Resources & Views

Introducing Jay Barney

Friends,

I hope that you and yours are all doing well on this Friday morning.

Let me begin by sharing some very exciting news. I recently learned that our little community is growing – and growing fast. We have now hit 3,000 weekly readers, an increase of roughly 2,000 in the last half year or so, and 1,000 since mid-December.

Without a doubt, this is made possible because of you. Subscription figures are also rising rapidly, but many find the newsletter through it being shared widely and broadly. This is flattering almost beyond words and helps me greatly. From the bottom of my heart, thank you.

I am aware that the last few weeks have been rather heavy on theory, and today is no exception. However, there is a point to it; by laying a proper foundation, we can begin to look at practice from new angles together. After all, this is what praxis means; theory informed practice in a continuous learning cycle.

Next week, we will shift up in gear, take some of what we have discovered and apply it to the very practical conundrum of horizontal stacking vs vertical integration, a burning topic in particular for companies going through digital transformations at the moment. But more on that then.

Now, onto the topic of the day.

Le plat du jour

Seven days ago, we revisited the behemoth of strategic management doctrine that is Michael Porter. Together with his generic strategies, the five forces framework provides a significant chunk of the basis for strategic positioning as many of you will know it. At its heart, it is very much an external-internal view of the organization. It begins with the competitive environment in which the business acts (or, perhaps more accurately, is intended to act) and assumes that the strategist is able to a) find the best spot to be in, and b) firmly place the company there.

Of course, it logically stands to reason that one could also do the exact opposite and instead begin with the organization.

One such internal-external view is the resource-based view of the firm, or just RBV for short. Although there are others that fall into the same category (such as Prahalad and Hamel’s concept of core competence), the RBV is arguably the most famous and influential, which is why we will focus on it here.

Although the origins of RBV remain a source of heated debate to this day, Jay Barney's 1991 article Firm Resources and Sustained Competitive Advantage is indisputably central to its popularization. At its core, his theory carries two assumptions.

Firstly, that firms within an industry or vertical may be heterogeneous with respect to the strategic resources under their control. These resources can be categorized into:

1. physical capital resources (physical technology, hardware, a valuable geographic location of a factory or headquarters, access to raw materials etc.),

2. human capital resources (training that has been completed, accumulated experience, judgment, intelligence, relationships, insights of individual managers and workers, and so on), and

3. organizational capital resources (e.g., reporting structures, formal and informal planning, controlling mechanisms, coordinating systems, and informal relations in groups within the firm and between the firm and its environment).

Secondly, that these resources may not be perfectly mobile across firms, which means that the heterogeneity may be long lasting.

Competitive advantage, it thus follows, is achieved by application of these valuable resources. The job of the strategists is no longer to look at the market, identify the most attractive segments and position the company and its products accordingly. Instead, her task is to look inside the organization and identify, develop and deploy the resources that maximize returns. This could take the form of all kinds of products being offered across any number of markets.

What ultimately determines the merit of the approach is, according to Barney, whether the resources are valuable, rare, inimitable and non-substitutional (typically referred to collectively as ‘VRIN attributes’).

Valuable resources are those that enable a company to conceive of or implement strategies that improve its efficiency and effectiveness (though what that entails is conveniently omitted). Rarity, as one might imagine, refers to the fact that a resource that is owned by a large number of competing (or potentially competing) firms cannot be a source for competitive advantage. Inimitability is required for competitive advantages to be sustained; if other firms can acquire the valuable and rare resources, any advantage created will only be temporary. Non-substitutability, lastly, means that the resources should not be possible to replace with other resources to the same effect.

Opposites attract

In other words, while the positioning school considers the industry as a unit for comparison, the RBV focuses on individual firms or resources within the firms.

Yet despite the two strategic movements appearing to be diametrically opposed, there are similarities. For one, their respective roots are found in neoclassical economic theory, which means that they share an assumption of rationality. There exists an accurate interpretation of facts, a correct way of doing things, a right answer to the question. This creates a structural analytical problem (‘laws upon laws’ – if the first is incorrect, all subsequent ones that build on it will be too) and a fundamental flaw in both lines of reasoning.

The suggestion that there would be an objectively best approach is demonstrably false in complex adaptive systems that lack linear material causality; there is no correct answer or ideal solution, only an endless stream of more or less coherent approaches given the relevant context.

In fairness to Barney, he does acknowledge this, albeit more or less in passing. The original piece notes that there is causal ambiguity in firms (a term coined to describe complexity by academics who did not understand what it entailed):

[C]asual ambiguity exists when the link between resources controlled by a firm and a firm’s sustained competitive advantage is not understood or understood only very imperfectly.

(A less kind soul than I might point out that this covers pretty much all of business analysis and management discourse. Far would it be it from me to ever make such an observation myself.)

When a firm with a competitive advantage does not understand the source of its competitive advantage any better than firms without this advantage, that competitive advantage may be sustained because it is not subject to imitation.

