sustaining competitive advantage chapter 11

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1. Economics of Strategy
Seventh Edition
Copyright 2016 John Wiley Sons, Inc.
Chapter 11
Sustaining Competitive
Advantage
Besanko, Dranove, Shanley, and Schaefer

2. Sustaining Competitive Advantage
Sustaining competitive advantage over time is not easy.
Rivals can imitate the formula for success.
Rivals can use new technologies, products and business
practices to erode the competitive advantage of industry
leaders.
Yet Some firms have been successful in sustaining their
competitive advantage (Coca-Cola, Dell Computers) for
long periods of time.

3. Perfect Competition & Competitive Advantage
In a perfectly competitive industry where firms
are price takers, competitive advantage does not
exist.
Even when the product varies on a cost-quality
continuum dynamics of perfect competition can
work.

4. Sustainability with Monopolistic Competition
In monopolistic competition, firms sell horizontally
differentiated products to consumers who differ in their
tastes.
Each seller faces a downward sloping demand curve
due to product differentiation
Sellers get to set the price above marginal cost but there
is no guarantee of economic profits.

5. Sustainability with Monopolistic Competition
Entrants can slightly differentiate their products from
the incumbents’ and create their own niche.
Free entry will cut into the market share of the
incumbents and make the economic profit become zero.
Profitability cannot be sustained unless entry is deterred

6. Threats to Sustainability
Even when incumbents can deter entry economic profits
may not be sustainable.
Sometimes good performance may be simply due to luck.
Over time profits regress to the mean.
Good performance is not always attributable to luck.
A firm might develop advantages that are hard to imitate.
Yet if the suppliers/buyers are powerful they can extract
the profits.

7. Evidence on the Persistence of Profitability
Dennis Mueller’s study of U. S. manufacturing firms
finds that:
Firms with abnormally high ROA will experience a decline
over time
Firms with abnormally low ROA will experience an
improvement over time and
high ROA firms and low ROA firms do not converge to a
common mean

8. Resource Based Theory of the Firm
Resource based theory of the firm explains sustained
competitive advantage in terms of heterogeneity in
resources and capabilities.
To support competitive advantage resources and
capabilities have to be
scarce
imperfectly mobile and
unavailable in the open market.

9. Resource Based Theory of the Firm
Immobile resources may be inherently non-tradable
(Example: Reputation for toughness)
Immobile resources may be relationship specific
(Example: Landing slots in an airline’s hub)

10. Isolating Mechanisms
Isolating mechanisms limit the rivals from eroding a
firm’s competitive advantage.
Isolating mechanisms are to firms what entry barriers
are to industries.
Two distinct types of isolating mechanisms are
Impediments to imitation
Early mover advantage

11. Impediments to Imitation
These mechanisms impede the potential entrants from
duplicating the resources and capabilities of the
incumbent firm
Five important types of impediments are
legal restrictions
Superior access to inputs/customers
Market size and scale economies
Intangible barriers

12. Legal Restrictions
Legal restrictions such as patents and copyrights as well
as government regulation through licensing and
certification can impede imitation.
Acquiring a patent or a copyright at open market prices
will not yield economic profits unless the firm can
deploy this asset in superior ways

13. Market Size and Scale Economies
Scale based barriers are likely to be effective when the
market demand can be met by one producer (Markets
for specialized products).
Scale based barriers may come down if the market
experiences growth and entry becomes profitable.

14. Intangible Barriers to Imitation
Barriers to imitation will be intangible if the firm’s
advantage lies in distinctive organizational capabilities.
Three such barriers to imitation can be identified.
Casual ambiguity
Historical circumstances
Social complexity

15. Casual Ambiguity
A firm’s superior ability to create value may be obscure
and imperfectly understood, even by those in the firm.
Casual ambiguity may become a source of
diseconomies of scale because the firm may be unable
to replicate its success from one plant to the next.

