Review: “The Resource-Based Theory of Competitive Advantage: Implications for Strategy Formulation” – Grant (1991)

Our review summarizes the main contents of the fundamental article “The Resource-Based Theory of Competitive Advantage: Implications for Strategy Formulation” published by Grant (1991) on the California Management Review; that clarifies resources, capabilities and strategic formulation, as well as relationships between resources, capabilities, competitive advantage, and profitability of the firm. Also, the mechanisms of sustaining competitive advantage are discussed. In addition, a practical framework of a resource-based approach to strategy analysis of five stages is developed.

Introduction

Strategy has been defined as: “the match an organization makes between its internal resources and skills… and the opportunities and risks created by its external environment” (p.114). In the resource-based approach to strategy formulation, Grant (1991) organized the article in a five-stage procedure for strategy formulation. The Figure 1 outlines this framework.

Figure 1. A Resource-Based Approach to Strategy Analysis: A Practical Framework

Source: Grant (1991, p. 115)

1. Resources and Capabilities as the Foundation for Strategy

Before discussing the five-stage procedure for strategy formulation, Grant (1991) clarified the role of Resources and Capabilities as the Foundation for Strategy of the firm. He indicated that: “The case for making the resources and capabilities of the firm the foundation for its long-term strategy rests upon two premises:” (Grant, 1991, p. 116).

Resources and Capabilities as a Source of Direction:

“First, internal resources and capabilities provide the basic direction for a firm’s strategy”. “When the external environment is in a state of flux, the firm’s own resources and capabilities may be a much more stable basis on which to define its identity” (Grant, 1991, p. 116).

Resources as the Basis for Corporate Profitability:

“Second, resources and capabilities are the primary source of profit for the firm”. “A firm’s ability to earn a rate of profit in excess of its cost of capital depends upon two factors: the attractiveness of the industry in which it is located, and its establishment of competitive advantage over rivals. In Resource-Based approach, the “competitive advantage rather than external environments is the primary source of inter-firm profit differentials between firms”. “For example, the ability to establish a cost advantage requires possession of scale-efficient plants, superior process technology, ownership of low-cost sources of raw materials, or access to low-wage labor. Similarly, differentiation advantage is conferred by brand reputation, proprietary technology, or an extensive sales and service network” (Grant, 1991, p. 117).

“We can go further. A closer look at market power and the monopoly rent it offers, suggests that it too has its basis in the resources of firms”. (Grant, 1991, p. 117). Figure 2 summarizes the relationships between resources and profitability. In Resource-Based approach, “business strategy is viewed less as a quest for monopoly rents that is the returns to market power; and more as a quest for Ricardian rents, that is the returns to the resources which confer competitive advantage over and above the real costs of these resources” (Grant, 1991, p. 117).

Figure 2. Resources as the Basis of Profitability

Source: Grant (1991, p. 118)

2. Identifying Resources

For the first stage of procedure for strategy formulation in figure 1, Grant distinguishes “six major categories of resource have been suggested: financial resources, physical resources, human resources, technological resources, reputation, and organizational resources” (Grant, 1991, p. 119). These “resources are inputs into the production process – they are the basic units of analysis. The individual resources of the firm include items of capital equipment, skills of individual employees, patents, brand names, finance, and so on” (Grant, 1991, p. 118). “But, on their own, few resources are productive” (Grant, 1991, p. 119).

For identifying the productive resources, firm managers should answer 2 following questions:

• “What opportunities exist for economizing on the use of resources? The ability to maximize productivity is particularly important in the case of tangible resources such as plant and machinery, finance, and people. It may involve using fewer resources to support the same level of business, or using the existing resources to support a larger volume of business” (Grant, 1991, p. 119).
• “What are the possibilities for using existing assets more intensely and in more profitable employment? A large proportion of corporate acquisitions are motivated by the belief that the resources of the acquired company can be put to more profitable use. The returns from transferring existing assets into more productive employment can be substantial” (Grant, 1991, p. 119).

