Threats to competitive advantage: imitation and substitution

Transcription

1 Bachelor thesis Threats to competitive advantage: imitation and substitution ANR : Name : Tjeerd van Loosbroek Topic : Industries, Firms, competitive dynamics, and competitive advantage Sub topic : Threat to competitive advantage: imitation and substitution. Study Program : Premaster Strategic Management. Tutor : Drs. A. Kramer Word Count :

2 Management summary The main question of this thesis is: How can a firm protect their competitive advantage against substitution and imitation by competitors? In order to be able to give a clear answer on this question competitive advantage, imitation and substitution will be explored. Competitive advantage is the implementation of a unique strategy that creates value (Barney,1991). It improves a firms effectiveness and efficiency and so increases profit (Wernerfelt, 1984). Competitive advantage is attained through either an internal or external change in the market (Grant, 2008). The change in competitive position is influenced by the magnitude of the change and the resources, capabilities or strategic positioning of a firm. A firm is able to respond to change through the implementation of their resources, capabilities and strategic positioning. Resources of competitive advantage are heterogeneously distributed and are perfectly immobile (Barney, 1991). This implies that different firms have different strategies, have diversified competitive advantage and thus different financial performance. The sustainability of a firms competitive advantage depends on the relative ease with which it can be imitated or substituted (Dierickx, Cool, & Barney, 1989). A sustained competitive advantage needs to be valuable, rare, imperfectly imitable and nonsubstitutable (Barney, 1991). Imitation of competitive advantage is an attempt to build the same assets which have created value for a firm (Dierickx, Cool, & Barney, 1989). Costs and time are important factors which determine the success of imitation. In order to successfully imitate a firms competitive advantage, a firm; must be able to identify, have an incentive, diagnose and must have the ability to require the resources (Grant, 2008). The relative ease with which a firm is able to imitate implies the time consuming and costs. The relative ease is determined by time compression diseconomies, asset mass efficiencies, interconnectedness of asset stock, asset erosion and causal ambiguity (Dierickx, Cool, & Barney, 1989). The latter offers the best protection against imitation. Ambiguity obscures the assets which create value for the firm. Tacitness, complexity and specificity lead to ambiguity (Reed & DeFillipi, 1990). Even though barriers exist to imitation it is never insurmountable that a firms competitive advantage will be lost (Porter, 1985). Substitution is the use of alternative resources to be able to achieve a performance objective 2

3 (Barney,1991). Substitution threatens competitive advantage because it can make the resource obsolete. Equal or superior substitutes diminish the revenues derived from competitive advantage. A substitute enables a firm to avoid competition on a competitors strength in comparison with the firms own relative weaknesses (McEvily, Das, & McCabe, 2000). Three different forms of substitution are possible; technology, business models and management practices. Barriers to substitution are not expressed in money or time. A substitute needs to overcome a performance hurdle in order for it to be come of interest to a firm (McEvily, Das, & McCabe, 2000). Continuous improvement, lock in and market deterrence can raise barriers to imitation. Raising barriers against substitution often opens doors to imitation. 3

4 Inhoudsopgave Management summary... 2 Chapter 1: Introduction Problem Indication Problem statement Research Questions Research Design and data collection Overview of the Rest of the Chapters... 8 Chapter 2: Competitive advantage Competitive advantage Market based view Resource based view Attaining a competitive advantage External sources of change Internal sources of change Sustained competitive advantage Resource heterogeneity and perfectly immobile resources VRIO model Conclusion Chapter 3: The concept of imitation Imitation Definition of imitation Reason to use imitation Imitation process Protection against imitation Relative ease of asset imitation Ambiguity Conclusion Chapter 4: The concept of substitution Substitution The definition of substitution Reason to use substitution Different levels of substitution Protection against substitution

5 4.2.1 Continuous improvement; Lock in Market deterrence Conclusion Chapter 5: Conclusion & Recommendations Conclusion How can a firm attain a competitive advantage? How can a firm protect its competitive advantage against imitation? How can a firm protect competitive advantage against substitution? Problem statement Discussion limitations Recommendations References