At first, it may seem unlikely that a firm with a sustained competitive advantage will not fully understand the source of that advantage. However, given the very complex relationship between firm resources and competitive advantage, such an incomplete understanding is not implausible. The resources controlled by a firm are very complex and interdependent. Often, they are implicit, taken for granted by managers, rather than being subject to explicit analysis.

Given the way in which Barney uses the word, it is clear that he does not fully grasp what complexity is – but the point nonetheless remains an important one. As we know, complex adaptive systems such as firms are not causal but dispositional, and inherently impossible to reduce. While the existence of complexity does not mean that everything is complex (a manufacturing process within a firm is ordered and predictable, for example), it does mean that despite columnist claim to the contrary, one cannot go ‘that company made it because of [insert single resource here] and so will you if you can obtain it too’.

If relationships between resources are complex and interconnected (they can be and typically are), the individual resource as a unit of analysis becomes useless and the overall argument undermined. Unfortunately, as Foss and Knudsen point out, the importance of these resource bundles and the way resources fit into a system is entirely overlooked in Barney’s work, which sees organizations as mechanistic with each resource an optimizable part. We know this to be untrue. In reality, the power of resources arises out of individual units as infrequently as inventions do from single minds.

A familiar foe

The RBV also suffers from – stop me if you have heard this one before – problems with terminology and logic. It bases its reasoning on competitive advantages (the issues with which we covered a couple of weeks ago) in a way that easily becomes circular. As Porter remarked in response to Barney’s piece, successful firms are deemed to be successful because they have unique resources, and they should nurture these resources to become successful.

Further, the definition of resource is by explicit design so broad as to cover everything and thereby anything. This means that one is faced with a chewing gum of an expression, easily stretched and manipulated to serve any particular purpose. Although one could argue, as Barney also does, that this allows for necessary contextual adaptation, it renders the exercise tautological. Resources cause competitive advantages, and anything that causes a competitive advantage is a resource.

Finally, on a more technical note, the RBV focuses almost entirely on economic rents. This means that it falls victim to what is called the factor price fallacy, to date best illustrated by Richard Rumelt:

Consider two pharmaceutical firms, each earning $100 million in profit. Both have the same market capitalization. Firm X’s profits are attributed to its portfolio of patents. Firm Y’s profits are attributable to its organizational acumen and managerial skills. According to standard neoclassical doctrine, firm X’s economic profits are zero because they are due to valuable factors (patents) which could be sold or rented instead of used in the business. That is, its profits are not profits but rents, which are “absorbed” by the factors which produce them. Firm Y, on the other hand, seems to have an economic profit because its valuable resources are not priced in factor markets.

Are we to actually define competitive advantage in a way such that firm Y has it and firm X does not? What if a wholly new market mechanism made firm Y’s skills marketable and priced; would that “hurt” the firm’s ability to compete or diminish its value? The problem here is not with the idea of advantage, but with the ideas of cost and profit! The truth is that neoclassical economic profit is a chimera; the only source of wealth in the economy is the ownership of valuable factors, whether priced or un-priced in factor markets. High rates of return are attributable to scarce intangible resources. Whether or not they are priced or tradeable does not affect the payment streams they garner. Owning a useful scarce resource is a good thing, and making the payments it receives even higher is a good thing. And it is an even better thing if the resource is priced and saleable.

Merits yet remain

Despite its glaring issues, I would still argue that study of the RBV has value as long as it is subsequently used as one of a number of approaches relevant to the particular corporate context. Although academic posturing is somewhat understandable (if wholly tiresome), the usefulness of binary schools of theoretical thought in practice is effectively zero. No pragmatic and intelligent strategist would ever look only at the external or the internal. They would, for reasons so obvious they need no further elaboration, look at both.

For example, applying the RBV can solve some of the common problems with SWOT analysis by forcing consideration as to whether any strengths possess inherent barriers to duplication by competitors. Companies that, say, rely on human capital – such as consultancy firms, investment advisors or advertising agencies – may find that their most valuable resources are individuals that can be lured away by competitors (something that we are also currently seeing en masse in the lazily denominated ‘war for talent’), a strategic risk that would need immediate attention.

Similarly, the RBV could help a strategist tasked with international expansion identify what firm resources are or could be enhanced by country resources (e.g., local government support for R&D activities through grants or beneficial legislation, or a particularly alluring capitalization climate), or identify potential companies to acquire for a comparable purpose.

Understanding the resources at an organization’s disposal is never a negative. Strategic insights are only really valuable if one has the requisite capacity to capitalize. Without also looking into the organization, there is no way of knowing whether one has.

This is, of course, nothing but common sense for any working strategists worth their salt. Both robustness and resilience hinge on understanding the corporate capabilities and resources in relation to the context in which the organization exists; the wider market, competition and general economy. A fact that will become evident next week when have a look at stacking vs integration.

Until then, I wish you the loveliest of weekends.

Onwards and upwards,
JP