Downing – Volume 16, Issue 2 (2018)

Journal of New Business Ideas & Trends Vol. 16, Iss. 2, September 2018, pp. 1-8. ”http://www.jnbit.org”

Dimensions of Competitive Advantage

James A Downing Department of Management College of Business Administration California State University, Chico Email: [email protected]

Abstract

Purpose: The purpose of this paper is to analyse industry structures and the components of a competitive advantage for firms operating in different markets. The intention is to provide a depth of understanding for how firms compete differently in fragmented industries. Design/methodology/approach: This paper is a theoretical discussion which develops general schemas from the literature. The schemas are then used to understand how firms create and appropriate . Originality/value: The paper provides an in-depth review of the literature to provide useful schemas on industry structure and competitive advantage. The ideas of competitive advantage for fragmented industries are unique when seen by the form of capital, industry politics, information asymmetry, and forms of competitive advantage.

Keywords: Competitive advantage; industry structure; cartel; ; fragmented industry.

JEL Classifications: D41; L10 PsycINFO Classifications: 3660 FoR Codes: 1503 ERA Journal ID #: 40840

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Introduction

Industry as a unit of analysis is considered a ‘system for ordering’, or an overall and allocation mechanism of industry resources among firms. The business strategy literature has used this ordering system foundation (Mason, 1937) as the main argument to the theory of industry structure determining firm behaviour (Bain, 1956), or the ‘structure-conduct-performance’ (S-C-P) paradigm. Structure refers to a set of related elements to characterize industries allowing for assessment of competitiveness or attractiveness. As structure elements are contrasted by a variety of overall metrics then a profile can be formed to determine the conduct available to firms participating in the industry. The conduct of output and pricing strategy will be based on the industry structure that determines the performance, defined as profitability and efficiency, for individual firms as well as the industry as a whole. Thus, the S-C-P approach suggests that highly competitive markets may be the most efficient structure for an industry. While the resource-based theories (Peteraf,1993) focus on resources and capabilities and is still being theorized today (Nason & Wikland, 2018), the S-C-P paradigm is concerned with positioning. In this regard, the S-C-P paradigm can be considered a modern-day 'invisible hand', depicting structure-determining behaviour due in response to the environment. This research analyses the elements of industry structure and the nature of positioning to understand the dimensions of competitive advantage.

Method

This paper employs a theoretical analysis in which discussion of the relevant issues is used to develop general schemas from the literature. The schemas are then used to understand how firms create and appropriate value. The approach used in this paper is an examination of the extant literature with particular attention to industry constructs which develops a conceptual understanding of different industry structures. The paper then uses those conceptual general schemas to develop the dimensions of competitive advantages, or the creation and appropriation of value, in different industry structures. The methodology is a qualitative approach to theoretical analysis of the literature.

Industry Structure

Industry structure limits the executable used to gain rents (Bain, 1956). For example, a consolidated industry (e.g., or cartels) has one or two dominate firms with a clear structure, which allow incumbent firms to benefit from the strong structural mechanisms of high entry and exit barriers (Williamson, 1975). Consolidated industries will likely experience and/or asset possession to ensure long-term performance (Chandler, 1990), while firms in fragmented industries behave differently due to a different set of limitations of executable strategies (Chandler, 1977). The general characteristics of fragmented industries are low entry barriers and hard- to-differentiate products. Low barriers to entry allow for a constant flow of competitor entry and exit, which maintains fragmentation and allows for unpredictable conduct (Downing & Ma, 2017). In addition, fragmented industries do not allow for scale economies as a strategy since value differentiation is based on a localized technology of customization (Downing & Shanley, 2017). Therefore, fragmented industries are characterized with many competitors and no structural mechanisms requiring different strategies for rents.

