Question

Explain the difference between the direct effect of commitment and the strategic effect of commitment.

Answer 1

Commitments have different types of effects on the profitability of a firm. They can be direct or strategic.

• The direct effect of commitment can be explained as the effect on the present value or the firms profit, provided the behaviour of the competitor does not change. Whereas the strategic effect considers the competitive side effects of commitment. These side effects may have a long term effect and hard to reverse.

• The direct effect of commitment is caused entirely due to the company's own tactical decisions. Whereas strategic effects are due to the effects on the tactical decision of the competitors. It can be either positive or negative where it helps or hurts the rivals.

• Direct effect does not affect the choice of the competitor. The strategic effect affects the choices of the competitors and can alter the expectations of the competitor.  

• A strategic effect should be visible, understandable and credible so as to achieve the desired results. Eg: Innovation, quality, etc. For a commitment decision to be taken, strategic effect is more important than direct effect as a positive strategic effect is more required for the better future of the firm.