When thinking about why once successful firms fall on harder times it's useful to go back to the fundamental principle of business strategy. Colloquially, if everyone can do it, it is difficult to create and capture value from it. More technically, this idea that in a perfectly competitive market, no firm realizes economic profits or what we sometimes refer to as economic rents. This is the idea that there must be some competitive advantage that a firm must have in order to succeed within a market. Now, we've also introduced the idea of the first corollary to the fundamental principle. Which, again, colloquially here, would be, 'imitation is the sincerest form of flattery'. Again, more technically, in some competitive positions are more favorable than others, we would expect firms to adopt those strategies. This goes back to again, this idea that to be successful in a marketplace, one has to carve out a favorable competitive position that is hard for others to imitate. It's something that is defensible and sustainable over time. Now then, once again going back to the examples we began this module with, each one of those companies arguably had a strong defensible position for years if not decades at those firms. So, this raises what we call the second corollary to the fundamental principle. Colloquially, the idea, change is the only constant. To put it more technically, over time, economic profits, these economic rents once again, tend to dissipate as markets evolve. So success in the past does not guarantee success in the future, and that we know markets are going to evolve in some way. New technologies are gonna come about, new business models, maybe simply customer preferences change over time, and as a result that past success might not continue moving into the future. So lets talk about our two core perspectives on where economic rents come from. First, we have this idea of a monopoly rent which comes out of this industrial organization view of economics. Very simply, the idea of a monopoly rent is that there's some barrier to entry here that prevents, and the way we have it illustrated in the graph, a shift out in the supply curve. A lowering of prices and this competitive outcome that we get in a perfectly competitive market here. The importance of this view is to emphasize the role of industry structure and how industry structure might protect certain competitive positions in certain markets here. Our second perspective on rents is the one we refer to as Ricardian Rents after the economist David Ricardo. In the strategy literature we often refer to this as the resource base view. Here the emphasis is on barriers to imitation. And it's a firm structure that matters most of all. The idea that some firms are simply better at doing something than another firm. This idea of competitive advantage is key here. So in our graph we have illustrated two firms who have different cost structures. So while they charge the same price for a good or service, Firm 1 actually has a lower cost structure than Firm 2 and as a result can do quite well in this market, which might otherwise be a competitive market. Well, let me introduce a third perspective on our economic rents, and this is a idea of an entrepreneurial rent, or what is sometimes referred to as a Schumpeterian rent. Schumpeterian is in reference to an Austrian economist, Joseph Schumpeter. Schumpeter had a very unique perspective on the way that markets work. In his view, the key to markets was to understand the evolutionary dynamics. The ways in which they evolve over time as competition ensues. Schumpeter was probably most famous for coining the phrase the gales of creative destruction. And what he meant by that is that what contributes to economic growth, what makes markets so powerful, is that ultimately they create the conditions under which new innovations, new technologies and business models come around and surplant the old, competitive order. So in the graph you see before you, there are three technologies and we can imagine over time these technologies rising and falling relative to one another. So we start with a technology. Let's think about our example of the Studebaker brothers, or the horse drawn carriages, horse drawn carriages that dominate technologies. They grow, they diffuse, they reach a mature stage. And then, ultimately, they begin to recede, as we see the emergence of an alternative technology. The internal combustion engine driven automobile. Now it's interesting to know that in this example there might be a third wave now beginning to take place when it comes to electric vehicles and we might see a similar dynamic where internal combustion engines become less and less a part of the market and electric vehicles become the dominant technology over time. So fundamental to this perspective on rents is this idea that markets are ultimately dynamic and that innovation is critical to our understanding about competition and success. So, once again, this module is going to focus on the role of competitive dynamics which sometimes referred to in the strategy literature as the dynamic capabilities perspective on the firm. The premise once again is that markets are ultimately dynamic, and that is fundamental to our understanding of them. To the extent we observe economic rents, they are due to temporal advantages. Short or potentially long, but not forever. And we refer to these again as Schumpeterian rents in honor of Joseph Schumpeter. In this type of world, timing and adaptation is critical for success. We're gonna discuss more how we can think about and analyze these types of dynamics.
