POST-CONFERENCE PUBLICATION The Sustainability of Exploitation Positions Towards an Integration of New Institutional Economics, Resource Based View and Austrian Economics

The aim of both marketing theorists and resource-based view proponents is to explain the creation and the sustainability of competitive advantages.1 What has not been considered so far is the role of exploitation positions within the competitive game. The purpose of this article is to investigate the consequences of a strategy concerning the active creation of exploitation positions on the side of the customers. The reason for this is the observed tendency in several industries – elevators, paper machines, gas turbines – to actively create such positions. The underlying assumption is that this strategy leads to a competitive advantage for the initial transaction as well as to higher profits for the supplier taking into account the entire relationship. Mainly the second advantage of a higher profit depends heavily on the sustainability of an exploitation position. Therefore, this paper identifies the drivers controlling the sustainability of an exploitation position. In order to derive a broad understanding three different theoretical approaches – Transaction Cost Economics, the Resource-Based View, and Market Process Theory (Austrian Economics) – will be used to explain the effects of exploitation on the competitive position and the profit of the supplier. Finally, the outcome of this paper is threefold : First, the competitive consequences of an exploitation strategy will be identified. Second, the impact of each theoretical approach on the question of exploitation will be analyzed. Third, the integrative potential of the three different theoretical approaches will be examined. More precisely, we discuss institutional economics and information asymmetry in a truly dynamic setting and the impact of radical ignorance and alertness on the idea of isolating mechanisms. This will be done in a parallel discussion of the problems in general and along one case study which focuses on the elevator market. * Dr. Mario Rese, Professor of Business Administration, in particular Marketing, University of Paderborn, Germany, 33098 Paderborn, Warburger Str. 100, Tel.: ++49/5251/60-3386, Fax: ++49/5251/60-3520, [email protected], http://fb5.upb.de/marketing ** Dipl-Kffr. Birgit Engel, Research Assistant, Institute for Industrial Marketing Management, Humboldt-University Berlin, Germany, 10178 Berlin, Spandauer Str. 1, Tel.: ++49/30/2093-5883, Fax: ++49/30/2093-5775, [email protected], http://www.wiwi.hu-berlin.de 1 Cf. Srivastava et al. (2001), p. 777. Rese/Engel, Sustainability of Exploitation Positions 2 Understanding the sources of a competitive advantage is discussed broadly in marketing theory literature as well as in resource-based view literature since Porter published the book “Competitive advantage”2 in 1985. Although the definition of a competitive advantage often differs and is not compatible marketing theorists point out that a competitive advantage is gained by offering greater value to the customers either through lower costs (and prices) or by providing more benefits that justify higher prices.3 On the other hand, across resource-based view domains there is a common emphasis on leveraging resources to create value for the organization’s stakeholders and in particular for the customers.4 Also, the sustainability of a competitive advantage is emphasized. A competitive advantage is sustained if it continues to exist after efforts to duplicate it have ceased.5 One possibility to gain an edge over competitors is the creation of exploitation positions. The case of the elevator industry serves to illustrate the importance of exploitation. In Germany, the four main suppliers of the installation and maintenance of elevators own one half of the entire business. Recently, lift prices declined dramatically due to suppliers themselves. Often lifts are even sold below the supplier’s full cost. One reason for this investment is the supplier’s hope to profit from the maintenance of lifts. In order to ensure overall profit from the relationship and therefore compensation for the loss made with the pure installation of the lift suppliers have found a way to tie-in the customer. Each lift is constructed in such a way that only the suppliers themselves are able to provide maintenance. After the lift is installed inside the customer’s building the supplier offers to maintain the lift at a price with whom he/she can obtain profit margins above average in comparison to the maintenance market. Thus, the supplier creates a hold-up position. This development can also be observed in other industries such as power plants, paper machines, pallet transporters and medical appliances. The suppliers of these products try to compensate self-created, previous losses with the follow-up service business. Exploitation positions particularly the implications for the supplier’s marketing concept are one focus of marketing theory concerning business relationships. Firms establish relationships to create a competitive advantage for a sequence of transactions over time. Instead of focusing on a single 2 Porter (1985). 3 Cf. Plinke (2000), p. 74-91. 4 Cf. Srivastava et al. (2001), p. 777-778. 