ECP 6701
Competitive Strategies in Expanding Markets
Sustaining Competitive Advantage
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Readings
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BDSS Chapter 12
Sustaining Competitive Advantage
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In a perfectly competitive market, price
competition will ensure that competitive
advantage will not be sustained
Even without perfect competition, sustaining
competitive advantage is not easy
Rivals can imitate a successful firm’s products
or neutralize the firm’s advantage through new
technologies, products and business practices
Sustaining Competitive Advantage
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Some firms have been successful in sustaining
their competitive advantage (Coca-Cola, Dell
Computers)
Others have allowed their competitive edge to
erode under pressure from their competitors
(Dominick’s Pizza, Silicon Graphics)
Perfect Competition and
Competitive Advantage
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In a perfectly competitive industry where firms
are price takers, competitive advantage does
not exist
Even when the product is not homogenous
(and varies on a cost-quality continuum),
dynamics of perfect competition can work
The Perfectly Competitive Dynamic
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The Perfectly Competitive Dynamic
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The efficient frontier is the theoretical boundary
that no firm can cross
Free entry and costless imitation will force all
the firms to move to the tangency point and the
economic profit will be zero
Threats to Sustainability
Regardless of Market Structure
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Even when incumbents can deter entry,
powerful suppliers/buyers can threaten
profitability regardless of market structure
Sometimes good performance may be simply
due to luck and over time profits regress to the
mean
Effect of Competitive Forces on
Profitability
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Entry, imitation and price competition will force
economic profits to eventually go to zero
Competitive forces will make return on assets
(ROA) to equal the cost of capital
Regardless of where a given firm is today, with
passage of time its profits will converge to
competitive levels
Evidence on the Persistence of
Profitability
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Dennis Mueller’s study of profit persistence
reports the following
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Firms with abnormally high ROA will experience a
decline over time
Firms with abnormally low ROA will experience an
improvement over time
High ROA firms and low ROA firms do not converge
to a common mean
Evidence on the Persistence of
Profitability
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Mueller’s results indicate that there are some
forces that push markets towards the
competitive rate of return and other forces that
impede that dynamic
The net result is a persistent ROA gap between
firms that start out as high ROA firms and firms
that start out as low ROA firms
Competitive Advantage of Firms
and Industry Profitability
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Industry conditions that determine industrywide profitability are distinct from forces that
sustain a firm’s competitive advantage
A firm in a fiercely competitive industry may
continue to have an edge over its rivals
Firms within an industry with high entry barriers
and higher than competitive profits may all be
equally profitable
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 occur in two ways
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Firms may differ with respect to resources and
capabilities and the differences persist
Isolating mechanisms (analogous to barriers to
entry) may work to protect the competitive
advantage of firms
Resource Based Theory of the Firm
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Resource based theory of the firm explains
sustained competitive advantage in terms of
heterogeneity in resources and capabilities
Scarce resources and capabilities that are
critical for value creation can be imperfectly
mobile and cannot be acquired in the open
market
Resource Based Theory of the Firm
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Resources may be non-tradable (Example:
Customer loyalty built through a frequent flyer
program)
Resources may be relationship specific
(Example: Landing slots in an airline’s hub)
Isolating Mechanisms
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Isolating mechanisms are to firms what entry
barriers are to industries
Two distinct types of isolating mechanisms can
be observed
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Impediments to imitation
Early mover advantage
Impediments to Imitation
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These mechanisms impede the potential
entrants from duplicating the resources and
capabilities of the incumbent firm
Five important types of impediments exist
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Legal restrictions
Superior access to inputs/customers
Market size and scale economies
Intangible barriers
Legal Restrictions
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Legal restrictions such as patents and
copyrights as well as government regulation
through licensing and certification can impede
imitation
Acquiring a patent in the open market will not
lead to economic profits unless the firm can
deploy this asset in superior ways
Superior Access to
Inputs/Customers
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Firms often achieve exclusive access to key
resources either through vertical integration or
long term contracts
Firms can deny rivals access to distribution
channels through the use of exclusive dealing
clauses
Superior Access to Inputs/Customers
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Competitive advantage may not exist if access
to channels was acquired at “below-market”
prices
Bidding for access in the open market brings in
the “winner’s curse” problem
Market Size and Scale Economies
