Chapter 14:Sustaining Competitive

Advantage

AEC 422 Fall 2012

Unit 5: Building and Sustaining Competitive Advantage

Monday, November 5

Reminder: Competitive Advantage and Value Creation 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

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 The “old world” wine model – use expertise and

limited supply to limit barriers to entry for the premium wine segment

Nest Fresh Eggs –

Dean Foods –

Sustaining Competitive Advantage: Examples The “old world” wine model – use expertise and

limited supply to limit barriers to entry for the premium wine segment

Nest Fresh Eggs– build on unique production knowledge – trying to integrate cause clarification into marketing, production contracts

Dean Foods –

Sustaining Competitive Advantage: Examples The “old world” wine model – use expertise and limited

supply to limit barriers to entry for the premium wine segment

Nest Fresh Eggs– build on unique production knowledge – trying to integrate cause clarification into marketing, production contracts

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 Monforte Dairy-

Sustaining Competitive Advantage: Examples Whole Foods -

Sustaining Competitive Advantage: Examples 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 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 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 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 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 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

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 A firm’s ability to create superior value

depends on its resources and capabilitiesResources: 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 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 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 inputsCo-specialized inputsProprietary processes

Isolating Mechanisms

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

Impediments to imitation Early-mover advantages

Impediments to Imitation

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

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

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

Intangible barriers to imitationThe basis of the firm’s advantage lies in

distinctive organizational capabilitiesCausal ambiguityDependence on historical circumstancesSocial complexity

Impediments to Imitation

Causal ambiguityTacit/non-codified knowledge/capabilitiesTacit 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, non-disclosure agreements, non-compete clauses

Impediments to Imitation

Dependence on historical circumstancesFirms 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

Social complexityPrice-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

Learning curveA 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

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

Buyer switching costsSwitching costs can confer a substantial

advantage to an early moverBut 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

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

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

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 high barriers to imitation by rivals

Preview of the Monsanto Case

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