This document contains all relevant information, all lecture slides, all teaching notes, references to the cases, comparisons across different weeks, ready for the exam.
Overview
● The central concern of strategy research is to understand how we can explain
differences in performance among firms.
● Firms that outperform their competitors apparently have a competitive advantage, and
much of the research in strategy is aimed at developing theories about competitive
advantage.
● This course asks:
○ What is competitive advantage?
○ How can competitive advantage be explained?
○ What can managers do to build competitive advantage?
1.1 Economic foundations of strategy
a. Overview of the strategy field
i. Overview of how the field of strategic management developed up until the year
2000 → Stoelhorst “Thinking about strategy” (2008):
1. 1960s: the design school 🡪 strategy as a conceptual process.
2. 1970: planning school 🡪 strategy as a formal process.
3. 1980: positioning school 🡪 strategy as fit → Porter.
4. 1990: resource-based school 🡪 strategy as stretch → Barney; Peteraf.
5. 1980s onwards: process school 🡪 strategy as collective learning.
ii. Thinking about strategic management: the process, content (theorizes about
what is a good strategy, and which strategies lead to competitive advantage that
give you superior financial performance?) and context of strategy.
iii. Types of strategy:
1. Corporate strategy 🡪 where to compete, parent level, portfolio decisions.
2. Competitive strategy 🡪 how to compete, SBU level, competitive advantage.
iv. The three layers of theory:
1. Economics 🡪
2. Strategic management 🡪
3. Management.
→ This course focuses on the positioning and resource-based school, and thus
on the content of competitive strategy, which is located in the strategic
management layer of theory.
b. Competitive advantage
i. Is an ambiguous concept → Rumelt “What in the world is competitive
advantage?” (2003). Rumelt lists the different definitions of competitive
advantage by several scholars, and some are even problematic:
1. Example: Ghemawat and Rivkin [1999: 49] say that “A firm such as Nucor
that earns superior financial returns within its industry (or its strategic
group) over the long run is said to enjoy a competitive advantage over its
rivals.” (Rumelt, 2003, 2) → This definition is problematic because it
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, conflates the concept of CA with the thing it has to help us explain (i.e.
financial performance).
ii. A first start:
1. Sources of advantage →
2. Competitive advantage →
3. Performance.
c. The neoclassical model of perfect competition
i. The model of perfect competition
1. The large numbers assumption 🡪 decreasing returns; a large number of
buyers and sellers; firms are price takers.
2. The homogeneity assumption 🡪 demand is homogeneous; standardized
products.
3. The mobility assumption 🡪 resources are perfectly mobile; free entry and
exit (for competing firms).
4. The rationality assumption 🡪 buyers and sellers have complete information
and maximize their utility and profit.
5. The transaction cost assumption 🡪 transactions are costless.
ii. Some basic concepts→ Besanko et al. “Economics of strategy” (2000):
1. Economic profit (versus accounting profit).
2. Economic costs (versus accounting costs).
3. Opportunity costs.
→ Accounting measures what comes in and goes out of a firm, the costs
being accounting costs and the profit being accounting profit. Economic
thinking also wants to take into account opportunity costs (there may be
costs from income that you do not get; foregone income). Economic cost
(=opportunity cost).
iii. To understand this, you need to understand the background of the theoretical
model
1. The model is about a world of ‘perfect decentralization’ in which rational
agents (Homo economicus) interact exclusively through price-mediated
exchange.
2. The model formalizes an intuition going back to Adam Smith: that free
market competition will maximize collective welfare despite (or even,
because of) the fact that individual economic agents are self-interested.
3. What the model considers as maximization of welfare is allocative
efficiency: the most efficient allocation of given scare resources, given a
certain level of productive knowledge (‘in perfect competition, there are no
opportunity costs left on the table’).
iv. Assumptions in the model of perfect competition
1. About competition → Competition is…price competition (agents respond
to price signals); entry & exit (free between industries to get the whole
system into general equilibrium, where because of perfect competition,
there is no opportunity cost left in the system anywhere and we have
maximized social welfare).
2. About the firm → Firms are…black boxes (resources in, products out);
unitary agents (seen as if they are like any other agent in the system, one
individual that acts rationally).
a. Firms are seen as implementing a given production function and
as rationally responding to prices (by increasing production until
marginal costs equal marginal returns)
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, 3. About human nature → We are homo economicus…fully rational
(maximizing utilities as buyers and profit as firms); self-interested (goes
after own interests, regardless of others).
v. A theoretical benchmark:
1. Sources of advantage 🡪 competitive advantage 🡪 performance.
2. No sources of advantage 🡪 identical firms 🡪 zero economic profit.
vi. Principles of strategy: perfect competition → Question: What will be the
performance of firms in a perfectly competitive market?
1. Principle 1: when the assumptions of the model of perfect competition are
met, there is no room for performance differences: all firms earn zero
economic profit.
2. Corollary: any deviation from the assumptions of the model of perfect
competition is a possible source of competitive advantage that can lead to
performance differences.
vii. Limitations of the neoclassical model
1. The firm is treated as a unitary agent
2. The firm is treated as a black box
3. Preferences are seen as given
4. Technology are seen as given
5. Agents are seen as fully rational (and entirely self-interested)
6. There is no room for increasing returns.
viii. The tension: ‘rigor’ versus ‘relevance’.
1. Economic theory is at the heart of theory development in strategic
management. On the one hand (‘love’), economic theory gives rigor to
strategy research, but on the other hand (‘hate’) it tends to make
assumptions that reduce the practical relevance of the resulting theories.
d. Schools of thought in (micro-)economics
i. Economic theories → Conner “A Historical Comparison of Resource-based
Theory and Five Schools of Thought within Industrial Economics: Do We Have a
New Theory of the Firm?” (1991): summary of the schools of thought that are
most relevant for strategy by contrasting them with the neoclassical view, and
with each other.
→ We focus on neoclassical (above), and the Bain-type IO, Chicago school,
Schumpeter and RBV step away from certain assumptions in the neoclassical
view of perfect competition.
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