Competitive Analysis and Strategy
R. Belderbos
Lecture notes and syllabus summary
Academic Year 2025–2026
1
,1) Horizontal Boundaries of
the Firm
2
,1. Economies of scale & economies of scope
Horizontal boundaries = what products and how much output a firm chooses to produce.
They are shaped mainly by:
Economies of scale = how costs change when quantity increases.
Economies of scope = how costs change when variety increases.
1° Economies of scale
Economies of scale = a production process has economies of scale when average cost (AC)
falls as output increases.
If AC falls with Q marginal cost of the last unit produced (MC) < AC
If AC rises with Q MC > AC (diseconomies of scale)
1) Average cost curve
Average cost curve = captures the relationship between average costs and output.
o Traditional view (U-shaped AC):
At low output, AC falls as fixed costs are spread.
At high output, AC rises again (ex. capacity limits, coordination / agency problems,
…).
In this case: small and large firms would have higher costs than medium-sized firms.
In reality, large firms rarely seem to be at a substantial cost disadvantage.
o Empirical view (L-shaped AC):
AC falls until a certain scale, then stays roughly flat.
Beyond minimum efficient scale (MES), larger firms often don’t have much cost
advantage.
Sometimes, production exhibits U-shaped AC in short run, as firms that try to expand output
run up against capacity constraints.
In the long-term: firms can expand their capacity by building new facilities (generates L-
shaped AC).
3
,2) Main source of scale economies: indivisibilities and fixed costs
Indivisible input = cannot be scaled down below a minimum size even with small output (ex.
delivery truck, warehouse, production line,…).
Create fixed costs, which lead to scale economies when output rises.
Same fixed cost spread over more units lower average fixed cost per unit lower AC.
Many activities have product-specific fixed costs (ex. special dies for aircraft parts, R&D for
a video game, training programs, website setup,…).
High fixed costs + underused capacity = strong incentive to scale up or exit.
Firm can choose different technologies to produce:
Fully automated: expensive machines (high fixed cost) but cheap per unit (low variable
cost).
Partially automated: cheaper machines (low fixed cost) but more labour per unit (higher
variable cost).
At low output choose low fixed / high variable.
At high output choose high fixed / low variable.
Rule of thumb: capital intensity & scale:
If an activity is capital-intensive (big machines, large plants,…) likely strong
economies of scale (big fixed costs to spread).
If activity is mainly labour or materials (costs go up directly with output) usually weak
economies of scale.
Exception: sometimes labour behaves like a fixed cost (ex. pharma sales reps, video game
development,…), which can still generate scale economies.
2° Economies of scope
Economies of scope = exist if the firm achieves savings as it increases the variety of goods
and services it produces.
Happens if it is cheaper for one firm to produce X and Y together than for two separate
firms to produce X and Y individually:
TC (Qx, Qy) < TC (Qx, 0) + TC (0, Qy)
Other way of saying: the extra cost of adding product X is lower when the firm already
produces Y.
“Leveraging core competencies” = exploiting scope economies:
Tesco: warehousing and distribution across many markets.
Apple: engineering and design used for phones, laptops, tablets,…
Ikea: design capabilities used for a wide range of furniture.
4
, Scale and scope economies can appear anywhere in the value chain: R&D, production,
logistics, marketing, retail,…
BUT “bigger” or “more variety” only helps if specific scale / scope mechanisms actually
exist.
1) Complementarities and strategic fit
Complementarities = one practice becomes more effective when combined with another.
Synergies among organizational practices: the presence of A makes B more valuable, and
vice versa.
Applied to organizational practices, not products.
Strategic fit = when a firm’s whole system of activities works together, and each activity
strengthens the others.
Strategic fit makes the strategy:
More powerful (whole > sum of parts).
Hard to imitate (you must copy the entire system, not just one practice).
3° Special sources of economies of scale and scope
1) Density
Economies of density = refer to cost savings that arise within a transportation network due
to a greater geographic density of customers.
Increasing number of customers using given network (ex. airline’s unit costs decline as
more passengers are flown over a given route).