3. Identifying and Appraising Capabilities

In the second stage of procedure for strategy formulation, “a firm’s capabilities can be identified and appraised using a standard functional classification of the firm’s activities” (Grant, 1991, p. 120). The term of “core competencies” can be used to describe these central, strategic capabilities. They are “the collective learning in the organization, especially how to coordinate diverse production skills and integrate multiple streams of technology” (Grant, 1991, p. 121). “There is a key problem in appraising capabilities is maintaining objectivity”, where “organizations frequently fall victim to past glories, hopes for the future, and wishful thinking” (Grant, 1991, p. 121).

“The critical task is to assess capabilities relative to those of competitors. In the same way that national prosperity is enhanced through specialization on the basis of comparative advantages, so for the firm, a successful strategy is one which exploits relative strengths. Conversely, failure is often due to strategies which extend the firm’s activities beyond the scope of its capabilities” (Grant, 1991, p. 121).

Capabilities as Organizational Routines: In general, “the concept of organizational routines offers illuminating insights into the relationships between resources, capabilities, and competitive advantage:” (Grant, 1991, p. 122). “Organizational routines are regular and predictable patterns of activity which are made up of a sequence of coordinated actions by individuals. A capability is, in essence, a routine, or a number of interacting routines. The organization itself is a huge network of routines. These include the sequence of routines which govern the passage of raw material and components through the production process, and top management routines which include routines for monitoring business unit performance, for capital budgeting, and for strategy formulation” (Grant, 1991, p. 122).

Concerning “the relationship between resources and capabilities, there is no predetermined functional relationship between the resources of a firm and its capabilities”. “However, a key ingredient in the relationship between resources and capabilities is the ability of an organization to achieve cooperation and coordination within teams. This requires that an organization motivate and socialize its members in a manner conducive to the development of smooth-functioning routines” (Grant, 1991, p. 122)

Concerning the trade-off between efficiency and flexibility, “Routines are to the organization what skills are to the individual”. “Hence there may be a trade-off between efficiency and flexibility. A limited repertoire of routines can be performed highly efficiently with near-perfect coordination-all in the absence of significant intervention by top management. The same organization may find it extremely difficult to respond to novel situations” (Grant, 1991, p. 122).

Concerning the economies of experience, because “just as individual skills are acquired through practice over time, so the skills of an organization are developed and sustained only through experience. The advantage of an established firm over a newcomer is primarily in the organizational routines that it has perfected over time”. “However, in industries where technological change is rapid, new firms may possess an advantage over established firms through their potential for faster learning of new routines because they are less committed to old routines” (Grant, 1991, p. 123).

Concerning the complexity of capabilities, “organizational capabilities differ in their complexity. Some capabilities may derive from the contribution of a single resource”. “Other routines require highly complex interactions involving the cooperation of many different resources”. As Grant shall see, “complexity is particularly relevant to the sustainability of competitive advantage” (Grant, 1991, p. 123).

4. Evaluating the Rent-Earning Potential

The third stage of procedure for strategy formulation consist to evaluate the Rent-Earning Potential, including two contents: “first, the sustainability of the competitive advantage which resources and capabilities confer upon the firm; and, second, the ability of the firm to appropriate the rents earned from its resources and capabilities” (Grant, 1991, p. 123).

4.1. Evaluating the Rent-Earning Potential: Sustainability

Concerning the sustainability, the “Resource-based approaches to the theory of competitive advantage point towards four characteristics of resources and capabilities which are likely to be particularly important determinants of the sustainability of competitive advantage: durability, transparency, transferability, and replicability” (Grant, 1991, p. 124), that are complement to the VRIN model of Barney (1991) (in which the resources that create sustainable competitive advantage for the firm must be valuable, rare, inimitable and nonsubstitutable).

Durability: means that how long until a resource becomes obsolete or depreciate. “In the absence of competition, the longevity of a firm’s competitive advantage depends upon the rate at which the underlying resources and capabilities depreciate or become obsolete. The durability of resources varies considerably: the increasing pace of technological change is shortening the useful life-spans of most capital equipment and technological resources. On the other hand, reputation (both brand and corporate) appears to depreciate relatively slowly, and these assets can normally be maintained by modest rates of replacement investment” (Grant, 1991, p. 124).

