Chapter 14:
Sustaining Competitive
Advantage
Monday, November 5
AEC 422 Fall 2012
Unit 5: Building and Sustaining Competitive Advantage
Reminder: Competitive Advantage
and Value Creation
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A firm has a competitive advantage in a market if it
earns a higher rate of economic profit than the average
firm in the same industry
Profitability is determined by market effects (Porter’s
five forces) and positioning effects (ability to create
economic value through cost or benefit leadership)
Consonance analysis projects the firm’s prospects for
creating value in the future, as a function of changes in
demand, technical progress, threats from other firms in
the industry and from other industries
Static vs. Dynamic Economies
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Preferences (trends, income, demography,
knowledge)
Scientific discoveries, technical change, capital
and knowledge accumulation
Natural resources discovery and attrition
Institutions and government regulation (the
“rules of the game”)
General business conditions (business cycle,
interest rate, exchange rate, globalization)
Low-probability extreme events (Katrina/Sandy,
drought)
Sustaining Competitive Advantage:
Examples
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The “old world” wine model – use expertise and
limited supply to limit barriers to entry for the
premium wine segment
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Nest Fresh Eggs –
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Dean Foods –
Sustaining Competitive Advantage:
Examples
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The “old world” wine model – use expertise and
limited supply to limit barriers to entry for the
premium wine segment
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Nest Fresh Eggs– build on unique production
knowledge – trying to integrate cause
clarification into marketing, production contracts
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Dean Foods –
Sustaining Competitive Advantage:
Examples
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The “old world” wine model – use expertise and
limited supply to limit barriers to entry for the
premium wine segment
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Nest Fresh Eggs– build on unique production
knowledge – trying to integrate cause
clarification into marketing, production contracts
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Dean Foods – lower cost through scale/scope
efficiencies (R&D, mgmt) but pursue product
extensions and food segmentation expertise
through branding, tapered integration
Sustaining Competitive Advantage:
Examples
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Monforte Dairy-
Sustaining Competitive Advantage:
Examples
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Whole Foods -
Sustaining Competitive Advantage:
Examples
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Whole Foods –
 Pursue
benefit leadership through superior local
sourcing (that other retailers can’t source)
 Build loyalty (core) by integrating social awareness
into full range of products
 Design store “experience” to support values-chain
marketing; superior HR program
 Pursue scale economies (such as they are) through
mergers to build natural foods market share
Sustaining Competitive Advantage:
Examples
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All of these firms are moving toward profitable
positions that, through different strategies, they
can maintain (at least for awhile).
Looking for paths that are difficult for others to
follow.
Threats to Profit Sustainability –
Perfectly Competitive Markets
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Producers have the same production function,
produce the same good, and face equal input
prices
Profit opportunities may arise exist in the short
run due to favorable market conditions
In the long-run, entry induces an increase in
industry output, which drives the price down to
the point where profits are zero
Threats to Profit Sustainability –
Monopolistic Competition
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Horizontal product differentiation
Mark-up pricing (P > MC)  positive operating
profit margin
The entry of firms with new differentiated
products entails market share and profit losses
by incumbents, up to the point where operating
profits just cover fixed costs
Solution to profit sustainability: entry deterrence
Threats to Profit Sustainability in
General
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Supplier and buyer power can erode the profits
of top firms within an industry
When suppliers/buyers have market power, they
can extract profits during good (or bad) times
Emergence of low-cost substitutes
Firm-Level Competitive Advantage
vs. Industry-Level Performance
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Market forces are a threat to profits, but only up to a
point. Other forces appear to protect profitable firms
Industry conditions that determine industry-wide
profitability are distinct from forces that sustain a firm’s
competitive advantage
A firm may have a persistent edge over its rival despite
strong internal rivalry and weak entry barriers
Firms in an industry with high entry barriers and/or price
coordination may enjoy higher-than-competitive returns,
but be equally profitable because it is easy for a firm to
duplicate or neutralize the competitive advantage of the
other firms
Sustaining competitive advantage
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Competitive advantage is sustainable if it
persists despite competitors’ efforts to duplicate
it or neutralize it
Sustainability can be attributed to two main
factors:
 Firms
exhibit differences in their resources and
capabilities endowment, which persist over time
 Isolating mechanisms protect the competitive
advantage of firms
The Resource-Based Theory of the
Firm
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A firm’s ability to create superior value
depends on its resources and capabilities
 Resources:
physical capital, human capital,
creative individuals, knowledge/technology,
intermediate inputs, intangible assets such as
brand reputation, customer base, established
distribution channels
 Capabilities: abilities to perform some
activities better than competitors
The Resource-Based Theory of the
Firm
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The uneven distribution of resources and
capabilities across firms explains observable
differences in performance within an industry
For competitive advantage to be sustainable, it
must rest on resources and capabilities that are
scarce and imperfectly mobile between firms
The Resource-Based Theory of the
Firm
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Why are some resources/capabilities
imperfectly mobile across firms?
 Non-tradable
inputs/location-specific inputs
(Customer base; KY Bourbon, Napa Valley
wine, Roquefort cheese, etc.)
