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COMPARATIVE ADVANTAGE, COMPETITIVE HETEROGENEITY

AND THE RESOURCE BASED VIEW

Short title: Comparative advantage, competitive heterogeneity and the RBV

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ABSTRACT

This paper is primarily concerned with inter-firm heterogeneity. By revisiting Ricardian economics and, in particular, introducing and applying the principles of comparative advantage to strategy inquiry, it advances current theoretical understanding of the phenomenon. Moreover, by introducing the notion of willingness-based isolating mechanisms, in contrast to ability-based ones, and integrating these with comparative and competitive advantage, the paper both complements the RBV as well as provides a more comprehensive understanding of heterogeneity and sustainable competitive advantage. Key word: comparative advantage, competitive heterogeneity, resource based view

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INTRODUCTION

Competitive advantage and comparative advantage are two important notions in

the economics and management literature. Generally speaking, scholars use comparative

advantage to depict the trade patterns between nations and competitive advantage to

depict a firm’s superior performance relative to its competitors. In recent years however,

scholars have blurred the application boundaries between these two phenomena. For

instance, Porter (1990) applied competitive advantage rationale at the national level to

enrich, extend and reformulate David Ricardo’s (1821) comparative advantage theory. In

going beyond the more static factor conditions (such as land) that provided the basis for

Ricardo’s landmark work, and by establishing a more dynamic ‘diamond’ model of a

nation’s competitive advantage---namely a nation’s demand conditions, firm rivalry

conditions, factor conditions, and supporting industries---Porter provides a more

comprehensive explanation of why some nations advance and prosper in certain

industries. Porter’s work has since stimulated much work on the competitive advantage

of industry clusters at the sub-national level (e.g., Storper, 1993; Maskell & Malmberg,

1999).

The application and logical extension of competitive advantage to the national

level leads to a relevant exploratory question: Can we likewise apply the notion of

comparative advantage at the firm level? And, if so, can we derive new implications for

strategy theory? In this paper, we show how comparative advantage can not only be

applied at the firm level but how it can also shed novel and constructive insights into

some fundamental issues in strategy, such as the determinants (sources) of heterogeneity

across competitors and the sustainability of competitive advantage.

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The issue of why firms differ and the durability of such differences has centrally

occupied much of strategy research in recent years, in particular the resource-based view

(RBV). In this paper, we propose that comparative advantage theory can help the RBV

integrate an important aspect of heterogeneity among rivals that it has not yet addressed.

At the RBV’s core, resource inimitability, due to the inability of rivals to replicate a focal

competitor’s rare and valuable resources, is central to explaining sustainable competitive

advantage. In contrast to such ability-based arguments, we use comparative advantage-

based logic to demonstrate the importance of a willingness-based rationale where, even if

able, rival or potentially rivalrous firms may choose to refrain from (i.e., be unwilling)

imitation because it does not make economic sense to do so. The essence of strategy

being the pursuit of rents (Rumelt, Schendel, & Teece, 1994), we demonstrate how

comparative advantage-based reasoning complements the RBV in its current form and

has significant implications for strategy theory.

Our paper is organized as follows. We first investigate what is comparative

advantage in the context of strategic management. In the process of doing so, we link

firms’ rent-earning capacity with their resource deployment and accumulation decisions

in a novel manner. Three scenarios are presented, dealing with use-based, user-based and

comparative advantage-based logic respectively. The last is more comprehensive in that it

combines both use- and user-based logic. Having established the theoretical basis of our

argument, we then relate it to ability and willingness-based isolating mechanisms and to

the sustainability of competitive advantage.

