Threats to Long-Run Profitability

• Competitive advantages that take years to build can be eroded through imitation and innovation.
• Some firms sustain their competitive advantages, like Coca-Cola, Tesco’s, and Nucor.
• This chapter is about threats to long-run profitability and innovation.

Market Structure and Threats to Sustainability

• Market structure affects the ability of firms to sustain long-run profitability.
• In perfect competition, profit opportunities will disappear because new entrants will flow into the market.
• With free entry, firms lacking advantages will earn zero profits.
• Monopolistically competitive markets involve sellers differentiated in distinct niches.
• These sellers can raise prices without losing all customers due to downward-sloping demand.
• Setting prices above marginal cost doesn't guarantee profits because firms must cover fixed costs.
• New firms enter by differentiating, taking business from incumbents until incremental profits cover fixed costs.
• Incumbents in both competitive and monopolistically competitive markets need to deter entry to preserve profits.
• Endogenous sunk costs can be created through branding and other strategies.
• Entry deterrence is less common in competitive and monopolistically competitive markets.
• Firms in competitive markets can prosper with efficient production processes or product enhancements.

Threats to Sustainability under All Market Structures

• In oligopolistic or monopolistic markets incumbents may not stay successful due to luck.
• Luck that managers can't control doesn't persist, and performance regresses to the mean.
• Extreme performance shouldn't be expected to repeat, and managers shouldn't receive excessive credit or blame.
• Genuine advantages may be difficult to duplicate, but firms may not be protected from powerful buyers and suppliers.
• Powerful buyers and suppliers can use bargaining leverage to extract profits.
• Major League Baseball is an example where supplier power (MLB Players' Association) has threatened sustainability.
• The MLBPA has increased player salaries significantly through job actions and litigation.

Evidence: The Persistence of Profitability

• Without impediments to competition, economic profits would converge to zero.
• With impediments, profits would persist with above-average profits today continuing in the future.
• Dennis Mueller's study of 600 U.S. manufacturing firms from 1950–1972 measured profit persistence.
• High-profit firms tend to decrease in profitability over time, while low-profit firms tend to increase.
• Profit rates of high and low-profit firms do not converge to a common mean.
• Firms starting with high profits have higher long-run profitability rates than low-profit firms.

The Resource-Based Theory of the Firm

• Market forces threaten profits, but other forces protect profitable firms.
• Some forces protect the competitive advantage of individual firms, distinct from Porter's five forces.
• Superior performance can be achieved in unprofitable industries with intense rivalry and low entry barriers.
• Competitive advantage is defined as a firm's ability to outperform its industry by creating more value than competitors.
• This ability relies on resources (firm-specific assets) and distinctive capabilities (activities done better than competitors).
• Sustainable competitive advantage persists despite competitors' efforts to duplicate or neutralize it, requiring persistent asymmetries.
• Resource heterogeneity is a cornerstone where firms must possess different resources and capabilities.
• Sustainable advantage must be underpinned by scarce and imperfectly mobile resources and capabilities.
• Scarce resources sustain competitive advantage, leading firms to bid for them, transferring profit to the original owner.

Imperfect Mobility and Cospecialization

• Imperfectly mobile scarce resources sustain advantage as they can’t "sell themselves" to the highest bidder.
• Real estate exemplifies imperfect mobility from the perspective of the owner.
• Talented employees represent mobile resources, captured by "superstar" lawyers and athletes.
• Firms can limit labor mobility through contracts or non-compete clauses and through cospecialization.
• Cospecialization involves resources that are more valuable when used together versus separately.
• Employees in productive work teams are cospecialized because their collective output exceeds individual output.

Isolating Mechanisms

• Critical resource scarcity and immobility are necessary but insufficient for lasting competitive advantage.
• A competitive advantage based on scarce and immobile resources can be undermined by replication or neutralization.
• Blockbuster Video inventory advantage was challenged by Netflix's distribution and streaming.
• Richard Rumelt coined "isolating mechanisms" to describe forces limiting duplication or neutralization.
• These mechanisms protect competitive advantages similar to entry barriers for industries.
• There are two types of isolating mechanisms: impediments to imitation and early-mover advantages.
• Impediments to imitation prevent resource and capability duplication.
• Early-mover advantages increase the economic power of the advantage over time.
• Cisco Systems' success established its Cisco IOS software as an industry standard benefitting its product line.

