Business

Resources-based theory Threats to sustainability under all market structure: - Regression to the mean: the firm should not be expected to keep performing extremely well or badly, as there are lots of factors which can affect firm performance, cannot be controlled ➢ One factor: powerful buyer & supplier -> share profit of a extremely well performed firm with their strong bargaining power, even the firm has inimitable advantages; BUT also return some gains to help the firm with extremely poor performance -> the firm facing strong buyer & supplier has threats on its profit sustainability as it is more unlikely to experience the extreme performance Profit persistence evidence: Mueller’s findings - Profit persistence: firms having profit that is higher than the average now should remain the performance; firms with lower than average profit now also should keep stable performance with low profit Mueller’s study of profit persistence Study results: - With the average industry ROA at 6%, extremely high profit firms with about 12% ROA will experience a profit decrease towards the average level during a period of time, approaching ROA about 8%; while firms with abnormally low profit with about 0% ROA will get an increase in its profit, reaching about 4.9% - BUT: the two groups of firms get closer but won’t finally converge to a common mean -> the firms with initially high profit will reach the profitability rate that are still higher than that of the firms with low profit at first - Further implication: market forces threat the profit, BUT only to a certain extent -> other forces seems to protect profitable firms ➢ the forces protect firm’s competitive advantage and allow its profit persistence -> the sources of the firm’s competitive advantage may be difficult to imitate so that its advantage is sustained for a long time Sustainable competitive advantage: The Resource-based Theory of the firm - Competitive advantage: ➢ Define: the ability of a firm to create more value than the competitors -> outstand in the industry competition to achieve a profit higher than the average ➢ Competitive advantage depends on the firm’s resources and distinctive capabilities from using those resources ← Resources (define): firm’s physical, human and organization capital, especially those activities the firm can do better than others ➢ Sustainable competitive advantage: need the special resources & capabilities that are scarce & imperfectly mobile () - Resources: • Scarce but mobile: ➢ As the resource are scarce -> competitors bid for it -> as the resources are mobile, will be sold to the highest bidder -> additional economic profit from the competitive advantage is transferred from the firm to the provider of the resources & harm the interests of winner ➢ E.g.: suppose the bidder F1, F2, F3, F4, F5 offer the price $101,121,141,161,181; E(v)=0.2*100 + 0.2*120 + …+0.2*180=140 -> F5 overpays by $21 (winner curse) ➢ E.g.: free-agent basketball superstar: talents offer the service to the highest bidder are mobile resources -> high profit contract paid to the free-agent basketball superstars -> solutions to limit the mobility: long-term labor contract • Imperfectly mobile: ➢ Non-tradable: such as the know-how of an organization; brand reputation ➢ Tradable but relationship specific: more valuable for an organization than others ➢ Co-specialized: more valuable when used together than separated (e.g.: teamwork members) ← Imperfectly mobile assets are so valuable that firms are willing to acquire them at a higher price -> E.g.: the land that is potentially valuable but can support only one retail outlet -> retailer may pay high price OR build a store before the land maximizes its value, lower the profitability of the location in advance • Immobile & abundant: less competition on the bidding of the resources ->quickly purchased by the less profitable firms at a relatively low price -> remove profit differential with those high profit firms through the efficient use of the key resources - Isolating mechanisms ➢ The key resources scarcity & immobility are still not enough for a sustainable competitive advantage, if the competitors can duplicate or neutralize the source of the advantage ➢ Isolating mechanisms (define): the economic forces that limit the extent to which a competitive advantage can be duplicated or neutralized through other firms’ resource-creation activities -> protect the competitive advantages & prevent other firms share the extra profit earned from the firm’s competitive advantage ➢ Two types of Isolating mechanisms: 1) Impediments to imitation: prevent existing/potential competitors from copying the resources & capabilities which support the firm’s competitive advantage ❖ Legal restrictions: ← Patents, copyrights, trademarks, governmental control on operating rights -> they are mobile -> firms try to secure a competitive advantage by purchase of a patent or an operating right at a competitive price -> require the firm to have sufficient information to make better use of it than other bidders to avoid loss ← 1985-1990: patent-protected products generated higher returns on investments than any single industry in the US ❖ superior access to inputs or customers: ← favorable access to inputs by ownership or long-tern exclusive contracts, to sustain cost & quality advantages that the competitors cannot imitate -> e.g.: Internal Nickel dominate the market by controlling the high-quality nickel deposits ← access to the best distribution channels or the most productive retail locations that block the access by competitors by the exclusive dealing arrangements with the retailer/distributor -> e.g.: exclusive dealing arrangements between American Big Three and their franchised dealers prevent the growth of Japanese automobile manufacturers in US market, while the end of the clauses shock the market position of the Big Three ← superior access to inputs & customers can support sustained competitive