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THE COMPARATIVE ADVANTAGE OF FIRMS

The McGraw-Hill dictionary of modern economics (1983: 88) defines

comparative advantage1 as “the special ability of a country to provide one product or

service relatively more cheaply than other products or services. This concept is generally

used in international trade theory, although it also applies to cost comparisons among

firms in an industry and among individual workers”2. Unlike the notion of competitive

advantage, which, before Porter (1990), had been strictly applied at the firm level,

comparative advantage can be broadly applied at multiple levels of analysis (Ricardo,

1821). As noted by Paul Samuelson (1969), the Nobel laureate in economics,

“comparative advantage is the only proposition in the whole of social science to be both

true and non-trivial” (in Davies & Ellis, 2000: 1199). Indeed, in his original work,

Ricardo applied comparative advantage thinking at the level of firm (or individual

entrepreneur) and further wrote:

“Two men can both make shoes and hats, and one is superior to the other in both employments; but in making hats he can only exceed his competitor by one-fifth or 20 per cent; and in making shoes he can excel him by one-third or 33 per cent: will it not be in the interest of both that the superior man should employ himself exclusively in making shoes, and the inferior man in making hats” (Ricardo, 1821: 136).

However, to better examine firms’ comparative advantage, we should take one

step beyond the dictionary definition and put the notion into the context of strategic

management. In the strategy field, there is an increasing consensus at the broader level

that the search for economic rent is the primary driver of firm’s strategic actions (Rumelt,

et al, 1994; Peteraf & Barney, 2003). From the RBV, firms are accordingly viewed as 1 A detailed illustration of comparative advantage by using Ricardo’s original example is available in the appendix. 2 Note that there is an implicit ceteris paribus assumption in this definition that all these products or services can render a similar level of perceived consumer benefits. That is, the profit margin of a product or service is determined by costs. Otherwise, firms/nations do not need to provide the relative cheaper product or service but to pursue the ones that can promise the largest difference between perceived benefits and costs (i.e., value creation, Peteraf & Barney, 2003).

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collections of resources and evolving capabilities “that are managed dynamically for the

purpose of earning rent” (Williams 1994: 229). In line with the logic, firms deploy

strategies to serve the ends of creating, enhancing and attaining economic rents (Barney,

1991; Peteraf, 1993; Makadok, 2001; Peteraf & Barney, 2003), these having been defined

as “returns to a factor in excess of its opportunity costs” (Peteraf & Barney, 2003: 315).

The notion of opportunity costs underpins many important theoretical issues in

the management literature. As Coase (1973:108) claims, “opportunity cost would seem to

be the only one which is of use in the solution of business problems because of its focus

on the alternative courses of action which are open to the executive”. The alternative

courses of action, embedded in the concept of opportunity costs, acknowledge firms’

options and liberties in making strategic choices, with firms being economically

motivated to pursue that strategy and to choose that course of action among alternatives

that further enhances its search for rents.

Despite the importance of opportunity costs, researchers have not reached a

consensus on what it really entails. From a use-based logic, opportunity costs are treated

as the value (for a focal user) of a resource in its alternative best use (Coase 1973; Chiles

& McMackin 1996). Consider this to be use-based opportunity costs. As a corollary, rent

would be the excess in value of a resource in a particular use over its next best use.

Notably, this treatment is primarily focused on resource use but implicitly neglects the

role of competition in determining resource value and rent-earning capacity. In contrast,

in her influential article, Peteraf (1993), citing Klein, Crawford and Alchian (1978), made

a useful distinction between use- and user-based opportunity costs, with the latter being

treated as the value of a resource to its second-highest valuing potential user. As a

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corollary, rent would be the excess in value of a resource in a particular use over its value

in such use by its next best user3. We illustrate this is more detail in scenario 2 below.

The distinction is subtle but significant. In the first case, the next best use refers to

the application of the particular resource by the same firm to another use. In the second

case, it refers to the application of the particular resource by another firm for the same or

similar use. The key difference between these two approaches is that the former is about

what can be done better within a firm as it seeks to earn rents whereas the latter focuses

on who can do it better between two firms. In this latter sense, the marginally productive

resource refers to the resource held by the inferior user/producer. We illustrate the two

logics and the limitations of considering only one type in strategic analysis through the

following stylized scenarios.

