Questions • 395

Michael Porter argues that competitive advantage originates in a firm’s local environment. He identifies four attributes in a firm’s home market that promote or impede its ability to achieve competitive advantage in global markets: factor conditions; demand conditions; related supplier or support industries; and strategy, structure, and rivalry.

QUESTIONS

1.“An analysis of sustainability is similar to a five-forces analysis.” Comment.

2.How do economies of scale affect sustainability?

3.Coke and Pepsi have sustained their market dominance for nearly a century. General Motors and Ford were hard hit by competition and never fully recovered. What is different about the product/market situations in these two cases that affects sustainability?

4.Provide an example of a firm that has cospecialized assets. Has the firm prospered from them? Why or why not?

5.Mercury is a hypothetical store that sells athletic shoes, particularly shoes for runners. Mercury is distinctive in the training of its sales staff. The store has a variety of diagnostic tools, including weight distribution analysis and slow-motion replay, and the staff are trained to use those tools to help customers figure out exactly which shoe will be best for them. Mercury also carries a wide assortment of shoes from the full range of athletic shoemakers, some of which are otherwise-hard-to- find models. Although Mercury is an independent store, it is part of a buying cooperative that enables it to obtain its shoes from suppliers at volume discount prices that would otherwise be available only to large chains. Mercury sponsors a variety of races in its greater metropolitan area, the largest of which is a highprofile annual marathon.

Of the following list of Mercury’s activities, which two have the greatest potential for cospecialization?

(a)Diagnostic skills of staff

(b)Buying cooperative membership

(c)Broad product assortment

(d)Race sponsorship

6.Which of the following circumstances are likely to create early-mover advantages?

(a)Maxwell House introduces the first freeze-dried coffee.

(b)A consortium of U.S. firms introduce the first high-definition television.

(c)SmithKline introduces Tagamet, the first effective medical treatment for ulcers.

(d)Wal-Mart opens a store in Nome, Alaska.

7.In light of the winner’s curse, must winning bidders in auctions necessarily “lose” in the sense of paying more than the item is worth? What steps can bidders take to prosper in auctions?

8.Two incompatible high-resolution audio formats, Super Audio CD (SACD) and DVD Audio (DVDA), were introduced in 2000. Both offered surround-sound music at a quality that approaches the original studio master recordings from which they are made. Both formats could be added to new DVD players for an

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additional $25 to $250 per format, depending on the quality. SACD was originally supported by Sony. While Sony has abandoned the format, it has since won support from numerous classical music and jazz labels that sell in small numbers to “audiophiles.” DVDA has been abandoned by its backers. Why do you think high-resolution audio remained a niche product?

9.Consider an industry in which firms can expect to sell 1,000 units annually at a market price of P. Before firms enter, they do not know their production costs with certainty. Instead, they believe that unit costs can be $2, $4, $6, or $8 with equal probability. Annualized sunk production costs are $1,500—firms cannot recover this expense should they choose to exit. What is the equilibrium price at which firms are indifferent about entering? What is the average profit of firms that are producing? (Hint: Firms will produce as long as the price equals or exceeds unit production costs.)

10. Is the extent of creative destruction likely to differ across industries? Can the risk of creative destruction be incorporated into a five-forces analysis of an industry?

11. Is patent racing a zero-sum game? A negative sum-game? Explain.

12. What are a firm’s dynamic capabilities? To what extent can managers create or “manage into existence” a firm’s dynamic capabilities?

13. “Industrial or antitrust policies that result in the creation of domestic monopolies rarely result in global competitive advantage.” Comment.

14. IQ, Inc., currently monopolizes the market for a certain type of microprocessor, the 666. The present value of the stream of monopoly profits from this design is thought to be $500 million. Enginola (which is currently in a completely different segment of the microprocessor market from this one) and IQ are contemplating spending money to develop a superior design that will make the 666 completely obsolete. Whoever develops the design first gets the entire market. The present value of the stream of monopoly profit from the superior design is expected to be $150 million greater than the present value of the profit from the 666.

Success in developing the design is not certain, but the probability of a firm’s success is directly linked to the amount of money it spends on the project (more spending on this project, greater probability of success). Moreover, the productivity of Enginola’s spending on this project and IQ’s spending is exactly the same: Starting from any given level of spending, an additional $1 spent by Enginola has exactly the same impact on its probability of winning. The following table illustrates this. It shows the probability of winning the race if each firm’s spending equals 0, $100 million, and $200 million. The first number represents Enginola’s probability of winning the race, the second is IQ’s probability of winning, and the third is the probability that neither succeeds.

Note: This is not a payoff table.

IQ’s Spending

Endnotes • 397

Assuming that

(i)each firm makes its spending decision simultaneously and noncooperatively;

(ii)each seeks to maximize its expected profit; and

(iii)neither firm faces any financial constraints,

which company, if any, has the greater incentive to spend money to win this “R&D race”? Of the effects discussed in the chapter (productivity effect, sunk cost effect, replacement effect, efficiency effect), which are shaping the incentives to innovate in this example?

ENDNOTES

1Mueller, D. C., “The Persistence of Profits Above the Norm,” Economica, 44, 1997,

pp. 369–380. See also Mueller, D. C., Profits in the Long Run, Cambridge, Cambridge University Press, 1986.

2Our characterization of these patterns of profit persistence is based on the results in Table 2.2 of Mueller’s book, Profits in the Long Run. Mueller’s study is far more elaborate than we have described here. He uses regression analysis to estimate equations that give persistence patterns for each of the 600 firms in his sample. Our grouping of firms into two groups is done to illustrate the main results.

