Myths and Fallacies in Strategic Management — Part I

15 May 2006 at 1:48 pm 17 comments

| Nicolai Foss |

Here is the beginning of what may become a regularly occurring post on http://www.organizationsandmarkets.com: An identification of common myths, mistakes, fallacies, non sequiturs, etc. in the strategic management field (I am sure my co-blogger will be happy to participate). Most of them have been picked up from conversations with colleagues, from listening to presentations in seminars and at the Strategic Management Society Meeting, and so on. Most relate to the resource-based view (i.e., Wernerfelt, Barney, Rumelt, Peteraf, etc.). OK, here goes:

1. Competitive advantage cannot be had from resources that are purchased rather than internally accumulated. Wrong — unless factor/resource/input markets are perfect. The sources of the confusion may be the critique by Dierickx and Cool (1989, Man Sci) of Barney (1986, Man Sci). The Dierickx and Cool paper has often been read as implying that — as a purely theoretical matter — only “non-tradeable” resources can produce a competitive advantage. (At the 2005 SMS conference, I repeatedly heard this argument invoked as serving as the criterion that could fundamentally differentiate the capabilities perspective from the RBV: The capabilities perspective focuses on those firm-specific and firm-level assets that cannot be traded and, hence, are the only real sources of competitive advantage). Unfortunately, this argument is a complete non sequitur: Traded resources can be sources of competitive advantage on the Barney strategic factor market arguments (i.e., their price is lower than their discounted net present value).

2. Knowledge resources are more important sources of sustained competitive advantage than other resources. This claim is usually given axiomatic status. Indeed, it does sound plausible, but in no way so obviously correct (like, “A is A”) that we shouldn’t treat it as a falsifiable hypothesis. And the fact is that we know very little about its truth status. Very few empirical tests exist that truly discriminate between knowledge resources and non-knowledge resources with respect to impact on sustained competitive advantage. In a recent PhD thesis (Determinants of Firm Success: A Resource-Based Analysis, Curtin University of Technology), Jeremy Galbreath tests this hypothesis “Compared to the contributions of tangible assets, intellectual property assets will make a larger contribution to firm success” and fails to confirm it. (He also fails to find support for ideas that capabilities are particularly important).

3. Success requires that strategies and the underlying resources are unique. This argument implicitly assumes that strategies are always substitutes. As we know, however, strategies may very well be complements, for example, pricing strategies in oligopolies or standard strategies in network industries.

More to come.

Entry filed under: - Foss -, Management Theory, Myths and Realities, Strategic Management.

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17 Comments Add your own

  • 1. Bo Nielsen  |  15 May 2006 at 4:50 pm

    To the first fallacy:

    Since no firm is an island (and thus alone in the market place) my question is: Why can the firm in question acquire those assets below their fair market value in competition with other potential bidders? Are they just lucky? If the firm in question has more insight than other potential bidders into what the acquired is really worth, what is the source of this superior insight? Is it a non-tradable firm specific advantage?

  • 2. Jung-Chin Shen  |  15 May 2006 at 7:28 pm

    I took Karel Cool’s Competitive Strategy course when I was a PhD student of INSEAD, and Dierickx & Cool (1989) is of course on our reading list. According to my memory and interpretation, Karel seems to be aware of the problem although he did not explicitly say it in the classroom. However, Karel did say that although people often pay most attention to the argument that Nicolai cited above as #1, their initial intention was just to use it as a motivation of the paper. The core argument that they wanted to deliver in the paper is that Barney’s argument is mainly concerned with creation of competitive advantage, but they want to supplement some arguments which can explain sustainability of competitive advantage. This is how the concepts of stock and flow come into play. However, most people seem to be more interested in the non-tradable part than in the accumulation part. If someone likes, I think Google Scholar’s citation pattern will confirm the observation.

  • 3. Nicolai Foss  |  16 May 2006 at 12:15 am

    @ Bo, Read Barney’s original statement (Barney, 1986, MS), or more recently, Denrell, Fang and Winter (2003, SMJ).

    @Jung-Chin, This is very interesting, and exactly how I myself would interpret Dierickx and Cool (1989).

  • 4. Bo Nielsen  |  16 May 2006 at 10:18 am

    Again I am looking at reality rather than theory here.

    The China National Offshore Oil Corporation is bidding to buy Unocal, ranked ninth among US oil producers. Can they afford this? Presumably they will be paying a premium price and one can wonder if they (given few years of experience and a poor track record) have any special management skills that will warrant this premium price.

  • 5. Nicolai Foss  |  16 May 2006 at 11:01 am

    @Bo, You seem to be missing the point. My critique was: It is not correct to state that — as a theoretical matter — only internally accumulated assets can be sources of CA. Obviously, this theoretical point has huge practical implications — of the kind you suggest. But the critique was theoretical.