Reducing the size of the area reducing cost of network, while maintaining same
number of customers.
2) Purchasing
Conventional wisdom: “purchasing power” through bulk buying invariable leads to discounts.
Why?
Might be less costly to sell to single buyer.
Bulk purchaser will be more price sensitive.
Supplier may fear costly disruption to operation if it fails to do business with a large
purchaser.
3) Advertising
Larger firms may enjoy lower advertising cost per consumer either because:
Lower costs of sending messages per potential consumer (due to important fixed costs).
Higher advertising reach (ex. umbrella branding: one brand, many products one
campaign helps all).
5
,4) R&D
Large firms can amortize R&D over many units / products, but small firms can be more
innovative in niche science.
Scale in R&D is not automatic !
5) Physical properties of production
Economies of scale may arise because of the physical properties of processing units.
Example: cube-square rule = states that as the volume of the vessel (ex. a tank or a pipe)
increases by a given proportion (ex. it doubles), the surface area increases by less than this
proportion (ex. it less than doubles).
In many production processes, production capacity is proportional to the volume BUT
total cost of producing at capacity is proportional to the surface area !
6) Inventories
Need to carry inventories creates economies of scale because large firms can centralize stock
and usually maintain a lower inventory to sales ratio lower AC.
7) Political scale advantages
Large firms may gain advantages because their size increases their influence on governments
and regulation.
o Important in highly regulated industries (ex. energy, pharma, finance, telecom,…).
o Large firms can invest in political business strategy:
Lobbying governments.
Participating in regulatory negotiations.
Influencing industry standards.
o These activities involve large fixed costs (lobbyists, legal experts, policy teams,…), which
large firms can spread across many markets and activities.
Size can therefore create bargaining power with governments, making large firms important
“partners” in policy discussion.
4° Sources of diseconomies of scale
Beyond some point, scale can raise costs:
Labour costs: large firms often pay higher wages / benefits.
Spreading key resources too thin: star managers or critical assets overextended.
Bureaucracy: red tape, slow decisions, weak incentives, poor information flows,…
! “Bigger” is not always “better” !
6
,5° The learning curve
Economies of scale lower unit cost when producing more at a given point in time.
Learning curve lower unit cost as cumulative output increases over time ! (‘dynamic’
economies of scale)
You can have:
Strong scale, weak learning (simple capital-intensive process).
Weak scale, strong learning (complex, labour-intensive tasks like law or surgery).
Learning gains justify:
Producing more now (even at low margin) to reduce future costs.
Sometimes pricing below short-run AC to move faster down the learning curve.
! When learning is important, the true marginal cost of an extra unit is lower than the current
unit cost because you gain future cost reductions !
2. Diversification
Why do firms diversify?
Diversification is costly! Therefore, any diversification must be justified by benefits that are
at least as large:
Efficiency (value-creating) reasons increase economic efficiency of the firm (ex. better
use of resources, better financing, better coordination,…).
Augments shareholder value.
Managerial (value-destroying) reasons behavioural reasons linked to managers’
incentives and biases (ex. power, prestige, job security,…).
May reduce shareholder value.
! Diversification creates value only if the benefits exceed the costs ! (often not the case)
1° Efficiency reasons
1) Economies of scope = lower average cost by reusing the same organizational resources
across different businesses and spreading their fixed costs.
o Not about spreading plant level fixed costs between totally different products.
o About spreading across businesses:
Firm-level functions whose fixed costs can be shared (ex. R&D, advertising,
distribution,…).
Organizational resources/capabilities (ex. brand and reputation, marketing know-
how, design and user-experience capabilities,…).
7
, o Dominant general management logic = managers sometimes have a way of thinking
and allocating resources that can be applied in different product markets.
o Only create value when the resources being shared are:
Relevant to the new business.
Underutilized (already paid for, not at full capacity).
Not too stretched (otherwise diseconomies appear).
2) Economizing on transaction costs in buyer-supplier relationships:
o Applies when a firm diversifies into a business that supplies it (vertically linked).
o If large relationship-specific investments and intensive coordination integrating
into related business can avoid hold-up problems and contract renegotiations.
