R S M 3 9 2 H 1 : COMPETITIVE STRATEGY

University of Toronto Rotman School of Management Undergraduate Seminar

PROFESSOR: K E V I N A . BRYAN

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FINAL EXAM APRIL 2 0 1 7

Name:

Student Number:

Academic integrity is taken very seriously i n this class. Attempts

to use outside aids or to copy f r o m your neighbors w i l l lead to out-
c o m e s y o u do n o t w a n t to experience.

The final is closed-book, 2 hours in length, and consists of five short an-
swer questions, each worth 15 points, and five multiple choice questions,
each worth 2 points. All questions including multiple choice should
be answered i n the blue books provided. This exam contains 9 pages
including the cover sheet. No outside aids such as calculators or notes
are permitted.

Very good answers will make detailed reference to the concepts we have
discussed in class, and excellent answers will tie multiple concepts to-
gether. Top scores are concise and precise.

Please restrict all answers to three paragraphs or less. Do not write on

more than one page or use more space than you are given on the exam
sheet. A n d m o s t importantly, good luck, and enjoy your well-earned
break once y o u are finished!

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 PACIFIC.///;
March 17, 2020

We are very grateful that you've agreed to take a look at the strategic
aspects of our business, PacificAir. We think we are doing the most in-
teresting technological work in aviation, but our new Board of Directors
is worried that, since our management team is composed mainly of folks
with an aeronautics background, we may be missing something of strate-
gic importance. The following summary includes details of our business,
our technology, our competitors, and our relative cost projections for your
perusal.

PACIFICAIR - PROSPECTUS

PacificAir is a n e w airline based in Toronto hoping to provide direct point-

to-point flights from Toronto and Vancouver to a series of smaller cities in
East and South Asia. We are led by our young but highly productive CEO
Tommy Brady, and our Board of Directors is largely made up of aviation
hobbyists, though none of us have founded an airline. We possess world-
leading talent in operations research, and think we can minimize airplane
turnaround time at our destinations.

There are two new airplanes, the Boeing 787-900, and the Airbus A350,
which we are considering purchasing. Both planes are smaller than jumbo
jets like the A380, seating only 250 to 270 passengers, but they have fuel
costs 20 percent lower than existing large jets, and they have range to make
transpacific flights. A major constraint historically on long distance flights
is that only large jets seating 350 to 500 passengers had both the range, in
terms of kilometers, and the cost structure to make transcontinental flying
financially viable. For this reason, direct flights from Canada to Asia only
reached a small number of cities. The A350 and the 787-900 can fly prof-
itably at long distance, and are the only planes which can do so. We plan to
fly to second-tier cities like Fukuoka (Japan), Kaohsiung (Taiwan), W u h a n
(China), Chengdu (China), Kolkata (India) and Hanoi (Vietnam). None of
these cities are currently served on direct flights from Canada since there
is not enough demand to fill a full-size jet on these flights, hence given

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current route networks anyone flying on our competitors would need to
make at least one connection. We expect to begin flying these routes within
the next year, although international travel requires government approval
of every route, and our government relations experts have yet to secure
approval on all routes. We anticipate receiving approval for each of our
12 initial routes, f r o m both Toronto and Vancouver to the six cities listed
above, h u t we cannot guarantee start dates as we do not have direct expe-
rience with government lobbying here.

Traditionally, intercontinental airlines like United, Cathay Pacific and Air

Canada operate using a "hub-and-spoke" system. This means that these
airlines r u n short flights to bring passengers from smaller cities to large
hubs like Hong Kong and Vancouver, then fly over the ocean only from
those locations. Our fundamental idea is that hub-and-spoke is an out-
dated idea n o w that new airplanes like the 787-900 and A350 can directly
connect smaller cities. Existing airlines fail to recognize this opportunity
since they are so heavily invested in operating out of large airports and
selling tickets the hub-and-spoke way, and so we expect at PacificAir to
be able to sneak up on existing airlines, especially our primary competitor
Air Canada.

In addition to running a completely different sort of route network from

existing airlines, we also possess a unique piece of pricing software that al-
lows us to adjust pricing to market conditions in real time more effectively
than existing airlines. This technology is proprietary and is currently pro-
tected as a trade secret, though we are considering patenting aspects of
the software. Essentially, we are able to draw on public data to predict de-
m a n d for air travel on specific routes, and hence to adjust our schedule to
avoid airplane downtime in such a way that we believe we can fly 8 per-
cent more passengers per day per airplane than the average international
airline. Most of our senior staff initially became interested in running an
airline w h e n we developed this technology together in our previous jobs
as computer engineers, and we are still closely connected to the scientific
community concerning cutting-edge optimal pricing algorithms.

