Competitive heterogeneity

Competitive Heterogeneity is a concept from strategic management that examines why industries do not converge on one best way of doing things. Microeconomics predicts that competition will result in industries composed of identical firms offering identical products at identical prices. This topic was taken up in industrial organization economics by scholars such as Harold Demsetz and Michael Porter. Demsetz argued that better managed firms would grow larger than their competitors. Thus, some firms would offer better products or lower prices. These firms would then be larger than the more poorly managed competitors. Porter argued that firms in an industry would cluster into strategic groups. Each group would be similar and movement between groups would be difficult and costly. Richard Rumelt and Stephen Lippman demonstrated how firms could differ in an industry in partial equilibrium-like circumstances. Richard Nelson and Sidney G. Winter discussed how firms develop differing capabilities. During this time, many economists (most?) believed that the differences between firms in an industry were trivial. This was a point of contention within strategy and between strategy and economics from about 1980 to the mid-1990s.

Early in the 1990s a number of papers were published under the rubrics of the Resource-based View and Capabilities. Both approaches continue to develop. However, the RBV won the public relations war (complete with removing dissenting opinions from Wikipedia). The RBV argues that firms vary in their resources and resource variances lead to varying competitive positions. Capability theories, building on earlier work by Nelson and Winter and Teece make a similar claim.

Developing ideas pioneered by Rumelt (1984) and discussed by Levinthal (1985) and Noda and Collis (2001)Hoopes, Madsen, and Walker (2003) use the term competitive heterogeneity to describe the performance differences between close competitors. Hoopes et al. argue that the RBV is but one of many possible explanations for competitive heterogeneity. Thus, the title of their paper and special issue, "Why is there a RBV?" In addition to economics based explanations noted above, Hoopes et al. point out that differing beliefs, preferences, and objectives lead firms pursuing similar customers to find and develop unique competitive positions.

Additionally, Hoopes et al. suggest that competitive advantage should be thought of in terms of each firm's "economic contribution. (Walker,2004; Hoopes Madsen, and Walker, 2003). Termed the V-C model, it is basically a bargaining model (see Tirole, 1986: 21-34). A buyer and supplier bargain over the price (P) for a good that contributes a value (V) to the buyer and costs the supplier some amount (C) to produce. "Value is the price a buyer is willing to pay for a good absent competing products or services yet within budget constraints and considering other purchasing opportunities. Most work considers costs in terms of marginal cost. The good’s market price lies between value and cost. So, the buyer receives a surplus of value minus the price (V-P), and the supplier receives a profit of price minus cost (P-C). The supplier’s resources and capabilities, in turn, influence the value of the good to the buyer and/or the cost of producing it (Hoopes, Madsen, and Walker (2003)." Also see Besanko, Dranove & Shanley, 1999: chapter 13; Ghemawat, 1991: chapter 4; Walker, 2004: chapter 2; see also Postrel, 2002). Competitive advantage is determined by largest difference between value and cost.

In summary, a theory of competitive heterogeneity seeks to explain why firms do not converge on a best way of doing things as predicted by simple microeconomics. The RBV contains one approach. In recent years capability theories have expanded RBV logic. Recently, more work that focuses on heterogeneity has been published in strategy journals.

References

• Besanko, D., D. Dranove and M. Shanley 1999. Economics of Strategy (2nd edition). MA: Wiley and Sons.
• Demsetz, H. 1973, "Industry Structure, Market Rivalry and Public Policy," Journal of Law and Economics.
• Demsetz, H. "Two systems of belief about monopoly," in H. Goldschmid, et al., eds., Industrial Concentration: The New Learning, Boston: Little Brown, 1974; (also chapter 7 in, Demsetz, Harold. Efficiency, Competition, and Policy. Cambridge MA: Basil Blackwell, 1989.)
• Ghemawat, P. 1991. Commitment: The Dynamic of Strategy. New York: Free Press.
• Hoopes, D.G.; Madsen, T.L.,; Walker, G. (2003) Guest Editors’ Introduction to the Special Issue: Why is There a Resource-Based View? Toward a Theory of Competitive Heterogeneity. Strategic Management Journal; 24, pp. 889–902.
• Levinthal, Daniel A. 1995. “Strategic Management and the Exploration of Diversity.” In:Resource-Based and Evolutionary Theories of the Firm: Towards a Synthesis. Montgomery,Cynthia A. (ed.) Dordrecht: Kluwer Academic Publishers.
• Nelson, R. and S. Winter. 1982. An Evolutionary Theory of Economic Change. Cambridge, MA: Harvard University Press.
• Noda, T. & D. J. Collis The Evolution of Intraindustry Firm Heterogeneity: Insights from a Process Study (in Special Research Forum: Change and Development Journeys into a Pluralistic World) The Academy of Management Journal, Vol. 44, No. 4. (Aug., 2001), pp. 897–925.
• Peteraf, M. A. (1993), "The cornerstones of competitive advantage: a resource-based view". Strategic Management Journal, Vol. 14, No. 3, pp. 179–191
• Postrel, S. 2002, Islands of shared knowledge: Specialization and mutual understanding in problem-solving teams”, Organization Science, 13 (3): 303-320.
• Porter, M. (1980) Competitive Strategy, Free Press, New York, 1980.
• Rumelt, R. P. 1984. “Towards a Strategic Theory of the Firm.” In R. B. Lamb (ed.), Competitive Strategic Management. Englewood Cliffs, NJ: Prentice Hall, pp. 556–570.
• Rumelt, R. P. (1991), "How much does industry matter?". Strategic Management Journal, Vol. 12, No. 3, pp. 167–185
• Teece, D. J. 1982. “Towards an Economic Theory of the Multiproduct firm.” Journal of Economic Behavior and Organization. 3: 39-64.
• Teece, D. J., G. Pisano, and A. Shuen 1994. “Dynamic Capabilities and Strategic Management.” Strategic Management Journal.
• Tirole, J. 1988. The Theory of Industrial Organization. Cambridge: MIT Press.
• Walker, G. 2004. Modern Competitive Strategy (2004), McGraw-Hill.