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The resource-based view and economics.

Andy Lockett (a,*)

Steve Thompson (b)

Abstract

This paper analyzes the link between economics and the resource-based view (RBV) of the firm. Although, historically there has been a strong link between the disciplines of strategy and economics, explicit citations of key RBV works has been disappointingly low in mainstream economics journals. However, there are substantial bodies of works that build implicitly on the ideas of the RBV, in particular the consequences of path dependency on firm behavior, to explain a number of different economic issues. The issues we review in the paper are all influenced by path dependency and include: (1) diversification and market entry, (2) corporate refocusing, and market exit, (3) explaining innovative activity among firms, (4) diversification and performance and (5) industry evolution with rapidly changing products. Furthermore, we identify a number of reasons that may have limited the explicit use of the RBV in economics, which include the problems of causal ambiguity, tautology and firm heterogeneity. Finally, potenti al areas for future research are identified, which include the interaction of the RBV and Agency Theory, the RBV as a dynamic theory, using the RBV to explain radical change and the application of the RBV to issues of antitrust. [c] 2001 Elsevier Science Inc. All rights reserved.

1. Introduction

Contributors to the Journal of Management's 1991 symposium on the Resource-Based View of the firm (RBV) took the opportunity to evaluate a (then) newly emergent perspective on the firm. Wernerfelt (1984), Barney (1986a,b) and others had used the lens of strategy to examine the implications of path dependent firm development, suggested in the work of Penrose (1959), Richardson (1972), and Teece (1980). The resulting approach offered an explanation for interfirm differences in both realized performance and current opportunities in terms of the unique development of each firm's resource set. Moreover, in contrast to much previous literature in corporate strategy and industrial organization, it gave an explanation for performance differentials that was internal to the firm rather than being dependent upon product market structure.

The current Special Issue revisits the RBV a decade on, during which time it has experienced what Thomas Kuhn (1962) described as a period of "normal science." This is the period in which new theories have their hypotheses tested, their results replicated in other contexts and themselves are subject to qualification, modification or extension, as necessary. The retrospective vantage of the current Special Issue offers two additional opportunities. First, to assess the impact that the diffusion of the RBV has had upon the field of strategy and cognate business disciplines. And second, to evaluate recent theoretical and empirical contributions in these areas that inform our understanding of the RBV.

This paper explores the relationship between the RBV and economics. In particular, it is concerned with two central issues. First, what has been the influence of the RBV on economics, or at least on those parts of the subject that are concerned with firm and industry matters? And second, what can researchers in strategy learn about the RBV from economicsbased research into firm and industry matters? The paper concludes that while the explicit use of the RBV in economics has been strictly limited, in our view disappointingly so, the implicit application of the central ideas behind the RBV has become widespread. In particular, economists have increasingly come to recognize two related propositions. First, that interfirm variations in performance are at least as important as interindustry differences. And second, that any satisfactory explanation of this must acknowledge that each firm's development is path dependent: that is that today's opportunities depend upon yesterday's decisions. This caries the implicati on that even within a set of firms operating within the same industry there will be intrinsic differences in performance. The paper aims to show that the incorporation of path-dependency into economics-based research on firm behavior and performance is generating a rich literature that is relevant to researchers in strategy. This work, much of it using econometric analysis on firm level data, is helping to empirically validate the RBV.

We recognize at the outset that the paper's treatment of field boundaries between strategy and economics is necessarily compromised by both subjectivity and convenience. Any attempt at a clear delineation between cognate fields of study is necessarily difficult. This is particularly so in the case of strategy and economics. Not merely does strategy share with two of the principal fields of economics, industrial organization (IO) and financial economics, a central concern with the processes determining firm performance, but it draws heavily upon economic models of firm behavior. This is most obviously seen in the influence of the Structure-Conduct-Performance (SCP) paradigm, rooted in the work of Bain (1954, 1968) and most clearly articulated in the strategy context by Michael Porter (1980, 1985). Furthermore, the RBV itself is rooted in insights from economics, such as those of Penrose (1959), Richardson (1972), and Teece (1980), and has been developed by individual scholars, many of whom have made significan t contributions in the economics literature and in some cases continue to do so. Moreover, much of the empirical research using firm-level data, published in economics and strategy journals, exhibits a considerable overlap in methodology and research questions, not surprisingly since many researchers publish in both areas. (1)

Unfortunately, for our purposes, the areas of greatest overlap between strategy and economics tend to contain the material of most importance to this paper. Thus, while it is easy to distinguish strategy from totally orthogonal fields of economics, such as macroeconomics or social choice theory, the distinction between strategy and much modem IO and financial economics is less clear cut. Therefore, in reviewing what is termed here "the economics-based literature," this paper inclines to a more inclusive view and certainly includes some contributions published in strategy, international business and other management journals. This, as argued above, comes about through commonalties of subject, methodology and even research personnel and in no way should be taken to represent subject imperialism.

The structure of the paper is as follows. The next section examines the link between the RBV, strategy and economics, contrasting the RBV with the traditional SCP approach in IO, on the one hand, and transaction cost economics and agency theory from new institutional economics, on the other. It considers some of the implications for the economics of the firm that arise from an acknowledgment of path-dependency and associated firm heterogeneity. The following section explores the impact of incorporating path-dependency in recent empirical literature on firm behavior. It focuses on five areas of firm behavior where outcomes (which may be management decisions with respect to the boundaries of the firm or performance consequences of those decisions) have come to be recognized as dependent upon the firm's past accumulation of resources. The penultimate section considers some of the factors that may have limited the use of the RBV in economics. A brief conclusion is followed by a discussion of some possible areas f or future research.

2. The resource-based view, strategy, and economics

The resource-based approach views the firm as a historically determined collection of assets or resources which are tied semipermanently to the firm's management (Wernerfelt, 1984). Some users of the RBV distinguish fully appropriable resources, such as physical capital or brand names, from less tangible assets, such as organizational routines and capabilities. Similarly, distinctions may be drawn between static and dynamic resources. The former are those that, once in place, may be considered to represent a stock of assets to be utilized as appropriate over a finite life. Dynamic resources may reside in capabilities, for example, such as an organization's capacity for leaming, that generate additional opportunities over time. Here we follow Combs and Ketchen (1999) in noting that the crucial requirements of the RBV are that the relevant resources, whatever their nature, are specific to the firm and not capable of easy imitation by rivals (Barney, 1991). Therefore, such resources constitute the source of Rica rdian rents that comprise a firm's competitive advantage and, to the extent that their replication by others is problematic, imply a sustainable advantage over the longer term. Because each firm's resource bundle is unique, the consequence of its past managerial decisions and subsequent experience, it follows that so is each firm's opportunity set.

Thus, it appears that the RBV directly addresses issues that are of central interest to researchers in strategy and economics alike. Strategy, in the sense of Andrews (1971), may be considered as the process of determining, exploiting and developing the firm's opportunity set. Here the RBV would appear to offer direct insights. Economics is fundamentally concerned with the efficiency of resource allocation to productive users. This includes, or certainly should include, a consideration of the behavior of the firm, as the principal productive unit in capitalist economies, as well as comparative institutional assessments of alternative configurations of economic activity (e.g., vertical integration vs. out-sourcing, franchising vs. ownership etc.). Here we would contend that the RBV offers important insights into the delineation of appropriate boundaries of the firm and hence for firm performance and economic organization.

However, when we compare explicit interest in the RBV across the disciplines of strategy and economics there is a clear and obvious asymmetry. In strategy the RBV has been highly influential. Hoskisson, Hitt, Wan and Yiu (1999) point out that from the 1960s, until the late 1980s, the subject was dominated by consideration of external (i.e., product market) sources of competitive advantage. This reflected the influence of SOP work, in general, and the particular success of Michael Porter (1980, 1985) in synthesizing this in a strategy context. Hoskisson et al. (1999) suggests that the growing popularity of the RBV since the late 1980s has refocused attention on internal sources of competitive advantage.

In the economics journals, by contrast, explicit references to the RBV are scarce. A citation search, covering 165 economics journals, (2) revealed that only a very small proportion of cites of the leading RBV papers occurs in the economics literature. For example, in not one of the key papers by Wernerfelt (1984) [19/433], Barney (1991) [12/594], and Conner (1991) [6/116] did the proportion of citations in the economics literature rise above five percent. Restricting attention to the ten leading "core" influential economics journals, following Stigler et al. (1995), produces an even bleaker picture with a total of three citations.