Firm conduct for economic rents will be those executable strategies to best compete within a given industry structure, so oligopoly firms will use collusion within a clear value

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chain, for example the metal mining industry (Spar, 1994). Firms in structured industries will look to long-term performance with valuable assets and distribution channels. Firms in fragmented industries will create value from individuals using general industry knowledge and individual relationships. The three industry structures (oligopoly, structured, fragmented) are delineating by the industry elements in Table 1. An industry’s basic descriptive elements will define or limit the executable strategies of firms participating in a particular industry. However, the conduct will be determined by the abilities and judgment of the firm’s entrepreneurs. The following general schemas developed from the literature in Tables 1 & 2are frequently seen in the literature to understand the ‘pure’ definitions of fragmented industries and competitive advantage.

Table 1: The Elements of Industry Structure

Industry Cartel/Oligopoly Perfect/Structured Fragmented Characteristics Number of Firms Firm size Very large Large to small Small # of competitors Few Many Many # of dominant firms One Few None # of buyers Few to many Many Many # of fringe firms None to few Few to many Many Output Level of output Low Low or High High Level of None/Low Low or High High Substitution Barriers Entry/Exit Barriers High entry/exit Varying entry/exit Low entry/some exit Structural Barriers Coercion/fiat Governmental (i.e., association licensing) certifications Scale Scale Economies Yes Maybe No Groups Strategic Groups One industry leader Yes, with one or more Many industry leaders Specificity Transaction Costs Commodity Asset Temporal Firm Strategy and Structure Firm Structure Agreements Hierarchical Flat/autonomous Firm Strategies Collaborative and Absolute cost advantage Performance entry threats and differentiation differentials and strategic groups Examples of Diamond jewellery Hotels or food trucks Strategic groups: Collaborative value network independent insurance agents or realtors

The economics literature clearly describes industry structural differences (Coase, 1937; Chandler, 1990) limiting the executable strategies for firms (Bain, 1956). While an industry may not seem attractive – in terms of a five forces analysis (Porter, 1980) – firms will either seek to limit their (i.e., geographic segmentation) or invest to create self- made structures. Thus, the traditional strategy concept of pricing in low-barrier industries does not consider behaviour when pricing experienced in fragmented industries is multi- dimensional. Therefore, fragmented industry elements will determine the competitive

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behaviour for an unattractive industry in the form of investments in reputation, branding collusion, alliance with complementary products or the like.

The business strategy literature has developed from the fundamental questions of ‘Why do firms exist?’ (Coase, 1937) and ‘Why do multi-person, multi-process firms exist?’ (Malmgren, 1961). These questions are usually answered by understanding the to be a system for allocating means between inputs and outputs, endlessly referred to as a ‘black box’. The allocation decisions of firms are made by individuals that plan and coordinate the economic activities for the firm. The dominate, contextual logic within strategy research has been to examine the actions and decisions of large firms possessing control over their industry. Firms competing in industries against non-cooperating rivals compete for resources and talent while responding to the competitive environment. Sir Dennis Robertson described the firm-industry relationship as “islands of conscious power in this ocean of unconscious cooperation like lumps of butter coagulating in a pail of buttermilk” (1928: 85). This metaphorical view describes a more dynamic understanding of the firm rather than the traditional strategy view of static positioning. The ‘Buttermilk’ metaphor also provides a good mental model of firms cooperating within a firm and the firm cooperating with competitors.

The devoted research efforts to understand competitive advantage for firms in structured product industries have provided relatively little attention to the unique aspects of gaining a competitive advantage in fragmented industries. While the competitive advantage research in economics is based on firm performance, the strategy research is concerned with decisions and behaviours which may be independent of outcomes and results. As a result, strategy scholars have developed theories of firm behaviour and performance mostly based on Coase’s (1937) theoretical work on the mechanism (i.e., the costs of negotiating and writing enforceable contracts) and cost minimization (i.e., reducing bureaucratic costs) strategies which are the foundations to the transaction costs perspective (Williamson, 1979). The research stream on firm behaviour has developed theory on routines and production capabilities for large manufacturing firms, as where Nelson and Winter perimetrically depict within their seminal work as “when we speak of production capabilities, we have manufacturing prominently in mind” (1982: 60). Another strategy research stream, and the most prominent, focuses on resource-based theories describing large dominate firms of an industry that maintain a competitive advantage by possessing superior assets. Contemporary strategy research persistently examines resource- based theories where the possession and deployment of unique resources are the keys to firm performance. There are limitations to this research stream however, stemming from a static, non-predictive notion “that virtually anything associated with the firm can be a resource” (Priem and Butler, 2001: 32). However, resource-based theories do have explanatory value realized reflective to obtaining a competitive advantage. Overall, strategy researchers have primarily relied on the study of large manufacturing oligopoly firms to answer research questions.

