Week 10 - Sustaining Competitive Advantage

Question 1

What happens to economic profits if the forces threatening sustainability are pervasive?

Answer 1

Economic profits in most industries should quickly converged to zero.

Question 2

What happens to profits when competitiveness/competition (competitive dynamics) is hindered?

Answer 2

Then profits should persist: firms that earn above-average profit today should continue to do so in the future; low profit firms today should remain low-profit firms in the future.

Question 3

FedEx V UPA in express-mail market:

Answer 3

• In 1973, FedEx became the first company to offer overnight delivery in the U.S
• For the better part of a decade, FedEx nearly monopolized the business
• At that time, UPS was the nation’s leading “longer-than-overnight” package delivery service
• In the early 1980s, UPS launched its own overnight delivery service
• UPS studied FedEx procedures for taking orders, scheduling, and delivering shipments.
• UPS even had its drivers follow FedEx trucks to learn their methods
• By 1985, UPS was able to match FedEx’s nationwide overnight service offerings and within a few years was also matching FedEx for reliability
• UPS now has about 35 percent of the total US express-mail market, compared with about 50 percent for FedEx
• Moreover, by taking advantage of the scale economies afforded by its existing fleet of delivery trucks, UPS could deliver overnight parcels at a lower cost than FedEx and enjoyed a substantially higher profit margin

Question 4

What is competitive advantage?

Answer 4

It is the ability of a firm to outperform its industry. I.e. to earn a higher rate of profit than the industry norm.

• To achieve a competitive advantage, a .rm must create more value than its competitors.
• A firm’s ability to create superior value depends on its stock of resources (patents, brand-name reputation, human assets,…).

Question 5

When is a competitive advantage sustainable?

Answer 5

Resources and capabilities alone do not ensure that a .rm can sustain its advantage. A competitive advantage is sustainable when it persists despite efforts by competitors or potential entrants to duplicate or neutralize it.

• For this to occur, firms must possess different resources and capabilities, and it must be difficult for underperforming firms to obtain the resources and capabilities of the top performers.
• The resource-based theory states that a competitive advantage can be sustained under 2 conditions.

Question 6

What 2 conditions does the resource-based theory state that a competitive advantage can be sustained under?

Answer 6

• Resources are scare

- Resources are imperfectly mobile

Question 7

What is imperfect mobility?

Answer 7

This means that the resource cannot “sell itself” to the highest bidder.

• Examples of imperfectly mobile resources: a valuable piece of real estate, the know-how an organisation has acquired through cumulative experience
• Examples of mobile resources: talented employees who can sell their labour services to the highest bidders (e.g. “superstar” lawyers and free agent athletes)

Question 8

Why aren’t scarcity and immobility of critical resources sufficient to sustain a competitive advantage?

Answer 8

A firm that has built a competitive advantage from a set of scarce and immobile resources may find that advantage is undermined if other firms can develop their own stocks of resources and capabilities that duplicate or neutralize the source of the firm’s advantage.

Question 9

What do isolating mechanisms refer to?

Answer 9

Isolating mechanisms refer to the economic forces that limit the extent to which a competitive advantage can be duplicated or neutralized through the resource-creation activities of other firms.

Isolating mechanisms are to a firm what an entry barrier is to an industry: just as an entry barrier impedes new entrants from coming into an industry and competing away profits from incumbent firms, isolating mechanisms prevent other firms from competing away the extra profit that a firm earns from its competitive advantage.

Question 10

What are the 2 types of isolating mechanisms?

Answer 10

I. Impediments to Imitation

II. Early-mover Advantages

Question 11

What are impediments to imitation?

Answer 11

Impediments to Imitation impede existing firms and potential entrants from duplicating the
resources that form the basis of the firm’s advantage.

Question 12

What are early move advantages?

Answer 12

Once a firm acquires a competitive advantage, these isolating mechanisms increase the economic power of that advantage over time.

• Cisco Systems, for example, dominates the market for products such as routers and switches, which link together LANs (local area networks).
• Its success in this business helped establish its Cisco International Operating System (Cisco IOS) software – now in its fifteenth version – as an industry standard.
• This, in turn, had a feedback effect that benefited Cisco’s entire line of networking products.

Question 13

What are the 4 impediments to imitation?

Answer 13

• Legal restrictions
• Superior access to inputs or customers
• Market size and scale economies
• Intangible barriers to imitating a firm’s distinctive capabilities: casual ambiguity, dependence on historical circumstances and social complexity.

Question 14

Explain the following impediment to imitation: legal restrictions

Answer 14

Legal restrictions include patents, copyrights, trademarks, and governmental control over entry into markets through licensing, certification, or quotas on operating rights.
- Patents, copyrights, trademarks, and operating rights can be bought and sold.
o These resources are scarce but could be highly mobile.
o For example, Google’s 2011 acquisition of Motorola Mobility was widely viewed as an effort to obtain Motorola’s 21,000 active and pending patents. The patents impede potential imitation from competitors and sustain Google’s competitive advantages.