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Scale based barriers are likely to be effective in
markets for specialized products where the
demand is large enough for only one producer
Scale based barriers may come down if the
market experiences growth
Intangible Barriers to Imitation
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Barriers to imitation will be intangible if the
firm’s advantage lies in distinctive
organizational capabilities
Three such barriers to imitation can be
identified
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Casual ambiguity
Historical circumstances
Social complexity
Casual Ambiguity
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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
Historical Circumstances
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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
Social Complexity
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Competitive advantage may be hard to
replicate if the advantage is rooted in socially
complex processes
Such processes include interpersonal
interactions among managers, both within the
firm and of the suppliers and customers
Even if the rivals understand the source of
competitive advantage, they cannot replicate
the complex social interactions
Intangible Barriers and
Organizational Change
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When major organizational changes are
undertaken, it is easy to overlook intangible
sources of competitive advantage (such as
casual ambiguity, historical circumstances and
social complexity)
Major organizational changes are more likely to
achieve the desired results in “greenfield”
plants than in established ones
Early-Mover Advantage
Four different isolating mechanisms fall under the
category of early mover advantage
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Learning curve
Reputation and buyer uncertainty
Switching costs
Network Effects
Learning Curve
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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
Reputation and Buyer Uncertainty
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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
Limitations of the Reputation
Effects
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Firms may overly rely on a brand and
overexploit its reputation
Reputation benefits may be appropriated by
powerful downstream players in the vertical
chain (Example: Mass merchandisers
exercising buyer power)
Limitations of the Reputation
Effects
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Demographic changes and changes in tastes
may undermine the value of an established
brand
Technology may narrow the quality gap
between the top brands and the lower brands
Switching Costs
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Consumers who make brand specific
investments (for example, learning to use a
software program) can end up with large
switching costs
Frequent buyer points in grocery stores and
frequent flyer miles from airlines are means of
increasing switching costs
The Downside of Switching Costs
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For established firms, a large installed base
could serve as a soft commitment
When a firm has a large installed base, it is
costly to compete on price for new customers
Network Effects
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Product shows network effects if customer
values the product depending on how many
others are using the product
The usefulness of joining a telephone network
depends on the number of customers already
on it (actual networks)
Use of complementary goods may create
virtual networks
Virtual Network
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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 (Example: computer
operating system and application software)
First Mover Advantage
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Network effects offer opportunities to the first
mover
Size of the network will attract new customers
Networks and Standards
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Many networks are based on standards
(telephone, railroads)
Established standards are difficult to replace
Two key questions:
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Should a firm compete “for the market” or “in the
market?”
Is it possible to topple the existing standard?
“For the Market” or “In the Market?”
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Monopoly in a smaller market may be more
valuable than competing as a small player in a
large market
It is critical to attract early adopters
Without a common standard, complementary
products may not be forthcoming
“For the Market” or “In the Market?”
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To enlist manufacturers of complementary
products, share value added with them
If the standards war gets too costly, agree on a
common standard
Fighting a Dominant Standard
Successfully
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Installed base gives the incumbent the edge
The challenger should offer superior quality
(Sony vs. Nintendo)
Should be able to tap into the complementary
goods market
Early Mover Disadvantages
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Early movers may lack the complementary
assets to make their products succeed
Early movers can make mistakes that lock
them into inferior technologies and others can
learn from these mistakes (Example: Wang
Laboratories)
Imperfect Imitability and Industry
Equilibrium
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With imperfect imitability and otherwise
competitive conditions, average firms will make
below average profits and some firms
consistently earn economic profits
If the firms are uncertain about their post-entry
position, pre-entry (ex-ante) expected
economic profit will be zero
Imperfect Imitability and Industry
Equilibrium
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Average firms earn below average profits since
below average firms may exit
Observed average profits for the industry will
be overstated due to survivorship bias