However, a concentration on the lack of explicit attention given to the RBV in economics conceals the very considerable influence that has been achieved by many of the ideas that underpin it. The same contributions that informed the architects of the RBV, particularly those of Penrose (1959), Richardson (1972), and Teece (1980) who at the time of these publications would have been considered mainstream economists,3 have received much greater attention in the economics literature than the subsequent RBV papers. For example, a comparable search suggested that since 1981 approximately one third of citations for these occurred in the economics journals: namely Penrose [165/556], Richardson [55/151], and Teece [81/239]. These papers appear to have helped economists trained in the neoclassical tradition to accept the importance of path-dependency in firm evolution. The result is that over the last decade or so, a period corresponding to the diffusion of the RBV in strategy, there has been a very substantial output of applied economics research that has sought to explain firm decision-making and firm performance in a context in which history matters. Firm behavior is typically modeled as a consequence of existing firm-level attributes many of which, (e.g., size, diversification, vertical integration, market, technological experience, and so forth) may be considered as proxies for the firm specific assets discussed by proponents of the RBV.

This growing economic literature on the importance of path-dependency in firm development is reviewed below. That it has largely bypassed any explicit consideration of the RBV does not, in our opinion, invalidate the conclusion that its findings provide a systematic body of evidence that is both largely supportive of the predictions of the RBV and, as such, worthy of the interest of strategy scholars. That is not to say, of course, that many of the papers reviewed would not have benefited from insights drawn from the RBV. This point is developed below.

2.1. Why economists don't use the RBV, but should do so

It is a paradox that while firms take the proximate decisions affecting resource allocation in the economy, neoclassical economics, which is centrally concerned with allocative issues, finds the concept of the firm difficult to handle. Traditionally, neoclassical economics worked within a strict dichotomy; in the long-run all factors of production (i.e., all resources) are variable and hence there is no distinctive role for institutions such as firms. In the short-run, when at least one factor, usually capital, is fixed, the firm has a role but this is usually confined to making an optimal price/output decision with regard to prevailing factor and product prices. Thus, the neoclassical theory of the firm, at least in its textbook manifestations, usually turns out to be something of a misnomer for a theory of the short-run behavior of markets. While game theory has offered ever more sophistication in modeling interfirm rivalry, including rivalry in dimensions well beyond the price/output decision, most of this work achieves tractability by assuming identical firms and symmetrical behavior. Where firms are allowed to differ it is usually only in one well-recognized respect, frequently sunk costs (Schmalensee, 1992). Modern game theorists go closer towards embracing pathdependence than their predecessors, in that outcomes are generally modeled as the endproduct of a sequence of successive stages. However, the assumptions of perfect foresight and backward induction, necessary to solve the typical game, go a long way towards emptying the models described of empirical content.

Even within the field of 10 the firm, as a concept, has played traditionally a limited role. The Harvard School, after Bain (1954, 1968), has continued to view the industry as the appropriate unit of analysis. Indeed, even Porter (1980, 1985), whose syntheses of 10 insights have been so influential in the field of strategy, presents an analysis of competitive advantage which depends heavily upon impediments to competition at the industry, or more properly, the strategic group level. The opposing Chicago School certainly does take a more firm-centered view, holding that although monopoly power is possible, it is unlikely to be sustainable unless supported by regulatory intervention. Therefore, persistent performance differences are attributed to interfirm variations in efficiency (Demsetz, 1973). However, the Chicago School has not been particularly concerned to analyze these differences, perhaps because its central presumption of competitive factor markets (Reder, 1982) sits uneasily with models, such as the RBV, that depend upon resource immobility.

In contrast to the neoclassical tradition, new institutional economics is concerned to explain and evaluate the alternative ways in which economic activity is organized. This includes a concern to explain both the existence of firms in the light of their apparent irrelevance in the neoclassical system (e.g., Coase, 1937; Aichian & Demsetz, 1972; Williamson, 1975, 1985) and the advantages and disadvantages of extending the boundaries of existing firms. However, new institutional economics has developed as collection of partially overlapping schools, including evolutionary theory (Nelson & Winter, 1982), property rights theory (Furobotn & Pejovich, 1974), transaction cost economics (Williamson, 1975, 1985), and the positive theory of agency (Fama & Jensen, 1983). Detailed comparisons between several or all of these are available elsewhere (e.g., Conner, 1991; Mahoney & Panadian, 1992; Combs & Ketchen, 1999) and will not be replicated here. Each approach addresses a different aspect of firm organization. For exa mple, evolutionary theory, like the RBV, explores path dependent development of institutions, while the property rights approach has been successful in explaining some fundamental firm characteristics in terms of reconciliation of the competing interests of holders of different financial claims (see Hart, 1995).

However, the two branches of the new institutional economics most directly concerned with firm organization and hence, as Combs and Ketchen (1999) point out, most directly relevant to the RBV are transaction cost economics (TCE) and the positive theory of agency (PTA). Both approaches share the assumption of opportunism and each defines an efficient set of institutional arrangements as one that minimizes the sum of organizational and production costs. Organizational costs are those that stem, at least in part, from the consequences of opportunistic behavior and attempts to limit it. TCE, following Williamson (1975), is concerned with all the costs of search, metering and monitoring associated with the transfer of resources and products across markets and within organizations. However, asset specificity, with its implications of small numbers bargaining, codependence, and vulnerability to hold-up, has emerged as the most important impediment to contractual relations among opportunistic agents. The recent exten sive empirical literature, reviewed in Shelanski and Klein (1995), reports strong support for the role of transactions cost drivers in determining a wide variety of institutional outcomes.

The PTA identifies costs of monitoring and bonding as necessary evils in making viable economic relations between a self-interested, opportunistic agent and principal. It suggests that organizational evolution will favor the emergence of arrangements that minimize the sum of these incurred costs plus such deadweight costs as arise from potentially useful collaborative relations rendered nonviable by the agency problem (Fama & Jensen, 1983). It is distinguished from the more formal field of principal-agent theory that typically looks to derive an optimal contract, one that maximizes the principal's welfare while securing the agent's continuing participation.

Although both transactions cost minimization and agency cost minimization have strong methodological similarities, each has tended to be applied to somewhat different problems. TCE has been used extensively to explain the location of the appropriate boundaries for the firm. Thus decisions on vertical integration or the "make/buy" choice, the use of franchising or company outlets, the use of joint- versus wholly owned ventures and so forth, have been analyzed extensively in transactional terms. Because these are key strategic decisions of managers, much of this work has appeared within the strategy literature. By contrast, much work within the PTA framework concentrates upon the important agency relationship between stockholders and managers. It typically centers on the success of market and nonmarket governance arrangements in securing an alignment of interest between the two groups and has become a central concem of the financial economics literature.

An obvious issue for researchers in strategy and economics concerns the extent to which the RBV and theories derived from the new institutional economics, especially TCE and PTA, are complements and the extent to which they offer competing explanations for similar phenomena. In part, this depends upon the nature of the questions being asked. For example, if the firm's resource set is seen as given and implying a profitable opportunity for expansion into, say, widget manufacture (conditional upon obtaining access to the widget market), the analysis of TCE is probably appropriate to contrast the alternative ways of securing widget outlets. Similarly, if the firm's activities are given but its ownership and hence governance arrangements change, say as the result of an IPO, the PTA will generate useful hypotheses about its likely shift in performance. However, we would contend that there are occasions when it is desirable to combine insights from the RBV with those from TOE or PTA in analyzing choices faced by fi rms.

First, it is sometimes impossible to separate decisions over the use of resources from decisions over their governance arrangements (or mode). For example, assume that firm A, which possesses existing underutilized resources, is faced with a choice between related diversification into producing new flavors of doughnuts (that could be produced in-house) and unrelated diversification into widgets (a strategy that would require a joint venture with firm B). Instead of constructing a hierarchy of decisions in which the choice of output (determined by the RBV) is made before the choice of mode (determined by TOE), or vice versa, an overall optimum must be assessed.

Second, with the exception of those resources, such as patents and licenses, which are themselves protected by intellectual property rights and thus whose characteristics are in general well-specified, specific resources which are difficult to imitate are likely to be those whose transfer attracts high transactions costs. For example, first mover reputations, capabilities rooted in organizational routines and location advantages are commonplace examples of resources identified in the RBV literature as potential sources of comparative advantage. The same resources are likely to be problematic for would-be transactors trying to secure their more complete utilization by trading the excess across market boundaries.

It is likely, as Combs and Ketchen (1999) contend, that the relationship between the RBV and TOE and/or PTA is sometimes "conflictive," in the sense that resource considerations point managers towards one solution, say collaboration with another resource owner, while transactional efficiency considerations point to another. The issue of joint venture formation is a good example in that this governance arrangement represents an obvious means of accessing specific resources. However, joint ventures are recognized to be frequently shortlived, often because of opportunist behavior on the part of one or both parties to the venture. Nevertheless, it is a manager's responsibility to form an overall assessment of the situation, if necessary evaluating the costs and benefits of the envisaged co-operation.

3. he RBV in economics: Present but unrecognized?

