Beyond Competitive Advantage

Beyond Competitive Advantage: What Can Theories of Strategy Explain?

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BEYOND COMPETITIVE ADVANTAGE:

WHAT CAN THEORIES OF STRATEGY EXPLAIN?

J.W. Stoelhorst

University of Amsterdam

Amsterdam Business School

The Netherlands

[email protected]

Flore Bridoux

Université Catholique de Louvain, Louvain School of Management

Facultés universitaires St. Louis

Belgium

[email protected]


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BEYOND COMPETITIVE ADVANTAGE:

WHAT CAN THEORIES OF STRATEGY EXPLAIN?

This paper critically evaluates the use of dependent variables in theories of competitive strategy

in general, and the resource-based view of the firm in particular. We show that seminal papers

diverge widely in their specification of what theories of competitive strategy should explain. We

argue that this divergence is the result of attempts to increase the managerial relevance of

theories of strategy. This is substantiated by a review of the explanatory moves that have been

made in the development of the resource-based view of the firm. In their search for relevance,

RBV papers have been moving between arguments derived from neoclassical, evolutionary, and

bargaining perspectives. We show that while these explanatory moves have indeed increased the

managerial relevance of the RBV, they have also put a strain on its theoretical rigor. We examine

what each of the three perspectives can, and more importantly, cannot explain when applied to

the study of competition between firms. We show that their explanatory logics, while

complementary, are based on incompatible assumptions. We demonstrate that each logic requires

a different concept of competitive advantage and discuss how these concepts complement each

other. We conclude that a balance between relevance and rigor in theories of competitive

strategy is most likely to be struck when we develop separate theories on the basis of each logic

and further our understanding of how to fruitfully move between them.

Keywords: competitive strategy, theoretical foundations, RBV, dynamic capabilities,

evolutionary theory, increasing returns, bargaining


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“The definition of competitive advantage is at the core of strategic management and

deserves a spirited debate” (Coff, 1999: 131)

INTRODUCTION

The question how firms achieve and sustain competitive advantage is perhaps the most

fundamental question in the field of strategic management (Rumelt, Schendel and Teece, 1994).

Explaining competitive advantage has been a centerpiece of theory development in the discipline

since the work of Porter (1980, 1985) and is a central concern of resource-based theories (e.g.

Barney, 1991; Teece, Pisano and Shuen 1997; Peteraf and Barney, 2003). However, despite its

widespread use in the theoretical discourse of the field, the notion of competitive advantage

remains elusive (cf. Winter 1995; Powell 2001; Rumelt 2003; Postrel 2006). Indeed, many

researchers use the term without stating explicitly what they mean. Some authors use the term as

synonym for superior financial performance (e.g. Peteraf, 1993; Ghemawat and Rivkin, 1999;

Foss and Knudsen, 2003). Others have defined competitive advantage in terms of certain firm

characteristics or attributes of strategy that enable financial performance (e.g. Porter, 1980;

Ghemawat, 1991; Barney 1991; Peteraf and Barney 2003).

This situation is problematic because it goes beyond a simple lack of consensus over the

definition of competitive advantage. Not only do different definitions of competitive advantage

coexist within the same stream of research, but also it is not very clear what role the concept

plays within the explanatory structure of the theories. It is sometimes treated as the dependent

variable of a theory, while at other times it is an intermediary construct that explains other

dependent variables. These other variables, in turn, differ across contributions and range from

profit and different types of rents, to value created and value appropriated, survival and growth.


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This calls into question fundamental issues with respect to the explanatory rigor of theories of

strategy (Powell, 2001).

Switching between dependent variables and their definitions within theories is likely to limit our

progress in developing theories of strategy. The lack of clarity surrounding the concept of

competitive advantage has already spurred some authors to develop clearer definitions of

competitive advantage (e.g. Peteraf and Barney, 2003; Postrel, 2006). The approach in this paper

is somewhat different. Our interest is in understanding the root causes of the lack of consensus

about the competitive advantage concept. We look beyond competitive advantage as such and

examine its place among the dependent and independent variables of theories in strategy. We ask

what theories of strategy have tried to explain and what they can reasonably be expected to

explain and we show that there are major discrepancies between the answers to these two

questions.

The focus of the paper is on the resource-based view (RBV), although we will argue that our

analysis also holds for theories of competitive advantage that have taken inspiration from

industrial organization (Porter 1980, 1981, 1991). We show that seminal contributions to the

literature on competitive strategy diverge widely in the dependent variables they use and in their

definitions of these variables. We argue that the resulting confusion over the explananda of

theories of strategy has its origins in attempts to increase the managerial relevance of the

competitive strategy literature. While these attempts are inherently worthwhile, they have led to

a number of explanatory moves that have put a strain on the explanatory rigor of theories of

strategy. The main purpose of this paper is to examine how future theory development in

competitive strategy can combine increased managerial relevance with explanatory rigor.


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The paper proceeds in three steps. First we review the use of dependent variables in seminal

contributions in the competitive strategy literature in general and the RBV in particular. We

show that there is considerable confusion over what theories of strategy should explain. We

argue that this confusion is the result of the fact that attempts to increase the relevance of

theories of strategy have led to the incorporation of different explanatory logics. While the

original statements of theories of competitive strategy were grounded in a neoclassical economic

logic, later contributions have incorporated arguments from evolutionary theory and a bargaining

perspective. As a result, our theories tend to incorporate arguments derived from different logics

that may not always be compatible, and the claim of this paper is that this incompatibility in turn

explains why we find ourselves switching between definitions and dependent variables within

streams of research.

The second part of the paper unravels the explanatory logic of neoclassical, evolutionary and

bargaining theory as they have been applied in strategy. Here we ask what each of these logics

can reasonably be expected to explain, what the nature of their explanations is, and which

assumptions they make to offer their particular explanation. We show that each of the logics

explains something essential about performance differentials between firms, but that the

explanations they offer are based on fundamentally different assumptions. Moreover, each of the

logics has inherent limitations, and none of them can explain all aspects of firm performance.

In the third part of the paper we link our analysis back to the notion of competitive advantage We

show that competitive advantage necessarily has a different meaning in the context of each of the

logics. We conclude that theories of strategy should not be pushed beyond what their underlying

logic can explain. Despite their power, each of the logics that have been used to develop theories

of strategy can only offer a partial explanation of performance differentials between firms.


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Moreover, given the fundamentally different nature of the assumptions that they make, attempts

to combine their explanations into one overarching theory will most likely merely add to the

confusion over the explananda of theories of strategy. We discuss how the explanations based on

the different logics complement each other and argue that attempts to combine rigor and

relevance in theories of strategy are best served by carefully moving between logics.

WHAT HAVE THEORIES OF STRATEGY TRIED TO EXPLAIN?

