Firms with consistently more accurate expectations concerning the value- creating potential of strategies they are implementing can expect to enjoy competitive advantages from implementing their strategies over the long run. In this sense, diﬀerences in ﬁrm expectations constitute a strategic factor market competitive imperfection.
Some have suggested that other diﬀerences between ﬁrms, besides dif- ferences in ﬁrm expectations, can create competitive imperfections in strategic factor markets. These ﬁrm diﬀerences, it is thought, can prevent certain ﬁrms from implementing strategies that other ﬁrms can imple- ment. However, close analysis of these other diﬀerences between ﬁrms suggests that, to the extent that they constitute competitive imperfections in strategic factor markets, they are actually a manifestation of diﬀerent expectations ﬁrms hold about the future value of strategies being imple- mented. In this sense, diﬀerences in ﬁrm expectations are the central source of competitive advantages from developing or acquiring resources to implement product market strategies.
1. LACK OF SEPARATION
It has been suggested that a competitive imperfection in a strategic fac- tor market exists when a small number of ﬁrms seeking to implement a strategy already control all the resources necessary to implement it. In this setting, these ﬁrms do not need to develop the resources necessary to implement a strategy, and thus apparently stand in some competitive advantage. An example of this lack of separation might include a uniquely well-managed ﬁrm seeking to implement a low-cost manufacturing strat- egy. Such a ﬁrm already controls most, if not all, the resources necessary to implement such a strategy and thus is apparently at an advantage compared to ﬁrms that would have to improve their eﬃciency in order to implement such a strategy (Porter 1980).
Indeed, Dierickx and Cool’s argument (1989) about the limitations of strategic factor market theory is a special case of this lack of separation argument. These authors suggest that many resources that are relevant in creating imperfect product market competition are not tradable, and thus not subject to the competitive pressures that exist in strategic factor markets. Dierickx and Cool (1989) argue that it is this lack of tradability, not imperfectly competitive factor markets, that enables ﬁrms to gain com- petitive advantages from exploiting their resources in creating imperfectly competitive product markets.
Of course, there is little doubt that some of the speciﬁc resources con- trolled by a ﬁrm are not tradable. For example, one ﬁrm cannot sell its culture to another ﬁrm; one ﬁrm cannot sell the teamwork among its managers to another ﬁrm. However, that these resources, individually, are not currently tradable does not mean that they are, and always have been, immune to the competitive pressures of strategic factor markets. This is true for several reasons.
First, the nontradable assets that a ﬁrm currently possesses are, accord- ing to Dierickx and Cool (1989) and Barney (1986b), developed over long periods. Indeed, the path-dependent nature of these resources is what creates the asset interconnectedness that Dierickx and Cool (1989) cite as one of the major reasons resources may not be tradable. However, over this period, these resources require investment and commitment in order to develop. The sum of these costs is what must be balanced against the revenues that any strategies exploiting these resources may create. If these costs are greater than this value, then even when ﬁrms use these resources to generate imperfect product market competition, no competitive advan- tages are generated.
While understanding these costs is important in understanding the full value created by a strategy, it is not unreasonable to believe that when these investments in an emerging resource are made, both those controlling these resources and those looking to invest in these resources will not have the same and perfectly accurate expectations about their future value. These resources evolve in ways that are diﬃcult to predict and may enable the implementation of product market strategies that cannot yet be antici- pated. That is, the strategic factor markets within which these resources are developed are clearly imperfect. If strategizers have more accurate expec- tations about the future value of the resources they are investing in than controllers and other strategizers, these ‘internally evolved’ resources can be expected to be sources of competitive advantage. If both strategizers and controllers underestimate the future value of these resources, competitive advantages can still be generated, but they will be a manifestation of a ﬁrm’s good luck.
Put diﬀerently, that resources are not tradable is not, by itself, the rea- son resources can be sources of competitive advantage. Rather, it is the imperfectly competitive factor markets through which these resources are developed that enable some of these resources to be sources of economic rents when they are used to implement product market strategies. Thus, rather than suggesting that strategic factor markets are irrelevant in under- standing the rent generating potential of resources, Dierickx and Cool’s argument (1989) identiﬁes several diﬀerent reasons that a particular strate- gic factor market may be imperfectly competitive.
