Notes

The economic profits achieved by firms are the result of:

• The average economic profit of the industry in which they operate (industry-level profitability).
• The ability to achieve better economic profits than rivals in the industry (within-industry variance).

An industry is a group of firms that produce goods or services that are close substitutes (banking industry, automobile industry, gas utilities industry).

Firms in an industry compete for the same costumers; so they are often engaged in a zero-sum game in which they have to overcome each other in order to achieve above- average returns.

Industries are more or less profitable, as a consequence of a set of forces that shape competition.

The most profitable industries are Toiletry & Cosmetics, Tobacco, Soft Drinks and Pharmaceutical industries. As a contrary Steel and Power industries aren't very profitable.

Every industry profits are the average of the differences in profits within the industry, therefore between the firms.

A firm is said to have a competitive advantage over its rivals if it has driven a wide wedge between the willingness to pay it generates among buyers and the costs it incurs, indeed, a wider wedge than its competitors have achieved.

A firm with a competitive advantage is positioned to earn superior profits within its industry. Having a competitive advantage depends on being unique (in a valuable way), that is, on doing something that cannot be replaced or imitated by competitors. Uniqueness means that the value created by the firm is larger than the value that competitors can create.

The essence of creating advantage is finding an integrated set of choices that distinguishes a firm from its rivals. The choices that establish a firm's advantage also influence whether the advantage can be sustained.

A costumer's willingness to pay for a product or service is the maximum amount of money that a costumer would be willing to part with in order to order to obtain the product or service.

The concept of supplier opportunity cost is precisely symmetrical to willingness to pay. It is the smallest amount of money that a supplier will accept for the service and resources requested to produce a good or service. We call this an "opportunity cost" because it is dictated by the best opportunities that the suppliers have to sell their services and resources elsewhere.

The total value created by a transaction is the difference between the costumers' WTP and the supplier opportunity cost.

The Added Value is the maximal value created in a transaction minus the maximal value that could be created without the firm. In practice, the added value of a firm is the value created by its goods/services compared to the value created by the next best option for the customers. The added value is important because, assuming that no barriers to competition exist ("unrestricted bargaining"), a firm can achieve positive economic profits only if it has positive added value. Said otherwise, the amount of value that a company can claim cannot exceed its added value. As a consequence, a firm will be able to apply a price that is no larger than the sum of its costs and the added value.

Therefore Final Price = Supplier Opportunity Cost + Added Value - 0.01 Discount.

Ultimately, competitive advantage consists in added value.

In turn, having added value depends on finding better ways to make and sell products, considering the network of suppliers, customers, and complementors that participate to transactions. Two strategies:

• Focusing on raising costumers' WTP without a commensurate increase in costs (differentiation strategy, by which we mean that the firm has boosted the willingness of costumers to pay, not simply that the company is different from its competitors).
• Focusing on reducing costs without a commensurate decrease in WTP (low cost strategy), better management of supplier relations is often underrated.

Rarely, firms may even achieve higher WTP and lower costs at the same time (dual advantage).