6 Chapter 1: Introduction This bachelor thesis addresses the topic of competitive advantage and imitation and substitution of competitive advantage. Hofer and Schendel (1978, as cited in Reed and Defillipi 1990) were the first that stated that there is a direct connection between a distinguishing competency and competitive advantage. This means that gaining an advantage, in perspective to the competitive players, is about attaining a unique position by deploying their competencies. A firm should use their competencies in a way it can create an advantage in comparison with the competitors. Further in this chapter a short introduction on imitation and substitution is given. 1.1 Problem Indication According to Reed and Defillipi (1990) academics agree with each other that competitive advantage has an important role in a firm s strategy. However in the literature there are 2 different views upon competitive advantage. Day and Porter (as cited from Reed and Defillipi, 1990) gave their view on competitive advantage by using competitive advantage as the objective of strategy. In their view it is the goal to use strategy with which a competitive advantage can be attained. The other view on competitive advantage is that competitive advantage ensues from competencies. These competencies can be managed by the firm. The reasoning behind attaining competitive advantage is that superior performance is a result of competitive advantage. By attaining competitive advantage over the competition this will lead to a higher performance (Reed & DeFillipi, 1990). Various sources can lead to a competitive advantage (Grant, 2008). After a firm has established an advantage over the competition it needs to sustain the advantage. Two threats can be identified to competitive advantage: imitation and substitution (McEvily, Das & McCabe, 2000). According to Barney (1991) it is an important research question to understand how firms can extend the time of which it has a competitive advantage. It is not calendar time that determines how long a firm has a competitive advantage but how long competitors are unable to imitate or substitute the advantage. McEvily, Das & McCabe (2000) argue that resources protected against imitation can be a source of durable competitive advantage, because a firm can profit from above average returns. How can firms protect their competitive advantages against these threats? The subject of this thesis will be 6

7 about how a firm can attain and protect their advantages against imitation and substitution. A competitive advantage creates an above average return when it offers a unique and highly valued product or service or when it ensures improvements in common criteria such as quality, time to market or cost (McEvily, Das & McCabe, 2000). To start with imitation, competitive players could investigate the source of the competitive player s higher performance. If a competitor finds the source of competitive advantage, this competitor could duplicate the source. The competitor uses this value creating strategy and in the worst case this competitor could perform better than the firm which initially had the competitive advantage. Academics have written about several techniques that raise the cost of duplication (Ghemawat, 1986;Mahoney & Pandian, 1992). These barriers can decrease the possibility of the occurrence of imitation. According to McEvily, Das & McCabe (2000) and Reed & DeFillipi (1990) the intrinsic characteristics of competencies offer the best protection against imitation. These characteristics are complexity, tacitness or specificity (McEvily, Das & McCabe, 2000; Reed & DeFillipi 1990). They obscure the source of competitive advantage, in a way that it makes it hard for the competition to imitate. This is also referred to as causal ambiguity (McEvily, Das & McCabe, 2000; Reed & Defillipi, 1990). Second there is substitution; substitution occurs when there are more than one valuable alternative assets or competences by which the same strategy can be put into operation (Barney, 1991). The other asset or competence can lead to the same value creating strategy, but because other firms are able to use the same strategy, the firm is not unique in the market and therefore it cannot be a source of sustainable competitive advantage. When substitution is possible causal ambiguity will not be enough for the firm to sustain the competitive advantage. According to McEvily, Das & McCabe (2000) it is not possible to directly prevent competitors from investing in substitution. What can be done is making, or making it look like, investing in substitutes is not profitable. Convincing competitors that no good substitutes for the competence are available is an example. There are three strategies that tackle the problem of substitution: continuous improvement, lock in and market deterrence (McEvily, Das & McCabe, 2000). 1.2 Problem statement How can a firm protect their competitive advantage against substitution and imitation by competitors? 7

8 1.3 Research Questions 1. How can a firm attain a competitive advantage? 2. How can a firm protect its competitive advantage against imitation? 3. How can a firm protect its competitive advantage against substitution? 1.4 Research Design and data collection In order to find the solutions for the problem statement and research questions a qualitative, descriptive research is conducted. In this type of study, research is done in order to describe the characteristics of the variables which are of interest to the research (Sekeran & Bougie, 2010). The variables which are of interest in this bachelor thesis are imitation, substitution and competitive advantage. Secondary data sources are used for this thesis. Secondary data is information which has been collected by other researchers and often can be found in databases (Sekeran & Bougie, 2010). Data which is gathered for this research comes from existing data sources. This data has been found through searching the University of Tilburg library catalogue on certain key words such as competitive advantage, substitution, imitation, causal ambiguity and sustainable advantage. Also Web of Science and Jstor will be used to gather data. For this literature study, the data that will be used are quality journals such as: Academy of Management Journal, Academy of Management Review, Management Science, Journal of Management and Strategic Management Journal. These journals offer this thesis a higher quality because most of these papers are published in academically highly valued journals, which is indicated by the impact factor of these journals. The impact factor of the journals which are used for this thesis have a value between. 1.5 Overview of the Rest of the Chapters First, in the second chapter an explanation of competitive advantage is given and there will also be explained the importance of having a competitive advantage and how competitive advantage can be attained. A definition of imitation and the reason for competitors to imitate are explained in the third chapter. In this chapter is also explained what a firm can do to protect their competitive advantage against imitation. The fourth chapter describes the concept of substitution and reasons for a competitor to search for substitutes. This chapter will also describe what a firm can do to protect their competitive advantage against substitution. In the final chapter the problem statement is solved and there will also be conclusions drawn. 8

