LF - Value Capture - Short

Stay focused!
Put away
electronic devises. Tablets
in “airplane” mode.
COMM 491
Value Capture
Prof. Limin Fang
Value Creation and Capture
LESSONS SO FAR
• Strategy is hard
– Understand the tradeoffs of your decisions
– Context dependent
• A firm must create value in order to have value to

capture as profits
• Play a game – how to capture value

Capturing Added Value
Exercise: Joint Venture

• There are 3 firms: A,B&C want to form a JV
• The returns of the JV are as follows:
– If the firms form a JV, the JV earns $100m
– The JV of A and B earns $80m
– The JV of B and C earns $40m
– The JV of A and C earns $70m
– Anyone not in a JV earns $15m
• The profit of a JV must be split among the
participating firms.
Your Response So Far
• A+B+C – 29 teams
• A+B – 4 teams
• A+C – 1 team
• B+C – 0 teams
Basic rule for stable outcome/equilibrium

No one has an incentive to deviate.
Who gets what?

Unique Answer A B C frequency
1 40 40 20 11
2 55 25 20 3
3 55 25 15 3
4 45 35 20 2
5 33.3 33.3 33.3 1
6 50 30 20 1
7 40 30 30 1
8 40 40 15 1
9 33.5 33.5 33 1
10 36 33 31 1
11 45 30 25 1
12 45 15 25 1
13 56 26 18 1
14 57 27 16 1
15 58 26 16 1
16 51 29 15 1
17 53 31 16 1
18 60 20 15 1
19 50 25 25 1
Who gets what?
Two guiding principles:
1. Outside option
2. Added value
First key principle: Outside Option

• We should be very surprised if anyone walks away with
less than 15.
– Anyone, by itself can achieve 15!
– This is the outside option.
• Your outside option is a lower bound on your return. What

you make by walking away!
You can improve your negotiating position by

improving your outside option
Second key principle: Added Value
• How much do I bring to the table?
• If you think about it, is the same as asking: What would

happen to the total value of the deal if I leave?”
• The idea of Added value formalizes the answer to this

question.
You cannot take home more than your added value

Added Value in the JV?

• A player’s added value is defined as the difference
between the value that can be created when all the
parties to the negotiation do the efficient thing, minus the
value that can be created when that player leaves
Value with you Value without Your Added

in the room you in the room Value

–A player’s added value is defined as the difference
parties to the negotiation do the efficient thing, minus
the value that can be created when that player leaves
$100 $40 $60
Firm A
Added Value $60m

$100 $70 $30
Firm B
Added Value $30m

$100 $80 $20
Firm C
Added Value $20m
Added Value Limits your Upside!

• You should be surprised if you are earning more than
your added value!
• When you earn more than your added value then, by

definition, the remaining players are earning less than
they could without you!
• Why haven’t they kicked you out yet and divided up the
spoils???
• So the outside option gives the minimum value

captured
• Added value limits the upper bound
• Is that the full range of firms’ payoffs?
• Can we do better?
• So far:
Firm Outside Option Added Value

A 15 60
B 15 30
C 15 20
• Can we do better?
They cannot take more!

• Since B has added value 30, and C has added value 20
we don’t expect them to get more than that
– That leaves at least 100 – 30 – 20 = 50 for Firm A!
– Conclusion: A gets between 50 and 60
• A player should in general expect to get no less than the
total value minus the sum of the added values of the
other players
• A is likely to do very well in this setting both because it
has high added value and because B and C have low
added value
You can improve your negotiating position by lowering the added
value of another player
They cannot take more!

Similarly!
• If A is getting at most 60 and C at most 20, then
that leaves at least 20 for B
– Conclusion: We should expect B to get
between 20 and 30
• If A is getting at most 60 and B at most 30, then

that leaves at least 10 for C
– But, 10 is less than C’s outside option of 15.
– Conclusion: We should expect C to get
between 15 and 20
Range of Equilibria:
Firm Min Max
A 50 60
B 20 30
C 15 20
Some observations…
• The added values of all players can sum to more than the
total value in the game: 60 + 30 + 20 = 110 > 100!
• Players’ actual payoffs depend on:

