Competitive Advantage
         In the previous lecture, we considered how 
         Porter's “five forces” operate at the level of 
         an industry. In this lecture, we look within an 
         industry and consider how differences 
         among firms –  and potentially among their 
         customers – give rise to “competitive 
         advantage.”
                                                                            ©2009 by Marvin Lieberman
    Porter (1980) proposed that there are 
    two types of “competitive advantage”
     • Cost Advantage
     • Differentiation Advantage
   Experts in business strategy hold differing views about the exact 
   nature and sources of competitive advantage.  Most would agree, 
   however, that competitive advantage must be based on cost or 
   differentiation factors.
   Let’s start by considering cost advantage.
                    *Michael E. Porter (1980).  Competitive Strategy. Free Press, Boston.
  Example 3.1
        Assume that that F1 and F2 can produce an identical product at a cost of 50 cents per unit.  
        Neither firm has an output constraint, and there is no collusion.
                                        F1            F2              In this case of identical costs, 
                                        c=.5          c=.5            neither firm has an advantage.
                                                                      Each buyer can play off the two 
                                       B1             B2              sellers to bargain the price down 
                                       wtp=1          wtp=1           to cost, or just slightly above.
          There are two potential buyers. Each buyer can consume one unit, and they are 
          willing to pay up to $1.  
      • What will be the price of the “product”?                   P = 0.5  (“Bertrand” competition) 
      •
        How much economic value is created?                        V = 1  ( = 0.5 x 2 )
      •
        Who captures that value?                                   F1 and F2 get zero 
                                                                   B1 gets 0.5
                                                                   B2 gets 0.5 
                                                                                                           ©2009 by Marvin Lieberman
  Example 3.2
        Now, assume that that F1 can produce at a cost of zero per unit.  Neither firm has an 
        output constraint.
                                                                      In this case, F1 has a cost advantage.   
                                        F1            F2              If F1 charges just below $.50, it can 
                                        c= 0          c=.5            drive F2 out of the market. Buyers 
                                                                      may try to get a lower price, but if F2 
                                       B1             B2              knows that they are willing to pay 
                                                                      $.50 or more, F2 can capture the full 
                                       wtp=1          wtp=1           value of its cost advantage over F1.
          There are two potential buyers. Each buyer can consume one unit, and they are 
          willing to pay up to $1.  
      • What will be the price of the “product”?                   P = 0.5 - ε   (“Bertrand” competition) 
      •
        How much economic value is created?                        V = 2  
      •
        Who captures that value?                                   F1 gets 1
                                                                   F2 gets zero 
                                                                   B1 gets 0.5
                                                                   B2 gets 0.5 
                                                                                                           ©2009 by Marvin Lieberman
                   Limiting the industry to two firms and two customers may 
                   seem restrictive, so let’s add greater realism by increasing 
                   the number of buyers, and then the number of sellers. 
                   We’ll start by considering the case of two firms with 
                   identical costs, facing multiple potential buyers who differ 
                   in their willingness to pay.
                                                                                                           ©2009 by Marvin Lieberman