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What in the World is Competitive Advantage?
Richard P. Rumelt Harry & Elsa Kunin Professor of Business & Society The Anderson School at UCLA Policy Working Paper 2003-105 August 5, 2003 In recent years the concept of competitive advantage has taken center stage in discussions of business strategy. Statements about competitive advantage abound, but a precise definition is elusive. In reviewing the use of the term competitive advantage in the strategy literature, the common theme is value creation. However, there is not much agreement on value to who, and when. According to one school of thought, value is created by favorable terms of trade in product markets. That is, sales in which revenues exceed costs. However, scrutiny of the concept of “cost” quickly reveals problems. What is the “cost” of a scarce resource? Another school of thought holds that advantage is revealed by “super-normal” returns. Again, questions quickly arise. Internal returns are normally measured by some type of market-book ratio. Such ratios include return on capital1, return on assets, market-to-book value, and Tobin’s Q. Given such a measure, are supernormal returns “super” relative to the expectations of owners, the economy as a whole, or the rest of the industry? A third school of thought ties advantage to stock market performance. According to financial economics, superior stock market performance stems from surprising increases in expectations. Thus, after 9/11, the stocks of defense companies rose dramatically. Does this signal competitive advantage? To illustrate various approaches to these issues, I summarize below a variety of thoughts on the subject by important contributors. • Porter says “competitive advantage is at the heart of a firm’s performance in competitive markets” and goes on to say that purpose of his book on the subject is to show “how a firm can actually create and sustain a competitive advantage in an industry—how it can implement the broad generic strategies.” Thus, competitive advantage means having low costs, differentiation advantage, or a successful focus strategy. In addition, Porter argues that “competitive advantage grows fundamentally out of value a firm is able to create for its buyers that exceeds the firm’s cost of creating it.” Peteraf [1993] defines competitive advantage as “sustained above normal returns.” She defines imperfectly mobile resources as those that are specialized to the firm and notes that such resources “can be a source of competitive advantage” because “any Ricardian or monopoly rents generated by the asset will not be offset entirely by accounting for the asset’s opportunity cost” (i.e., its value to others). Barney [2002: 9] says that “a firm experiences competitive advantages when its actions in an industry or market create economic value and when few competing firms are engaging in

Each of this measure mixes market prices with historical costs in a different way. All omit the “cost” of some scarce intangible assets.


similar actions.” Barney goes on to tie competitive advantage to performance, arguing that “a firm obtains above-normal performance when it generates greater-than-expected value from the resources it employs. In this final case, the owners of resources think they are worth $10, and the firm creates $12 in value using them. This positive difference between expected value and actual value is known as an economic profit or an economic rent.” • Ghemawat and Rivkin [1999: 49] say that “A firm such as Nucor that earns superior financial returns within its industry (or its strategic group) over the long run is said to enjoy a competitive advantage over its rivals.” Besanko, Dranove, and Shanley [2000: 389] say “When a firm earns a higher rate of economic profit than the average rate of economic profit of other firms competing within the same market, the firm has a competitive advantage in that market.” They also carefully define economic profit [1999:627] as “the...
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