– Rules (e.g. take-it-or-leave-it offers, who goes first,…)
– Timing (e.g. who moves when, when is information revealed)
– Negotiating skills (e.g. bluffing, coalition building, inspiring trust)
– Patience
• Therefore, our predictions are bounds, not a precise

number!
It is really important to: Know Thyself

Observation I:
• For A and B, the lower bound on
their share was determined by total
value minus the maximum claims of
the others
– Their outside option plays little role
– If they are worried about their worst
case, they should be working on
decreasing someone else’s added
value
Observation II:
• But, for C, the outside option is the key to the lower bound on returns
• C should not worry about the claims of others, but rather on improving
its outside option
Added Value vs. Value

• Added value is only high to the extent that they produce
something unique, or of better quality, or to the extent
that there is scarcity in the market-place, so that other
firms could not step up production to fill the gap created
by the absence of one of their peers.
• Added value gets higher if a firm does not have

competitors
What are the ways to capture more value?
• Improve outside option
• Increase own added value
• Decrease opponents’ added values

Samsung v.s. Google
• What is the nature of Samsung and Google’s

partnership?
• What do Samsung and Google each bring to the table?
• What are the strategies Samsung and Google use to

improve their bargaining positions?
SOME EXTENSIONS
Coalitions
• Sometimes, two players will manage to credibly
act as a team
– Mergers
– Tacit collusion
• This can drastically change the added value
calculations
• For example, let’s put B and C into a single firm
D
Exercise: Joint Venture

• Compute the min and Max payoff if B+C=D
• Recall:
– If the firms form a JV, the JV earns $100m
– The JV of A and B earns $80m
– The JV of B and C earns $40m
– The JV of A and C earns $70m
– Anyone not in a JV earns $15m
• The profit of a JV must be split among the
participating firms.
Coalitions
Firm Min Max

A 15 60
D(B+C) 40 85
Without coalitions
Firm Min Max
A 50 60
B 20 30
C 15 20
Coalitions
• D’s added value is 100 – 15 = 85
• That is a whole lot bigger than 20 + 30
• Key point is that B and C are to a large degree
substitutes for each other. Most of the value is
created by having A and EITHER B or C
– Having C is a lot less important if B is already around,
and vise versa
– But, D is utterly critical
– In fact, A needs D more than D needs A
• In the negotiation between A and D, A can
guarantee only 15
Coalitions: real world examples?

• Workers forming a union
• Two firms at the same stage of a value chain

that merge
• Firms that have learned not to under-cut each

other, because they expect swift retaliation, and
where the information conditions allow such
“tacit collusion”
• All these situations correspond to Substitutes!

iClicker Question
What determines a firm’s maximum value captured?

a) Outside option
b) Added value
c) Firm’s bargaining power
d) Market share of a firm
Next Class
• Performance Indicator case.
• I posted the assigned questions on Canvas
• Due right before class.
• Mark/no mark, regardless of whether you
attend class.

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Stay focused!

• A firm must create value in order to have value to

• Play a game – how to capture value

Exercise: Joint Venture

Your Response So Far

Basic rule for stable outcome/equilibrium

Who gets what?

Who gets what?

Two guiding principles:

First key principle: Outside Option

• Your outside option is a lower bound on your return. What

You can improve your negotiating position by

Second key principle: Added Value

• How much do I bring to the table?

• If you think about it, is the same as asking: What would

• The idea of Added value formalizes the answer to this

You cannot take home more than your added value

Added Value in the JV?

Value with you Value without Your Added

Added Value in the JV?

$100 $40 $60

Added Value in the JV?

$100 $70 $30

Added Value in the JV?

$100 $80 $20

Added Value Limits your Upside!

• When you earn more than your added value then, by

• So the outside option gives the minimum value

• Added value limits the upper bound

• Is that the full range of firms’ payoffs?

Firm Outside Option Added Value

They cannot take more!

They cannot take more!

• If A is getting at most 60 and B at most 30, then

• Players’ actual payoffs depend on:

• Therefore, our predictions are bounds, not a precise

It is really important to: Know Thyself

Added Value vs. Value

• Added value gets higher if a firm does not have

What are the ways to capture more value?

• Improve outside option

• Increase own added value

• Decrease opponents’ added values

Samsung v.s. Google

• What is the nature of Samsung and Google’s

• What do Samsung and Google each bring to the table?

• What are the strategies Samsung and Google use to

Exercise: Joint Venture

Firm Min Max

Coalitions: real world examples?

• Two firms at the same stage of a value chain

• Firms that have learned not to under-cut each

• All these situations correspond to Substitutes!

What determines a firm’s maximum value captured?

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