Our expected fixed and variable costs, as compared to competition, over

time are listed in Appendix 1. In this Appendix, "Sales" includes the cost
of attracting customers and setting prices, which we anticipate will fall

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quickly as we gain experience using our pricing algorithm and as we ex-
pand the number of flights we offer. Our planes are more expensive be-
cause they are newer, but the lower fuel costs make up for this.

We currently have 200 full time employees w h o work at headquarters. Pi-

lots and flight attendants will be hired over the next year, and we have not
decided whether to hire our own check-in staff, reservations agents and
ground staff, or whether to work with existing subcontractors. There are
two major international subcontractors who can staff our terminals in all
cities, but of course significant training would be needed for these workers
to ensure that they know our reservations system.

As PacificAir is "a new type of airline for the Pacific century", our pay
structure differs from most firms. We currently pay our workers 20 percent
less than the industry average wage, but we believe workers will w a n t to
stay with us despite lower salaries because we offer both cash incentives in
each division, and we offer the potential for rapid advancement within our
new company. Appendix 2 lists the speech our management team gives
new employee recruits about w h y they should take a job with our firm.
We perform annual reviews for each worker, and provide bonuses on the
basis of specific criteria. An example of this annual review is shown on
Appendix 3.

There is some debate within our team about possible exit strategies. We
are largely funded by a series of venture capitalists, and have just barely
enough funding to begin operating the airline, using passenger revenues
from that point on. We do not expect to be profitable for at least our first
five years of operation, as we begin to build up passenger numbers and ex-
pand into more Canadian and Far East cities. We do not currently possess
any bank financing or lines of credit. The venture capitalists insist that we
begin providing return on investment within five years, meaning that we
either sell ourselves to an existing airline, or go public. Our management
team at present is very much opposed to planning to sell to an existing
airline, as we believe our model is superior to hub-and-spoke models.

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A P P E N D I X 1: E X P E C T E D COSTS PER SEAT PER MILE F L O W N , I N $ U S

Year | Plane Lease |Sales | Fuel |Other

PacificAir
2021 .07 .07 .20 .10
2022 .07 .06 .20 .10
2023 .07 .05 .20 .10
2024 .07 .04 .20 .09
2025 .07 .03 .20 .09
2026 .07 .02 .20 .08
2027 .07 .01 .20 .08

Primary Competitor
2021 .05 .04 .23 .08
2022 .05 .04 .23 .08
2023 .05 .04 .23 .08
2024 .05 .04 .23 .08
2025 .05 .04 .23 .08
2026 .05 .04 .23 .08
2027 .05 .04 .23 .08

A P P E N D I X 2 : S A M P L E L E T T E R TO N E W M A N A G E M E N T R E C R U I T

Congratulations! We are delighted to be offering you a position in our

Expansion Planning team on a salary of $52,000 per year. We understand
that this salary is lower than the standard industry pay for this position.
However, this position offers a number of unique benefits. First, unlike at
traditional airlines, working here you will be heavily trained on our highly
specific method of airport expansion. Second, as we are a new airline, we
hope to be able to promote quickly, and will do our best to promote in-
ternally whenever an internal candidate is superior to outside applicants
(which we are sure will always be the case with you!) Third, we anticipate
being able to offer profit sharing and annual bonuses as soon as it is in
the interest of both the firm and our employees, who are our most valued
asset! Nothing is more important to PacificAir than promoting a mutually
trustworthy environment, where expectations about our company's values
are clear.

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A P P E N D I X 3 : SAMPLE A N N U A L R E V I E W

Ms. XXXXX[REDACTED],
Contained herein is your annual review for 2019. As was mentioned by
your supervisor at the beginning of last year, bonuses for 2019 will be based
80% on the direct performance of your team (in your case, performance of
the Government Relations division, including you and four teammates),
and 20% on the subjective evaluation of your boss, who heads the Gov-
ernment Relations division. As we have not yet seen progress on securing
government approval for the six routes we will need, and due to certain
negative feedback we have heard from competitors about the team's ef-
fort, PacificAir scores the Government Relations team a 12/100. Your su-
pervisor noted that, due to the frequent international travel of your team,
she was unable to precisely observe your personal effort, though she as-
sures the airline that you are well qualified to work in your area. She also
assures us that you went out of your w a y to help support new staffers out-
side your particular team, that you were involved heavily in recruiting of
new employees, and that you have provided substantial assistance to the
Media Relations team. We do not currently award bonuses for these types
of cross-division activities, but be assured that they are appreciated by the
firm. The combination of these factors means that we can only offer you a
bonus of 3% of salary for 2019, though we trust that you and your team's
performance will improve over the next year.