Scenario 1: The use-based rationale: Consider, in line with the use-based

approach, that Firm A can employ its internal resources for making widgets and/or

gadgets. To simplify our illustration, let us assume that these two products have the same

level of perceived consumer value, say $40 per unit. If Firm A produces widgets more

efficiently than gadgets, say 4 units/hour versus 3 units/hour respectively (see Figure 1a

for a visual illustration), then it should choose to produce widgets rather than gadgets. In

other words, since Firm A’s use-based opportunity costs in producing widgets (i.e., the

costs of giving up the opportunity to produce gadgets at 3 unit/hour) are lower than the

opportunity costs of producing gadgets (i.e., the costs of giving up the opportunity to

produce widgets at 4 unit/hour), producing widgets is more efficient and makes more

economic sense for Firm A. Thus, from the use-based logic, the emphasis is on efficiency

3 Later, Peteraf and Barney (2003) define rent as a return above the opportunity cost of the marginally resources, the latter referring to the value generated by the resources held by the inferior producer/user.

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in resource utilization between two products, with Firm A potentially earning greater

rents by producing widgets than gadgets.

****Insert Figure 1a****

Scenario 2: The user-based rationale: In more recent work, RBV scholars such

as Peteraf and Barney (2003) have questioned the use-based argument of rent creation

above. They take inter-firm competition into consideration and re-examine opportunity

costs from a more user- and competitor-focused perspective. Therefore, even though Firm

A is better at producing widgets than gadgets, this need not be the most sensible strategy

in the pursuit of rents. What if its competitor is even better? In other words, can Firm A

still earn rents by producing widgets, given the existence of competition?

****Insert Figure 1b****

The answers to these questions can be illustrated with the assistance of the Value-

Price-Cost (VPC) model (See Figure 1b). Consider that Firm A has a competitor, Firm B,

which also has capabilities to produce widgets4 and is more efficient than Firm A, say 5

unit/hour.5 Assuming for the sake of simplicity that the operating costs for both firms are

$60/hour, then Firm A’s economic costs of producing one unit of widgets are $15 (i.e.,

$60 /4unit) and Firm B’s economic costs of producing one unit of widgets are $12 (i.e.,

$60/5unit). Moreover, for illustrative purposes, we arbitrarily set the price of widgets at

$20/unit.6

As mentioned above, in contrast to the use-based view where the focus was on the

4 In this particular context therefore, the VPC model can be considered as a thorough examination between two firms over the widget dimension in Figure 1a. 5 Here efficiency is defined broadly level in a manner consistent with Peteraf & Barney (2003:311) in that it is not just concerned with lowering costs, “but also with creating greater value or net benefits”. 6 In reality, we can consider that the price is set up by the least efficient producer capable of breaking even, given the

existence of multiple competitors.

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difference between two products or uses for a particular firm, the focus of the user-based

logic here is on the difference between two competitors or users for a particular product.

The difference between the value of a resource to a particular user over another becomes

a source of rent (Peteraf, 1993; Peteraf & Barney, 2003), such rent representing a return

to efficiency differences between two firms with respect to resources in a particular use.

Let us illustrate this by applying it to our context above. The value created by

Firm A and Firm B in using similar resources to produce the same product is $25 (i.e.,

$40-$15) and $28 (i.e., $40-$12) respectively. Therefore Firm A, as an inferior producer,

cannot attain rents in a competitive situation because any such rent would be competed

away (See figure 1b and, for a detailed discussion, see Peteraf & Barney, 2003). In the

case where economic rent dwindles down to 0, A could simply choose to rent its

resources to the superior producer, B, for $25. In line with the definition of opportunity

cost as value to next best user and rent as excess return over opportunity cost, Firm A’s

user-based opportunity cost for using that resource to make widgets is in effect higher at

