pankaj ghemawat - competition and business strategy in historical perspective

Harvard Business SchoolCompetition & Strategy Working Paper Series

Working paper number: 798010

Working paper date: July 1997Revised: April 2000

Competition and Business Strategy inHistorical Perspective

Pankaj Ghemawat (Harvard University)

This paper can be downloaded without charge from theSocial Science Research Network electronic library at:http://papers.ssrn.com/paper.taf?abstract_id=264528

http://papers.ssrn.com/paper.taf?abstract_id=264528

Copyright © 2000 Pankaj Ghemawat

Working papers are in draft form. This working paper is distributed for purposes of comment anddiscussion only. It may not be reproduced without permission of the copyright holder. Copies of workingpapers are available from the author. Professor Pankaj Ghemawat, drawing upon an earlier draft prepared byDr. Peter Botticelli. The author has benefited from helpful comments by Walter A. Friedman, Thomas K.McCraw and three referees.

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Competition and Business Strategy in Historical Perspective

Abstract

This paper is a history of ideas about business strategy and how they came to beinfluenced by competitive thinking. Both academics and practitioners’ contributions arenoted. The bulk of the paper focuses on efforts in the 1970s and the 1980s to deepen theanalysis of industry attractiveness and competitive position and, since then, to add ahistorical or time-dimension to what used to be predominantly static modes of analysis.

Strategy is a term that can be traced back to the ancient Greeks, for whom it meant achief magistrate or a military commander-in-chief. More recently, the term has been refinedby military analysts like Carl von Clausewitz, who wrote that whereas “tactics…[involve] theuse of armed forces in the engagement, strategy [is] the use of engagements for the object ofthe war.”1 But the use of the term in business dates only to the twentieth century, and its usein a self-consciously competitive context only to the second half of the twentieth century.This historical note describes the evolution of ideas about business strategy and how theycame to be influenced by competitive thinking.

Historical Background

The First Industrial Revolution (roughly the mid-1700s to the mid-1800s) witnessedintense competition among industrial firms but, by and large, they did not have muchindividual influence on competitive outcomes. Instead, in most lines of business—with theexception of a few commodities in which international trade had developed—firm had anincentive to remain small and to employ as little fixed capital as possible. The chaoticmarkets of this era led economists such as Adam Smith to describe market forces as an“invisible hand” that was largely beyond the control of individual firms. The small industrialand merchant firms that were emerging required little or no formal planning or strategy in themodern sense.

The Second Industrial Revolution, which started in the second half of the nineteenthcentury, saw the emergence of strategy as a way to control market forces and to shape the

Competition and Business Strategy

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competitive environment. In the United States, the building of the railroads after 1850 led tothe development of mass markets for the first time. Along with improved access to capitaland credit, mass markets encouraged large-scale investment to exploit economies of scale inproduction and economies of scope in distribution. Adam Smith’s “invisible hand” wasgradually tamed by what the historian, Alfred D. Chandler, Jr., has termed the “visible hand”of professional managers. By the late nineteenth century, a new type of firm began toemerge, first in the United States and then in Europe: the vertically integrated,multidivisional (or “M-form”) corporation that made large investments in manufacturing andmarketing, and in management hierarchies to coordinate those functions. Over time, thelargest M-form companies managed to alter the competitive environment within theirindustries and even across industry lines.2

The need for a formal approach to corporate strategy was first articulated by topexecutives of M-form corporations. Alfred Sloan (chief executive of General Motors from1923 to 1946) devised a strategy that was explicitly based on the perceived strengths andweaknesses of Ford.3

In the 1930s, Chester Barnard, a top executive with AT&T, argued thatmanagers should pay especially close attention to “strategic factors” which depend on“personal or organizational action.”4

The organizational challenges involved in World War II were a vital stimulus tostrategic thinking. The problem of allocating scarce resources across the entire economy inwartime led to many innovations in management science. New operations researchtechniques (e.g., linear programming) were devised, which paved the way for the use ofquantitative analysis in formal strategic planning. In 1944, John von Neumann and OskarMorgenstern published their classic work, The Theory of Games and Economic Behavior.This work essentially solved the problem of zero-sum games (most military ones, from anaggregate perspective) and framed the issues surrounding non-zero-sum games (mostbusiness ones). Also, the concept of “learning curves” became an increasingly important toolfor planning. The learning curve was first discovered in the military aircraft industry in the1920s and 1930s, where it was noticed that direct labor costs tended to decrease by a constantpercentage as the cumulative quantity of aircraft produced doubled. Learning effects figuredprominently in wartime production planning efforts.

World War II encouraged the use of formal strategic thinking to guide managementdecisions. Peter Drucker argued that “management is not just passive, adaptive behavior; itmeans taking action to make the desired results come to pass.” He noted that economictheory had long treated markets as impersonal forces, beyond the control of individualentrepreneurs and organizations. But in the age of M-form corporations, managing “impliesresponsibility for attempting to shape the economic environment, for planning, initiating andcarrying through changes in that economic environment, for constantly pushing back thelimitations of economic circumstances on the enterprise’s freedom of action.”5 This insightbecame the rationale for business strategy—that by consciously using formal planning, acompany could exert some positive control over market forces.

However, these insights on the nature of strategy lay fallow for the decade afterWorld War II because wartime destruction led to excess demand, which limited competitionas firms rushed to expand capacity. Given the enormous job of rebuilding Europe and muchof Asia, it was not until the late 1950s and 1960s that many large multinational corporations


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were forced to consider global competition as a factor in planning. In addition, the wartimedisruption of foreign multinationals enabled U.S. companies to profit from the postwar boomwithout effective competitors in many industries.

A more direct bridge to the development of strategic concepts for businessapplications was provided by inter-service competition in the U.S. military after World WarII. In this period, American military leaders found themselves debating the arrangementsthat would best protect legitimate competition among military services while maintaining theneeded integration of strategic and tactical planning. Many argued that the Army, Navy,Marines and Air Force would be more efficient if they were unified into a singleorganization. As the debate raged, Philip Selznick, a sociologist noted that the NavyDepartment “emerged as the defender of subtle institutional values and tried many times toformulate the distinctive characteristics of the various services.” In essence, the “Navyspokesmen attempted to distinguish between the Army as a ‘manpower’ organization and theNavy as a finely adjusted system of technical, engineering skills—a ‘machine-centered’organization. Faced with what it perceived as a mortal threat, the Navy became highly self-conscious about its distinctive competence.”6 The concept of “distinctive competence” hadgreat resonance for strategic management, as we will see.

Academic Underpinnings

The Second Industrial Revolution witnessed the founding of many elite businessschools in the United States, beginning with the Wharton School in 1881. Harvard BusinessSchool, founded in 1908, was one of the first to promote the idea that managers should betrained to think strategically and not just to act as functional administrators. Beginning in1912, Harvard offered a required second-year course in “Business Policy,” which wasdesigned to integrate the knowledge gained in functional areas like accounting, operations,and finance, thereby giving students a broader perspective on the strategic problems faced bycorporate executives. A course description from 1917 claimed that “an analysis of anybusiness problem shows not only its relation to other problems in the same group, but alsothe intimate connection of groups. Few problems in business are purely intra-departmental.”Also, the policies of each department must maintain a “balance in accord with the underlyingpolicies of the business as a whole.”7

In the early 1950s, two professors of Business Policy at Harvard, George AlbertSmith Jr., and C. Roland Christensen, taught students to question whether a firm’s strategymatched its competitive environment. In reading cases, students were taught to ask: do acompany’s policies “fit together into a program that effectively meets the requirements of thecompetitive situation?”8 Students were told to address this problem by asking, “‘How is thewhole industry doing? Is it growing and expanding? Or is it static; or declining?” Then,having “sized up” the competitive environment, the student was to ask: “on what basis mustany one company compete with the others in this particular industry? At what kinds ofthings does it have to be especially competent, in order to compete?”9

In the late 1950s, another Harvard Business Policy professor, Kenneth Andrews, builton this thinking by arguing that “every business organization, every subunit of organization,


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and even every individual [ought to] have a clearly defined set of purposes or goals whichkeeps it moving in a deliberately chosen direction and prevents its drifting in undesireddirections.” (emphasis added) Like Alfred Sloan at GM, “the primary function of the generalmanager, over time, is supervision of the continuous process of determining the nature of theenterprise and setting, revising and attempting to achieve its goals.”10 The motivation forthese conclusions was supplied by an industry note and company cases that Andrewsprepared on Swiss watchmakers, which uncovered significant differences in performanceassociated with different strategies for competing in that industry.11 This format ofcombining industry notes with company cases, which had been initiated by a professor ofmanufacturing at Harvard, John MacLean, became the norm in Harvard’s Business Policycourse. In practice, an industry note was often followed by multiple cases on one or severalcompanies with the objective, inter alia, of economizing on students’ preparation time.12

By the 1960s, classroom discussions in the Business Policy course focused onmatching a company’s “strengths” and “weaknesses”—its distinctive competence—with the“opportunities” and “threats” (or risks) that it faced in the marketplace. This framework,which came to be referred to by the acronym SWOT, was a major step forward in bringingexplicitly competitive thinking to bear on questions of strategy. Kenneth Andrews put theseelements together in the following manner:


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Exhibit 1 Andrews’ Strategy Framework13

Environmental Conditions and Trends

EconomicTechnicalPhysicalPoliticalSocial

CommunityNationWorld

Environmental Conditions and Trends

EconomicTechnicalPhysicalPoliticalSocial

CommunityNationWorld

Opportunities and Risks

IdentificationInquiryAssessment of Risk

Opportunities and Risks

IdentificationInquiryAssessment of Risk

Consideration ofall combinations

Consideration ofall combinations

Evaluation to determinebest match of

opportunity and resources

Evaluation to determinebest match of

opportunity and resources

Choice of Productsand Markets

Economic Strategy

Choice of Productsand Markets

Economic Strategy

Distinctive Competence

Capabilities:FinancialManagerialFunctionalOrganizational

ReputationHistory

Distinctive Competence

Capabilities:FinancialManagerialFunctionalOrganizational

ReputationHistory

Corporate Resources

As extending or constrainingopportunity

Identification ofstrengths andweaknesses

Programs forincreasingcapability

Corporate Resources

As extending or constrainingopportunity

Identification ofstrengths andweaknesses

Programs forincreasingcapability

In 1963, a business policy conference was held at Harvard which helped diffuse theSWOT concept in academia and in management practice. Attendance was heavy, and yet thepopularity of SWOT—which was still used by many firms in the 1990s, including Wal-Mart—did not bring closure to the problem of actually defining a firm’s distinctivecompetence. To solve this problem, strategists had to decide what aspects of the firm were“enduring and unchanging over relatively long periods of time” and “those that arenecessarily more responsive to changes in the marketplace and the pressures of otherenvironmental forces.” This distinction was crucial because “the strategic decision isconcerned with the long-term development of the enterprise” (emphasis added).14 Whenstrategy choices were analyzed from a long-range perspective, the idea of “distinctivecompetence” took on added importance because of the risks involved in most long-runinvestments. Thus, if the opportunities a firm was pursuing appeared “to outrun [its] present