In the previous section it was acknowledged that economics had been surprisingly silent on many aspects of firm behavior. This, it was suggested, was partly because it is difficult to accommodate firm heterogeneity within a strict neoclassical framework, and partly because much sophisticated modeling operates at a high level of abstraction and typically assumes identical firms for reasons of tractability. It was seen that while the new institutional economics, especially TCE and PTA, is concerned with the organization of activities within and across firms, researchers publishing on this area within the economics literature appeared to have been slow to make use of the RBV, certainly by comparison with strategy scholars.

However, the explicit neglect of the RBV only tells part of the story. Economics has experienced a considerable move from the equilibrium-dominated subject of 20 years ago. Now there is a widespread and growing acknowledgment of the importance of pathdependency. That is, current outcomes are seen to depend upon past decisions and are not to be viewed as unique long-run equilibria. This recognition that outcomes are path dependent (i.e., history matters) is now widespread, for example, in macroeconomics and labor economics, where previous labor market experience is seen to be a major determinant of current labor supply (see, e.g., Jenkinson, 1988). Similarly in trade theory, where "new economic geography" suggests that pecuniary externalities in the presence of increasing returns generate a competitive advantage for regions enjoying early access to some activity/technology, even where the initial reasons for such a location of such an activity/technology no longer apply (Krugman, 1991). In these, and other, fi elds it is acknowledged that random shocks and/or conscious decisions by important agents have the effect of shifting the trajectories of key variables.

It will be seen below that the economist's belated recognition of the importance of history has been particularly thoroughgoing in empirical IO. In part this is a consequence of the widespread rejection of interindustry analysis in favor of single industry studies since the 1980s (for an early advocacy of this approach see Schmalensee, 1988). Such work circumvents the problems of industry interheterogeneity but forces the researcher to confront interfirm differences. In part this may be ad hoc empiricism where the researcher, seeking to explain some facet of firm behavior, comes across important determinants rooted in the firm's past experience without necessarily having used much, or even any, theory in their search. In other cases where researchers have drawn upon some theoretical justification for the inclusion of variables capturing firm-specific experience, the cited sources tend to lie within the economics literature. This is most obviously seen (as noted above) in the use of contributions such as Penro se (1959), Richardson (1972), and Teece (1980). In other words, although the RBV is rarely directly cited as justification for path dependent modeling, empirical economists do draw upon some of the contributions that previously influenced those developing the RBV (i.e., they have a common heritage).

The next section presents a review of empirical evidence drawn from the economics literature, broadly defined, on the consequences of path-dependency for firm behavior. The studies covered embrace a wide range of industries and countries, explore different strategy and performance outcomes and involve models of widely differing sophistication. We would contend that collectively they provide strong support for the importance of path dependent firm development and thus for the RBV. It may be that some strategy academics will find this unsurprising. However, it is important in evaluating any theory to determine how far it yields predictions that are general, testable and helpful in identifying key characteristics necessary in analyzing future problems. This is especially so if the theory is to be defended from charges of tautology.

4. Path-dependency, firm behavior and performance: A review of the empirical evidence

It was noted above that a major implication of the RBV is that each firm's opportunity set is unique, a product of the resources acquired as a result of its past experience. Therefore, it follows that decisions about the appropriate boundaries of a firm's activities should reflect its existing resource bundle. If firms face a similar external environment, in the sense of similar product and factor markets, the RBV suggests that those firms with a similar initial resource endowment should display similar ceteris paribus patterns of behavior and performance. While it is clear that a full identification of the relevant resource bundle from the outside is unlikely, if the RBV is to have general explanatory power it should be possible to identify salient resources ex-ante and observe their subsequent impact on behavior and performance outcomes. This is precisely what a great deal of firm-level research in the economics literature is doing.

There are many aspects of firm behavior in which economic research has unearthed significant path-dependency. Here we ignore those that relate to short-term decision making, for example with respect to price or advertising decisions, and concentrate instead on five areas of behavior and performance outcome with obvious interest to academics in the field of strategy. Three of these relate to key strategic decisions over the boundaries of the firm. These are the literatures on (1) diversification and market entry; (2) corporate refocusing, and market exit, which explore the circumstances under which firms change their sets of existing activities; and on (3) explaining innovative activity among firms, that is, the situation whereby firms are able to exploit their dynamic capabilities to develop new activities to add to their existing sets. A fourth issue explored concerns the relationship between (4) diversification and performance, particularly the conjecture that related diversification should be more successf ul than unrelated diversification. Finally, the section reviews some of the very recent literature on (5) industry evolution with rapidly changing products. Here early mover advantages attaching to the initially successful firm (or firms) typically shape the evolution of the entire industry over what may be a relatively short product life cycle.

4.1. Patterns of diversification: New entry

Perhaps the most successful explicit and implicit application of the RBV in economics has been in the literature examining patterns of diversification via new market entry. Econometric studies by Lemelin (1982), MacDonald (1985), Montgomery and Hariharan (1991), and Ingham and Thompson (1995) have shown that diversification is not a purely random process, driven by idiosyncratic managerial decisions, but instead follows a pattern consistent with the exploitation of existing identifiable resources. Lemelin (1982) found that diversification tended to occur across industries using similar resources. MacDonald (1985) and Montgomery and Hariharan (1991) used U.S. firm level data to demonstrate a similar outcome. Ingham and Thompson (1995) used financial services deregulation in the U.K. as a "natural experiment" to show that diversification into previously prohibited, but nonetheless related, financial product markets followed the firms' resource endowments at the time of deregulation.

While the RBV has been used explicitly and implicitly in analyzing firms' diversifying expansions into new product markets, the firm's decision to expand its operation by producing its existing products in new regions or national markets involves directly analogous reasoning. Here the dominant internalization paradigm (see Caves, 1996, for a survey) used to explain the internationalization of business, suggests that firms choose to become multinational when the specific assets they possess are more economically transferred across international boundaries within the firm rather than by using markets. Internalization theory's focus is upon the role of comparative levels of transactions costs in determining the optimal form of expansion, and therefore, it might be considered as an application of TCE. However, because the transactions costs usually considered to drive this decision are those attaching to intangible assets and firm-specific attributes, where replication is also problematic, there is an obvious rel evance for the RBV. Nonspecific resources pose far fewer problems for market contracting but, conversely, because activities depending upon them alone can be easily replicated, offer little opportunity for sustaining a competitive advantage.

The evidence on foreign direct investment, at industry and firm levels, is generally consistent with the internalization perspective (see Caves, 1996). It points to concentrations of multinational activity in R&D-intensive industries (where proprietary technology is important) and advertising-intensive industries, where marketing and brand name issues are important. Of particular relevance to the RBV is the firm-level evidence (e.g., Grubaugh, 1987; Caves, 1996) that confirms the effect of proprietary assets and relative R&D and advertising outlays on the probability of a large firm having multinational operations.

An important element of the RBV is the assumption that those resources forming the basis of an existing firm's competitive advantage are rarely easy to identify from the outside (the causal ambiguity problem) and, if identified, are difficult to replicate. Firms seeking to extend their profitable activities typically require assets to complement their existing resource bundles and frequently need to obtain these from existing firms. Mergers and acquisitions, joint ventures and other collaborative associations have been analyzed quite extensively as alternative mechanisms for the acquisition of complementary assets for domestic and foreign expansions alike. In some instances, for example, in obtaining access to specific assets in countries with poorly developed capital markets or with restrictions on private and/or foreign ownership, the costs associated with acquisition may be prohibitive. In others, joint venturing with the desired party may turn out to be simply unattainable. However, a growing body of rese arch suggests that where a choice exists, joint venturing tends to be associated with a lack of specific expertise (of markets, technology, cultures etc.) on the part of the firm concerned. Thus, Singh and Kogut (1989) using foreign entrants to the U.S., Hennart and Reddy (1997) for Japanese entrants to the U.S., and Thompson (1999) using domestic and foreign expansions by diversifying U.K. utility companies, all report that having controlled for size, prior market experience encourages expansion by acquisition rather than joint venture. Such a result is supportive of the RBV in that it confirms that outsiders with incomplete resources need to secure specific resources via cooperation with the insider. The experienced entrant is able to purchase the relevant resources by acquiring a suitable company. Of course, this does not preclude joint venturing having other advantages. (4)

Single industry studies, whether at a national or international level, generally allow a more detailed specification of relevant resource variables than would be possible in interindustry work. Recent examples include case studies of the US TV receiver industry, by Klepper and Simons (2000), Internet service providers (ISPs), by Greenstein (2000), and the generic pharmaceutical industry by Scott Morton (1999). Klepper and Simons (2000) show that prior experience in radio technology was a major determinant of success among entrants to the rapidly expanding TV receiver market in the 1950s through 1970s period. Furthermore, the advantage conferred by radio experience continued to exert a statistically significant effect, even after 1965 when color TV began to dominate the market. Greenstein (2000) demonstrates that although entrants to the ISP sector have come to a completely new industry, their prior experience, commercial background, and local market characteristics determine their subsequent development and s pecialization. Scott Morton (1999) shows that among the set of generic pharmaceutical producers, prior technological, scientific, and marketing experiences determine which new product markets, created by compound discovery or patent lapse, individual firms choose to enter. Thus prior expertise with a particular class of compounds, delivery mechanism or disease treatment market will increase the probability of entry. Interestingly, she notes how different firm capabilities, the result of divergent experiences, assist the industry by preventing the simultaneous entry of large numbers of producers with inevitable widespread losses (Scott Morton, 1999, p. 436). This confirms the classic argument of Richardson (1972) on the importance of firm heterogeneity in the orderly diffusion of innovations.

