Heterogeneous expectations in strategic factor markets

These perfect competition dynamics, and the zero economic rents from implementing strategies they imply, depend, of course, on the very strong assumption that all strategizers and controllers have the same, and perfectly accurate, expectations concerning the future value of strategies. This is a condition that is not likely to exist very often in real strategic factor markets.

More commonly, different strategizers and controllers in these mar- kets will have different expectations about the future value of a strategy. Because of these differences, some expectations will be more accurate than others, although strategizers and controllers will typically not know, with certainty, ahead of time, how accurate their expectations are. When dif- ferent strategizers and controllers have different expectations concerning the future value of a strategy, it will often be possible for some strategizers to generate rents from developing or acquiring the resources necessary to conceive and implement a product market strategy and then implementing that strategy.

Consider first the return potential of a strategizer that has more accurate expectations concerning the future value of a particular product market strategy than others—either other strategizers or controllers—who might be interested in this strategy. Two likely possibilities exist. On the one hand, several others might overestimate a strategy’s return potential. This over- estimation will typically lead to strategic factor market entry, competition, and the setting of a price for the relevant strategic resource greater than the actual value of that resource when it is used to implement a strategy.

In this situation, those with more accurate expectations concerning the return potential of a strategy will usually not enter the strategic factor market, for they will believe that in doing so they will probably sustain an economic loss by paying more for a strategic resource than that resource is worth in implementing a strategy. Thus, in the long run, those with more accurate expectations will usually be able to avoid economic losses associated with buying overpriced strategic resources. Those that do pay for these overpriced resources suffer from the ‘winner’s curse’, that is, the fact that they successfully develop the resources in question suggests that they overpaid (Bazerman and Samuelson 1983).

The second possibility facing those with more accurate expectations is that others, rather than overestimating the return potential of a strategy, might underestimate that strategy’s true future value. Competition in the strategic factor market would, in this case, typically lead to a strategic resource price less than the actual future value of the strategy. In this situation, those with more accurate expectations about the future value of the strategy in question will enter the strategic factor market and will pay the same for the relevant strategic resource as those with less accurate (i.e. pessimistic) expectations. The cost of these resources will not be any less to those with more accurate expectations because of the inaccurate expec- tations held by ill-informed controllers and strategizers. And those with more accurate expectations will certainly not want to spend more than nec- essary for these resources. As strategies are implemented, equal competitive advantages will accrue to all those firms that use the resource in question to implement this strategy, the well-informed and ill-informed alike.

Thus, on the one hand, those with more accurate expectations con- cerning the future value of a strategy can avoid economic losses due to optimistic expectations. On the other hand, these firms will also be able to anticipate and exploit any opportunities for competitive advantage in strategic factor markets when they exist. Thus, by avoiding losses and exploiting rent generating opportunities, these firms, over the long run, can expect to perform better than firms with less accurate expectations about the future value of strategies.

Despite the advantages of having a superior understanding of a strategy’s return potential when acquiring or developing the resources necessary to implement that strategy, firms without this superior insight can still obtain economic rents when implementing strategies. This can occur when several of these firms underestimate the potential of a strategy to create economic value. Because of this underestimation, the cost of the resources necessary to implement a strategy will be less than the actual future value of the strategy. In this sense, these firms are able to buy a strategy generated cash flow for less than the value of that cash flow. However, this competitive advantage must be a manifestation of these firms’ good fortune and luck, for the price of the strategic resource developed was based on expectations about the value-creating potential of that strategy. Value greater than what was expected is, by definition, unexpected. Unexpected superior economic returns are just that, unexpected, a surprise, and a manifestation of a firm’s good luck, not of its ability to accurately anticipate the future value of a strategy.

Even well-informed firms can be lucky in this manner. Whenever the actual value created by a strategy is greater than expected returns, the resulting difference is a manifestation of a firm’s unexpected good fortune. The more accurate a firm’s expectations about a strategy’s potential, the less a role luck will play in generating competitive advantages. In the extreme, though probably very rare case, where a firm knows with certainty the value potential of a strategy before that strategy is implemented, there can be no unexpected value created by implementing strategies and thus no financial surprises. However, to the extent that a firm has less than perfect expec- tations, luck can play a role in determining a firm’s competitive advantage from implementing its strategies.

Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.

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