Session 8 THE SEARCH FOR VALUE AND SUSTAINABLE COMPETITIVE ADVANTAGE

Sustainable competitive advantage The ultimate determinants of success and failure in the firm’s search for value. Are there any useful generalisations to be made which can help to guide the strategy process?

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? Porter’s 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:: Peteraf’s model. Conclusions

Part 1: Porter’s approach Porter’s five forces approach (industry attractiveness) sees industry performance as a function of industry structure/conduct. (P&S, table 10.1) BUT within industries firm performance varies, So what determines relative firm performance? In ‘Competitive Advantage’ he tried to answer this ?

Porter, cont. ‘Competitive advantage’ argues that it depends on the firm’s 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.

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.

Porter’s 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 can’t be the ultimate source. The ultimate source is surely who or what produces the low cost/differentiation advantage.

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

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 90’s suggested a new approach (although it turned out its origins were much earlier)

Prahalad and Hamel (1990): core competencies Management’s 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. Sony’s 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.

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.

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.

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!)

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 P&S)

Distinctive capabilities Kay identifies only three basic types of distinctive capability: Corporate Architecture Innovation Reputation.

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. Can’t simply be bought ‘off the shelf’.

Strategic assets There may of course be room for debate in some cases. 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.

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 P&S chap 4. How to focus individuals on achieving organisational goals.

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 .

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.

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

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

Reputation as a distinctive capability This is about conveying information to consumers about quality. But it isn’t 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.

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.

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.

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?

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).

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 don’t fully understand.

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 R&D 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

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:

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, M&S supply chain organisation.

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!

Appropriability Resources such as people are marketable and can capture their full market value. So the organisation’s 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.

To sum up The value of the organisations capability requires that the competition: Can’t see it easily. Can’t imitate it. Can’t find a sub for it. Can’t just buy it.

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.

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 firm’s 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.

Peteraf model Heterogeneity Ex-post limits to competition Imperfect mobility Ex-ante limits to competition Rents obtained Rents captured by the firm Rents sustained Rents not offset by building costs Competitive advantage Peteraf model

Peteraf’s 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 Imperfect Mobility Ex-ante limits to competition 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

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.

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.

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.

Ex ante limits to competition The source of a firm’s 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’

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.

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.

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 90’s looks to the development and deployment of a distinctive set of resources and capabilities.

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 can’t simply be bought ‘off the shelf’. Organisational architecture is a fundamental source of advantage. Strategy and structure are closely connected as determinants of success.

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 hasn’t, how might it go about achieving better performance? Evaluate the key capabilities of your main competitor.