$28 than the value that Firm A can create by making widgets ($25). Consequently, there

are no excess returns, i.e. rent = 0. For Firm B on the other hand, the user-based

opportunity cost of not making widgets would be $25 whereas it creates value of $28. In

our example therefore, the rent to Firm B, or returns in excess of opportunity cost (i.e.,

the value generated by Firm A, the inferior producer, from the resources it holds), would

at minimum be $3 ($28-25). Given the definition of competitive advantage, which is a

firm’s ability “to create relatively more economic value” (Peteraf & Barney, 2003: 314)

and “is an indicator of a firm’s potential to best its rivals in terms of rents…” (p.313), we

can therefore derive in the above scenario Firm B has competitive advantage over Firm A

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in producing widgets.

Both the approaches have contributed to the development of strategic

management theory, yet the lack of integration between them hinders a more

comprehensive understanding of the appropriate strategy for firms as they deploy and

accumulate resources in the search for rents. On the one hand, as already mentioned, the

use-based argument overlooks the role of competition. On the other hand, note that

although the user-based argument above highlights the competitive dimension in the rent-

earning process, it neglects the possibility for firms to take alternative courses of action,

i.e., what can be done better with the focal resource. By assuming “two single-business

firms competing in a production market, one of which has a competitive advantage over

the other” (Peteraf & Barney, 2003:315; italics added)7 and “(t)he use to which the

potential user may wish to put it may be exactly the same (as the focal firm)” (Peteraf,

1993: 184; italics added), the argument over-simplifies the competitive process. As

Lippman and Rumelt (2003) point out, without considering the alternative courses of

action, the single-product market model jeopardizes the operational meaning of

opportunity cost, in that the notion only has meaning when firms have multiple

approaches to create value through different resource allocation strategies.

To integrate the two perspectives therefore, we need to further inquire into the

following question: Suppose Firm B has the option of employing its internal resources in

another alternative, would it still be motivated to produce widgets in competing with

Firm A?

7 Note Peteraf and Barney (2003: 313) consider competitive advantage as a “fundamental type of competitive edge…an indicator of the firm’s potential to best its rivals in terms of rents, profitability, market share, and other outcomes of interest”. To keep our argument consistent with the RBV, we subscribe to this interpretation of competitive advantage in this paper. Moreover, this interpretation is also applied to the later discuss of comparative-based competitive advantage.

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Scenario 3: The comparative advantage rationale: Combining use and user-based

logic. The above question brings us to a two-firm two-product world8, where the notion

of firms’ comparative advantage can be naturally introduced. Following the above

discussion, consider that Firm B, just as Firm A in scenario 1, can also employ its internal

resources to produce gadgets, the next best use (See Figure 1c below). Also consider that

Firm B’s efficiency in producing gadgets is actually higher than producing widgets (say 6

units per hour for gadgets versus 5 units per hour for widgets). Then a problem that could

not happen in a single-product world emerges. As elaborated above, following the user-

based logic above, we can derive that Firm B can actually earn economic rents by

producing widgets, or at least has the potential to do so. However, from the resource-

efficiency sense, this goes against conventional use-based logic in that producing widgets

compromises the pursuit of economic rents by not allocating resources in the most

efficient (or optimal) way, since the value of the alternative use, i.e. producing gadgets, is

higher than the current value in producing widgets. 9 So, how does one resolve this

dilemma? Conceptually speaking, another way of asking the above questions is: how can

firms A and B find better strategies in their search for rents under this type of competition,

given their limited managerial and production resources?

****Insert Figure 1c****

To address this problem, let us examine the two-firm two-product world more

closely. We visually illustrate this scenario in Figure 1c by overlapping the production

8 Of course resources can be applied to multiple products and face multiple competitors. In our model however, we are concerned with the next best use and the next best competitor. 9 Certainly the above argument does not deny that firms can diversify and manage multiple competitive areas simultaneously. However, as Penrose (1945) pointed out, firms’ managerial services, as limited resources, can be only gradually released and become available in managing the diversification. Thus, given limited managerial service at any point in time, the key question is which direction of resource allocation and deployment a firm should pursue and focus on.

