The Cornerstones of Competitive Advantage: A Resource-Based View (Margaret Peteraf, 1993) Group 1 Meredith, Barclay, Woo-je, and Kumar

Motivation and Paper Outline To develop a general model of resources and firm performance that integrates the various strands of research and provides a common ground for further work Two main sections of paper: 1) Discussion of four (cornerstone) conditions that ALL must be met for (sustainable) competitive advantage 2) Applications to business and corporate strategy

Condition #1 : Resource Heterogeneity Assumption of resource-based work: resources and capabilities are heterogeneous across firms (Barney, 1991) Ricardian Rents (name originates from Ricardo, 1817): Heterogeneity may reflect superior productive factors Productive factors often quasi-fixed - cannot be expanded rapidly Thus, inferior resources are brought into production as well (Ricardian argument that can be understood by assuming superior resource firms have lower average costs than other firms) (See Figure 1)

Scarcity rents w/ heterogeneous factors This model consistent with competitive behavior in product market - Firms are price takers and produce where price equals MC. High returns to low cost firms cannot be attributed to artificial restriction of output or to market power. Key point: superior resources remain in limited supply - cannot be expanded freely or imitated by other firms. (See figure 2 to see what happens when this isn’t the case.)

Rent dissipation from Imitation Now, only normal economic returns will be earned by efficient producers (now homogeneous).

Note: Monopoly Rents Condition of heterogeneity consistent with models of market power and monopoly rents Monopoly models - heterogeneity may result from spatial competition, product differentiation, localized monopoly, size advantages Firms maximize profits by CONSCIOUSLY restricting their output relative to competitive levels Apparently homogeneous firms may earn monopoly rents: Cournot Behavior Collusive Behavior In this case, heterogeneity occurs across incumbent firms and potential entrants (depends on barriers to entry)

Condition #2: Ex-Post Limits to Competition Sustained competitive advantage requires that heterogeneity be preserved - must be forces that limit competition for rents (Figure 2 shows how ex-post competition erodes Ricardian rents) Resource-based work has focused on 2 critical factors that limit ex post competition: Imperfect imitability Imperfect substitutability - substitutes reduce economic rents by making the demand curves of monopolists/oligopolists more elastic More attention has been given to the condition of imperfect imitability.

Imperfect Imitability Rumelt (1984) - “Isolating mechanisms” - phenomena that protects firm from imitation Property rights to scarce resources Quasi-rights (lags, info asymmetries, and frictions) (Rumelt, 1987) Producer learning, buyer switching costs, reputation, buyer search costs, economies of scale (Rumelt, 1987) Causal ambiguity (Lippman & Rumelt, 1982) - uncertainty regarding causes of efficiencies Yao (1988) - production economies and sunk costs, transaction costs, and imperfect information Ghemawat (1986) - inimitable positions derive from size advantages, preferred access to resources or customers, restrictions on competitors’ options Dierickx & Cool (1989) - how imitable an asset is depends on nature and process by which it was accumulated. They suggest the following impede imitation: time compression diseconomies, asset mass efficiencies, interconnectedness of asset stocks, asset erosion, and causal ambiguity

Condition #3: Imperfect Mobility Resources are perfectly immobile if they cannot be traded Dierickx & Cool (1989) - one of their examples are resources for which property rights are not well defined Williamson (1979) - resources that have no other use outside the firm Teece (1986) – co-specialized assets, which have higher economic value when employed together Williamson (1975), Rumelt (1987) - resources may be imperfectly mobile because of very high transactions costs Opportunity cost of imperfectly mobile resource is significantly less than the value to the present employer (firm). Here, Peteraf defines opportunity cost in terms of next best potential user (e.g. firm), rather than next best use. Rents will be shared between factor (input) owners and the firm employing them, thus - bilateral monopoly where rent distribution is indeterminate: Imperfect factor mobility necessary for SCA

Condition #4: Ex Ante Limits to Competition Prior to any firm’s establishing a superior resource position, there must be limited competition for that position Performance of firms depends not only on returns from their strategies, but also on cost of implementing those strategies (Barney, 1986) Without imperfections in strategic factor (input) markets, firms can only hope for normal returns One example: Walmart’s acquisition of real estate in rural areas Another example: Price of acquisition Key here is: Cost

4 Conditions that Must be Met

Applications Single Business Strategy Nobel prize winning scientist, although may be a unique resource, is an unlikely source of SCA unless she has firm-specific ties License new technology or develop internally? If potential value of technology cannot be well communicated to others because of the risk of revealing proprietary info, may be best to develop internally Might depend on co-specialized assets such as established relationships with vendors who are reluctant to switch suppliers Consideration of how imitable innovation is: If innovation is no more than a complex assembly of relatively available technologies, a firm could consider building other co- specialized resources that are less available

Applications Corporate Strategy Resource-based model fundamentally concerned with internal accumulation of assets, asset specificity, and less directly with transactions costs - Thus, naturally lends itself too questions of firm boundaries Diversification Barney (1988) - abnormal returns from diversification depend on how rare and imitable resulting combination of resources Montgomery & Hariharan (1991) - shown that firms with broad resource bases tend to pursue diversification Theory of diversification is resource-based: diversification is the result of excess capacity in which resources have multiple uses and for which there is market failure

Applications Paradox of how “excess capacity” in resources may lead to “scarcity rents” for resource holders: Resources are “scarce” relative to total demand for their overall use, despite excess capacity relative to specific markets Example: Kodak Montgomery & Wernerfelt (1989) - diversification viewed as matching a firm’s resources to the set of market opportunities Firms with more specialized resources are more constrained to enter into widely different product markets - and specialized resources relatively scarce, thus higher rents Firms with more generalizable resources may face a wider opportunity set - yet lower rents

Applications Peteraf suggests that although they do not say so, Montgomery & Wernerfelt’s (1989) model implies an optimal extent of diversification.

Contributions Peteraf provides a synthesis of previous work in RBT Shows how concepts and ideas in RBT are consistent with a Ricardian view of economic rent and competitive advantage Provides a detailed and tractable discussion of precisely why these four (cornerstone) conditions must be met for SCA Resource-based Theory - only theory of corporate scope capable of explaining the range of diversification