This section asks what theories of strategy have tried to explain. This question will be answered

by reviewing seminal contributions to the literature on competitive strategy. We focus our review

on the ‘modern’ resource-based view of the firm, but will show that our analysis of the way in

which the RBV has developed over time also applies to the work of Porter (1980, 1981, 1985,

1990, 1991). We structure our review of seminal papers in the RBV around three major shifts in

the object of study. These are, first, the shift in focus from resources acquired in factor markets

to resources developed within the firm, second, the move from resources and capabilities

towards dynamic capabilities, and third, the move from the generation of value to its

appropriation. This allows us to distinguish among four ‘streams’ of research: a market

imperfections stream, a capabilities stream, a dynamic capabilities stream, and a bargaining

stream. This evolution in the focus of the RBV is not merely anecdotic, but can be read as a

balancing act between rigor and relevance. The explanatory moves can be seen as worthwhile

attempts to increase the managerial relevance of the RBV. However, these moves have also

resulted in strains on the rigor of its explanatory logic that have not been sufficiently

acknowledged.


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A perusal of the dependent variables suggested by seminal papers in the RBV illustrates the

strains on the rigor of the explanatory logic of the RBV. Table 1 shows that there has been

substantial disagreement about what the RBV should explain, and that this confusion continues

until today. Key RBV papers discuss different dependent variables and disagree about the

definition of these variables. Some of the shifts in dependent variables and their definitions have

been beneficial for the field by clarifying what the RBV can or should explain, but the overall

trend has been of a proliferation of variables and a resulting confusion about the explananda of

the theory. Below, we argue that where changes in the nature of the dependent variable have

been suggested, these suggestions have typically not gone far enough, because they have failed

to match the explanatory moves that have been made in the RBV. This has resulted in a situation

where theoretical arguments are linked to dependent variables that they are unable to explain.

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Insert Table 1 about here

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Market imperfections

Early papers in the ‘modern’ resource-based view were positioned relative to neo-classical

microeconomics (Barney, 2001). They explained resource and performance heterogeneity in

terms of departures from the assumptions of the perfect competition model. For instance,

Lippman and Rumelt (1982) relaxed the assumption of perfect information and showed that

uncertain imitability could explain the persistence of interfirm differences in cost efficiency.

Barney (1986) similarly reasoned in terms of deviations from the model of perfect competition.

His focus on imperfections in factor markets flowed from the observation that “if strategic factor

markets are perfect the cost of acquiring strategic resources will approximately equal the


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economic value of these resources once they are used to implement product market strategies”

(Barney, 1986: 1231). However, when factor markets are imperfect and firms and resource

owners have different expectations regarding the future value of a resource, firms can obtain

above normal returns by having superior information about the future value of a resource or by

simply being lucky (Barney, 1986).

Other foundational publications in the RBV also used market imperfection logic. Wernerfelt

(1984) discussed mergers and acquisitions as providing “… an opportunity to trade otherwise

non-marketable resources and to buy or sell resources in bundles. […] As is well known, this is a

very imperfect market … A key implication … is that a given target will have different values

for different buyers […] (Wernelfelt, 1984: 175). Peteraf (1993) developed her four conditions

for sustained competitive advantage in terms of departures from the assumptions of perfect

competition. Heterogeneity and ex ante limits to competition enable the firm to establish a

superior resource position, while ex post limits to competition and imperfect resource mobility

make it possible for the firm to sustain this competitive advantage in equilibrium.

Positioning this early body of RBV research relative to neo-classical microeconomics had the

advantage of rigor. First, the authors in this early stream agreed upon the nature of the dependent

variable of the theory. They developed arguments to explain positive economic profit (also called

rents) sustained in equilibrium. Second, the logic used to explain this dependent variable was

clear: departures from the assumptions of perfect competition explain differences in performance

that are not eroded by competition.

From factor market imperfection to capabilities


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While making use of neo-classical microeconomics brought rigor to strategy theory, it also

limited the managerial relevance of early RBV research. One of the problems of using neo-

classical theory as a benchmark was that it is based on a very simplistic theory of the firm

(Rumelt, 1984). Neoclassical economics was developed to study the working of the price system

and black-boxed the firm by reducing it to a production function. In contrast, what happens

inside firms is a central concern of strategic management research, and the first shift in the

perspective of the RBV occurred when strategy researchers started moving away from the

neoclassical perspective on the firm.

The resulting explanatory move is evident in Dierickx and Cool’s (1989) recognition that

resources with the highest rent earning potential are developed internally rather than acquired in

factor markets. Dierickx and Cool (1989) responded to Barney (1986) by pointing out that

resources critical to competitive advantage are often nontradeable and must be accumulated

inside the firm. In their view market incompleteness rather than market imperfection is the source

of persistent performance differentials among firms. Their arguments resonated with a large

audience within the nascent RBV. For instance, Barney (1991) argued that resources could be

imperfectly imitable because they are socially complex. Similarly, Peteraf (1993) explained that

non-tradeability causes imperfect mobility, which is a necessary condition for sustained

competitive advantage. Others emphasized resource complementarities and co-specialization

within the firm (e.g., Black and Boal, 1994) or the resource of management (Mahoney, 1995) as

major sources of performance. Many researchers have since focused their attention on resources

and capabilities built inside the firm (e.g., Helfat 2003).

Opening the black box of the neoclassical firm increased the managerial relevance of the field,

and the focus on firm specific resources and capabilities generated new insights with respect to


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possible sources of competitive advantage. However, this explanatory move also resulted in

confusion about the appropriate dependent variable in RBV research. For instance, Barney

(1991) set out to explain sustained competitive advantage in terms of unique product market

strategies sustained in equilibrium. Other authors maintained a focus on rents, but started

differentiating among many different types of rent. These types of rent include, but are not

limited to economic concepts such as Ricardian rents, Marshallian rents, monopoly rents, and

quasi rents (Peteraf 1993, 1994; Amit and Schoemaker 1993; Mahoney 1995). Amit and

Schoemaker (1993) specifically proposed to focus on ‘organizational rents’ as the dependent

variable of the RBV. “These are economic rents that stem from the organization’s Resources and

Capabilities, and that can be appropriated by the organization (rather than any single factor)”

(Amit and Schoemaker, 1993: 36). More recently, Peteraf and Barney (2003) responded to Foss

and Knudsen’s (2003) critique of the resulting ‘resource-based tangle’ by advocating competitive

advantage as the dependent variable of RBV. In their view, competitive advantage is seen as an

intermediate outcome in the path leading from critical resources to economic rents. Greater

economic value supports the generation of rents, but does not automatically lead to sustained

superior performance because rents may be fleeting or may be appropriated by others. Since

then, Ray, Barney and Muhanna (2004: 24) have proposed the effectiveness of business

processes as an alternate class of dependent variables because “… a firm may excel in some

business processes, be only average in others, and be below average in still others. A firm’s

overall performance depends on, among other things, the net effect of these business processes

on a firm’s position in the market place”.

From capabilities to dynamic capabilities


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A second shift in the focus of the RBV occurred when researchers started investigating the

process by which capabilities are developed and change over time. Rumelt (1984, in Foss, 1997:

134) already called for the investigation of “the appearance and adjustment of unique and

idiosyncratic resources”. He dismissed the use of static equilibrium condition to study these

phenomena to the benefit of Schumpeter’s vision of competition as a process of ‘creative

destruction’ and Nelson and Winter’s evolutionary approach.

