About the prof

Prof of Economics, Wms School of Commerce, Washington and Lee University, Lexington VA

Natl Beer Day

Political Calculations has a history of beer container patents, replete with drawings from the patents. They also append long list of links to previous posts. All that I’ve read are “serious”, I’ll let you judge whether that results in deadpan humor, or comes out flat.

OPEC: Cartels, Cheating and Saudi Arabia

I provide no links, it’s easy enough to the find info below, or see me in office hours.

Saudi Arabia faces dire challenges: a burgeoning population that lives off of oil, and a growing royal family that lives extravagantly off of oil. The country is now running budget deficits, and otherwise is clearly living beyond its current means

…the Saudi’s hope is to stave off the day when they are the [political] disruptor of the Middle East…

So Saudi Arabia would like production cutbacks to drive up prices. What does the logic of cartels suggest will happen?

First, real-time data on OPEC production do not exist. That’s because cheating is rampant, and countries understate actual production. Scan the news and you’ll find stories galore on both the lack of data and (given that constraint!) the likely magnitude of cheating. After all, Saudi Arabia is not alone in finding itself squeezed between low oil prices and bedrock. Small producers pay lip service to the cartel, but in practice are selling all they can pump.

What of Saudi Arabia themselves? They currently pump about 1 in 8 barrels of oil, that is, 10 million of a global 80 million barrels per day. (OPEC pumps 42% officially, a bit more in reality.) So if Saudi Arabia cuts output 10% or 1 million barrels, global output falls 1.2%. Price does respond to demand, but even if it’s quite inelastic (0.3) that means price will go up by less than 5%. Hence Saudi revenue would fall 5%. Or more. So they simply cannot afford to cut output.

The greater the extent that others are capable of boosting output on the margin (think drillers in the US), the worse off the Saudis would be. (At present, for example, the US is sitting on record high inventories. As interest rates rise, that will pressure those “long” in the market to sell. A Saudi-induced bump in prices would accelerate that process, to the detriment of the Saudis.)

That doesn’t mean prices will necessarily remain low. Demand can change for a variety of reasons, and supply is subject to political disruptions. The Saudi’s hope is to stave off the day when they are the disruptor.

Proofreading your own stuff

You – like this post author – are “…almost incapable of reading anything that [you’ve] written before. It’s just too boring when you already know what the next sentence is going to say; at best [you] can skim. So it’s very hard for [YOU] to catch mistakes…” WHERE – whoops, there goes a typo – where I substituted the second person in brackets for the author’s first person prose. USE THE COMMCENTER and trade papers with friends. It helps if you incentivize them. How about 25¢ for each typo? – you can probably come up with a feasible mechanism that won’t necessarily involve money. One might be “if you only find 3 typos in my paper, I’ll stop after I find the 3rd typo in your paper.” Or another might be “whoever finds the most typos…” or “can justifiably red-line the most prose” gets XXX.

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Why BEVs Won’t Be Disruptive

Mike Smitka, Torino Italy, November 23, 2016 reposted from the Autos and Economics blog

In 2030 I expect that Toyota, VW and GM will remain the top 3 global automotive producers (though not necessarily in that order). The flip side is that neither vehicle electrification nor autonomy nor Mobility 2.0 businesses will prove disruptive.

…Disruptive Technologies? Not in Automotive!…

Each of these purported threats have their own challenges as technologies and businesses. That is for other blog posts. All three however have a common feature: new technologies roll out slowly, and in the auto industry they roll out very slowly. Even with rapid commercialization, in 2030 only 1 in 10 vehicles on the road will be BEVs (battery electric vehicles).

New technology adoption and diffusion follows a logistics process: slow early on, then accelerating, and slow again towards peak. That is true in theory: few are willing to chance adopting a technology when no one they know has done so. Similarly, towards the peak those who have yet to adopt a technology have refrained not because (or not only because) they are obstinate but due to idiosyncratic circumstances. This is a robust empirical finding, dating back to Zvi Griliches’ classic 1957 study of hybrid corn. Commercial hybrids were first developed in 1923. While half of Iowa farmers used such seeds by 1938, farmers in regions where corn was less widely planted continued to sow non-hybrid cultivars until the 1960s.

