance and the use of alternative strategic instruments. These models are: structure-conduct-performance approach, five forces model, and transaction cost approach. The first objective of this study is to review these key theoretical models. According to the former two models, market structure plays major role in “success” of these instruments. In order to clarify the importance of market structure, we overview three strategic instruments: namely, pricing, advertising, and R&D. In addition to this, in order to demonstrate the significance of transaction cost approach, we include another important strategic instrument: integration. We show that the recent advances in transaction cost approach have greatly improved our understanding about integration, acquisition, and mergers.