 Relationship-specific inputs
 Co-specialized inputs
 Proprietary processes
Isolating Mechanisms
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Isolating mechanisms are to a firm what an entry
barrier is to an industry
 Isolating
mechanisms prevent other firms from
acquiring the resources and developing the
capabilities that would allow them to duplicate or
neutralize the competitive advantage of a firm
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Impediments to imitation
Early-mover advantages
Impediments to Imitation
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Legal restrictions
 Imitation
is limited by legal restrictions protecting
intellectual property: patents, copyrights, and
trademarks
 Government regulatory policies controlling entry into
markets: licensing, quotas on operating rights (ex.
Tobacco quotas), and certification
 Acquiring a patent or an operating right in the open
market will not lead to economic profits unless the
firm can deploy the asset in superior ways (through
superior capabilities or complementary resources)
Impediments to Imitation
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Superior access to inputs or customers
 Firms
often achieve favorable access to inputs by
controlling the sources of supply through ownership
or long-term exclusive contracts
 Firms can prevent rivals from accessing retail
distribution channels through the use of exclusive
dealing clauses
 Again, securing access to inputs or customers may
not lead to competitive advantage as the price of
locations or contracts that give the firm control of
scarce inputs or distribution channels would be bid up
until extra profits are captured by their original owners
Impediments to Imitation
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Market size and scale economies
 Imitation
(by existing firms and entrants) may be
deterred when the minimum efficient scale is large
relative to the market demand and one firm has
secured a large share of the market
 Examples in the bio-tech industries: equine drugs,
pesticides for minor-use crops (avocados,
tangerines), GMO crops for developing countries
Impediments to Imitation
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Intangible barriers to imitation
 The
basis of the firm’s advantage lies in
distinctive organizational capabilities
 Causal ambiguity
 Dependence on historical circumstances
 Social complexity
Impediments to Imitation
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Causal ambiguity
 Tacit/non-codified
knowledge/capabilities
 Tacit capabilities are typically developed
through trial and error, refined through
practice and experience
 It is difficult to transfer superior tacit
capabilities from one location/business to
another
 Rationale for proprietary information, nondisclosure agreements, non-compete clauses
Impediments to Imitation
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Dependence on historical circumstances
 Firms
take strategic actions in order to adapt
to the constraints of their business
environment; different firms are subject to a
different set of constraints, and thus develop
different capabilities over time
 Historical dependence implies that a firm’
strategy may be viable for only a limited time
Impediments to Imitation
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Social complexity
 Price-based
market exchanges vs. long-term
relationships; interpersonal relations among a
firm’s managers, and with suppliers and
customers
 Examples: relationships between Toyota and
its suppliers; education, dentist, car mechanic,
etc.
Early-Mover Advantage
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Learning curve
A
firm that has produced more output than its
competitors in earlier periods has moved
farther down the learning curve and is able to
produce at a lower unit cost
 Dynamic effect: lower unit cost  lower price
 greater cumulative output  …
 Example: bio-tech industries
Early-Mover Advantage
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Reputation and buyer uncertainty
 In
the case of experience goods, consumers who
have had a positive experience with a firm’s brand will
be reluctant to switch to competing brands if there is a
chance that their products fail to satisfy them  early
mover advantage (ex.: Maker’s Mark, Mondavi)
 Pioneering brands can influence the formation of
consumers’ preferences, and consumers may
consider the attributes of a pioneer brand the ideal for
a certain type of product  early mover advantage
 Technology, marketing/advertising and other factors
can narrow the effective and/or perceived quality gap
between early-mover brands and later-comer brands
(private labels for instance)
Early-Mover Advantage
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Buyer switching costs
 Switching
costs can confer a substantial
advantage to an early mover
 But a firm that has created switching costs for
established customers may be at a
disadvantage competing for new customers
because if it cuts prices to attract them, the
profit margin on sales to its loyal customers
also declines
Early-Mover Advantage
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Network effects
A
product exhibits network effects when its value to
consumers increases with the number of consumers
using it
 Actual networks/virtual networks and the role of
complementary products
 The first firm that can establish a large installed base
of customers in a market with network effects obtains
a sustainable competitive advantage (ex.: Chicago
agricultural futures and options markets)
Remarks
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Business opportunities don’t last forever
Sometimes success cannot be imitated easily
because it is due to luck or trivial circumstances
Sure is good to know what keeps you ahead of
your competition
Preview of the Monsanto Case
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Shift in strategic positioning, from an agricultural
chemical products based business (Roundup) to a
biological products based firm (GMO)
Superior value creation: plant-made pharmaceutical
molecules, feed and processing use value enhancement,
Roundup incremental improvement
Capabilities expansion through strategic alliances with
seed companies and other agribusinesses
Early mover in the plant biotechnology industry and the
use of molecular breeding to create new commercial
varieties
Learning and scope economies in R&D intensive
activities, patenting
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high barriers to imitation by rivals
Preview of the Monsanto Case
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Historical circumstances: profits from the agricultural
chemical business unit allowed Monsanto to invest
heavily in biotech R&D
Response to changes in energy markets’ fundamentals