the business of economics is business

The Business ofEconomics is BusinessDavid Stout

Advances in the subject have greatlydeveloped the ways in which economistswithin a business can contribute tostrategic decisions. Unilever is a case inpoint. The two keys to the change in therole of industrial economists have beenthe prevalence of strongly contested globaloligopoly markets of the kind Unileverfaces, and developments in theapplication of game theory. Economistsstill have to tread carefully insidecompanies and combine with other skillsand especially with the decision-takers.Four examples are given of thecontribution economists can make andshould be making.

“When we replace the flickerings of mood withthe relentless specificities of economics, we findourselves closer to the value known as truth....Economics is prepared to acknowledge thesheer complexity of human existence. Thereare always, after all, costs, even when thereduction of cost is the strategic goal of ouraction.” - Stephen Trachtenberg (1997)

“A strategic move is one that influences theother person’s choice, in a manner favourableto one’s self, by affecting the other person’sexpectations on how one’s self will behave.One constrains the partner’s choice byconstraining one’s own behaviour. The objectis to set up for one’s self, and communicatepersuasively to the other player, a mode ofbehaviour - including conditional responsesto the other’s behaviour - that leaves the othera simple maximisation problem whose solutionfor him is the optimum to one’s self, and todestroy the other’s ability to do the same.” -Thomas Schelling, (1960)

BeginningsMy personal conviction that economics was of somepractical commercial use came to me by chance. I wasworking on a vegetable farm in southern New SouthWales, on my first long vacation. We would loadcabbages in the evening and drive them down to theSydney market overnight. One morning, there wouldbe a glut, and we would have to unload them for ashilling a dozen, or haul them back to feed to the cows.That evening, we would cut no cabbages. As like asnot, we would hear next day that the price hadbounced back, and off we would go again. Iremembered the lecture about the “hog cycle” andsuggested we exploit what appeared to be a one-day

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production lag in the response of our fellow producersby cutting when the price had dropped and staying athome when it rose. It worked; I earned a bonus at theend of the season and stuck with economics.

Strangely, even these days, economists employedin industry are often immured in cells within acompany, where they spend much of their time talkingto other economists. In 1982, some of the teamengaged on IBM Europe’s defence against a Section86 charge of abuse of dominance of the Europeanmarket invited the company’s economists in Stuttgartto comment on a draft of the economic argument. Itwas disconcerting to find that they not only had notseen any of the earlier drafts - they were barely awarethat a case was in progress. They were fully engagedwith building a model of the world economy to runon the new IBM 370.

Later that year, on joining Unilever, I found abattalion of 93 economists, distributed betweenLondon and Rotterdam, who were almost whollysegregated from the operational decisions of theconcern, who produced regular reports that few hadsolicited and even fewer took any notice of, and who,at best, performed the somewhat ritualistic functionof providing deceptively exact numbers for growthand inflation to adorn the Country Annual Plans. Thelittle microeconomics that was done was somewhatmechanical - estimating demand elasticities orextrapolating raw material price changes.

Meanwhile, in the world outside the Blackfriarshead office of Unilever in Britain, the character ofindustrial economics had moved on. The focus oftheory had begun what was to be a long shift fromthe industry to the firm. Structure was being shownto be determined by the interaction of the agentsengaged in the market. The intricacies and paradoxesof the competitive process were being explored. Yeteven in this decade, as John Kay (1991) remarked,economists in industry were largely missing the point,and chasing the industry, not the firm.

Changing Economics in UnileverUnilever, in 1982, decided that it was time foreconomists to get out of their empty box and becomemore directly useful. The perception was growing thatthe market was not something “out there”, itsstructure fixed and determining what was theappropriate conduct of any and all firms in that rigidlybounded market. Rather it was “in here”, shaped andreshaped by the interactions of the players, the paceof change and the complex unchoreographed dance

of competition. To change the metaphor, economicshad been concentrating on the sets on the stage - thescene rather than the scenario - and had lost the plot.A study of the characters was necessary if the scriptof the next act was to turn out well.