9 Chapter 2: Competitive advantage. The research question addressed in this chapter is: How can a firm attain a competitive advantage? Therefore first a definition is described of competitive advantage and two different views on competitive advantage are discussed. In section 2.2. is discussed how a firm can attain a competitive advantage. After a competitive advantage is established it is important to create sustained competitive advantage, this is discussed in section Competitive advantage. A firm has a competitive advantage when it is putting a strategy into operation which creates value, but a competitive firm, potential or existing, may not be using or putting this value creating strategy into operation simultaneously (Barney, Firm resources and sustained competitive advantage, 1991). Value creation is described by Wernerfelt (1984) as improving a firm s effectiveness and efficiency, or it can also be noted that it does not reduce a firm s effectiveness or efficiency. Therefore the firm with the competitive advantage earns a higher profit or potentially gives him a superior profit rate over the competition (Grant, 2008). The second condition, being unique in the market, considers all current competitors in the industry, but also potential competitors who might enter the industry (Baumol, Panzar, & Willig, 1982). Attaining competitive advantage over the competition will lead to a higher performance, because the firm is able to improve its quality, lower production costs and time to market (Conner, 1991; Peteraf, 1993). In the academic literature there are 2 different views upon competitive advantage. The market based view and the resource based view, these two views will be discussed shortly in the following subsections Market based view The view of Day (1984) and Porter (1985) is that competitive advantage is the objective of strategy. According to this theory it is the goal to use strategy to achieve competitive advantage. Porter (1985) argues that there are two ways a firm is able to gain competitive advantage over a competitor namely: same product against a lower price or a product that is different in a way that a customer is willing to pay more for it. On this basis Porter has developed 3 different strategies on which competitive advantage could be based; cost, differentiation and focus strategy. A firm chooses to follow one of these strategies must exploit all the resources available to execute the strategy. Choice of strategy is based on external factors. 9

10 2.1.2 Resource based view The usual factors which determine a strategy do not always offer enough stability (Grant, 2008). External factors such as customer preference and technology can change rapidly. These volatile external factors can be a reason to formulate strategy based on internal factors such as resources and capabilities of the firm. Resource based view assumes that competitive advantage ensues from organizational capabilities (Prahalad & Hamel, 1990). Capabilities implies what the firm is able to do and arise from resources. Resources are the productive assets owned by the firm (Grant, 2008, P. 130). Grant (2008) describes three different types of resources; tangible, intangible and human resources. 1. Tangible resources; physical assets such as financial resources and material property. 2. Intangible resources; non physical assets such as brand names, reputation and knowledge. 3. Human resources; the experience and effort that is brought to the firm by its employees. In this paper we acknowledge both views on competitive advantage. Though in this paper the thought of the resource based view of the firm is adopted because capabilities can be developed and managed by the firm through managing resources. 2.2 Attaining a competitive advantage. Why is competitive advantage so important and how can a firm attain a competitive advantage? In this subsection these questions will be enlightened. Furthermore the sources of competitive advantage are explained. As stated earlier, a competitive advantage has two conditions; value creation and uniqueness. To put a value creating strategy in to practice the firm needs to have valuable assets (Dierickx, Cool & Barney, 1989). Assets are a strategic and cumulative effect of following a number of policies over a long time period (Dierickx, Cool and Barney, 1989). These assets deliver value to the firm and therefore deliver an improvement to the firms efficiency and effectiveness. Dierickx, Cool & Barney (1989) state that not all assets are tradable and therefore they cannot be bought or sold. Non tradable assets have to be build over time. For example, reputation for toughness, which is built by having a history of being an aggressive player. According to Grant (2008) competitive advantage creates a disequilibrium in the market. Then there is no even balance in the players competitive position vis à vis. 10

11 One or more firms may have a considerably higher profit compared to other firms in the industry. Competitive advantage appears when change occurs within the industry (Grant, 2008). Change creates opportunities in the market for a firm. Identifying and analyzing changes is a core management function (Grant, 2008). According to figure 2. 1 the source of competitive advantage is twofold. Theree is an external and an internal source of change. These changes will be discussed in the following subsections. The existencee of competitive advantage External sources of change Customer demandd Change in price Technology Internal sources of change Figure 2.1: The emergence of competitive advantage, (Grant, 2008) External sources of change External sourcess of change come from factors outside the firm. Porter (1985) and Ghemawat (1986) discuss the following external factors of change in; customer demand, price and technology. 1. Customer demand; change occurs when your customerss desire something else or desire more than the firm is able to deliver. 2. Price; change occurs because of a price increase or decrease. In a price decrease situation the firm needs be make sure it can lower their production costs. 3. Technology; a change occurs when the current technology is improved or new inventions have been introducedd to the market that positively influence the product or service sold by the firm. The competitivee position of the firm is influenced by the magnitude of the external change and the result for each firm is different depending on their diverse resources, capabilities or strategic positioning (Grant, 2008). Firms have differences in resources, capabilities and strategic positioning and these determine how a firm is able to respond to change (Lipmann 11