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distinctive competence,” then the strategist had to consider a firm’s “willingness to gamblethat the latter can be built up to the required level.”15

The debate over a firm’s “willingness to gamble” its distinctive competence in pursuitof opportunity continued in the 1960s, fueled by a booming stock market and corporatestrategies that were heavily geared toward growth and diversification. In a classic 1960article, “Marketing Myopia,” Theodore Levitt was sharply critical of firms that seemed tofocus too much on delivering a product, presumably based on its distinctive competence,rather than consciously serving the customer. Levitt thus argued that when companies fail,“it usually means that the product fails to adapt to the constantly changing patterns ofconsumer needs and tastes, to new and modified marketing institutions and practices, or toproduct developments in complementary industries.”16

However, another leading strategist, Igor Ansoff, argued that Levitt was askingcompanies to take unnecessary risks by investing in new products that might not fit the firm’sdistinctive competence. Ansoff argued that a company should first ask whether a newproduct had a “common thread” with its existing products. He defined the common thread asa firm’s “mission” or its commitment to exploit an existing need in the market as a whole.17

Ansoff noted that “sometimes the customer is erroneously identified as the common thread ofa firm’s business. In reality a given type of customer will frequently have a range ofunrelated product missions or needs.”18 Thus, for a firm to maintain its strategic focus,Ansoff suggested the following categories for defining the common thread in itsbusiness/corporate strategy:

Exhibit 2 Ansoff’s Product/Mission Matrix19

Present Product New Product

Present Mission Market Penetration Product Development

New Mission Market Development Diversification

Ansoff and others also focused on translating the logic built into the SWOTframework into a series of concrete questions that needed to be answered in the developmentof strategies.20

In the 1960s, diversification and technological changes increased the complexity ofthe strategic situations that many companies faced, and their need for more sophisticatedmeasures that could be used to evaluate and compare many different types of businesses.Since business policy groups at Harvard and elsewhere remained strongly wedded to the ideathat strategies could only be analyzed on a case-by-case basis that accounted for the uniquecharacteristics of every business, corporations turned elsewhere to satisfy their craving forstandardized approaches to strategy making.21 A study by the Stanford Research Instituteindicated that a majority of large U.S. companies had set up formal planning departments by


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1963.22 Some of these internal efforts were quite elaborate. General Electric (GE) is abellwether example: it used Harvard faculty quite extensively in its executive educationprograms, but also developed an elaborate computer-based “Profitability OptimizationModel” (PROM) on its own in the first half of the 1960s that appeared to explain asignificant fraction of the variation in the return on investment afforded by its variousbusinesses.23 Over time, like many other companies, GE also sought the help of privateconsulting firms. Although the consultants made multifaceted contributions (e.g., toplanning, forecasting, logistics and long-range R&D), the section that follows focuses ontheir impact on mainstream strategic thinking.

The Rise of Strategy Consultants

The 1960s and early 1970s witnessed the rise of a number of strategy consultingpractices. In particular, the Boston Consulting Group (BCG), founded in 1963, had a majorimpact on the field by applying quantitative research to problems of business and corporatestrategy. BCG’s founder, Bruce Henderson, believed that a consultant’s job was to find“meaningful quantitative relationships” between a company and its chosen markets.24 In hiswords, “good strategy must be based primarily on logic, not…on experience derived fromintuition.”25 Indeed, Henderson was utterly convinced that economic theory would somedaylead to a set of universal rules for strategy. As he explained, “in most firms strategy tends tobe intuitive and based upon traditional patterns of behavior which have been successful in thepast.” However, “in growth industries or in a changing environment, this kind of strategy israrely adequate. The accelerating rate of change is producing a business world in whichcustomary managerial habits and organization are increasingly inadequate.”26

In order to help executives make effective strategic decisions, BCG drew on theexisting knowledge base in academia: one of its first employees, Seymour Tilles, wasformerly a lecturer in Harvard’s Business Policy course. But it also struck off in a newdirection that Bruce Henderson is said to have described as “the business of selling powerfuloversimplifications.”27 In fact, BCG came to be known as a “strategy boutique” becauseearly on, its business was largely based, directly or indirectly, on a single concept: theexperience curve (discussed below). The value of using a single concept came from the factthat “in nearly all problem solving there is a universe of alternative choices, most of whichmust be discarded without more than cursory attention.” Hence, some “frame of reference isneeded to screen the…relevance of data, methodology, and implicit value judgments”involved in any strategy decision. Given that decision making is necessarily a complexprocess, the most useful “frame of reference is the concept. Conceptual thinking is theskeleton or the framework on which all other choices are sorted out.”28

BCG and the Experience Curve

BCG first developed its version of the learning curve—what it labeled the“experience curve,” in 1965-66. According to Bruce Henderson, “it was developed to try toexplain price and competitive behavior in the extremely fast growing segments” of industriesfor clients such as Texas Instruments and Black and Decker.29 As BCG consultants studiedthese industries, they naturally asked why “one competitor outperforms another (assuming


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comparable management skills and resources)? Are there basic rules for success? There,indeed, appear to be rules for success, and they relate to the impact of accumulatedexperience on competitors’ costs, industry prices and the interrelation between the two.”30

The firm’s standard claim for the experience curve was that for each cumulativedoubling of experience, total costs would decline roughly 20 to 30 percent due to economiesof scale, organizational learning and technological innovation. The strategic implication ofthe experience curve, according to BCG, was that for a given product segment, “theproducer…who has made the most units should have the lowest costs and the highestprofits.”31 Bruce Henderson claimed that with the experience curve, “the stability ofcompetitive relationships should be predictable, the value of market share change should becalculable, [and] the effects of growth rate should [also] be calculable.”32

From the Experience Curve to Portfolio Analysis

By the early 1970s, the experience curve had led to another “powerfuloversimplification” by BCG: the so-called “Growth-Share Matrix” (reproduced below),which was the first use of what came to be known as “portfolio analysis.” The idea was thatafter experience curves were drawn for each of a diversified company’s business units, theirrelative potential as areas for investment could be compared by plotting them on thefollowing grid:

Exhibit 3 BCG’s Growth-Share Matrix33

High Share Low Share

High Growth “Star” “QuestionMark”

Slow Growth “Cash Cow” “Dog”

BCG’s basic strategy recommendation was to maintain a balance between “cashcows” (i.e., mature businesses) and “stars,” while allocating some resources to feed “questionmarks,” which were potential stars. “Dogs” were to be sold off. Put in more sophisticatedlanguage, a BCG vice-president explained that “since the producer with the largest stablemarket share eventually has the lowest costs and greatest profits, it becomes vital to have adominant market share in as many products as possible. However, market share in slowlygrowing products can be gained only by reducing the share of competitors who are likely tofight back.” If a product market is growing rapidly, “a company can gain share by securingmost of the growth. Thus, while competitors grow, the company can grow even faster andemerge with a dominant share when growth eventually slows.”34


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Strategic Business Units (SBUs) and Portfolio Analysis

Numerous other consulting firms came up with their own matrices for portfolioanalysis at roughly the same time as BCG. McKinsey & Company’s effort, for instance,began in 1968 when Fred Borch, the CEO of General Electric (GE), asked McKinsey toexamine GE’s corporate structure, which consisted of 200 profit centers and 145 departmentsarranged around 10 groups. The boundaries for these units had been defined according totheories of financial control, which the McKinsey consultants judged to be inadequate. Theyargued that the firm should be organized on more strategic lines, with greater concern forexternal conditions than internal controls, and a more future-oriented approach than waspossible using measures of past financial performance. The study recommended a formalstrategic planning system, which would divide the company into “natural business units,”which Borch later renamed “strategic business units,” or SBUs. GE’s executives followedthis advice, which took two years to implement.

However, in 1971, a GE corporate executive asked McKinsey for help in evaluatingthe strategic plans that were being written by the company’s many SBUs. GE had alreadyexamined the possibility of using the BCG growth-share matrix to decide the fate of itsSBUs, but its top management had decided then that they could not set priorities on the basisof just two performance measures. And so, after studying the problem for three months, aMcKinsey team produced what came to be known as the GE/McKinsey 9-block matrix(shown below). The 9-block matrix used about a dozen measures to screen for industryattractiveness and another dozen to screen for competitive position, although the weights tobe attached to them were not specified.35


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Exhibit 4 The Industry Attractiveness—Business Strength Matrix36

High

High

Low

Low

Medium

Medium

Selective Growth Selectivity

Harvest/ Divest

Investment and Growth

Selective Growth

Harvest/ Divest

Harvest/ DivestSelectivity

Selectivity

Industry Attractiveness

Busi

ness

Stre

ngth

Another, more quantitative approach to portfolio planning was developed at roughlythe same time under the aegis of the “Profit Impact of Market Strategies” (PIMS) program,which was the multicompany successor to the PROM program that GE had started a decadeearlier. By the mid-1970s, PIMS contained data on 620 SBUs drawn from 57 diversifiedcorporations.37 These data were used, in the first instance, to explore the determinants ofreturns on investment by regressing historical returns on variables such as market share,product quality, investment-intensity, marketing and R&D expenditures and several dozenothers. The regressions established what were supposed to be benchmarks for the potentialperformance of SBUs with particular characteristics against which their actual performancemight be compared.