Question 15

Explain the following impediment to imitation: superior access to inputs or customers

Answer 15

A firm that can obtain high-quality inputs will be able to sustain cost and quality advantages that competitors cannot imitate. A firm that secures access to the best distribution channels or the most productive retail locations will outcompete its rivals for customers.
- For example, International Nickel dominated the nickel industry for three-quarters of a century by controlling the highest-grade deposits of nickel in western Canada.

Control of scarce inputs or distribution channels allows a firm to earn economic profit in excess of its competitors only if it acquired control of the input supply when other firms or individuals failed to recognise its value or could not exploit it.

Question 16

What is the winner’s curse?

Answer 16

Firms that lack a unique advantage expose themselves to the possibility of a winner’s curse, in which the winning bidder ends up worse off than the losers. In the example of the uranium mine, all of the bidding firms would have first engaged in research to estimate its value. This is an excellent example of a common value auction.

• Although the uranium site is worth the same amount regardless of which firm wins the bidding, the firms’ estimates of the value of the site might vary widely, depending on how each firm performs its geological studies.
• Because these firms are likely to be highly experienced at valuing mining sites, we might expect the average bid to be a pretty good predictor of the mine’s actual value.
• But the firm that submits the highest bid and wins this common value auction will usually be the one that has the highest estimate of its value.
• This means that the winning bidder tends to be overoptimistic, which implies that if it bid anywhere close to its estimate, it will have probably paid too much.

Firms often convince themselves that they have a unique advantage that justifies a higher bid. But other firms may also have their own unique advantages, which can lead to a different kind of winner’s curse – the winning bidder thought too highly of its own uniqueness. The bottom line is that it is difficult to prosper by purchasing someone else’s scarce asset’s.

Question 17

Explain the following impediment to imitation: market size and scale economies

Answer 17

Imitation may be deterred when minimum efficient scale is large relative to market demand and one firm has secured a large share of the market.

Question 18

Explain the following impediment to imitation: intangible barriers to imitating a firm’s distinctive capabilities

Answer 18

There are three intangible barriers to imitation:

• Causal ambiguity
• Dependence on historical circumstances
• Social complexity

Question 19

Explain the following intangible barrier to imitation: causal ambiguity

Answer 19

Situations in which the causes of a firm’s ability to create more value than its competitors are obscure and only imperfectly understood. Causal ambiguity is a consequence of the fact that a firm’s distinctive capabilities typically involve tacit knowledge.

Question 20

Explain the following intangible barrier to imitation: dependence on historical circumstances

Answer 20

For example, in the 1960s and 1970s, Southwest Airlines was constrained by U.S. regulatory policy to operate out of secondary airports in the unregulated (and thus is highly price competitive) intrastate market in Texas. The operational efficiencies and the pattern of labour relations it developed in response to these conditions may be difficult for other airlines, such as American and United, to imitate.

Question 21

Explain the following intangible barrier to imitation: social complexity

Answer 21

Every one of Toyota’s competitors may understand that an important contributor to Toyota’s success is the trust that exists between it and its component suppliers. But it is difficult to create such trust, however desirable it may be.

Question 22

What are the 4 early mover advantages?

Answer 22

• Learning curve
• Reputation and buyer uncertainty
• Buyer switching costs
• Network effects

Question 23

Explain the following early-mover advantage: learning curve

Answer 23

A firm that has sold higher volumes of output than its competitors in earlier periods will move farther down the learning curve and achieve lower unit costs than its rivals.

Question 24

Explain the following early-mover advantage: reputation and buyer uncertainty

Answer 24

In the sale of experience goods – goods whose quality cannot be assessed before they are purchased and used – a firm’s reputation for quality can give it a significant early-mover advantage. Buyer uncertainty coupled with reputational effects can make a firm’s brand name a powerful isolating mechanism.

Explain the following early-mover advantage: buyer switching costs
For some products, buyers incur substantial costs when they switch to another supplier. Switching costs can arise when buyers develop brand-specific know-how that is not fully transferable
to substitute brands.
- Frequent-flier programs increase buyers’ switching costs.
- Manufacturers can offer warranties that become void if the product is serviced at a nonauthorized dealer. Consumers will thereby tend to patronize authorized dealers, who usually charge higher fees and share the resulting profits with the manufacturer.
- A consumer who develops intensive knowledge in using apps developed for the iPhone would have to reinvest in the development of new know-how upon switching to a smart phone that uses Google’s Android operating system.

Question 25

Explain the following early-mover advantage: network effects

Answer 25

Consumers often place higher value on a product if other consumers also use it: telephone, mobile phones, social media networks, video gaming, DVD players, and e-Bay.
- Many networks evolve around standards. The persistence of standards makes standard- setting a potentially powerful source of sustainable competitive advantage and raises two key issues:
o Should firms in fledging (new) markets attempt to establish a standard?
o What does it take to topple a standard?

e.g. fax machines

Question 26

What are some early-mover disadvantages?

Answer 26

Some firms pioneer a new technology or product but fail to become the market leader:

• Royal Crown in diet cola.
• EMI with computerized axial tomography (the CAT scanner). EMI Ltd., a British music and electronics company perhaps best known for signing the Beatles to a record contract in the early 1960s, lacked the production and marketing know-how to successfully commercialize the CT scanner developed in its R&D laboratory, and it sold this business to GE in the late 1970s.