Others have argued that when only one ﬁrm can implement a strategy, then a strategic factor market competitive imperfection exists (Arthur 1984). Such a ﬁrm may have a unique history or constellation of other assets, and thus may uniquely be able to pursue a strategy. In such settings, competitive dynamics cannot unfold, and uniquely strategizing ﬁrms could obtain competitive advantages from acquiring strategic resources and implement- ing strategies.
However, as before, a ﬁrm’s uniqueness is actually a manifestation of the expectational attributes of previous strategic factor markets. The key issues become: ‘How did the strategizing ﬁrm obtain the unique assets that allow it to develop the unique strategy it is implementing?’, ‘What price did this ﬁrm have to pay for these assets?’, ‘What price must potential strategizers pay in order to reproduce this set of organizational assets so that they can enter and create a competitive strategic factor market?’, and ‘What are the opportunity costs associated with using these resources to implement a strategy?’ If the current value of ‘unique’ resources in implementing a strategy was anticipated at the time those resources were acquired or developed, then competitive advantages would not exist.
3. LACK OF ENTRY
Another source of an apparent competitive imperfection in a strategic factor market exists when ﬁrms that could enter such a market by becom- ing strategizers do not do so. This lack of entry, however, like separation and uniqueness is actually a special case of the expectations ﬁrms hold about the future value of strategies. Lack of entry might occur for one of at least three reasons. First, ﬁrms that, in principle, could enter might not because they are not attempting to act in a proﬁt-maximizing manner. Second, potential strategizers may not have suﬃcient ﬁnancial strength to enter a strategic factor market and compete for strategic resource. Finally, ﬁrms that, in principle, could enter, may not know how to, for they may not understand the return generating characteristics of the strategies that cur- rent strategizers are implementing. Each of these possibilities is considered in order.
Firms may abandon proﬁt-maximizing behavior for several reasons. For example, managers may engage in activities that improve their situation in a ﬁrm, even if those activities do not maximize ﬁrm performance (Jensen and Meckling 1976). Also managers may be subject to a variety of systematic biases in their decision-making, biases that lead to decisions that are inconsistent with proﬁt maximization (Busenitz and Barney 1997; Hirshleifer and Hirshleifer 1998). For these and other reasons, it would not be surprising to see ﬁrms fail to engage in proﬁt-maximizing behavior some of the time.
However, over the long term, failure to maximize proﬁts can put a ﬁrm’s survival at risk. Moreover, markets typically react whenever a ﬁrm veers from proﬁt maximizing in some signiﬁcant ways: additional corporate governance is put into place to reign in agency problems (Jensen 1986) and unfriendly takeovers replace managers engaging in grossly biased decision- making (Jensen 1988). In the long run, as these reasons for not engag- ing in proﬁt-maximizing become less relevant, one possible reason why a ﬁrm may not enter into a strategic factor market remains: Diﬀerences in expectations about the future value of these resources. In this setting, it is not that ﬁrms are abandoning a proﬁt-maximizing motive. Rather, ﬁrms may legitimately disagree how to realize this proﬁt (Alchian 1950). This disagreement about the value of resources in implementing a product market strategy is what leads to the lack of entry, not abandoning proﬁt- maximizing behavior (Shleifer 2000).
Another apparent strategic factor market competitive imperfection exists when only a few ﬁrms have enough ﬁnancial backing to enter a strategic factor market and attempt to acquire or develop the resources needed to implement a product market strategy. Because only a few ﬁrms are com- peting for the relevant strategic resources, perfect competition dynamics are less likely to unfold, and it may be possible to obtain competitive advantages from using the acquired resources to implement a strategy.
However, even large diﬀerences in ﬁnancial strength typically reﬂect expectational diﬀerences in strategic factor markets rather than diﬀer-ences between the ﬁnancial strengths of ﬁrms, per se. Two ways in which diﬀerences in ﬁnancial strength represent these diﬀerences in ﬁrm expec-tations are considered below.
