Value-Based Strategy with Frictions

Abstract

We extend the formal literature on the value-based foundations of strategy, an approach which seeks to integrate industry-level and firm-level analyses of superior performance. The value-based approach starts with the set of players in an industry value chain and their value creation possibilities based on heterogeneous resources and capabilities and it then links these elements to the performance (value capture) of individual firms. While the received theory assumes frictionless interactions and perfect rivalry, there is a long tradition in strategy that explores the effect of imperfect competition on firm performance. To incorporate imperfect competition, we add a simple friction parameter into value-based analysis that moderates the degree of rivalry in the market, as well as adding a parameter for barriers to entry. We then analyze a variety of classic issues in competitive strategy. We show that the effects of rivalry and barriers to entry on industry attractiveness cannot be analyzed independently. Firm heterogeneity emerges naturally in our setting and depends on the degree of frictions. We find that firms with a competitive advantage prefer industries with lower levels of frictions than their disadvantaged rivals. Overall, we show that introducing frictions makes value-based strategy even more effective at providing an integrated approach to industry-level and firm-level analyses.