In all these applications, segmenting diversified corporations into SBUs became animportant precursor to analyses of economic performance.38 This forced “deaveraging” ofcost and performance numbers that had previously been calculated at more aggregated levels.In addition, it was thought that with such approaches, “strategic thinking was appropriatelypushed ‘down the line’ to managers closer to the particular industry and its competitiveconditions.”39

In the 1970s, virtually every major consulting firm used some type of portfolioanalysis to generate strategy recommendations. The concept became especially popular afterthe oil crisis of 1973 forced many large corporations to rethink, if not discard, their existinglong-range plans. A McKinsey consultant noted that “the sudden quadrupling of energycosts [due to the OPEC embargo], followed by a recession and rumors of impending capitalcrisis, [the job of] setting long-term growth and diversification objectives was suddenly anexercise in irrelevance.” Now, strategic planning meant “sorting out winners and losers,setting priorities, and husbanding capital.” In a climate where “product and geographic


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markets were depressed and capital was presumed to be short,”40 portfolio analysis gaveexecutives a ready excuse to get rid of underperforming business units while directing mostavailable funds to the “stars.” Thus, a survey of the “Fortune 500” industrial companiesconcluded that by 1979, 45% of them had introduced portfolio planning techniques to someextent.41

Emerging Problems

Somewhat ironically, the very macroeconomic conditions that (initially) increased thepopularity of portfolio analysis also began to raise questions about the experience curve. Thehigh inflation and excess capacity (due to downturns in demand) induced by the “oil shocks”of 1973 and 1979 disrupted historical experience curves in many industries, suggesting thatBruce Henderson had oversold the concept when he circulated a pamphlet in 1974 entitled,“Why Costs Go Down Forever.” Another problem with the experience curve was pinpointedby a classic 1974 article by William Abernathy and Kenneth Wayne, which argued that “theconsequence of intensively pursuing a cost-minimization strategy [e.g., one based on theexperience curve] is a reduced ability to make innovative changes and to respond to thoseintroduced by competitors.”42 Abernathy and Wayne pointed to the case of Henry Ford,whose obsession with lowering costs had left him vulnerable to Alfred Sloan’s strategy ofproduct innovation in the car business. The concept of the experience curve was alsocriticized for treating cost reductions as automatic rather than something to be managed, forassuming that most experience could be kept proprietary instead of spilling over tocompetitors, for mixing up different sources of cost reduction with very different strategicimplications (e.g., learning vs. scale vs. exogenous technical progress) and for leading tostalemates as more than one competitor pursued the same generic success factor.43

In the late 1970s, portfolio analysis came under attack as well. One problem was thatin many cases, the strategic recommendations for an SBU were very sensitive to the specificportfolio-analytic technique employed. For instance, an academic study applied four differentportfolio techniques to a group of fifteen SBUs owned by the same Fortune 500 corporation,and found that only one out of the 15 SBUs fell in the same portion of each of the fourmatrices and only five out of the 15 were classified similarly in terms of three of the fourmatrices.44 This was only a slightly higher level of concordance than would have beenexpected if the 15 SBUs had been randomly classified four separate times!

An even more serious problem with portfolio analysis was that even if one couldfigure out the “right” technique to employ, the mechanical determination of resourceallocation patterns on the basis of historical performance data was inherently problematic.Some consultants acknowledged as much. In 1979, Fred Gluck, the head of McKinsey’sstrategic management practice, ventured the opinion that “the heavy dependence on‘packaged’ techniques [has] frequently resulted in nothing more than a tightening up, or finetuning, of current initiatives within the traditionally configured businesses.” Even worse,technique-based strategies “rarely beat existing competition” and often leave businesses“vulnerable to unexpected thrusts from companies not previously considered competitors.”45

Gluck and his colleagues sought to loosen some of the constraints imposed by mechanisticapproaches by proposing that successful companies’ strategies progress through four basicstages that involve grappling with increasing levels of dynamism, multidimensionality and


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uncertainty and that therefore become less amenable to routine quantitative analysis (seeExhibit 5 below).

Exhibit 5 Four Phases of Strategy46

1. Financial Planning: Meet Annual Budget

2. Forecast-Based Planning: Predict the Future

3. Externally Oriented Planning: Think Strategically

4. Strategic Management: Create the Future

Static Analysis

Dynamic Analysis

The most stinging attack on the analytical techniques popularized by strategyconsultants was offered by two Harvard professors of production, Robert Hayes and WilliamAbernathy, in 1980. They argued that “these new principles [of management], despite theirsophistication and widespread usefulness, encourage a preference for (1) analytic detachmentrather than the insight that comes from ‘hands on experience’ and (2) short-term costreduction rather than long-term development of technological competitiveness.”47 Hayes andAbernathy criticized portfolio analysis especially as a tool that led managers to focus onminimizing financial risks rather than investing in new opportunities that required a long-term commitment of resources.48 They went on to compare U.S. firms unfavorably withJapanese and, especially, European ones.

These and other criticisms gradually diminished the popularity of portfolio analysis.However, its rise and fall did have a lasting influence on subsequent work on competitionand business strategy because it focused attention on the need for more careful analysis of thetwo basic dimensions of portfolio-analytic grids, industry attractiveness and competitiveposition. While these two dimensions had been identified earlier—in the General SurveyOutline developed by McKinsey & Company for internal use in 1952, for example—portfolio analysis underscored this particular way of analyzing the effects of competition onbusiness performance. And U. S. managers, in particular, proved avid consumers ofadditional insights about competition because the exposure of much of U.S. industry tocompetitive forces increased dramatically during the 1960s and 1970s. Thus one economistcalculated, admittedly roughly, that heightened import competition, antitrust actions andderegulation increased the share of the U.S. economy that was subject to effectivecompetition from 56% in 1958 to 77% by 1980.49


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Exhibit 6 Two Basic Dimensions of Strategy

IndustryAttractiveness

Competitive Advantage

The next two sections describe attempts to unbundle these two basic dimensions ofstrategy.

Unbundling Industry Attractiveness

Thus far, we have made little mention of economists’ contributions to thinking aboutcompetitive strategy. On the one hand, economic theory emphasizes the role of competitiveforces in determining market outcomes. But on the other hand, economists have oftenoverlooked the importance of strategy because, since Adam Smith, they have traditionallyfocused on the case of perfect competition: an idealized situation in which large numbers ofequally able competitors drive an industry’s aggregate economic profits (i.e., profits inexcess of the opportunity cost of the capital employed) down to zero. Under perfectcompetition, individual competitors are straitjacketed in the sense of having a choice betweenproducing efficiently and pricing at cost, or shutting down.

Some economists did address the opposite case of perfect competition, namely puremonopoly, with Antoine Cournot providing the first definitive analysis.50 This work yieldedsome useful insights, such as the expectation of an inverse relationship between theprofitability of a monopolized industry and the price-elasticity of the demand that it faced—an insight that has remained central in modern marketing. Nevertheless, the assumption ofmonopoly obviously took things to the other, equally unfortunate, extreme by ruling out alldirectly competitive forces in the behavior of firms.

This state of affairs began to change in the 1930s, as a number of economists,particularly those associated with the “Harvard school,” began to argue that the structure ofmany industries might permit incumbent firms to earn positive economic profits over longperiods of time.51 Edward S. Mason argued that the structure of an industry would determinethe conduct of buyers and sellers—their choices of key decision variables—and, byimplication, its performance along such dimensions as profitability, efficiency andinnovativeness.52 Joe Bain, also of the Harvard Economics Department, advanced theresearch program of uncovering general relationships between industry structure andperformance through empirical work focused on a limited number of structural variables—most notably, in two studies published in the 1950s. The first study found that theprofitability of manufacturing industries in which the eight largest competitors accounted formore than 70% of sales was nearly twice that of industries with eight-firm concentrationratios less than 70%.53 The second study explained how, in certain industries, “established


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sellers can persistently raise their prices above a competitive level without attracting newfirms to enter the industry.”54 Bain identified three basic barriers to entry: (1) an absolute costadvantage by an established firm (an enforceable patent, for instance), (2) a significantdegree of product differentiation, and (3) economies of scale.

Bain’s insights led to the rapid growth of a new subfield of economics, known asindustrial organization, or “IO” for short, that explored the structural reasons why someindustries were more profitable than others. By the mid-1970s, several hundred empiricalstudies in IO had been carried out. While the relationships between structural variables andperformance turned out to be more complicated than had been suggested earlier,55 thesestudies reinforced the idea that some industries are inherently much more profitable or“attractive” than others, as indicated below.

Exhibit 7 Differences in the Profitability of Selected Industries, 1971-199056

Industry Return on Equity

Drugs 21.4Printing and Publishing 15.5Petroleum and Coal 13.1Motor Vehicles and Equipment 11.6Textile Mill Products 9.3Iron and Steel 3.9

Harvard Business School’s Business Policy Group was aware of these insights fromacross the Charles River: excerpts from Bain’s book on barriers to entry were even assignedas required readings for the Business Policy course in the early 1960s. But the immediateimpact of IO on business strategy was limited. While many problems can be discerned inretrospect, two seem to have been particularly important. First, IO economists focused onissues of public policy rather than business policy: they concerned themselves with theminimization rather than the maximization of “excess” profits. Second, the emphasis of Bainand his successors on using a limited list of structural variables to explain industryprofitability shortchanged the richness of modern industrial competition (“conduct” withinthe IO paradigm).

Both of these problems with applying classical IO to business-strategic concernsabout industry attractiveness were addressed by Michael Porter, a graduate of the joint Ph.D.program between Harvard’s Business School and its Economics Department. In 1974, Porterprepared a “Note on the Structural Analysis of Industries” that presented his first attempt toturn IO on its head by focusing on the business policy objective of profit maximization ratherthan the public policy objective of minimizing “excess” profits.57 In 1980, he released hislandmark book, Competitive Strategy, which owed much of its success to Porter’s elaborateframework for the structural analysis of industry attractiveness. Exhibit 8 reproducesPorter’s “five forces” approach to understanding the attractiveness of an industryenvironment for the “average” competitor within it.