  • 6. Bo Nielsen  |  16 May 2006 at 1:35 pm

    OK – then we are on the same page.

  • 7. JC  |  8 June 2006 at 9:47 pm

    But we are still left with the core question about the circumstances under which a firm may acquire rent-yielding resources, as surfaced by Barney (1986). If the theory of sustainable advantage is made central to the theory of the firm it has to be about rents, no? There are other theories of the firm, of course, but which is being invoked here? Not many that would appeal to real economists or those proto-economists celebrated in Barney & Ouchi (1986) [my, how time flies!!]

    If we dismiss all circumstances save those of ‘perfect’ markets then there are no posiibilities for acquiring rent-yielding resources at less than the net-present value of their rent-streams. OK, we get it – or did I miss something? But Nicolai’s point seems to be that there are markets, or at least trading possibilities, which lie beyond the scope of this analysis. But what are they?

    To fall back immediately onto NONE and so to the notion that such resources MUST be internally generated may be cavalier, unrealistic, and miss key differences between markets in theory and markets real. OK, but what kinds of ‘trade’ do we have in mind here. Seller’s ignorance, like ‘the lesser fool’ theory does not seem an adequate basis for the kind of general theory being sought here.

    Nicolai writes: “Traded resources can be sources of competitive advantage on the Barney strategic factor market arguments (i.e., their price is lower than their discounted net present value).”. Ugh? Really? How does this work? What notions of firm and market are being invoked here?

    On point 2. Perhaps I simply don’t get it, but if we are talking competitive advantage how can we NOT be talking about heterogeneity – a slightly looser notion than ‘unique’ but standing on the same conceptual ice-floe nonetheless.

    There are a rat’s nest of problems here. How can a firm be both unique and yet a memeber of the set of all firms? What is a firm anyway? If we say it is a bundle of resources, then the only possible source of uniqueness lies in the resources themselves.

    Bu if we wander off into Rob Grant’s territory and say the essential characteristic of the firm is not its resources but the manner of their combination – a suitably Penrosian notion – then we might ask how such combination could be traded rather than generated internally. A recipe for sale? The CEO moving from one firm to another? Yeah, right, and at the same time arguing in court that s/he is ‘unfamiliar’ with the details of the business and the value-adding processes, being ‘big pcture’ (and big check) guys.

    Do CEOs know something or not? Are they the essence of the firm or not? How many different ways do we want to have our cake and eat it? I think we’re looking at intellectual obesity here, and yet the emperor actually has no clothes. Ugh! What is the essence of the firm we are trying to theorize?.

  • 8. Nicolai Foss  |  9 June 2006 at 5:36 am

    JC,
    I am not sure I understand you completely , but let me try.
    1) I wrote: “Traded resources can be sources of competitive advantage on the Barney strategic factor market arguments (i.e., their price is lower than their discounted net present value).”. You comment: “Ugh? Really? How does this work? What notions of firm and market are being invoked here?.” All Barney (1986) is saying is that asymmetric information may mean that some firms can “beat the market” and buy resources at a price

  • 9. JC  |  9 June 2006 at 6:50 am

    Right, asymmetric info. But is this an explanation or an observation? If the former the asymmetry needs to be explained. Either that or there needs to be total information about the asymmetry. Random distribution cannot lead to a theory of competitiive advantage.

  • 10. Nicolai Foss  |  9 June 2006 at 7:34 am

    JC, I would certainly say it is an explanation. But I see your point: We often routinely posit “asym info,” actually treating it as an unexplained category that just happens to make the analysis work. Have you seen the paper by Denrell, Fang and Winter in SMJ 2005? They link “asymmetric information” and the Barney factor market logic to differential capabilities in a very convincing manner.

  • 11. Brian  |  9 June 2006 at 8:26 am

    Regarding the first fallacy and the ensuing posts, isn’t it necessary to clarify whether you are discussing competitive advantage vs. the generation of economic rents? Although it seems common in the field to use these interchangeably (i.e., competitive advantage necessarily implies economic rents), my reading of Barney (1986) and subsequent writings would lead me to conclude that these are not interchangeable.

    I believe the perfect factor market argument referenced in the first fallacy applies to the presence of economic rents, not the existence of competitive advantage. Resources that generate competitive advantage can exist even in the presence of perfect factor markets; however, those resources will not generate economic rents.

  • 12. Jung-Chin Shen  |  9 June 2006 at 11:21 pm

    Nicolai,

    My reading is slightly different. I take Makadok and Barney’s (2001) Management Science piece as an attempt to answer JC’s question regarding the sources of information asymmetry. To me, Denrell, Fang and Winter’s SMJ piece is to point out another source of competitive imperfections in the strategic factor market: market incompleteness. Am I wrong?

