Resource-based theory, like any theory, draws on prior theoretical work in developing its predictions and prescriptions. In the case of resource- based theory, important prior theoretical work comes from at least four sources: (a) the traditional study of distinctive competencies, (b) Ricardo’s analysis of land rents, (c ) Penrose (1959), and (d) the study of the antitrust implications of economics. Each of these prior theories is briefly discussed in turn.
1. TRADITIONAL WORK ON DISTINCTIVE COMPETENCIES
For sometime now, scholars have tried to answer the question, ‘Why do some firms persistently outperform others?’ Before more economic approaches to answering this question began to dominate this discussion (beginning with Porter 1979), this effort focused on what were known as a firm’s distinctive competencies. Distinctive competencies are those attributes of a firm that enable it to pursue a strategy more efficiently and effectively than other firms (Learned et al. 1969; Hrebiniak and Snow 1982; Hitt and Ireland 1985, 1986).
Among the first distinctive competencies identified by those trying to understand persistent performance differences between firms was general management capability. General managers are managers in firms who have multiple functional managers reporting to them. Typically, general man- agers have full accounting profit and loss responsibility in a firm. And when they do not have this responsibility, general managers are likely to lead cost centers. Whether profit center or cost center managers, general managers can have a significant impact on the strategies a firm decides to pursue and on the ability of a firm to implement the strategies it develops.
Given the impact that general managers can have on a firm’s strategy, it naturally follows that firms that have ‘high-quality’ general managers will usually outperform firms that have ‘low-quality’ general managers. In this context, choosing high-quality general managers is the most important strategic choice that can be made by a firm, and training high-quality gen- eral managers is the most important mission of business schools (Gordon and Howell 1959; Pierson 1959).
The emphasis on general managers as distinctive competencies was important not only in the field of strategic management, but in closely related fields as well. For example, through the early 1950s, the study of business history was confined largely to the study of individual business people and firms. Traditionally, business historians were reluctant to gen- eralize beyond individual biographies and firm histories to discuss broader trends in the economy that may have led to different forms of business organization, let alone the efficiency characteristics of these different orga- nizational forms. For business history, like strategic management, explana- tions of the growth and success of firms were no more than the biographies of those who created and managed those firms (Chandler 1984).
Indeed, there is little doubt that general managers can have a very sig- nificant impact on firm performance (Mackey 2006). There continues to be a tradition of leadership research that examines the skills and abili- ties of leaders and documents their impact on the performance of firms (Finkelstein and Hambrick 1996). Some of the best of this work focuses on general managers as change agents and emphasizes the impact that these ‘transformational leaders’ can have on a firm’s performance (Tichy and Devanna 1986). Most observers can point to specific general managers who have been instrumental in improving the performance of the firms within which they work. The continuing popularity of books, articles, and seminars (e.g. Bennis 1989, 2003; Covey 1989; Kanter, Stein, and Jick 1992; Pfeffer 1994; Kotter 1996; Ulrich 1997; Kotter and Cohen 2002; Zenger and Folkman 2002; Finkelstein 2003) that describe the attributes of individuals that enable them to become leaders in their firms is a testament to the popularity of the belief that leaders, and in particular, general managers, are the most important determinant of a firm’s performance.
Unfortunately, there are some very important limitations of this general management approach to explaining persistent performance differences among firms. First, even if one accepts the notion that general management decisions are the most important determinants of firm performance, the qualities and characteristics that make up a high-quality general manager are ambiguous and difficult to specify. In fact, the qualities of a ‘good’ general manager are just as ambiguous as the qualities of good leaders (Yukl 1989). In the case literature, general managers with widely different styles are shown to be quite effective. For example, John Connelly, former president of Crown Cork & Seal, was intensely involved in every aspect of his organization (Hamermesh and Rosenbloom 1989). Other successful chief executive officers (CEOs) tend to delegate much of the day-to-day management of their firms (Stogdill 1974). Yet both types of general man- agers can be very effective.