12 & Rumelt, Uncertain imitability: an analysis of interfirm differences in efficiency under competition, 1980) Internal sources of change Internal sources of change come from within the firm and are often generated by innovation (Grant, 2008). Innovation involves value creation for customers from new business models. For example innovation can come from experience, products, product delivery or bundling (Grant, 2008). There are four approaches to formulate innovative strategies (Grant, 2008). These have been developed to make analysis of innovations possible. 1. The concept of reinventing the game; the common industry value chain is altered. For example a firm which does the exact opposite of the competition and does not start production in advance but only manufactures when an order has been placed. 2. Applying, at first hand conflicting dimensions which create combined an unexpected value for the customers. For instance high quality production and low cost production are normally opposite to each other. However the combination delivers valuable customer contentment. 3. Blue ocean strategy; a firm is capable of creating new markets within existing markets or reinvention of the market. A firm does not pay attention to the competition and expands the current boundaries of the game. A firm introduces a innovative new concept. 4. Innovation in management; Hamel (2006) aruges that competitive advantage goes nowadays much further than superior products, markets or technologies. Innovation in management is according to Hamel (2006) the most valuable basis for creating an advantage over the competition. For example innovative management of brands, production system or development of management. 2.3 Sustained competitive advantage. In this subsection the sustainability of a firms competitive advantage will be explored and to which requirements does a competitive advantage satisfy to become a sustained competitive advantage. 12

13 Sustainability of a firm s asset position hinges on how easily assets can be substituted or imitated (Dierickx, Cool and Barney, 1989, p. 1504). McEvily, Das and McCabe (2000) argue that resources (or bundles of resources) protected against imitation can be a source of durable competitive advantage, because the firm can profit longer from an above average market return. According to Barney (1991) it is an important research question to understand how firms can extend the time of which it has a competitive advantage. It is not calendar time that determines how long a firm has a competitive advantage but how long competitors are unable to imitate or substitute the competitive advantage. Sustained competitive advantage can be defined by the following definition: A firm is said to have a sustained competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitor and when these firms are unable to duplicate the benefits of this strategy (Barney, J., 1991, p. 102). Barney (1991) has developed a theoretical model in which he acknowledges 2 assumptions; resource heterogeneity and perfectly immobile resources. These will be discussed in the next subsection, after that the theoretical model (VRIO) will be discussed Resource heterogeneity and perfectly immobile resources. Barney (1991) assumes that for his model to be correct resources have to be distributed heterogeneous and resources have to be perfectly immobile. The distribution of resources is heterogeneous when resources are not equally distributed. When the opposite is considered, then all the firms in the industry are capable of putting the same strategy into operation, because the necessary resources are available to the competition. If all the players could implement the same strategy, the increase in efficiency and effectiveness is equal and is also in the same amount. Therefore for attaining a sustained competitive advantage it is necessary that barriers to entry or mobility are present. Perfectly immobile resources cannot easily be acquired by competing firms which potentially want to enter the industry. When resources are not distributed equally, but are acquired easily then firms are able to use the resources which are necessary to put a strategy into operation; it therefore can put the same strategy into operation. With the assumption that resources are not easily acquired firms can implement a different strategy with which they possibly can create a sustained competitive advantage. 13

14 2.3.2 VRIO model The assumptions that resources are heterogeneous distributed and perfectly immobile is the basis for understanding resources of sustained competitive advantage. According to Barney (1991) four conditions are necessary for achieving sustained competitive advantage; valuable, rare, imperfectly imitable, non substitutable. 1. Valuable resources; the source of the competitive advantage must add value to the firm does it want to be a source for sustained competitive advantage. Valuable is described as an improvement to the firms efficiency and effectiveness (Wernerfelt, 1984). If a charismatic leader is a valuable resource then this person improves the firms efficiency, effectiveness or both. 2. Rare resources; as long as the number of firms that have possession over the resource is smaller than the number of firms that is needed to create perfect competition in the industry then the resource is rare. If a large number of firms have possession over a valuable resource (or bundle of resources) then they all have the capability of exploiting this resource and thereby not one of the firms has a (sustained) competitive advantage. If the firm has a unique possession over a resource then this resource has potential of becoming a source for sustained competitive advantage. 3. Imperfectly imitable; the competition should not be able to possess the same valuable and rare resources. Resources which are valuable and rare cannot be a source of sustained competitive advantage if the competition is able to attain these resources. 4. Substitutability; are other resources available in the industry which could be a substitute for the firms valuable, rare and imperfectly imitable resource with which they could implement and execute the same strategy. The resource can be called a sustained competitive advantage when there are no other resources which can substitute for the valuable, rare and imperfectly imitable resource. 2.4 Conclusion Competitive advantage is the implementation of a unique strategy that creates value (Barney,1991). It improves a firms effectiveness and efficiency and so increases profit (Wernerfelt, 1984). Competitive advantage is attained through either an internal or external change in the market (Grant, 2008). The change in competitive position is influenced by the 14