Teece, Pisano and Shuen (1997: 516) developed such a perspective with their dynamic

capabilities view (DCV). Dynamic capabilities were defined as “the firm’s ability of integrate,

build, and reconfigure internal and external competences to address rapidly changing

environments”. The competitive advantage of firms was seen as being shaped by managerial and

organizational processes that are in turn shaped by the firm’s specific asset position and the paths

available to it. This perspective again emphasized the importance of resources that must be built

because they cannot be bought, but added an explicitly dynamic view on competition that

emphasized path dependence. Such path dependence was seen as being amplified when

increasing returns exist.

This additional explanatory move aimed to increase further the managerial relevance of the

resource-based view by putting center stage dynamics and the key role of strategic management

in adapting to a changing environment. However, increased managerial relevance again went

hand in hand with confusion about the dependent variable of the theory. The opening statement

of Teece et al.’s paper mentions no less than four different dependent variables:

‘The fundamental question in the field of strategic management is how firms achieve and sustain

competitive advantage. We confront this question here by developing the dynamic capabilities


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approach which endeavors to analyze the sources of wealth creation and capture by firms …

The approach endeavors to explain firm-level success and failure. We are interested in building a

better theory of firm performance …’ (p.509, emphasis added)

In contrast to the explicit effort the paper makes to define its independent variables, none of

these dependent variables is defined and the table that summarizes the contribution of the paper

in relation to extant perspectives in competitive strategy (I/O, RBV, bargaining) claims a fifth

dependent variable: ‘Schumpeterian rents’. The notion of Schumpeterian (or, entrepreneurial)

rents had also been proposed in other calls for the incorporation of the role of managers and

path-dependence to understand how organizational learning affects the evolution of resources

over time (Mahoney and Pandian 1992; and Mahoney 1995).

Despite ambiguities about its dependent variable, the dynamic capabilities perspective has had a

major impact on the further development of the RBV. Not only has it made the need for a more

dynamic version of the RBV abundantly clear, but also most researchers today seem to agree that

a dynamic version of the RBV should be an evolutionary theory (e.g. Barney, 2001; Helfat and

Peteraf, 2003; Zott, 2003). Moreover, a consensus seems to have emerged that dynamic

capabilities explain how resource configurations are changed and how firm heterogeneity arises

in the process (Eisenhardt and Martin, 2000; Helfat and Peteraf, 2003; Winter, 2003; Zott, 2003).

However, the link with competitive advantage remains unclear. Seminal articles do refer to the

concept, but without offering definitions.

Bargaining: From value generated to value appropriated

Bargaining has always been present in the ‘modern’ resource-based view. For instance,

Wernerfelt (1984) started his analysis of the relationship between resources and profitability by


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referring to the bargaining power of resource suppliers and buyers. Peteraf (1993) argued that

imperfect resource mobility is necessary for rents to accrue to the firm because the resource

owners would otherwise appropriate them. However, recent work has gone further by more

explicitly integrating the resource-based view with a bargaining approach.

Coff (1999) was the first to offer an in depth discussion of the link between rent generation and

rent appropriation within firms. He moved away from the representation of the firm as a unitary

actor that the RBV had imported from neoclassical economics, and saw the firm as a nexus of

contracts. On the basis of the bargaining power literature, Coff showed that characteristics that

make resources more likely to be sources of sustainable advantage, such as causal ambiguity,

firm-specificity and social complexity, also grant employees substantial bargaining power. In

consequence, his work mounted a fundamental challenge to the use of above normal financial

performance as the dependent variable in the RBV. The generation of economic rents does not

automatically lead to sustained superior performance for the firm because the owners of the

resources employed by the firm, for example its employees, may appropriate the rents generated

by the firm by bargaining for better payment for their services.

Coff (1999) assumed that suppliers and customers lack bargaining power to be able to focus on

how internal stakeholders (management, employees, and shareholders) appropriate rents. He

mentioned, however, that when the firm is seen as a nexus of contracts the distinction between

inside and outside shareholders no longer applies. Other authors have included all resource

suppliers and customers in their analysis of the value captured by the firm. For instance,

Bowman and Ambrosini (2000: 9) argued that how much of the value created is retained by the

firm in the form of profit cannot be determined solely by an examination of the processes within

the firm. It is rather determined by: “(1) comparisons customers make between the firm’s


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product, their needs, and feasible competing offerings from other firms, and (2) comparisons

resource suppliers make between the deal they have struck with this firm, and possible deals they

could make with alternative buyers of their resources”.

A small but growing body of strategy research has made use of cooperative game theory to

model bargaining among economic actors (e.g., Brandenburger and Stuart, 1996; Lippman and

Rumelt, 2003b; MacDonald and Ryall, 2004). To understand better how the value created by co-

specialized resources is divided among these resources, Lippman and Rumelt (2003a&b) favor

the formalizations of cooperative game theory over a neoclassical logic. They argue that

cooperative game theory can replace the neoclassical logic of partial equilibrium analysis with a

formal system in which value created is known, but its division is subject to negotiation. Such an

explanatory move is seen as a contribution to the relevance of the RBV because it would

circumvent the limitations of the neoclassical logic, not least by replacing the “chimera” of

economic profit (Rumelt 2003) by observable payments to resources.

Comparing RBV to Porter

We may conclude that the RBV has made use of three different logics: a neoclassical logic, an

evolutionary logic and a bargaining logic. That these three logics capture something essential

about competitive strategy is perhaps best illustrated by the fact that the mainstream theory of

competitive strategy in the 1980s, exemplified in Porter’s work, made use of these same logics.

Porter’s (1980) five forces framework was firmly anchored in industrial organization economics,

a perspective in which equilibrium is a necessary feature of formalization. In this framework,

competitive advantage is derived from positions that exploit market imperfections such as entry

barriers, mobility barriers or switching costs. Porter (1985) subsequently moved on to address

the internal activities of the firm as sources of competitive advantage. With this new focus on


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relative efficiency rather than market power, the meaning of competitive advantage shifted to the

superior coordination of activities (Porter 1985, 1991). Moreover, in addition to using the logic

of market imperfections, his work also builds on bargaining and evolutionary logic. Both logics

were already present in Porter’s early work. Bargaining logic is manifested in the horizontal part

of the five forces model, which specifically addresses the bargaining power of suppliers and

buyers. Evolutionary logic underwrites the last part of the 1980 book where Porter discusses the

evolution of markets and technologies in terms of industry lifecycles, but Porter’s (1990, 1991)

later work is even more explicitly evolutionary (Foss, 1996).

WHAT CAN THEORIES OF STRATEGY BE EXPECTED TO EXPLAIN?

To understand what theories of strategy can reasonably be expected to explain, we must look at

what the underlying logics of these theories are actually capable of explaining. The previous

section has shown that mainstream theories of strategy have made use of three distinct logics: a

neoclassical logic, an evolutionary logic, and a bargaining logic. This section shows that each of

these logics has inherent strengths and limitations. Each logic can explain something essential

about performance differentials among firms, but does so on the basis of very specific

assumptions. Below, we discuss each of the three logics in turn. We clarify the nature of the

explanations they can offer by specifying the dependent variables they address, the independent

variables used to address them, and the causal logic that links independent and dependent

variables. We also specify how the assumptions that are made limit the scope of what each logic

can reasonably be expected to explain when applied to strategy.