Second, general managers are an important possible distinctive com- petence for an organization, but they are not the only such competence. An exclusive emphasis on general managers as an explanation of supe- rior performance ignores a wide variety of firm attributes that may be important for understanding firm performance. For example, it may be the case that a firm possesses very highly skilled general managers but lacks the other resources it needs to gain performance advantages. Or it may be the case that a firm has other resources that enable it to gain per- formance advantages, even though it does not have unusual managerial talent. In the end, general managers in organizations are probably similar to baseball managers: they receive too much credit when things go well and too much blame when things go poorly.
A sociologist named Phillip Selznick was among the first scholars to recognize that general management skill was only one of several distinctive competencies that a firm might control. In a series of articles and books, culminating in his book Leadership and Administration (Selznick 1957), Selznick examined the relationship between what he called institutional leadership and distinctive competence.
According to Selznick, institutional leaders in organizations do more than carry out the classic general management functions of decision- making and administration. In addition, they create and define an orga- nization’s purpose or mission (Selznick 1957). In more contemporary terms, institutional leaders help create a vision for an organization around which its members can rally (Finkelstein and Hambrick 1996; Collins and Porras 1997). Institutional leaders also organize and structure a firm so that it reflects this fundamental purpose and vision. With this organization in place, Selznick suggests, institutional leaders then focus their attention on safeguarding a firm’s distinctive values and identity—the distinctive vision of a firm—from internal and external threats. This organizational vision, in combination with organizational structure, helps define a firm’s distinctive competencies—those activities that a particular firm does better than any competing firms.
Selznick did not go on to analyze the competitive or performance impli- cations of institutional leadership as a distinctive competence in any detail. However, it is not difficult to see that firms with distinctive competencies have strengths that may enable them to obtain superior performance, and that leaders as visionaries and institution builders, rather than just as decision-makers and administrators, may be an important source of this performance advantage (Selznick 1957).
Selznick’s analysis of distinctive competence has much to recommend it, but it has limitations as well. Most important of these is that Selznick’s analysis focuses only on senior managers (his institutional leaders) as the ultimate source of competitive advantage for a firm, and on a single tool (the development of an organizational vision) that senior managers can use to create distinctive competencies. Although these are important possible explanations of performance differences across firms, they are not the only possible such explanations.
2. RICARDO’S ANALYSIS OF LAND RENTS
Research on general managers and institutional leaders as possible expla- nations of differences in firm performance focuses exclusively on top man- agers, but the next major influence on the evolution of resource-based theory—Ricardo’s analysis of land rents—traditionally included little or no role for managers as possible sources of superior performance. Instead, David Ricardo was interested in the economic consequences of the ‘orig- inal, unaugmentable, and indestructible gifts of Nature’ (Ricardo 1817). Much of this early work focused on the economic consequences of owning land.
Unlike many factors of production, the total supply of land is relatively fixed and cannot be significantly increased in response to higher demand and prices. Such factors of production are perfectly inelastic, since their quantity of supply is fixed and does not respond to price changes. In these settings, it is possible for those that own higher-quality factors of production with inelastic supply to earn an economic rent. As suggested earlier, an economic rent is a payment to an owner of a factor of pro-duction in excess of the minimum required to induce that factor into employment.
Ricardo’s argument concerning land as a factor of production is sum- marized in Figure 1.1. Imagine that there are many parcels of land suit- able for growing wheat. Also suppose that the fertility of these different parcels of land varies from high fertility (low costs of production) to low fertility (high costs of production). The long-run supply curve for wheat in this market can be derived as follows: at low prices, only the most fertile land will be cultivated; as prices rise, production continues on the very fertile land and additional crops are planted on less fertile land; at still higher prices, even less fertile land will be cultivated. This analysis leads to the simple market supply curve presented in panel A of Figure 1.1. Given market demand, P ∗ is the market-determined price of wheat in this market.
Figure 1.1. Ricardian rents and the economics of land with different levels of fertility
Now consider the situation facing two different kinds of firms. Both of these firms follow traditional profit-maximizing logic by producing a quantity (q ) such that marginal cost equals marginal revenue. How- ever, this profit-maximizing decision for the firm with less fertile land (in panel B of Figure 1.1) generates zero economic profit. On the other hand, the firm with more fertile land (in panel C of Figure 1.1) has average total costs less than the market-determined price and thus is able to earn an economic rent.
