Abstract
This paper explores the various strategies that the managerial team can adopt under varying market situations especially with rising cost of inputs and changing demand and elasticity. The conflicts arising in taking strategic decisions regarding long term investment to expand the firm’s operation to expand market horizon and enhance market power, are discussed based on literature survey. The situations where the convergence of interests of stockholders and managers can take place have also been discussed referring to the evidences from several empirical studies conducted in the past. The issue of the relevance of government regulation has been delved into. It has been observed that, with globalization there have been an increase in the possibility of underlying conflicts in spite of the flow of financial information and technique that globalization ensures. The paper provides insight into the future areas of study that such conflicts, arising from strategic decisions for long-term investment, induces.
The pricing strategy of a product in a market economy is a complex derivative of a multitude of exogenous as well as endogenous factors. The size of the firm, the objective of the firm which is again dependent to a large extent on the extent of separation of management from ownership, the sales promotion activities, the ability of the firm in product innovations through research and development, the production technology applied and a plethora of other endogenous factors are controllable by the firm. Apart from that there are factors like government policies, the marketing strategies of other firms in the same industries, the price and demand of complementary products, the price and availability of inputs and many other factors are external to the firm, which the firm has to consider in its decision making process. The current study is an attempt to identify how the demand as well as the elasticity of the product, government intervention and differences in the interests of managers and shareholders influences a firm’s decision making process on long-term capital expansion plans in a situation of rising costs, in this era of globalization. For a better exposition of our analysis, we consider the case of a firm that produces microwaveable frozen health food with two other firms existing in the market with a monopolistic kind of market, which is evident from a somewhat inelastic demand.
Marketing Strategy to Influence Demand and Elasticity
If the firm has to raise prices in the face of rising costs of input it has an option of taking a combination of varying strategies. First and foremost effective advertisement and other sales promotion and marketing techniques can be implemented to make the demand for the product more inelastic so that a rise in price would not reduce the demand to any significant amount and in turn result in an increase in revenue for the firm. Product differentiation techniques will also be quite effective in increasing market power and shifting the consumers’ preferences towards the product of the incumbent firm from the other two competing firms even in the face of rising prices as the consumers will now view the product as superior and unique compared to the substitutes.
A second option can be to consider a move to a related market segment like heat-n-eat kind of food which may not require a microwave oven, or ready-to-eat food or similar others. Since consumers differ in their choices and preferences, producing diversified products will cater to unserved segment of the market and expand the horizon of operation of the firm leading to increased sales in a wider market.
A third strategy can be an increase in the scale of production of the firm. Such an expansion in scale of operation will allow the firm to reap the benefits of economies of scale thereby reducing the average cost of production. It will also enable the firm to take up more aggressive marketing strategies. The firm will be able to afford more selling costs. A highly publicized brand of a large firm sells more successfully compared to the products of the smaller firms. ( Mason, 1939).
Fourthly, the firm can substitute the input, which is subject to a price increase, with the cheaper input. This is possible only when elasticity of substitution is high, that means when there is substitution possibility between different inputs used in production by the firm. (Gardner,1975).
Role of Government
Government intervention influences the functioning of firms to a large extent. The tools of government intervention include taxes, subsidies, price ceilings and price floors, tariffs, quotas, etc. Government policies do play an important role in a market economy. There are many instances of economies where market economy co-exists with the system of planning.(Roller,1994). Regulation may become necessary in a market economy when the situation demands it. The necessity may arise due to conflicting interests of the market players, social obligations, environmental concerns or even political exigencies.
In the example that we have taken into consideration the government has scope of intervening into the market. Since the product is a health food the government can take promotional measures which will corroborate to the objectives of the health department of the government. The measures may come in terms of tax concessions or even subsidies, or a ceiling on price of inputs to boost the health food industry which will benefit our firm to a large extent. The government regulation may also come in the form of restrictions imposed on junk food market which will result in a shift of demand towards this health food.
There are instances of government regulation in a market economy under different situations. For instance: a) The section of the population left out of the market system because of low purchasing capacity are catered to by the government social aid scheme. The public distribution system of food is one such example. b) In case of products which have health hazards or other harmful sociological implications government regulation is required to restrict such products. The high taxes and other statutes on the sale of tobacco products is one such example.
Convergence of Interests of Stock Holders and Mangers
The classical microeconomic theory of the firm is based on the notion that the objective of the firm is profit maximization. This is true when the owner organizes and manages the firm. With the emergence of joint stock companies the management got separated from ownership. The interests of the managers differed from that of the owners. While the owners’ aim is profit maximization the managers are more interested in sales promotion, market expansion and gaining market power. So there is a conflict of interest between the stockholders and the managers. This conflict can be reduced when the manager owns a substantial part of the firm’s equity. This leads to higher market valuation of the firm. (Morck et al., 1988).
The conflict of interests between the management and the shareholders have several instances. In 1995 Chrysler faced such a problem when the shareholders wanted a cash hoard of $7billion to be distributed among them but the management intended to maintain the reserves. But finally the management’s decision prevailed as the shareholders had confidence in the management’s efficiency in running the firm. (Bebchuk, 2004).
The fact that managerial ownership makes the interests of the managers and shareholders to fall in line have been supported by a large number of empirical studies like that of Jensen and Meckling (1976), Demsetz(1983), Stulz (1988).
Globalization and Cost of Investment
The financial market had welcomed globalization on the expectation that greater capital flow will boost the financial sector and lead to an expansion of operation of the firms. But there are thinkers who have sounded a word of caution about whether too much of interconnection of financial markets may lead to adverse effects on the economy. Globalization has both its pros and cons. With increased foreign capital inflow, there is more competition among the investors which reduces the cost of capital. There are more inflow of skill and technology in the financial market. But there is also the fear of takeover as the firm is now a small entity in the global perspective. But with inflow of information and technology the managers can now take up new financial techniques leading to a conflict of interests between the managers and stockholders. (Stulz, 1999).
Conclusion
The strategies adopted by the managers under myriad market conditions characterized by varied demand and elasticity levels, differing degrees of competition and government control. The decisions are often results in conflicts between different stakeholders in the system. Though the current study has touched upon only the conflicts of interest between shareholders and managers, it is also important to consider other stake holders who have no less weightage as economic decision making units. The strategic decision is finally a balancing act taking into considerations the interests of the entities involved in the system while adjusting to the whims of the market.
References
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