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Exhibit 8 Porter’s Five-Forces Framework for Industry Analysis

Suppliers

Sources of Bargaining Power:

Switching costsDifferentiation of inputsSupplier concentrationPresence of substitute inputsImportance of volume to suppliersImpact of inputs on cost or differentiationThreat of forward/backward integrationCost relative to total purchases in industry

Suppliers

Sources of Bargaining Power:

Switching costsDifferentiation of inputsSupplier concentrationPresence of substitute inputsImportance of volume to suppliersImpact of inputs on cost or differentiationThreat of forward/backward integrationCost relative to total purchases in industry

New Entrants

Entry Barriers:

Economies of scaleBrand identityCapital requirementsProprietary product differencesSwitching costsAccess to distributionProprietary learning curveAccess to necessary inputsLow-cost product designGovernment policyExpected retaliation

New Entrants

Entry Barriers:

Economies of scaleBrand identityCapital requirementsProprietary product differencesSwitching costsAccess to distributionProprietary learning curveAccess to necessary inputsLow-cost product designGovernment policyExpected retaliation

Industry Competitors

Factors affecting Rivalry:

Industry growthConcentration and balanceFixed costs/value addedIntermittent overcapacityProduct differencesBrand identitySwitching costsInformational complexityDiversity of competitorsCorporate stakesExit barriers

Industry Competitors

Factors affecting Rivalry:

Industry growthConcentration and balanceFixed costs/value addedIntermittent overcapacityProduct differencesBrand identitySwitching costsInformational complexityDiversity of competitorsCorporate stakesExit barriers

Substitutes

Threat determined by:

Relative price performanceof substitutes

Switching costsBuyer propensity to substitute

Substitutes

Threat determined by:

Relative price performanceof substitutes

Switching costsBuyer propensity to substitute

Buyers

Bargaining Power of Buyers:

Buyer concentrationBuyer volumeSwitching costsBuyer informationBuyer profitsSubstitute productsPull-throughPrice sensitivityPrice/total purchasesProduct differencesBrand identityAbility to backward integrateImpact on quality/performanceDecision makers’ incentives

Buyers

Bargaining Power of Buyers:

Buyer concentrationBuyer volumeSwitching costsBuyer informationBuyer profitsSubstitute productsPull-throughPrice sensitivityPrice/total purchasesProduct differencesBrand identityAbility to backward integrateImpact on quality/performanceDecision makers’ incentives

In developing this approach to strategy, Porter noted the trade-offs involved in using a“framework” rather than a more formal statistical “model.” In his words, a framework“encompasses many variables and seeks to capture much of the complexity of actualcompetition. Frameworks identify the relevant variables and the questions that the user mustanswer in order to develop conclusions tailored to a particular industry and company”


16

(emphasis added).58 In academic terms, the drawback of frameworks such as the five forcesis that they often range beyond the empirical evidence that is available. In practice,managers routinely have to consider much longer lists of variables than are embedded in therelatively simple quantitative models used by economists. In the case of the five forces, asurvey of empirical literature in the late 1980s—more than a decade after Porter firstdeveloped his framework—revealed that only a few points were strongly supported by theempirical literature generated by the IO field.59 (These points appear in bold print in theexhibit above.) This does not mean that the other points are in conflict with IO research;rather, they reflect the experience of strategy practitioners, including Porter himself.

In managerial terms, one of the breakthroughs built into Porter’s framework was thatit emphasized “extended competition” for value rather than just competition among existingrivals. For this reason, and because it was easy to operationalize, the five-forces frameworkcame to be used widely by managers and consultants. Subsequent years witnessedrefinements and extensions, such as the rearrangement and incorporation of additionalvariables (e.g., import competition and multi-market contact) into the determinants of theintensity of five forces. The biggest conceptual advance, however, was one proposed in themid-1990s by two strategists concerned with game theory, Adam Brandenburger and BarryNalebuff, who argued that the process of creating value in the marketplace involved “fourtypes of players—customers, suppliers, competitors, and complementors.”60 By a firm’s“complementors,” they meant other firms from which customers buy complementaryproducts and services, or to which suppliers sell complementary resources. AsBrandenburger and Nalebuff pointed out, the practical importance of this group of playerswas evident in the amount of attention being paid in business to the subject of strategicalliances and partnerships. Their Value Net graphic depicted this more complete descriptionof the business landscape—emphasizing, in particular, the equal roles played by competitionand complementarity.

Exhibit 9 The Value Net61

Customers

ComplementorsCompetitors Company

Suppliers

Other strategists, however, pointed out some of the limiting assumptions built intosuch frameworks. Thus, Kevin Coyne and Somu Subramanyam of Mckinsey argued that thePorter framework made three tacit but crucial assumptions:


17

First, that an industry consists of a set of unrelated buyers, sellers,substitutes, and competitors that interact at arm’s length. Second, that wealthwill accrue to players that are able to erect barriers against competitors andpotential entrants: in other words, that the source of value is structuraladvantage. Third, that uncertainty is sufficiently low that you can accuratelypredict participants behavior and choose a strategy accordingly.62

Unbundling Competitive Position

The second basic dimension of business strategy highlighted by Exhibit 6 iscompetitive position. While differences among the average profitability of industries can belarge, as indicated in Exhibit 7, differences in profitability within industries can be evenlarger.63 Indeed, in some cases firms in unattractive industries can significantly outperformthe averages for more profitable industries, as indicated in Exhibit 10. In addition, one mightargue that most businesses in most industry environments are better placed to try to alter theirown competitive positions rather than the overall attractiveness of the industry in which theyoperate. For both these reasons, competitive position has been of great interest to businessstrategists.

Exhibit 10 Profitability Within the Steel Industry, 1973-199264

ROA (%)

20

15

10

5

0

-50 1,000 2,000 3,000 4,000 5,000 6,000

SALES($ M)

OREGON STEEL MILLS •

WORTHINGTON • •

NUCOR

• ARMCO

• INLAND STEEL• USX-US STEEL

• BETHLEHEM• LTV

•

• • ••••

••

•

••

Traditional academic research has made a number of contributions to ourunderstanding of positioning within industries, starting in the 1970s. The IO-based literature


18

on strategic groups, initiated at Harvard by Michael Hunt’s work on broadline vs. narrowlinestrategies in the major home appliance industry, suggested that competitors within particularindustries could be grouped in terms of their competitive strategies in ways that helpedexplain their interactions and relative profitability.65 A stream of work at Purdue exploredthe heterogeneity of competitive positions, strategies and performance in brewing and otherindustries with a combination of statistical analysis and qualitative case studies. Morerecently, several academic points of view have emerged about the sources of performancedifferences within industries—views that are explored more fully in the next section. But itdoes seem accurate to say that the work that had the most impact on business-strategicthinking about competitive positions in the late 1970s and the 1980s was more pragmaticthan academic in its intent, with consultants once again playing a leading role.

Competitive Cost Analysis

With the rise of the experience curve in the 1960s, most strategists turned to sometype of cost analysis as the basis for assessing competitive positions. The interest incompetitive cost analysis survived the declining popularity of the experience curve in the1970s but was reshaped by it in two important ways. First, more attention was paid todisaggregating businesses into their component activities or processes as well as to thinkingabout how costs in a particular activity might be shared across businesses. Second,strategists greatly enriched their menu of cost drivers to include more than just experience.

The disaggregation of businesses into their component activities seems to have beenmotivated, in part, by early attempts to “fix” the experience curve to deal with the rising realprices of many raw materials in the 1970s.66 The proposed fix involved splitting costs intothe costs of purchased materials and “cost added” (value added minus profit margins) andredefining the experience curve as applying only to the latter. The natural next step was todisaggregate a business’s entire cost structure into activities whose costs might be expectedto behave in interestingly different ways. As in the case of portfolio analysis, the idea ofsplitting businesses into component activities diffused quickly among consultants and theirclients in the 1970s. A template for activity analysis that became especially prominent isreproduced below.

Exhibit 11 McKinsey’s Business System67

Technology

Design

Development

Manufacturing

Procurement

Assembly

Distribution

Transport

Inventory

Marketing

Retailing

Advertising

Service

Parts

Labor

Activity analysis also suggested a way of getting around the “freestanding”conception of individual businesses built into the concept of SBUs. One persistent problemin splitting diversified corporations into SBUs was that with the exception of pureconglomerates, SBUs were often related in ways that meant that they shared elements of their


19

cost structure with each other. Consulting firms, particularly Bain and Strategic PlanningAssociates, both of whose founders had worked on a BCG study of Texas Instruments thatwas supposed to have highlighted the problem of shared costs, began to emphasize thedevelopment of what came to be called “field maps”: matrices that identified shared costs atthe level of individual activities that were linked across businesses, as illustrated below.68

The second important development in competitive cost analysis over the late 1970sand early 1980s involved enrichment of the menu of cost drivers considered by strategists.Scale effects, while officially lumped into the experience curve, had long been looked atindependently in particular cases; even more specific treatment of the effects of scale wasnow forced by activity analysis which might indicate, for example, that advertising costswere driven by national scale whereas distribution costs were driven by local or regionalscale. Field maps underscored the potential importance of economies (or diseconomies) ofscope across businesses rather than scale within a business. The effects of capacityutilization on costs were dramatized by macroeconomic downturns in the wake of the two oilshocks. The globalization of competition in many industries highlighted the location ofactivities as a key driver of competitors’ cost positions, and so on. Thus, an influential mid-1980s discussion of cost analysis enumerated ten distinct cost drivers.69

Customer Analysis

Increased sophistication in analyzing relative costs was accompanied by increasedattention to customers in the process of analyzing competitive position. Customers had neverbeen entirely invisible: even in the heyday of experience curve analysis, market segmentationhad been an essential strategic tool—although it was sometimes used to gerrymander marketsto “demonstrate” a positive link between share and cost advantage rather than for anyanalytical purpose. But according to Walker Lewis, the founder of Strategic PlanningAssociates, “To those who defended in classic experience-curve strategy, about 80% of thebusinesses in the world were commodities.”70 This started to change in the 1970s.

Increased attention to customer analysis involved reconsideration of the idea thatattaining low costs and offering customers low prices was always the best way to compete.More attention came to be paid to differentiated ways of competing that might let a businesscommand a price premium by improving customers’ performance or reducing their (other)costs. While (product) differentiation had always occupied centerstage in marketing, the ideaof looking at in a cross-functional, competitive context that also accounted for relative costsapparently started to emerge in business strategy in the 1970s. Thus, a member of Harvard’sBusiness Policy group recalls using the distinction between cost and differentiation, whichwas implicit in two of the three sources of entry barriers identified by Joe Bain in the 1950s(see above), to organize classroom discussions in the early 1970s.71 And McKinseyreportedly started to apply the distinction between cost and “value” to client studies later inthat decade.72 The first published accounts, in Michael Porter’s book, Competitive Strategy,and in a Harvard Business Review article by William Hall, appeared in 1980.73

Both Hall and Porter argued that successful companies usually had to choose tocompete either on the basis of low costs or by differentiating products through quality andperformance characteristics. Porter also identified a focus option that cut across these two“generic strategies” and linked these strategic options to his work on industry analysis:


20

In some industries, there are no opportunities for focus ordifferentiation—it’s solely a cost game—and this is true in a number of bulkcommodities. In other industries, cost is relatively unimportant because ofbuyer and product characteristics.74

Many other strategists agreed that except in such special cases, the analysis ofcompetitive position had to cover both relative cost and differentiation. There wascontinuing debate, however, about the proposition, explicitly put forth by Porter, thatbusinesses that were “stuck in the middle” should be expected to underperform businessesthat had targeted lower cost or more differentiated positions. Others saw optimal positioningas a choice from a continuum of trade-offs between cost and differentiation rather than as achoice between two mutually exclusive (and extreme) generic strategies.

