The second document of the series "Theories of strategy: Exam Preparation".
We will go through my personal development of each of the twelve study questions fundamental for passing the course's exam. The actual exam will include (100% sure) one of these questions, most probably one of the last on...
MSc Business Administration 2020/2021
Theories of Strategy
Lecturer: J.W. Stoelhorst
– Full Exam Preparation: Developed Exam Questions –
***These are the answers to the questions given by the lecturer, one of which is 100% sure to be asked in the actual exam. The questions are given to all the students at mid-course time, here you can find my
personal answers that led me to a grade of 8. However, I suggest you to get inspired by these and try to develop yours giving your personal touch ☺ ***
*** One of the first questions will be asked in the first assignment,
*** the last 4 questions have bigger chance to be asked in the exam.
1. How can the neoclassical theory of perfect competition inform theories of competitive
advantage?
Neoclassical theory of perfect competition is often used by subsequent theories such as High
Church of RBV and Porter’s “positional school”, as a “theoretical benchmark”. The reason why this
is useful when trying to explain what causes a firm to benefit from a competitive advantage, is
explained in this essay.
The neoclassical theory of perfect competition build on the idea of perfect market conditions by
adhering to a set of foundamental assumptions.
These are; the large numbers assumption, which means large number of buyers and sellers in a
market where firms are price takers and returns are decreasing. The homogeneity assumption, which
stands for homogeneous demand and standardized products. The mobility assumption, which makes
resources perfectly mobile and firms can enter and exit the markets costless. The rationality
assumption, which assumes that all agents have complete information and maximize their utility
and profit. Finally, the transaction costs assumption, which assumes that all transactions are
costless. All these assumptions together, make it impossible for individual firms to obtain any
sustained competitive advantage and/or above-normal returns. All parties have perfect and complete
information, advanatges are common knowledge and firms are seen as identical, and therefore not
capable to distinguish from one another. The result is that there are no sources of advantage because
of the assumptions which stand at the basis of this theory. Firms will always earn profit equal to
zero (normal profit), which means that they earn just what they need to survive.
Eventually, this means that any deviation from the perfect conditions of the Neoclassical framework
will result in a source of of competitive advantage and thus performance differentials.
, In conclusion, the Neoclassical theory of perfect competition can inform theories of competitive
advantage by setting up the perfect conditions to deviate from in order to obtain above-normal
profits. Moreover, if any of the assumptions isn’t met, it means that a possible source of advantage
is available.
2. How does Porter’s early view on strategy (see Ghemawat, 1999; Porter, 1979; lecture
materials) explain differences in performance among firms?
By linking Industrial Organization (I/O) research to managerial frameworks, Michael Porter (1981) has
contributed greatly to the field of strategic management (Stoelhorst, 2018). Now known as the ‘positioning
school’, Porter, in his early view, identifies several ways by which differences in performance among firms
may be explained. This paper will examine how Porter’s early view explains differences in performance
among firms. This will be done by discussing the industry effect, the strategic group effect and the firm
effect (Stoelhorst, 2018).
According to Porter (1979), I/O research is primarily focused on industry structure as a determinant of firms’
behavior or conduct, whose joint conduct then determines the collective performance of the firms in the
market. Building on this theory, Porter (1979) firstly identifies industry-wide traits of market structure that
influence the profits of all firms in an industry, and thus average industry performance. As a result, some
industries are considered to be more attractive than others. In order to assess an industry’s profit potential,
Porter created the Five Forces Model, through which an industry’s profit potential can be analyzed
(Ghemawat, 1999). The Five Forces Model identifies the threats of five “forces” - or barriers to competition
- at the industry level that affect the average profitability of those industries’ firms (Ghemawat, 1999). This
effect is called the industry effect (Stoelhorst, 2018). Because of these barriers to competition, firms that are
well-positioned within an industry can achieve market power, which can lead to economic profit (Stoelhorst,
2018).
Next to the industry effect, Porter identifies strategic groups, which play an important role in explaining the
differences in performance among firms. Within an industry, strategic groups are clusters of firms which
hold “similar strategies in terms of key decision variables” (Porter, 1979, p. 215). Firms within a strategic
group are expected to behave in similar ways and can anticipate on each others’ actions. A strategic group
can act as a safeguard for firms, as it is able to create high mobility barriers for competitors (Porter, 1979).
Mobility barriers are ways by which firms are limited to enter, exit or move industries. How high the
mobility barriers of a specific strategic group are, determines its profitability (Porter, 1979). For instance,
high mobility barriers allow firms to be protected from rivalry, which limits the amount of possible
substitutes for the created product. Limited amounts of substitutes generate low elasticity in demand.
Moreover, firms within the group have high bargaining power with immediate industries. According to
Porter (1979, p. 219), a firm will enjoy greater performance if it’s located in a strategic group where there are
high mobility barriers that limit intergroup rivalry and disallows substitute products to enter the market.
Moreover, the group must have the least number of possible members and some bargaining power with
immediate industries. Lastly the group must allow suitability to the firm’s execution ability (Porter, 1979).
The third factor that influences the differences in performance among firms, is the firm effect. According to
Porter, the generic strategies of product differentiation, cost leadership and focus can create a competitive
advantage for firms (Stoelhorst, 2018). For instance, product differentiation and focus allows firms to
carefully choose a product market position that is different from competitors and thus may lead to
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