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THEORIES OF STRATEGYProf. dr. ir. J.W. Stoelhorst
Reading list 2022-2023 + Summaries
WEEK 1.1 Economic foundations of strategy
1. Stoelhorst J.W. ([1997] 2008), Thinking about Strategy, 3d edition. Teaching note, University of Amsterdam
(26 pages, reading time approx. 1 hour 30 minutes)
What is their main message?
Competitive strategy
The author tries to summarize all the different schools of strategic
management. He looks at differences and similarities between the
schools. It provides the different schools and chronically describes
the evolution.
How are they trying to convince you? (what kind of arguments are presented)
The author states that strategic management can be distinguished in three aspects: the process, the
content, and the context of strategy. Furthermore, the author states that the development of strategic
management can roughly be summarized in terms of the relative influence of the five different schools of
thought; 1960 the design school, 1970 the planning school, 1980 the positioning school, 1990 the
resource-based school which are prescriptive schools and the 1980 s and onwards the process school
which are descriptive schools.
Eventually he states a list of point of agreement across different schools of thought. Strategy concerns
both organization and environment, the substance of strategy is complex, strategies exist on different
levels, strategy involves issues on both content and process, strategy involves various thought processes,
strategies are not purely deliberate.
Why is their message valuable?
It provides a clear chronological overview of strategy development in the last 50 years.
Key constructs
When strategy scholars think about the process of strategy they are interested in where strategies come
from. The How's. When strategy scholars think about the content of strategy, they are interested in what
good strategies are. The What’s. Finally, when strategy scholars think about the context of strategy they
are interested in how specific organizational or environmental contexts affect the process or content of
strategy. How does the environment effect the content and process of the strategy?
Differences
Porter vs Barney:
Porter: positioning, outside-in perspective on strategy (strategy analysis should focus on the characteristics
of the industry), deterministic view on strategy (the environment determines the optimal strategy for a
firm)
Barney: resource-based, inside-out perspective on strategy: strategy analysis should focus on the
characteristics of the firm itself; voluntaristic view on strategy: firms can actively influence the
environment through their strategy
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,2. Rumelt, Richard P. (2003), What In the World is Competitive Advantage?, Working paper, Anderson Business
School, UCLA. (7 pages, reading time approx. 30 minutes)
According to Rumelt: competitive advantage is an ambiguous concept. It has something to do with creating value.
Some authors refer to competitive advantage as stemming from low costs or the ability to differentiate its products.
Other authors define competitive advance as being sustained above normal returns and they go on to say that such
sustained above normal returns can be traced back as a resource-based advantage. Other authors explain competitive
advantage as when a firm earns a higher rate of eco- nomic profit than the average rate of economic profit of other
firms competing within the same market, the firm has a competitive advantage in that market. Rummelt summarizes
these observations in the fact that competitive advantage has something to do with creating value. He asks two
questions in his paper: But value to whom? and when is value created?
Competitive advantage is an ambiguous concept, it should be disentangled from performance, it should be clear over
whom a firm has an advantage (and which time perspective), it has something to do with value creation (but also with
value appropriation) and it has something to do with creating value in excess of costs (but which costs?).
Be able to account for the main assumptions of neoclassical economic theory of perfect competition.
Principle: When the assumptions of the model of perfect competition are met, there is no room for performance
differences: all firms earn zero economic profit.
In consequence: Any deviation from the assumptions of the model of perfect competition is a possible source of
competitive advantage that can lead to performance differences. This in essence provides a foundation for strategic
management theorie to further articulate such market imperfections and sources of competitive advantage.
Be able to distinguish other key economic schools of thought in terms of how they explain performance differences
among firms
3. Besanko, David, Dranove, David and Shanley, Mark (2000), Economics of Strategy, 2nd edition, New York: Wiley.
(p. 20-22 ‘Economic Costs and Profitability’ and p. 30-36: ‘Theory of the Firm: Pricing and Output Decisions’ and
‘Perfect Competition’) (10 pages, reading time approx. 45 minutes)
At the heart of neoclassical economics is the model of perfect competition. The core idea of neoclassical economics is
that if all markets would be perfectly competitive, then economic welfare would be maximized. These readings
summarize the main elements of the model of perfect competition. The model of perfect competition is also the main
theoretical benchmark for theories of competitive strategy.
Economic versus Accounting Costs
The costs that appear in accounting statements are not necessarily appropriate for decision making inside a firm.
Business decisions require the measurement of economic costs, which are based on the concept of opportunity costs.
This concept says that the economic cast of deploying resources in a particular activity is the value of the best forgone
alternative use of those resources.
