Estimating Value Creation from Revealed Preferences: Application to Value‐based Strategies

Abstract

Research summary: We develop and apply a new set of empirical tools consistent with the tenets of valuebased business strategies, leveraging the principle that "no good deal comes undone" and the methods of revealed preferences, to empirically estimate drivers of value creation. We demonstrate how to use these tools in an analysis of value creation in buyer-supplier relationships in the UK corporate legal market. We show that our approach can uncover evidence of subtle mechanisms that traditional methods cannot easily distinguish from each other. Furthermore, we show how the estimates can be used as parameters of biform games for outof-sample analyses of strategic decisions. With readily available data on relationships between firms, this approach can be applied to many other contexts of interest to strategy researchers.Managerial summary: Managers need to understand the drivers of value creation for customers in order to make competitive positioning decisions and understand when they can capture value under competition. However, estimates of the relative importance of each driver are typically difficult to obtain. In this article, we help remedy this problem by demonstrating a novel method that obtains estimates of the contribution of various drivers of value creation from commonly available data of buyer-supplier relationships. These estimates can then be used to inform the strategy-making process. Research abstractWe develop and apply a new set of empirical tools consistent with the tenets of value-based business strategies, leveraging the principle that "no good deal comes undone" and the methods of revealed preferences, to empirically estimate drivers of value creation. We demonstrate how to use these tools in an analysis of value creation in buyer-supplier relationships in the UK corporate legal market. We show that our approach can uncover evidence of subtle mechanisms that traditional methods cannot easily distinguish from each other. Furthermore, we show how the estimates can be used as parameters of biform games for out-of-sample analyses of strategic decisions. With readily available data on relationships between firms, this approach can be applied to many other contexts of interest to strategy researchers.Word count: 125 words.Keywords: value-based strategy, revealed preferences, cooperative game theory, buyer-supplier relationships, client-specific economies of scope Managerial abstractManagers need to understand the drivers of value creation for customers in order to make competitive positioning decisions and understand when they can capture value under competition. However, estimates of the relative importance of each driver are typically difficult to obtain. In this paper, we help remedy this problem by demonstrating a novel method that obtains estimates of the contribution of various drivers of value creation from commonly available data of buyer-supplier relationships. These estimates can then be used to inform the strategy-making process.Word count: 84 words.3

Demand‐side strategy, relational advantage, and partner‐driven corporate scope: The case for client‐led diversification

“…A related question that naturally arises from our research is whether and when client‐led diversification improves firm performance, especially in light of recent studies that suggest that the costs of diversification may outweigh the benefits of economic synergies (Chatain & Mindruta, ; Siggelkow, ) and that firms may not be able to capture the anticipated level of additional business from existing customers (Nayyar, ; Schmidt et al, ). Thus the expansion of firms’ horizontal scope to leverage partner‐specific relational assets potentially presents them with both opportunities and challenges.…”

“…Furthermore, the ability to leverage previously accumulated relational assets arguably reduces the costs and risks associated with such diversification. At the same time, horizontal expansion may strain firms’ corporate resources and managerial slack, and thus incur diseconomies of scope (Chatain & Mindruta, ). Moreover, firms may also risk becoming too closely tied to their clients, which may decrease their bargaining power and imperil their ability to develop and maintain specialized expertise and capabilities (Baker, ; Chatain & Zemsky, ).…”

“…The implications of changes in client diversification for a focal firm's own diversification are palpable from the demand‐side view, which posits that the sources of customer value are important determinants of firm strategy and competitive advantage. Clients may perceive value in buying from the same supplier for multiple reasons, including one‐stop shopping (Chatain & Zemsky, ; Cottrell & Nault, ), reduced search costs for new suppliers (Chatain & Mindruta, ; Klemperer & Padilla, ; Priem, ), potential complementarities between ongoing and new outsourced activities (Moeen et al, ; Novak & Stern, ; Siggelkow, ), client‐specific knowledge (Chatain, ; Mayer, Somaya, & Williamson, ), and other sources of relational capital such as shared governance, interorganizational routines and joint problem solving (Dyer & Singh, ; Macneil, ; Zander & Zander, ). Moreover, because many of these sources of value are at least in some degree specific to the supplier firm, they constitute opportunities for added value that can confer to the firm a competitive advantage in the provision of these services (Ye et al, ).…”

“…Therefore, in such contexts, clients may have greater confidence in their ability to jointly create value and perceive a modicum of control over the risks and hazards of outsourcing by working with an existing supplier (Nayyar, ). Not surprisingly, classic managerial writings on knowledge‐based services often advise firms to expand by leveraging existing client relationships instead of sourcing new clients, as the latter can involve significant risks and costs in client development and mutual learning (Chatain & Mindruta, ; Maister, ; Wilkins, ). Moreover, if suppliers don't respond to the new needs of existing clients, rival suppliers may have an opportunity to poach those clients in the long run (Bower, ) by establishing new relationships and/or increasing their added value (Chatain, ; Seabright, Levinthal, & Fichman, ).…”

“…However, both prior research and managerial experience indicate the potential relevance and importance of this research question. Consistent with relational capital being a source of customer‐specific synergies, research has found that buyers often prefer to select an existing supplier when they have a new outsourced need (Chatain, ; Chatain & Mindruta, ) and that firms may have an “inside track” to new business opportunities with their customers (Zander & Zander, ). Additionally, buyer firms may prefer to buy from the same supplier when interdependencies or complementarities exist between these outsourced needs (Moeen, Somaya, & Mahoney, ; Novak & Stern, ; Ye et al, ).…”