Before continuing this discussion, a few additional comments about resource-based theory are needed. These concern the confusion about terms describing factors of production controlled by a firm and the definition of competitive advantage in resource-based theory. These clari- fications will greatly simplify the discussion in the remainder of this book.
1. TERMS TO DESCRIBE FACTORS OF PRODUCTION CONTROLLED BY A FIRM
First, there continues to be some ongoing confusion about the terms used to describe factors of production controlled by a firm. Through the 1990s, various authors have tried to develop typologies of these tangible and intangible assets in an effort to suggest that different types of assets can have different competitive effects for firms. For example, Wernerfelt (1984) and Barney (1991b) simply called these assets ‘resources’ and made no effort to divide them into any finer categories. Prahalad and Hamel (1990) devel- oped the concept of ‘core competencies’ and, building on Selznick (1957) and others, added the term competence to the resource-based lexicon. Stalk, Evans, and Shulman (1992) argued that there was a difference between competencies and capabilities, and thus this term (capabilities) was added to the terminological fray. Teece, Pisano, and Shuen (1997) emphasized the importance of the ability of firms to develop new capabilities, a perspective emphasized by their choice of the term ‘dynamic capabilities’. (Note: these are ‘capabilities that are dynamic’.) Several authors have suggested that knowledge is ‘the’ most important resource that can be controlled by a firm and have developed what they call a ‘knowledge-based theory’ of sustained superior firm performance (see, e.g. Grant 1996; Liebeskind 1996; Spender and Grant 1996).
In principle, distinctions among terms like ‘resources’, ‘competencies’, ‘capabilities’, ‘dynamic capabilities’, and ‘knowledge’ can be drawn. For example, in their textbooks, Hill and Jones (1992) and Hitt, Ireland, and Hoskisson (1997) distinguish between resources and capabilities by sug- gesting that resources are a firm’s ‘fundamental’ financial, physical, indi- vidual, and organizational capital attributes, while capabilities are those attributes of a firm that enable it to exploit its resources in implement- ing strategies. Drawing upon Amit and Schoemaker (1993), Makadok (2001) defines capabilities as special types of resources that are ‘organi- zational embedded non-transferable firm-specific resources whose pur- pose is to improve the productivity of other resources’. Makadok (2001) notes complementary and substitute effects between ‘resource-picking’ and ‘capability-building’—these are distinct rent-creation mechanisms. Teece, Pisano, and Shuen’s concept (1997) of dynamic capabilities tends to focus on the ability of firms to learn and evolve (Lei, Hitt, and Bettis 1996). Among the stream of work exploring this perspective, Eisenhardt and Martin (2000) define dynamic capabilities as ‘the antecedent orga- nizational and strategic routines by which managers alter their resource base—acquire and shed resources, integrate them together, and recombine them—to generate value-creating strategies.’ General practice suggests that the concept of competencies is most often applied in the context of a firm’s corporate diversification strategy. Knowledge is clearly a special case— albeit an important one—of some of these other terms or concepts.
While these distinctions among types of resources can be drawn and can be helpful in understanding the full range of resources a firm may possess, the effort to make these distinctions has had at least one unfortu- nate side effect: those who have developed new ways to describe a firm’s resources have often labeled their work as a ‘new’ theory of persistent superior performance. Thus, the strategic management literature currently has proponents of ‘resource-based theories of superior performance’, ‘capa- bility theories of superior firm performance’, ‘dynamic capability theories of superior performance’, ‘competence theories of superior performance’, and ‘knowledge-based theories of superior performance’.
While each of these ‘theories’ has a slightly different way of characteriz- ing firm attributes, they share the same underlying theoretical structure. All focus on similar kinds of firm attributes as critical independent variables, specify about the same conditions under which these firm attributes will generate persistent superior performance, and lead to largely interchange- able empirically testable assertions. Battles over the label of this common theoretical framework are an extreme example of a classic academic ‘tem- pest in a tea pot’—‘full of sound and fury but signifying nothing’.
