More on Strategic Factor Markets

2 September 2006 at 1:03 pm Nicolai Foss Leave a comment

| Nicolai Foss |

Jay Barney’s 1986 paper, “Strategic Factor Markets: Expectations, Luck and Business Strategy,” is a classic of recent strategic management literature and one of the key contributions to the resource-based view. It is also one of those papers where the argument — in this case that firms can only gain a competitive advantage if they buy at least some inputs at a price below the net present value of those inputs — seems so irritatingly obvious — that is, after you have read the paper.

Barney’s argument shifted the sources of competitive advantage from imperfections in product markets to imperfections in strategic factor markets (of course, one can always argue that those who reason in terms of product market imperfections implicitly invoke factor market imperfections, as in recent industrial organization economics). Moreover, as Barney shows in this 10 pages long paper, this simple argument have some pretty radical implications, for example, for whether Porter style industry analysis can form the basis of competitive advantage.

I remember reading Barney’s paper in the beginning of the 1990s and not being entirely happy with it. My misgivings were based on Barney treating all imperfections as informational in nature (the paper is based on finance notions of market efficiency). Surely, the distribution of bargaining powers on the supply and demand sides of factor markets would also matter. Market forms (or game forms) would matter. But this was not analyzed in Barney (1986) (and I wasn’t capable of modelling this point).

Later work has supplied some of the missing points of the original analysis, in particular Richard Makadok’s important work (e.g., this paper). (At the recent Academy Meetings, Barney quipped that Makadok used to introduce any paper or talk with “The reason Jay Barney’s 1986 paper is wrong is that … [insert new argument]”).

A couple of weeks ago I came across another very interesting contribution to strategic factor market theory which took me back to my initial reasing of Barney (1986) 15 years ago: a very interesting dissertation by Ilgaz T Arikan, “Essays on the Theory of Auctions and Economic Rents” (it is apparently no longer online, but perhaps you can get a copy if you write Ilgaz at iarikan@gsu.edu ). A key point in the dissertation is that when firms compete in factor markets they make strategic choices concerning using spot markets with posted prices, negotiation markets with bargaining, or auction markets with bidding. Pricing is endogenized as the strategic variable. The choice is shown to depend on bargaining powers, heterogeneity of expectations, risk preferences, search costs, and market thickness.