The Resource Based View of the Firm

B189Simon Rodan, PhD

Recap

• Three ‘levers’ involved in generating

economic profit:

– Creating value

– Appropriating value (raising prices)

– Managing (reducing) costs

• Profit (producer surplus) = (price –

cost)*quantity

The RBV

• RBV helps us answer the question:“What kind of resources does a firm need to create and appropriate value over time?”

• It is a theory of sustainable competitive advantage

The Object of Strategic Analysis

• Explain why a firm or a group of firms is making above normal returns

– i.e. More than their long run average

costs

Normal returns

• Revenue = long run average costs• Assumes resources are optimally

deployed (no opportunity costs)• Normal returns =>economic profit is

zero• Above normal returns = economic

profit• Accounting profit may be larger than

economic profit since it ignores opportunity cost of misused resources

Why are firms making profits?

• Two possible explanations

– It’s something to do with the industry

in which they operate

External analysis – Porter’s 5 Forces

– It’s something the firm has

Internal analysis, the RBV

The Resource Based View

• Empirical observation: some firms in ‘competitive industries’ make above normal returns– First explanation proposed - uncertain imitability

(Lipmann & Rumelt, 1982)

• Empirical study: what accounts for variation in performance, firms or industries?(Rumelt, 1992)

• ‘Market’ for strategic factors:– Efficient Market Hypothesis (Barney, 1986)

– Implications for inimitable resources (Dierickx & Cool, 1989)

• What gives a firm a sustainable competitive advantage?– Properties of resources that support profitable value creating

activity

Classic microeconomic assumptions

• Firms in competitive markets are identical– Either at inception– Or adopt and acquire identical

production technologies

• All firms sell the same number of units, at the same price and make the same profit

A Puzzle…

• In some highly competitive industries some firms are making above normal returns

• Some industries are concentrated despite having no obvious barriers to entry

Uncertain imitability

• Two assumptions

– Firms are all different in some way

– Firms cannot figure out exactly what other firms do

and why they are ‘better’ (uncertain imitability)

• Theses two assumptions are all that are

needed to explain:

– Concentrated industries with no obvious entry

barriers

– Many (if not all) of those firms make above normal

returns.

Lippmann and Rumelt’s Model

• Each period firms consider entering the industry

• Based on their expected costs, the entering firm

calculates its expected profit

• If current industry prices are above its estimated

costs it enters.

• If it enters it finds out what its costs really are

• All firms (new entrant and incumbents) recalculate

their optimal quantity - a new industry price emerges

• Firms whose costs exceed this new price leave

Hypothetical example: mobile phones

E[cost] = ? Frequency band B (4c / min)

Frequency band A (5c / min)

Frequency band C (3c / min)

Three different frequency bands, A, B and CAllocated by the FCC through a lottery…

p=1/3

p=1/3

p=1/3

Hypothetical example: mobile phones

E[cost] = 4c / min Frequency band B (4c / min)

Frequency band A (5c / min)

Frequency band C (3c / min)

Best estimate of likely cost is…

p=1/3

p=1/3

p=1/3

Hypothetical example: mobile phones

E[cost] = 4c / cal

Imitation allows all firm to achieve 3c / call costs

If firms can imitate their more efficient competitors…

Hypothetical example: mobile phones

E[cost] = 4c / call

Any 5c firms are forced out when price falls below 5c

Without imitation, firms retain their initial costs, good or bad…

4c firms are forced out and entry ceases

Profitability (ROS): Rumelt v.s. Cournot

0 %

1 0 %

2 0 %

3 0 %

4 0 %

5 0 %

6 0 %

7 0 %

8 0 %

9 0 %

1 0 0 %

Rumelt Cournot

Time

Implications of the model

• Barriers to entry are not needed to explain industry concentration

• Above normal returns can come from both firm heterogeneity and industry concentration

• The focus is on firms and the factors that lead to uncertain imitability

Rumelt’s 1992 study

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Firm Profit

Rumelt’s 1992 study

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Firm Profit

If industry was all that mattered…

Indy A Indy B Indy C

Rumelt’s 1992 study

Firm Profit

Rumelt found that within industry variance about twicethat found between industries…

Indy A Indy B Indy C

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Conclusion

• Most (~60%) of the variation in firm performance is a function of the firm rather the industry in which the firm operates

• Implications– Internal resource focus– Horizontal integration and market

power

So, what resources do firms need?