In studying strategy, we are interested in analyzing why firms make their decisions and what distinguishes good
decisions from poor ones, given the opportunities and the constraints firm dace. I our formal theories of firm behavior,
we thus emphasize economic costs rather than historical accounting costs. The concept of opportunity cost provides
the best basis for good economic decisions when the form must choose among competing alternatives. A firm that
consistently deviated from this idea of cost would miss opportunities for earning higher profits. In the end, it might be
driven out of business by firms that are better at seizing profit-enhancing opportunities.
• Accounting profit = sales revenue - accounting costs
• Economic profit = Accounting profit - economic costs
(EP = SR - AP - EC)
When a firm firm's accounting earnings do not cover this opportunity cost, the firm will earn a positive accounting
profit but a negative economic profit. A negative economic profit indicates that when the assets of the firm were
liquidated a deployed elsewhere, the firm would have earned more. Firms can also have a positive economic profit
this means that a firm creates more income for its owners than its sources would have created for themselves if they
liquidated its own assets and invested them in their best alternative use.
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,Theory of the firm: Pricing and output decisions
This theory sheds light on how prices are established in markets, and it also provides tools to aid managers in making
pricing decisions. The theory of the form assumes that the firm's ultimate objective is to make as large a profit as
possible.
When determining the amount, it wants to sell, the firm simultaneously determines the price it can charge from its
demand curve. How is the optimal output determined? This is where the concepts of marginal revenue and marginal
costs become usefull. Marginals are rates of change (change in cost of revenue per one-unit change in output Q. Where
Q can either represent an increase in output, in which case it is a positive amount, or a decrease in output, in which
case it is a negative amount:
The firm clearly would like to increase profit. Here's how:
• If MR > MC, the firm can increase profit by selling more (Q > 0), and to do so it should lower its price.
• If MR < MC, the form can increase profit by selling less (Q < 0), and to do so, it should raise its price.
• If MR = MC, the form cannot increase profits either by increasing or decreasing output. It follows that output
and price must be at their optimal levels.
A firm should lower its price whenever the
price elasticity of demand exceeds the
reciprocal of the percentage contribution
margin on the additional units it would
well. And a firm should raise its price when
the price elasticity of demand is less than
the reciprocal of the percentage
contribution margin of the units it would
not sell by raising its price.
Perfect competition
This theory highlights how market forces shape and constrain a firm's behaviour and interact with the firm's decisions
to determine profitability. The theory deals with a stark competitive environment: an industry with many firms
producing identical products. (so that consumers choose among firm solely on the basis of price) and where firms can
enter or exit the industry at will. Because firms in a perfectly competitive industry produce identical products, each
firm must charge the same price. This market price is beyond the control of any individual firm; it must take the market
price as a given. Each firm must decide how much to produce. According to the theory the firm should produce at the
point where marginal revenue equals marginal cost. When the firm's demand curve is horizontal, each additional unit
it sells adds sales revenue equal to the market price. Thus, the firm's marginal revenue equals the market price and
the optimal output, is where marginal cost equals the market price.
The firms, marginal revenue equals the market
price, and the optimal output, is where
marginal cost equals the market price. if we
were to graph how a firm's optimal output
changed as the market price changed, we
would trace out a curve that is identical to the
firm's marginal cost function. This is known as
the firm's supply curve. It shows the amount
of output the perfectly competitive firm would
sell at various market prices. Thus, the supply
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, curve of a perfectly competitive form is identical to its marginal cost function.
4. Conner, Kathleen R. (1991), A Historical Comparison of Resource-based Theory and Five Schools of Thought within
Industrial Economics: Do We Have a New Theory of the Firm?, Journal of Management, 17, p. 121-154.
(Note: you only need to read pages 121-134) (14 pages, reading time approx. 1 hour 30 minutes)
Much of (competitive) strategy theory consists of elaborations on theories and concepts from various schools of
thought in economics. These various schools of thought, in turn, can most easily be understood in terms of how they
deviate from the standard view of neoclassical economics and its ‘ideal type’ model of perfect competition. Conner
gives a nice and very readable summary of the schools of thought that are most relevant for strategy by contrasting
them with the neoclassical view, and with each other.
A resource-based approach to strategic management focuses on costly-to-copy attributes of the firm as sources of
economics rents and therefore, as the fundamental drivers of performance and competitive advantage. Interest
presently exists in whether explicit acknowledgement of the resource-based view may form the kernel of a unifying
paradigm for strategy research. This article addresses the degree to which a resource-based view represents a
fundamentally different approach from theories used in industrial organization (IO) economics.
With the regard to the question of why firms exist, it is useful to note that each theory discussed here takes as a given
that the ultimate purpose of the firm is to maximize profits. These theories differ from each other with regard to the
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