The STR Divison’s Teaching Committee asked outstanding strategy teachers to share some of their innovative teaching practices and materials. This post features Professor Tammy Madsen (link to webpage), interviewed on behalf of the Division’s Teaching Committee by Assistant Professor Hakan Ener (link).
Tammy Madsen is Professor of Management at Santa Clara University’s Leavey School of Business in California, and past chairperson of our Division. One of her popular MBA strategy courses is “Strategic Analysis” where she features the “Value-Price-Cost” framework throughout her course in innovative ways. She recently described her approach and experiences in an interview.
What is the “Value – Price – Cost” framework and how do students learn it?
The “Value – Price – Cost” framework is becoming increasingly popular in teaching strategy. Based on a bargaining model (see Tirole, 1988: 21-34), the framework is very helpful to understand why some firms create and capture more economic value compared to others, and is based on a growing body of research (see Barney and Peteraf, 2003; Besanko, Dranove & Shanley, 1999; Hoopes, Madsen & Walker, 2003; Brandenburger and Stuart, 1996). In this framework, the firm that produces the largest difference between value and cost has an advantage over rivals. It can either attract buyers due to the better surplus that its product offers (Value – Price) or make a higher profit (Price – Cost) or both. The framework explains how firms achieve an advantage relative to rivals by generating a larger gap between the Value of a good or service to a customer and the Cost to produce and deliver the good or service. The buyer or customer receives a surplus, Value minus Price (V-P) and the supplier receives a profit of Price minus Cost (P-C). Additionally, the framework illustrates that simply having costly-to-imitate resources and capabilities does not necessarily yield a competitive advantage.
Many of Tammy Madsen’s students in the “Strategic Analysis” course at Santa Clara University’s part-time MBA program have an engineering background and work for firms in Silicon Valley. These students learn the “Value – Price – Cost” framework through a series of case analyses in the context of strategic decisions for enhancing profitability, merger and acquisition activity, and strategic alliances. Having completed prior coursework in managerial economics, marketing, finance and analytics, the students are familiar with concepts such as buyer utility, discrete choice models, regression, attribute valuation, and conjoint analysis (see link for an explanatory note). This is important because Tammy Madsen asks her students to estimate the Value minus Cost position of firms such as Apple & Samsung (using data from their smartphone patent litigation, see link), Hulu, Google, Microsoft, Netflix, and Nintendo, relative to rivals. These analyses involve estimating the difference between Value and the Cost incurred to create that value for the focal firm and its rivals (e.g., conducting relative Value and relative Cost analyses).
How do students conduct these analyses? Prof. Madsen starts with a very simple stylized comparative example using Starbucks and Dunkin’ Donuts (comparing them on Value and Cost) and builds to more complex applications throughout the term. She explains that the most challenging part for students typically is estimating Value. In the past, her students have done this in multiple ways, depending on whether the firm was operating in a Business-to-Consumer (B-2-C) or a Business-to-Business (B-2-B) context. For example, in a B-2-C context, publicly available information containing customer satisfaction ratings, as well as reviews and rankings in publications such as “Consumer Reports” provided the students with insights on what features customers valued the most. The students were then able to relate this information to sales through quantitative analyses such as binary choice models (e.g. logit regression models) and conjoint analyses. In the B-2-B context, buyer usage cost serves as a proxy measure of buyer value.
How do students integrate the “Value – Price – Cost” framework with everything else they learn about strategy?
Similar to other strategy courses, Prof. Madsen’s course features a Capstone Team Project where students apply and integrate strategy frameworks and theories in order to figure out whether a recently announced strategic move by a company makes good business sense. The focus on a recent move forces the students to analyze an unframed problem and its inherent uncertainty. By focusing on publicly traded firms, the students can leverage detailed information on costs, revenues and profitability for the firms and their rivals.
Whether a strategic move will yield an advantage requires estimating whether the move generates a larger gap between Value and Cost relative to rivals and relative to the focal firm’s Value minus Cost position prior to the move. In the past, students have worked on examples such as Nintendo’s launch of the Wii, which they found would deliver greater economic value to customers while increasing the value captured by the firm as well. In their analyses, they used information on valuable product features from large-scale customer surveys carried out among the community of gamers, as well as cost information from product “tear-downs” that revealed the cost of product components. The students’ analyses foretold the success of Nintendo’s new product, whereas a recent project explored Nintendo’s introduction of the Switch console.
What can other faculty members do to teach the “Value – Price – Cost” framework?
Introducing this framework in strategy teaching is not difficult at all. Tammy Madsen gets her students in the habit of thinking strategically about value, price and cost by conducting simple exercises and frequent classroom polls (in the form of a vote) using examples from recent business news. Asking students to think about value creation and value appropriation is useful for grasping the key elements of unframed strategic problems.
In terms of teaching materials, Tammy Madsen asks her students to read the “Building Competitive Advantage” chapter of the strategy textbook that she co-authored (Walker and Madsen, Modern Competitive Strategy) in addition to working with case studies. Some of the more recent case studies that allow students to carry out detailed analyses in this area include Hulu (link) and Samsung Electronics (link) cases. Examples of Harvard case studies that lend to a quantitative relative cost analysis and a qualitative relative value analysis include Airborne Express (link), Matching Dell (link), eHarmony (link), Microsoft Search (link), and Ryanair (link).
For students who have not taken managerial economics courses prior to a strategy course, a good resource to learn about the basic vocabulary of value, price and cost would be to review the materials of a free open online course titled “Pricing” by Prof. Catherine Tucker at MIT. The course link is here, and lecture notes on “Pricing Economic Value to the Customer” are here. Another useful resource is “Analyzing Relative Costs” by Jan W. Rivkin and Hanna Halaburda, published by Harvard Business School Press.
References:
Besanko D, Dranove D, Shanley M. 1999. Economics of Strategy (2nd edition). Wiley: New York.
Brandenburger, A.M. and Stuart, H.W., 1996. Value‐based business strategy. Journal of Economics & Management Strategy, 5(1), pp.5-24
Hoopes, D.G., Madsen, T.L. and Walker, G., 2003. Guest editors’ introduction to the special issue: why is there a resource‐based view? Toward a theory of competitive heterogeneity. Strategic Management Journal, 24(10), pp.889-902.
Peteraf, M.A. and Barney, J.B., 2003. Unraveling the resource‐based tangle. Managerial and Decision Economics, 24(4), pp.309-323.
Tirole J. 1988. The Theory of Industrial Organization. MIT Press: Cambridge, MA.
Walker and Madsen, 2016. Modern Competitive Strategy (4th edition). McGraw-Hill: New York.