Porter’s 1985 book, Competitive Advantage, suggested analyzing cost anddifferentiation via the “value chain,” a template that is reproduced below. While Porter’svalue chain bore an obvious resemblance to McKinsey’s business system, his discussion of itemphasized the importance of regrouping functions into the activities actually performed toproduce, market, deliver and support products, thinking about linkages among activities, andconnecting the value chain to the determinants of competitive position in a specific way:

Competitive advantage cannot be understood by looking at a firm as awhole. It stems from the many discrete activities a firm performs indesigning, producing, marketing, delivering, and supporting its product. Eachof these activities can contribute to a firm’s relative cost position and create abasis for differentiation. . . . The value chain disaggregates a firm into itsstrategically relevant activities in order to understand the behavior of costsand the existing and potential sources of differentiation.75

Exhibit 12 Porter’s Value Chain76

Marketing & Sales ServiceOutbound

LogisticsOperations InboundLogistics

Firm Infrastructure

Human Resource Management

Technology Development

Procurement

SupportActivities

PrimaryActivities

Putting customer analysis and cost analysis together was promoted not only bydisaggregating businesses into activities (or processes) but also by splitting customers intosegments based on cost-to-serve as well as customer needs. Such “deaveraging” ofcustomers was often said to expose situations in which 20% of a business’s customersaccounted for more than 80% or even 100% of its profits.77 It also suggested new customersegmentation criteria. Thus, Bain & Company built a thriving “customer retention” practice,


21

starting in the late 1980s, on the basis of the higher costs of capturing new customers asopposed to retaining existing ones.

Competitive Dynamics and History

The development of business systems, value chains, and similar templates naturallyrefocused attention on the problem of coordinating across a large number of choices linked incross-section that was highlighted, in a cross-functional context, in the original description ofthe Harvard Business School’s Business Policy course. But such attention tended to crowdout consideration of longitudinal linkages among choices emphasized by Selznick’s work onorganizational commitments and distinctive competences and evident in Andrews’ focus onthe aspects of firm behavior that were “enduring and unchanging over relatively long periodsof time.”

The need to add the time dimension back into predominantly static ideas aboutcompetitive position was neatly illustrated by the techniques for “value-based strategicmanagement” that began to be promoted by consulting firms such as SPA and Marakon,among others, in the 1980s. The development and diffusion of value-based techniques,which connected positioning measures to shareholder value using spreadsheet models ofdiscounted cash flows, was driven by increases in capital market pressures in the 1980s,particularly in the United States: merger and acquisition activity soared; hostile takeovers ofeven very large companies became far more common; many companies restructured to avoidthem; levels of leverage generally increased; and there was creeping institutionalization ofequity holdings.78 Early value-based work focused on the spread between a company ordivision’s rate of return and its cost of capital as the basis for “solving” the old corporatestrategy problem of resource allocation across businesses. But it quickly became clear thatestimated valuations were very sensitive to two other, more dynamic drivers of value: thelength of the time horizon over which positive spreads (competitive advantage) could besustained on the assets in place, and the (profitable) reinvestment opportunities or growthoptions afforded by a strategy.79 At the same time, analyses of business performance startedto underscore the treacherousness of assuming that current profitability and growth couldautomatically be sustained. Thus, analysis of 700 business units by Pankaj Ghemawatrevealed that nine-tenths of the profitability differential between businesses that were initiallyabove average and those that were initially below average vanished over a 10-year horizon,as depicted below.80


22

Exhibit 13 The Limits to Sustainability

0

10

20

30

40

1 3 4 5 6 7 8 9 10

Year

RO

I%

2

The unsustainability of most competitive advantages was generally thought to reflectthe “Red Queen” effect: the idea that as organizations struggled to adapt to competitivepressures, they would become stronger competitors, sending the overall level of competitionspiraling upward and eliminating most if not all competitive advantages.81 In the late 1980sand early 1990s, both academics and consultants started to wrestle with the dynamic questionof how businesses might create and sustain competitive advantage in the presence ofcompetitors who could not all be counted on to remain inert all of the time.

From an academic perspective, many of the consultants’ recommendations regardingdynamics amounted to no more and no less than the injunction to try to be smarter than thecompetition (e.g., by focusing on customers’ future needs while competitors remainedfocused on their current needs). The most thoughtful exception that had a truly dynamicflavor was work by George Stalk and others at BCG on time-based competition. In an articlepublished in the Harvard Business Review in 1988, Stalk argued that “Today the leadingedge of competition is the combination of fast response and increasing variety. Companieswithout these advantages are slipping into commodity-like competition, where customers buymainly on price.”82 Stalk expanded on this argument in a book co-authored with ThomasHout in 1990, according to which time-based competitors

Create more information and share it more spontaneously. For theinformation technologist, information is a fluid asset, a data stream. But to themanager of a business…information is fuzzy and takes many forms—knowing a customer’s special needs, seeing where the market is heading…83


23

Time-based competition quickly came to account for a substantial fraction of BCG’sbusiness. But eventually, a sense of its limitations also settled in. In 1993, George Stalk andAlan Webber wrote that some Japanese companies had become so dedicated to shorteningtheir product development cycles that they had created a “strategic treadmill on whichcompanies were caught, condemned to run faster and faster but always staying in the sameplace competitively.”84 In particular, Japanese electronics manufacturers had reached aremarkable level of efficiency, but it was an “efficiency that does not meet or create needsfor any customer.”85

For some, such as Stalk himself, the lesson from this and similar episodes was thatthere were no sustainable advantages: that “Strategy can never be a constant. . . . Strategy isand always has been a moving target.”86 However others, primarily academics, continued towork in the 1990s on explanations of differences in performance that would continue to beuseful even after they were widely grasped.87 This academic work exploits, in differentways, the idea that history matters: that history affects both the opportunities available tocompetitors and the effectiveness with which competitors can exploit them. Such work canbe seen as an attempt to add a historical or time-dimension, involving stickiness andrigidities, to the two basic dimensions of early portfolio-analytic grids, industry attractivenessand competitive position, whose unbundling was discussed in the last two sections. The restof this section briefly reviews four strands of academic inquiry that embodied newapproaches to thinking about the time dimension.

Game Theory

Game theory is the mathematical study of interactions among players whose payoffsdepend on each others’ choices. A general theory of zero-sum games, in which one player’sgain is exactly equal to other players’ losses, was supplied by John von Neumann and OskarMorgenstern in their pathbreaking book, The Theory of Games and Economic Behavior.88

There is no general theory of nonzero-sum games, which afford opportunities for cooperationas well as competition, but research in this area does supply a language and a set of logicaltools for analyzing the outcome that is likely—the equilibrium point—given specific rules,payoff structures and beliefs if players all behave “rationally.”89

Economics trained in industrial organization (IO) started to turn to game theory in thelate 1970s as a way of studying competitor dynamics. Since the early 1980s, well over one-half of all the IO articles published in the leading economics journals have been concernedwith some aspect of (nonzero-sum) game theory.90 By the end of the 1980s alone,competition to invest in tangible and intangible assets, strategic control of information,horizontal mergers, network competition and product standardization, contracting andnumerous other settings in which interactive effects were apt to be important had all beenmodeled game-theoretically.91 The effort continues.

Game-theoretic IO models tend, inspite of their diversity, to share an emphasis “onthe dynamics of strategic actions and in particular on the role of commitment.”92 Theemphasis on commitment or irreversibility grows out of game theory’s focus on interactiveeffects. From this perspective, a strategic move is one that “purposefully limits your freedomof action. . . . It changes other players’ expectations about your future responses, and you can


24

turn this to your advantage. Others know that when you have the freedom to act, you alsohave the freedom to capitulate.”93

The formalism of game theory is accompanied by several significant limitations: thesensitivity of the predictions of game-theoretic models to details, the limited number ofvariables considered in any one model, and assumptions of rationality that are often heroic, toname just a few.94 Game theory’s empirical base is also limited. The existing evidencesuggests, nonetheless, that it merits attention in analyses of interactions among smallnumbers of firms. While game theory often formalizes preexisting intuitions, it cansometimes yield unanticipated and even counterintuitive predictions. Thus, game-theoreticmodeling of shrinkage in and exit from declining industries yielded the prediction that otherthings being equal, initial size should hurt survivability. This surprising prediction turns outto enjoy some empirical support!95

The Resource-Based View of the Firm

The idea of looking at companies in terms of their resource endowments is an oldone, but was revived in the 1980s in an article by Birger Wernerfelt.96 Wernerfelt noted that“The traditional concept of strategy (Andrews, 1971) is phrased in terms of the resourceposition (strengths and weaknesses) of the firm, whereas most of our formal economic toolsoperate on the product market side.”97 While Wernerfelt also described resources andproducts as “two sides of the same coin,” other adherents to what has come to be called theresource-based view (RBV) of the firm argue that superior product market positions rest onthe ownership of scarce, firm-specific resources.

Resource-based theorists also seek to distinguish their perspective on sustainedsuperior performance from that of IO economics by stressing the intrinsic inimitability ofscarce, valuable resources for a variety of reasons: the ability to obtain a particular resourcemay be dependent on unique, historical circumstances that competitors cannot recreate; thelink between the resources possessed by a firm and its sustained competitive advantage maybe causally ambiguous or poorly understood; or the resource responsible for the advantagemay be socially complex and therefore “beyond the ability of firms to systematically manageand influence” (e.g., corporate culture).98 Game-theoretic IO, in contrast, has tended to focuson less extreme situations in which imitation of superior resources may be feasible butuneconomical (e.g., because of preemption).

Resource-based theorists therefore have traditionally tended to see firms as stuck witha few key resources, which they must deploy across product markets in ways that maximizetotal profits rather than profits in individual markets. This insight animated C. K. Prahaladand Gary Hamel’s influential article, “The Core Competence of the Corporation,” whichattacked the strategic business unit (SBU) system of management for focusing on productsrather than underlying core competencies in a way that arguably bounded innovation,imprisoned resources and led to underinvestment:

“In the short run, a company’s competitiveness derives from the price/performance attributes of current products. . . . In the long run,competitiveness derives from the . . . core competencies that spawnunanticipated new products.”99


25

To many resource-based theorists, the core competencies that Prahalad and Hamelcelebrate are simply a neologism for the resources that the RBV has emphasized all along.Whether the same can be said about another, more distinct line of research on dynamiccapabilities that emerged in the 1990s is an open question.

Dynamic Capabilities

In the 1990s, a number of strategists have tried to extend the resource-based view byexplaining how firm-specific capabilities to perform activities better than competitors can bebuilt and redeployed over long periods of time. The dynamic capabilities view of the firmdiffers from the RBV because capabilities are to be developed rather than taken as given, asdescribed more fully in a pioneering article by David Teece, Gary Pisano and Amy Shuen:

If control over scarce resources is the source of economic profits, thenit follows that issues such as skill acquisition and learning becomefundamental strategic issues. It is this second dimension, encompassing skillacquisition, learning, and capability accumulation that . . . [we] refer to as “thedynamic capabilities approach” . . . Rents are viewed as not only resultingfrom uncertainty . . . but also from directed activities by firms which createdifferentiated capabilities, and from managerial efforts to strategically deploythese assets in coordinated ways.100

Taking dynamic capabilities also implies that one of the things that is most strategicabout the firm is “the way things are done in the firm, or what might be referred to as its‘routines,’ or patterns of current practice and learning.”101 As a result, “research in such areasas management of R&D, product and process development, manufacturing, and humanresources tend to be quite relevant [to strategy].”102 Research in these areas supplies somespecific content to the idea that strategy execution is important.