The appreciation of the endogeneity of marketstructure meant the end of the old static formulationof barriers to entry. A high concentration ratio wasno impediment to cross-entry from a neighbouringtechnology, whose advent automatically broadened therelevant market. A high ratio of historic minimumefficient size of plant tototal market was madeirrelevant by new, moreflexible manufacturingtechniques. Productdifferentiation, reflectedin low short-run cross-price-elasticities, exposedbright new niche entry opportunities which couldbecome bridgeheads to the destruction of hithertoentrenched positions.

Most of Unilever’s main products - detergents,margarine, tea, soap, toothpaste, shampoo - were, inthe early 1980s, typical fast-moving consumer goods,in markets fought for in countries all over the worldby a very few companies in each, often with a powerfullocal competitor in the frame as well. Each was in aposition to influence the behaviour of its rivals anddid so, often without systematic design or evenconscious purpose. Here was an opportunity foreconomists to get involved. In 1983, the plan of theEconomics Department included, for the first time, astatement of purpose, which read, in part: “to informthose decisions which anticipate change, to eliminateroutine reporting and to design and apply to thebusiness dynamic economic models with behaviouralfeedbacks, lags, costs and rewards built into them.”

Six sections were reduced to three. “Environment”,pared down, continued to provide some regionalforecasts as context for individual country plans,where these could not be relied upon from specialistsources within the country. Otherwise, that sectionturned its attention to new market opportunitiesoutside what Unilever pleased to call, in those days,“the Unilever World”. “Intelligence” acted as thecentral clearing house for the raw data that was theeconomists’ resource. And “Market” was theindustrial economics engine room, supportingeverything from corporate strategy reformulations,through Product Group strategies, to entry tactics in

“Unilever, in 1982,decided that it wastime for economists toget out of their emptybox and become moredirectly useful”

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particular markets - ice-cream in Spain or preparedmeals in Thailand.

The CEO of Unilever - its Special Committee -remarked at that time that it was more important foreconomists to influence the main direction and provideadvice to help strategic decisions than to do routinework for individual management groups. In the event,

salaries have to be paid,and a compromise wasreached. Most of thework of the slimmed-down department wascommissioned and paidfor, task by task, by theclient Product and

Regional Groups, and performed, in the main, by smallteams dedicated to that client. A corporate team,loosely formed with changing members as the needsdemanded, was also created to tackle higher orderpolicy issues and to service a corporate strategyadvisory committee of Main Board members whichreported to Special Committee.

The bulk of the work of the economists, in theyears that immediately followed, increasingly becamestrategic and long-term - major acquisitions, theimpact of new technologies, new businessopportunities like chilled foods or medical diagnostics,and the fathoming and anatomising of major globalcompetitors. This was in contrast to much of the earlierwork which had been concerned, almost to the pointof obsession, with measurement, at the expense ofexplanation. There had been much use of the PIMS

database to derivecorrelations betweenadvertising spend andprofitability or labourintensity and return oninvestment, with no

causal direction and often misleading implications. Weeconomists had been like the drunk searching for hiskeys under the lamp-post because the light was betterthere.

Two Keys to ChangeTwo keys turned economics in Unilever into aninstrument for action in the early 1980s. One was thefact of oligopoly. Almarin Phillips (1962) had longago pointed out that the little local interdependenciesbetween firms - the actions and reactions that couldbe found between corner groceries as well as amonggiant oil companies - rendered oligopoly ubiquitous.

With its decentralised structure, Unilever’s subsidiaries,and the brand managers within them, had beenengaged for decades in skirmishes with rival brands.Not much attention had been paid to the fact that, inmany of these battles, it was a different face of theidentical competitor - the same Nestlé or the sameProcter & Gamble. In most of its main markets outsidefood, Unilever is involved in a struggle for marketdominance with a handful of equally determinedglobal would-be leaders. (Even in food, this isincreasingly the case, for by 1990, the top three UKfirms, for example, controlled 70% or more of thesales in each of the major categories.)

