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ECP 6701Competitive Strategies in Expanding Markets

The Origins of Competitive Advantage

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Readings

BDSS Chapter 13

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Entrepreneurship and Competitive Advantage

Competitive advantage arises from a firm’s entrepreneurial ability to exploit market shocks and discontinuities

Schumpeter’s “creative destruction”: New sources of competitive advantages displacing the established ones

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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

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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

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Creative Destruction and Monopoly

Schumpeter’s ideas have been used to defend monopoly

Presumably monopoly leads to greater investment in innovation and higher long term growth

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Creative Destruction and Competitive Advantage

Creative destruction implies that the isolating mechanisms that protect a firm’s competitive advantage will not be permanent

The life expectancy of a competitive advantage shrinks as technology and tastes change rapidly

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Life Cycle of Competitive Advantage

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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)

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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

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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

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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 D’Aveni, 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

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Hypercompetition Strategies

A firm’s 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

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Incumbent’s 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

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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

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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

Monopolist’s incentive will be less since it will be replacing itself

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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

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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

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Innovation Competition

Staying even slightly ahead of the rivals will produce disproportionate benefits

Firms engaged in a contest must anticipate the rival’s efforts to formulate their own strategy

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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

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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?)

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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

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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

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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

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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

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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

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Evolutionary Economics and Dynamic Capabilities

Usually a firm’s 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

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Factors that Limit Dynamic Capabilities

A firm’s 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

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Path Dependence

Firm’s 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 firm’s competitiveness

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Windows of Opportunity

Early in a product’s 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

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Competitive Advantage and the Environment

Michael Porter suggests that the firm’s 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

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Competitive Advantage and the Environment

A firm’s 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

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Competitive Advantage and the Environment

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Factor Conditions

A firm’s 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

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Demand Conditions

A firm’s 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

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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

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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

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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

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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