15 magnitude of the change and the resources, capabilities or strategic positioning of a firm. A firm is able to respond to change through the implementation of their resources, capabilities and strategic positioning. Resources of competitive advantage are heterogeneously distributed and are perfectly immobile (Barney, 1991). This implies that different firms have different strategies, have diversified competitive advantage and thus different financial performance. The sustainability of a firms competitive advantage depends on the relative ease with which it can be imitated or substituted (Dierickx, Cool, & Barney, 1989). A sustained competitive advantage needs to be valuable, rare, imperfectly imitable and nonsubstitutable (Barney, 1991). 15

16 Chapter 3: The concept of imitation. In this chapter the research question addressed is: How can a firm protect its competitive advantage against imitation? First, imitation is defined, furthermore in section the reason for a firm to use imitation is explored and the process of imitation in section How a firm can protect their competitive advantage is discussed in section 3.2. The relative ease for firms to imitate and ambiguity are discussed in paragraph and paragraph In the final section a conclusion is given. 3.1 Imitation This section is divided in to 3 pieces; first the concept of imitation will be defined. Second, the question is addressed why firms use imitation and after that the four requirements which are necessary to successfully use imitation are discussed Definition of imitation Imitation is the replication of valuable and rare assets of a firm and is an attempt to build similar valuable and rare assets (Dierickx, Cool, & Barney, 1989). The success of the replication depends on the costs and time needed. This is also referred to as the relative ease with which the competition is capable of building similar assets (Dierickx, Cool, & Barney, 1989). This will be discussed in paragraph According to Grant (2008) the advantage of, for example a store lay out, point of sale technology, extended opening hours can be easily imitated by other firms. A firm which has invested in building an asset with which they created value for their customer, wants to profit from this competitive advantage for as long as possible. Therefore they have to protect their competitive advantage against imitation Reason to use imitation As stated in the previous chapter, some assets create value for the firm and cannot be bought and/or traded between firms (Dierickx, Cool, & Barney, 1989). For instance, competitive advantage from having superior production caused by the best machines in the market can relatively simple be restored. The competition could buy the same production machines. However, having a superior production because employees are very experienced with the production system is something that has evolved over time. The firm that has attained a competitive advantage is profiting from higher revenues because the firm has increased its efficiency and effectiveness (Reed & DeFillipi, 1990). Earning more money than 16

17 the competition increases the chance to survive. This higher profit offers financial headroom for investment and the possibility to increasingly develop the competitive advantage (Reed & DeFillipi, 1990). Assuming that all the firms strive for profit maximization, the firms without competitive advantage have an incentive to catch up. If they cannot develop their own assets to improve the firms efficiency and effectiveness then imitation could be an option Imitation process. For imitation to be successful there are four requirements which have to be met; identification, incentive, diagnosis and resource acquisition (Grant, 2008). These requirements give a general view of which steps have to be taken for a competitive firm to successfully imitate a firm s assets. 1. Identification; a competitor must be able to comprehend that a rival firm has attained a competitive advantage. Therefore the identification of competitive advantage is necessary. Financial results can be a source of information, because it could show that a competitive firm has a considerable higher profit. 2. Incentive; the competitive firm must have an incentive to use imitation. This is in most cases the belief that imitation gives rise to a considerable improvement in the firms efficiency and effectiveness. 3. Diagnosis; for the competitive firm it is necessary to determine the elements which have given rise to the competitive advantage. 4. Resource acquisition; the firm must be able to attain the assets needed in order to implement the same value creating strategy. 3.2 Protection against imitation. Imitation of an asset is only able to the extent that a firm is able to copy the characteristics of an asset (Dierickx, Cool, & Barney, 1989). Barriers against imitation are therefore raised by firms. A barrier restrains or obstructs the firm from imitating (Reed & DeFillipi, 1990). Whether imitation of a particular asset stock will be time consuming, costly or both depends on the relative ease with which rival firms are able to accumulate a similar asset stock of their own (Dierickx, Cool, & Barney, 1989, P. 1507). The relative ease consists of the following characteristics; time compression diseconomies, asset mass efficiencies, 17

