Rethinking Competitive Advantage: Why Mid-Sized Businesses may have the Advantage

"A firm is said to have competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitors." That is, competitive advantage is the basis of the superior performance of a firm relative to its competitors. Over the last twenty years or so, the most popular explanation of competitive advantage has been based on the notion that the firm possesses something special in the form of superior resources and capabilities. In other words, firms that possess superior resources and capabilities would have a competitive advantage over their rivals in a given market, and hence they would show extraordinary profits and performance. Fellows of the NCMM, Anand and Lu, challenge this simplistic notion on the grounds that it is difficult to know which firms actually possess superior resources and capabilities until after the evidence of competitive advantage and superior performance is already in. This issue is particularly salient for middle-market firms and has significant implications for understanding the foundations of superior performance. One important lesson from their research is don't walk away from a opportunity by assuming that if a competitor has already entered that market it has superior abilities! This is counter to common sense about first movers, and thus frequently forgotten!

Consider, for example, the case of a new and novel market opportunity. Several firms may be potentially interested in entering this market in order to enhance their profits. Conventional wisdom suggests that firms that have superior capabilities pertinent to this market opportunity will enter this market. However, firms with inferior capabilities may sit it out because entry into this market entails costs but no payoffs due to competition from superior rivals. Therefore, when expectations of both superior and inferior firms converge, only the firms with superior capabilities will enter this market.

But what if the firms are unsure of the resource and capability requirements in the new market simply because of its newness and novelty? In that case, firms that "believe" that they possess superior capabilities will enter the market and firms that "believe" that they possess few or inferior capabilities will not enter the market despite its attractiveness. The "false positives", i.e., firms that don't possess superior capabilities, but believe that they do and enter the market, may discover their mistake if they land up facing superior competitors. On the other hand, "false negatives", i.e., firms that don't enter the market under the mistaken belief that they are inferior in their capabilities, may never get to know their mistake. Further, if an inferior firm mistakenly enters the market, and the superior firm mistakenly stays out, neither of the two "mistakes" may be detected, and an observer may falsely conclude that the entering firm must have been superior to have done so.

The Fellows' develop three (formal game theory) models to capture how well firms figure out their own and their competitors' capabilities and consequently who decides to enter a market:

  1. A first model in which all firms can observe their own and their competitors' capabilities, i.e., firms possess perfect information,
  2. A second model in which firms can observe their own capabilities but not their competitors' capabilities, and
  3. A third one in which firms are not able to accurately observe their own or others' capabilities. This may be closest to the real world.

The Fellows find that in only the first case (with perfect information), superior resources and capabilities do predict the entry decisions accurately - the best step forward. Firms with superior capabilities enter the market and firms with lesser capabilities decide to stay out. However, this relationship between superior resources and capabilities and entry decisions breaks down in the other two that involve imperfect information.

Imperfect observability of capabilities – second and third models - better describes the real world and has practical implications. Let us consider the competition between Boeing and Airbus in the market for very large aircraft (VLA). For the 40 years since Boeing launched its flagship model, the Boeing 747, it has remained the market leader in the large aircraft segment. In the early 1990s, demand for air travel was expected to witness rapid growth, thus inciting Boeing and Airbus to consider building a super jumbo jet. In the year 2000, Airbus announced plans for its A-380 model and invested $11.9 billion. Responding to this move by Airbus, Boeing subsequently announced that it was backing out from this segment. These interactions between Airbus and Boeing raise interesting questions. For instance, Ghemawat and Esty (2002)[1] note that:

"...Specifically, one particular line of game-theoretic modeling offers the non-obvious insight that although the incumbent, Boeing, would earn higher operating profits if it could somehow deter the entrant, Airbus, from developing a superjumbo, entry-deterrence through new product introductions may be incredible even if the incumbent enjoys large cost advantages in new product development (e.g., because of line-extension economies)..."

A potential reason why Boeing did not enter the super jumbo market even though it may have possessed capabilities in terms of scale economies, was that it was uncertain about potential scope economies that Airbus could exploit upon entering this market. Thus, both Boeing and Airbus essentially faced imperfect observability of the other firm's resources. In hindsight, one can also ponder this question: What if Boeing held erroneous beliefs about its own capabilities? This counterfactual case cannot be observed since Boeing decided not to compete. However, it is certainly plausible that Boeing may have been able to capture sustainable advantages if it indeed had not withdrawn. The final outcome suggests that even in the presence of heterogeneous resources, Boeing's inability to completely observe its own resources and that of Airbus may have potentially influenced its decision to not enter.

These considerations are very relevant for mid-market firms. It is important to note that firms in the mid-market segment are likely to possess complex enough resources and capabilities to generate uncertainty about their competitive advantage, unlike start-ups and smaller firms that possess a smaller set of resources. Larger and more prominent firms, on the other hand, are highly visible and generally public. Their actions and reactions or frequently analyzed and speculated upon. It is the mid-market firms that may represent the most likely scenario of"flying under the radar." And, the lesson for middle market managers is to think harder about your own resources and capabilities, and those of your competitors. You might think differently about your competitive advantage!

[1] Ghemawat P, Esty BC. 2002. Airbus vs. Boeing in super-jumbos: A case of failed preemption, Harvard Business School Working Paper # 02-061

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