3This definition is adapted from Barney, J., “Firm Resources and Sustained Competitive Advantage,” Journal of Management, 17, 1991, pp. 99–120.

4Presentations of this theory can be found in numerous publications, including Barney, J., “Firm Resources and Sustained Competitive Advantage,” Journal of Management, 17, 1991, pp. 99–120; Peteraf, M. A., “The Cornerstones of Competitive Advantage: A Resource-Based View,” Strategic Management Journal, 14, 1993, pp. 179–191; and Dierickx, I., and K. Cool, “Asset Stock Accumulation and Sustainability of Competitive Advantage,” Management Science, 35, 1989, pp. 1504–1511. The pioneering work underlying the resource-based theory is Penrose, E. T., The Theory of the Growth of the Firm, Oxford, Blackwell, 1959.

5Morris, Kathleen, “The Rise of Jill Barad,” Business Week, May 25, 1998, pp. 112–119. 6Rumelt, R. P., “Towards a Strategic Theory of the Firm,” in Lamb, R. (ed.), Competitive

Strategic Management, Englewood Cliffs, NJ, Prentice-Hall, 1984, pp. 556–570.

7See, for example, Chapter 5 of Ghemawat, P., Commitment: The Dynamic of Strategy, New York, Free Press, 1991, or Yao, D., “Beyond the Reach of the Invisible Hand,” Strategic Management Journal, 9, 1988, pp. 59–70.

8Quotation from p. 359 in Rumelt, R. P., “Towards a Strategic Theory of the Firm,” in Lamb, R. (ed.), Competitive Strategic Management, Englewood Cliffs, NJ, Prentice-Hall, 1984, pp. 566–570.

9Williams, J., “How Sustainable Is Your Advantage?” California Management Review, 34, 1992, pp. 1–23.

10Quoted in Beard, D., “The Champ Returns,” Fort Lauderdale Sun Sentinal, December 1, 1996, p. 1G.

11White, L., “The Automobile Industry,” in Adams, W. (ed.), The Structure of American Industry, 6th ed., New York, Macmillan, 1982.

12See, for example, Scherer, F. M., and D. Ross, Industrial Market Structure and Economic Performance, 3d ed., Boston, Houghton Mifflin, 1990, pp. 563–564.

13For further discussion of the winner’s curse and the difficulties of finding an optimal bidding strategy, see Thaler, R., “Anomalies: The Winner’s Curse,” Journal of Economic Perspectives, 2(1), 1988, pp. 191–202.

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14Rumelt, R. P., “Towards a Strategic Theory of the Firm,” in Lamb, R. (ed.), Competitive Strategic Management, Englewood Cliffs, NJ, Prentice-Hall, 1984, pp. 556–570. See also Reed, R., and R. J. DeFillipi, “Causal Ambiguity, Barriers to Imitation and Sustainable Competitive Advantage,” Academy of Management Review, 15, 1990, pp. 88–102.

15Teece, D., “Applying Concepts of Economic Analysis to Strategic Management,” in Harold Pennings and Associates (eds.), Organizational Strategy and Change, San Francisco, Jossey-Bass, 1985.

16Lippman, S. A., and R. P. Rumelt, “Uncertain Imitability: An Analysis of Interfirm Differences in Efficiency under Competition,” Bell Journal of Economics, 13, Autumn 1982, pp. 418–438.

17We calculated the equilibrium price through trial and error. A systematic method exists for calculating the equilibrium price in this market, but its discussion would add little to the economic insights that this example generates.

18Schumpeter, J., Capitalism, Socialism, and Democracy, New York, Harper & Row, 1942, p. 132.

19Ibid., pp. 84–85.

20Christensen, C., The Innovator’s Dilemma, New York, Harper Business, 2000. 21Stein, J., “Internal Capital Markets and the Competition for Corporate Resources,”

Journal of Finance, 52(1997), pp. 111–133.

22Arrow, K., “Economics Welfare and the Allocation of Resources for Inventions,” in Nelson, R. (ed.), The Rate and Direction of Inventive Activity, Princeton, NJ, Princeton University Press, 1962.

23This term was coined by Jean Tirole. Tirole discusses the replacement effect in his book, The Theory of Industrial Organization, Cambridge, MA, MIT Press, 1988.

24Teece, D., 1986, “Profiting from Technological Innovation: Implications for Integration, Collaboration, Licensing, and Public Policy,” Research Policy, 15, pp. 285–305.

25Much of the information for this example was drawn from Zygmont, J., 2003, Microchip, Cambridge, MA, Perseus Publishing.

26Nelson, R. R., and S. G. Winter, An Evolutionary Theory of Economic Change, Cambridge, MA, Belknap Press, 1982.

27Teece, D. J., G. Pisano, and A. Shuen, “Dynamic Capabilities and Strategic Management,” University of California at Berkeley, Strategic Management Journal, 18, August 1997, pp. 509–534. See also Teece, D. J., R. Rumelt, G. Dosi, and S. Winter, “Understanding Corporate Coherence: Theory and Evidence,” Journal of Economic Behavior and Organization, 23, 1994, pp. 1–30 for related ideas.

28Porter, M., The Competitive Advantage of Nations, New York, Free Press, 1998. 29This example is drawn from Landes, David, Revolution in Time, Cambridge, MA,

Belknap Press, 1983.

PART FOUR

INTERNAL ORGANIZATION

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