“Firm capabilities have the potential to be more durable than the resources upon which they are based because of the firm’s ability to maintain capabilities through replacing individual resources (including people) as they wear out or move on” (Grant, 1991, p. 124). And, “one of the most important roles that organizational culture plays in sustaining competitive advantage may be through its maintenance support for capabilities through the socialization of new employees” (Grant, 1991, p. 125).

Transparency: “The firm’s ability to sustain its competitive advantage over time depends upon the speed with which other firms can imitate its strategy”. “If a firm wishes to imitate the strategy of a rival, it must first establish the capabilities which underlie the rival’s competitive advantage, and then it must determine what resources are required to replicate these capabilities. I refer to this as the “transparency” of competitive advantage” (Grant, 1991, p. 125).

“With regard to the first transparency problem, a competitive advantage which is the consequence of superior capability in relation to a single performance variable is more easy to identify and comprehend than a competitive advantage that involves multiple capabilities conferring superior performance across several variables” (Grant, 1991, p. 125).

“With regard to the second transparency problem, a capability which requires a complex pattern of coordination between large numbers of diverse resources is more difficult to comprehend than a capability which rests upon the exploitation of a single dominant resource” (Grant, 1991, p. 125). “Imperfect transparency is the basis […] of “uncertain imitability”: the greater the uncertainty within a market over how successful companies “do it,” the more inhibited are potential entrants, and the higher the level of profit that established firms can maintain within that market” (Grant, 1991, p. 125).

Transferability: Firm can proceed resources and capacities necessary for a competitive challenge in the markets for these inputs. However, “most resources and capabilities are not freely transferable between firms” (Grant, 1991, p. 126). Imperfections in transferability arise from several sources as follows:

• Geographical immobility: “The costs of relocating large items of capital equipment and highly specialized employees” (Grant, 1991, p. 126).
• Imperfect information: “Assessing the value of a resource is made difficult by the heterogeneity of resources (particularly human resources) and by imperfect knowledge of the potential productivity of individual resources” (Grant, 1991, p. 126).
• Firm-specific resources: For example: reputation; “an employee’s productivity is influenced by situational and motivational factors, then it is unreasonable to expect that a highly successful employee in one company can replicate his/her performance when hired away by another company” (Grant, 1991, p. 126).
• The immobility of capabilities: “Capabilities, because they require interactive teams of resources, are far more immobile than individual resources-they require the transfer of the whole team” (Grant, 1991, p. 126).

Replicability: “The second route, [with by market], by which a firm can acquire a resource or capability is by internal investment” (Grant, 1991, p. 127). However, “much less easily replicable are capabilities based upon highly complex organizational routines” (Grant, 1991, p. 127). “Even where replication is possible, the dynamics of stock- flow relationships may still offer an advantage to incumbent firms. Competitive advantage depends upon the stock of resources and capabilities that a firm possesses. In practice, “firms which possess the initial stocks of the resources required for competitive advantage may be able to sustain their advantages over time.” Among the stock-flow relationships they identify as sustaining advantage are: “asset mass efficiencies” – the initial amount of the resource which the firm possesses influences the pace at which the resource can be accumulated; and “time compression diseconomies” – firms which rapidly accumulate a resource incur disproportionate costs” (Grant, 1991, p. 127).

4.2. Evaluating Rent-Earning Potential: Appropriability

“The returns to a firm from its resources and capabilities depend not only on sustaining its competitive position over time, but also on the firm’s ability to appropriate these returns. The issue of appropriability concerns the allocation of rents where property rights are not fully defined. Once we go beyond the financial and physical assets valued in a company’s balance sheet, ownership becomes ambiguous. The firm owns intangible assets such as patents, copyrights, brand names, and trade secrets, but the scope of property rights may lack precise definition. In the case of employee skills, two major problems arise: the lack of clear distinction between the technology of the firm and the human capital of the individual; and the limited control which employment contracts offer over the services provided by employees. Employee mobility means that it is risky for a firm’s strategy to be dependent upon the specific skills of a few key employees. Also, such employees can bargain with the firm to appropriate the major part of their contribution to value added” (Grant, 1991, p. 128).

