Chapter 11

Sustaining competitive advantage

 Sustaining Competitive Advantage
• In a perfectly competitive market, price competition
will ensure that competitive advantage will not be
sustained
• Even without perfect competition, sustaining
competitive advantage is not easy
• Rivals can imitate a successful firm’s product or
neutralize the firm’s advantage through new
technologies, products and business practices

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 Sustainability with Monopolistic Competition

• In monopolistic competition, firms sell horizontally differentiated

products to consumers who differ in their tastes
• Each seller faces a downward sloping demand curve due to product
differentiation and sets the price above marginal cost
• Entrants can slightly differentiate their products from the incumbents’
and create their own niche
• Free entry will cut into the market share of the incumbents and make
the economic profit become zero (while price > marginal cost)
• Profitability cannot be sustained unless entry is deterred

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 Threats to Sustainability Regardless of Market Structure

• Even when incumbents can deter entry, powerful

suppliers/buyers can threaten profitability regardless of
market structure
• Entry, imitation and price competition will force
economic profits to eventually go to zero
• Regardless of where a given firm is today, with
passage of time its profits will converge to competitive
levels

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Life Cycle of Competitive Advantage

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 Sustaining Competitive Advantage

• Competitive advantage is sustainable if it persists

despite competitors’ efforts to duplicate it or neutralize
it
• Sustainability can occur in two ways
1. Firms may differ with respect to resources and
capabilities and the differences persist
2. Isolating mechanisms (analogous to barriers to
entry) may work to protect the competitive
advantage of firms

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1. Resource Based Theory of the Firm

• Resource based theory of the firm explains sustained

competitive advantage in terms of heterogeneity in
resources and capabilities

• Scarce resources and capabilities that are critical for

value creation can be imperfectly mobile and cannot be
acquired in the open market

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Resource Based Theory of the Firm

• Resources may be non-tradable (Example: Customer

loyalty built through a frequent flyer program)

• Resources may be relationship specific (Example:

Landing slots in an airline’s hub)

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2. Isolating Mechanisms

• Isolating mechanisms are to firms what entry barriers

are to industries

• Two distinct types of isolating mechanisms can be

observed
1) Impediments to imitation
2) Early mover advantage

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 1) Impediments to Imitation

• These mechanisms impede the potential entrants from

duplicating the resources and capabilities of the
incumbent firm

• Four important types of impediments exist

• Legal restrictions
• Superior access to inputs/customers
• Market size and scale economies
• Intangible barriers (causal ambiguity, social complexity and historical causes)

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2) Early-Mover Advantage

Four different isolating mechanisms fall under the

category of early mover advantage
a) Learning curve
b) Reputation and buyer uncertainty
c) Switching costs
d) Network Effects

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 a) Learning Curve

• A firm that sells more than its competitors in the early

periods moves farther down the learning curve and
achieves lower unit costs than its rivals

• The lower unit cost allows the firm to undercut its

rivals, increase volume and further move down the
learning curve

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 b) Reputation and Buyer Uncertainty

• For experience goods, a firm’s reputation for quality

provide a significant early mover advantage

• Pioneering brands can influence the formation of

consumer preferences and present the attributes of the
brand as the ideal for the product category

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c) Switching Costs

• Consumers who make brand specific investments (for

example, learning to use a software program) can end
up with large switching costs

• Frequent buyer points in grocery stores and frequent

flyer miles from airlines are means of increasing
switching costs

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d) Network Effects

• Product shows network effects if customer values the

product depending on how many others are using the
product
• The usefulness of joining a telephone network depends
on the number of customers already on it (actual
networks)
• Use of complementary goods may create virtual
networks

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Virtual Network

• In virtual networks, consumers are not physically

linked
• Increase in the number of the consumers increases the
demand for complementary goods
• Supply of complementary goods enhances the value of
the network (Example: computer operating system and
application software)

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Summary CA and sustainability

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Dynamic Capabilities

Firms with dynamic capabilities can adapt their

resources and capabilities and exploit
opportunities

• In turbulent environments
• Through an embedded system and culture in order to
innovate and adapt continuously

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 Factors that Limit Dynamic Capabilities

• A firm’s dynamic capabilities are inherently limited

because of
• the path dependence of competitive advantage
• limited availability of complementary assets and
• “windows of opportunity” that do not stay open for
long

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Path Dependence

• Firm’s routines can only change incrementally and

cannot have a clean break from the past
• The new source of advantage will mostly be path
dependent
• With threats from new entrants, even small path
dependencies can have major implications for the
firm’s competitiveness

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Sources for Competitive advantage and Sustaining CA for
clusters and their firms: the regional/national environment
or “Diamond” and the concept of “Shared value”

(additional slides on Porter’s Diamond framework and Creating

Shared Value)
“What creates prosperity?”