18 interconnectedness of asset stocks, asset erosion and causal ambiguity (Dierickx, Cool, & Barney, 1989) Relative ease of asset imitation. 1. Time compression diseconomies; the time needed for a firm to develop the assets which give rise to the competitive advantage. A competitive advantage is easier sustained when it takes more than a decade to develop this asset. The competitor needs to invest approximately the same amount of time to attain this asset. Scherer (1967) and Mansfield (1968) argue that doubling the investment in for instance a R&D department does not double the accumulation process of knowledge. If a firm holds an asset which costs a lot of time to accumulate then it will not be that easily imitated. 2. Asset mass efficiencies; the current amount of knowledge available to the firm influences the future accumulation process of the firm. The possession of a considerably larger amount of knowledge or experience could lead to a better position to take big steps accumulating knowledge. Firms with little knowledge on assets have great difficulties in catching up on the firms who are continuously accumulating their knowledge. 3. Interconnectedness of asset stock; the process of knowledge accumulation within a firm is also influenced by the level of knowledge on other assets (Von Hippel, 1978). It takes a given level of knowledge on a certain asset in order to accumulate a high degree of knowledge on other assets. Accumulating a high degree of technology know how can become difficult if there is not an extensive service network. 4. Asset erosion; how fast is the decay process of assets. Asset erosion might occur because of technological obsolescence. A relation exists between entry deterrence and asset erosion (Eaton & Lipsey, 1980). To credibly deter potential entrants the firm must be devoted to undertake disciplinary actions. Credibility depends on the source of the asset. Flow variables as a source of asset such as output and advertising policies can be adjusted after entry and are therefore less credible. Stock variables such as capacity and brand loyalty cannot be adjusted after entry and therefore are more credible to use for market entry deterrence (Eaton & Lipsey, 1980). Eaton & Lipsey (1980) state that stock variables are a better source for market entry deterrence and the more a firm has, the slower the asset erosion. 5. Causal ambiguity; the degree to which a competitor is not able to determine what the decisive assets are which have given rise to the competitive advantage. If it is easy for a competitive player to understand which assets cause the competitive advantage then 18

19 the chance of success increases (Reed & DeFillipi, 1990). For instance the store layout and extended opening hours can easily be copied because this is easily identified. The above explained options 1 raise barriers for imitation. The characteristics of ambiguity offer the best way to protect competitive advantage (Reed & Defilipi, 1990). Ambiguity will be discussed in more detail in the next subsection Ambiguity Ambiguity is concealing or obscuring the sources of competitive advantage and consists of three characteristics; tacitness, complexity and specificity (Reed & DeFillipi, 1990). Where the other barriers create difficulties to imitate, they do not hide the source of competitive advantage. 1. Tacitness; this is knowledge that exists unaware and is developed over time by doing the same routine. A property of tacit knowledge is the inability to notice and register what causes the increased performance. Because the critical resources of competitive advantage cannot be monitored a rival firm is not able to succesfully use imitation. 2. Complexity; complexity makes sure that the competition is not able to use imitation because of the multifaceted knowledge necessary to understand what causes the competititve advantage. Complexity is caused by the use of several different technologies, organizational routines and individual or teambased knowledge. There are only a few individuals, and sometimes even none, who fully understand the overall knowledge of what has given rise to the competitive advantage (Nelson & Winter, 1982). This way the competitive advantage is protected against recruition of crucial employees by competitors. 3. Specificity; the firm could have developed highly specific assets over time because of certain transactions. Diverse Investments could have been necessay (e.g. employee training, production site) for these transactions and have resulted in long term relationships between customers and the firm. These relationships enables the firm to remain their competencies and resources ambiguous and with that raise a barrier to imitation for the competition (Reed & DeFillipi, 1990). 1 The options explained are not all the barriers which have been identified; academics argue that economies of scale, switching costs and first mover advantage also raise barriers (Reed & Defilipi, 1990). These barriers do not hide the source of competitive advantage, but they offer protection because they deter potential entrants but do not protect against imitation. 19

20 Eventhough several barriers can be risen by firms to protect competitive advantage, imitation is never insurmountable (Porter, 1985). Porter (1985) discusses that there is a difference in the height of barriers and the difficulty to conquer them. Though the height of the barrier does determine the sustainability of the competitive advantage, still it can very easily be lost because of an internal (e.g. innovation) or external change (e.g. customer demand, price or technology). 3.3 Conclusion Imitation of competitive advantage is an attempt to build the same assets which have created value for a firm (Dierickx, Cool, & Barney, 1989). Costs and time are important factors which determine the success of imitation. In order to successfully imitate a firms competitive advantage, a firm; must be able to identify, have an incentive, diagnose and must have the ability to require the resources (Grant, 2008). The relative ease with which a firm is able to imitate implies the time consuming and costs. The relative ease is determined by time compression diseconomies, asset mass efficiencies, interconnectedness of asset stock, asset erosion and causal ambiguity (Dierickx, Cool, & Barney, 1989). The latter offers the best protection against imitation. Ambiguity obscures the assets which create value for the firm. Tacitness, complexity and specificity lead to ambiguity (Reed & DeFillipi, 1990). Even though barriers exist to imitation it is never insurmountable that a firms competitive advantage will be lost (Porter, 1985). 20