Since industry structure will influence a firm’s strategy then it will also determine the firm’s structure. Thus, a strategy of value-chain dominance is not available for firms in fragmented industries because there are no scale economies available to them. However, in an oligopoly where there are scale economies and the strategy is collaborative then firm structures will take the form of coercible agreements. Similarly, in structured industries where the strategies are to obtain cost or differentiation advantages then firm structures will adopt a hierarchical design to command assets. When the gathering of valuable assets and value chain control is not an option, then there must be ways to obtain economies and structure for reliable rents. Strategic approaches in fragmented industries are to create performance differentials and to collaborate with a firm structure that is flat in order to allow for autonomous individual production. The strategy literature stream on strategic groups has sketched out this strategic approach (Peteraf & Shanley, 1997). © JNBIT Vol.16, Iss.2 (2018) 4

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Industry structure (including industry size) will influence the size of the firm, since managerial choices to increase the size of the firm can be justified more in some industries than in others. The composition of the firm can also be influenced by industry, both in the diversification of units and the extent to which forward or backward integration may be justified. In fragmented industries, however, there will be fewer of the bases for large size and differentiated organization that is possible in oligopolies. Chandler (1977; 1990) shows how large firm size and articulated structures are associated with oligopolistic industries. In fragmented industries, however, synergies and scope economies may only be achievable by cooperation among smaller competitors and their suppliers and buyers. Firms in fragmented industries can only imitate large structured firms by informal associations, or strategic groups, rather than formal structures.

The investments firms make in defining their collective strategies, limit mimicking and new entry – what Caves and Porter (1977) call mobility barriers – are not easily identified and measured (Shanley and Peteraf, 2005). When the investments made by group members are observable costs, such as research and development or , then they are easily quantifiable. However, observable costs do not include the many intangible types of mobility barriers, for example, reputation and image (Peteraf and Shanley, 1997). Even when these unobservable barriers can be estimated, it is difficult linking them to performance. Mobility barriers are often the result of collusive efforts from members in a strategic group. The profitability for group members depends on the industry and the firm’s characteristics. If industry rivalry is based on pricing dimensions of skill, preferences, information flow, or relative power among firms, then the group investment for mobility barriers will be along one or more of these strategic differences.

Fragmented industries are especially sensitive to contextual dynamics and firms may not possess the capital for investments large enough to favourably impact the industry structure. Investments may not be “financial” capital; it can be in the form of shared reputation or through cooperative efforts of valuable professionals. Industries will experience several different strategic groups delineated by member investments and a variety of different benefits for members. For example, strategic groups may form to benefit from geographical proximity while other groups in the same industry seek to benefit from scale or scope economies. These benefit differences among firms, along with the difficulties of linking unobservable value-added to performance, highlight the complexities of industry and stress the importance of industry context (Mascarenhas & Aaker, 1989).

Competitive Advantage

A competitive advantage schema can be created on the elements of competitive advantage within industry structure. There is little research investigating the competitive advantages used in fragmented industries. My theoretical examination of competitive advantage is a positive theoretical approach to the value creation and appropriation process, as depicted in Table 2, by the delineating elements of the primary form of capital, politics, price , value creation and appropriation, and mobility barriers.