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possibility frontiers of the two firms. In this two-firm two-product world, every unit of

widget for Firm A is produced by giving up 3/4 unit of gadget, and conversely every unit

of gadget is produced by giving up 4/3 units of widget. Similarly, for Firm B, every unit

of widget is produced by giving up 6/5 units of gadget, and conversely every unit of

gadget is produced by giving up 5/6 unit of widget. From the point of view of Firm B, the

relative opportunity costs for widgets for Firm B is greater than for Firm A (i.e. 6/5 > 3/4),

and conversely is lower in the case of gadgets (5/6 < 4/3). Since, taking into account both

efficiency in resource use as well as competition, the costs of alternatives foregone for

Firm B relative to Firm A is greater in the case of widgets than gadgets, it therefore

makes more economic sense for Firm B to concentrate its resources on gadgets in order

to maximize rents, even though it may be superior to Firm A in both products. Moreover,

from Firm A’s perspective, although it is inferior to Firm B in an efficiency sense, since it

is relatively cheaper (between widgets and gadgets) for Firm A to produce widgets than

for Firm B, it still make more sense for Firm A to concentrate on making widgets.

Based on the dictionary definition provided earlier, Firm A has comparative

advantage in producing widgets and firm B has comparative advantage in producing

gadgets. We name this superiority (i.e., that Firm B has over Firm A in producing gadgets)

comparative-based advantage (CBA) to distinguish from the notion of competitive

advantage based on the one-product situation.

Some recent research attests to the above argument (Jacobides & Hitt, 2005;

Jacobides & Winter, 2005). Through studying mortgage banks, Jacobides and colleagues

found that mortgage banks tend to follow comparative advantage logic rather than simply

the use-based or user-based logic in determining their subsequent patterns of resource

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deployment decisions. More specifically, they found that if a mortgage bank has superior

productive capabilities in more than two parts of the value chain, say loan origination

(including credit analysis and underwriting) and loan servicing (including payment

collections), than its rivals, the mortgage bank will give priority to the development of

comparative advantage rather than equally developing the two absolute advantages

simultaneously.

From the above discussion of the three stylized scenarios, we can derive that there

are many differences between these three theoretical frameworks. Table 1 summarizes

some key differences between the use-based view, the user-based VPC model and the

comparative advantage-based reasoning.

***Insert Table 1 here***

The use-based view, as in the first scenario, is based on a one firm-two product

model; accordingly, it is more interested in the issue of what can be done better in a firm,

and focuses on how to enhance a firm’s internal efficiency with respect to resource

utilization. In contrast, the second scenario, as put forward by Peteraf and Barney (2003)

in their recent elaboration of the RBV, is based on the situation of two firms and one

product; accordingly, its interest is on the issue of who, among two firms, can produce the

product in a superior manner (more efficiently and effectively) and create more value.

In the third scenario above, the comparative advantage-based reasoning is based

on a two firm-two product model, one that better reflects the complexity and dynamics of

business competition; accordingly, it is interested in the issue of what can be done better

by who. It looks both within and across firms and thus incorporates use and user-driven

criteria in its calculus regarding production choices. Being more comprehensive in its

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approach, it recognizes that, in their search for rents, firms have alternative opportunities

for utilizing their specific resources and can and should make optimal choices among

these avenues, factoring in both internal efficiency and competitive pressures in

designing and implementing their rent-seeking strategy. The comparative advantage-

based reasoning goes one step beyond extant approaches. The resultant strategic choices,

based on both use- and user-driven compulsions, can affect a firm’s resource

accumulation and allocation process and thus ultimately cause more durable differences

across firms. Comparative advantage-based reasoning can therefore help and complement

the RBV in better explaining firms’ strategic choices and actions as well as the causes of

inter-firm heterogeneity.

