376 • Chapter 11 • Sustaining Competitive Advantage

be overoptimistic, which implies that if it bid anywhere close to its estimate, it will have probably paid too much.

If firms are to make money in a common value auction, they must anticipate that winning bidders tend to be overoptimistic and they must shade their bids accordingly.13 By bidding below their estimates, firms can be sure that when they do win an auction, their winning bid is realistic. Firms often convince themselves that they have a unique advantage that justifies a higher bid. But other firms may also have their own unique advantages, which can lead to a different kind of winner’s curse—the winning bidder thought too highly of its own uniqueness. The bottom line is that it is difficult to prosper by purchasing someone else’s scarce asset.

Market Size and Scale Economies

Imitation may also be deterred when minimum efficient scale is large relative to market demand and one firm has secured a large share of the market. We have already discussed this situation in Chapters 2 and 6, where we described how economies of scale can limit the number of firms that can “fit” in a market. Scale economies can also discourage a smaller firm already in the market from seeking to grow larger to replicate the scale-based cost advantage of a firm that has obtained a large market share. Figure 11.4 illustrates the logic of this isolating mechanism. Two firms, one large and one small, produce a homoge-

FIGURE 11.4

Economies of Scale and Market Size as an Impediment to Imitation

A large firm and a small firm are currently competing in a market in which the product cannot be effectively differentiated. The downward-sloping straight line is the market demand curve. Production technology is characterized by economies of scale, with the long-run average cost function (LAC) declining until the minimum efficient scale of 4,000 units per year is reached. The large firm currently has a capacity of 5,000 units per year, while the small firm has a capacity of 1,000 per year. If the small firm attempted to expand capacity to 4,000 units, and both firms produced at full capacity, the market price would fall to $4.25. At this price, the small firm would be unable to cover the costs of its investment in the new plant. Thus, although the small firm could theoretically imitate the source of the large firm’s cost advantage, it would be undesirable to do so.