3) Internal capital markets = allocation of available working capital within the firm (as
opposed to debt and equity financing).
o In a diversified group HQ can use cash from a cash-rich division too fund profitable
projects in cash-constrained division.
o BCG’s growth / share matrix:
Cash cows (high share, low growth) generate cash.
Rising stars / problem children (high growth) need cash.
HQ acts like internal bank, shifting funds from cows to stars, to exploit learning
curves and the product life cycle.
o Why might this be better than external finance?
Asymmetric information: outsiders don’t know as much about the project
charge high interest or refuse.
Existing debt: new investors are junior and may be reluctant.
Monitoring is costly for external investors.
4) Risk diversification:
o Limited: shareholders already use personal portfolio diversification.
They can spread investments across many independent firms, and do not need
managers to build conglomerates to do this for them.
Weak justification.
o Can slightly reduce bankruptcy risk and perhaps make a firm “too big to fail”, but this
is a side effect, not a strong value-creation logic.
8
,5) Buying undervalued firms:
o Diversify by acquiring established firms in unrelated industries profitable if
identify firms that are undervalued by the stock market.
o Problems:
CEO must spot mispricing that professional investors have not seen (very
unlikely).
Other bidders may come in bidding war price is driven up.
Winner’s curse: the most optimistic bidder tends to win, meaning they likely pay
more than what the firm is actually worth.
Result: acquiring firm may destroy value instead of creating it.
How can it be avoided?
Unique synergies (economies of scope): if acquiring firm can create extra
value that other bidders cannot, paying more may still be profitable.
Superior information: if acquirer knows the true value of the target better
than other bidders, it may avoid overpaying.
2° Managerial reasons
Key idea: in large corporations, ownership and control are separated.
Managers make decisions, but shareholders bear the consequences.
Creates agency problems: managers may not act in shareholders’ best interest.
Important to know whether managers undertake diversifying acquisitions that do not
generate net benefits for firm’s shareholders.
Why do managers want to diversify?
1) Empire building:
o Managers may value firm size and diversity of activities for personal reasons:
Higher social prominence, prestige, political power,…
More visibility, more board seats in other firms, more attractive CV,…
o Although diversification is not a useful way to reduce investor risk, it may lessen
managerial risk reduces risk of poor results and job loss.
o Problem: growth can be profitable or unprofitable:
Shareholders only want profitable growth.
Managers might pursue growth even when it reduces shareholder value.
2) Hubris (overconfidence):
o Successful CEOs may believe they have superior general management skills and can
fix any business.
o This belief makes them overconfident, overoptimistic, and more willing to pay too
9
much or enter industries where their real capabilities do not apply.
, 3° Problems of corporate governance
Why can’t shareholders stop this?
Managerial motives rely on the existence of some failure of corporate governance =
mechanisms through which corporations and their managers are controlled by shareholders.
Managerially driven acquisitions would disappear if shareholders could:
1) Determine which acquisition lead to increased profits and which ones don’t.
2) Direct management to undertake only those that will increase shareholder value.
In practice, neither conditions hold !
Information problem: shareholders often don’t know whether a proposed acquisition is
good or bad.
Control problem: CEOs often have influence over board composition and can push
through deals.
1) Agency problems
Agency problem = conflict of interest arising when an agent (ex. manager) authorized to act
for a principal (ex. shareholder) pursues their own self-interest instead of the principal’s goals.
Managers may act against shareholders’ interest because:
1) Their goals differ (security, prestige,… vs. profit).
2) Their actions are hard to observe or verify.
3) Effort is costly.
4) Risk preferences differ.
This creates classic inefficiencies:
Underinvestment in hard-to-measure tasks.
Overinvestment in activities that boost the manager’s image.
Resistance to restructuring or downsizing.
2) Coordination problems
Coordination problems = arise when the best action for one person to take depends on the
actions taken by other or on the information held by others.
Even when managers are well-intentioned, departments inside the firm may not coordinate:
Misaligned incentives between units.
Information silos.
Sequential processes where delays cascade.
Local objectives conflicting with firm-wide goals.