“Where ownership is ambiguous, relative bargaining power is the primary determinant of the allocation of the rents between the firm and its employees where. If the individual employee’s contribution to productivity is clearly identifiable, if the employee is mobile, and the employee’s skills offer similar productivity to other firms, then the employee is well placed to bargain for that contribution” (Grant, 1991, p. 129).

“The degree of control exercised by a firm and the balance of power between the firm and an individual employee depends crucially on the relationship between the individual’s skills and organizational routines. The more deeply embedded are organizational routines within groups of individuals and the more are they supported by the contributions of other resources, then the greater is the control that the firm’s management can exercise” (Grant, 1991, p. 128). So, “the less identifiable is the individual’s contribution, and the more firm-specific are the skills being applied, the greater is the proportion of the return which accrues to the firm” (Grant, 1991, p. 129).

5. Formulating Strategy

The fourth stage of procedure for strategy formulation bases on the above conclusions that “the firm’s most important resources and capabilities are those which are durable, difficult to identify and understand, imperfectly transferable, not easily replicated, and in which the firm possesses clear ownership and control”.

“Designing strategy around the most critically important resources and capabilities may imply that the firm limits its strategic scope to those activities where it possesses a clear competitive advantage” (Grant, 1991, p. 130). “The ability of a firm’s resources and capabilities to support a sustainable competitive advantage is essential to the time frame of a firm’s strategic planning process. If a company’s resources and capabilities lack durability or are easily transferred or replicated, then the company must either adopt a strategy of short-term harvesting or it must invest in developing new sources of competitive advantage”. “Where a company’s resources and capabilities are easily transferable or replicable, sustaining a competitive advantage is only feasible if the company’s market is unattractively small or if it can obscure the existence of its competitive advantage” (Grant, 1991, p. 130).

For the industries that competitive advantages based upon differentiation and innovation can be imitated, “firms must be concerned not with sustaining the existing advantages, but with creating the flexibility and responsiveness to that permits them to create new advantages at a faster rate than the old advantages are being eroded by competition” (Grant, 1991, p. 131).

“Transferability and replicability of resources and capabilities is also a key issue in the strategic management of joint ventures. Studies of the international joint ventures point to the transferability of each party’s capabilities as a critical determinant of the allocation of benefits from the venture” (Grant, 1991, p. 131).

6. Identifying Resource Gaps and Developing the Resource Base

“Resource-based approach to strategy is concerned not only with the deployment of existing resources, but also with the development of the firm’s resource base”. In the fifth stage of procedure for strategy formulation, “this includes replacement investment to maintain the firm’s stock of resources and to augment resources in order to buttress and extend positions of competitive advantage as well as broaden the firm’s strategic opportunity set. This task is known in the strategy literature as filling “resource gaps” (Grant, 1991, p. 131).

Also, “through pursuing its present strategy, a firm develops the expertise required for its future strategy […] as “dynamic resource fit”“ (Grant, 1991, p. 132). “The development of capabilities which can then be used as the basis for broadening a firm’s product range is a common feature of successful strategies of related diversification” (Grant, 1991, p. 132). In addition, “in order both to fully exploit a firm’s existing stock of resources, and to develop competitive advantages for the future, the external acquisition of complementary resources may be necessary” (Grant, 1991, p. 133).

Discussion and Conclusion

The article focuses on the Resource-Based Theory of Competitive Advantage by clarifying resources, capabilities and strategic formulation, as well as relationships between resources, capabilities, competitive advantage, and profitability. Grant (1991) concludes that “The resources and capabilities of a firm are the central considerations in formulating its strategy: they are the primary constants upon which a firm can establish its identity and frame its strategy, and they are the primary sources of the firm’s profitability” (p.133). Designing a strategy based on the most important resources and capabilities may imply that a firm limits its strategic scope to activities for which it has a clear competitive advantage. This article on Resource-Based Theory of Competitive Advantage contributes as foundation of the resource-based view of competitive advantage, especially for strategy formulation by developing a practical framework of a resource-based approach to strategy analysis.

Source: Grant RM. (1991), “The Resource-Based Theory of Competitive Advantage: Implications for Strategy Formulation”, California Management Review, 33 (3), p.114-135, https://doi.org/10.2307/41166664