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The Origins of Competitive Advantage

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The Origins of Competitive Advantage
ECP 6701
Competitive Strategies in Expanding Markets
The Origins of Competitive
Advantage
1
Readings
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2
BDSS Chapter 13
Entrepreneurship and Competitive
Advantage
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3
Competitive advantage arises from a firm’s
entrepreneurial ability to exploit market shocks
and discontinuities
Schumpeter’s “creative destruction”: New
sources of competitive advantages displacing
the established ones
Creative Destruction
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Markets have periods of comparative quiet
punctuated by shocks and discontinuities
During the period of quiet firms that posses
superior products and technology earn
economic profits
Entrepreneurs who exploit the opportunities
created by the shocks enjoy economic profits
during the next period of quiet
Creative Destruction and Growth
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5
Schumpeter considered static efficiency allocative efficiency at a point in time - to be
less important than dynamic efficiency
Society benefits much more from competition
between new products, new technologies and
new forms of organization than from price
competition
Creative Destruction and Monopoly
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6
Schumpeter’s ideas have been used to defend
monopoly
Presumably monopoly leads to greater
investment in innovation and higher long term
growth
Creative Destruction and
Competitive Advantage
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Creative destruction implies that the isolating
mechanisms that protect a firm’s competitive
advantage will not be permanent
The life expectancy of a competitive
advantage shrinks as technology and tastes
change rapidly
Life Cycle of Competitive
Advantage
8
Disruptive Technologies
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Many of the disruptive technologies have
higher perceived benefits and lower costs
Some times disruptive technologies can have
lower benefits and much lower costs (example:
MP3 versus CD)
Sustainability and Creative Destruction
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10
Access to ongoing scientific expertise is
essential for riding the wave of creative
destruction
Biotech and pharmaceutical firms stay in close
touch with the scientific and academic
community
They reward scientist for generating general
scientific knowledge
Strategic Intent and Strategic
Stretch
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11
According to Hamel and Prahalad, successful
firms like CNN, SONY and Honda tend to have
strategic intent - an obsession with global
dominance in their industries
For these firms, there is a gap - strategic
stretch - between their strategic intent and their
current resources and capabilities
Hypercompetition
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12
Firms are said to enter a state of
hypercompetition state when competitive
advantages can only be sustained for very
short periods
According to Richard D’Aveni, several
industries are in this state and firms in these
industries can sustain their economic profits
only by continually seeking new sources of
competitive advantage
Hypercompetition Strategies
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13
A firm’s chief strategic goal should be to disrupt
the existing sources of advantages including its
own
A firm that relies solely on its existing source of
advantages will be displaced by more
innovative rivals
Firms may be able to create shocks on their
own rather than waiting for them to occur
Incumbent’s Incentives to Innovate

Established firms face certain incentives to
refrain from innovation
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They also face certain incentives to become
innovators
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14
Sunk cost effect
Replacement effect
Efficiency effect
The Sunk Cost Effect
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For established firms, costs incurred to commit
to a particular technology are sunk costs
Established firms tend to favor the current
technology
Replacement Effect
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The opportunity to innovate is assumed to be
available to either an incumbent monopolist or
a potential entrant
If the entrant innovates it can displace the
monopolist and its incentive to do so depends
on the value of becoming the monopolist
Monopolist’s incentive will be less since it will
be replacing itself
Efficiency Effect
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If the monopolist anticipates that the entrant
may get an opportunity to innovate, its
incentives to innovate will be stronger
The monopolist can continue to be monopolist
by innovating, its incentives will greater than
the potential entrants
All three effects will work simultaneously to
determine if the incumbent will innovate or not
Innovation Competition
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Competition to innovate can be like a “winner
take all” contest
When firms compete to develop the same
product, the firm that does it first will enjoy a
significant advantage
The winner may be able to get a patent and/or
the advantages of a first mover
Innovation Competition
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19
Staying even slightly ahead of the rivals will
produce disproportionate benefits
Firms engaged in a contest must anticipate the
rival’s efforts to formulate their own strategy
Patent Race
In a “winner take all” race to obtain a patent, a
firm should look at the following factors before
deciding whether or not to increase its R & D
investment
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Effect of additional investment in R & D productivity
Response by the rivals to increased investment by
the firm
The number of competitors in the field
Choosing the Technology for R & D
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When multiple R & D methodologies are
available, a firm should consider the following
characteristics
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Riskiness of each methodology (uncertainty about
the anticipated completion date)
Correlation between methodologies (when the
uncertainties are resolved, how often are the
outcomes similar?)