…
10
R. Belderbos
Lecture notes and syllabus summary
Academic Year 2025–2026
1
,1) Horizontal Boundaries of
the Firm
2
,1. Economies of scale & economies of scope
Horizontal boundaries = what products and how much output a firm chooses to produce.
They are shaped mainly by:
Economies of scale = how costs change when quantity increases.
Economies of scope = how costs change when variety increases.
1° Economies of scale
Economies of scale = a production process has economies of scale when average cost (AC)
falls as output increases.
If AC falls with Q marginal cost of the last unit produced (MC) < AC
If AC rises with Q MC > AC (diseconomies of scale)
1) Average cost curve
Average cost curve = captures the relationship between average costs and output.
o Traditional view (U-shaped AC):
At low output, AC falls as fixed costs are spread.
At high output, AC rises again (ex. capacity limits, coordination / agency problems,
…).
In this case: small and large firms would have higher costs than medium-sized firms.
In reality, large firms rarely seem to be at a substantial cost disadvantage.
o Empirical view (L-shaped AC):
AC falls until a certain scale, then stays roughly flat.
Beyond minimum efficient scale (MES), larger firms often don’t have much cost
advantage.
Sometimes, production exhibits U-shaped AC in short run, as firms that try to expand output
run up against capacity constraints.
In the long-term: firms can expand their capacity by building new facilities (generates L-
shaped AC).
3
,2) Main source of scale economies: indivisibilities and fixed costs
Indivisible input = cannot be scaled down below a minimum size even with small output (ex.
delivery truck, warehouse, production line,…).
Create fixed costs, which lead to scale economies when output rises.
Same fixed cost spread over more units lower average fixed cost per unit lower AC.
Many activities have product-specific fixed costs (ex. special dies for aircraft parts, R&D for
a video game, training programs, website setup,…).
High fixed costs + underused capacity = strong incentive to scale up or exit.
Firm can choose different technologies to produce:
Fully automated: expensive machines (high fixed cost) but cheap per unit (low variable
cost).
Partially automated: cheaper machines (low fixed cost) but more labour per unit (higher
variable cost).
At low output choose low fixed / high variable.
At high output choose high fixed / low variable.
Rule of thumb: capital intensity & scale:
If an activity is capital-intensive (big machines, large plants,…) likely strong
economies of scale (big fixed costs to spread).
If activity is mainly labour or materials (costs go up directly with output) usually weak
economies of scale.
Exception: sometimes labour behaves like a fixed cost (ex. pharma sales reps, video game
development,…), which can still generate scale economies.
2° Economies of scope
Economies of scope = exist if the firm achieves savings as it increases the variety of goods
and services it produces.
Happens if it is cheaper for one firm to produce X and Y together than for two separate
firms to produce X and Y individually:
TC (Qx, Qy) < TC (Qx, 0) + TC (0, Qy)
Other way of saying: the extra cost of adding product X is lower when the firm already
produces Y.
“Leveraging core competencies” = exploiting scope economies:
Tesco: warehousing and distribution across many markets.
Apple: engineering and design used for phones, laptops, tablets,…
Ikea: design capabilities used for a wide range of furniture.
4
, Scale and scope economies can appear anywhere in the value chain: R&D, production,
logistics, marketing, retail,…
BUT “bigger” or “more variety” only helps if specific scale / scope mechanisms actually
exist.
1) Complementarities and strategic fit
Complementarities = one practice becomes more effective when combined with another.
Synergies among organizational practices: the presence of A makes B more valuable, and
vice versa.
Applied to organizational practices, not products.
Strategic fit = when a firm’s whole system of activities works together, and each activity
strengthens the others.
Strategic fit makes the strategy:
More powerful (whole > sum of parts).
Hard to imitate (you must copy the entire system, not just one practice).
3° Special sources of economies of scale and scope
1) Density
Economies of density = refer to cost savings that arise within a transportation network due
to a greater geographic density of customers.
Increasing number of customers using given network (ex. airline’s unit costs decline as
more passengers are flown over a given route).
Reducing the size of the area reducing cost of network, while maintaining same
number of customers.
