Other apparent competitive imperfections: the question of tradability

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.


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.


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.

Profit maximizing

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).

Financial strength

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.

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