4.2. Corporate refocusing: Market exit

Nowhere is the interplay between the RBV and the PTA seen so clearly as in the literature on corporate refocusing. It is reasonably well established (see Markides, 1995; Haynes, Thompson & Wright, forthcoming) that in the U.S.A. and U.K. there was a continuing increase in diversification among larger firms until the early 1980s. Thereafter, there has been a discernible trend towards corporate refocusing, defined here as the disposal of peripheral activities and the renewed concentration upon core businesses. This has frequently involved the divestment of unrelated activities acquired in the conglomerate merger boom of the 1960s and 1970s (Shleifer & Vishny, 1991). This trend reversal suggests a number of interesting questions for researchers. First, why did so many firms engage in apparently unsuccessful diversification, especially unrelated diversification, in the 1960s and 1970s? Second, what caused this policy to be reversed? And third, why did this reversal occur in the 1980s?

The answers offered by the RBV and PTA to these questions are, at least in part, both substitutes and complements. From the perspective of the RBV, there are at least two contending explanations for widespread overdiversification among large firms. First, a large number of managers, perhaps acting on incorrect suppositions of internal capital market superiority may have simply got it wrong. In the RBV, as in Austrian economics (see below), there appears to be no necessary presumption that managers always make correct decisions. Second, it is possible that previously optimally organized firms found themselves overdiversified because the comparative advantage of the M-form had declined. This has been alternatively attributed to capital market innovations and a reduction in transaction costs (Hoskisson & Turk, 1990) and a decline in scarcity rents to the resource of general management (Goold & Luchs, 1993). Because these changes coincided with the internationalization and deregulation of capital markets in the 1980s, the reversal of corporate diversification also dates from this time (Haynes et al., forthcoming).

By contrast, the PTA hypothesis attributes overdiversification to the diversion of free cash flow into preferred (sometimes negative NPV) investments by managers insulated from capital market discipline by weak corporate governance arrangements (Jensen, 1986). The widespread subsequent reversal of this process is again attributed to capital market changes, particularly the rise of hostile and debt-financed takeovers in the 1980s that tended to pressurize managers into a return towards value-maximizing behavior (Jensen, 1986, 1993).

A growing volume of empirical studies of corporate refocusing provides support for both strategy and governance hypotheses in explaining the phenomenon (Johnson, 1996). Markides (1992) found that refocusing firms were highly diversified and suffered from poor performance relative to their industry counterparts. He also found that the higher the R&D intensity of the core business the lower the likelihood that the firm would refocus. (5) Haynes et al. (forthcoming), using a panel of large U.K. firms, include strategic and governance variables in an analysis of divestment activity. They find that divestment, variously measured, increases with size, diversification and market share in the firm's core business, while falling with performance. However, they also report a significant positive coefficient for leverage, in line with Jensen's (1993) free cash flow reasoning, and tellingly, a large and highly significant increase in divestment in the year following the publication of a bid rumor. They find some support for strategy-governance interaction effects. For example, firms with "strong" governance regimes, defined in terms of management equity ownership and the existence of substantial "blockholders," experience a much larger sensitivity to poor performance. In contrast to Johnson (1996), who finds internal and external antecedents to corporate refocusing in the U.S., Haynes et al. (forthcoming) do not find a significant role for senior management changes.

While the RBV does not unambiguously support the superiority of related diversification over unrelated diversification (see Chaterjee and Wernerfelt, 1991), there is a presumption in much of the refocusing literature that divesting peripheral activities to concentrate upon those more closely related to one another should raise performance. This is reinforced by arguments, dating back at least to Penrose (1959), that suggest the costs of management rise with size and complexity and unless these are offset by comparable benefits, as promised, for example, by the M-form hypothesis, performance may be enhanced by decoupling. These conjectures have been supported by a number of studies of the effects of divestiture on corporate performance. Montgomery and Thomas (1988), John and Ofek (1995), and Hoskisson and Johnson (1992) all reported an improvement in ROA following corporate asset sales. Markides (1995) found a large and statistically significant increase in profitability following reductions in diversification , although his results also suggest that the gains were larger for the earlier cases of refocusing in his sample. Haynes, Thompson and Wright (forthcoming), in a dynamic panel study of firm profitability, report statistically significant positive shocks following divestment for up to four years after the event. This study also explores the effect of "complexity," measured as the interaction of size and the level of diversification, and reports that the benefits of divestment are substantially greater for "complex" firms.

4.3. Explaining innovative activity by firms

Econometric studies of firm performance (e.g., Geroski, Machin & Van Reenan, 1993) point to the significant role of innovation in raising corporate profitability. While there are obvious dangers of sample selection biases here, particularly where innovations are defined with reference to some success criteria, this does raise the question of why don't firms innovate until the returns from so doing are driven down to zero? The RBV supplies the answer that firm heterogeneity implies that innovation is a cheaper and/or more attractive option to some firms rather than others. That is some firms appear to possess a dynamic capability that gives them a comparative advantage in developing new processes or products.

Geroski et al. (1993) found that innovating firms outperformed noninnovating rivals even before these firms derived the very innovation that the researchers used in their classification, suggesting some firm-specific capabilities that drive both innovation and performance. Furthermore, some firms were associated with multiple innovations, while many others had no recognizable innovations to their credit. They interpreted these findings in the light of two possible roles for innovation. First, they suggested that each innovation would have a discrete, and perhaps temporary, impact on profitability, which they termed the "product effect." Second, they suggested that the experience of innovating would develop capabilities within the firm that should themselves assist further innovation and other nonroutine aspects of firm behavior. They and Geroski and Machin (1993) then used a large panel of UK manufacturing firms to compare the performance of innovating and noninnovating firm samples. This research suggested t hat innovators are not merely more profitable, but also that the performance of such firms is less vulnerable to cyclical factors. Less robustly, it also indicated that firms in the innovating category were better able to take advantage of spillover effects from their industries, perhaps indicating superior learning capabilities.

Geroski (1994), reflecting upon the above results, considers that innovation may trigger a form of virtuous circle in which, " ... the process of innovation transforms the internal resources of the firms themselves, altering their ability to react to various types of cost and demand shocks" (Geroski, 1994, p. 151). He concludes, "That the process of producing an innovation makes a firm more perceptive, flexible and adaptable (among other things enabling it to benefit more extensively from spillovers) is probably uncontroversial, but it is less clear. ... how big (such benefits) really are. Our calculations suggest these benefits are relatively large" (Geroski, 1994, p. 153).

The search for the internal determinants of innovative activity, apart from firm size, is in its infancy. Del Canto and Gibzales (1999) explicitly deploy a resource-based framework in their analysis of the R&D decisions of 100 large Spanish firms. While their results display considerable interindustry variation, human capital and prior exporting experience emerge as significant explanatory factors. Further support for the importance of path dependence in explaining R&D behavior comes in the findings of Patel and Pavit (1997), who report that large firms' search for innovations is heavily constrained by their existing principal product range. They note that industry and country factors, proxying the technological opportunity set, strongly influence the level of such activity. Mowery, Oxley and Silverman (1998) also use an RBV framework to demonstrate how firms' existing technological capabilities, measured by patent citations, help to predict the choice of partner in technology-driven strategic alliances. It a lso appears likely that dynamic capabilities, such as the capacity to innovate, are related to the firm's ability to learn, a characteristic that varies widely across individual firms even within the same industry (Jarmin, 1994).

The decision to invest in R&D, like other issues in strategy implementation, has a PTA or governance interpretation. In the latter framework groups of agents within the firm are unlikely to be indifferent between committing funds to R&D rather than, say, higher dividends. Some of the resource-based research on the determinants of R&D (e.g., Del Canto & Gonzales, 1999) includes controls for managerial financial autonomy. Similarly, the financial control system in operation may influence the nature of the firm's innovative activity. Hitt, Hoskisson, Johnson and Moesel (1996) found that governance characterized by strategic control was positively related to internal innovation of the firm and that financial control-based governance was negatively related to internal innovation by the firm. The same study found a positive relationship between the use of financial control-based governance and the adoption of external innovations. These findings supported earlier evidence that firms which employed strategic control s are more focused and give more emphasis to the long term-development of their core business (Goold & Campbell, 1987; Hoskisson, Hitt & Hill, 1991).