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QUESTION 1: List all aspects of PacificAir's relationship w i t h em-
ployees that are guided by a relational contract. W h i c h aspects of
this contract possess credibility problems? W h i c h aspects of the
contract s h o u l d be done w i t h a formal contract instead?

QUESTION 2: Evaluate f r o m the perspective of two theories of the

f i r m w h e t h e r PacificAir should hire p e r m a n e n t staff to work as check-
i n agents and other ground workers, or w h e t h e r it should continue
to hire contractors i n each city to do this.

PacificAir'S costs are initially higher t h a n the compe-

Q U E S T I O N 3:
tition. Discuss the role of learning curves i n this difference. W h a t
strategy pursued by rivals is m o s t l i k e l y to hinder PacificAir's at-
tempts to b e c o m e competitive by p u s h i n g d o w n that particular learn-
i n g curve?

QUESTION 4: W h a t intellectual property does PacificAir possess?

H o w s h o u l d it best be protected, and h o w e v e r is it protected, is the
IP best profitably exploited by PacificAir or ought it be sold?

PacificAir claims t h e y will "disrupt" the l o n g distance

Q U E S T I O N 5:
airline business. Evaluate w h e t h e r PacificAir's business m o d e l is a
disruptive t e c h n o l o g y f r o m the perspective of existing airlines (in
either of the senses w e discussed), and discuss the costs and benefits
of a "competing" stance against existing airlines like Cathay Pacific
and Air Canada.

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MULTIPLE CHOICE QUESTIONS 5 questions, 2 points each

Question 7: The multitasking problem is best defined as the prob-

l e m whereby:
A) Multiple job responsibilities lead to confusion among employees
B) Incentive payments distort effort toward easy to measure tasks and away
from hard to measure ones
C) When a firm cannot tell which person is most responsible for a team's
output, team members will attempt to freeride on the tasks performed by
others
D) Some information relevant to a decision is not publicly known and
hence optimal contracts cannot be designed

Question 8: Low price guarantees are used by firms primarily be-

cause:
A) Low price guarantees "lock in" existing customers and make them pre-
fer your product in particular above the product sold by rivals
B) Low price guarantees serve as a form of horizontal differentiation
C) By making it so consumers don't have to search for a good deal, willingness-
to-pay goes up
D) With a low price guarantee, rivals have less incentive to undercut you
on price

Question 9: A n industry is likely to see limited entry by n e w firms

if:
A) Existing firms manufacture themselves, and a dominant design has been
established
B) Customer tastes are varied and cost-reducing R<^D is relatively unim-
portant
C) Learning curves for manufacturing are steep and manufacturing is out-
sourced to third-party firms
D) Transaction costs between suppliers and firms are relatively high

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Question 10: It m a y be m o s t difficult to i d e n t i f y the importance of
the firm-level learning curve if
A) Workers are paid in piece rates (that is, depending on how much they
produce)
B) The firm is a service provider rather than a manufacturing firm
C) Production is outsourced to third parties
D) Economies of scale are large and firms in the industry are growing
quickly

Question 11: Browser cookies made it possible to track internet

users and offer customized coupons. These cookies will:
A) Make differentiation for online firms a more profitable strategy
B) Make differentiation for online firms a less profitable strategy
C) Leave the costs and benefits of differentiation for online firms unchanged

BONUS QUESTION: For two bonus points, in a famous "Histoires Vécues,"

which pilot (who was famous for much more than flying!) wrote: "Old
friends cannot be created out of hand. Nothing can match the treasure of
common memories, of trials endured together, of quarrels and reconcili-
ations and generous emotions. It is idle, having planted an acorn in the
morning, to expect that afternoon to sit in the shade of the oak." (I hope
that in this class we have planted just this type of acorn of knowledge to
sprout a full oak in your future!)