16. Historical Circumstances
Distinctive capabilities may be bound up with the
history of the firm
Dependence of the capabilities on historical
circumstances may limit the firm’s growth potential
Historical dependence may also mean that the strategies
may be viable for only a limited time

17. Social Complexity
Competitive advantage may be hard to replicate if the
advantage is rooted in socially complex processes
Such processes include interpersonal interactions among
managers, suppliers and customers.
Complex social interactions are not easily imitated even
when understood.

18. Intangible Barriers & Organizational Change
When major organizational changes are undertaken, it is
easy to overlook intangible sources of competitive
advantage.
Major organizational changes are more likely to achieve
the desired results in “greenfield” plants than in
established ones.

19. Early-Mover Advantage
Four different isolating mechanisms fall under the
category of early mover advantage
Learning curve
Reputation and buyer uncertainty
Switching costs
Network Effects

20. Learning Curve
A firm that sells more than its competitors in the early
periods moves farther down the learning curve and
achieves lower unit costs than its rivals.
The lower unit cost allows the firm to undercut its
rivals, increase volume and further move down the
learning curve.

21. Reputation and Buyer Uncertainty
For experience goods, a firm’s reputation for quality
provide a significant early mover advantage.
Pioneering brands can influence the formation of
consumer preferences and present the attributes of the
brand as the ideal for the product category

22. Switching Costs
In some situations buyers end up incurring
significant switching costs if they change to
another supplier.
Consumers who make brand specific investments (for example,
learning to use a software program)
When sellers develop buyer specific knowledge (for example
in banking)
Customers who belong to loyalty programs in grocery stores or
frequent flyer programs of airlines

23. Network Effects
Product shows network effectsif customer values the
product depending on how many others are using the
product
There are actual networkswhose usefulness depends on
the number of customers already on it (telephone
networks, social networks)
Virtual networksarise from the use of complementary
goods (software and PCs)

24. Virtual Network
In virtual networks, consumers are not physically
linked.
Increase in the number of the consumers increases the
demand for complementary goods.
Supply of complementary goods enhances the value of
the network.

25. Networks and Standards
Many networks are based on standards (telephone,
railroads)
Established standards are difficult to replace
Two key questions:
Should a firm compete “for the market” or “in the market?”
What does it take to topple the existing standard?

26. “For the Market” or “In the Market”?
Standards war may discourage the production of
complementary products, hurting the entire industry.
To win the standards battle manufacturers of
complementary products may have to be offered a
greater share value added.

27. Early Mover Disadvantages
Early movers may lack the complementary assets to
make their products succeed
Early movers can lock themselves into inferior
technologies and rivals can learn from these mistakes
(Example: Wang Laboratories)

28. Imperfect Imitability & Industry Equilibrium
With imperfect imitability, but otherwise competitive
conditions, some firms consistently earn economic
profits.
Yet to potential entrants the industry appears to offer
zero expected profits
Lippman and Rumelt explain this outcome using
entrants’ uncertainty regarding their costs.

29. Imperfect Imitability & Industry Equilibrium
Competition makes entrants’ pre-entry (ex-ante)
expected economic profit zero
Entrants are uncertain about their post-entry cost
structure.
Ex-post if an entrant turns out to be a high cost producer
it quits.
Observed average profits for the industry will be
positive due to survivorship bias.

30. Creative Destruction
Markets have periods of comparative quiet punctuated
by shocks and discontinuities
During the period of quiet firms that posses superior
products and technology earn economic profits
Entrepreneurs who exploit the opportunities created by
the shocks enjoy economic profits during the next
period of quiet

31. Creative Destruction and Growth
Schumpeter considered static efficiency -allocative
efficiency at a point in time -to be less important than
dynamic efficiency
Society benefits much more from competition between
new products, new technologies and new forms of
organization than from price competition

32. Creative Destruction & Competitive Advantage
Creative destruction implies that the isolating
mechanisms that protect a firm’s competitive advantage
will not be permanent
The life expectancy of a competitive advantage shrinks
as technology and tastes change rapidly

33. Disruptive Technologies
Many of the disruptive technologies have higher
perceived benefits and lower costs
Some times disruptive technologies can have lower
benefits and much lower costs (example: Downloadable
MP3 recordings versus higher resolution in CDs)

34. Innovation and the Market for Ideas
If there is a market place for ideas, the incumbent can
acquire the technology of the entrant.
The entrant can sell its ideas for full value.
Incumbent has incentive to invest in R & D to improve its
bargaining position.
Incumbent may also skip R & D investment to avoid
duplication.