In traditional economic analysis, the economic rent earned by the firm with more fertile land should lead other firms to enter into this market, to obtain some land and begin production of wheat. However, all the land that can be used to produce wheat in a way that generates at least zero economic profits given the market price P ∗ is already in production. In particular, there is no more very fertile land left, and fertile land (by assumption) cannot be created. This is what is meant by land being inelastic in supply. Thus the firm with more fertile land and lower production costs has a higher level of performance than farms with less fertile land, and this performance difference will persist, since fertile land is inelastic in supply. Of course, at least two events can threaten this sustained performance advantage. First, market demand may shift down and to the left. This would force firms with less fertile land to cease production, and it would also reduce the economic rent of the firm with more fertile land. If demand shifted far enough, this economic rent may disappear altogether.
Second, firms with less fertile land may discover low-cost ways of increasing their land’s fertility, thereby reducing the performance advan- tage of the firm with more fertile land. For example, firms with less fertile land may be able to use inexpensive fertilizers to increase their land’s fertility, and they may be able to reduce their production costs to be closer to the costs of the firm that had the more fertile land initially. The existence of such low-cost fertilizers suggests that though land may be in fixed supply, fertility may not be. If enough firms can increase the fertility of their land, then the rent originally earned by the firm with the more fertile land will disappear, and firms competing in this market can expect to earn only zero economic rents.
Traditionally, most economists have implicitly assumed that relatively few factors of production have inelastic supply. Most economic models presume that if prices for a factor rise, more of that factor will be pro- duced, increasing supply and ensuring that suppliers will earn only normal economic rents. However, resource-based theory suggests that numerous resources used by firms are inelastic in supply and are possible sources of economic rents. Thus although labor per se is probably not inelastic in supply, highly skilled and creative laborers may be. Although individual managers are probably not inelastic in supply, managers who can work effectively in teams may be. And although top managers may not be inelastic in supply, top managers who are also institutional leaders (as suggested by Selznick and others) may be. Firms that own (or control) these kinds of resources may be able to earn economic rents by exploiting them.
One issue that Ricardo did not examine but which becomes very impor- tant in resource-based theory is: ‘How did farms with more fertile land end up with that land?’ Or, more precisely, ‘What price did farms with more fertile land pay for that land?’ Resource-based theory suggests that if the price that farmers pay to gain access to more fertile land anticipates the economic rents that that land can create, then the value of those rents will be reflected in that price, and even though it may appear that farms with more fertile land are outperforming farms with less fertile land, this is not the case. This argument, originally developed by Barney (1986a), is discussed in more detail in Chapter 2.
3. PENROSE
In 1959, Edith Penrose published a book titled The Theory of the Growth of the Firm. Penrose’s objective was to understand the process through which firms grow and the limits of growth. Traditional economic models had analyzed firm growth using the assumptions and tools of neoclassical microeconomics (Penrose 1959). Most important of these, for Penrose, was the assumption that firms could be appropriately modeled as if they were relatively simple production functions. In other words, traditional economic models assumed that firms simply observed supply and demand conditions in the market and translated these conditions into levels of production that maximized firm profits (Nelson and Winter 1982).
This abstract notion of what a firm is, had, and continues to have utility in some circumstances. However, in attempting to understand constraints on the growth of firms, Penrose (1959) concluded that this abstraction was not helpful. Instead, she argued that firms should be understood, first, as an administrative framework that links and coordinates activities of numerous individuals and groups, and second, as a bundle of productive resources. The task facing managers was to exploit the bundle of produc- tive resources controlled by a firm through the use of the administrative framework that had been created in a firm. According to Penrose, the growth of a firm is limited (a) by the productive opportunities that exist as a function of the bundle of productive resources controlled by a firm, and (b) the administrative framework used to coordinate the use of these resources.
Besides looking inside a firm to analyze the ability of firms to grow, Penrose made several other contributions to what became resource-based theory. First, she observed that the bundles of productive resources con- trolled by firms could vary significantly by firm—that firms, in this sense, are fundamentally heterogeneous even if they are in the same industry.