First, in some circumstances, the actual future value of a given strategy may be the same for whatever ﬁrm implements it. In this case, if capital markets are eﬃcient and well informed concerning the actual future value of a strategy, then funds will ﬂow to ﬁrms wishing to enter a strategic factor market with anticipated positive economic rents. Sources of capital will recognize the possibility of these rents and will provide whatever funds are necessary to ensure that potential strategizers will enter and become actual strategizers (Copeland and Weston 1979). The same holds true for controllers. In this way, competition within a strategic factor market will grow, and any anticipated rents will approach zero. This entry will only not occur if capital sources are under-informed about the possibility that ﬁrms can obtain competitive advantage from acquiring resources to implement a strategy. In this situation, potential strategizers and controllers would not be able to obtain adequate ﬁnancial backing from under-informed sources of capital to enter into the strategic factor market. This lack of entry creates the possibility of competitive advantages for ﬁrms that do enter.
However, when are capital sources likely to be under-informed con- cerning the anticipated returns from implementing a strategy? If potential strategizers and controllers are as well informed as actual strategizers and controllers, then it seems likely that the relevant information needed to generate return expectations falls into the general category of ‘publicly available information’, and thus would be taken into consideration by capital sources in making funding decisions (Fama 1970; Copeland and Weston 1979). Thus, only when actual strategizers and controllers have expectational advantages over potential strategizers and controllers is it likely that sources of capital will be under-informed. Thus, in this case, the lack of entry into a strategic factor market due to insuﬃcient ﬁnancial backing is, once again, a reﬂection of the expectational advantages enjoyed by some ﬁrms in a strategic factor market.
In an eﬃcient capital market, when the actual future value of strate- gies does not depend on which ﬁrm implements them, then the inability of ﬁrms to attract suﬃcient ﬁnancial support to enter and compete for strategic resources must reﬂect diﬀerences in expectations among current and potentially competing ﬁrms. However, sometimes a strategy imple- mented by one ﬁrm will have a greater future value than that same strategy implemented by other ﬁrms. In this situation, and under the assumption of eﬃcient and well-informed capital markets, capital will ﬂow to high- proﬁt potential ﬁrms, while low-proﬁt potential ﬁrms may not receive such ﬁnancial backing (Copeland and Weston 1979). This lack of ﬁnancial backing may prevent entry and thus constitute a competitive imperfection in a strategic factor market.
However, when can one ﬁrm implementing a strategy obtain compet- itive advantages from doing so compared to other ﬁrms implementing this strategy? The answer must be that this ﬁrm already controls other strategically relevant assets not controlled by other ﬁrms (Barney 1991a). Thus, this ﬁrm’s ability to attract ﬁnancial backing is a reﬂection of its unique portfolio of strategically valuable assets and resources, resources not controlled by other ﬁrms. In this sense, lack of entry is simply a special case of a ﬁrm implementing a unique strategy, and the previous discussion of expectations in strategic factor markets applies here as well. In short, ﬁrms with unique resources that give them the opportunity to gain competitive advantages are either exploiting special insights they had into the future value of those resources when those resources were acquired, or, if they enjoyed no such insights, they are simply enjoying their good fortune.
Lack of understanding
A ﬁnal reason entry might not occur is that entrants may not understand the value generating processes underlying a strategy. Firms form their return expectations about speciﬁc strategies based on their understanding of the processes by which strategies generate economic value, that is, on their understanding of the cause and eﬀect relations between organiza- tional actions and economic value (Lippman and Rumelt 1982). Some of this understanding may be of the ‘learning-by-doing’ variety (Williamson 1975), and thus not available to potential strategizers and controllers. When potential entrants do not understand the relationship between orga- nizational actions and economic value as well as current actors in a strate- gic factor market, potential entrants are likely to incorrectly estimate the true value of strategies. If they underestimate this value, then these ﬁrms will not enter the strategic factor market, even when expectations set with a more complete understanding of a strategy’s value generating processes would suggest that entry was appropriate. Again this lack of entry, and the competitive imperfection that it might create, reﬂects the diﬀerent expectations ﬁrms have about the potential of strategies to be implemented to generate economic value.
Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.