Operating head to head across so many localmarkets and with so many shared product categories,there is apparent a strategic advantage that mightfollow from organising scattered information aboutthe will, resources, strengths and weaknesses, andabove all the patterns of response of a key rival acrossyears, across products and across countries. FlorisMaljers, who was later to become the Dutch Chairmanand was himself an economist by training, remarkedat the time that the proper role for economics inbusiness is not the traditional one of looking outwardat the impervious external forces, the winds to whicha company must bend, but at the internal forces whichcan be tempered and directed. The fact of competitionamong the few was the first key.

The second key was that change in the disciplineof industrial economics itself. The history of the battlesfor territory, the characters of the main rivals, theresources they chose to build and command, thechanging technologies they employed and thestrategies they adopted - all these altered a marketstructure never settled for long, never in Marshallianlong-term equilibrium. Tides of change could bediscerned, life cycles of individual products evolvedas the means of satisfying a demand: uncertaintiesindeed, but not chaos.

These were processes that could be understood,influenced and turned to advantage by the companywhich was best organised, best informed and bestdirected. With the firm rather than the industry as thecentre of attention, the concepts used to understandcompetition became those of conflict strategy and non-collusive games.

Fighting PrejudiceWhen economists in industry try to get a piece ofthe action, they can run up against some deeplyentrenched positions and ingrained preconceptions and

“Two keys turnedeconomics in Unileverinto an instrument foraction in the early1980s. One was thefact of oligopoly”

“The second key wasthat change in thediscipline of industrialeconomics itself”

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prejudices among the other functions and among theoperators - the real decision takers - about the placeof economics. Like the old IBM Europe team andlike the old “E and S” Department in Unilever,economists are still often seen as the crankers of thehandles of black boxes, out of which pop forecastswhich you take on trust or ignore. They were supposedto produce information that might be used as a pumpmight be, rather than metabolically. It is the fault ofin-house economists themselves if such misconceptionsare not scotched; but the label “economics” itself cansometimes be a handicap, and a group of economistsmay make a bigger and faster impact in a companyif they change their title.

Particular skills occupy the stage. Business decisionsdepend upon the flair that comes with selection andwith operating experience. They are informed byestimates of costs and capital requirements which arethe province of accountants; by the knowledge ofthe effects of price and quality and selling effortupon market shares which is the stamping groundof market research; by considerations of first moveradvantage and innovative lead-times which drawin Research and Engineering and the Patents team.And not to step beyond the unwritten or the writtenrules of competition is the business of the corporatelawyers.

Yet all these, and particularly their strategiccombination in a setting which will be mutated by thecompany’s own choices, is the stuff of industrialeconomics as it has developed. The trick is to becomeinvolved as the synthesiser of a team of particularexpertises: not to expect to displace them, but toconnect them to the advantage of the ultimatedecision-takers. Most of the private language ofeconomics is best avoided, at least until it has becomecommon property by cautious introduction. Jargon isanathema. No “folk theorems”, no “boundedrationality”, no “conjectural variations”, not even anoccasional “chain store paradox”. Gradually key ideaslike sunk costs, incentive compatibility, the Prisoner’sDilemma and the other more accessible paraphernaliaof game theory become familiar currency that can passabout.

Why Economists?When this happens, and when, at the same time, theplurality of possible outcomes is apprehended,economists will have to parry a different challenge.“Why do we need to pay economists to tell us this? Itis all such common sense and so obvious!” Like

Moliere’s Bourgeois Gentilhomme, “we have beenspeaking prose all our lives and never knew it”. Andfurthermore, “you cannot give us that certaintyabout outcomes which we really crave”. This is ahard challenge to meet. It is best done by keepingwell out of sight the arcane mysteries of the modelsbehind the conclusions - but known to be there, andavailable for inspectionif required. Theconclusions themselvesneed to be appealing.Intuitive acceptance isalways more likely tolead to action thananalytical rigour. This islargely a matter of presentation. Decisions that lookcounter-intuitive are rarely taken. Persuasive skill iscalled for to change a mind-set; there is more scopehere for metaphor and analogy than there is formathematics. And a picture is worth a thousandwords.