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Table of content

1. Frameworks supporting competitiveness analysis

2. Determinants of Competitiveness “The Core Framework”
A. Endowments
B. Macroeconomic competitiveness
C. Microeconomic competitiveness
3. Creating Shared Value

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 1. Frameworks supporting competitiveness analysis

• 5-forces analysis: Porter Five Forces Model lays out

the five forces that directly influence
the competitiveness of a (small) business in an
industry/market with regard to industrial structure and
profit margins. (Porter, 1985 and 2008)
• Resource-based view: is a framework to determine the
strategic resources with the potential to
deliver competitive advantage to a firm = inside-out
analysis (Barney, 1991) Both help to
analyse which
• Diamond framework: Porter's Diamond (1990) Model
details the four factors that influence competitive
the competitive environment of a nation and its advantage a firm
has over its rivals
industries, which impacts businesses’ competitiveness (if
rivals are influences by other diamond models, so from
other regions or countries) = outside-in analysis.

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2. Determinants of Competitiveness “The Core Framework”

“What determines competitiveness?”

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 A. Endowments

• Endowments are elements a country inherits, including natural

resources, geographical location, population and land area, .. etc.

• Endowments create a foundation for prosperity, but true prosperity

arises from productivity in the use of endowments

Ø Endowments can help, but are not sufficient to create

competitiveness

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2. Determinants of Competitiveness “The Core Framework”

“What determines competitiveness?”

27
 B. Macroeconomic competitiveness

1. Sound monetary and fiscal policy:

• Fiscal policy refers to the use of government spending and tax policies
to influence the economy
Ø “Normal” levels of debt seem to be sustainable, but very high levels of debt
will eventually negatively impact growth.

• Monetary policy consists of the management of money supply and

interest rates, aimed at achieving macroeconomic objectives such as
low inflation rates.
Ø High inflation rates reduce the value of the currency and reduce the
purchasing power of the citizens.

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B. Macroeconomic competitiveness

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 B. Macroeconomic competitiveness
2. Human Development and Effective Public Institutions:

• Human Development: Basic education, health care, equal opportunity

• Rule of Law: Property rights, personal security, and personal rights

• Government Institutions: Stable and effective political and governmental organizations

and processes

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2. Determinants of Competitiveness “The Core Framework”

“What determines competitiveness?”

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 C. Microeconomic competitiveness
1. Sophistication of company operations and strategy
• “All wealth is created within the firm at the mirco-level”
= The level of the firm (company-level) and the environment surrounding the businesses

Ø Sound macroeconomic policies are necessary but not sufficient to create

competitiveness.

Ø The competitiveness of the economy is the reflection of the competitiveness of the

firms within that economy:

o The internal skills, capabilities, and management practices that enable companies
to attain the highest level of productivity and innovation possible

o Firms are competitive when being able to achieve competitive advantage

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 C. Microcompetitiveness
1. Sophistication of company operations and strategy
• How to achieve competitive advantage?

1. Differentiation: Firm is able to produce very unique products/services

or products/services with higher quality (value)
compared to competitors, for which it can charge a
premium price.

2. Lower cost: Firm is able to operate very efficiently which results

in lower costs compared to competitors.

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 C. Microcompetitiveness
1. Sophistication of company operations and strategy
Ø The value chain explains how functional an organization
is, how it manages all the different activities within the
organization.

Ø Companies have to find ways to improve these activities,

find better ways to perform these activities compared to
competitors in order to be able to achieve competitive
advantages.