The process of capability development is thought to have several interestingattributes. First, it is generally “path-dependent.” In other words, “a firm’s previousinvestments and its repertoire of routines (its “history”) constrains its future behavior . . .because learning tends to be local.” Second, capability development also tends to be subjectto long time lags. And third, the embeddedness of capabilities in organizations can flip themaround into rigidities or sources of inertia—particularly when attempts are being made tocreate new, nontraditional capabilities.103

Commitment

A final historically-based approach to thinking about the dynamics of competitionthat is intimately related to the three discussed above focuses on commitment orirreversibility: the constraints imposed by past choices on present ones.104 The manageriallogic of focusing on decisions that involve significant levels of commitment has beenarticulated particularly well by a practicing manager:

A decision to build the Edsel or Mustang (or locate your new factoryin Orlando or Yakima) shouldn’t be made hastily; nor without plenty of inputs


26

. . . [But there is] no point in taking three weeks to make a decision that can bemade in three seconds—and corrected inexpensively later if wrong. Thewhole organization may be out of business while you oscillate between baby-blue or buffalo-brown coffee cups.105

Commitments to durable, firm-specific resources and capabilities that cannot easilybe bought or sold account for the persistence observed in most strategies over time. ModernIO theory also flags such commitments as being responsible for the sustained profitdifferences among product market competitors: thought experiments as well as formalmodels indicate that in the absence of the frictions implied by commitment, hit-and-run entrywould lead to perfectly competitive (i.e., zero-profit) outcomes even without large numbersof competitors.106 And a final attraction of commitment as a way of organizing thinkingabout competitor dynamics is that it can be integrated with other modes of strategic analysisdescribed earlier in this note, as indicated in Exhibit 14.

Exhibit 14 Commitment and Strategy107

Capabilities(Opportunity Sets)

Resource Commitments

Product MarketActivities

The ideas behind the exhibit are very simple. Traditional positioning concepts focuson optimizing the fit among product market activities on the right-hand side of the exhibit.The bold arrows running from left to right indicate that choices about what activities toperform and how to perform them are constrained by capabilities and resources that can bevaried only in the long run and that are responsible for sustained profit differences amongcompetitors. The two fainter arrows that feed back from right to left capture the ways inwhich the activities that the organization performs and the resource commitments that itmakes affect its future opportunity set or capabilities. And finally, the bold arrow that runsfrom capabilities to resource commitments serves as a reminder that the terms on which anorganization can make resource commitments depend, in part, on the capabilities that it hasbuilt up.

Markets for Ideas at the Millenium108

A teleology was implicit in the discussion in the last three sections: starting in the1970s, strategists first sought to probe the two basic dimensions of early portfolio-analyticgrids, industry attractiveness and competitive position, and then to add a time- or historicaldimension to the analysis. Dynamic thinking along the lines discussed in the last section andothers—e.g., options management, systems dynamics and disruptive technologies, to cite justthree other areas of enquiry—has absorbed the bulk of academic strategists’ attention in thelast fifteen-plus years. But when one looks at the practice of strategy in the late 1990s, thissimple narrative is complicated by an apparent profusion of tools and ideas about strategy inparticular and management in general, many of which are quite ahistorical. Both points are


27

illustrated by the influence indexes for business ideas, i.e., importance-weighted citationcounts, calculated by Richard Pascale that are reproduced in Exhibit 15.109 A completeenumeration, let alone discussion, of contemporary tools and ideas is beyond the scope ofthis note, but a few broad points can and should be made about their recent profusion andturnover.

19601950 1970 1980 1990 1995

Influ

ence

Inde

x

Exhibit 15. Ebbs, Flows and Residual Impact of Business Fads* 1950-1995

Self-Managing Teams

Care Competencies

Horizontal Organizations

Business Process ReengineeringContinuous Improvement/Learning Organization

EmpowermentWorkout

VisioningCycle Time/Speed

BenchmarkingOne Minute Managing

Corporate CultureIntrapreneuring

Just in Time/KanbanMatrix

MBWAPortfolio Management

Restructuring/Delayering“Excellence”

Quality Circles/TQM

WellnessDecentralization

Value Chain

“Theory Z”

Management by Objectives

Conglomeration

“Theory Z”T-Group Training

BrainstormingTheory X and Theory Y

Satisfiers/Dissatisfiers

Decision Trees

Managerial Grid

Zero Base BudgetingStrategic Business Units

Experience Curve

Some of the profusion is probably to be celebrated. Thus, there are advantages tobeing able to choose off a large menu of ideas rather than a small one, especially in complexenvironments where “one size doesn’t fit all” (and especially when the fixed costs of ideadevelopment are low). Similarly, the apparently rapid turnover of many ideas can beexplained in benign terms as well: the world is changing rapidly, arguably faster than everbefore; the rapid peaking followed by dropoffs of attention to ideas may reflect successfulinternalization rather than discreditation; and at least some of the apparent turnoverrepresents a rhetorical spur to action, rather than real change in the underlying ideasthemselves. 110

It is difficult to maintain, however, that all the patterns evident in Exhibit 15 conformto monotonic ideals of progress. Consider, for example, what happened with business


28

process reengineering, the single most prominent entry as of 1995. Reengineering waspopularized in the early 1990s by Michael Hammer and James Champy of the consultingfirm CSC Index.111 Hammer originally explained the idea in a 1990 article in the HarvardBusiness Review: “Rather than embedding outdated processes in silicon and software, weshould obliterate them and start over. We should…use the power of modern informationtechnology to radically redesign our business processes in order to achieve dramaticimprovements in their performance.”112 Hammer and Champy’s book, Reengineering theCorporation, which came out in 1993, sold nearly 2 million copies. Surveys in 1994 foundthat 78% of the Fortune 500 companies and 60% of a broader sample of 2,200 U.S.companies were engaged in some form of reengineering, on average with several projectsapiece.113 Consulting revenues from reengineering exploded to an estimated $2.5 billion by1995.114 But after 1995, there was a bust: consulting revenues plummeted, by perhaps two-thirds over the next three years, as reengineering came to be seen as a euphemism fordownsizing and as companies apparently shifted to placing more emphasis on growth(implying, incidentally, that there had been some excesses in their previous efforts toreengineer).

Much of the worry that the extent of profusion or turnover of ideas aboutmanagement may be excessive from a social standpoint is linked to the observation that thisis one of the few areas of intellectual enquiry in which it actually makes sense to talk aboutmarkets for ideas. Unlike, say, 25 or 30 years ago, truly large amounts of money are at stake,and are actively contested for, in the development of “blockbuster” ideas such asreengineering—a process that increasingly seems to fit with the endstate described bySchumpeter as the “routinization of innovation.” Market-based theoretical models indicatethat on the supply side, private incentives to invest in developing new products are likely, inwinner-take-all settings, to exceed social gains.115 To the extent that market-based, i.e.,commercial, considerations have increasing influence on the development of new ideas aboutmanagement, that is a source of increasing concern.

Concerns about supply-side salesmanship are exacerbated by the demand-sideinformational imperfections of markets for ideas as opposed to more conventional products.Most fundamentally, the buyer of an idea is unable to judge how much information is worthuntil it is disclosed to him, but the seller has a difficult time repossessing the information incase the buyer decides, post-disclosure, not to pay very much for it. Partial disclosure mayavoid the total breakdown of market-based exchange in such situations but still leaves aresidual information asymmetry.116 Performance contracting is sometimes proposed as anantidote to otherwise-ineradicable informational problems of this sort, but its efficacy anduse in the context of management ideas seem to be limited by noisy performancemeasurement. Instead, the market-based transfer of ideas to companies appears to besustained by mechanisms such as reputation and observational learning. Based onmicrotheoretic analysis, such mechanisms may lead to “cascades” of ideas, in whichcompanies who choose late optimally decide to ignore their own information and emulate thechoices made earlier by other companies.117 Such fadlike dynamics can also enhance thesales of products with broad as opposed to niche appeal.118 And then there are contractingproblems within rather than between firms that point in the same direction. In particular,models of principal-agent problems show that managers may, in order to preserve or gainreputation when markets are imperfectly informed, prefer either to ‘hide in the herd’ not to beevaluable, or to ‘ride the herd’ in order to prove quality.119 The possible link to situations in


29

which managers must decide which, if any, new ideas to adopt should be obvious. Morebroadly, demand-side considerations suggest some reasons to worry about patterns in thediffusion of new ideas as well as the incentives to develop them in the first place.

Whether such worries about the performance of markets for ideas actually make theireffects felt in the real world of management is, ultimately, an empirical matter. Carefulempirical analysis of product variety and turnover in management ideas is more complicated,however, than it would be in the case of, say, breakfast cereals, given the different natures ofthe “product.” It is harder to count ideas, especially when one considers the distinctivedifficulties of distinguishing between mere variants and distinct varieties and accounting forthe pattern of relationships among ideas over time. It is hard to obtain data on theperformance of ideas since such information tends to be privately- and closely-held. Andeven when performance data are available, there are difficulties in inferring an intrinsic lackof efficacy from a record of failure: the problems may reside in implementation, rather thanin the ideas themselves.120

Regardless of one’s judgment about how poorly or well the market for managementideas works, it is useful to conclude by emphasizing, particularly to academics who operatein the ostensibly nonmarket/nonprofit sphere, that the importance of the market-based or for-profit sphere is large and growing. One way of seeing this is to look at some relevantrevenue streams. As of the mid-1990s, revenues in the United States from MBA and (third-party) executive education amounted to approximately $5 billion, compared to more than $20billion from management consulting.121 Backwarding these numbers at a growth ratedifferential in favor of consulting of 20% plus tends to imply a crossover point 10 or feweryears ago; even at a very conservative growth rate differential of 10%, the crossover pointoccurs only 15-20 years ago.122 It is only since the crossover point that revenues fromconsulting have grown to exceed revenues from MBA and executive education. And lookingbeyond the revenue numbers, consultants play a much more important role in writing booksand contributing to (and even financing) practitioner-oriented journals than ever before, andare starting to make large investments in knowledge management.123

Based on these trends, the likelihood is that in the future, consultants will exerciseeven more influence, relative to academics, on the development and diffusion of new ideasabout strategy in particular and management in general than they have done in recentdecades. And even if this likelihood does not materialize, the coexistence of the nonprofitsector with a large for-profit sector raises questions about the interface between the two,particularly in regard to innovation, that had previously been considered only in the contextof technological issues in specific industries such as biotechnology and software. One of thechallenges for future historians of business strategy will be to help provide better answers tosuch questions by shedding more light on the interactions between academics, businessexecutives and consultants in the development and diffusion of new ideas.