5 Cf. Rumelt (1997[1984]), p. 141. Rese/Engel, Sustainability of Exploitation Positions 3 transaction, the supplier extends the scope of his/her competitive advantage. The aim of the supplier is to transfer the competitive advantage he/she obtained in one market into another. This phenomenon explains our interest in exploitation positions. Till this day marketing literature has focused on transaction cost theory and the explanation of the existence of exploitation positions through asymmetric specific investments. Therefore, the starting point of our analysis will be the transaction cost theory (chapter “Static analysis of exploitation positions”). Since transaction cost theory analyzes a single transaction or a sequence of transactions in the dyad statically, the impact of the out-supplier as well as changes in the general conditions are neglected. An analysis based on transaction cost theory does therefore not provide the possibility to assess the sustainability of exploitation positions. Therefore, the chapter “Dynamic analysis of exploitation positions“ describes the impact of the resource based view of the firm on the sustainability of exploitation. Also, we explain how Austrian Economics with respect to the discovery of knowledge deepens our understanding of the sustainability of exploitation positions. Knowledge about an exploitation position might attract other suppliers to offer the same product or service. If the out-supplier is also able to transform his/her knowledge into a marketable offer, the at first reduced competition will increase again. The extent of competition in the service market depends on the out-supplier’s ability to imitate products and services and the knowledge expansion in the market. This article illustrates how a resource-based view perspective on the evolution of self-created exploitation positions can refine and extend the way of analyzing profit opportunities gained by achieving them. In the last chapter conclusions and managerial implications of our analysis are presented. The goals of this article are fourfold. First, it is illustrated how exploitation positions can be created. Second, it is explained how the resource-based view improves our understanding of generating and sustaining a competitive advantage through exploitation positions. Third, the considerations of the Austrian Economics – mainly the evolutionary effects – in the common understanding of the usage of exploitation positions are integrated. And finally a set of managerial as well as theoretical implications of these results is posited. Rese/Engel, Sustainability of Exploitation Positions 4 Static analysis of exploitation positions Conditions So far, marketing literature has explained exploitation positions mainly with arguments from transaction cost theory.6 Rather than describing Williamson’s well-known framework7 the factors influencing the potential of exploitation will be emphasized. The objective of relationships is to increase profit through a sequence of transactions instead of focusing on single transactions. The existence of relationships is not self-explaining. The supplier could choose another institutional alternative such as integration or purchasing goods autonomously.8 The governance decision depends on the amount of transaction costs arising with each institutional alternative. Transaction costs are mainly influenced by the frequency with which transactions occur, the degree and type of uncertainty which the transactions are subject to, and most importantly the asset specificity of the transaction.9 The term “asset specificity” refers to the extent to which the investments made to support a particular transaction have a higher value to that transaction compared to the value if they were redeployed for any other purpose.10 Williamson distinguishes between four different types of asset specificity: site specificity, physical asset specificity, human asset specificity, and dedicated assets. In the presence of uncertainty and in conjunction with the behavioral assumptions of bounded rationality and opportunism asset specificity is of higher importance.12 With the existence of uncertainty, both parties face an unpredictable situation under which they have to make decisions. Therefore, both parties cannot specify all contingencies in a contract. Bounded rationality can be described as “intendedly rational, but only limitedly so.”14 Williamson describes opportunism as “(...) self-interest seeking with guile.”15 Through the inability of both parties to predict all consequences of a transaction contracts are not complete and the possibility for opportunistic behavior emerges.16 The assumption of 6 E.g. Backhaus/Büscken (1999); Söllner (1999). 7 Cf. Williamson (1985). 8 Cf. Backhaus/Büschken (1999), p. 245. 9 Cf. Williamson (1996), p. 59. 10 Cf. McGuiness (1991). p. 69. 11 Cf. Williamson (1985), p. 55. 12 Cf. Williamson (1985), p. 56. 13 Cf. Söllner (1999), p. 220. 14 Simon (1961), p. xxiv quoted by Williamson (1985), p. 45. 15 Williamson (1985), p. 47. 16 Cf. Milgrom/ Roberts (1992), p. 130. Rese/Engel, Sustainability of Exploitation Positions 5 opportunism does not imply that all human agents are continually given to opportunism. “Rather, the assumption is that some individuals are opportunistic some of the time and that it is costly to ascertain differential trustworthiness ex ante.”17 The specificity of assets in combination with imperfect contracting lies at the core of the hold -up problem.18 The hypothetical device of the “quasi-rent” is used to describe the degree of specificity. Alchian defines the quasi-rent as “the return on the investment cost that is non-salvageable if the other resource to which it is specifically dependent disappears (...).”19 To clarify this definition, the quasi-rent can be formalized as follows:20 QR = R1 – C1V – max{(R2-C2V-N); V}