  • 13. Nicolai Foss  |  10 June 2006 at 1:24 am

    Jung-Chin, You are right that Denrell et al. stress missing markets as an important source of competitive imperfections (which Barney doesn’t (but Dierickx and Cool do)). This brings innovation into the picture, e.g., the production of new products. However, even with missing markets (for the innovation) the demand and the supply side on the markets for the inputs that are needed for the production of the new products could, in principle, be perfect — i.e. the the seller(s) and the buyer(s) could entertain similar expectations concerning the value of the inputs. So we are back to asymmetric information. The source of superior information on the buyer side would then lie in the buyer firm having private knowledge of the value of its innovation, something that is dependent on the buyer’s capabilities. In that reading, Denrell et al. is a refinement of a Barney rather than pointing to a different source of competitive imperfections. Am I wrong?

  • 14. Nicolai Foss  |  10 June 2006 at 1:33 am

    Brian, Right, it may be important to distinguish between CA and rent. But if CA is thought of as the ability of a firm to create more value (for its stakeholders) for a certain kind of transactions than the competition is capable of (for the same kind of transactions), isn’t it the case that perfect factor markets will eliminate CA, i.e., that part of the additional value creation which is appropriable by the firm will be captured by the factor markets (eliminating CA). Am I wrong?

  • 15. Jung-Chin Shen  |  10 June 2006 at 2:54 am

    Nicolai,

    A thoughtful response will require me to go back to some literature. My first response to your post is that I disagree with your explanation, and if it is the argument of Denrell, Fang and Winter (2003), I would say Denrell et al. does not go far enough along the line they used to criticize Barney. (In their language, perhaps my bold position should be stated as “the better news is that the good news could be better.” ;-)

    Your explanation reminds me Stiglitz 2000 in which he argues that incomplete contract and incomplete enforcement are not really a problem in the absence of information asymmetry. I would argue that information asymmetry is not a necessary condition for competitive imperfections in the strategic factor market theory, if it is what Barney and Derell et al. mean. For example, incomplete information is another source of competitive imperfections. Assume that certain economic outcomes require two or more parties work together (e.g., joint R&D requires coordination), and that each party has identical but incomplete information (so there is not information asymmetry). When they jointly conduct the work in an incomplete market, they uncover new opportunities that were not available before. Is this situation not covered by Barney and Denrell et al.? Another case in my mind is the concept of common knowledge in game theory. What do you think?

  • 16. Brian  |  13 June 2006 at 9:12 am

    Nicolai,

    Do you think the field has a clear, agreed-upon definition of “competitive advantage” and a sense of how exactly it should be measured? We certainly use the term quite a bit, but it’s not always entirely clear to me what it is and how exactly we decide whether it is or is not present. It seems the definition in your post has at least four parts. To identify a competitive advantage, we would need to identify a particular kind of “transaction” for a defined set of “competition.” Then, we would need to define / measure “value” for the relevant group of “stakeholders” of each firm to be able to compare. Let’s say we could deal with the first two – that still leaves us with quite a challenge in measuring value for stakeholders, especially since there appears to be at least a fair amount of disagreement on who are the stakeholders to whom management has responsibility (a topic I am sure you will be dealing with in your Theory of the Firm course with Joe Mahoney this week).

    Getting back to the original issue, I would mention a Barney and Arikan (2001) chapter from The Blackwell Handbook of Strategic Management. In that chapter, they discuss perfect factor markets being consistent with a firm having a competitive advantage but not generating economic rent. They state, “a firm may enjoy a competitive advantage by being one of a small number of firms implementing a particular product market strategy, but not earn an economic rent, because the price paid to acquire or develop the resources needed to implement this strategy fully anticipates is value in the product market.” (p. 135). For reference, they say a firm has a competitive advantage “when it is implementing valuable product market strategies not currently being implemented by several other competing firms.” (p.176, note 4). When Barney uses the term “valuable,” I believe he refers to being able to deliver at a lower cost or command a higher price than the competition – so it does not appear to necessarily be an economic rents argument.

  • 17. Nicolai Foss  |  13 June 2006 at 1:47 pm

    Brian,

    Thanks for your comments.

    I do indeed think that the field is confused on the meaning of CA. Your analysis of my notion of CA is entirely correct. I do believe CA should be defined in terms of transactions, that we need to carefully the “competition” etc.

    I also think that they Barney and Arikan definition of CA is problematic. They are referring to a situation in which the firm in question does not have a potential to create more value than the competition etc. In that case, I don’t think it is meaningful to speak of a CA.

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