• If higher than normal profits are possible in industries without barriers to entry, what should firms in competitive industries look for?

• Something that make them distinctive, different, unique

• Distinctiveness that stems from resources…– That help create something of value to customers

– Not available off the shelf (no market for strategic factors)

– That are hard to imitate• E.g. based on tacit knowledge, hard to transfer skills

• Time compression diseconomies

• a complex (social) system

Resource “properties”

• Resources that deliver competitive

advantage must be:

– Valuable

– Rare and non-substitutable

– Inimitable

Barriers to imitation

• Property rights– Patents, copyrights

• Tacit knowledge – Riding a bicycle

• Dispersed knowledge– Formula for Coke

• Time• Complex social system (culture)• Complex “activity systems”

Three questions

• Do we create value? – for our customers – for ourselves

• Is it rare – We can only appropriate if we

have a distinctive advantage• Is our advantage inimitable

– Is is sustainable»V.R.I.

Resources and economic transformation

TANGIBLE RESOURCESPhysical assets

Finished product

or service

INPUT RESOURCESRaw materialsEnergy, Parts

INTANGIBLE KNOWLEDGE-BASED

‘TRANSFORMING’ RESOURCES

(CAPABILITIES)Knowledge,

SOPs and routines, skills

Resources and economic transformation

INTANGIBLE KNOWLEDGE-BASED

‘TRANSFORMING’ RESOURCES

(CAPABILITIES)Knowledge,

SOPs and routines, skills

TANGIBLE RESOURCESPhysical assets

Finished product

or service

INPUT RESOURCESRaw materialsEnergy, Parts

COMPETENCE

Terminology

• Capabilities

(knowledge resources)– know-how, skills,

routines, SOP’s• Competencies

– particular configuration of capabilities and input resources that successfully transform the inputs into more valuable outputs.

• Distinctive competencies– a unique competence,

i.e one other firms don’t have

• Core competencies– a distinctive

competence that has multiple applications

Competence

Distinctive competence

Core Competenc

e

Knowledge Resourcesor Capabilities

Tangible Resources

Fruin’s ‘bow tie’ model of core competency

Capabilities and resources

e.g. HondaSmall internal

combustion engine

Products

Motorcycles

Cars

Lawn mowers

Outboard motors

ATVs

Generators

Core (distinctive) competency

“V.R.I.”

• Valuable – To customers

• Which means we may be able to raise prices above those of our less valued competitors.

– To us • Which means we may be able to maintain lower costs

than our competitors• Their costs are a floor below which prices will not fall,

leaving us with a profit even when they have none.

• Rare– If customers have no alternative they will have to

pay more than it costs us to make the product or deliver the service

– We can appropriate some of the value we create• Inimitable

– ensures rarity into the future

Resource “properties”

• Valuable

– a competence

– May not be distinctive

– May be temporary

• Rare (and non-substitutable)

– A distinctive competence

– May be temporary

• Inimitable

– Sustainable competitive advantage

“V.R.I.N.” – raising prices

• Valuable

• Rare

• Inimitable

Value

Price

P C

Competitors

… to customers

“V.R.I.N.” - reducing costs

• Valuable

• Rare

• InimitableCost

Cost

… to you

P C

Competitors

Complex activity systems

• Some firms are made up of complicated interlocking systems

• Complicated systems are hard to copy

• One missing piece and the entire system will not work

Summary

• If there is no structural advantage in our industry, we must look for sources of competitive advantage inside our firm

• Firm levels factors that deliver competitive advantage must be – Valuable (i.e. a competence) – Rare and non-substitutable (i.e. distinctive)– Inimitable (and thus persist over time)

• Distinctive competences with multiple uses are termed ‘core’ competences