All successful operators, in whatever stratum ofmanagement, are liable to be prejudiced by theirown particular experience which is treated as ifcurrent, and from which they will generalise. Thisis inescapable. Paradoxically, they will also tend toregard each market as having unique features whichdiscourage drawing conclusions based on experienceoutside their own. Also “no operator has succeededby looking backward”, so the lessons of history,apart from the most personal, are rarely learned.Secrecy is prized, and optimism, so that the realreasons for failure andsuccess are oftensuppressed in favour ofconventional explanations.Success is demanded ofstrategic action withinimpracticably short timeframes if the advantagesare to appear before thedecision-taker has movedon for others to enjoy or suffer the consequences.Above all, there is little time allowed to think. Theoperators are intensely involved in the dangerousperformance of sanctioning irreversible actions.Thinking is a luxury enjoyed by the functionalmanagers - the priesthood of “knowledge-workers”that may sometimes include economists as arch-priests. They alone have the time to develop andfollow through the processes of strategy.

“Success is demandedof strategic actionwithin impracticablyshort time frames ifthe advantages are toappear before thedecision-taker hasmoved on”

“Like Moliere’sBourgeoisGentilhomme, ‘wehave been speakingprose all our lives andnever knew it’ ”



Strategic ThinkingThe consultants Booz Allen (1983) describe strategicplanning as requiring “credibility, innovation and non-linear thinking. It is data-driven, highly analytical andintensely focused; yet it requires judgment, intuition,vision and the ability to reach global decisions. It mustbe rooted in quantitative analysis of economics, marketand segment dynamics, technologies and competitivepositioning, but nevertheless qualitatively responsiveto organisation behaviour, management style and theenvironment. Most important, strategic planning mustbe integrated, cutting across a broad swathe of issues,functions and organisational entities.” Economics cannow lay claim to be the lead discipline among this“broad swathe of functions”. Dynamic systemsmodelling was adapted from engineering science byGeorge Baumol, Richard Goodwin and others longbefore it became a discipline in its own right.

Speeds of response, feedbacks, competitiveescalation and control systems are the work-in-tradeof economic modellers. In a fundamental sense, thewhole of economics is about identifying and measuringthe trade-offs between the costs and advantages ofalternative choices. The selection, weighing andcomparison of causes and effects with incompatibledimensions of more and less quantifiable gains andlosses, risks and rewards, nearness and distance, arethe essence of the subject.

A typical exercise within Unilever was developinga model to inform decisions about whether and whereto concentrate production across Europe inanticipation of the Single European Market in 1992:

weighing increasedtransaction costs, therisks of industrialaction, governmentpressures and thesacrifice of localknowledge against thepotential economies of

scale and other logistical advantages of consolidation.Added to this, in-house economists are particularlywell-placed to generate and maintain a warehouse ofrelevant intelligence about the consequences of actionselsewhere and elsewhen - an objective memory thatcan inform future action.

Game TheoryWithin the industrial economist’s tool-kit, the mostpowerful instrument for competitive analysis is gametheory. A chief delight of game theory is the way its

results demonstrate, time and again, how asuperficially plausible outcome may not happen, orhow misguided may be an intuitively appealing courseof action. The solution of the Prisoner’s Dilemma isunsatisfactory for both parties. So are most price wars.The theory explains both why they occur and howthey may be avoided. Delegation of responsibility foraction from owners to managers looks likely, on theface of it, to compromise the maximisation ofshareholder value. Thomas Schelling (1960)demonstrated how timely delegation, visible to rivals,might convey strategic advantage when it implied acredible, if on the face of it irrational, response toterritorial threat. Revealing one’s hand to rivals maysometimes be the cheapest way of winning. I shall givetwo examples of the application of game theory withinUnilever later on.

