THE SEARCH FOR VALUE AND SUSTAINABLE COMPETITIVE ADVANTAGE

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Session 8

• THE SEARCH FOR VALUE AND SUSTAINABLE COMPETITIVE
  ADVANTAGE

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Sustainable competitive advantage

• The ultimate determinants of success and failure
  in the firms search for value.
• Are there any useful generalisations to be made
  which can help to guide the strategy process?

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Sustainable competitive advantage and resource
based theory

• Introduction an examination of the sources of
  sustainability of profits
• Why are some firms able to sustain success over a
  long period?
• Porters approach to business performance
  competitive advantage.
• The capabilities approach to firm performance
• The nature and significance of capabilities
• Architecture, reputation, and innovation
• The value of capabilities
• A resource based theory of firm performance
  Peterafs model.
• Conclusions

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Part 1 Porters approach

• Porters five forces approach (industry
  attractiveness) sees industry performance as a
  function of industry structure/conduct. (PS,
  table 10.1)
• BUT within industries firm performance varies,
• So what determines relative firm performance?
• In Competitive Advantage he tried to answer
  this ?

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Porter, cont.

• Competitive advantage argues that it depends on
  the firms ability to manage the cost drivers/
  differentiation drivers so as to produce a cost
  advantage or a differentiation advantage.
• But this approach has problems and is incomplete.
  

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Some questions about Porter

• Why does the successful firm not buy the
  unsuccessful and teach it how to minimise costs?
• Why does the successful firm not sell its
  expertise in cost reducing to less successful
  firms?
• Why does the successful firm not cut its prices
  and drive its competitors out of business?
• Why does the unsuccessful firm not bid for the
  executive(s) in charge of cost drivers from the
  successful firm?
• These do happen e.g. battle between General
  Motors and Volkswagen for the services of cost
  guru Mr. Lopez.

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Porters recipe

• If it is possible for Michael Porter to describe
  how to create and sustain competitive advantage
  then surely all firms have equal access to this
  knowledge once Porter has codified it. So can it
  be a source of SCA? Beware recipes!
• Finally, low cost/differentiation cant be the
  ultimate source. The ultimate source is surely
  who or what produces the low cost/differentiation
  advantage.

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Beyond Porter

• Does anyone offer a better explanation of the
  roots of business performance?
• In the 90s a capabilities approach emerged as a
  new orthodoxy leading to a distinctive
  resource based view of the firm and strategy.

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Part 2 The capabilities approach

• Question What could give a particular firm a
  sustainable edge over its rivals?
• A series of influential articles in the HBR
  during the 90s suggested a new approach
  (although it turned out its origins were much
  earlier)

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Prahalad and Hamel (1990) core competencies

• Managements ability to consolidate technology
  and production skills into competencies so the
  business can adapt quickly to changing
  opportunities/circumstances.
• Core competencies collective learning of the
  organisation about prod/tech/markets.e.g. Sonys
  miniaturisation skills.
• Competencies have to be built over a long
  period.
• They are difficult to identify precisely and hard
  to imitate.
• Many firms fail to identify their own core
  competencies and so fail to nurture them properly
  or exploit them fully.

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Stalk, Evans, and Shulman (1992) capabilities

• Competitive advantage is based on the ability to
  respond to evolving opportunities which depends
  on business processes or capabilities. Business
  success involves choosing the right capabilities
  to build, managing them carefully, and exploiting
  them fully. e.g. Honda, Canon.

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Chandler (1990) initial risky investments

• Chandler (1990) successful giants such as IBM
  and Bayer derive from the initial heavy and risky
  investments in building organisational knowledge
  and capabilities which allowed them to exploit
  the opportunities available to exploit scale and
  scope economies.

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Collis and Montgomery (1995) competing on
resources

• Competitive advantage derives ultimately from the
  ownership of a valuable resource.
• Superior performance derives from developing a
  competitively distinct set of resources and
  deploying them in a well conceived strategy.
• Resources can be physical, intangible, or
  organisational capabilities.
• Example Marks and Spencer (poor timing!)

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John Kay (1993) Distinctive capabilities.

• In his best seller, The foundations of corporate
  success Kay argues that the source of
  competitive advantage is the creation and
  exploitation of distinctive capabilities.
• The value of any advantage created depends on its
  sustainability and its appropriability.
• Kay provides a detailed analysis of this (see
  also PS)

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Distinctive capabilities

• Kay identifies only three basic types of
  distinctive capability
• Corporate Architecture
• Innovation
• Reputation.

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Distinctive capabilities

• What is it about these things in particular?
• Difficult to build and maintain.
• Difficult to codify/ make into recipes.
• Difficult to copy/ emulate.
• Cant simply be bought off the shelf.

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Strategic assets

• He also discusses market dominance (monopoly)
  based on the ownership of strategic assets as a
  source of success.
• Natural monopolies such as utility networks, or
  licensed monopolies such as the national lottery.
  