4.4. Diversification and performance

In an economics' textbook world of homogeneous goods markets, populated by symmetrically behaving firms, interindustry not interfirm variation in performance would merit examination. However, economists have come to recognize that, in reality, interfirm differences in profits tend both to dominate interindustry effects and to persist over time. Mueller (1997), for example, using a sample of 600 US corporations over a 20-year period, found that although there is some convergence between high and low profit subsamples, over time, this stopped well short of a return to the mean. The resulting persistent and substantial differences in profit could not be explained by any identifiable risk characteristics. McGahan (1999) has recently attempted to quantify the relative size of firm and industry effects on performance. She used an unbalanced panel of almost 5,000 U.S. corporations in 648 4-digit SIC industries over the period 1981 through 1994. She found both firm and industry fixed effects to be substantial, with t he former explaining somewhat over one third of performance variation and the latter accounting for somewhat under one third. In addition, she found substantial transient firm-level effects, such that the overall firm influence is approximately twice as great as that of the industry; although it is perhaps more volatile.

It is one thing to show that the variation in firm performance is consistent with the RBV but it is quite another to use the latter to predict the determinants of the former. Indeed, in general the theory's ability to generate predictions about specific firm performance is qualified by serious caveats: a major assumption of the RBV (see below) is that "causal ambiguity" prevents outsiders from easily determining (and hence replicating) the particular resources that generate any firm's competitive advantage. However, as discussed above, the RBV does suggest a rationale for diversifying expansion to exploit economies of scope arising from the accumulation of underutilized resources. Because economies of scope will tend to be greater for pairs of products that are related by technology or market characteristics, this does suggest that the performance effects of diversifying expansions will depend on the degree of "relatedness" between the firm's activities.

The measurement of "relatedness" is not straightforward, especially in large sample work. Two basic approaches are found in the literature. The first is to calculate a concentration measure, such as the entropy index, across the firm's revenues from different higher level SIC codes. The underlying logic is that activities within the same code will tend to display greater similarities of technology and markets than those in different codes. The alternative approach, following Wrigley (1970), Rumelt (1974), and so forth, has been to classify each firm's overall diversification status according to the proportions of its aggregate sales falling into "single product", "related product", and "unrelated product" categories. In either case the outside researcher is dependent upon the quality of segmental data available and the suitability of the industry typology employed for the purpose. (6)

Studies that have examined the link between diversification and stock market valuation, highlight the market's deep distrust of highly diversified firms. Research using market value based measures such as Tobin's q (Wernerfelt & Montgomery, 1988; Lang & Stultz, 1994) and industry multipliers (Berger & Ofek, 1995; Lins & Servaes, 1999; Graham, Lemmon & Wolf, 2000) confirms the existence of a "diversification discount." In the U.S. this consistently averages 13 to 15% of the firm's predicted value, using size-weighted averages from the industries in which the firm operates. This literature has usually taken its definition of a "diversified firm" to be one operating in two or more two-digit industries. Therefore, the "diversification discount" is essentially the market's assessment of an unrelated diversifier against a control of true single product firms and related diversifiers.

The "diversification discount" story is broadly corroborated by the many event studies that analyze the shareholder wealth effects of merger announcements. These studies, for example, Singh and Montgomery (1987), typically report a more favorable stock market reaction where the participants' activities are related in industry coverage than elsewhere and typically report an overall negative effect for conglomerate acquisitions. However, it must be allowed that the market's sentiment may be fickle. Hubbard and Palia (1999), for example, report no adverse market reaction to diversifying mergers during the conglomerate boom of the 1960s and 1970s.

Attempts to use measures of relatedness to explain the profitability of diversified firms have met with more mixed success. A number of cross sectional studies in the strategy literature have used Wrigley-Rumelt type categorizations of diversification as explanatory variables in profitability equations and generally concluded, with Rumelt (1974), that profitability does indeed decline at higher levels of diversification. (7) However, a minority report an inconclusive (Lubatkin, 1987) or even negative (Rajagopalan & Harrigan, 1986) performance-relatedness relationship. Given the cross sectional design and the difficulties associated with measuring relatedness, the ambiguities in this literature are unsurprising. The cross sectional approach is problematic if, as expected, there are important persistent fixed effects in firm profitability and where there are obvious correlations between the explanatory variables, especially with respect to size (see Johnson & Thomas, 1987), raising issues of the possible existe nce of reverse causality.

Recent research has sought to address these concerns. McGahan (2000), follows Wernerfelt and Montgomery (1988), in constructing a specific measure of focus or unrelatedness based upon the degree of overlap between the firm's activity segments using 1-, 2-, 3-, and 4-digit SIC codes. In the event she finds that focus explains rather little of the variation in performance. It accounts for merely a small transient portion of the variation in Tobin's q and has a small significant positive effect on profitability, but only for diversified firms.

Fan and Lang (2000) develop measures of relatedness and industry complementarity, using input-output tables to determine the technological association between industries, and then use these to analyze excess value across an unbalanced panel of 1000 US corporations between 1979 and 1997. They report that while the number of segments is unambiguously associated with lower value, vertical relatedness and industry complementarities are more complex in their effects. Vertical relatedness generally lowers firm value. Complementarity, despite its importance from the resource-based perspective, has merely a weakly significant overall effect and one that is substantial for the 1979 through 1982 subperiod alone. This appears to be because an interaction of complementarity and number of segments produces a consistent set of negative coefficients, suggesting that complementarity reduces value for the more highly diversified firms and increases it elsewhere.

Chaterjee and Wernerfelt (1991) have cautioned that the RBV does not unconditionally generate the hypothesis that related diversification is superior to unrelated diversification. They suggest that some resources may actually encourage unrelated diversification. For example, assume with Myers and Majluf (1984) that managers, motivated to maximize shareholder value, possess information on the prospects for unrelated projects that is difficult to communicate to the market. Given the external capital market's antipathy towards unrelated diversification, investing internally generated funds may be the only appropriate way to fund the projects. A firm possessed of suitable cash-generating activities or debt-raising capabilities could, in these circumstances, have an optimal strategy of unrelated diversification. Chaterjee and Wernerfelt argue, therefore, that while firms possessed of intangible assets and/or excess capacity among their physical assets will tend to benefit from related diversification, those enjoyi ng a surplus of internally generated funds and/or underutilized debt raising capacity may optimally follow a strategy of unrelated diversification. Of course, their argument requires that managers are able to identify profitable opportunities in unrelated directions and that these managers are motivated to maximize shareholder value and not, for example, by the desire to misappropriate free cash flow (Jensen, 1986).

4.5. Industry evolution with rapidly changing products

Traditionally, IO economists took the set of industries as given. Industry concentration was determined by (largely constant) cost and demand considerations with transient fluctuations in profitability, sales and so forth creating short-run opportunities/problems resulting in new entry/exit; see the models of Orr (1974) and Shapiro and Khemani (1987). More recent work has explicitly treated market structure as endogenous, determined by sunk costs associated with advertising and R&D expenditure (e.g., Sutton, 1998). However, in industries such as microelectronics and information technology, technological advances are now creating many entirely new products, often with short product life cycles. These markets typically possess the feature that industry structure depends upon the particular evolution of a small number (perhaps only one) of early movers in those markets. That is, firm level path-dependency also determines industry outcomes, with all that is implied for the subsequent competitive behavior within t he industry. Specifically, such products possess the following characteristics.

First, learning economies are substantial: semiconductors, for example, display such steep learning curves that prices typically halve in 18 months (Flamm, 1996). Second, there are typically network externalities such that the attraction of the product to consumers rises with the number of users. This is most obviously true for products such as the ATM, where any extension of the network expands consumer options for use. However, it also holds for more conventional private goods if success creates additional facilities. An example is provided by Varian and Shapiro (1999) who outline the process whereby the success of some computer games consoles encouraged other parties to develop new compatible games software so adding to the attraction of the established consoles. Third, consumers typically need to make complementary investments in learning or in ancillary products, such as compatible hardware and software, so that there are nontrivial switching costs associated with changing the basic microelectronics/IT p roduct. Finally, it may be possible to engineer second and subsequent generations of a successful product in such a way as to retain compatibility with the complementary investments by consumers.

Together these characteristics imply very substantial early mover advantages. Even in a high tech sector, technological superiority may be insufficient to challenge a dominant incumbent who enjoys significant learning economies and/or a large customer base. The result is that observed industry structure will reflect the particular pattern of successful entry into each new product market. It is not technologically determined, by the relationship of minimum efficient scale to demand, as in conventional textbook industries. Instead, it reflects the initial decisions of market participants.