The neoclassical logic


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Theories of competitive strategy derive their rigor from being embedded in economic logic, and

at the heart of this logic is neoclassical partial equilibrium analysis. The neoclassical model of

perfect competition grounds theories of competitive strategy not because it is an accurate

description of reality, but because it serves as a useful theoretical benchmark. In markets where

the assumptions of the model of perfect competition are met there is no room for performance

differentials between firms. It follows that when we do observe performance differentials, the

markets in question must deviate from the assumptions of the neoclassical model.

The assumptions that underwrite the neoclassical model are well known. The following

assumptions must hold in product and factor markets to have perfect competition:

1. There are many buyers and sellers in the market, no one of which is large enough to

affect the going market price. In consequence, buyers and sellers are price takers. With

respect to firms, this assumption can only hold if we assume decreasing returns,

otherwise some firms would grow larger over time and could exert power over prices.

2. There is no product differentiation. Buyers are totally indifferent as to which seller they

buy from, they choose among firms solely on the basis of price.

3. Sellers enjoy complete freedom of entry and exit. Entry and exit costs are negligible. This

assumption can only hold if resources are perfectly mobile and divisible.

4. Sellers and buyers are perfectly rational and have perfect information. Buyers maximize

utility and sellers maximize profits.

Under these conditions an equilibrium will be reached in which firms will earn zero economic

profit. Firms will make just enough to be able to pay for their resources and continue their

operations. When we observe levels of profit up and above what is strictly necessary to continue

a firm’s operations, this must be explained in terms of a deviation from the assumptions of the


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model of perfect competition. It is on these deviations that theories of strategy have focused.

Anchored in industrial organization, Porter’s (1980) work has emphasized deviations from the

large numbers and homogeneity assumptions, while early RBV work has emphasized deviations

from the resource mobility assumption (e.g., Barney, 1986).

Explanations of performance differentials based on deviations from the model of perfect

competition are grounded in a rigorous logic, but are also wedded to the inherent limitations of

neoclassical partial equilibrium analysis (cf. Lipmann and Rumelt, 2003a). The model of perfect

competition assumes away many phenomena that are of interest to strategy researchers such as

“(1) transaction costs, (2) limits on rationality, (3) technological uncertainty, (4) constraints on

factor mobility, (5) limits on information availability, (6) markets in which price conveys quality

information, (7) consumer or producer learning, and (8) dishonest and/or foolish behavior”

(Rumelt, 1984, in Foss, 1997: 133). Moreover, the neoclassical logic can only address a very

specific concept of profits, namely economic profits, i.e., rents that accrue to a firm when

competition has played out and the price mechanism has resulted in market equilibrium. Rents,

in turn, are revenues paid to resource owners over and above their opportunity costs. Note that

the neoclassical concept of profits is only defined in relation to a perfectly competitive market in

equilibrium. Economic profits are emphatically not the same as the accounting profits that are of

interest to managers and that can be readily observed empirically (Rumelt, 2003). In other words,

theories grounded in a neoclassical logic can offer at most a possible, and in all likelihood

partial, explanation of accounting profits.

Another limitation of the neoclassical logic lies in the equilibrium notion itself. This feature of

the explanatory logic renders it incapable of giving a dynamic explanation of performance

differentials between firms. Being grounded in this logic, mainstream theories of strategy have


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found it difficult to move beyond static explanations of profit differentials. A rigorous

explanation of performance differentials based on neoclassical logic can only be given in terms

of market conditions prevailing at a specific moment in time. This is what I/O and RBV do when

they explain profit differentials in terms of positional advantages in product or factor markets

that are sustained by barriers to competition. But they do not have much to say about the

dynamic process that explains where these barriers to competition come from (cf. Lieberman and

Montgomery, 1998; Hoopes, Madsen and Walker, 2003; Helfat and Peteraf, 2003).

In essence, the neoclassical logic has brought rigor to the discipline, but the theories that are

based on this logic also fall prey to its inherent limitations. They can only uphold their rigor

within the context of the assumptions of neoclassical partial equilibrium analysis. In its pure

form, the neoclassical world of perfect competition is a world in which technology and

preferences are given, and firms are black boxes that act as unitary agents. The further theories of

strategy move away from these assumptions, the more strain is put on the rigor of their

explanatory logic.

The evolutionary logic

As theories of strategy have tried to develop more dynamic explanations of why some firms

outperform others, they have increasingly turned to evolutionary arguments. This is a

fundamental shift in perspective. Evolutionary explanations do not make use of equilibrium

analysis, but offer a dynamic explanation of change over time in terms of the interplay of

variation, selection and retention mechanisms. The important difference in nature between an

evolutionary explanation and a neoclassical explanation has not received much attention in the

strategy literature. Evolutionary theories offer an algorithmic explanation of change over time

that is fundamentally at odds with equilibrium analysis. The essence of the evolutionary


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algorithm is that a combination of mechanisms of variation, selection and retention will

necessarily lead to evolution. Evolutionary theory applies to populations of entities. If there are

mechanisms to keep introducing variations in the population, consistent selection pressures, and

mechanisms to retain the variations that work, the population of entities will become adapted to

its environment. The crux of this explanation is the feedback loop from success (or lack thereof)

in interacting with the environment to the retention of certain behaviors. This feedback loop

means that an evolutionary explanation makes use of a recursive causal logic.

The standard evolutionary explanation assumes a regime of negative feedback in which

unsuccessful entities are eliminated. The original Darwinian logic is that nature selects the

organisms that are best adapted to their environment, but this ‘natural selection’ does not result

from any positive act of the environment but is simply the result of the fact that the genes of

organisms that come up short in the competition for scarce resources are eliminated. The

Darwinian algorithm proceeds through endless cycles of generating new variations, testing these

variations in environmental interaction, and retaining successful variations by eliminating

unsuccessful ones for the next cycle.

Such a regime of negative feedback is not unlike a neoclassical world in which market

competition drives out inefficient firms. But there is one crucial difference. Evolutionary models

do not have to take technology and preferences as given, and as a consequence an evolutionary

world is about out-of-equilibrium competition. The competitive context is changing continuously

as a result of endogenously generated variation. As a result, the variation-selection-retention

algorithm is uniquely suited to explain how adaptive fit evolves under conditions of uncertainty.


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However, like any theoretical perspective, the evolutionary logic also has its limitations. Note

that there is nothing in an evolutionary logic that can explain profit. When applied to firms,

profits may be an essential part of the feedback loop from selection to retention (Nelson and

Winter, 1982), but as such they are part of the explanans of evolutionary theory, and not the

explanandum. The appropriate dependent variable in an evolutionary explanation is adaptive fit

and its dynamic relationship to differential survival. To be able to explain profits, we would have

to revert back to an equilibrium explanation in terms of competitive barriers that cause market

imperfections.