• And those based on heavy sunk costs which
  discourage challengers for the first mover.
• But he argues that in these case it is
  essentially structural factors that count not
  distinctive capabilities.
• There may of course be room for debate in some
  cases.

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Architecture as a distinctive capability

• Concerns organisational effectiveness in the
  search for value.
• Connects back to the discussion of corporate
  objectives and the co-operation needed to get
  things done in PS chap 4.
• How to focus individuals on achieving
  organisational goals.

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Architecture

• The network of contractual relationships which
  defines the firm. The capacity of organisations
  to
• 1. Create and store organisational knowledge and
  routines
• 2. Promote more effective co-operation between
  the members.
• 3. Achieve an open and easy flow of information
  between members.
• 4. Adapt rapidly and flexibly
• .

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Architecture

• Architecture is largely about how you organise to
  get things done as effectively as possible.
• But NB it also influences what you choose to do
  (strategy) in the first place. Because?
• Architecture is about organisational form,
  incentive mechanisms, work organisation,
  performance evaluation, and governance.

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Architecture

• e.g. IBM in its heyday, Marks and Spencer (back
  when!), Liverpool Football Club.
• e.g. Many Japanese firms the Japanese employment
  system, its supplier networks, the close
  relations between industry and finance, the great
  emphasis on co-operation and collaboration, the
  development of long term commercial
  relationships, and the generally higher level of
  trust which encourages co-operation

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Architecture

• Now a specialised study area.
• See for example, Brickley, Smith, and Zimmerman
  Economics and Organisational Architecture.

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Reputation as a distinctive capability

• This is about conveying information to consumers
  about quality. But it isnt equally important
  for all goods and services. It applies to a
  particular category of goods called,
• Long term experience goods.
• These are goods where product quality is vital to
  the consumer but where it is difficult for the
  consumer to establish quality except through time
  and experience.

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Reputation

• Kay mentions car hire services, legal services,
  accountancy services, funeral services (?),
  consumer durables. Add vitamin pills, roofing
  services, pension funds, and
• All students are very familiar with the problem
  involved.

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Reputation

• Problem is that you want quality, but that
  quality takes time to manifest itself.
• All suppliers will guarantee satisfaction.
• How can you distinguish between them?
• If difficult then consumers will assume low
  quality and pay only low prices.
• If you can convince them you can obtain a premium
  price for quality assurance.

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Reputation

• Selling on reputation is saying we have made an
  investment in an asset so we have a lot to lose
  if we fail to satisfy. So you can trust us, but
  not the hit and run suppliers who sell on (low)
  price alone.
• How might it be done. Longevity (est.1768 sort
  of thing). Warranties.
• Advertising?

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Advertising and reputation

• Heavy advertising may be a way.
• Adv is a sunk cost which implies commitment to
  the service. There is something to lose.
• Evidence is that long term experience goods do
  have the highest adv/sales ratio(5). (B.S.R.
  1992).

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Reputation and diversification

• Note for later,
• Reputation might be a basis for growth through
  diversification but Kay notes that an expensively
  created reputation can be damaged by unwise
  diversification when firms stray into areas they
  dont fully understand.

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Innovation as a distinctive capability

• A capacity for lowering costs or improving its
  products or introducing new products ahead of its
  competitors.
• Innovation by itself as a source of competitive
  advantage is actually quite rare.
• Innovation is very difficult. It is uncertain,
  and it is hard to manage properly. There are no
  recipes. It can be difficult for firms which
  invest in RD to secure or appropriate all the
  returns. So being able to do it well will
  undoubtedly give you a good edge.
• However many firms which seek competitive
  advantage by this route fail.
• Often what appears to be competitive advantage
  based on a capability for innovation is actually
  based ultimately on architecture. e.g. Sony and
  Glaxo

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The Value of Capabilities

• Distinctive capabilities generate success which
  attracts competitors.
• Their value depends on their sustainability and
  the appropriability of the value they generate.
  (see also Collis et al HBR 95)
• These in turn depend on the following factors

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The Value of Capabilities

• Transparency how easy is it to identify and
  understand? J. management techniques?
• Replicability how easy to imitate/replicate? A
  team formation such as 4-4-2 is easy, but German
  efficiency or Brazilian flair is more
  difficult.
• Substitutability How easy to find a substitute
  for. Sony o/m of innovation, MS supply chain
  organisation.

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The Value of Capabilities

• Who captures the income stream from the
  capability? The organisation or the underlying
  resources. This is the issue of appropriability.
  
• To be valuable to the organisation the capability
  has to be immobile/ organisationally specific.
  Not able to walk!

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Appropriability

• Resources such as people are marketable and can
  capture their full market value.
• So the organisations capability has to be more
  than the sum of its (marketable) parts.
• Take Manchester United and the Roy Keane effect
  (50,000 per week!).
• To be a valuable business MU must produce a team
  capability beyond the market value of its
  expensive players and coaches.