The driving inspiration behind the application ofgame theory and other aspects of the “new” industrialeconomics to corporate decisions is the focus uponthe competitor, both present and potential. In Unilever,we developed a rudimentary duopoly game for playingon a PC. The game was set up so that the character ofa particular real or imagined competitor could belocked into the computer: attentive or oblivious tothe human rival’s moves; aggressive or co-operativein its positioning in neighbouring product space or inits pricing; opportunist or long-term in its objectives;gambling or risk-averse; technology-driven or market-driven. A game consisted of a succession ofsimultaneous moves by the two players on price,capacity investment, product positioning, new productintroduction, research and marketing spend. There wasno set limit to the number of moves and so no end-game strategy of defection.

Most interesting and most difficult to build in wasan artificial intelligence element. The computer learnt,by observation, about the strategy of its human rival,and adapted its own responses in the course of thegame, according to its own character. So it was possibleto parry threats, to signal, to build credibility aboutthe human’s own reaction to predation or to defectionfrom earlier established tacit accommodation. Thechief benefits of the crude version of the game wedeveloped was to familiarise operating managers, intheir training sessions, with the conflict strategy ideasand to let them try their hands at reading, from itsresponses - the character hidden in the box - and tryingto outsmart it by “tit-for-tat” or by other strategies oftheir own, in competing teams. A more sophisticatedprogramme, fed with real information of actual moves

“Within the industrialeconomist’s tool-kit,the most powerfulinstrument forcompetitive analysis isgame theory”

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and responses drawn from a history of actualencounters with a global competitor across times andplaces and truncating twenty years into a day, couldbe developed into a powerful strategic tool.

In principle, one could investigate individual tacticslike crowding out by brand proliferation, cloisteringa rival in a stagnant part of the wider market,aggressive building of spare capacity to deter entry,the costs and benefits of reputation building, patentraces, pre-emptions, “facilitating practices” like atough environment policy which forced the hands ofless well-placed rivals, or the impact of a stronglysignalled change in the character of the CEO.

There is also scope for smaller, more easilymanageable game theoretic programmes, applied tospecific markets and issues. We wrote, at one time, aso-called “meta-game” programme into which couldbe fed the current price-set and cross-price-elasticitiesof all the competing brands in a particular market.From it could be predicted the eventual stable pricestructure which would result from the price movesand reactions and jockeying for position in the interim.The local company, applying this off-the-shelfprogramme could then short circuit the priceadjustment process with advantage - pass GO, as itwere, without visiting gaol.

Corporate ResponseFor several reasons, the application of game theory toa company’s competitive strategy meets with a gooddeal of sceptical resistance and occasional outrighthostility. Usually, the scepticism arises becauseeveryone can think of situations where signallingdoesn’t work or hasn’t worked: when one or bothplayers com-pletely misjudge their relative strengths;when the opponent is deaf or deliberately andostentatiously not attending to what one is doing;when the level of background “noise” in the marketis too high; or when the market is immature andchaotic, with large-scale entry going on, for example.Deafness or inattention is a particular worry. Burningone’s bridges is expensive, and there is little point indoing it if the enemy cannot see the smoke. As DrStrangelove said to the Russian ambassador, “whatwas the point of building a Doomsday machine whenyou kept it a secret?”

Hostility has different roots. It is partly territorial.Communication with competitors, even the mostindirect communication where actions speak louderthan words, spells trouble to the corporate lawyer.Signalling by investing a dollar or an ECU more than

is absolutely necessary will raise the accountant’shackles. The marketing director resists any distractionof attention away from the consumer. And all deplore,at first, what Nelson and Winter (1982) called “thewidth of possible outcomes within the organizingconcept of game theory”.

What is often regarded as game theory’s Achilles’heel is, in fact, its shield. Scenarios are inevitably pluraland outcomes uncertain. There is no point in a theorythat abolishes that uncertainty in favour of animagined and precise equilibrium. Game theory admitsthe variety of outcome and sets boundaries to it. Iwas encouraged by a letter at an early stage from thethen Chairman of Unilever Australia Ltd, which madethis point. He wrote: “I find this information to be ofconsiderable interest and potentially valuable for thebusiness. So much described is recognizable in whathas taken place and what is likely to take place in anumber of areas. What I like about this approach isthat it does not offer any ready-made formulae forsuccess, but stimulates rational, strategic thinking andbrings home the often-overlooked point thatcompetitors are not likely to sit back and watch youpursue your fondest objectives.” (Mike Little 1983)