In the next section, we further elaborate on how firms’ economic incentives in

rent seeking affect the direction of resource accumulation and allocation by introducing

some variations to our basic argument above. We also further show how comparative

advantage-based reasoning can help the RBV integrate an important aspect of competitor

heterogeneity that the latter has not yet addressed. In extending the concept of isolating

mechanism to go beyond the ability aspects and also include the willingness aspects, and

by additionally combining these with competitive and comparative advantage, we

integrate comparative advantage theory into the RBV to address the issue of inter-firm

heterogeneity across rivals more comprehensively. In the process, we also extend current

understanding of sustainable competitive advantage and distinguish which type of

advantage (comparative, competitive, or both) can lead to a truly sustainable competitive

advantage.

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COMPARATIVE ADVANTAGE-BASED THEORY, ISOLATING MECHANISMS AND COMPETITIVE HETEROGENEITY

The question of why firms differ can be partitioned into two different

components. First, why are firms unable to imitate one another? Second, and equally

important, even if able, why would rival or potentially rivalrous firms choose to refrain

(i.e. be unwilling) from imitation?

The RBV has largely focused on first part of the question. Traditionally, three

general isolating mechanisms have been identified to prevent the imitation of resources:

property rights, learning and development costs, and causal ambiguity (Rumelt, 1984).

Note that all three types focus on the fact that competitors lack the ability to imitate, and

can be considered as ability-based isolating mechanisms (AIM). This ability-based

explanation works well in a single-dimensional VPC model, where firms either can or

cannot compete with each other at a certain efficiency level. However, when extending

the VPC model to a two-firm two-product model of comparative advantage, we can

integrate a firm’s strategic choices into consideration. This steps beyond and extends the

question of “can or cannot” to the examination of “will or will not” a firm imitate its

competitor given its other strategic choices. Therefore, differing from the standard RBV

interpretation of firm heterogeneity, comparative advantage theory suggests that the

reason firms differ can be due to their different (economic) incentives to imitate one

another, in our particular case economic incentives rooted in comparative advantage

logic. This can be considered what one may term as a willingness-based isolating

mechanism (WIM) 10 . The emphasis shifts from mere ability towards the economic

motivations that underlie firm’s choices in its resource deployment decisions.

10 There are other logics that can also account for such willingness-based isolating mechanisms. For instance, applying

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The innovative explanation proffered by comparative advantage-based reasoning

can complement and extend extant understanding of isolating mechanisms in explaining

the existence and persistence of firm heterogeneity. The effects will be particularly

noticeable in situations where the ability-based isolating mechanisms do not function

notably as the major factor in causing firm heterogeneity. As Hoopes, Madsen and

Walker (2003: 891) point out in their discussion of competitive heterogeneity, “if

resources or capabilities associated with sustained performance heterogeneity are not

protectable, then its persistence must be due to something other than costly imitation”.

Carroll (1993) poses a similar question regarding the persistence of heterogeneity once

the strategic and organizational recipes for success become known. Supporting this line

of thought, Knott (2003) found in her study that close but able rivals did not copy

superior but imitable franchise routines that they recognized as important. She therefore

questioned whether the RBV has been overly and too narrowly concerned with resource

imitability, since there may be other factors reducing the incentive of rivals to imitate

even though they could (also see Jacobides and Hitt 2005). Similarly, in a recent

exchange, Barney (2006) notes that two reasons can account for inter-firm heterogeneity

in the current computer industry: one is that rivals like HP can not easily imitate what

Dell is doing; the other is what Dell’s rivals choose not to do because, given alternatives,

it does not make economic sense to do so. According to Barney, although the first reason

has received the most attention from the existing RBV scholars, the second reason is

more likely to be the determining one.

an institutional theory perspective, Oliver (1997) argued that firms would be unwilling to imitate a rival due to various internal and external institutional constraints. In contrast, we focus more strictly on underlying economic considerations.