21 Chapter 4: The concept of substitution. This chapter addresses the concept of substitution. The research question explored is: How can a firm protect its competitive advantage against substitution? In the first section, substitution is defined. In and the reason why firms would use substitution and the different levels of substitution are explored. Paragraph 4.2 addresses what firms are able to do in order to protect their competitive advantage against substitution. 4.1 Substitution This section is divided in to 3 pieces; first the concept of substitution will be defined. Second, the question is addressed why firms use substitution. In section the different levels on which substitution might occur is discussed The definition of substitution. Substitution is the use of different resources or competencies in order to be able to realize a certain strategy and produce outcomes derived from this strategy (Barney, 1991). The basis of substitution is using different resources and still be able to achieve the same goal. For instance, if coordination is the goal and it can be achieved by a formal planning system or a charismatic leader (Barney, 1992). The formal planning system and charismatic leader are substitutes because there is a clear difference but they reach an equal goal. Substitutes that are equal (or superior) diminish the revenue generated by a firm s competitive advantage. Where imitators copy the exact asset which creates competitive advantage, substitution finds different assets in order to achieve a similar competitive advantage Reason to use substitution. As discussed in chapter two, a firm has incentive to strive for profit maximization and therefore have an incentive to catch up on a firm that already has improved its efficiency and effectiveness. According to McEvily, Das & McCabe (2000) substitution lies at the basis of competitive strategy development. By the use of substitution a firm can avoid competing on a firm s strengths and its own relative weaknesses. Because while ambiguity obscures the source of competitive advantage (Reed & DeFillipi, 1990), it is not enough to offer protection against substitution (McEvily, Das, & McCabe, 2000). 21

22 4.1.3 Different levels of substitution. Here will be described the different types of substitution. Technology, Business Models and Management Practices are alternative competences on which substitution could be based (McEvily, Das, & McCabe, 2000). 1. Technology; the use of different techniques in order to exploit the physical properties of raw materials or the use of a distinctive design approximation are substitute skills of technology. For instance, x ray imaging and nuclear imaging are different technologies though they can substitute each other (Mitchell, 1989). 2. Business models; alternative use of ways to add value to the firm. Substitution based on new business models is also be referred to as innovation (McEvily, Das, & McCabe, 2000). Innovation has been described in section For instance, a generic drug manufacturer whose business model is based on high volume production can threaten high R&D focussed drug manufacturers by imitating their products. Though both manufacturers have very different resources and capabilities they compete for the same customers. 3. Management practices; the use of alternative corporate governance in order to achieve similar or superior goal. Centralized and decentralized decision making or hierarchical and autonomous management can be substitutes to each other (Aoki, 1986; Rediker & Seth, 1995) 4.2 Protection against substitution. McEvily, Das, & McCabe (2000) state that even when (sustained) competitive advantage is not threatened by imitation because high barriers have been raised. It still can be exposed to substitution. A competitive advantage can only become sustained as long as there are no substitutes available in the market (Barney, Firm resources and sustained competitive advantage, 1991). There is a considerable chance that the sustainability of competitive advantage is lost because of substitution. Especially because substitution cannot be prevented directly (McEvily, Das, & McCabe, 2000). The barrier of substitution does not correspond to cost or time it is more a performance hurdle that has to be overcome. The alternative resource has to reach this performance hurdle for it to be profitable. Ambiguity as a barrier is not good enough for a firm to protect its competitive advantage against substitution. McEvily, Das & McCabe have identified barriers in order to delay substitution. These barriers are; continuous improvement, lock in and market deterrence. These barriers 22

23 are specifically focussed on the levels on which substitution could occur (i.e. technology, business models and management practices) Continuous improvement; If a firm continuously improves their own performance level then it enables them to profit from asset mass efficiencies and time compression diseconomies (Dierickx, Cool, & Barney, 1989; McEvily, Das, & McCabe, 2000). Continuous improvement can be used in order to delay substitute management practices. Improving the firms performance level increases the gap between the competition. Continuous improvement is hard for a successful firm to accomplish, it does not have incentive to jeopardize its advantage by experimenting with innovation (Bromiley, 1991). Where a firm that does not perform well does have incentive to change. In general a firm, without considering its financial performance, can accomplish continuous improvement by implementing variable pay. There exists a relation between salary and the performance achieved by employees ( (Fast, 1975; Rumelt, 1995). Emphasis is placed on the performance of the firm and therewith incentive to use alternative measures is provided. Miller (1992) criticizes the variable pay policy and its high failure rate because managers cannot stick to agreed upon performance objectives. The challenge of a variable pay structure is to develop it in such a way that it provides suitable motivation and binding. Therefore the firm has to exchange information about performance and management practices so that a good variable pay policy can be created (Bean & Gros, 1992; Zenger & Hesterly, 1997) Lock in Lock in occurs when customers and suppliers invest in firm specific skills, knowledge, equipment and organizational processes and so become more dependent of a firm. Lock in can be used in order to delay substitute technologies. Customers and suppliers are tied to the firm and are only able to move their business at a high expense (McEvily, Das, & McCabe, 2000). This raises barriers for competition because their chance to succeed depends on the willingness of customers to change supplier. A substitute technology is only of interest to the customer when the performance improvement is greater than the costs incurred to switch (Lieberman & Montgomery, 1988). The costs, such as investments in new firm specific skills and knowledge that have to be made in order for the firm to switch supplier generates time for a firm to further adjust their products and services to the performance level of the competition (Mitchell, 1989; Tripsas, 1997). If complementary goods and services are not compatible with competing technology then encouraging a supplier to develop specialized complementary goods further delays the competition. The 23