Team-workMany different skills have to be combined in theprosecution of conflict strategy. Psychology lies nearthe heart of it. One primitive theorem is that to fool arival into believing that one’s costs are lower than theyreally are will enhance one’s share of a growing marketby deterring him from contesting it. In practice, sucha bluff is much morelikely to reboundagainst one, since therival, galvanised by hisapparently inferiorperformance, will sethimself new benchmarks, drive out X-inefficiency andend up with a long-term cost advantage over thebluffer. In Unilever, we found that, for greatesteffectiveness, it was helpful for Economics to combinewith Research and Engineering, IT and MarketResearch, and sometimes Patent Division, and for ourpreliminary results to be presented to operators andother senior managers to be argued over, modified,and sometimes with good reason rejected.

From the hundreds of commissions over my tenyears at Unilever, I select four to illustrate differentaspects of the contribution economists can make tobusiness. They are necessarily somewhat veiled as to

“What is often regardedas game theory’sAchilles’ heel is, in fact,its shield”


the detail of the market, since all are still live strategicissues. Neither with all of these four, nor with severalof the others, did we always carry the day. When wedid not, it was because we presented our case badly,or missed some key facts, or were not involved closelyenough with the decision-takers themselves. But wehad a good number of successes, and when our advicewas rejected, it was almost always leaving a clearerview than had existed before. We survived the toughestof tests over those ten years, the market test, recovering80% of the Department’s budget from tight-pursedcorporate clients against the competition of outsideconsultants.

Case 1: Country Risks in the Eye of theBeholderIt is common for multi-domestic companies to consultfrom time to time commercially available tables ofoverall economic and political risk, expecting to doless well, on average, in politically volatile or inflation-prone countries. One such index is the BERI (Business

Environmental RiskIndex), which reducesseveral kinds ofexternally perceived riskto a single number foreach country. Commonsense suggested that

one of Unilever’s core strengths was the range anddepth of its experience across more than seventycountries.

Profit is not the reward for bearing uncertainty. Itis the reward for being sure when others are uncertain.We set out to test this. The company’s experience ofproducing locally in five continents over severaldecades might enable it to prosper where others werefearful and unambitious. We ran a simple cross-country regression of BERI risk against Unileverprofitability and presented the results at a conferenceof the heads of our overseas businesses. Without goinginto detail, in general terms, the higher the outsideworld’s perceived risk in a country, the better Unileverdid. Once again, what turned out to matter was notthe state of the external environment but thecompany’s relative strength vis-a-vis its local andglobal competitors, knowledge derived from successfuloperations elsewhere and transferred to sensitive newmarkets. Outside risk factors were swamped by thebenefits of market leadership, technological andmarketing applications, and the ability to adaptconfidently to each country’s stage of development.

Case 2. Product Evolution and GraduationOut of the store of privileged data, kept up to date inthe central information warehouse within thedepartment - data collected on sectors and sub-sectorsof demand in many countries over many years - itwas possible to build a model of market evolutionand the changing life-cycles of particular “vintages”of product across countries at different stages ofdevelopment and per capita real income. To take anobvious example: as populations become richer, theymove, in washing their clothes, from hard soaps,through detergent paste to powders and eventually toliquid detergents and fabric softeners. All productssurvive, and many exist side-by-side in countries withlarge differences between rich and poor.

The cross-section demonstrates the progressionthrough the vintages in any one country, and themigration of the more sophisticated variants from themore developed to the less developed as they grow,with the horizon which is created by the mostadvanced variant continually moving throughcompetitive innovation. From work of this kind,exploiting income elasticities and other determinantsof choice across the world uncovered by the researchlabs and market researchers, a moving picture of theevolution of future demand can be built up, whichsupports long-term investment decisions in bothtraditional and new washing media. Locating andriding the product life cycle was a large part of ourwork across the Regional and Product Groups.