Impediments to Imitation

• Isolating mechanisms consist of: legal restrictions, superior access to inputs/customers, market size/scale economies and intangible barriers
• Initial positions are equal along cost and quality until propelled by shock, which refers to new changes
• In this new competitive scene, G achieves high-quality/low cost, whereas mechanisms hinder imitation by other firms
• Early mover advantage allows first mover to benefit from a shock, widening its competitive advantage

Early Mover

• After Shock, G wins first-mover advantage where competitors can't replicate G's superior cost-quality position
• If shocks are isolated/infrequent, firm competitive advantages will be long-lived where strategies can be taken as given

Impediments to Imitation

• These include legal restrictions, superior access to inputs and customers, market size and scale economics, and intangible barriers

Legal Restrictions

• Patents and copyrights are a powerful impediment offering higher returns in investment
• Google acquired Motorola Mobility to obtain active patents; in that vein, this could be related to asset mobility
• Securing competitive advantage through patents/rights requires superior information and complementary resources
• Target firms are mobile assets; the evidence shows acquirers lose money unless there are complementarities

Superior Access to Inputs or Customers

• Superior access to high-quality or high-productivity inputs sustains advantages that competitors can't imitate
• International Nickel had a global advantage due to its control of nickel deposits
• Topps monopolized markets for baseball cards; this network long-term contracts were then declared illegal
• An example of this is manufacturer imposing guidelines where the suppliers/retailers can only sell their brand

Cola Wars in Venezuela

• In the long run, powerful brands like Coca-Cola had demonstrated sustainable advantage over its competition, Pepsi
• The owner of a potential competing cola even risked his life to boost his cola's brand image
• These name brands do not share their international markets equally; Venezuela was Pepsi's home until sold to Coke
• If you buy up all the sources, you must eventually sell it
• This created more competition as both companies were made more profitable

Market Size and Scale Economies

• Imitation can be deterred when low-cost, large-scale strategy has more of a market share
• The small firm has a harder time increasing its scale
• Both a large and small firm compete the same
• Large-scale-based advantage grows with growing markets as they match leaders like Compaq and Hewlett-Packard
• Over time, prices grew more intense leading profits made in pcs fail to keep pace

Intangible Barriers to Imitation

• These restrictions are tangible barriers, whereas it is equally important for them to be intangible
• In relation to organizational capabilities, barriers may seem conceptual and distinct: these can be casual, and depend on circumstance
• Lastly, it is a social complexity

Causal Ambiguity

• Rumelt states it stands for cases where the creation of value is not well understood, and is difficult to articulate
• It may impede imitation and cause dis-economies of scale, meaning that more capabilities are needed
• David Teece mentions causal ambiguity might prevent transferring operational success from one plant to the other

Dependence on Historical Circumstances

• Competitors fail to imitate the capabilities underlying a company's competitive advantage, bound by history
• The history of a firm causes experience, and adapting could influence imitable resources
• Historical dependence can make a strategy viable for a limited time leading to carriers renegotiating new labor contracts

Social Complexity

• This may stem deeply from the processes and operations of the firm
• All the competitors must understand the connection of Toyota's trust, but it cannot be readily created

Early Mover Advantage

• Includes learning, reputation, switching costs and creates network effects
• Firms who can sell higher volumes in earlier periods will move down their learning curve and cut costs for the long-run
• With consumer experience comes trust. Customers become reluctant to competing brands if there is a chance they will fail

The value of reputation

• This can prove and isolate one firm over the long-run where competitors must lower prices to sell similar product

Switching Costs

• With customer loyalty becomes brand switching costs, and vice versa
• Examples can be brand-specific know-how, and customization
• Sellers can offer coupons as frequent customer points that tie to certain discounts and/or products

Networking

• Consumers will place a higher value on a higher product
• It's easier to sell into an established networking base due to the customer following
• One can also bundle other products such has headphones

Lego's

• A simpler set to build can create a higher-priced item to buy due to the ease of use and popularity. Such as a child's toy

Market Share Competing

• This entails lowering overhead to be a contender to compete within the given market's economy
• Where if it lowers further, an entire economy sector could shrink

Dynamic Capabilities

• It creates the long-term sustainable goals, allowing to create value

Long-Lasting Advantage Creation

• Must be created, before it is exploited; opportunities will only be seen if other firms overlook that factor
• An individual with confidence can and will overcome resistance and requirements for entrepreneur abilities

Creative Destruction

• States in essence that will not be replaced
• Markets revolve where certain products get replaced with old; it must be of product, tech, or a type of org
• In the short-run, economy is benefited from new markets created, but competition occurs until benefit for all

Disruptive Technologies

• High B - C than the original, but now new techs drastically C
• Innovation causes markets evolved with new positive and negative; to take advantage, there comes a Shock to the company brand
• For small business to exist: it leads up to increase with financial incentives, productivity, replacement etc.

In summary

• All of this will impact decisions into whether the corporation has more incentive vs financial constraints