Given this state of affairs, the following conventions have been adopted throughout this book. First, the terms resources and capabilities will be used interchangeably and often in parallel. Second, the term core compe- tence is applied only in discussions of the conception or implementation of corporate diversification strategies (Prahalad and Hamel 1990).
A variety of authors have generated lists of firm resources, capa- bilities, and competencies that enable firms to conceive and imple- ment value-creating strategies (Thompson and Strickland 1983; Hitt and Ireland 1986; Grant 1991; Hall 1992; Amit and Schoemaker 1993; Collis and Montgomery 1995; Hitt, Ireland, and Hoskisson 1997). For pur- poses of this discussion, these numerous possible firm resources can be conveniently classified into four categories: physical capital resources (Williamson 1975), financial capital resources, human capital resources (Becker 1964), and organizational capital resources (Tomer 1987). Phys- ical capital resources include the physical technology used in a firm, a firm’s plant and equipment, its geographic location, and its access to raw materials. Financial capital resources include all a firm’s many revenues, including its debt, equity, and retained earnings. Human capital resources include the training, experience, judgment, intelligence, relationships, and insight of individual managers and workers in a firm. Organizational capi- tal resources include attributes of collections of individuals associated with a firm, such as a firm’s culture, its formal reporting structure, its formal and informal planning, controlling, and coordinating systems, its reputation in the marketplace, as well as informal relations among groups within a firm and between a firm and those in its environment.
2. THE DEFINITION OF COMPETITIVE ADVANTAGE IN RESOURCE-BASED THEORY
Second, there has also been much debate recently about the dependent variable in resource-based theory, variously identified as ‘competitive advantage’, ‘sustained competitive advantage’, and ‘economic rents’. Com- petitive advantage can be defined as follows:
An enterprise has a Competitive Advantage if it is able to create more economic value than the marginal (break even) competitor in its product market. (Peteraf and Barney 2003: 314)
This definition is consistent in spirit with the definition of competi- tive advantage provided by Barney (1986a, 1991a) and with the usage of this term by Porter (1985). It is consistent, as well with the value- based approach to competitive advantage presented in Peteraf (2001). It resembles the value-creation frameworks of Brandenburger and Stuart (1996) and of Besanko et al. (2000), though it differs in terms of its reference point. Its precise meaning, of course, depends on a clear defin- ition of what it means to ‘create economic value’. Thus ‘economic value’ is defined in concert with the definition of competitive advantage.
The Economic Value created by an enterprise in the course of providing a good or service is the difference between the perceived benefits gained by the purchasers of the good and the economic cost to the enterprise. (Peteraf and Barney 2003: 314)
Several things about this definition are notable. First, it is a net benefits approach to value creation. It is the benefits produced by a firm’s under- takings, net of their costs. Chapter 2 of this book focuses on identifying precisely what the total costs associated with conceiving and implementing a strategy are.
Second, it is a view of value creation closely aligned with fundamental economic principles. Value is expressed in terms of the difference between perceived benefits, or customer willingness-to-pay, on the one hand, and economic costs on the other. This is, in essence, the same as the economic concept of total surplus, which equals the sum of the economic rents (pro- ducer surplus) and customers’ ‘value for the money’ or consumer surplus. The definition supports the notion that the value that an enterprise creates has the potential to enhance the welfare of all of its stakeholders. It is independent of the price of the product, though prices serve to allocate the surplus (see Figure 1.2).
Third, it emphasizes perceived benefits, suggesting that the perceptions of consumers, rather than some absolute notion of quality differentials, are what really matter. This is consistent with a marketing view of how value is created.
Finally, greater value implies greater efficiency. To create more value than its rivals, an enterprise must either produce greater benefits for the same cost or the same benefits for a lower cost. Thus it supports an efficiency view of resource-based theory.
Taken together, these two definitions (of competitive advantage and of economic value) provide a precise picture of what a competitive advantage consists, as well as how it may be achieved, in the most general terms.