In extreme cases, the early mover advantages (for one or more firms) are so pronounced that positive feedback creates a de facto industry standard. Bresnahan and Greenstein (1999) describe a number of such outcomes in the computer industry, including IBM's development first of the 360/370 series mainframe computers and then of the personal computer (PC). In some cases the developer maintains a proprietary interest in the standard (e.g., Microsoft's Windows operating system), in others the developer is able to allow rival producers to utilize the basic design, but still enjoys rents from its production of compatible products (e.g., as in the IBM PC).

Perhaps the best examples of the importance of path-dependence in the evolution of industry structure come in the resolution of standards wars (Varian & Shapiro, 1999). These confrontations arise where two or more competing technological solutions to the same problem are each embodied in rival products. Competition between the products is such that the one to secure sufficient first-mover advantages tends, in time, to completely eliminate its rival. Examples of rapidly resolved conflicts include the war between JVC's VHS and Sony's Betamax as the VCR standard in the 1980s and the rivalry between CPIM and Microsoft's DOS operating system after 1981. In some other cases :the losing standard is able to survive much longer, having been initially successful in securing a reasonably large installed base of customers who are then locked in by switching costs. Apple Macintosh and the PC emerged as rivals in the minicomputer market twenty years ago and the former remains in business despite the PC's subsequent dominance. As Sutton (1998) has observed, the specifics of the standards war make it impossible to apply more general explanations of the determinants of industry structure to markets so affected: "Each standards battle is likely to have individual aspects that exert a significant impact on outcomes, making any attempt to generalize across industries hopelessly difficult" (Sutton, 1998, p. 411). Sutton points out that the technology associated with the VHS versus Betamax battle was such that a relatively low level of concentration would be predicted, but the "virtuous circle" associated with network effects eliminated the l oser and led to a "monopoly outcome."

The emergence of industry standards associated with proprietary technology creates enormous complexity for antitrust analysis. However, the significance of the underlying policy issues and the commercial and technological importance of the industries concerned have forced economists to take seriously path dependence at the firm-level. The on-going Microsoft case provides a myriad of examples. The company's Windows operating system represents a platform, in the terminology of Bresnahan and Greenstein (1999), in that it provides a common base for a wide variety of software applications. Microsoft makes the basic product available to computer manufacturers at a price which is low compared to most software applications and certainly well below the monopoly price (see Schmalensee, 2000), although still above short-run marginal cost. It then makes rather more income from the sale of compatible applications. Included within the basic Windows package has been the company's Internet Explorer product, to the disadvanta ge of its principal Web browser rival Netscape Navigator. However, Microsoft's strategy is open to alternative interpretations. Is the company bundling products with complementary demands to exclude rivals? Or is it making optimal use of its resource base by developing related products whose convenience to users constitutes the source of massive Ricardian rents? Those inclining to the former explanation favor the breaking up of Microsoft into separate operating system and software application companies. However, from the perspective of the RBV (or the related Chicago IO tradition, see Davis & Murphy, 2000) any fragmentation of the firm's resource base that inhibits the development of further complementary products is potentially problematic. The issue of how the RBV may be able to better inform antitrust analysis is examined later in the paper.

5. Impediments to the economists' use of the REV

This paper has expressed the view that economists interested in firm behavior have much to learn from a consideration of the RBV and an application of its insights into their empirical work. It has been further suggested that although disappointingly little explicit use of the RBV occurs in the economics literature, certainly by comparison with the case in strategy, the implicit picture is very different. The previous section has attempted to demonstrate that the idea of the firm's strategic choices being path dependent, the product of the firm's prior individual historical experience, has permeated deeply in applied 10 and financial economics. This has had the result that much economics-related research on industry and, especially, firm behavior now incorporates variables to capture firm heterogeneity arising from the past acquisition of specific tangible and intangible resources. In turn, the results of this research constitute a powerful body of evidence, much of it offering support for the reasoning under pining the RBV, which should be of interest to strategy researchers.

In part, no doubt, the neglect of the RBV by economists stems from a reluctance to read beyond the journals in their field. However, there are some more fundamental issues relating to methodological difficulties associated with the RBV, which may be offered. Three inter-related difficulties have been identified. First, if rivals wishing to replicate a successful firm's activities face a fundamental problem in identifying the key specific assets (as the RBV contends, the so-called "causal ambiguity problem"), then a similar difficulty must be expected to confront the outside researcher, especially in the case of large sample work. The problem is compounded as the researcher confronts the less tangible forms of asset, especially those that are "systemic" to the firm's organization or management (see Miller & Shamsie, 1996). Second, empirical research using the RBV needs to be able to specify the relationship between outcomes and resources in a nontautological fashion, a task that is not always straightforward ( see Priem & Butler, 2001a, b; Barney, 2001). Third, path dependent firm evolution, in generating a heterogeneous resource base, simultaneously generates problems for the researcher interested in generating a homogeneous sample of firms for testing specific hypotheses.

Barney (1991) has emphasized that a major assumption of the RBV is that the link between resources and competitive advantage is opaque, particularly to those outside the firm. That is causal ambiguity hinders the outsider's ability to analyze the sources of a rival's success and thus easily replicate that success. Not simply is there a "degrees of freedom" problem, with firms differing in a sufficiently large number of respects to make the attribution of causality problematic, but the resources themselves may be difficult to conceptualize, let alone measure. The causal ambiguity problem is compounded where the more intangible assets are concerned. For example, where these involve capabilities that are inherent in the organization or culture of the firm (see Miller & Shamsie, 1996), there are obvious difficulties in obtaining unambiguous measures for quantitative work. More generally, the increasing emphasis on the importance of knowledge-based capabilities in the literature (see Conner & Prahalad, 1996) moves key resources away from straightforward quantification. Confronted with these problems, it is perhaps not surprising that many economists cling to the notion that the firm's inner workings are inherently opaque. This position still finds favor with some traditions in economics. The older IO approach did explicitly treat the firm's inner workings as a "black box," while even the Austrian school of economists, who do acknowledge the importance of interfirm differences, argue that the sources of firm success are largely unobservable and depend upon subjective entrepreneurial perception (Jacobson, 1992).

Priem and Butler (2001), extending the criticism of Bacharach (1989) argue that the RBV is fundamentally tautological in nature. They reduce it to the statement that only valuable and rare resources can be sources of competitive advantage. This proposition is true by definition and, therefore, not amenable to empirical testing. Barney (2001), in response, argues that all strategic management theories (which could include Porter's industry analysis and TCE) could be reduced to tautologies following the logic of Priem and Butler. (8) Refuting the charge of tautology requires the specification of testable hypotheses in which the relevant (i.e., rent-yielding) resources are independently identified. TCE provides a useful comparison here. It is potentially open to similar charges of tautology. Namely, TCE predicts that in a competitive environment those institutional arrangements that persist will be the ones that minimize the sum of production and transaction costs. Consequently, it is tautological to infer an ef ficient solution from survival. However, TCE has to a considerable extent avoided this criticism because of the success of empirical researchers in identifying major sources of transaction costs, especially where economic agents have to incur sunk costs in specific assets (see Shelanski & Klein, 1995). The specified sources of transaction costs are then used in framing refutable hypotheses about efficient institutional design. The RBV has perhaps not yet achieved comparable success in isolating the relevant resources for specifying general testable hypotheses about firm success. In principle this should be straightforward. In practice, causal ambiguity and firm-specific opportunity sets (see below) make it difficult.

Since the RBV holds that behavioral and performance differences arise because of historically determined differences in the firms' endowments, the formal testing of hypotheses presents a particular difficulty. The generation of a sample of suitable firms requires homogeneity in characteristics other than those whose influence is to be investigated. However, firms' opportunity sets diverge with their differing experience creating fundamental heterogeneity. It follows that research using large samples of firms will frequently need to exploit opportunities in environments in which firm diversity has been restricted, often by regulation. Thus, as seen in the previous section, the formal econometric testing of the RBV has proceeded further when some event, such as deregulation, patent life expiry and so forth, can be isolated that presents a common opportunity for large numbers of firms.