Ø Companies should try to find ‘key resources’ within their

value chain (which are tangible or intangible assets,
capabilities that are superior compared to those of the
competition).
o Criteria: VRIN
o Key resources are the most important internal strengths
(‘the source’) to create a sustained competitive advantages

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 C. Microcompetitiveness
2. Quality of the Business Environment
Ø Porter’s Diamond Model (1990):

• Michael Porter argues the competitive advantage of a firm or cluster

originates in the local environment in which the firm or the cluster
is based

• Porter identifies 4 attributes in a firm’s business environment that

promote or impede a firm’s ability to achieve competitive advantage
in global markets:

o Factor Conditions
o Demand Conditions
o Firm Strategy, Structure and Rivalry
o Related and Supporting Industries

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 C. Microcompetitiveness
2. Quality of the Business Environment
Ø Porter’s Diamond Model (1990):

1. Factor conditions:

• The term ‘factor conditions’ refers to the factors of production that are needed to compete in a
particular industry/cluster

• Factor conditions can be divided into two main groups:

o Basic/general factors:
ü Factors that are easy for a company to create and maintain since they are commonly
readily available
ü These include among others capital, physical resources, human resources/labor, raw
material, land and infrastructure
o Specialized factors:
ü Factors that are adapted to the particular needs of the industry (e.g. access to
specialized inputs of very high quality, very specialized skills or knowledge)

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 C. Microcompetitiveness
2. Quality of the Business Environment
Ø Porter’s Diamond Model (1990):

2. Demand Conditions:

• These conditions include the size, the growth and the nature (sophistication) of the home demand for
the firm’s product

• Even in a world in which markets continuously become more global, the importance of home demand
remains crucial

• Sophisticated demand conditions on the domestic market are the main drivers of innovation and
quality improvement of a firm and their distributed products.

o Highly sophisticated buyers demand high standards in terms of service, features and quality

o A sophisticated home demand pushes companies to achieve competitive advantages which are more
sophisticated than those of their foreign rivals

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 C. Microcompetitiveness
2. Quality of the Business Environment
Ø Porter’s Diamond Model (1990):

3. Strategy, Structure and Rivalry:

• Competitiveness is linked to the strategies and structures of the companies operating in a particular
industries:

o Different strategies and structures may prove to be successful in different industries, there does
not exist one single strategy or structure that is ‘best for all’.

o Companies have to find the most suitable structure and strategy within a certain industry to be able
to achieve competitive advantages

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 C. Microcompetitiveness
2. Quality of the Business Environment
Ø Porter’s Diamond Model (1990):

3. Strategy, Structure and Rivalry:

• Rivalry in the home market is another important part of the competitive context:

o Porter places particular emphasis on the role of ‘intense domestic rivalry’.

ü Firms that are able to survive “severe” local competition prove to be more efficient and more
innovative than are international rivals competing within more softer local conditions.

ü Domestic rivalry has a greater influence than international competition due to the fact that home-
based rivalry often takes place on a common national platform whereby the competition is
perceived as more emotional and personal.

Ø Domestic rivalry thus provides a greater stimulus for upgrading and creating competitive advantage
than international rivalry.

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 C. Microcompetitiveness
2. Quality of the Business Environment
Ø Porter’s Diamond Model (1990):

4. Supporting and related industries:

• Companies that operate in a home market with a strong base of internationally competitive suppliers and
supporting industries are more likely to achieve competitive advantages

• Although many inputs are mobile, exchanging ‘key inputs’ (e.g. scarce production know-how), does require
geographic proximity:

Ø The closer the physical distance and the relationship between the suppliers and end users, the more
the products and services provided by one company will meet the needs of the other company and the
more efficient the exchange of ideas and information will be.

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 C. Microcompetitiveness
3. State of cluster development
Ø What’s a cluster?

• A cluster is a geographically proximate group of interconnected companies and associated institutions

in a particular field that are linked by commonalities or complementarities.

• Clusters take varying forms depending on their depth and sophistication. Most include:

o End-product companies or services

o Suppliers of specialized inputs, components, machinery and services
o Downstream industries (e.g. channels or costumers)
o Supporting and related industries (industries that pass through a common channel or produce
complementary products or services, or use similar specialized inputs, technologies, know-how.. etc.)
o Specialized infrastructure providers
o Government agencies
o Other institutions offering specialized training, education, information, research or technical support
(universities, training providers, research institutes)
o Trade associations and other collective private sector bodies (institutions for collaboration) that support
cluster members

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 C. Microcompetitiveness
3. State of cluster development

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 C. Microcompetitiveness
3. State of cluster development
Ø Why are clusters important?

1. Clusters increase productivity and operational efficiency:

• Firms located in a cluster have efficient access to specialized inputs, services and employees (‘local’
outsourcing)
ü Lower transaction costs compared with ‘distant’ outsourcing
ü Close relationships with local suppliers offer cost and quality advantages

• Firms located within clusters have better access to information or at a lower cost
ü More rapid diffusion of knowledge and best practices

• Firms located within clusters have access to institutions and public goods:
ü Public and private investments from local institutions are more aligned with the needs of the cluster,
which makes it possible for firms to access benefits at very low costs.
ü Clusters transfer ‘key inputs’ into public goods

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 C. Microcompetitiveness
3. State of cluster development
Ø Why are clusters important?

