As most British universities recommence for the next academic year, many fledgling learners will be starting on these courses as the last cohort of students to go through university without the up to £9000 debt annually. Faced with the prospects of student debt in their selection of degree course, many 'freshers' will be more selective about achieving a degree course that is a saleable asset in the labour market. In this respect, a degree in economics could be highly regarded in the aspirations of these 'freshers'. There is an assumption that a good degree in economics would give those individuals a competitive advantage. Competitive advantage however, is an illusive concept.
How might we define what is meant by the nebulous notion of competitive advantage? In this discussion my purpose is to outline a number of ideas which might clarify the thinking, as an economist, on what might be meant or conveyed by the idea of competitive advantage. Defining what competitive advantage is, in robust economic terms, would be a good starting point. I have always found that competitive advantage is, in an economic sense, in need of clarification; at times the idea can mean all things to all people. As an economist I am occasionally doubtful of this vague and omnipresent feature of business success.
However, Economics, as a discipline, is traditionally poor at identifying the features of business success. The subject historically regarded these aspects as the product of the market structure within which a firm finds itself: market structures range from 'perfect competition', where firms are numerous and largely invariant to similar business within the same market structure, to 'monopoly' where the firm is the industry. In this respect, the discipline of economics does very little to explain the contributions made by separate managerial teams or business entrepreneurs. In the context of this intellectual lacuna, the study of 'Management' grew to fill the void. Yet recent contributions from economic thinking can help to illuminate business thinking.
If Everyone Can Do It, Then No One Can Make Money Out Of It
An understanding of economics should suggest to business people, that if everyone can do it, then no one can make money [or RENT] out of it: This insight comes from the work of Sharon Oster (1990). In this view 'Distinctiveness' should be the foundation of an understanding of corporate success. The basic, neo-classical economic 'Conditions, Structure, Conduct, Performance' paradigm, does little to identify why one company is distinct from other firms.
Yet sound reasoning should provide an economic approach to an understanding of business success. Companies are complex organisations, their managers constantly make decisions that affect the economic viability of the firms in which they operate. In reality, companies succeed while others fail; yet economic thinking could provide more to identify the ingredients of business success to company managerial teams to guide them as to how to steer or reverse the fortunes of declining firms. Emerging companies frequently succeed in highly competitive industries, whereas the traditional economic 'Conditions, Structure, Conduct, Performance' idea, provides very little to explain why.
Peters and Waterman's 1982 best seller, In Search of Excellence: Lessons from America's best-run companies, provided an effective list of how the author's succeeded; but in writing their work, it was there on the page for everyone else to copy and replicate. The work of Michael Porter again does little to identify any aspect of firm distinctiveness. The formula provided sets out a recipe for companies to gain a positional success. This may provide firms with a temporary or transitory exclusivity giving some success but this is not safe from the inevitable process of replication in the face of market competition. Many firms have sought the passing advantage of being a 'cost leader' or 'differentiators' but the position has frequently proved to be a short lived benefit to the company's share price. By reducing product prices the former, cost leadership strategy has also been beneficial to the company's customers. However the ease of replication, is the strategy's principal undoing.
The 'Public Policy' and consumer welfare, traditions of economics have perhaps hindered the discipline's development of insights in business economics, in addressing why firms, in similar market conditions, may be distinct from one another. The work of John Kay, Foundations of Corporate Success, Oxford, (1995) attaches much more significance to this issue of uniqueness or distinctiveness in business success. Unlike previous work on company success, Kay has done more to embrace the need to identify aspects of company practice that are distinct and thereby difficult to replicate.
Transaction Cost Economics: Why Do Firms Exist?
Kay's ideas are informed by developments from transaction cost economics. This branch of the discipline raised the question "Why Do Firms Exist?" Traditionally neo-classical economics provides a theoretical proposition that regards the world as being perfectly rational, in this view there is no inherent reason why, in a frictionless setting, the marginal product of factors should differ whether they are hired out or kept for your own use. Transaction costs are the costs of using the market. And indeed some managerial teams are more successful in overcoming these costs than others. Hence some firms are more successful than others.
Transaction costs are why firms exist and why some firms, from superficially similar settings are more successful than others. The governance of firms, through market contracts and especially through internal contract structures, is the task of management and managerial teams. Superior contract structures enable firms in superficially similar industrial structures to outperform others through an economy of transactions or governance costs. Such thinking begins to allude to the elusive notion of entrepreneurial capacity.
Company contract structures which cannot be readily copied are crucial to enduring corporate success. Many successful companies achieve this distinctive quality and capability through a myriad of different routes. Usually these contracts are not easy to replicate: often in many successful organisations through the role of the people in the firm. Much of the treatment of competitive advantage lacks this understanding and this is why academic economists are slightly dubious of the issue. Competitive advantage is, in economic terms, weak. But so too is the Structure, Conduct, Performance paradigm. Firms are distinct from each other, but apart from transaction cost economics the discipline of economics does little to embrace this reality.