It may be that many of the insights of the RBV, particularly where less tangible resources are involved, can only be explored using a case study approach, something many economists have been reluctant to do. Employing a case study methodology involves trading off some of the generality obtainable from large-sample econometric work for a greater appreciation of the complexity of organizations. However, given the difficulties of identifying idiosyncratic resources among a set of heterogeneous firms it may be that this approach leads to greater understanding. Such an approach was formerly employed to good effect, for example, in the classic Penrose (1960) study of the Hercules Power Corporation. (9) Kay's (1997) recent study of corporate evolution offers a modern example. An acceptance of qualitative methods does not reduce the importance of the traditional positivist economic method, rather it should be considered to be complementary. Borenstein, Farrell and Jaffe (1998), for example, make an eloquent case for this, while Genesove and Mullin (2001) offers an excellent recent example. However, economists embarking upon case study work would do well to heed the warning of Siegel, Waldman and Link (1999) who point out that qualitative fieldwork should be conducted with respect to established methodological guidelines on best practice. (10)

6. Discussion and suggestions for further research

This paper has shown that there exists considerable interest among economists in exploring the consequences of historically determined firm circumstances in explaining firm behavior. In some of the applications covered this has been extremely successful. For example, studies of market entry, exit and survival, usually conducted on single industry data sets, have clearly demonstrated the importance of identified assets and expertise in successfully predicting outcomes. Such results would appear to be strongly supportive of the RBV and add weight to the views of those, such as Barney (2001), who have rejected the notion that the RBV is a mere tautology. In respect of other resources, especially the more intangible and/or knowledge-based ones, progress in the operationalization of the RBV has been more uneven. The paper has suggested that this is a consequence of the difficulty of the unambiguous identification of appropriate resources, the specification of testable hypotheses and the construction of suitable sa mples. Here it has been suggested that if economists want to probe the sources of differential firm performance more deeply, it may be necessary to sacrifice some of the generality of quantitative investigation for a more qualitative attention to detail. More generally, it may be necessary to recognize that a plurality of research methodologies is required to understand some aspects of firm behavior.

In some areas, recognition of the importance of path dependence is having a major impact on the way in which economists model firm and market behavior. It has been seen how markets in new technological products, particularly ones characterized by network externalities, learning economies and de facto industry standards become "winner-takes-most" races. In such industries conventional market structural analyses offer little value and hence little guide to, for example, antitrust analysis. Instead the industry exhibits Schumpeterian competition over a product life cycle which is typically too short to permit any countervailing tendencies to return it to a conventional neo-classical equilibrium.

The above discussion has highlighted a number of interesting issues to be addressed at the interface between the RBV and economics. First, is the potential link between the RBV and AT, both at a conceptual and empirical level. Second, the role Austrian economics may play in facilitating a dynamic interpretation of the RBV. Third, the need to think about how the RBV may be developed to examine the issue of radical change rather than just incremental change. Fourth, the ability of the RBV to better inform our understanding of issues of antitrust. These areas for future research are expanded upon below.

6.1. The resource-based view and new institutional economics

It has been noted above that there is still something of a tendency for the RBV and the branches of "new institutional economics," especially TCE and PTA, to be used in isolation from one another. For example, much research in financial economics still assumes away firm heterogeneity, except perhaps for industry membership, and concentrates upon the agency problem, while some strategy research ignores agency considerations as belonging to a lower level or strategy implementation dimension. This division is far from universal and it was seen above that the analysis of corporate refocusing issues has drawn liberally upon both traditions. However, one consequence of the bifurcation is the relative neglect of governance-RBV interactions. It was noted earlier that the internal governance devices adopted by the firm (the composition of its board, the control systems covering its divisional management etc.) do not merely have implications for the level of agency costs, but have implication for the optimal configurat ion of the firm's activities.

The firm's governance mechanisms (both internal and external) while primarily considered from a PTA perspective may, under certain circumstances, be considered as a relevant resource. For example, in the U.S.A. or U.K. these could include the skills of the nonexecutive directors and in Germany could include the firm's interlocking directorships with suppliers and customers and its banker relationships (Cable & Dirrheimer, 1983). Similarly, the firm's set of transactional arrangements with suppliers and customers is not simply a cost-minimizing device, in terms of TCE, but a resource that may yield competitive advantage." In general, this suggests that firms may need to secure an appropriate fit between the set of activities undertaken and the governance mechanisms and transactional arrangements in place. For example, external factors, such as the debt-equity funding mix and the extent of equity ownership concentration may influence the optimal mix of activities (Demsetz & Lehn, 1985). Similarly, internal fact ors, including the choice between strategic and financial control systems, may determine the appropriate extent of diversification.

6.2. The RBV as a dynamic theory

It is perhaps inevitable that the RBV, given its convenience as a tool for understanding observed competitive advantage, is widely (if implicitly) presented as a static theory. That is, the possession of some difficult-to-replicate firm-specific advantage allows the firm to sustain rents in the face of competition from less fortunate rivals. Some critics have argued that this characterization reflects the dominance of the traditional IO thinking, with its associated reliance on equilibrium, in strategy (Jacobson, 1992; McWilliams & Smart, 1995). They contend that the RBV is better understood as a dynamic or evolutionary theory, in which each firm's resource bundle is evolving along its own unique trajectory as a consequence of the firm's unique history. On such a view, thinking has been overly dominated by the static approach of IO theory. The result is that interest in the REV has encouraged a shift in focus from external to internal advantages, but led to little change in methods (McWilliams & Smart, 1995; McWilliams & Smart, 1993).

It is suspected that some potentially useful insighis into the REV may be obtained from a comparison with Austrian economics (Jacobson, 1992). Although there are considerable differences of thought within the Austrian school, Austrian economics may be broadly considered to view markets as being characterized by disequilibrium. Profit seeking is viewed as a quest of entrepreneurial discovery, but the sources of business success are generally unobservable (Jacobson, 1992). These points may be considered, briefly, in turn.

First, because the Austrian school believes that markets are constantly in disequilibrium, differences in firm performance are not necessarily associated with market power. Therefore, there is no need for the existence of limits to market competition to create a position of competitive advantage.

Second, in Austrian economics, as in the REV, firm success depends upon the identification and exploitation of opportunities. Indeed, the concept of entrepreneurial discovery, and thus the role of the entrepreneur, is central to Austrian economics (see Schumpeter, 1934, 1942; Mises, 1949; Kirzner, 1973, 1979; Hayek, 1945). A recognition of this point helps to build a link between the REV and entrepreneurship research (see Alvarez & Busenitz, this issue).

Third, and building on the importance of the entrepreneur, the Austrian school argues that the sources of business success are largely unobservable. This position is similar to Barney's (1991) notion of causal ambiguity but, to the Austrian school, it is rooted in the subjective nature of perception. It is also a central part of the Austrian school view that entrepreneurs can and do make mistakes. Thus, firm evolution does not necessarily follow an optimal trajectory.

6.3. Explaining radical change

A strength of the RBV lies in it being a form of theory of the firm in the medium-run, a time interval long enough to encompass strategic decisions over market entry and so forth, but sufficiently short that its opportunity set is determined by the resource bundle currently available to it. It is not clear, however, how long that is or, equivalently, how far management's strategic agenda should be considered constrained by the firm's current resource bundle. For example, consider a vertically integrated corporation that, like so many in the U.S., finds its upstream division relatively unprofitable. While the historical decision to integrate backwards no doubt continues to influence short-run decisions regarding supplies to the downstream division, the corporation will in time consider the option of divesting its upstream division. Indeed it may consider divesting itself of its entire manufacturing operations as others have done. The RBV needs to be able to reconcile its role in explaining incremental change a long a firm's existing trajectory, with the jump to a new trajectory associated with such a radical reconfiguration of the firm's assets as has been described.

It is possible to argue, with Castanias and Helfat (1991), that the management team itself is a specific asset and potential source of rents and its optimal utilization requires that the firm's spread of activities be kept under review. One such view of radical change would be appropriate if managers perceive more profitable opportunities for employing their own talents. In an alternative approach, Teece, Pissano and Shuen (1997) have coined the term dynamic capabilities to denote the firm's ability to update and improve the sources of its own competitive advantage. It has been seen above that empirical evidence does suggest that a firm's the abilities to learn, to innovate and so forth are themselves resources the firm has to generate. However, these dynamic capabilities, resting as they do on past experience, may turn out to be heavily path dependent and better able to explain incremental rather that radical change. It is suspected that there will usually be some more proximate cause for radical change to e nter the organization's agenda.

6.4. RBV and issues of antitrust

The link between the RBV and Austrian economics (see above) may hold important insights into the issue of antitrust. Traditionally the antitrust agenda, both in terms of research and public policy, has largely been dominated by the S-C-P approach of IO economics. This emphasizes the importance of market power and implicitly and explicitly focuses on profit margins as indicators of allocative efficiency and thus social welfare. However, this position is one that is being challenged by the efficiency paradigm (a term commonly associated with Austrian and Chicago economists--see McWilliams & Smart, 1993), who view market competition as a process that generates efficient industry performance (Singleton, 1986). This paradigm attributes the existence of sustained above normal returns to differences in the abilities of firms to satiate consumer demand (McWilliams & Smart, 1993) rather than to the presence of barriers to entry. While market processes operate and move resources in the direction of an equilibrium, this cannot be reached because of intrinsic market imperfections, including imperfect foresight, positive transaction costs (Alchian, 1950; McGee, 1988) and differences in firm level resources (McWilliams & Smart, 1993). This is akin to Kirzner's (1973) argument that although profits will move toward a normal level, those firms that posses more skill and/or luck in being able to deal with their environment will be able to earn above average profits (McWilliams & Smart, 1993).

