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Summary Theories of Strategy - Study Questions

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This document contains comprehensive answers to all Study Questions in the Theories of Strategy course (MSc Business Administration). The answers are formulated in essay-format, which your are also required to do on the exam. These answers helped me get an 8 for my exam last year ()

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  • 14 oktober 2019
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Voorbeeld van de inhoud

1. How can the neoclassical theory of perfect competition inform theories of competitive
advantage?

Competitive advantage, according to Rumelt (2003), is an ambiguous concept that should be
disentangled from performance. Also, competitive advantage has something to do with value
creation, and it should be clear over whom a firm has a competitive advantage (Rumelt, 2003).
Multiple theories of strategy try to address what exactly explains competitive advantage, and as
Rumelt’s (2003) statements show, it can be quite difficult to fully get a grasp of what exactly causes
firms to have an edge over other firms. One of the theories that is often used as a “theoretical
benchmark” when explaining theories of competitive advantage is the neoclassical theory of
perfect competition. The reason why is that this particular theory is often used to inform theories
of competitive advantage is explained in this essay.
The neoclassical theory of perfect competition assumes perfect circumstances where the
firm is seen as black boxes and unitary agents, meaning that productive knowledge and value
appropriation within the firm are excluded or ignored. Humans are “homo economicus”, meaning
that they are self-interested and fully rational. Accordingly, firms (and all agents) adhere to a set of
assumptions. These assumptions are the large number assumption (assumes large number of
buyers and sellers, where firms are price takers and returns are decreasing), the homogeneity
assumption (assumes that demand is homogeneous and products are standardized), the mobility
assumption (assumes that resources are perfectly mobile, and firms can enter and exit markets
without at zero costs), the rationality assumption (assumes that all agents have complete
information and maximize their utility and profit), and the transaction cost assumption (assumes
that all transactions are costless). As all parties have perfect and complete information, it is
impossible to have sustained competitive advantage: all possible advantages that a firm may have
are common knowledge. Moreover, the neoclassical view of perfect competition assumes all firms
to be identical, therefore the achievement of above normal returns is impossible. In the
neoclassical view, the only competition is on price and on entry or exit. There are no sources of
advantage because of the assumptions made by the model. As a result, these assumptions cause
that firms will always earn 0 economic profits.
This however also means that any deviation from these assumptions is a possible source of
competitive advantage that can lead to performance differences. Therefore, the neoclassical
theory of perfect competition sets the perfect conditions for competitive advantage to deviate
from in order to obtain economic surplus. Moreover, if the assumptions of the neoclassical theory
aren’t met, a possible source competitive advantage is present.

,2. How does Porter’s early view on strategy 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 performance differentials. Moreover, exploring the
different ways of production resulting in the most cost-efficient practices may lead to higher
economic profit, according to Porter (1979).
To conclude, Porter in his early view, determines different ways by which
performance differences among firms can be explained. Our analyses first examined the industry
effect where Porter’s model of five forces played a crucial role. According to Porter (Stoelhorst,
2018), barriers to competition can positively affect the average profitability of firms, thereby

, creating market power and thus increasing performance. The same goes for strategic groups; a firm
located in a strategic group with high mobility barriers can enjoy higher average profitability than
other firms. Lastly, firms who develop generic strategies focused on product differentiation, cost
leadership and focus may enjoy higher relative profitability, resulting in a higher performance
compared firms who don’t take these factors into consideration.

3. What are the similarities and differences between the RBV and Porter’s early view of
competitive advantage?
A well-accredited framework to explain the sustainable competitive advantage that firms may
enjoy is the Resource-Based View (RBV), as opposed to Porter’s positioning school, thought of by
Barney (1986). The RBV states that firms can earn an economic profit without having market
power, if they control superior resources for which they did not pay the full economic cost. This
short paper will examine what the similarities and differences are between the resource-based
view and Porter’s early view of competitive advantage. This will be done by looking at the
similarities and differences of the notion of sustained competitive advantage, above normal returns
and the sources of these returns.
Firstly, Porter's early view and the RBV agree on the idea of sustained competitive
advantage, yet both schools disagree on how to achieve it. By taking the perfect market as a
theoretical benchmark from which to deviate from, in both views the ultimate goal for firms to
achieve is sustained competitive advantage. However, Porter’s Five Forces model describes
sustained competitive advantage as above normal returns over a long period of time (Ghemawat,
1999). The RBV takes a different approach, stating that sustained competitive advantage is
achieved when the competition ceases their attempts to disrupt a firm’s competitive advantage
(Barney, 1991; Rumelt, 1984).
Secondly, both schools assume that above normal returns can be made. However,
the schools differ in their views on how above normal returns are made. The positioning school
focuses on the external forces at play in the product market. Only when a firm is able to secure its
position in the competitive product market, above normal returns may be acquired (Stoelhorst,
2018; Porter, 1980). As a result, firms that are well-positioned within an industry can achieve
market power, which can lead to economic profit (Stoelhorst, 2018). According to the RBV
however, the returns obtained due to a strategy exceed the costs of implementing a strategy,
above normal returns can be made. These above normal returns are achieved by either having
more accurate expectation of the future value of strategic resources compared to other
competitors, or by luck when they underestimate the true future value of the resource (Barney,
1986). Therefore, one could state that the positioning school’s approach focuses only on product
markets, while the RBV suggests that above normal returns can be achieved by acting on strategic
factor markets.
Thirdly, and accordingly, Barney (1991) states that for a resource to be a source of
sustained competitive advantage, it must be (among valuable and rare) non-substitutable and
inimitable. These concepts bare a great resemblance to the threat of substitution and the threat of
new entrants as described in Porter’s Five Forces (Ghemawat, 1999). However, as stated before,
whereas the RBV describes the characteristics of resources in the factor market, Porter’s threats
are relevant for goods in the product market.
Lastly, although both schools acknowledge the existence of above normal rents,
they both regard the outcome of it in different ways. In the RBV, the source of above normal
returns are a result of efficiency and the obtainment of superior resources in the strategic factor
market (Barney, 1986). The resulting above normal returns are considered Ricardian rents that are

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