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Article | RAND Journal of Economics | spring 1987

Second-Sourcing and the Experience Curve: Price Competition in Defense Procurement

by James J. Anton and Dennis A. Yao

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Abstract

We examine a dynamic model of price competition in defense procurement that incorporates the experience curve, asymmetric cost information, and the availability of a higher cost alternative system. We model acquisition as a two-stage process in which initial production is governed by a contract between the government and the developer. Competition is then introduced by an auction in which a second source bids against the developer for remaining production. We characterize the class of production contracts that are cost minimizing for the government and that induce the developer to reveal private cost information. When high costs are revealed, these contracts result in a credible cutoff of new system production in favor of the still higher cost alternative system.

Keywords: Acquisition; Government and Politics; Price; Competition; Mathematical Methods;

Format: Print 20 pages Find at HarvardPurchase

Citation:

Anton, James J., and Dennis A. Yao. "Second-Sourcing and the Experience Curve: Price Competition in Defense Procurement." RAND Journal of Economics 18, no. 1 (spring 1987): 57–76. (Harvard users click here for full text.)

About the Author

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Dennis A. Yao
Lawrence E. Fouraker Professor of Business Administration
Unit Head, Strategy
Strategy

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More from the Author

  • Article | Strategic Management Journal | October 2017

    Elevating Repositioning Costs: Strategy Dynamics and Competitive Interactions

    Anoop R. Menon and Dennis Yao

    This paper proposes an approach for modeling competitive interactions that incorporates the costs to firms of changing strategy. The costs associated with strategy modifications, which we term “repositioning costs,” are particularly relevant to competitive interactions involving major changes to business strategies. Repositioning costs can critically affect competitive dynamics and, consequently, the implications of strategic interaction for strategic choice. While the literature broadly recognizes the importance of such costs, game-theoretic treatments of major strategic change, with very limited exceptions, have not addressed them meaningfully. We advocate greater recognition of repositioning costs and illustrate with two simple models how repositioning costs may facilitate differentiation and affect the value of a firm’s capability to reduce repositioning costs through investments in flexibility.

    Keywords: "repositioning costs; strategy dynamics; strategic interaction; game theory; capabilities; Cost; Strategy; Change; Game Theory; Organizational Change and Adaptation;

    Citation:

    Menon, Anoop R., and Dennis Yao. "Elevating Repositioning Costs: Strategy Dynamics and Competitive Interactions." Strategic Management Journal 38, no. 10 (October 2017): 1953–1963.  View Details
    CiteView DetailsFind at Harvard Related
  • Chapter | The Palgrave Encyclopedia of Strategic Management | 2017

    Product Market Strategy

    Anoop Menon and Dennis Yao

    Product market strategy is the collection of choices, actions and activities of a firm that determines how it positions itself in its product markets, and allows it to achieve and maintain a COMPETITIVE ADVANTAGE. This article examines product market strategy from the perspective of positioning, using the value-based strategy framework.

    Keywords: Product Positioning; Competitive Advantage;

    Citation:

    Menon, Anoop, and Dennis Yao. "Product Market Strategy." In The Palgrave Encyclopedia of Strategic Management. Continuously updated edition, edited by Mie Augier and David J. Teece. Palgrave Macmillan, 2017. Electronic. (Pre-published, October 2013.)  View Details
    CiteView DetailsFind at HarvardPurchase Related
  • Working Paper | HBS Working Paper Series | 2017

    Rationalizing Outcomes: Mental-Model-Guided Learning in Competitive Markets

    Anoop R. Menon and Dennis Yao

    This paper explores how mental models affect the analysis of dynamic strategic interactions. We develop an explanation-based view of mental models founded on a regression analogy and implement this view in simulations involving market competition between two firms with possibly differing mental models regarding the structure of demand. The paper addresses the following questions: (1) How sticky are incorrect mental models, and how are market observations interpreted in such models? (2) What is the impact of the interaction of different mental models on each firm’s learning? (3) Can firms with less accurate mental models outperform firms with more accurate mental models and, if so, why? We find that incorrect mental models can easily “rationalize” market outcomes and shape how a firm and its rival learns. Furthermore, this learning process does not push the firms to make increasingly convergent output choices, but rather causes those choices to diverge slowly. Finally, we identify situations where the firm with the less accurate mental model outperforms the firm with the more accurate mental model.

    Keywords: Mental models; strategic interactions; rationalization; explanation-based view; Learning; Competition; Performance; Analysis;

    Citation:

    Menon, Anoop R., and Dennis Yao. "Rationalizing Outcomes: Mental-Model-Guided Learning in Competitive Markets." Harvard Business School Working Paper, No. 17-095, May 2017.  View Details
    CiteView Details Read Now Related
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