The three primary forms of capital used to gain a competitive advantage are economic, cultural, and social. Economic capital is immediately convertible to . Cultural capital is the formal and informal norms instituted by a firm. Typically, cultural capital is a firm-level investment that is not easily transferrable. Social capital is an individual-level investment made up of social connections with ‘credentials,’ providing the individual to perceived credit. The amount of social capital that can be generated is limited to the size of the network of connections that can be effectively mobilized (Itami and Roehl, 1987). The network of the relationships is the product of investment strategies to establish

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Table 2: Dimensions of Competitive Advantage

Competitive Cartel/ Oligopoly Perfect/Structured Fragmented Advantage Dimensions Primary Form of Cultural Economic Social Capital Politics No Collaborative Economic Collaborative Social Collaborative Price Elasticity No Maybe Yes Information No Some Yes Asymmetry Value Creation Collusion Asset Specificity Individual knowledge Value Appropriation Collusion Asset Specificity Individual relationships Form of Competitive Sustainable - Control Temporary - Control of Transactional - Control of Advantage of Value Chain Rare/Valuable Resources Asymmetrical Information and transform existing contingent relations into relationships of durable obligations (Bourdieu, 1986). The process of generating social capital is a continuous series of exchanges to establish trust. The individual investment is a significant expenditure of time and effort that requires a specific competence in acquiring and maintaining relationships. Social capital enhances a firm’s competitive advantage by endearing trust with others for potential collaborative. The use of social capital to gain a competitive advantage will require a firm structured more as a political coalition than a hierarchy. The theory of the firm as a political coalition (March, 1962) describes the process of selecting members of coalitions to maximize rents in relation to their demands, while maintaining a manageable number of coalitions at any particular time. This is similar to fragmented activity of many firms forming coalitions to gain an advantage.

The ways firms compete are determined by an industry structure and the capital available to them to gain an advantage. Oligopoly firms create and appropriate value by collusion as seen through the coercion approach used by DeBeers in the diamond industry (Spar, 1994). Firms in structured industries follow the traditional strategy approach to create and appropriate value by obtaining unique assets and distribution channels. Firms in fragmented industries create value with individuals using general industry knowledge and then appropriate the value with individual relationships through political coalitions that enhance their reputation or brand.

Conclusion

This paper uses general schemas to provide a basic overview of industry through the lens of Bain’s ‘structure-conduct-performance paradigm. A schema is then developed to understand the conduct of firms given industry structure. For example, the politics of industry participation involves some level of collaboration with industry players. The industry structure will determine how the participants are able to compete. This study breaks down the industry elements to understand how firms position themselves to utilize certain dimensions of a competitive advantage. For instance, firms in a fragmented industry will collaborate for a competitive advantage (Downing & Shanley, 2017) or invest in social capital (Downing & Ma, 2017). The nature of competitive collaboration still allows firms to differentiated themselves (Downing & Parrish, 2019) which is unique to fragmented industries. Since much of the strategy literature has been formed on the study of large oligopolies with recent discussions on the control of rare/valuable resources, there is less known on the dimensions of competitive advantage for fragmented industries. It is

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important to understanding the dimensions of competitive advantage to develop new business models and ways to compete.

The fragmented industry is extremely common, yet the concentration of research has not provided much insight into the transactional and collaborative approach to obtaining a competitive advantage. These observations are now being noticed (Shanley, 2017) with calls to refocus how we study strategy with a focus on the process and context (Shanley and Peteraf, 2006). Future research should use the schemas developed above to examine how firms in fragmented industries organize to obtain a competitive advantage. As strategy research progresses towards a pragmatic (Joas, 1993, 1996), process (Van de Ven, 1992) and craft perspective (Shanley, 2017, Sennet, 2008) to understanding fragmented market strategies, the fundamental schemas developed from Bain’s ‘structure-conduct- performance’ paradigm will provide an underlying foundation to further develop theory. In addition to the theoretical contributions, this research provides practical views for business professional to explore ways to obtain a competitive advantage by starting with the industry structure.

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