advantages only if the firm can acquire the advantage at ‘below-market’ prices ← risks: the firm may overpay for the assets as the price is bid up and the economic profits are transferred to the original owner -> leaving the firm with no higher profit gained than the failing bidder ← solution: acquire the control of scarce inputs & distribution channels before the competitors recognizing its value -> then the firm can earn economic profits in excess of the competitors ❖ market size & scale economies: ← Figure 12.4 in pp411: if the smaller firm tries to expand capacity to the minimum efficient scale, the falling market price will be too low for it to cover its initial investment on the production expansion -> smaller firm is undesired to imitate the large firm’s cost advantage ← When the minimum efficient scale is large relative to the total market demand & the existing large firm has a large market share already -> prevent the entry & discourage an existing smaller firm to imitate the scale-based cost advantage by expansion ❖ intangible barriers: I. Causal ambiguity: the source of the firm’s competitive advantages are difficult to understand as it may include the tacit knowledge which is accumulated during practice and cannot be expressed clearly to others ← the competitors don’t know the right way to imitate & even the superior firm’s management is also unable to conclude their distinct success factors -> make them unable to translate their success pattern to another one of their own plants for expansion II. Historical circumstances: certain competitive advantage is acquired under a unique condition -> may be viable for only a limited period of time & difficult to replicate by others ← E.g.: no competitors can imitate the Southwest Airlines’ smaller operation scale which is historically constrained by the US policies in 1960s III. Social complexity: the unique advantage from the relations between managers, suppliers and distributors, etc -> different from the ‘causal ambiguity’: here, competitors can exactly know the source of the advantage, but it’s difficult or impossible for them to create the same conditions -> e.g.: Toyota: high trust between it and its suppliers 2) Early-mover advantages: (benefits from the adopting a new strategy before the competitors do) ❖ Economies of learning: ← Figure ppt15: the firm produces larger output earlier than competitors move further down along the learning curve with more accumulated experience -> achieve cost advantage and enhance the advantage for further capacity expansion -> prevent the imitation because (Figure in ppt16) while the late mover try to achieve higher production volume & lower cost, the first mover expands the production & decrease cost even more with more total knowledge than the competitors ever-> sustained its advantage ❖ Reputation & buyer uncertainty: ← Especially for the experience good which must be used so that the consumer can assess its quality (e.g.: medicine): buyers are loyal to the first mover and unwilling to switch to a late mover’s new product because first mover’s reputation & buyers are uncertain about other products’ quality -> it’s so difficult or even impossible to imitate by building up such a reputation for the Late movers, they may have to charge lower price or make advertising, BUT consumers’ preference that strongly affected by the first mover is so difficult to change ← E.g.: 46% of IBM’s customers continued to choose this brand although 20% discount is offered from other competitors ❖ Buyer switching costs: (buyers incur the costs if switch to another seller) ← buyers have invested in the specific brand and relationships with the first mover -> there are costs if switching to the late mover: cost to learn to use the new product & lose the customized service from the first mover who has developed extensive knowledge about the buyer ->e.g.: customers who develop extensive knowledge on the use of the Microsoft Word will incur the cost to learn the new knowledge if they switch to Word Perfect; people who invest in the relationship with the bank manager who is familiar with his business can also face the cost if he change the bank ← First mover also design the product/service to increase switching cost -> e.g.: offer complementary products; loyalty cards ← Late mover may have to charge a lower price to compensate part of buyer’s switching costs ← Limitation of first-mover advantage of switching costs: costly rewards or other strategies to keep customer loyalty; less willing to compete on price to obtain new customers which will cut its profit obtained from the old customers -> the chance for the newcomer to increase market shares-> e.g.: the less sales but higher growth software package STATA compared with traditional brands ❖ Network effects: the more users involved, the higher value the product/service is ← Actual network (e.g.: e-mail networks): users are physically linked and communicate with each other through the network -> more users in the same network, more communication achieved, greater the value of the network is ← Virtual networks (e.g.: computing operating systems ): no communications between users -> more users, increasing demand for complementary products -> more supply of complementary goods ->each user benefits from the increasing value of the network (e.g.: supply of software to used in Windows-based PCs) ← In the market with network effects: first mover with relatively large client group get the advantage and attract new customers with its more valuable network compared with the late mover - Early-mover disadvantages: fail to achieve a competitive advantage ➢ Only invest in the assets needed for production, BUT lack the complementary assets for the commercialization & marketing of the product ➢ Uncertainty about the technology & market demand -> BUT, if the early mover can set up the standard with network effects, which can significantly help to resolve the uncertainty