1 ECP 6701 Competitive Strategies in Expanding Markets The Origins of Competitive Advantage

2 Readings BDSS Chapter 13

3 Entrepreneurship and Competitive Advantage Competitive advantage arises from a firms entrepreneurial ability to exploit market shocks and discontinuities Schumpeters creative destruction: New sources of competitive advantages displacing the established ones

4 Creative Destruction 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

5 Creative Destruction and Growth 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

6 Creative Destruction and Monopoly Schumpeters ideas have been used to defend monopoly Presumably monopoly leads to greater investment in innovation and higher long term growth

7 Creative Destruction and Competitive Advantage Creative destruction implies that the isolating mechanisms that protect a firms competitive advantage will not be permanent The life expectancy of a competitive advantage shrinks as technology and tastes change rapidly

8 Life Cycle of Competitive Advantage

9 Disruptive Technologies 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)

10 Sustainability and Creative Destruction 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

11 Strategic Intent and Strategic Stretch 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

12 Hypercompetition Firms are said to enter a state of hypercompetition state when competitive advantages can only be sustained for very short periods According to Richard DAveni, 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

13 Hypercompetition Strategies A firms 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

14 Incumbents Incentives to Innovate Established firms face certain incentives to refrain from innovation – Sunk cost effect – Replacement effect They also face certain incentives to become innovators – Efficiency effect

15 The Sunk Cost Effect For established firms, costs incurred to commit to a particular technology are sunk costs Established firms tend to favor the current technology

16 Replacement Effect 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 Monopolists incentive will be less since it will be replacing itself

17 Efficiency Effect 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

18 Innovation Competition 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

19 Innovation Competition Staying even slightly ahead of the rivals will produce disproportionate benefits Firms engaged in a contest must anticipate the rivals efforts to formulate their own strategy

20 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 – 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

21 Choosing the Technology for R & D When multiple R & D methodologies are available, a firm should consider the following characteristics – Riskiness of each methodology (uncertainty about the anticipated completion date) – Correlation between methodologies (when the uncertainties are resolved, how often are the outcomes similar?)

22 Riskiness of Methodologies 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

23 Riskiness of Methodologies 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

24 Correlation Between Methodologies 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

25 Correlation Between Methodologies 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

26 Evolutionary Economics and Dynamic Capabilities 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

27 Evolutionary Economics and Dynamic Capabilities Usually a firms 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

28 Factors that Limit Dynamic Capabilities A firms dynamic capabilities are inherently limited because of – the path dependence of competitive advantage – limited availability of complementary assets and – windows of opportunity that do not stay open for long

29 Path Dependence Firms 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 firms competitiveness

30 Windows of Opportunity Early in a products 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

31 Competitive Advantage and the Environment Michael Porter suggests that the firms 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

32 Competitive Advantage and the Environment A firms home nation and home markets play an important role in its ability to sustain its competitive advantage – by supporting the accumulation of valuable resources and capabilities and – by exerting pressure on the firm to innovate, invest and improve

33 Competitive Advantage and the Environment

34 Factor Conditions A firms 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

35 Demand Conditions A firms 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

36 Related and Supporting Industries 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

37 Strategy, Structure and Rivalry 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

38 Managing Innovation 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

39 Managing Innovation 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