372 • Chapter 11 • Sustaining Competitive Advantage

FIGURE 11.3

Impediments to Imitation and Early-Mover Advantages

(a)The initial cost-quality position of all firms in the markets is (C0, q0). Following a shock, firm G achieves a competitive advantage based on higher quality and lower cost.

(b)Impediments to imitation: As time passes, G’s competitors may be able to reduce costs and increase quality, but they cannot duplicate G’s superior cost-quality position. (c) The dynamics of an early-mover advantage: As time passes, G’s cost and quality advantage over competing firms grows more pronounced.

to major shifts of competitive positions in a market. Examples of shocks are proprietary process or product innovations, discoveries of new sources of consumer value or market segments, shifts in demand or tastes, or changes in regulatory policy that enable firms to significantly shift their strategic position in a business. Isolating mechanisms that impede imitation prevent other firms from fully replicating G’s advantage. This is shown in Figure 11.3b as the inability of other firms to match G’s. Early-mover advantages work somewhat differently. Because G was the first firm to benefit from a shock, it can eventually widen its competitive advantage over other firms in the market. This is shown in Figure 11.3c. Just to reiterate, Figure 11.3a depicts the initial shock, Figure 11.3b depicts the effect of isolating mechanisms, and Figure 11.3c depicts the effect of an early-mover advantage.

If shocks are infrequent and isolating mechanisms are powerful, a firm’s competitive advantage will be long-lived. Firms whose competitive advantages are protected by isolating mechanisms, Rumelt argues, may be able to take their strategies as given for a long time, while still earning higher returns than existing competitors (or new entrants that might come into the business). The companion insight is that consistently high profitability does not necessarily mean that a firm is well managed. As Rumelt notes, “even fools can churn out good results (for a while).”8

In the next two sections, we discuss impediments to imitation and early-mover advantages in greater detail.

IMPEDIMENTS TO IMITATION

In this section, we discuss four impediments to imitation:

1.Legal restrictions

2.Superior access to inputs or customers

Impediments to Imitation • 373

3.Market size and scale economies

4.Intangible barriers to imitating a firm’s distinctive capabilities: causal ambiguity, dependence on historical circumstances, and social complexity

Legal Restrictions

Legal restrictions, such as patents, copyrights, and trademarks, as well as governmental control over entry into markets, through licensing, certification, or quotas on operating rights, can be powerful impediments to imitation. Jeffrey Williams points out that patent-protected products as a group have yielded higher returns on investment than any single industry in the United States.9

Patents, copyrights, trademarks, and operating rights can be bought and sold. For example, Google’s 2011 acquisition of Motorola Mobility was widely viewed as an effort to obtain Motorola’s 21,000 active and pending patents, prompting many analysts to ask why Google did not purchase the patents rather than the entire company. Though scarce, these assets may be highly mobile. As discussed earlier in this chapter, asset mobility implies that a firm that tries to secure a competitive advantage by purchase of a patent or an operating right may have to pay a steep price to get it. If so, the purchase of the asset will be a breakeven proposition unless the buyer can deploy it in ways that other prospective purchasers cannot. This requires superior information about how to best utilize the asset or the possession of scarce complementary resources to enhance the value of the asset. Google paid $12.5 billion for Motorola Mobility but believes that the acquisition can create value because Motorola Mobility’s patents complement Google’s Android operating system.

We encountered this issue in Chapter 2 in our discussion of acquisition programs by diversifying firms. Target firms are mobile assets—their owners may sell them to the highest bidder. The evidence shows that acquirers generally lose money unless there are complementarities between the business units of the acquiring and target firms. (In Chapter 2, we used the term relatedness to describe such complementarities.) Otherwise, the owners of the target firm reap all the profits from the acquisition. Google believes that the Motorola deal passes the relatedness test.

The owner of a mobile asset may be better off selling it to another firm. For example, many universities sell the patents obtained by faculty members, realizing that it makes sense for other firms to commercialize these inventions. Likewise, Motorola Mobility’s patents may be more valuable when employed by Google. These examples illustrate a key point about patents and other operating rights: once a patent or operating right is secured, its exclusivity gives it sustainable value. Whoever holds that asset holds its value. But maximizing that value is ultimately a make-or-buy decision, whose resolution rests on the principles developed in Chapter 3.

Superior Access to Inputs or Customers

A firm that can obtain high-quality or high-productivity inputs, such as raw materials or information, on more favorable terms than its competitors will be able to sustain cost and quality advantages that competitors cannot imitate. Firms often achieve favorable access to inputs by controlling the sources of supply through ownership or long-term exclusive contracts. For example, International Nickel dominated the nickel industry for three-quarters of a century by controlling the highest-grade deposits of nickel, which were concentrated in western Canada. Topps monopolized the

Impediments to Imitation • 375

The flip side of superior access to inputs is superior access to customers. A firm that secures access to the best distribution channels or the most productive retail locations will outcompete its rivals for customers. A manufacturer could prevent access to retail distribution channels by insisting on exclusive dealing clauses, whereby a retailer agrees to sell only the products that manufacturer makes. Before World War II, most American automobile producers had exclusive dealing arrangements with their franchised dealers, and according to Lawrence White, this raised the barriers to entering the automobile business.11 Most of these clauses were voluntarily dropped in the early 1950s, following antitrust decisions that seemed to threaten the Big Three’s ability to maintain their exclusive dealing arrangements. Some observers speculate that the termination of these exclusive dealing requirements made it easier for Japanese manufacturers to penetrate the American market in the 1970s and 1980s.12

Just as patents and trademarks can be bought and sold, so too can locations or contracts that give the firm control of scarce inputs or distribution channels. Thus, superior access to inputs or customers can confer sustained competitive advantage only if the firm can secure access at “below-market” prices or if the firm has unique resources or capabilities that enable it to create more value from the inputs and customers it acquires. For example, suppose that a certain site in South Australia is widely known to contain a high-quality supply of uranium and the owners of the site have elected to put it up for auction. At auction, the price of that land would be bid up until the economic profits were transferred to the original owner, and the profitability of the firm that purchases the land would be no higher than the profitability of the losing bidders.

The corollary of this logic is that control of scarce inputs or distribution channels allows a firm to earn economic profits in excess of its competitors only if it acquired control of the input supply when other firms or individuals failed to recognize its value or could not exploit it. Continuing our example, the firm that buys the South Australia uranium site can profit only if it has some unique knowledge of the value of the site, or some unique ability to extract uranium from that site. Either might occur if the firm is already mining an adjacent site. In that case, it could buy the land at a price that just exceeds what other firms thought it was worth, and use its unique position to create value in excess of the winning bid.

The Winner’s Curse

Firms that lack a unique advantage expose themselves to the possibility of a winner’s curse, in which the winning bidder ends up worse off than the losers. Returning one more time to the example of the uranium mine, all of the bidding firms would have first engaged in research to estimate its value. Suppose that there are no mines adjacent to the South Australia uranium site, so that the value of the site is largely independent of which firm wins the bid. This is an excellent example of a common value auction. Oil tracts, loose diamonds, and treasury bills, among many other commodities, are also sold in common value auctions. Although the uranium site is worth the same amount regardless of which firm wins the bidding, the firms’ estimates of the value of the site might vary widely, depending on how each firm performs its geological studies. Some firms will have optimistic estimates, some pessimistic, and some will come pretty close to estimating the actual value. Because these firms are likely to be highly experienced at valuing mining sites, we might expect the average bid to be a pretty good predictor of the mine’s actual value. But the firm that submits the highest bid and wins this common value auction will usually be the one that has the highest estimate of its value. This means that the winning bidder tends to