Resources and Transaction Costs: How Property Rights Economics Furthers the Resource-Based View Authors: Kirsten Foss and Nicolai J. Foss Strategic Management Journal (2005), 26: Presented by: Bradley Skousen

Purpose and Contribution This paper seeks to integrate property rights economics into the resource-based view by exploring the relationships between transaction costs, and value creation, and appropriation. The authors suggest that their contribution to the literature is to clarify the micro-foundations of the resource-based view by explicitly focusing on the influence of transaction costs. In particular, how transaction costs explain how value can be created by reducing transaction costs and how transaction costs help to explain how appropriating can create value beyond bargaining.

Unit of Analysis In Property Rights theory the unit of analysis is the individual property right. According to the authors, “resources are often better thought of as ‘molecules’ that are composed of bundles of rights to attributes.” Further, “Attributes consist of the different functionalities and services that assets can supply.” Property rights are held to such attributes and consist of the right to consume, obtain income from, and alienate such attributes.

Resources as Bundles of Property Rights According to the authors, attributes are often traded in bundles rather than individually in an effort to economize the costs. If transactions costs are reduced the resource owner will be able to appropriate more value from the resource. If resources are thought of as property rights to attributes, it suggests that resources are not given but are the outcomes of processes of economizing with transaction costs.

Resource Value and Transaction Costs The Property Rights theory asserts that transaction costs influence the value that a resource owner can create and appropriate. Value creation and value appropriation will depend on the specific rights the owner has to the attributes (i.e. the rights to exclude non-owners, and the costs associated with trading the rights). In sum, to maximize the value of a resource the transaction costs must be considered.

Controlling Property Rights: The Capture and Protection of Property Rights Property rights are not fully protected. As a consequence firms must engage in activities to protect their rights. The authors’ define capture as “resource-consuming activities to appropriate value from other strategizers without compensating them.” Examples include: Moral Hazard, Adverse Selection, Hold-up, etc. To avoid “capture” firms engage in “protection efforts.” Protection efforts are defined as “resource-consuming activities that strategizers undertake to reduce other strategizers’ incentives to capture property rights. The authors’ argue that the RBV needs to consider a broader set of protection efforts (not just imitation, etc.) and that property rights theory has implications for value creation, appropriation, and sustained competitive advantage that can add to our understanding of the RBV.

Relating Transaction Costs to Value Creation and Appropriation Under the Coase Theorem (i.e., in the absence of transaction costs) the maximum value is achieved. Extending the logic to property rights, if the costs of exchanging property rights are zero then resources will be optimally bundled resulting in the maximum value realized. Under the assumption of zero transaction costs, value creation is independent of value appropriation. Under the Coase Theorem RBV and Property Rights theory are consistent. Therefore to gain a better understanding of how resources lead to a sustainable competitive advantage we must relax our assumption.

Value Dissipation and Value Erosion Dissipation of value must occur because transaction costs erode value compared to zero transaction costs. Two kinds of dissipation identified: Direct - specific costs of protection and capture Indirect - cases where property rights are indirectly hindered and lead to suboptimal outcomes. In sum, by considering the influence of direct and indirect value dissipation from the property rights perspective adds clarity to the concept of value erosion in the RBV framework.

Transaction Costs and Sustained Competitive Advantage Unlike RBV, Property Rights theory does not directly address the concept of sustained competitive advantage. However, the value that is realized and appropriated from resources depends on transactions costs and many such costs are associated with the protection and capture of property rights. Property Rights theory has focused on how transaction costs influence competition over less than perfectly protected property rights. This angle helps provide a different insight into understanding the conditions for sustained competitive advantage as explained using RBV.

Heterogeneity RBV stresses as the source of heterogeneity the inherent efficiencies of resources and differences in resource complementarities. Property Rights theory suggests that resources are outcomes of processes of economizing transaction costs, and that resources vary in their efficiencies and potential for being combined in a complementary manner because they encompass different attributes.

Barriers to ex ante and ex post competition The RBV stresses informational barriers to ex ante competition as a necessary condition for rents. Property Rights suggests that rent capture is connected to transaction costs and that attributes of resources is an important dimension of rent capture. Both RBV and Property Rights suggest that barriers to ex post competition are a necessary condition for the sustainability of competitive advantage. However, Property Rights adds the concept of ex post competition (i.e. ex post capture in the form of moral hazard, adverse selection, etc.) for unprotected property rights over resource attributes.

Conclusion When transaction costs are positive, strategic opportunities arise for the firm. Transaction costs influence value creation and value appropriation by firms. Property Rights theory sheds a different perspective on the concept of resources (i.e. resources viewed as a bundle of property rights to attributes). By incorporating how firms protect and capture property rights to reduce dissipation provides a better understanding of RBV’s analysis of sustained competitive advantage.