Automotive technologies are no different. Initial costs of a new technology will be high, while performance will still have room to improve. Historically many technologies appeared first as an option on luxury cars. If the uptake was good, one or more firms might make it a standard feature. As the volume rose, suppliers would reduce the price point, and OEMs would migrate it to high-volume products.

Feasible BEV Rollout Scenario

Year

Global new vehicle output

BEV share

BEV share vehicles on road

2020

100

1%

0%

2021

103

1%

0%

2022

106

2%

0%

2023

109

2%

1%

2024

113

3%

1%

2025

116

5%

1%

2030

134

41%

11%

2035

156

77%

35%

2040

181

81%

55%

This process is thus constrained by the commercialization process, by the standard “learning curve” and economies of scale effects, and by the time needed for the supply chain to add new capacity. It is also constrained by the new model development process, because it is highly unusual for a feature to be introduced in the middle of a model year. So the use of new technologies can only expand as models are redesigned, which for standard sedans is done a rolling 4-year cycle. That puts a limit on the pace of adoption. Furthermore, it may only be possible to introduce a radical technology with a new platform; those are developed on a rolling 6-10 year cycle. Drivetrains are also redesigned less often. And heavy trucks may not be fundamentally redesigned for as much as 20-30 years. (One major brand uses an H-frame first introduced in the 1960s, before the advent of the steel and aluminum alloys that are widespread in the passenger car market.)

[The bulk of the engineering for a standard passenger vehicle model takes place over roughly a 12-month period, with a smaller advance team working on model specifications at the front end of the process, and at the tail end a smaller team seeing the design through to SOP (the start of production). The full process thus spans 18-24s months. The rolling development cycle is thus due to staffing constraints in the development process, and the desire of the marketing and dealership end to have a steady stream of new models, but not a flood of them.]

In the past, even rapid rollouts of technology in the automotive space, such as when there is a “hard” regulatory deadline, has required over a decade. The fastest example of which I’m aware is the replacement of carburetors by technically superior fuel injectors, the latter necessary to meet emissions requirements. They had been used intermittently in racing from the 1950s, and began to appear on low-volume luxury cars in Europe in the 1970s. However, they were complex and costly mechanical contraptions. That changed with the introduction of microprocessor engine control units (ECUs), which also made fuel injectors much more effective. The first Motorola ECU was launched in 1980, and by 1990 GM had converted the last of its engines to the new technology. At the firm level, the rollout was over one decade, but for the industry as a whole it followed a logistics curve. Pulling off this fast introduction required huge investment. To facilitate the fast pace and not be hostage to Motorola, GM invested in its own semiconductor manufacturing operation; for a time it was the fourth largest chip maker in the world.

…15 years from now BEVs will still account for less than half of production. That’s hardly disruptive!…

So what does it look like if you combine industry specifics with a logistics curve? First, by 2020 global production will be 100 million vehicles, and slowly increasing. Globally there will be perhaps 1 billion vehicles in operation, with 8% scrapped in a given year (at which rate the average vehicle on the road will be 11.5 years old). Finally, because large vehicles are unlikely to be BEVs, it’s sensible to assume diffusion peaks at 80% of the market. You can read the numbers for yourself.

This is an excerpt from one section of a paper on new vehicle technologies that I presented at the “Toronto-Torino Conference” organized by the Munk School of Global Affairs at the University of Toronto, Collegio Carlo Alberto, and Politecnico di Torino. Along with wonderful food and wine, the conference also included a tour of the Torino assembly plant of Maserati.

Additional Text

A New Year’s surprise for me, Just out today on Amazon, so in time for this term. I’ve been increasing the technology component with each iteration of the course, this term will be no exception.

  • Mike Smitka & Peter Warrian, A Profile of the Global Auto Industry: Innovation and Dynamics. Business Expert Press, 2016. Paperback ISBN 978-1631572968, ASIN (eBook) B01MS2ALIU.