3. Cross-parrying to Contain a RivalThis case directly involved the application of aprinciple of game theory that goes back many centuriesto Sun Tzu’s Art of War (1963). It illustrates a dictumof Schelling’s (1960), namely that “the essence of thesetactics is some voluntary but irreversible sacrifice offreedom of choice” (in this case a heavy sunk cost).“They rest on the paradox that the power to containan adversary may depend on the power to bind one’sself.” In a large and fast-growing overseas market,the company suddenly found itself facing ferociousdeep-pocket price-cutting and promotion of a rivalproduct in its hitherto private preserve at the top endof the product scale. This competition was comingfrom a powerful, well-connected and technologicallyadvanced local producer who enjoyed a nearmonopoly at the very large-volume, low-margin,bottom end of the broad market, the end whichUnilever had abandoned as being too labour-intensive,necessarily low-tech and likely to be deserted as

“Profit is not the rewardfor bearing uncertainty.It is the reward forbeing sure when othersare uncertain”

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consumers moved up-market. The rival was able tosubsidise, out of the margins on the large volumebottom-end product, an attack with a look-alike, butin no sense inferior brand, supported by profligate gifts.

We visited the market, studied the rival at closequarters, and put together all the information we couldget on the ground. We developed some game theoreticscenarios based on what we had found out. Theevidence of moves and counter-moves over recent yearsand what we knew of the character of the companyled us to conclude that he confidently expected thatwe would never counterattack it in his bottom end“home territory”. We were also able to show, thanksto the help of the Research labs, that the high volumeproduct need not be inferior at all, and had indeed, inother parts of the world, extended its life cycle byappealing to more sophisticated consumers. Afterassessing the “innocent” and “strategic” barriersto our entry, we recommended that Unilever’s beststrategy was to re-enter the rival’s “bread-basket”market with a technically superior product, and ona visibly committed and large scale.

We had reason to believe that small-scaleretaliatory entry would not be credible to the rival,our exit costs being then too low. Colin Mayer (1985)has made this point: if an entrant’s sunk costs (itscapital costs less the present value of their disposal onexiting) are too small relative to those of theincumbent, then the incumbent can credibly threatenan undercutting price strategy to the point where theentrant would want to leave. We also found that small-scale entry would not eat sufficiently into his abilityto cross-subsidise. There was a touch of “tit-for-tat”in the strategy proposed. As well as distracting therival from its foreign adventure in order to protect hishome base, it signalled a believable intention to fightfor, and indeed transform, what had been the low techpreserve of the rival. The decision to do so was taken,but, as is usually the case, not solely on the strengthof the game theoretic case, but on its own merits.

Case 4. A Competitor War-roomAs I have pointed out, the nature of Unilever’s businessis to a large degree a series of head-to head battles fordominance or leadership, with equally determinedopponents. In fragrances, it was with IFF; in foodswith Nestlé and Philip Morris and RJR Nabisco andseveral others; in detergents around the world thereare just five other serious players - Procter & Gamble,Henkel, Kao and Lion based in Japan and Colgate.Similar configurations persist in most of the other main

markets. The bread-and-butter work of the economistswas competitor monitoring and auditing - establishingthe characters, motives, strengths and weaknesses ofeach main rival, set against Unilever’s own, and tryingto identify the particular contributions of differentfactors to overall differences in market share and profitperformance.

A first cut at such an analysis would typically breakdown an operating margin difference into five plussesand minuses - product mix effect, regional mix effect,price-cost edge, R&D expense per unit and marketingand administrative cost per unit. The hard analysiswould then begin, on the reasons for the price-costedge, and the interdependencies between the fiveelements.

Knowing where to fight, where to sit tight, andwhen and where to withdraw requires one to knowone’s competitor better than he knows himself. Thestudy needs to be continuous and to display bothmemory and foresight. There were many such auditsin those ten years. I hope they are continuing, because,of all the uses to which economists may be put in aglobal business with few contestants, this strikes meas being the most useful.