Firms that have superior resources and/or are better able at deploying those resources, than others will be able to earn above average returns. However, in the presence of changes in demand and innovation, sustained above average returns do not necessarily indicate the presence of barriers to entry. The RBV makes a positive contribution to explaining why some firms are better able to earn persistently higher rates of profit than others. In particular, case-studies on markets that are characterized by high degrees of change may benefit greatly from insights from the RBV. This can be seen in the application of the issue of path dependency to the case of industries with rapidly changing products (see empirical section above).

The issue of path dependency is central to the RBV, but also holds important insights into the issue of market contestability. The theory of contestable markets, and in particular, the issue of ultrafree entry into markets (see Baumol, Panzar & Willig, 1982), has been very influential in the field of economics and public policy. Contestability theory holds that if a firm can freely enter a market, undercut price, sell its output while at least covering its costs and then exit the market before the incumbent firm(s) respond, then the incumbent firm(s) will price optimally. If this "hit-and-run" entry is feasible, it need not necessarily be observed. The threat of entry alone is sufficient to induce competitive pricing (Gilbert, 1989; Cairns, 1996). Contestability has received serious criticisms on the grounds of both the robustness of its predictions and the realism of its assumptions (e.g., see the critique of Shepherd, 1984). However, perhaps the most damaging evidence against contestability has come in empi rical work on the U.S. airline industry, the preferred example of Baumol et al. This work (see Baker & Pratt, 1989; Hurdle, Johson, Joskow, Werden & Williams, 1989) has repeatedly shown that incumbent firms typically possess advantages, in the form of experience, control of strategic resources, economies of scope in related activities and so forth, that would-be entrants lack. This asymmetry inevitably functions as a barrier to entry and thus a potential source of competitive advantage.

The RBV offers a framework for a general critique of contestability theory. The latter requires that entrants incur no sunk costs and thus implies symmetry between incumbents and potential entrants. Conversely, the RBV emphasizes the heterogeneity of existing firms that results from their particular experience. The factors that have been identified in empirical work as impediments to contestability (learning economies, economies of scope across related markets, possession of specific resources such as landing slots or reservation systems etc.) are precisely the results of the incumbent firms' path dependent development. Reversing the would-be entrant's disadvantage with respect to the incumbent(s) will typically require some sunk cost investment by the former party. That is, entrants' sunk costs appear likely to be ubiquitous in a world of path dependent heterogeneity. This has important implications for antitrust policy, especially in the case of the regulation of monopolies. Not least, because outcomes depe ndent upon the existence of a homogeneous set of actual and potential producers are unlikely to be realized.

In many ways the RBV offers a way of integrating many of the different economic perspectives that have been applied to antitrust. The RBV does not assert that markets are fundamentally efficient, and therefore, is not necessarily in conflict with the SCP view of market power. However, the RBV shares many commonalities with the efficiency paradigm, not least the conclusion that firms possess different opportunity sets and so manifest difference performance outcomes. Therefore, the RBV is an important approach in that it may be considered to be occupying some form of middle ground between SCP and efficiency theory. For example, if a company persistently earns above normal profit the SCP suggests some form of market power is present and there is a prima facie case for regulatory intervention or antitrust. The Chicago efficiency approach assumes that, in the absence of state-assisted barriers to trade, superior profitability denotes superior productive arrangements. The RBV, while not denying the possibility of m onopoly profits or returns to efficiency, suggests that observed above-normal returns may be the Ricardian rents (Peteraf, 1993) to currently held specific resources. The latter are a consequence of the firm's past experience and may reflect superior (or perhaps merely fortuitous) past decision-making. Therefore, while the RBV (like the Chicago approach) suggests that firms that consistently outperform their competitors should not be penalized for being successful per se, it also offers a potential mechanism for analyzing that success.

This paper has examined the diffusion of the RBV in the economics literature. We have shown that while elements of the theory have permeated much empirical work on firm behavior, explicit recognition has been more limited. In reflecting upon those aspects of firm behavior that remain imperfectly understood, it is important to remember that the RBV is still a relatively recent construct. The key papers that synthesized it date back no later than the mid-1980s. The rapid diffusion of the RBV is more recent still and owes no small debt to the Journal's 1991 Special Issue. In these circumstances, it is the more noteworthy how much the approach has contributed to our understanding and informed research design in the intervening period. Nevertheless, it is hoped that we have identified a number of potentially fruitful directions for research that combines elements of the RBV with concepts drawn from economics.

Acknowledgments

The authors are indebted to the editors, two anonymous referees of the Journal for numerous and detailed helpful suggestions, and to colleagues Alistair Bruce, Don Siegel, and especially Mike Wright, with whom the subject matter of this paper was discussed. The usual disclaimer applies.

Andy Lockett received his doctorate from Nottingham University in 2001 and is currently a lecturer in strategic management at Nottingham University Business School. His primary research interests straddle the areas of economics, strategy and entrepreneurship (including a focus on the economic and strategic implications of technological change, internationalization, and collaboration). He has published in management and economics journals including: OMEGA: The International Journal of Management Science, Small Business Economics, Journal of Technology Transfer, Journal of Strategic Marketing, Venture Capital, Journal of Marketing Management, and Research Policy.

Steve Thompson received his PhD in Organizational Economics from the University of Newcastle on Tyne, England, in 1982. He is currently Professor of Economics at the University of Leicester, England, and has previously taught in business schools or economics departments at Nottingham University and UMIST (England), Cork (Ireland) and Bentley College, Waltham, Massachusetts. Steve's current research interests center on mergers, divestiture, corporate governance, and the organization of activities within and between firms, including joint venturing, franchising and the resource-based view of the firm. He has published approximately 80 papers in economics and management journals that include: the Review of Economics and Statistics, Journal of Industrial Economics, Journal of Economic Behavior and Organization, Strategic Management Journal, Economic Journal and International Journal of Industrial Organization. He is a former European Editor of Managerial and Decision Economics.

(a.) Nottingham University Business School, Jubilee Campus, Wollaton Road, Nottingham, NG8 1BB, UK

(b.) Department of Economics, University of Leicester, Leicester, LEI 7RH, U.K.

Received 14 March 2001; received in revised form 31 August 2001; accepted 20 September 2001

(*.) Corresponding author. Tel.: +44 115 951 5268; fax: +44 115 846 6667. E-mail address: andy.lockett@nottingham.ac.uk (A. Lockett).

Notes

(1.) Citing names runs the risk of committing sins of omission, but the names of Richard Caves, Cynthia Montgomery, David Teece, Birger Wernerfelt, and Oliver Williamson have appeared with considerable regularity on the contents pages of both economics and strategy journals.

(2.) As listed by the Social Sciences Citation Index (SSCI).

(3.) Although each went on to do work in other areas and, in the case of Richardson, in enterprise management.

(4.) It can avoid some of the management/digestion problems associated with the acquisition of diversified firms (see Kay, 1997). An expanding firm entering a joint venture can target the resources it requires without having to acquire and subsequently dispose of (see Ravenscraft & Scherer, 1987) the unwanted remainder. Similarly, the lower level of sunk commitment associated with joint venturing may reduce risk by comparison with a full acquisition (see Balakrishna & Korza, 1993).

(5.) A result that suggests that diversification is beneficial in capturing the spillover effects of R&D.

(6.) Not least it depends upon the extent of intraindustry diversity. The SIC, like any other typology, exhibits varying degree of intracategory diversity. Even in biology, where there is a clear species definition, based on the inability of two separate species to interbreed and produce fertile offspring, there is considerable interspecies variation in the extent of intraspecies diversity.

(7.) See the comprehensive literature review in Chatterjee and Wernerfelt (1991).

(8.) Priem and Butler (2001b) argue that the RBV as coneptualized by Barney (1986, 1991) contains a theory of sustainability but not competitive advantage (i.e., value creation). Therefore, a challenge for RBV is to develop a theory that explains the creation of, and not just the sustainability, of value. Indeed, Barney (2001) himself highlights the importance of theories of creativity and the entrepreneurial process. The importance of the entrepreneurial process is central to Austrian economists and is discussed below.

(9.) Rouse and Daellenbach (1999) argue that Penrose's (1960) paper of the Hercules Power Corporation was prepared for inclusion in her book The Theory of the Growth of the Firm (1959) to illustrate her arguments. The omission was because of space limitations.

(10.) See, for example, the seminal works of Eisenhardt (1989), Yin (1989), Miles and Huberman (1994) on approaches to conducting qualitative research, and in particular, to building theory from such approaches. Rouse and Daellenbach (1999) outline an agenda for pursuing case-based methodology into the RBV.

(11.) There are, of course, numerous examples in the strategy literature of contractual arrangements as sources of competitive advantage: these include supply chain management, franchising, and so forth.

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