In its pure form an evolutionary perspective does not have much to say about where barriers to

competition come from. However, the emergence of barriers to competition in the evolutionary

process can be addressed when a regime of positive feedback is assumed. Such a regime is

presented in the increasing returns literature. This literature also gives an algorithmic explanation

of change over time, but relaxes what is arguably the most fundamental assumption of the

neoclassical model of perfect competition: that there are decreasing returns at the margin. When

there are increasing returns to scale, firms experience a regime of positive feedback, in which

there is a “tendency for that which is ahead to get further ahead, for that which loses advantage

to lose further advantage” (Arthur, 1996: 100). Positive feedback mechanisms can operate on the

supply side to lower costs (e.g. scale economies) or on the demand side to increase value (e.g.

network externalities).

The positive feedback of increasing returns mechanisms changes the evolutionary model in some

fundamental ways. In the version with negative feedback we have a world in which each entity,

be it organism in biology or firm in economics, is small in relation to the overall population of

entities with which it competes for resources. In biology this situation is an empirical fact,


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because each organism can only consume a limited amount of energy. In neoclassical economics

this situation is merely assumed. As soon as we allow for increasing returns, the population

dynamics change dramatically. We no longer have a situation in which we can predict that a

population of entities will become better and better adapted to the specific environmental

selection pressures that it faces, but one in which we can expect the entity that, for whatever

reason, gets ahead of its competitor to corner the market. Given pure increasing returns, this is a

logical consequence of the recursive causality by which firms that get ahead of the competition

incur advantages in customer value and costs. Such advantages will help a firm with a

competitive lead to get even further ahead of its competitors, which in turn increases the value of

its products and cost position, and so on until it corners the market.

The bargaining logic

The bargaining logic is another approach in which neoclassical assumptions are relaxed to shed

light on phenomena that would otherwise escape rigorous analysis. Here the crucial difference

with neoclassical theory is that firms are no longer assumed to be unitary agents (Coff, 1999).

Instead the firm is seen as a legal shell containing property rights to a set of resources or, in the

case of humans, resources-services (Lippman and Rumelt, 2003b). In other words, the firm is a

nexus of contracts (Coff, 1999) bringing together a coalition of resource providers (among which

employees and owners) within a supply chain of suppliers, complementors and buyers. These

different parties are at the same time collaborators in generating economic value and competitors

in claiming a share of the value that is created.

By considering a coalition of claimants that bargain over the appropriation of the value generated

by their joint activities, the bargaining perspective moves away from the neoclassical view of

market prices as drivers of economic behaviors. Instead it considers that rents appropriated by


22

resource suppliers are the “negotiated payments for the services of scarce valuable resources”

(Lippman and Rumelt, 2003b). These negotiated payments depend on the values that resource

suppliers could have created by bundling their resource with resources from alternative buyers of

their resource (Bowman and Ambrosini, 2000; Lippman and Rumelt, 2003b). The bargaining

perspective treats relations with buyers and sellers in a symmetrical way, so prices paid by

customers are similarly the result of negotiations between the firm and customers based on

“comparisons customers make between the firm’s product, their needs, and feasible competing

offerings from other firms” (Bowman and Ambrosini, 2000). Thus, in a bargaining perspective,

the important driver of behaviors is not a market price but the value that could have been

appropriated in alternative coalitions.

In the strategy literature, we observe two complementary versions of the bargaining perspective.

There is work that has concentrated on bargaining between firms (Brandenbruger and Nalebuff,

1995; Brandenburger and Stuart, 1996; McDonald and Ryall, 2004) and there is work that has

concentrated on bargaining within firms (Coff, 1999; Lipmann and Rumelt, 2003b), although

some authors have considered both simultaneously (e.g., Bowman and Ambrosini, 2000). When

studying bargaining between firms, the focus is on how the value generated by a supply chain is

divided among the focal firm, its suppliers, and its buyers. In other words, the dependent variable

in this version of the bargaining approach is the value appropriated by the firm. The value

generated by the coalition of players that is the subject of bargaining is bound by buyers’

willingness-to-pay and the suppliers’ willingness-to-sell. When studying bargaining within firms,

the focus is on how the value appropriated by the firm is divided between its ‘internal’ resource

suppliers, especially employees and owners. In consequence, the dependent variable this version


23

of the bargaining approach addresses is the value appropriated by a stakeholder or a group of

stakeholders (e.g., employees, shareholders).

The bargaining logic offers an essential complement to the explanations of performance

differentials between firms based on neoclassical and evolutionary perspectives, but also has its

limitations. The most obvious limitation is that the bargaining perspective has very little to say

about value creation. It assumes that value is created and focuses its analysis on how this value is

divided among claimants. Moreover, when formalized, the bargaining perspective uses

cooperative game theory to address how economic value is divided among claimants. While a

useful tool, cooperative game theory offers only a partial answer to the question of how much

value a player is going to appropriate. Brandenburger and Stuart (1996) explained that, under the

assumption of ‘unrestricted bargaining’ (i.e., all favorable coalitions are identified and sought out

by the players, which rules out imperfect information), each player will capture at least the value

that it would appropriate in alternative coalitions and will not be able to capture more than the

value it adds to the coalition. This value is the difference between the value generated by the

coalition with the player included and the value that the other players of the coalition would

generate by replacing the player by the best alternative. Where the value appropriated by the

player falls in this interval depends on the structure of the game and may be formally

indeterminate (MacDonald and Ryall, 2004). Elements such as negotiation skills are not taken

into account in formal cooperative game theory even though in practice they may help explain

where the value appropriated by the player falls in the interval described above. Furthermore,

Lippman and Rumelt (2003b) pointed to Brandenburger and Stuart’s (1996) use of a specific

solution concept, called the core, to define solutions. According to Lippman and Rumelt (2003b),

solutions to the bargaining game may well lie outside the core. They applied several solution


24

concepts for simple bargaining games, showing that these different solution concepts lead to

different results. Thus, in contrast to neo-classical microeconomics that provides a unique

equilibrium, cooperative games often have multiple equilibria.

COMPETITIVE ADVANTAGE

What do the fundamental differences between the logics discussed above mean for our

understanding of competitive advantage? While many authors have explicitly used competitive

advantage as the dependent variable of their theories, recent publications tend to argue that the

notion is better seen as an intermediate variable that can help explain some other aspects of

performance differentials between firms (Powell, 2001; Peteraf and Barney, 2003; Postrel,

2006). We concur. A first step towards clarifying the nature of competitive advantage is to

disentangle explicitly the notion itself from the performance differentials between firms it should

help explain. A second step is to specify competitive advantage in terms of a specific advantage

over specific others. Together, these two steps lead to three questions: (1) Which aspect of

performance differentials do we want to explain? (2) In terms of which advantage can this aspect

of performance be explained? (3) Over whom does the firm need to establish this advantage?

Answering these questions shows that competitive advantage necessarily means different things

in the context of the different logics (see Table 2). This is a direct consequence of the dependent

variables they are able to explain, the nature of their explanatory logic, and their underlying

assumptions.

-------------------------------

Insert Table 2 about here

-------------------------------


25

Within the context of the neoclassical logic of partial equilibrium analysis, competitive

advantage means a positional advantage over the break-even competitor in equilibrium, i.e., once

competition has played out (cf. Peteraf and Barney, 2003). It is such an advantage that explains

the firm’s ability to earn rents, which are defined as returns to a factor in excess of its

opportunity costs (Peteraf and Barney, 2003). The follow-up question concerns the nature of this

positional advantage. The advantages that have been proposed in the literature are twofold:

positional advantages in terms of a higher willingness-to-pay for the firm’s offering relative to

competitors, and positional advantages in terms of the firm’s ability to produce its offering more

efficiently than competitors. These positional advantages are in turn explained in terms of

product and factor market imperfections.