Riskiness of Methodologies
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A monopolist will be indifferent about risk as
long as the expected completion date is the
same for all methodologies
When firms compete, each firm will end up
choosing a high variance strategy over a low
variance strategy, if the expected completion
date is the same
Riskiness of Methodologies
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If all the other firms follow a low variance
methodology, a firm that follows a high
variance methodology improves its odds of
being the first to reach the desired outcome
Every firm faces the same incentive to switch
to a high variance methodology and no firm will
choose a low variance methodology
Correlation Between Methodologies
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Society benefits more if firms pursue
uncorrelated methodologies (compared with
correlated ones) since the probability of any
one firm reaching the goal is higher with
uncorrelated methodologies
It turns out that firms left to decide on their own
will choose uncorrelated strategies
Correlation Between Methodologies
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If many firms pursue the same methodology,
each firm will have a small probability of
success
Any one firm will benefit by pursuing an
uncorrelated methodology and increase its
chance of winning
This incentive to deviate from the rest applies
to all the firms
Evolutionary Economics and
Dynamic Capabilities
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In traditional economics, a firm is assumed to
make decisions to maximize economic profit
Evolutionary economics views decisions made
by a firm as determined by established routines
Evolutionary Economics and
Dynamic Capabilities
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Usually a firm’s routines change slowly over
time if they do change
To ensure survival, firms need to continuously
improve their routines
Firms with dynamic capabilities can adapt their
resources and capabilities and exploit
opportunities created by market shocks and
discontinuities
Factors that Limit Dynamic
Capabilities
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A firm’s dynamic capabilities are inherently
limited because of
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the path dependence of competitive advantage
limited availability of complementary assets and
“windows of opportunity” that do not stay open for
long
Path Dependence
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Firm’s routines can only change incrementally
and cannot have a clean break from the past
The new source of advantage will be path
dependent
With threats from new entrants, even small
path dependencies can have major
implications for the firm’s competitiveness
Windows of Opportunity
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Early in a product’s life, its design and
specifications will be fluid and firms will have
room for experimentation
Over time a narrow set of design and
specifications emerge as dominant and it is
hard for new firms to challenge market leaders
Those who do not exploit the window of
opportunity get shut out
Competitive Advantage and the
Environment
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31
Michael Porter suggests that the firm’s local
environment is a major influence on its
competitive environment
Even as a modern firm transcends local
markets, the source of its competitive
advantage remains localized
Competitive Advantage and the
Environment
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A firm’s home nation and home markets play
an important role in its ability to sustain its
competitive advantage
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by supporting the accumulation of valuable
resources and capabilities and
by exerting pressure on the firm to innovate, invest
and improve
Competitive Advantage and the
Environment
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Factor Conditions
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A firm’s competitive advantage in the global
markets is enhanced by the availability of
specialized factors of production in the home
market
To be globally competitive, availability of highly
skilled workers in the home nation may be
more important than availability of low wage
workers
Demand Conditions
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A firm’s competitive advantage is enhanced by
the size, growth and nature of demand in the
home market
When home market places a high value on
quality, the firm is stimulated to make
improvements in the quality dimension
Unique local conditions can also be a source of
innovations
Related and Supporting Industries
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A strong base of competent suppliers and
support industries at home will help a firm
achieve competitive advantage globally
Sharing scarce production know-how is easier
with geographical proximity
Strategy, Structure and Rivalry
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Local management practices, corporate
governance norms and nature of the local
capital markets can influence the competitive
advantage of global firms
Local rivalry may hold down local profits but
make the firms well positioned in the global
arena
Firms that enjoy local protection often fail to
make a mark outside the home nations
Managing Innovation
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To ensure that entrepreneurial spirits are not
stifled by bureaucracy, companies have been
setting up corporate venture departments
Spin-offs, joint ventures, strategic alliances are
other means of facilitating the creation of new
capabilities
Managing Innovation
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A firm has to contend with two opposing forces
in trying to manage innovation
To foster innovation, creativity and
entrepreneurship, the organization should be
sufficiently flexible
However, coordination of innovative activities
will require formal structure and controls
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