I do not require a standard textbook, but you can find used copies of several online, and I encourage you to pick one up. Old editions are fine, all have presentations of our core graphical/algebraic models, some are more thorough, case studies vary. These and other texts have far, far more material than we can cover in our 12-week term. Here are two suggestions:

  • Luis Cabral, Introduction To Industrial Organization, MIT Press, 2000.
  • Stephen Martin, Industrial Organization in Context, Oxford University Press, 2010.
  • There are also books by Victor and Carol Tremblay; Pepall and Richards; and Waldman and Jensen.
  • An outstanding but very challenging book that emphasizes pure theory is Paul Belleflamme and Martin Peitz, Industrial Organization: Markets and Strategies, Cambridge University Press, 2015. If you’re thinking of graduate school in economics, you should pick this up. I’d be happy to help you work through some of the extensions they develop of the basic models that we will examine in class, though that might best be done as an independent study some subsequent term.

Winter 2017

Economics of Strategy

MWF 12:20-1:15 Early-Fielding 109

Text: Ogle, M. (2007). Ambitious brew: the story of American beer. Orlando: Harcourt. 978-0-15-603359-6. Order yourself, lots of cheap used copies out there so not worth asking the bookstore to get it. (Amazon link also available for Kindle for $8.99). The bookstore will get in 5 copies. I will add 1-2 more industry-specific books, one is forthcoming end-December, will add if publisher meets their schedule.

For Winter the Economics of Strategy will include an extended case study of beer, drawing upon the above book by Margaret Ogle. We will use a second, forthcoming book on the auto industry but the ebook order link isn’t functioning. We will not use the Martin “Industrial Organization” text.

This course requires only Micro Principles (Econ 101) and is aimed at anyone interested in issues of business strategy and the organization of industries; it is potentially open to freshmen, but if demand is constrained, priority will be given to sophomores and above. In most recent iterations only about half of the members of the course are economics majors. Our focus is on the producer side; sometimes what is good for firms is also good for consumers, but except in passing we ignore that larger set of questions. Similarly, most books assume a 2-semester sequence and so cover antitrust and regulation at considerable length. We note the theoretical issues, but avoid the nitty-gritty of competition policy, antitrust laws and the like.

We will explore a couple simple models of entry to give a flavor of the subject matter, beginning with the launch of Lite beer. We can then ask a different sort of entry question, on whether a car company (pick your favorite) should enter the “New Mobility” market. We will return perhaps 2x every 3 weeks to these sorts of real world examples. These problems will also allow us to introduce two “tools” – models in which consumers differ, models in which firms interact in strategy – that are not part of the repertoire you would have from Principles or from Micro Theory.

After the introduction, though, we need to build a set of tools to guide our thinking. First we will review the model of firms in perfect competition, and then the model of a pure monopolist. Those are clear extremes, and straightforward. We will spend most of our time on the messier world of oligopoly – or rather, for the sake of simplicity, duopoly. This segment concludes with a cautionary analysis of mergers and predation, and an analysis of the logic of franchising.

We then return to advertising, product differentiation, price differentiation and bundling, choices on how to place products. The concluding 3-4 weeks of the term will pick up questions of technology and intellectual property rights.

You will be asked to do a series of short papers on case study material, and a midterm and a final on the theory component of the course.

Wholesale Beer Prices

I am surprised at the divergence of canned and bottled beer. Now since most beer is sold in cans (my educated guess from what’s on Kroger’s shelves), it does though make sense that the overall index is close to that for canned beer. Note that the PPI is likely weighted by volume, and so is dominated by the pricing of AB InBev and Molson Miller Coors. It would be interesting to be able to track similar data for craft brewers.

Minimills Around the World

Tokyo Steel Mizushima Continuous Caster

Note that this plant sits across from a refinery; the ship on the left is two football fields (600″) in length. As big as it is, this EAF minimill is still smaller than the footprint of an integrated steel producer. Oh, and like Nucor, Tokyo Steel has often been far more profitable than behemoths such as JFE.

Other heavy industry complexes are adjacent to it, including a Mitsubishi Motors assembly plant that I’ve visited – all told it’s about 15 square miles total of factory next to chemical plant next to… You don’t fish in Mizushima Bay!

Okayama Electric Furnace

Tokyo Steel Okayama

Tokyo Steel Okayama [Mizushima] Plant

Microbrews around the world

LaBodegaBogota, Colombia from the author of the Principles book used by Prof. Hooks. Not just the US…though my sense is that Japan has a dearth of small brewers, long inhibited by a minimum tax that was not connected to how much a firm brewed or sold. [click on image to enlarge]