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Clearly, both types of isolating mechanisms are important in competition between

firms. To better illustrate how the traditional RBV and the comparative advantage

reasoning, and correspondingly AIM and WIM, work together, we resort to the use of a

two-by-two table with corresponding figures to each cell. For clarity, we focus our

discussion (in Table 2) solely on the situation where Firm A produces widgets. Also,

every cell in Table 2 corresponds to the situation under the same number in Figure 2. For

instance, cell 1 represents that of Figure 2, situation 1; cell 2 represents Figure 2, situation

2; and so on.

****Insert Table 2****

****Insert Figure 2****

In the case of cell 1 situation 1, Firm A has neither comparative nor competitive

advantage in producing widgets. Thus, it cannot be protected by AIM or WIM in

producing widgets. In other words, if Firm A chooses to produce widgets in this situation,

Firm B is both able and willing to imitate Firm A.

Now take the case (cell 2; Figure 2, situation 2) where only AIM exists and WIM

does not exist, i.e., Firm A has competitive but no comparative advantage in producing

widgets. Traditionally, AIM is considered as a necessary and sufficient condition for the

existence of sustainable competitive advantage. However, when only AIM exists but

WIM does not, competitors lack the capability to imitate in the short-to-medium run but

not the motivation. This is a situation where the focal firm has would-be and motivated

imitators, who attempt to do so. Ultimately, these imitators will catch up with the focal

firm and the focal firm loses its competitive advantage.

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We may find of course that with time and environmental change, the competitive

relationship between Firm A and Firm B in producing widgets may evolve from case 2 to

case 1. For instance, a unique patent holder (being protected by an AIM) can sustain its

competitive advantage due to the legal protection, which prevents potential competitors

from imitating. However, note that this type of competitive advantage is restrained by

calendar time, geographic scope, and institutional or technological changes. More

important to our argument, as evident from the short period within which most patents

are circumvented (Levin, Klevorick, Nelson, & Winter, 1987), sheer concerted effort by a

motivated imitator results in the cultivation of the desired capabilities over time. It

implies that with the protection of AIM, firms can only achieve temporary competitive

advantage, which could be competed away by would-be and well-motivated competitors.

In the third case, only WIM exists and AIM does not exist, i.e., Firm A has

comparative but no competitive advantage in producing widgets (cell 3; Figure 2

situation 3). Here, suppose that Firm A specializes in the comparative advantageous

product (i.e., widgets). Even though, as a result of competitive advantage, Firm B has the

ability and knowledge to produce widgets, given the limited managerial resources, it may

not be economically motivated or willing to do so. That is, even though AIM does not

exist and hence can not prevent Firm B from imitating Firm A, WIM can still protect

Firm A, since Firm B can achieve higher rents by pursuing comparative advantage-based

rents, which in this scenario is gadgets. Unless distorted by other factors (e.g. to spread

investment risks, strategic positioning, etc) or with the increase of managerial services,

Firm B may not launch an attack. To put it differently, if only WIM exists, the focal

firm’s competitors have the ability to attack it but choose not to do so since this would

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not be an optimal allocation of resources. Note however that under this market situation

the lack of imitation is not a strategic failure of Firm B; rather it is a ‘natural’ side effect

of Firm B pursuing a rent-seeking strategy in its production choices. Thus, in this

scenario, we can say that Firm A may enjoy a temporary competitive advantage in

producing widgets until Firm B chooses to attack for whatever reason.

In the final case, both AIM and WIM exist, i.e., Firm A has both comparative and

competitive advantage in making widgets (cell 4; Figure 2 situation 4). Only when both

WIM and AIM work together can a competitive advantage be sustained for a long term.

In this scenario, rivals not only have little incentive to imitate but also are limited in their

abilities to do so. This ‘double protection’ results in a truly sustainable competitive

advantage.