35. Market for Ideas
For the innovator to realize the full value of the
innovation
technology should be protected by patents and
the required expertise in production and marketing of the
innovative products is not scarce
The balance of power shifts away from the innovator to
the established firms if such expertise is scarce.

36. Market for Ideas
Incentives in allocating capital to innovation differ
between small and large firms.
Small firms face the external capital market with
uninformed investors.
Large firms use internal capital markets where
allocation can shift away from faltering projects quickly.

37. Innovation Competition
Staying even slightly ahead of the rivals will produce
disproportionate benefits
First innovator will benefit from
patent protection
network externalities (even when there is no patent protection) and
consumer perceptions.

38. Patent Race
In a “winner take all” race to obtain a patent, a firm
should look at the following factors before deciding
whether or not to increase its R & D investment
Effect of additional investment in R & D productivity
Response by the rivals to increased investment by the firm
The number of competitors in the field

39. Evolutionary Economics and
Dynamic Capabilities
In traditional economics, a firm is assumed to make
decisions to maximize economic profit.
Evolutionary economics views decisions made by a firm
as determined by established routines.
Routines include methods of production, hiring policies,
etc.

40. Evolutionary Economics
and Dynamic Capabilities
Usually a firm’s routines change slowly over time (if
they do change).
To ensure survival, firms need to continuously improve
their routines.
Firms with dynamic capabilitiescan adapt their
resources and capabilities and exploit opportunities
created by market shocks and discontinuities.

41. Factors that Limit Dynamic Capabilities
A firm’s dynamic capabilities are inherently limited
because of
the path dependenceof sources of competitive advantage
limited availability of complementary assets
“windows of opportunity” that do not stay open for long

42. Path Dependence
Firm’s routines can only change incrementally and
cannot have a clean break from the past
The new source of advantage will be path dependent
With threats from new entrants, even small path
dependencies can have major implications for the firm’s
competitiveness

43. Complementary Assets
Complementary assets are assets that are valuable only
with a product or technology.
If changes in a routine lowers the value of
complementary assets, the firm will be reluctant to
adopt the changes.

44. Windows of Opportunity
Early in a product’s life, its design and specifications
will be fluid and firms will have room for
experimentation.
Over time a narrow set of design and specifications
emerge as dominant and it is hard for new firms to
challenge market leaders.
Those who do not exploit the window of opportunity get
shut out.

45. The Environment
Michael Porter suggests that the firm’s local
environment is a major influence on its competitive
environment.
Even as a modern firm transcends local markets, the
source of its competitive advantage remains localized.

46. The Environment
A firm’s home nation and home markets play an
important role in its ability to sustain its competitive
advantage
by supporting the accumulation of valuable resources and
capabilities and
by exerting pressure on the firm to innovate, invest and
improve

47. Factor Conditions
A firm’s competitive advantage in the global markets is
enhanced by the availability of specialized factors of
production in the home market.
To be globally competitive, availability of highly skilled
workers in the home nation may be more important than
availability of low wage workers.

48. Demand Conditions
A firm’s competitive advantage is enhanced by the size,
growth and nature of demand in the home market.
When home market places a high value on quality, the
firm is stimulated to make improvements in the quality
dimension.
Unique local conditions can also be a source of
innovations.

49. Related and Supporting Industries
A strong base of competent suppliers and support
industries at home will help a firm achieve competitive
advantage globally.
Sharing scarce production know-how is easier with
geographical proximity.

50. Strategy, Structure, and Rivalry
Local management practices, corporate governance
norms and nature of the local capital markets can
influence the competitive advantage of global firms.
Local rivalry may hold down local profits but make the
firms well positioned in the global arena.
Firms that enjoy local protection often fail to make a
mark outside the home nations.

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