Within the context of the population dynamics of an evolutionary logic the analysis shifts from a

static equilibrium comparison with the break-even competitor to a dynamic comparison with the

average firm in the population of competitors. In an evolutionary context, uncertainty and

endogenously generated change force firms to adapt continuously to changing circumstances.

Here, the dependent variable is adaptive fit and its dynamic relationship to differential survival.

Whether a firm will be able to secure the necessary resources to survive from the environment

depends on how it compares to the average competitor. Over time, firms that do better than

average will survive while firms that perform below the average will fail. Note that this means

that the average performance in the industry is a moving target. This in turn means that this

notion of competitive advantage is fundamentally different from the equilibrium notion in the

neoclassical logic.

Within the context of increasing returns logic, the dependent variable is market share. As is the

case with evolutionary explanations, the explanatory logic of increasing returns builds on a


26

recursive causal logic. The difference is that the evolutionary algorithm is one of negative

feedback (underperforming firms are selected out), while the increasing returns logic is one of

positive feedback (firms that get ahead enjoy a self-reinforcing advantage). Positive feedback

changes the population dynamics in the sense that firms that do better expand, while firms that

do worse contract. At the limit, in a world dominated by increasing returns, only the best firm

survives. This means that competitive advantage is only defined in terms of an advantage over

the best alternative.

Finally, in the bargaining logic, the dependent variable is value appropriated by a stakeholder or

group of stakeholders. These stakeholders can be external or internal to the firm as the notions of

inside and outside the firm do not apply when the firm is conceived as a coalition of resource

suppliers and buyers. Here the analysis shifts to considering the outcome of bargaining over the

value generated. Competitive advantage is therefore best defined in terms of a bargaining

advantage over all other claimants.1 This bargaining advantage depends on the stakeholders’

access to key information, replacement cost for the coalition (which is the difference between the

value generated by the coalition with the stakeholder and the value generated by the coalition

with the best available replacement for the stakeholder), cost of moving to another coalition, and

capability of acting in a unified manner (Coff, 1999).

DISCUSSION

Our examination of the different logics that ground theories of strategy suggests an obvious

explanation for the fact that we have a tendency to switch between dependent variables and still

face definitional problems with respect to central constructs like competitive advantage. Each of

the logics discussed above highlights a crucial aspect of competitive advantage, but each logic


27

can only offer a partial explanation of performance differentials between firms. Consequently,

attempts to offer a complete explanation of performance differentials within theories of strategy

have invariably led to frameworks that combine arguments from multiple logics. While such

theory development may indeed increase the relevance of theories to practitioners, it comes at

the expense of rigor and opens the door to confusion about the nature of the dependent variable.

The evolution of Porter’s work is a case in point. The managerial relevance of his frameworks is

beyond doubt, and his work was instrumental in precipitating the ‘economic turn’ in strategy that

brought rigor to the discipline. However, Porter’s (1980) five forces model mixes a neoclassical

logic with a bargaining logic, and it should therefore come as no surprise that modifications to

the model have been suggested from a bargaining perspective. It has been argued that the threat

of substitution should be outside of the framework because it affects the overall value created by

the industry rather than within-industry competition (Brandenburger, 2002; Postrel, 2006).

Moreover, by putting the dynamics of the industry lifecycle center stage, the second part of

Porter’s 1980 book developed an evolutionary perspective that does not combine well with the

underlying equilibrium logic of the five forces model (Foss, 1996). These strains on the

explanatory logic of his frameworks are also present in his later work. In his book on the firm

specific nature of the sources of competitive advantage, Porter (1985) still grounded his

arguments in the theory of industrial organization even if this approach is not particularly well

equipped to capture the complexities of internal activities. And his work towards a more

dynamic theory of strategy (Porter, 1991) continued to mix evolutionary arguments with notions

based on equilibrium analysis.

Current attempts to develop the RBV into a more dynamic theory face similar difficulties in

balancing relevance and rigor. Such attempts typically make use of evolutionary concepts, but


28

the increasing use of evolutionary arguments to explain firms’ abilities to adapt to environmental

change in the face of uncertainty makes the resulting explanation of competitive advantage more

and more difficult to integrate with the original RBV explanation of a firm’s ability to earn rents

in terms of factor market imperfections. While a neoclassically grounded RBV and an

evolutionary DCV can complement each other, their different logics mean that they simply

cannot, as some have claimed, be integrated into one overarching theory without losing

explanatory rigor. In that sense, claims for the development of different resource-based theories

(Barney, 2001) are more in line with the analysis presented above, but even then the idea of an

‘evolutionary resource-based theory’ (Barney, 2001, 2003) only makes sense if we explicitly

recognize that such a theory will necessarily address another dependent variable than the

traditional RBV and will also lead to a different conception of competitive advantage.

We believe that a balance between relevance and rigor in the development of theories of strategy

is best struck by carefully distinguishing among the different explanatory logics and by carefully

moving between them. There is no simple answer to what the appropriate dependent variable of a

theory of strategy should be. Our discipline is probably best served by focusing on variables that

are managerially relevant and easily observed empirically. The most obvious variables that meet

these criteria are survival, growth, and profit. But the explanatory logics that ground our theories

may not be particularly suited to explain these variables. We have seen that each of the logics

can offer a rigorous explanation of an important aspect of firm performance, but that none of

them can explain everything that would interest managers and be observable in empirical

research. We believe that it will be impossible to offer such all-encompassing explanations on

the basis of one overarching theory. A more fruitful road ahead would be to develop rigorous,


29

but necessarily partial, explanations of performance differentials between firms, and further our

understanding of how these explanations may complement each other.

--------------------------------

Insert Figure 1 about here

--------------------------------

Figure 1 presents a step towards this goal by showing how the different logics relate. It

incorporates the proposal by Hoopes et al. (2003) that a ‘value-price-cost’ model may serve as a

generic framework for theories addressing competitive heterogeneity. We have modified this

framework by replacing price by revenue, which represents the mathematical product of price

and number of products sold. The different logics discussed above are represented as four

different angles on this concept of competitive heterogeneity.

In the bottom left corner, the evolutionary algorithm offers a way to explain how competitive

heterogeneity emerges out of processes of variation, selection and retention at the level of the

population of competing firms. Under conditions of uncertainty, variations in the resource

configurations of competing firms are generated continuously and endogenously. The resource

configurations of firms that are able to survive are retained in the population, and as a result the

population of surviving firms becomes better and better adapted to its environment. This logic is

about differential survival and as such it has nothing to say about profit. It simply differentiates

between firms that are able to survive and those that fail. Survival does not require profit, but

merely that the revenues (R) of the firm offset its costs (C). In other words, the relevant

advantage is that of the break-even competitor over competing firms that fail. However, over

time the level of efficiency at which firms in the population can break even will increase, so that


30

firms need to adapt continuously to a changing competitive environment. As such this mode of

explanation is about differences in the learning abilities of firms.