CONCLUSION

Our paper integrates the two kinds of isolating mechanisms and two types of

advantages to provide a more holistic view of competitive heterogeneity. This is notable

since, as Peteraf and Barney state, “so fundamental is the condition of heterogeneity, that

it is the sine qua non of this theory” (2003: 311; italics in original). We believe that

comparative advantage-based reasoning will help consummate the RBV toward a more

complete resource-based theory. In a sense, AIM and WIM are complementary to one

another in directing firms’ resource allocation and deployment decisions. That is, they co-

determine the competitive heterogeneity phenomena in an industry. Notably also, a shift

in frame from the ability to imitate to the incentive to do so implies that, besides the

characteristic of resources in and of themselves, isolating mechanisms may also lie within

the domain of management and managerial choice.

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In conclusion, by complementing and extending the RBV, this paper contributes

to the theory building of heterogeneity among rivals from a resources and capabilities

perspective. As Rumelt et al. (1994) propose, a comprehensive understanding of inter-

firm heterogeneity requires different streams of theories. By introducing comparative

advantage theory into strategy study, our paper extends current understanding of

competitive advantage and isolating mechanisms in a distinctive manner and further

sheds light on the phenomenon of inter-firm heterogeneity. The matter is important since

competitive advantage, especially when sustainable, potentially culminates in

performance differences across rival firms. The implication for firms is that they should

also analyze comparative opportunity costs in deciding which strategies and activities to

pursue to enhance rents. A potential avenue for research is to uncover other sources of

willingness-based isolating mechanisms, which in turn would further enhance our

understanding of inter-firm heterogeneity across firms.

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24

Table 1. Summary of the three perspectives

The use-based view The user-based (VPC) model

The comparative advantage-based view

Basic model One firm two products

Two firms one product

Two firms two products

Key approach towards opportunity costs

Use-based User-based Both

Key area of focus Internal efficiency; Within a firm

Efficiency relative to competition; Between two firms

Both; Within and between firms

Visual illustration Figure 1 a Figure 1b Figure 1 c Key question What can be done

better in a firm Who can do it better What can be done

better by whom Key argument on inter-firm heterogeneity

Not applicable Ability to imitate Willingness to

imitate

25

Table 2.

No AIM AIM exists

No WIM 1

A has no advantage in x (neither comparative nor competitive advantage)

2 A has a temporary competitive advantage in x

(competitive but no comparative-based advantage)

WIM exists 3

A has a temporary advantage in x (comparative but not competitive advantage)

4 A has a sustainable competitive advantage in x

(comparative-based advantage)

26

Table 3.

England Portugal

1 Unit of Cloth 0.833 Unit of Wine 1.125 Unit of Wine

1 Unit of Wine

1.2 Unit of Cloth 0. 88 Unit of Cloth

27

APPENDIX

First, Let us look at Portugal. If with 80 men, Portugal can produce 1 unit of wine in a

year. However, with the same number of men, Portugal can produce only 80/90 (0.88)

unit of cloth in a year. If Portugal chooses to produce 1 unit of wine, she is giving up the

opportunity to produce 0.88 unit of cloth. On the other hand, if Portugal chooses to

produce 1 unit of cloth, she is giving up 1/.88 (1.125) units of wine.

Now, let us look at England. If with 120 men, England can produce 1.2 units of cloth

in a year. However, with the same number of men, England can produce only 1 unit of

wine in a year. If England chooses to produce 1 unit of wine, she is giving up the

opportunity to produce 1.2 units of cloth. On the other hand, if England chooses to

produce 1 unit of cloth, she is giving up 1/1.2 (0.833) unit of wine.

As shown in Table 3, we can see that the opportunity cost of producing one unit of

cloth is lower for England (0.8333) than for Portugal (1.125). On the other hand, the

opportunity cost of producing one unit of wine for Portugal (0.88) is lower than for

England (1.2). Therefore, Portugal has comparative advantage in producing wine; while

even though England does not have any absolute advantage in producing either cloth or

wine, but she has comparative advantage in producing cloth.