2. Clusters stimulate and enable innovations :

• Incentives and performance measurement:

ü Local rivalry motivates companies to innovate because of “the ease of comparison” (equal local
conditions)
ü The pride and desire to perform better than the competitor motivate and stimulate companies to innovate

• Density enables recognition of innovation opportunities:

ü Firms within a cluster benefit from the concentration of firms and institutions with knowledge e.g.
changes in buyer needs, evolving technologies, .. etc. which enables them to more clearly and rapidly
identify new innovation opportunities

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 C. Microcompetitiveness
3. State of cluster development

“What allowed Finland to become the world-leading nation in the mobile communications cluster?”

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 C. Microcompetitiveness
3. State of cluster development
• Mobile Telecommunications (Finland)
Factor Conditions
• Huge R&D investments: Investment in IT & telecom
related R&D (know-how)
• Universities and research institutions providing
specialized knowhow in telecom (12 Universities,
many research centres in Finland) (specialized
workforce)
Firm strategy, structure and rivalry
• Policy in favour of open competition:
ü Finnish telephone network was never
monopolized (which was mostly the case in
other countries)
ü Fierce competition for mobile service
providers, mobile phone manufacturers, .. etc.
ü Threat of nationalizing stimulated private
operators to upgrade their technology
Related and supporting Industries
• Radio-technology development
• Internet (early adopter)
Demand conditions
• Finns: Early IT adopters
• Sophisticated demand (low population density
=> expensive fixed line)
ü The use of mobile phones was highest in
the Nordic countries; Highest penetration
rate compared to other European
countries
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 3. Creating Shared Value (CSV)
• At a very basic level, the competitiveness of a company and the health of the communities
around it are closely intertwined:
Ø There is a clear link between progress in society and the productivity of firms
“Creating shared value is thinking about new ways to create economic value, competitive
advantages and economic success. It’s about rethinking what capitalism is, about doing
business in a whole different way by understanding that there are huge opportunities to
make profit for companies while also having fundamental impact on major issues of
society.”
• Creating Shared Value = Creating economic value in a way that also creates value for society
by addressing the needs and challenges of society
• CSV is rooted in the idea that economic value for companies and societal value are not
mutually exclusive, but are, instead, reinforcing: a company can create shared value - that is
economic value for itself as well as societal value - by integrating societal impact into the core
of the business.
 3. Creating Shared Value (CSV)
“CSR is about responsibility; while CSV is about
≠ Corporate social responsibility (CSR) creating value..”

• Most companies are stuck in a “social responsibility”

mind-set in which societal issues are at the
periphery, not the core.

• Shared value is not social responsibility, or even

philanthropy, but a new way to achieve economic
success. It is not on the margin of what companies
do but at the center.

• Corporate responsibility initiatives— are mostly a

reaction to external pressures have emerged largely
to improve firms’ reputations and are mostly treated
as a necessary expense. Anything more is seen by
many as an irresponsible use of shareholders’
money
3. Creating Shared Value (CSV)
 3. Creating Shared Value (CSV)

Examples (1):

“Google’s investing a huge amount of money in the working conditions and satisfaction of
employees: luxury offices, trainings, free gourmet cafeteria for their employees, free gym
membership and intramural sports, and rights for a 3-month leave for employees to give
time to travel”
 3. Creating Shared Value (CSV)

Examples (2):

“Tesla is accelerating the world's transition to sustainable

energy with electric cars, solar panels and renewable energy
solutions for homes and businesses”
 3. Creating Shared Value (CSV)

Examples (3):

“Panos will once again sell colorful donuts for the benefit of the
Brussels vzw ToekomstATELIERdelAvenir (TADA). The
sandwich bar will donate 30 cents to TADA per donut sold.”
 3. Creating Shared Value (CSV)

Examples (4): “Novartis saw an opportunity in selling their pharmaceuticals in rural India, where 70% of
the population lives.

The obstacle was not the prices they charged but the social conditions in the region:
healthcare providers with no healthcare training, and tens of thousands of local clinics
without a reliable supply chain.

Novartis saw these social problems as business opportunities: they hired hundreds of
community health educators, held training camps for providers, and built up a distribution
system for 50,000 rural clinics”