24 greater the firm specific investment the better, one could conclude. Though Williamson (1985) discusses that customers are exposed to ex post opportunistic behaviour. Ex post opportunistic behaviour occurs after a firm has made highly specific investments so becoming highly depended. Price increases or delivering a lower quality product are forms by which a firm can cheat upon the agreed. This can be resolved by writing long term contracts, but as long as it is not possible to include all the risks in the contract that could occur and affect price or product quality, the contract is not credible (Milgrom & Roberts, 1982). Customers are therefore not very eager to commit themselves on a long term basis. Researchers argue that buyers are more willing to commit themselves to a specific firm if there exists at least a second firm in the market which is able to deliver a similar product (Taylor 1984). This enables imitation because knowledge of the firm s technology needs to be shared. Though the firm is able to make their own selection of competitors and agreements can be made not to compete directly for the same customers it is still a risk. Rockett (1990) argues that a market with good players is better and also direct and stronger competition is discouraged to enter Market deterrence Market deterrence discourages potential entrants to enter the market. Potential entrants have to be convinced that the market they want to enter is not a very profitable market. Substitution from alternative business models is delayed because of market deterrence (McEvily, Das, & McCabe, 2000). By showing potential entrants that the firm is committed to compete aggressively, this deters potential entrants. A firm has an incentive to compete aggressively when their capabilities are complex and highly market specific (McEvily, Das, & McCabe, 2000). Their capabilities cannot be easily implemented in another market so they have to require their profits from a specific market. Therefore the firm needs to signal a potential entrant that the rate of return received is not high enough so the potential entrant will not be enticed to enter. Lipmann & Rumelt (1982) have shown that a potential entrant will cease entry if the entrant is only able, with a certain amount of risk, to reach the same level of efficiency. The greater the uncertainty, the sooner entry will be ceased. So the goal is to clear any uncertainty about the efficiency of the firm. This can be done by sharing information about its business model in for instance, business cases and articles. 24

25 4.3 Conclusion Substitution is the use of alternative resources to be able to achieve a performance objective (Barney,1991). Substitution threatens competitive advantage because it can make the resource obsolete. Equal or superior substitutes diminish the revenues derived from competitive advantage. A substitute enables a firm to avoid competition on a competitors strength in comparison with the firms own relative weaknesses (McEvily, Das, & McCabe, 2000). Three different forms of substitution are possible; technology, business models and management practices. Barriers to substitution are not expressed in money or time. A substitute needs to overcome a performance hurdle in order for it to be come of interest to a firm (McEvily, Das, & McCabe, 2000). Continuous improvement, lock in and market deterrence can raise barriers to imitation. Raising barriers against substitution often opens doors to imitation. 25

26 Chapter 5: Conclusion & Recommendations 5.1 Conclusion The main question for this thesis is: How can a firm protect their competitive advantage against substitution and imitation by competitors? This question has been divided into three research questions to give an answer. First an answer is given to each of the research questions then the main problem is discussed How can a firm attain a competitive advantage? Competitive advantage can be created from responding to internal or external changes. Resources, capabilities and strategic position enable a firm to respond to change (Grant, 2008). For a strategy to become a competitive advantage it needs to satisfy two conditions (Barney, Firm resources and sustained competitive advantage, 1991). First, it has to create value for the firm, thus it must improve the firms effectiveness and efficiency (Wernerfelt, 1984). The second condition, the strategy has to be unique in the industry (Barney, Firm resources and sustained competitive advantage, 1991). In order for a firm to implement a strategy, the firm must have the possession over assets or must build assets (Dierickx, Cool, & Barney, 1989). Use of valuable and unique assets enables a firm to implement a unique and value creating strategy. A sustained competitive advantage also needs to be perfectly imitable and non substitutable. Which implies that the competitive advantage cannot be imitated or substituted for (Barney, Firm resources and sustained competitive advantage, 1991) How can a firm protect its competitive advantage against imitation? Competitive advantage subjected to imitation looses its value because the strategy is no longer unique in the industry (Barney, Firm resources and sustained competitive advantage, 1991) Imitation is successful if the imitator is able to build the same valuable and rare assets (Dierickx, Cool, & Barney, 1989). A firm can protect their competitive advantage by raising barriers to imitation. Time compression diseconomies, asset mass efficiencies, interconnectedness of asset stock, asset erosion and ambiguity raise barriers to protect the firms competitive advantage (Dierickx, Cool, & Barney, 1989). Reed & Defilipi (1990) argue that ambiguity is the most effective barrier because the source of competitive advantage is obscured or concealed by either tacitness, complexity and specificity. Tacitness raises a 26