The Resource Based View of the Firm (RBV) B290

The object of strategic analysis… Explain why a firm or a group of firms is making above normal returns –i.e. More than their long run average costs Two possible explanations –It’s something to do with the industry in which they operate External analysis - Porter 5 Forces –It’s something the firm owns or controls Internal analysis, the RBV

Why some firms make more $ than others If firms are identical and their products are commodities –Industry concentration –Up and down stream bargaining power –Threat of new entry or substitution If products or firms are heterogeneous –Differences in: Cost structure Value created (innovation, brand) Value appropriated (brand, switching costs)

Two puzzles Some industries with no apparent industry barriers to entry are concentrated and profitable In some fragmented industries some firms making substantial profits –e.g., Nucor in steel

If Industry Mattered Most…

In fact, Firms Matter Most…

Why some firms make more $ than others Economic assumption –Imitation should reduce difference in technology –And thus differences between firms’ returns Only if imitation is difficult or impossible, will firms with favourable initial resource endowments make consistently higher profits –E.g., Alcoa

Concentration Regulatory barriers to industry entry Economies of scale –Minimum efficient scale –Total sales / MES = # Firms –If no MES => monopoly Entry deterrence (overcapacity) Uncertain imitability MES

Uncertain imitability Two assumptions –Firms are all different in some way –Firms cannot figure out exactly what other firms do and why they are ‘better’ (uncertain imitability) Theses two assumptions lead to competitive industries (i.e. with no entry barriers) in with fewer firms than one would expect which (some) firms make money.

Lippman & Rumelt’s model… Each period firms consider entering an industry Based on their expected costs, the firm considering entry calculates its expected profit If current industry prices are above its estimated long run costs, it enters. If it enters, it finds out what its costs really are All firms (new entrant and incumbents) recalculate their optimal quantity - a new industry price emerges Firms whose costs exceed this new price leave

The Resource Based View Empirical observation: some firms in ‘competitive industries’ make above normal returns –First explanation proposed - uncertain imitability (Lipmann & Rumelt, 1982) Empirical study - firm differences account for much more variation in performance than industry differences (Rumelt 1992) ‘Market’ for strategic factors – –efficient market hypothesis (Barney 1986) –Implications for inimitable resources (Dierickx & Cool, 1989) Properties of resources that support profitable value creating activity - the heart of the RBV Something is giving such firms a sustainable competitive advantage

Hypothetical example: mobile phone licenses E[cost] = ? Frequency band B (4c / call) Frequency band A (5c / call) Frequency band C (3c / call) Three different frequency bands, A, B and C Allocated by the FCC though a lottery… p=1/3

Hypothetical example: mobile phone licenses E[cost] = 4c / call Frequency band B (4c / call) Frequency band A (5c / call) Frequency band C (3c / call) p=1/3 Best estimate of likely cost is…

E[cost] = 4c / min Imitation allows all firm to achieve 3c / call costs Irrespective of initial estimates firms know that 3c/min is achievable Hypothetical example: mobile phone licenses

E[cost] = 4c / min Without imitation, firms retain their initial costs, good or bad… 4c / min remains the expected cost With 5 firms, prices would fall below expected costs, so no 5 th firm enters Hypothetical example: mobile phone licenses

Implications Dynamic rather than static model –conceptually simple but not easily solvable analytically Limit to firm entry more realistic –Not an infinite number of firms in the market More uncertainty regarding the resource bundle to be imitated… –fewer firms enter –surviving firms makes higher returns

Market for ‘strategic factors’ Imagine there was a market for ‘strategic factors’ the resources that make one firm more profitable than another… –Firms could buy the resources they needed to be as good as the best in the industry –But how much would they pay? –Up to the present value of the expected value of the benefit the resource conferred –In an industry with several firms, bidding would reduce gains from such a purchase to zero SO: if firms do make profits, they cannot have bought the resources on a ‘strategic factor’ market –Which means rent generating resources have to be created in-house – (and acquisitions are often unprofitable for the acquiring company)

So, what resources do firms need? [Resources are the things firms use to create its products and services] Something that makes them distinctive, different, unique… Distinctiveness stems from unique resources… –Create products of value to customers –Not available off the shelf –Are hard to imitate (barriers to imitation - not entry)

Barriers to Imitation Patents, copyrights Brand Tacit knowledge –Riding a bicycle Dispersed knowledge –Formula for Coke Complex “activity systems” Complex social system (culture)

Three questions Does the resource create value? –for our customers Higher prices –for the firm Lower costs Is it rare? –We can only appropriate if we have a unique advantage Is our advantage inimitable? –i.e., will that unique advantage persist over time? »V.R.I.

Resources and economic transformation INTANGIBLE KNOWLEDGE-BASED ‘TRANSFORMING’ RESOURCES (CAPABILITIES) Knowledge, SOPs and routines, skills TANGIBLE RESOURCES Physical assets Finished product or service INPUT RESOURCES Raw materials Energy, Parts TECHNOLOGY

Resources and economic transformation INTANGIBLE KNOWLEDGE-BASED ‘TRANSFORMING’ RESOURCES (CAPABILITIES) Knowledge, SOPs and routines, skills TANGIBLE RESOURCES Physical assets INPUT RESOURCES Raw materials Energy, Parts COMPETENCE Finished product or service

A Heirarchy Competence Distinctive competence Core Competence Knowledge Resources or Capabilities Tangible Resources

Fruin’s ‘bow tie’ model of core competency Capabilities and resources e.g. Honda Small internal combustion engine Products Motorcycles Cars Lawn mowers Outboard motors ATVs Generators Core (distinctive) competency

“V.R.I.” Valuable –To customers Which means we may be able to raise prices above those of our less valued competitors. –To us Which means we may be able to maintain lower costs than our competitors Their costs are a floor below which prices will not fall, leaving us with a profit even when they have none. Rare –If customers have no alternative they will have to pay more than it costs us to make the product or deliver the service –We can appropriate some of the value we create Inimitable –ensures rarity into the future

Complex activity systems Some firms are made up of complicated interlocking systems Complicated systems are hard to copy One missing piece and the entire system will not work

Summary If there is no structural advantage in our industry, we must look for sources of competitive advantage inside our firm Firm levels factors that deliver competitive advantage must be –Valuable (i.e. a competence) –Rare and non-substitutable (i.e. distinctive) –Inimitable (and thus persist over time) Distinctive competences with multiple uses are termed ‘core’ competences