In the upper left corner, the explanation based on deviations from the neoclassical model of

perfect competition starts where the evolutionary explanation stops. It assumes the resource

heterogeneity that emerges from the evolutionary process, and explains economic rents in terms

of market imperfections prevailing when competition has played out and equilibrium has been

obtained. In this view, firms that are able to generate more economic value than the break-even

competitor will be able to earn economic rents. Economic rents can be earned when the buyers

willingness-to-pay for a firm’s products (V) is higher than that of the break-even competitor,

and/or when the costs of the resource configuration used to generate this value for buyers (C) is

lower than that of the break-even competitor. This is a mode of explanation that is based on

efficiency differentials between firms. However, it has nothing to say about who appropriates the

economic value created.

The bargaining logic in the upper right corner takes value created as given and focuses on how

value is appropriated by different claimants. It starts its explanation where the neoclassical

explanation stops and explains value appropriated in terms of the bargaining power of the

different members of the coalition that has generated the economic value to be divided. The

lower bound of the value that can be appropriated is set by the opportunity cost of each member

of the coalition (C), while the upper bound is set by the perceived value of the product produced

by the combined resources of the coalition (V). The bargaining logic explains where the

revenues (R) that accrue to individual claimants fall within this interval. This mode of

explanation is based on bargaining power. However, the bargaining power of the individual


31

claimants depends on the specific situation they face, and the bargaining logic as such does not

explain how these situations obtain.

In the lower right corner, the positive feedback logic of increasing returns gives a dynamic

explanation of how firms can achieve market power. Whether the conditions for increasing

returns are present and to what extent they play a role in the industry in question will determine

if this industry will become more or less concentrated. Under conditions of increasing returns, an

increase in market share will increase the perceived value of the product of the firm (V) and

lower its costs (C). Under such conditions, relative growth rates (R) affect relative value and

costs. This mode of explanation is based on how strategizing or luck can help a firm make use of

the positive feedback mechanisms of increasing returns. It complements the static notions of the

neoclassical and bargaining perspectives by showing how path dependent processes can affect

both the economic value created (under increasing returns the gap between V and C widens with

increased R) and the bargaining situations that firms may face (under increasing returns firms

can build bargaining power by dominating markets).

CONCLUSION

Our main conclusion is that individual theories should not be pushed beyond what their

underlying logic can explain. The different logics derive their strength from their ability to

explain very specific dependent variables, but the nature of these variables, and the assumptions

made to be able to explain them, differ between logics. When we try to explain all aspects of

firm performance at the hand of a single theory, we unavoidably have to mix logics and

conflicting assumptions. Doing so means losing rigor and diminishes rather than increases the

explanatory power of our theories. This, in turn, leads to definitional problems with respect to the


32

dependent variables that we attempt to explain. A better solution is to develop separate theories

that can uphold their rigor and focus on the ways in which they can complement each other.

1 This definition of competitive advantage differs significantly from MacDonald and Ryall’s (2004) proposal to call ‘competitive advantage’ the minimum that an individual is guaranteed to appropriate in excess of the normal rate of return. This minimum is the result of the competition among economic actors and is unrelated to bargaining.


33

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Table 1: Dependent variables and their definitions in the competitive strategy literature Source Dependent

variable(s) Definition of the dependent variable(s)

Positioning School Porter (1980) Competitive

advantage “Competitive advantage grows fundamentally out of value a firm is able to crate for its buyers that exceeds the firm’s cost of creating it.”

Porter (1985) Competitive advantage

“The fundamental basis of above-average performance in the long run is sustainable competitive advantage. Though a firm can have a myriad of strengths and weaknesses vis-à-vis its competitors, there are two basic types of competitive advantages a firm can possess: low cost or differentiation.” (p. 11).

Porter (1991) Superior market positions relative to best rivals

“The reason why firms succeed or fail is perhaps the central question in strategy.” (p. 95) “… I will assume that firm success is manifested in attaining a competitive position or series of competitive positions that lead to superior and sustainable financial performance. Competitive position is measured, in this context, relative to the world’s best rivals. Financial success derived from government intervention or from the closing of markets is excluded. A successful firm may ‘spend’ some of the fruits of its competitive position on meeting social objectives or enjoying slack. Why a firm might do this, however, is treated as a separate question” (p. 96)

Ghemawat (1991) Competitive advantage

“…the extent to which the benefit-cost gap for its product exceeds the benefit-cost gaps for competitors’ products.” (p. 68)

Ghemawat & Rivkin (1999)

Competitive advantage

“A firm [...] that earns superior financial returns within its industry (or strategic group) over the long run is said to enjoy a competitive advantage over its rivals” (p. 49)

Early RBV Lippman & Rumelt (1982)

Level of surplus profit in equilibrium

Rumelt (1984) • Firm’s survival and profitability (sections 1 & 5) • Positive economic profit in equilibrium or rents (sections 2, 3& 4)

• “Business policy is concerned with those aspects of general management that have material effects on the survival and success of business enterprises” (p. 132) • No definition

Wernerfelt (1984) Profitability No definition Barney (1986) Greater than normal

economic performance

“… greater than normal economic performance… obtained from creating imperfectly competitive product market” (p. 1231)

Conner (1991) Above normal returns = economic rents

“The firm’s ultimate objective in a resource-based approach generally is taken to be above-normal returns. In the resource-based view, obtaining such returns requires either that (a) the firm’s product be distinctive in the eyes of buyers (e.g., the firm’s product must offer to consumers a dissimilar and attractive attribute/price relationship, in comparison to substitutes), or (b) that the firm selling an identical product in comparison to competitors must have a low-cost position” (p. 132)

Peteraf (1993) Rents “Firms endowed with [superior] resources are able to produce more economically and/or better satisfy customer wants.” (p. 180) “Firms with superior resources will earn rents” (p. 180) “Earnings in excess of breakeven are called rents, rather than profits, if their existence does not induce new competition.” (p. 180)

First move: towards resources built internally Dierickx & Cool (1989)

Competitive advantage, above-normal returns

No definition

Barney (1991) Competitive advantage and sustained competitive

“…a firm is said to have a competitive advantage when it is implementing a value-creating strategy not simultaneously being implemented by any current or potential competitors.” (p. 102)


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advantage “A firm is said to have a sustained competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitors and when these other firms are unable to duplicate the benefits of this strategy.” (p. 102)

Mahoney & Pandian (1992)

Rents “Rent is defined as return in excess of a resource owner’s opportunity cost” (p. 364)

Amit & Schoemaker (1993)

Organizational rents “The challenge facing a firm’s managers is to identify, ex ante, a set of Strategic Assets (SA) as grounds for establishing the firm’s sustainable competitive advantage, and thereby generate Organizational Rents. These are economic rents that stem from the organization’s Resources and Capabilities, and that can be appropriated by the organization (rather than any single factor).”

