1. How can the neoclassical theory of perfect competition inform theories of competitive advantage?
Neoclassical theory of perfect competition:
Characteristics of perfect competitive market:
- Large numbers assumption (decreasing returns, many buyers/sellers, firms are price takers)
- Homogeneity assumption (demand is homogeneous: no differentiation in products)
- Mobility assumption (resources are mobile, free entry and exit)
- Rationality assumption (buyers/sellers have complete information and are rational: buyers
maximize utility, sellers maximize profit)
- Transaction cost assumption (no transaction costs)
Perfect competition is a theoretical abstraction, it does not exist in the real world. The model describes
the circumstances under which firms can only compete on price. These circumstances lead to an
equilibrium. In this equilibrium there are no differences in performance, meaning that every firm earns
zero economic profit. And because all firms earn the same, there is no competitive advantage.
Zero economic profit means that firms cover their accounting costs plus their opportunity costs.
Answer to the question
In a perfect competitive market, all firms earn zero economic profit, which means that there are no
differences in performance and there is no competitive advantage. This also means that a deviation from
the assumptions of perfect competition can lead to a competitive advantage.
The schools of thought that are discussed in this course can all be described as a deviation from these
assumptions. They all relax one or more of the assumptions of the neoclassical theory of perfect
competition.
- Porter’s Industry Effect: market power (barriers to competition)
- Porter’s Firm Effect: generic strategies (differentiation and cost leadership).
- RBV: costly to copy resources
- Schumpeterian: entrepreneurial / opportunity creation / creative destruction
- Capabilities view: firms need to do something with resources
- Knowledge-based view: (tacit) knowledge -> inimitable and imperfect mobile
- Dynamic capabilities view: resources must be build, cannot be bought
The neoclassical theory of perfect competition informs theories of competitive advantage because it gives
a theoretical benchmark. With this theoretical benchmark, real world situations can be compared.
Deviations from this benchmark lead to a competitive advantage. Therefore, the neoclassical theory of
perfect competition not only creates a theoretical benchmark, it also creates views to deviate from the
benchmark to obtain a competitive advantage.
, 2. How does Porter’s early view on strategy explain differences in performance among firms?
Describe performance in perfect competition
- Zero economic profit
- No differences in performance
- No competitive advantage
Describe Bain-type IO and how that deviates from perfect competition
- Industries differ from each other in terms of their structure: some industries are more attractive
than others.
- Bain IO describes performance through industry structure and firm conduct (S-C-P)
- Bain IO uses this to increase competition to improve social welfare.
Describe Porter and how he turned Bain IO on its head
- Porter uses the S-C-P model by analyzing industry structure through 5-forces, and firm conduct
through its generic strategies.
- He turns Bain IO on its head: instead of making industries more competitive to increase social
welfare, Porter uses the S-C-P model to understand how to avoid competition and improve
performance.
Describe Porter’s early work
- 5 forces (average profitability of an industry)
o Threat of new entrants, bargaining power suppliers and buyers, threat of substitutes,
rivalry among firms in industry.
o The stronger the force, the less attractive the industry.
- Strategic groups
o Different strategic groups within the same industry
o Example: aviation. KLM and Lufthansa vs. EasyJet and Ryanair (same industry, different
strategic group)
- Generic strategies (firms differ in terms of their market position within the industry)
o Cost leadership
o Differentiation
Describe performance through S-C-P model
Sources of CA Competitive Advantage Performance
Bain-type IO: Industry Firm conduct Performance
Porter Barriers to Market power Economic profit
(industry effect) competition
Porter Generic strategies Economic profit
(firm effect)
Principle 2: Firms can earn an economic profit if they are in a position of market power (i.e. if they have
(some) control over price).
Neoclassical theory of perfect competition:
Characteristics of perfect competitive market:
- Large numbers assumption (decreasing returns, many buyers/sellers, firms are price takers)
- Homogeneity assumption (demand is homogeneous: no differentiation in products)
- Mobility assumption (resources are mobile, free entry and exit)
- Rationality assumption (buyers/sellers have complete information and are rational: buyers
maximize utility, sellers maximize profit)
- Transaction cost assumption (no transaction costs)
Perfect competition is a theoretical abstraction, it does not exist in the real world. The model describes
the circumstances under which firms can only compete on price. These circumstances lead to an
equilibrium. In this equilibrium there are no differences in performance, meaning that every firm earns
zero economic profit. And because all firms earn the same, there is no competitive advantage.
Zero economic profit means that firms cover their accounting costs plus their opportunity costs.
Answer to the question
In a perfect competitive market, all firms earn zero economic profit, which means that there are no
differences in performance and there is no competitive advantage. This also means that a deviation from
the assumptions of perfect competition can lead to a competitive advantage.
The schools of thought that are discussed in this course can all be described as a deviation from these
assumptions. They all relax one or more of the assumptions of the neoclassical theory of perfect
competition.
- Porter’s Industry Effect: market power (barriers to competition)
- Porter’s Firm Effect: generic strategies (differentiation and cost leadership).
- RBV: costly to copy resources
- Schumpeterian: entrepreneurial / opportunity creation / creative destruction
- Capabilities view: firms need to do something with resources
- Knowledge-based view: (tacit) knowledge -> inimitable and imperfect mobile
- Dynamic capabilities view: resources must be build, cannot be bought
The neoclassical theory of perfect competition informs theories of competitive advantage because it gives
a theoretical benchmark. With this theoretical benchmark, real world situations can be compared.
Deviations from this benchmark lead to a competitive advantage. Therefore, the neoclassical theory of
perfect competition not only creates a theoretical benchmark, it also creates views to deviate from the
benchmark to obtain a competitive advantage.
, 2. How does Porter’s early view on strategy explain differences in performance among firms?
Describe performance in perfect competition
- Zero economic profit
- No differences in performance
- No competitive advantage
Describe Bain-type IO and how that deviates from perfect competition
- Industries differ from each other in terms of their structure: some industries are more attractive
than others.
- Bain IO describes performance through industry structure and firm conduct (S-C-P)
- Bain IO uses this to increase competition to improve social welfare.
Describe Porter and how he turned Bain IO on its head
- Porter uses the S-C-P model by analyzing industry structure through 5-forces, and firm conduct
through its generic strategies.
- He turns Bain IO on its head: instead of making industries more competitive to increase social
welfare, Porter uses the S-C-P model to understand how to avoid competition and improve
performance.
Describe Porter’s early work
- 5 forces (average profitability of an industry)
o Threat of new entrants, bargaining power suppliers and buyers, threat of substitutes,
rivalry among firms in industry.
o The stronger the force, the less attractive the industry.
- Strategic groups
o Different strategic groups within the same industry
o Example: aviation. KLM and Lufthansa vs. EasyJet and Ryanair (same industry, different
strategic group)
- Generic strategies (firms differ in terms of their market position within the industry)
o Cost leadership
o Differentiation
Describe performance through S-C-P model
Sources of CA Competitive Advantage Performance
Bain-type IO: Industry Firm conduct Performance
Porter Barriers to Market power Economic profit
(industry effect) competition
Porter Generic strategies Economic profit
(firm effect)
Principle 2: Firms can earn an economic profit if they are in a position of market power (i.e. if they have
(some) control over price).