Relative market share is the most powerful driverof profitability in every oligopoly market. The shareof industry profit overthe share of industrysales is typically two ormore for a dominantcompany in a regionalmarket (wheredominant is defined as>1.25 times the nextlargest). It is typically0.25 or less for a “follower” (defined as one <0.75times the largest). Of course this is heavily influencedby all the factors independent of relative size whichaffect both share and profitability. But after accountis taken of all these, the signal advantages ofdominance remain. For this reason, if for no other,competition among the few prevails as fiercely as itdoes among the many.

ConclusionsPerhaps the best way to describe the contribution ateam of industrial economists can make to strategicdecisions within a business is as a moderator andbalance for the many special interests, skills andmotivating forces, both operational and functional,within the company. The economist’s viewpoint tends

“Knowing where tofight, where to sit tight,and when and where towithdraw requires oneto know one’scompetitor better thanhe knows himself”


to be more analytical and more long-term than theother members of a team. His or her perspective (morethan half my team were women) will not alwaysprevail; nor should it. The economist may urge thatentry into a new market where there is a dominantincumbent should be on a grand scale, with heavyand visible commitment to maximise the likelihoodof reluctant acquiescence rather than total war. Theaccountant will argue just as convincingly for aminimal commitment and the use of third partymanufacturers, where possible, to lower the exit costsin the event of failure to establish a viable market sharein a given time. It is for the CEO to weigh the two setsof considerations and to decide whether and whenand how to enter.

The in-house economist may set a higher value ona potential acquisition target than does the Mergersand Acquisitions team, who value the tangible andintangible assets, because he (or she) throws into thecalculation the present value of the future damage thatwould be done if the target were acquired, along withits brands and its bases, by a particular rival. Again,which basis of valuation should prevail depends uponcritical value judgments about the direction of thecompany as a whole which are not for the economistto make.

My experience is very particular. It relates largelyto one company. It leads me nonetheless to venture ageneral conclusion. Probably, across most of thecorporate sector, economists are wasted, or allowthemselves to be wasted, when they do not use thetools that they now have to hand to addresscompetitive strategy. Aside from fast movingconsumer goods, their happy hunting groundincludes the oil companies, the major softwarehouses, the beleaguered cigarette companies (whocould no doubt have predicted the particular versionof the Prisoner’s Dilemma played out by Liggett), thepharmaceutical majors, the global chemical companies- indeed everywhere where the actions of one companyshape the responses of both rivals and other agentswithin strategic groups. Insofar as these companiesare not using economists in all these ways, it will to alarge extent to be the fault of the economiststhemselves.

Teamwork, with other functions and skills, is thesine qua non. Economists working alone are ineffectivein a business. They must be prepared to sacrifice theluxury of precision and high theory. They should nevercomplain, as I once heard a colleague complain at anoligopoly theory conference in Oxford, that

“introducing that much reality would make myproblem intractable”. Their watchword should betransparency, not mystification. The watch will neverbe found under the lamp-post. A good plan is to gethold of a torch.

ReferencesBooz-Allen (1983) Olwer, A. R. and Garber, J. R.,Implementing Strategic Planning, Business Horizons,26, March-April, pp49-51.Kay, J. (1991) Economics and Business, EconomicJournal, 101, January, pp57-63.Mayer, Colin (1985) The Assessment: RecentDevelopments in Industrial Economics and theirImplications for Policy Oxford Review of EconomicPolicy Vol 1 No3.Nelson, R. and Winter, S. (1981) An EvolutionaryTheory of Economic Change, Cambridge, Mass:Belknap Press of the H.U.P.Phillips, A. (1962) Market Structure, Organisation andPerformance, Harvard University Press, p23.Schelling, T. C. (1960) The Strategy of Conflict, NewYork: Oxford University PressSun Tzu (1963) The Art of War, Translated by Griffith,S. B. Oxford University PressTrachtenberg, S. (1997) in The Wall Street Journal,January 2.

David Stout is Director ofthe Centre for Business

Strategy at London BusinessSchool and formerly headedthe Economics Department

at Unilever plc.

66 David Stout

the business of economics is business

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