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Endnotes

1 Carl von Clausewitz, On War, Book Two, p. 128.2 Alfred D. Chandler, Jr., Strategy and Structure (Cambridge: MIT Press, 1963) and Scale

and Scope (Cambridge: Harvard University Press, 1990).3 See Alfred P. Sloan, Jr., My Years with General Motors (New York: Doubleday, 1963).

4 Chester I. Barnard, The Functions of the Executive (Cambridge: Harvard University Press,1968; first published 1938), pp. 204-205.

5 Peter Drucker, The Practice of Management (New York: Harper & Row, 1954), p. 11.

6 Philip Selznick, Leadership in Administration (Evanston, Illinois: Row, Peterson, 1957),pp. 49-50.

7 Official Register of Harvard University, March 29, 1917, pp. 42-43.

8 George Albert Smith, Jr. and C. Roland Christensen, Suggestions to Instructors on PolicyFormulation (Chicago: Richard D. Irwin, 1951), pp. 3-4.

9 George Albert Smith, Jr., Policy Formulation and Administration (Chicago: Richard D.Irwin, 1951), p. 14.

10 Kenneth R. Andrews, The Concept of Corporate Strategy (Homewood, Illinois: DowJones-Irwin, 1971), p. 23.

11 See Part I of Edmund P. Learned, C. Roland Christensen and Kenneth Andrews, Problemsof General Management (Homewood, Illinois: Richard D. Irwin, 1961).

12 Interview with Kenneth Andrews, April 2, 1997.

13 Kenneth Andrews, The Concept of Corporate Strategy, Revised Edition (Homewood Il.:Richard D. Irwin, 1980), p. 69.

14 Kenneth R. Andrews, The Concept of Corporate Strategy (1971), p. 29.

15 Kenneth R. Andrews, The Concept of Corporate Strategy (1971), p. 100.

16 Theodore Levitt, “Marketing Myopia” Harvard Business Review (July/August 1960), p.52.

17 Igor Ansoff, Corporate Strategy (New York: McGraw-Hill, 1965), pp. 106-109.

18 Igor Ansoff, Corporate Strategy, pp. 105-108.


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19 This is Henry Mintzberg’s adaptation of Ansoff’s matrix. Henry Mintzberg, “GenericStrategies” in Advances in Strategic Management, vol. 5 (Greenwich, Connecticut:JAI Press, 1988), p. 2. For the original, see Igor Ansoff, Corporate Strategy (NewYork: McGraw-Hill, 1965), p. 128.

20 Michael E. Porter, “Industrial Organization and the Evolution of Concepts for StrategicPlanning,” in T. H. Naylor, ed., Corporate Strategy (New York: North-Holland,1982), p. 184.

21 Adam M. Brandenburger, Michael E. Porter and Nicolaj Siggelkow, “Competition andStrategy: The Emergence of a Field,” paper presented at McArthur Symposium,Harvard Business School, October 9, 1996, pp. 3-4.

22 Stanford Research Institute, “Planning in Business,” Menlo Park, 1963.

23 Sidney E. Schoeffler, Robert D. Buzzell and Donald F. Heany, “Impact of StrategicPlanning on Profit Performance,” Harvard Business Review (March-April 1974), p.139.

24 Interview with Seymour Tilles, October 24, 1996. Tilles credits Henderson forrecognizing the competitiveness of Japanese industry at a time, in the late 1960s,when few Americans believed that Japan or any other country could competesuccessfully against American industry.

25 Bruce Henderson, The Logic of Business Strategy (Cambridge, Massachusetts: BallingerPublishing, 1984), p. 10.

26 Bruce D. Henderson, Henderson on Corporate Strategy (Cambridge, Massachusetts: AbtBooks, 1979), pp. 6-7.

27 Interview with Seymour Tilles, October 24, 1996.

28 Bruce D. Henderson, Henderson on Corporate Strategy, p. 41.

29 Bruce Henderson explained that unlike earlier versions of the “learning curve,” BCG’sexperience curve “encompasses all costs (including capital, administrative, researchand marketing) and traces them through technological displacement and productevolution. It is also based on cash flow rates, not accounting allocation.” Bruce D.Henderson, preface to Boston Consulting Group, Perspectives on Experience(Boston: BCG, 1972; first published 1968).

30 Boston Consulting Group, Perspectives on Experience, p. 7.

31 Patrick Conley, “Experience Curves as a Planning Tool,” BCG Pamphlet (1970), p. 15.

32 Bruce Henderson, preface, Boston Consulting Group, Perspectives on Experience.


32

33 See George Stalk, Jr. and Thomas M. Hout, Competing Against Time (New York: FreePress, 1990), p. 12.

34 Patrick Conley, “Experience Curves as a Planning Tool,” pp. 10-11.

35 Interview with Mike Allen, April 4, 1997.

36 Arnoldo C. Hax and Nicolas S. Majluf, Strategic Management: An Integrative Perspective(Englewood Cliffs, New Jersey: Prentice-Hall, 1984), p. 156.

37 Sidney E. Schoeffler, Robert D. Buzzell and Donald F. Heany, “Impact of StrategicPlanning on Profit Performance,” Harvard Business Review (March-April 1974), pp.139-140, 144-145.

38 See Walter Kiechel, “Corporate Strategists under Fire,” Fortune (December 27, 1982).

39 Frederick W. Gluck and Stephen P. Kaufman, “Using the Strategic Planning Framework,”McKinsey internal document: Readings in Strategy (1979), pp. 3-4.

40 J. Quincy Hunsicker, “Strategic Planning: A Chinese Dinner?,” McKinsey Staff Paper(December 1978), p. 3.

41 Philippe Haspeslagh, “Portfolio Planning: Uses and Limits,” Harvard Business Review(January/February 1982), p. 59.

42 William J. Abernathy and Kenneth Wayne, “Limits of the Learning Curve,” HarvardBusiness Review (September/October 1974), p. 111.

43 Pankaj Ghemawat, “Building Strategy on the Experience Curve,” Harvard BusinessReview (March/April) 1985.

44 Yoram Wind, Vijay Mahajan and Donald J. Swire, “An Empirical Comparison ofStandardized Portfolio Models,” Journal of Marketing 47 (Spring, 1983), pp. 89-99.The statistical analysis of Wind et al.’s results is based on an unpublished draft byPankaj Ghemawat.

45 Frederick W. Gluck and Stephen P. Kaufman, “Using the Strategic Planning Framework,”McKinsey internal document in Readings in Strategy (1979), pp. 5-6.

46 Figure adapted from Frederick W. Gluck, Stephen P. Kaufman, and A. Steven Walleck,“The Evolution of Strategic Management,” McKinsey Staff Paper (October 1978), p.4. Reproduced in modified form in the same authors’ “Strategic Management forCompetitive Advantage,” Harvard Business Review (July/August 1980), p. 157.

47 Robert H. Hayes and William J. Abernathy, “Managing Our Way to Economic Decline,”Harvard Business Review (July/August 1980), p. 68.


33

48 Robert H. Hayes and William J. Abernathy, ibid, p. 71.

49 William G. Shepherd, “Causes of Increased Competition in the U.S. Economy, 1939-1980,” Review of Economics and Statistics (November 1982), p. 619.

50 Antoine A. Cournot, Recherches sur les Principes Mathematiques de la Theorie desRichesses (Paris: Hachette, 1838), sections 26 and 27 and Jurg Niehans, A History ofEconomic Theory (Baltimore: Johns Hopkins Press, 1990), pp. 180-182.

51 Economists associated with the Chicago School generally doubted the empiricalimportance of this possibility—except as an artifact of regulatory distortions.

52 Mason’s seminal work was “Price and Production Policies of Large-Scale Enterprise,”American Economic Review (March 1939), pp. 61-74.

53 Joe S. Bain, “Relation of Profit Rate to Industry Concentration: American Manufacturing,1936-1940,” Quarterly Journal of Economics (August 1951), pp. 293-324.

54 Joe S. Bain, Barriers to New Competition (Cambridge: Harvard University Press, 1956),p.†3.

55 See, for instance, Harvey J. Golschmid, H. Michael Mann and J. Fred Weston, eds,Industrial Concentration: The New Learning (Boston: Little Brown, 1974).

56 Source: Anita M. McGahan, “Selected Profitability Data on U.S. Industries andCompanies,” HBS Publishing No. 792-066 (1992).

57 Michael E. Porter, “Note on the Structural Analysis of Industries,” HBS Publishing 376-054.

58 Michael E. Porter, “Toward a Dynamic Theory of Strategy” in Richard P. Rumelt, Dan E.Schendel and David J. Teece, eds., Fundamental Issues in Strategy (Boston: HarvardBusiness School Press, 1994), pp. 427-429.

59 Richard Schmalensee, “Inter-Industry Studies of Structure and Performance,” in RichardSchmalensee and R. D. Willig, eds., Handbook of Industrial Organization, vol. 2(Amsterdam: North-Holland, 1989).

60 Adam M. Brandenburger and Barry J. Nalebuff, Co-opetition, (New York:Currency/Doubleday, 1996).

61 Adam M. Brandenburger and Barry J. Nalebuff, Co-opetition, p.17.

62 Kevin P. Coyne and Somu Subramanyam, “Bringing Discipline to Strategy,” MckinseyQuarterly 1996 No.4, p.16.


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63 See, for instance, Richard P. Rumelt, “How Much Does Industry Matter?,” StrategicManagement Journal (March 1991), pp. 167-185.

64 David Collis and Pankaj Ghemawat, “Industry Analysis: Understanding Industry Structureand Dynamics,” in Liam Fahey and Robert M. Randall, The Portable MBA inStrategy (New York: John Wiley, 1994), p. 174.

65 See Michael S. Hunt, “Competition in the Major Home Appliance Industry,” DBAdissertation, Harvard University, 1972. A theoretical foundation for strategic groupswas provided by Richard E. Caves and Michael E. Porter, “From Entry Barriers toMobility Barriers,” Quarterly Journal of Economics (November 1977), pp. 667-675.

66 This is based on one of the authors’ (Ghemawat’s) experience working at BCG in the late1970s.

67 Adapted from Carter F. Bales, P. C. Chatterjee, Donald J. Gogel and Anupam P. Puri,“Competitive Cost Analysis,” McKinsey Staff Paper (January 1980), p. 6.