Figure 1.2. Prices allocate the value created
Competitive advantage is expressed in terms of the ability to create rela- tively more economic value. To create more value than its rivals, an enter- prise must produce greater net benefits, through superior differentiation and/or lower costs. The benchmark for comparison is the marginal com- petitor. This implies that a competitive advantage may be held by several or even many firms in a given industry and suggests that there may be several different routes to competitive advantage. It simply requires an enterprise to be a superior value generator, relative to the least efficient competitor capable of breaking even. An enterprise with competitive advantage need not be the very best performer in all dimensions.
These definitions can also link competitive advantage to economic rents. Begin by comparing the situation of two single-business firms competing in a product market, one of which has a competitive advantage over the other (see Figure 1.3). For illustrative purposes, we assume that the focal firm, firm A, creates $180 of economic value for each unit of output that it provides the market, while its rival, firm B, creates only $150 of value per unit of output. Note that economic value can be expressed in monetary terms, since the level of perceived benefits is reflected in the customers’ maximum willingness-to-pay for the good, while economic costs have a corresponding dollar counterpart.
In this scenario, product price determines how much of the economic value created by a firm is distributed to customers, in terms of benefits received over and above their cost to the consumer (price paid). If each firm delivers the same level of benefits to consumers, say $100, firm A will have a pool of residual value that exceeds that of firm B by $30 ($80−$50). What is residual value? It is what is left over after the consumers have been allocated a share of the total value. This is the share of total value that remains to be divided among other claimants, including the firm. In Figure 1.3, the residual value available to firm A is $80, while firm B has only $50 of total value left to allocate. Firm A has a positive differential in residual value of $30 ($80−$50). What does this positive differential in residual value represent? This, of course, is firm A’s competitive advantage over firm B, and it provides a protective cushion for A against competition from B.
Figure 1.3. Greater economic value supports the generation of rent
To illustrate this, imagine that fierce price competition breaks out in this product market. Under such conditions, each firm will continue to lower prices in an effort to attract one another’s customers until prices reach that point at which one of the firms is no longer willing to supply. For either firm, that will occur at the point that its residual value dips below zero. (When the residual pool of value is zero, there is nothing left for the firm to claim over and above its economic costs. When the residual value is negative, the firm cannot even recover its costs.) Since B will reach that point first, B will become the marginal, breakeven competitor and prices will stabilize. Firm A can continue to produce profitably, due to its cushion of $30 per unit.
Alternatively, the competition between A and B could take place on the cost side, through, say, greater advertising or auxiliary services. This kind of competition will also whittle away at the residual value. Once again, the limit to this competition occurs when the residual value of the least efficient firm is completely dissipated. That firm again is firm B, leaving A with a residual of $30 per unit.
This pool of excess residual value is equal to the economic rents attribut- able to the more efficient factors of firm A. Economic rents are defined as returns to a factor in excess of its opportunity costs. To understand why it is possible to view this excess value as a rent, consider a firm that possesses scarce resources and capabilities that enable it to increase the amount of economic value it creates. The greater value that is generated by these res- ources and capabilities is properly viewed as a rent to these scarce critical resources. It is a ‘return’ to resources in the sense that the production of the rent is dependent on the efficiency differences among the resources in use. Without the more efficient resources, the rent would cease to exist. It is a return above the opportunity costs of resources of this general type, in that it exceeds the opportunity cost of the marginally productive resources. It is greater than the return necessary to draw resources of this general type into production. It is not, however, a return to the resource in the sense that the resource holder necessarily receives the surplus value. How this excess residual value is divided among the firm and other claimants requires further analysis (Peteraf 1993, 2001; Coff 1999). See Figure 1.4 for a summary of the connection between resources, residual value, and rents. Of course, the rents that are generated in this manner may be fleeting and of limited consequence. What is more interesting is whether the rents can be sustained for some period and whether the firm has any hope of claiming them in the form of superior profits. These questions are also addressed by resource-based theory and are discussed later in this book (Barney 1991a; Peteraf 1993).
Figure 1.4. The chain of logic from resources to rents
Because, in general, it is possible to always link competitive advantages and economic rents, these two terms are used interchangeably through- out this book. However, since firms do not necessarily appropriate all the competitive advantage and economic rents they generate, the term firm profits will only be applied to that part of the competitive advan- tage/economic rent a firm is able to appropriate.
Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.