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To sum up

• The value of the organisations capability
  requires that the competition
• Cant see it easily.
• Cant imitate it.
• Cant find a sub for it.
• Cant just buy it.

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Isolating mechanisms

• Name given to barriers preventing the replication
  of organisations capabilities.
• Causal ambiguity.
• Time compression diseconomies. Extra costs of
  accumulating resources and capabilities quickly
  to take on a first mover.

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PART 3 RESOURCE BASED THEORY OF THE FIRM

• A distinctive resource based theory of the
  firm has emerged trying to formalise the
  capabilities approach.
• The resource-based approach is concerned with
  the nature of the firms resources and how these
  resources are combined into capabilities.
• Key example is Peteraf (1993). Her approach is
  outlined below and summed up in this figure.
  Note she uses the term RENT common in US writing
  to connote the result of sustainable competitive
  advantage. The Linn example is from a student
  case study.

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Peteraf model
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Peterafs model - Linn Products
Ex-post limits to competition
Heterogeneity
The industry is made of firms with access to
different resources and skills. Linn has
particular distinctive competencies.
Specialist knowledge and reputation
Competitive Advantage
Ex-ante limits to competition
Imperfect Mobility
Linn has demonstrated an ability to leverage the
potential of existing technologies
Shared specialist knowledge and reputation
ALL THESE LEAD TO SUSTAINABLE COMPETITIVE
ADVANTAGE THROUGH DIFFERENTATION
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Competitive Advantage a la Peteraf

• A firm is said to have a competitive advantage
  when it can
• achieve rents which requires resource
  heterogeneity between firms (some better bundles
  than others).
• enjoy rents that are not offset by the costs of
  achieving a superior set of resources which
  requires ex ante limits to competition for those
  resources.
• appropriate those rents for the firm which
  requires imperfect resource mobility.
• sustain those rents which requires ex-post
  limits to competition.

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Heterogeneity

• Bundles of resources and capabilities are
  heterogeneous across firms. Heterogeneity implies
  that firms with superior resources/ capabilities
  will earn superior returns.
• An important class of resources are those which
  are limited in the short run but may be renewed
  and expanded within firms that use them. Prahalad
  and Hamel (1990) argue that core competencies -
  particularly knowledge-based resources - are
  enhanced as they are used because of learning.

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Ex-post limits to competition

• Forces which limit competition from imitators.
  These arise from sources already discussed
• Imperfect imitability, replicability, and
  substitutabilityof resources/ capabilities
  isolating the firm from challengers.

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Ex ante limits to competition

• The source of a firms rents is a superior
  resource position.
• But imagine the situation before any firm has
  achieved this position.
• If many firms recognised its potential, a
  competitive struggle would ensue to obtain the
  resources and build the capabilities to occupy
  that position.
• This process would compete away all rents that
  could be obtained from occupying the position.
  For example,
• North Sea Oil fields.
• Manchester United team!
• National Lottery licence.
• Sony licence for transistor.
• The script for Four weddings and a Funeral

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Entrepreneurship and rent

• So a firm needs the foresight to acquire
  resources and build capabilities in the absence
  of such competition. This requires the presence
  of uncertainty and incomplete information and a
  willingness to take risks.
• The essence of successful ENTREPRENEURSHIP is of
  course foresight and taking advantage of
  uncertainty and incomplete information before
  someone else does.
• So what Peteraf seems to be saying here is simply
  that all rents begin with an entrepreneurial act.
  Which seems inherently sensible.

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Imperfect resource mobility

• This refers to the marketability or otherwise of
  the underlying resources and capabilities.
• See discussion above of appropriability.
• Thus good high street locations are important for
  retailers but competition means the rental costs
  reflect this fact. The value of the location is
  captured by the property owner not the retailer
  per se.

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Summing up on SCA

• The ultimate determinants of success and failure?
  
• No recipes but the starting point is being
  cheaper, or better, or faster to market.
• The capabilities approach developed in the 90s
  looks to the development and deployment of a
  distinctive set of resources and capabilities.

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Summing up

• The value of distinctive capabilities lies in the
  fact that they are hard to create and maintain,
  hard to codify or make into recipes, hard to copy
  or emulate, and cant simply be bought off the
  shelf.
• Organisational architecture is a fundamental
  source of advantage. Strategy and structure are
  closely connected as determinants of success.

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TEAM TASKS 8

• What is competitive advantage and how according
  to Porter might it be achieved?
• What according to Kay are the ultimate sources of
  superior business performance?
• What is it about the nature of things like
  innovation and corporate architecture which make
  them fundamental to business success?
• Evaluate the extent to which your case enterprise
  has Sustainable competitive advantage.
• If it has it how did it get it, on what is it
  based?
• If it hasnt, how might it go about achieving
  better performance?
• Evaluate the key capabilities of your main
  competitor.