68 Walter Kiechel III, “The Decline of the Experience Curve,” Fortune (October 5, 1981).

69 Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), chapter 3.

70 Quoted in Walter Kiechel III, “The Decline of the Experience Curve,” Fortune (October 5,1981).

71 Interview with Hugo Uyterhoeven, April 25, 1997.

72 Interview with Fred Gluck, February 18, 1997.

73 Michael Porter, Competitive Strategy (New York: Free Press, 1980), ch. 2, and William K.Hall, “Survival Strategies in a Hostile Environment,” Harvard Business Review(September/October, 1980), pp. 78-81.

74 Michael E. Porter, Competitive Strategy, pp. 41-44.

75 Michael E. Porter, Competitive Advantage, p. 33.

76 Michael E. Porter, Competitive Advantage (New York: Free Press, 1985), p. 37.

77 Talk by Arnoldo Hax at MIT on April 29, 1997.

78 F. M. Scherer and David Ross, Industrial Market Structure and Economic Performance(Boston: Houghton Mifflin, 1990), chapter 5.

79 Benjamin C. Esty, “Note on Value Drivers,” HBS Publishing No. 297-082.


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80 Pankaj Ghemawat, “Sustainable Advantage,” Harvard Business Review(September/October 1986), pp. 53-58 and Pankaj Ghemawat, Commitment (NewYork: Free Press, 1991), chapter 5.

81 The first economic citation of the “Red Queen” effect is generally attributed to L. VanValen. See L. Van Valen, “A New Evolutionary Law” Evolutionary Theory 1 (1973),pp. 1-30. The literary reference is to Lewis Carroll’s Alice’s Adventures inWonderland and Through the Looking Glass (New York; Bantam Books, 1981; firstpublished 1865-1871), in which the Red Queen tells Alice that “here, you see, it takesall the running you can do, to keep in the same place. If you want to get somewhereelse, you must run at least twice as fast…” (p. 127).

82 George Stalk, Jr., “Time—The Next Source of Competitive Advantage,” HarvardBusiness Review (July-August 1988).

83 George Stalk, Jr. and Thomas M. Hout, Competing Against Time, p. 179.

84 George Stalk, Jr. and Alan M. Webber, “Japan’s Dark Side of Time,” Harvard BusinessReview (July/August 1993), p. 94.

85 George Stalk, Jr. and Alan M. Webber, “Japan’s Dark Side of Time,” Harvard BusinessReview (July/August 1993), p. 98-99.

86 George Stalk, Jr. and Alan M. Webber, “Japan’s Dark Side of Time,” Harvard BusinessReview (July/August 1993), pp. 101-102.

87 This test of stability is due to the game theorists, John von Neumann and OskarMorgenstern. See their Theory of Games and Economic Behavior (Princeton:Princeton University Press, 1944).

88 Op. cit.

89 There is also a branch of game theory that provides upper bounds on players’ payoffs iffreewheeling interactions among them are allowed. See Adam M. Brandenburger andBarry J. Nalebuff’s Co-opetition (New York: Doubleday, 1996) for applications ofthis idea to business.

90 Pankaj Ghemawat, Games Businesses Play (Cambridge: MIT Press, 1997), p. 3.

91 For a late 1980s survey of game-theoretic IO, consult Carl Shapiro, “The Theory ofBusiness Strategy,” RAND Journal of Economics (Spring 1989), pp. 125-137.

92 Carl Shapiro, op cit., p. 127.

93 Avinash K. Dixit and Barry J. Nalebuff, Thinking Strategically (New York: W. W.Norton, 1991), p. 120. Their logic is based on Thomas C. Schelling’s pioneering


36

book, The Strategy of Conflict (Cambridge: Harvard University Press, 1979; firstpublished in 1960).

94 For a detailed critique, see Richard P. Rumelt, Dan Schendel and David J. Teece,“Strategic Management and Economics,” Strategic Management Journal (Winter1991), pp. 5-29.

95 For a discussion of the original models (by Ghemawat and Nalebuff) and the supportingempirical evidence, consult Pankaj Ghemawat, Games Businesses Play (Cambridge:MIT Press, 1997), chapter 5.

96 In the same year, Richard Rumelt also noted that the strategic firm “is characterized by abundle of linked and idiosyncratic resources and resource conversion activities.” Seehis chapter, “Towards a Strategic Theory of the Firm,” in R. B. Lamb ed.,Competitive Strategic Management (Englewood Cliffs: Prentice-Hall, 1984), p. 561.

97 Birger Wernerfelt, “A Resource-based View of the Firm,” Strategic Management Journal5 (1984), p. 171. In addition to Andrews, Wernerfelt cited the pioneering work ofEdith Penrose, The Theory of the Growth of the Firm (Oxford: Basil Blackwell,1959).

98 Jay B. Barney, “Firm Resources and Sustained Competitive Advantage,” Journal ofManagement (March 1991), pp. 107-111.

99 C. K. Prahalad and Gary Hamel, “The Core Competence of the Corporation,” HarvardBusiness Review (May/June 1990), p. 81.

100 David J. Teece, Gary Pisano and Amy Shuen, “Dynamic Capabilities and StrategicManagement,” mimeo (June 1992), pp. 12-13.

101 David Teece and Gary Pisano, “The Dynamic Capabilities of Firms: An Introduction,”Industrial and Corporate Change 3 (1994), pp. 540-541. The idea of “routines” as aunit of analysis was pioneered by Richard R. Nelson and Sidney G. Winter, AnEvolutionary Theory of Economic Change (Cambridge: Harvard University Press,1982).

102 David J. Teece, Gary Pisano and Amy Shuen, “Dynamic Capabilities and StrategicManagement,” mimeo (June 1992), p. 2.

103 Dorothy Leonard-Barton, “Core Capabilities and Core Rigidities: A Paradox in ManagingNew Product Development,” Strategic Management Journal (1992), pp. 111-125.

104 For a book-length discussion of commitments, see Pankaj Ghemawat, Commitment (NewYork: Free Press, 1991). For connections to the other modes of dynamic analysisdiscussed in this section, see chapters 4 and 5 of Pankaj Ghemawat, Strategy and theBusiness Landscape (Reading, Mass.: Addison Wesley Longman, 1999).


37

105 Robert Townsend, Up the Organization.

106 See, for instance, William J. Baumol, John C. Panzar and Robert D. Willig, ContestableMarkets and the Theory of Industry Structure (New York: Harcourt BraceJovanovich, 1982) for an analysis of the economic implications of zero commitmentand Richard E. Caves, “Economic Analysis and the Quest for CompetitiveAdvantage,” American Economic Review (May 1984), pp. 127-132 for comments onthe implications for business strategy.

107 Adapted from Figure 3, Pankaj Ghemawat, “Resources and Strategy: An IO Perspective,”Harvard Business School Working Paper (1991), p. 20.

108 For a more extended discussion of the ideas in this postscript, see Pankaj Ghemawat,“Competition among Management Paradigms: An Economic Analysis,” HarvardBusiness School Working Paper (2000).

109 For additional discussion of the methodology employed, consult Richard T. Pascale,Managing on the Edge, (New York: Simon and Schuster, 1990), pp. 18-20.

110 Richard D’Aveni, among many others, asserts unprecedented levels of environmentalchange in Hypercompetition: Managing the Dynamics of Strategic Maneuvering,(New York: The Free Press, 1994). William Lee and Gary Skarke discuss apparentlytransient ideas that are permanently valuable in “Value-Added Fads: From PassingFancy to Eternal Truths,” Journal of Management Consulting (1996), pp. 10-15.Robert G. Eccles and Nitin Nohria emphasize the rhetorical uses of changing thewrappers on a limited number of timeless truths about management in Beyond theHype: Rediscovering the Essence of Management, (Boston, Mass.: Harvard BusinessSchool Press, 1992).

111 See Michael Hammer and James Champy, Reengineering the Corporation (New York:Harper Business, 1993). See also John Micklethwait and Adrian Wooldridge, TheWitch Doctors (New York: Times Books, 1996). Micklethwait and Wooldridgedevote a chapter to CSC Index.

112 Michael Hammer, “Reengineering Work: Don’t Automate, Obliterate,” Harvard BusinessReview (July/August 1990), p. 104.

113 John Micklethwait and Adrian Wooldridge, The Witch Doctors (New York: Times Books,1996), p. 29.

114 See James O’Shea and Charles Madigan, Dangerous Company: The ConsultingPowerhouses and the Businesses They Save and Ruin (New York: Times Books,1997).

115 For a general discussion, see Robert H. Frank and Philip J. Cook, The Winner-Take-AllSociety (New York: The Free Press, 1995) and, for formal modeling and a discussionspecific to the management idea business, Pankaj Ghemawat (2000), op cit..


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116 See, for example, James J. Anton and Dennis A. Yao, “The Sale of Ideas: StrategicDisclosure, Property Rights, and Incomplete Contracts,” unpublished working paper,Fuqua School of Business, Duke University (1998).

117 See Sushil Bikhchandani, David Hirshleifer and Ivo Welch, “Learning from the Behaviorof Others: Conformity, Fads and Informational Cascades,” Journal of EconomicPerspectives, 1998: 151-170.

118 See Daniel L. McFadden and Kenneth E. Train, “Consumers’ Evaluation of NewProducts: Learning from Self and Others,” Journal of Political Economy (August1996): 683-703.

119 These models derive some of their real-world appeal from the use of relative performancemeasures to evaluate managers. See Robert Gibbons and Kevin J. Murphy, “RelativePerformance Evaluation of Chief Executive Officers,” Industrial and Labor RelationsReview, February 1990: 30S-51S.

120 See, for instance, Nelson P. Repenning, “A Simulation-Based Approach to Understandingthe Dynamics of Innovation Implementation,” Department of OperationsManagement/Systems Dynamics Group Working Paper, Sloan School ofManagement, MIT, 1999.

121 The estimate of consultants’ revenues is based on Consultants’ News. Estimates of themarket for MBA education are based on total enrollment in MBA programs in theUnited States, and of the market for executive education on a study by a majorconsulting firm for a leading business school. Note that in-house managementeducation programs are excluded from these numbers, but might double the size ofthe education market if included.

122 Total employment grew at significantly less than 10% per annum in recent years for U.S.-based management academics versus close to 20% for U.S.-based managementconsultants. And consultants’ salaries have probably increased more rapidly.

123 See Miklos Sarvary, “Knowledge Management and Competition in the ConsultingIndustry.” California Management Review 41, no. 2 (1999): 95-107.

pankaj ghemawat - competition and business strategy in historical perspective

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