Second, Penrose adopted a very broad definition of what might be con- sidered a productive resource. Where traditional economists (including Ricardo) focused on just a few resources that might be inelastic in supply (such as land), Penrose began to study the competitive implications of such inelastic productive resources as managerial teams, top management groups, and entrepreneurial skills. Finally, Penrose recognized that, even within this extended typology of productive resources, there might still be additional sources of firm heterogeneity. Thus in her analysis of entre- preneurial skills as a possible productive resource, Penrose observed that some entrepreneurs are more versatile than others, some are more ingen- ious in fund-raising, some are more ambitious, and some exercise better judgment.
4. THE ANTITRUST IMPLICATIONS OF ECONOMICS
As a field of study, economics has always been interested in the social policy implications of the theories it develops. One of the most impor- tant ways that economics has been used to guide social policy is in the area of antitrust regulation. Based on the conclusion that social welfare is maximized when markets are perfectly competitive, economists have developed various techniques for describing when an industry is less than perfectly competitive, what the social welfare implications of this imper- fect competition are, and what remedies, if any, are available to enhance competitiveness and restore social welfare (Scherer 1980).
One of the most obvious ways that an industry may be less than per- fectly competitive is if that industry is dominated by only a single firm (the condition of monopoly) or by a small number of cooperating firms (the condition of oligopoly). In both these settings, according to traditional economic analyses, prices will be higher than what would exist in a com- petitive market, and thus social welfare will be less than what would be the case in that more competitive market.
This approach to analyzing social welfare and antitrust developed into the ‘structure-conduct-performance’ (SCP) paradigm mentioned earlier in this chapter (Bain 1956). The SCP paradigm suggests that the structure of a firm’s industry defines the range of activities that a firm can engage in— so-called conduct—and, in turn, the performance of firms in that industry. Firms that operate in industries with structures that are different from the perfectly competitive ideal in important ways may have conduct options that will enable them to obtain levels of performance that reduce social welfare in significant ways. In the extreme, this view of the determinants of firm performance suggests that any persistent superior performance enjoyed by a firm must, by definition, reflect noncompetitive firm conduct that is antithetical to social welfare.
Beginning in the early 1970s, a small group of antitrust scholars began to question the SCP and related approaches to antitrust regulation. Among the first of these was Harold Demsetz. In 1973, Demsetz published an arti- cle in the Journal of Law and Economics that argued that industry structure was not the only determinant of a firm’s performance. Even more funda- mentally, Demsetz (1973) argued that a firm earning persistent superior performance could not be taken as prima facie evidence that that firm was engaging in anticompetitive activities. Indeed, anticipating resource- based theory, Demsetz argued that some firms might enjoy persistent performance advantages either because they are lucky or because they are more competent in addressing customer needs than other firms. Demsetz (1973: 3) argues
Superior performance can be attributed to the combination of great uncer- tainty plus luck or atypical insight by the management of a firm … Even though the profits that arise from a firm’s activities may be eroded by competitive imitation, since information is costly to obtain and techniques are difficult to duplicate, the firm may enjoy growth and a superior rate of return for some time . . .
Superior ability also may be interpreted as a competitive basis for acquiring a measure of monopoly power. In a world in which information is costly and the future is uncertain, a firm that seizes an opportunity to better serve customers does so because it expects to enjoy some protection from its rivals because of their ignorance of this opportunity or because of their inability to imitate quickly.
While developed in the context of discussions of antitrust regulation, Demsetz clearly anticipates some important tenets of resource-based the- ory. It is interesting that Demsetz develops his arguments as an alternative to SCP-based theories of antitrust. And since Porter (1979, 1980) traces the theoretical roots of his work back to the SCP paradigm, in an important sense, Demsetz also anticipates the theoretical debates that have emerged between resource-based theory and the Porter framework.
Thus we see that resource-based theory, far from emerging out of nowhere to become an important explanation of persistent superior firm performance in the field of strategic management, has deep theoretical roots in both economics and sociology. These theoretical streams have been united and modified to develop what has become resource-based theory.
Source: Barney Jay B., Clark Delwyn N. (2007), Resource-Based Theory: Creating and Sustaining Competitive Advantage, Oxford University Press; Illustrated edition.