2) Purchasing
Conventional wisdom: “purchasing power” through bulk buying invariable leads to discounts.
Why?
Might be less costly to sell to single buyer.
Bulk purchaser will be more price sensitive.
Supplier may fear costly disruption to operation if it fails to do business with a large
purchaser.
3) Advertising
Larger firms may enjoy lower advertising cost per consumer either because:
Lower costs of sending messages per potential consumer (due to important fixed costs).
Higher advertising reach (ex. umbrella branding: one brand, many products one
campaign helps all).
5
,4) R&D
Large firms can amortize R&D over many units / products, but small firms can be more
innovative in niche science.
Scale in R&D is not automatic !
5) Physical properties of production
Economies of scale may arise because of the physical properties of processing units.
Example: cube-square rule = states that as the volume of the vessel (ex. a tank or a pipe)
increases by a given proportion (ex. it doubles), the surface area increases by less than this
proportion (ex. it less than doubles).
In many production processes, production capacity is proportional to the volume BUT
total cost of producing at capacity is proportional to the surface area !
6) Inventories
Need to carry inventories creates economies of scale because large firms can centralize stock
and usually maintain a lower inventory to sales ratio lower AC.
7) Political scale advantages
Large firms may gain advantages because their size increases their influence on governments
and regulation.
o Important in highly regulated industries (ex. energy, pharma, finance, telecom,…).
o Large firms can invest in political business strategy:
Lobbying governments.
Participating in regulatory negotiations.
Influencing industry standards.
o These activities involve large fixed costs (lobbyists, legal experts, policy teams,…), which
large firms can spread across many markets and activities.
Size can therefore create bargaining power with governments, making large firms important
“partners” in policy discussion.
4° Sources of diseconomies of scale
Beyond some point, scale can raise costs:
Labour costs: large firms often pay higher wages / benefits.
Spreading key resources too thin: star managers or critical assets overextended.
Bureaucracy: red tape, slow decisions, weak incentives, poor information flows,…
! “Bigger” is not always “better” !
6
,5° The learning curve
Economies of scale lower unit cost when producing more at a given point in time.
Learning curve lower unit cost as cumulative output increases over time ! (‘dynamic’
economies of scale)
You can have:
Strong scale, weak learning (simple capital-intensive process).
Weak scale, strong learning (complex, labour-intensive tasks like law or surgery).
Learning gains justify:
Producing more now (even at low margin) to reduce future costs.
Sometimes pricing below short-run AC to move faster down the learning curve.
! When learning is important, the true marginal cost of an extra unit is lower than the current
unit cost because you gain future cost reductions !
2. Diversification
Why do firms diversify?
Diversification is costly! Therefore, any diversification must be justified by benefits that are
at least as large:
Efficiency (value-creating) reasons increase economic efficiency of the firm (ex. better
use of resources, better financing, better coordination,…).
Augments shareholder value.
Managerial (value-destroying) reasons behavioural reasons linked to managers’
incentives and biases (ex. power, prestige, job security,…).
May reduce shareholder value.
! Diversification creates value only if the benefits exceed the costs ! (often not the case)
1° Efficiency reasons
1) Economies of scope = lower average cost by reusing the same organizational resources
across different businesses and spreading their fixed costs.
o Not about spreading plant level fixed costs between totally different products.
o About spreading across businesses:
Firm-level functions whose fixed costs can be shared (ex. R&D, advertising,
distribution,…).
Organizational resources/capabilities (ex. brand and reputation, marketing know-
how, design and user-experience capabilities,…).
7
, o Dominant general management logic = managers sometimes have a way of thinking
and allocating resources that can be applied in different product markets.
o Only create value when the resources being shared are:
Relevant to the new business.
Underutilized (already paid for, not at full capacity).
Not too stretched (otherwise diseconomies appear).
2) Economizing on transaction costs in buyer-supplier relationships:
o Applies when a firm diversifies into a business that supplies it (vertically linked).
o If large relationship-specific investments and intensive coordination integrating
into related business can avoid hold-up problems and contract renegotiations.