Black & Boal (1994)

Sustainable competitive advantage

Mahoney (1995) Rents “Rents may be achieved by owning a valuable resource that is scarce (Ricardo, 1817). [..] Second, monopoly rents may be achieved by government protection or by collusive when barriers to potential competitors are high (Conner, 1991). Third, entrepreneurial (Schumpeterian) rent may be achieved by risk-taking and entrepreneurial insight in an uncertain/complex environment (Rumelt, 1987; Schumpeter, 1934). Fourth, the firm may be able to appropriate rents when resources are firm-specific (Aharoni, 1993). The difference between the first-best and second-best use value of a resource – the so-called composite quasi-rent (Klein, Crawford, and Alchian, 1978) – is precisely the amount that a firm may appropriate to achieve above-normal returns.” (pp. 91-92)

Peteraf & Barney (2003)

Competitive advantage Rents

“An enterprise has a Competitive Advantage if it is able to create more economic value than the marginal (breakeven) competitor in its product market.” (p. 314) “The Economic Value created by an enterprise in the course of providing a good or a service is the difference between the perceived benefits gained by the purchasers of the good and the economic cost to the enterprise.” (p. 314) “Greater economic value supports the generation of rent” In equilibrium (“the limit of this competition occurs when the residual value of the least efficient firm is completely dissipated” (p. 315)), “this pool of excess residual value is… equal to the economic rents attributable to the more efficient factors…” (p. 315) “We define economic rents as returns to a factor in excess of its opportunity costs.” (p. 315)

Ray, Barney & Muhanna (2004)

Effectiveness of business processes

“An alternative class of dependent variables – the effectiveness of business processes – is proposed as a way to test resource-based logic” (p. 24) because:

1) “… a firm may excel in some of its business processes, be only average in others, and be below average in still others. A firm’s overall performance depends on, among other things, the net effect of these business processes on a firm’s position in the market place” (p. 24)

2) “… it is possible for a firm’s stakeholders to appropriate the economic profits that can be generated by a firm’s business processes before those profits are reflected in a firm’s overall profitability” (p. 25)

Second move: Dynamic capability approach Teece et al. (1997)

Competitive advantage; wealth creation and capture by firms; firm level success and failure; firm performance; Schumpeterian rents

No definitions

Eisenhardt & Martin (2000)

Competitive advantage

Competitive advantage is not defined. However, the paper distinguishes between long-term competitive advantage and temporary advantages: “Dynamic capabilities are necessary, but not sufficient, conditions for competitive advantage” (p.1106) “... their value for competitive advantage lies in the resource configurations that they create, not in the capabilities themselves ... [they] can be used ... in the pursuit of long term competitive advantage ... They are, however, also very frequently used to build new resource configurations in the pursuit of temporary


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advantages” (p.1106) Helfat & Peteraf (2003)

Heterogeneity of capabilities and resources in a population of firms

Zott (2003) A firm’s resource configuration; Differential firm performance

Dynamic capabilities are modeled as leading to changes in a firm’s resource configuration Firm performance is modeled in terms of profit

Bargaining approach Brandenburger & Stuart (1996)

Value created by the vertical chain and value captured by a firm

Value created by the vertical chain (the firm together with its suppliers and buyers) = buyers’ willingness-to-pay – suppliers’ opportunity cost Under the assumption that there is no friction in the marketplace that prevents every favorable deal from being sought out, each player captures an amount of value which is no greater than that player’s added value: Valued added by the firm = value created by all players in the vertical chain – value created by all players without the firm

Coff (1999) Observable rent in performance measures (rent that accrues to shareholders)

“In order to predict when rent will be apparent in performance measures, we must examine two questions in concert… : 1) what resources generate rent? And 2) who has bargaining power to appropriate rent?” (p. 119) “[R]esearchers have generally assumed that strategic capabilities lead to above normal financial performance that is easily observable. […] [I]f rent from a resource-based advantage were observable in traditional performance measures, it would reflect the “tip of the iceberg”. Employees would typically capture much of the rent […]. This assertion arises from a core premise of the resource-based view – sustainable advantages stem from causally ambiguous, firm-specific, or socially complex assets. […] Thus, the factors that generated rent in the nexus also enhance employee bargaining power” (p. 129)

Bowman & Ambrosini (2000)

Perceived use value, exchange value, profit realized

Perceived use value is “the amount the customer is prepared to pay for the product” (p. 4) Exchange value is “the amount paid by the buyer to the producer for the perceived use value” (p. 4) How much of the exchange value captured from customer is retained by the firm in the form of profit realized “cannot be determined solely by an examination of the processes within the firm. […] The amount of profit realized on exchange of those products is determined by:

(1) comparisons customers make between the firm’s product, their needs, and feasible competing offerings from other firms;

(2) comparisons resource suppliers make between the deal they have struck with this firm, and possible deals they could make with alternative buyers of their resources” (p. 9)

Lippman & Rumelt (2003a)

Simple rent payments for the services of resources

“In contrast to the neoclassical view, in the Payment Perspective there are no difficult-to-define economic profits: the payments to the firm’s resource base are the observed cash flows” (p. 1070). These payments are the simple rents. “Simple rent measures the value of the scarce resource. […] Were the resource not scarce, then simple rent would be zero” (p. 912)

Lippman & Rumelt (2003b)

Rents “rents appears as the negotiated payments for the services of scarce valuable resources. The use of [cooperative game theory] permits analysis of the division of surplus as determined by the relative values created by different use combinations of resources.” (p. 1084)

MacDonald & Ryall (2004)

Value appropriated by a firm Competitive advantage

Positive value extraction from a cooperative game in all distributions that are feasible (sum to at most grand coalition payoffs) and stable (immune to subgroup defections) An individual has a competitive advantage when the minimum that the individual is guaranteed to appropriate exceeds the normal rate of return. This minimum is the result of the competition among economic actors and is unrelated to bargaining.

Other Hoopes et al. (2003)

Competitive advantage = superior

“[T]he firm that produces the largest difference between value and cost has an advantage over rivals. It can either attract buyers due to the better surplus its


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performance product offers (V-P) or make a higher profit (P-C) or both.” (p. 892) “Value is the price a buyer is willing to pay for a good absent competing products or services yet within budget constraints and considering other purchasing opportunities. Most work considers costs in terms of marginal cost.” (p. 891)

Table 2: The four logics

Neoclassical Evolutionary negative feedback

Evolutionary positive feedback

Bargaining

Dependent variable

Rents Adaptive fit Market share Value appropriated

Explanans Differential efficiencies

Differential survival

Differential growth

Bargaining power

Explanatory logic

Neo-classical equilibrium

Variation-selection-retention mechanisms

Increasing returns mechanisms

Game theoretic equilibrium

Neoclassical assumptions

that are relaxed

There are market imperfections

Productive knowledge is endogenous

There are increasing returns

The firm is a coalition of claimants

Meaning of ‘competitive advantage’

Advantage in economic value created over the break even competitor in equilibrium

Advantage in ability to adapt over the moving average of the population of competitors

Advantage in growth rate over the best alternative among the competitors

Advantage in bargaining power over the other players in the coalition that generates the value


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Figure 1: How do the logics relate?

V

R

C

NEOCLASSICAL BARGAINING

EVOLUTIONARY negative feedback

EVOLUTIONARY positive feedback

Economic rents

Value appropriated

Market share

Adaptive fit

Beyond Competitive Advantage

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