3) Internal capital markets = allocation of available working capital within the firm (as
opposed to debt and equity financing).
o In a diversified group HQ can use cash from a cash-rich division too fund profitable
projects in cash-constrained division.
o BCG’s growth / share matrix:
Cash cows (high share, low growth) generate cash.
Rising stars / problem children (high growth) need cash.
HQ acts like internal bank, shifting funds from cows to stars, to exploit learning
curves and the product life cycle.
o Why might this be better than external finance?
Asymmetric information: outsiders don’t know as much about the project
charge high interest or refuse.
Existing debt: new investors are junior and may be reluctant.
Monitoring is costly for external investors.
4) Risk diversification:
o Limited: shareholders already use personal portfolio diversification.
They can spread investments across many independent firms, and do not need
managers to build conglomerates to do this for them.
Weak justification.
o Can slightly reduce bankruptcy risk and perhaps make a firm “too big to fail”, but this
is a side effect, not a strong value-creation logic.
8
,5) Buying undervalued firms:
o Diversify by acquiring established firms in unrelated industries profitable if
identify firms that are undervalued by the stock market.
o Problems:
CEO must spot mispricing that professional investors have not seen (very
unlikely).
Other bidders may come in bidding war price is driven up.
Winner’s curse: the most optimistic bidder tends to win, meaning they likely pay
more than what the firm is actually worth.
Result: acquiring firm may destroy value instead of creating it.
How can it be avoided?
Unique synergies (economies of scope): if acquiring firm can create extra
value that other bidders cannot, paying more may still be profitable.
Superior information: if acquirer knows the true value of the target better
than other bidders, it may avoid overpaying.
2° Managerial reasons
Key idea: in large corporations, ownership and control are separated.
Managers make decisions, but shareholders bear the consequences.
Creates agency problems: managers may not act in shareholders’ best interest.
Important to know whether managers undertake diversifying acquisitions that do not
generate net benefits for firm’s shareholders.
Why do managers want to diversify?
1) Empire building:
o Managers may value firm size and diversity of activities for personal reasons:
Higher social prominence, prestige, political power,…
More visibility, more board seats in other firms, more attractive CV,…
o Although diversification is not a useful way to reduce investor risk, it may lessen
managerial risk reduces risk of poor results and job loss.
o Problem: growth can be profitable or unprofitable:
Shareholders only want profitable growth.
Managers might pursue growth even when it reduces shareholder value.
2) Hubris (overconfidence):
o Successful CEOs may believe they have superior general management skills and can
fix any business.
o This belief makes them overconfident, overoptimistic, and more willing to pay too
9
much or enter industries where their real capabilities do not apply.
, 3° Problems of corporate governance
Why can’t shareholders stop this?
Managerial motives rely on the existence of some failure of corporate governance =
mechanisms through which corporations and their managers are controlled by shareholders.
Managerially driven acquisitions would disappear if shareholders could:
1) Determine which acquisition lead to increased profits and which ones don’t.
2) Direct management to undertake only those that will increase shareholder value.
In practice, neither conditions hold !
Information problem: shareholders often don’t know whether a proposed acquisition is
good or bad.
Control problem: CEOs often have influence over board composition and can push
through deals.
1) Agency problems
Agency problem = conflict of interest arising when an agent (ex. manager) authorized to act
for a principal (ex. shareholder) pursues their own self-interest instead of the principal’s goals.
Managers may act against shareholders’ interest because:
1) Their goals differ (security, prestige,… vs. profit).
2) Their actions are hard to observe or verify.
3) Effort is costly.
4) Risk preferences differ.
This creates classic inefficiencies:
Underinvestment in hard-to-measure tasks.
Overinvestment in activities that boost the manager’s image.
Resistance to restructuring or downsizing.
2) Coordination problems
Coordination problems = arise when the best action for one person to take depends on the
actions taken by other or on the information held by others.
Even when managers are well-intentioned, departments inside the firm may not coordinate:
Misaligned incentives between units.
Information silos.
Sequential processes where delays cascade.
Local objectives conflicting with firm-wide goals.
…
10
