This paper develops a resource-based—knowledge-based—theory of the firm. Its thesis is that the organizational mode through which individuals cooperate affects the knowledge they apply to business activity. We focus on the polar cases of organization within a firm as compared to market contracting. There will be a difference in the knowledge that is brought to bear, and hence in joint productivity, under the two options. Thus, as compared to opportunism-based, transaction-cost theory, we advance a separate (yet complementary) answer to the question: why do firms exist? Our aim is to develop an empirically relevant and complementary theory of why firms are formed: a theory based on irreducible knowledge differences between individuals rather than the threat of purposeful cheating or withholding of information. We assume limited cognitive abilities on the part of individuals (bounded rationality), and assume that opportunistic behavior will not occur. The latter allows us to determine whether resource-based theory has independent force, as compared to the opportunism-based, transaction-cost approach. The paper predicts choice of organizational mode, identifying whether firm organization or market contracting will result in the more valuable knowledge being applied to business activity. The resource-based predictions of organizational mode are compared and contrasted with corresponding opportunism-based, transaction-cost ones. A principal point is that knowledge-based considerations can outweigh opportunism-related ones. The paper also establishes the relation of a theory of the firm to a theory of performance differences between competing firms.

A resource-based approach to strategic management focuses on costly-to-copy attributes of the firm as sources of economic rents and, therefore, as the fundamental drivers of performance and competitive advantage. Interest presently exists in whether explicit acknowledgement of the resource-based view may form the kernel of a unifying paradigm for strategy research. This article addresses the degree to which a resource-based view represents a fundamentally different approach from theories used in industrial organization (10) economics. The central thesis is that, put informal terms, the resource-based approach is reaching for a theory of the firm. To determine its distinctiveness in comparison to IO, therefore, an appropriate comparison is with other theories of the firm developed within that tradition. Section I summarizes and analyzes five theories that have been significant in the historical evolution of IO. These are neoclassical theory's perfect competition model, Bain-type IO, the Schumpeterian and Chicago responses, and transaction cost theory. The first part of Section II analyzes the resource-based approach in terms of similarities to and differencesfrom these IO-related theories. The conclusion is that resource-based theory both incorporates and rejects at least one major element from each of them; thus resource-based theory reflects a strong IO heritage, but at the same time incorporates fundamental differences from any one of these theories. The second part of Section II analyzes resource-based theory as a new theory of the firm.

An important business strategy research theme concerns finding ways to minimize competition faced by the firm. This paper, however, focuses on a different set of situations: the model developed suggests that an innovator's best strategy may be to encourage “clones” of its product when a network externality is present. Key factors to consider in assessing whether encouraging cloning is the innovator's best strategy are: (1) the benefit to be derived in terms of added user base “contributed” by the clone sales, traded-off against (2) the unit sales that will be lost to the clone(s). These factors in turn depend upon the strength of the network effect and the degree to which the innovator's product quality is perceived by consumers to be superior to the clone's. The model further suggests that both the innovator and clone earn their highest payoffs when the clone takes the lead in price-setting, i.e., when the clone establishes its own price by considering, for each price it might set, how the innovator will react to that price, and the innovator, as price-follower, responds to the price the clone chooses. The paper demonstrates that the clone-leader/innovator-follower situation represents the unique Nash equilibrium in price-setting strategies. A central implication is that when operating in a network externality environment, instead of a problem to be avoided, clones may be valuable assets to an innovating firm, building up the user base for the innovator's technology by bringing lower-valuing consumers into the market, which in turn makes the innovator's product more attractive to high- and medium-valuing purchasers. Thus when the above-described conditions hold, being cloned can be more profitable for an innovating firm than dominating the market alone.

This paper explores the question of when (or if) a market leader firm is best off with a strategy of product cannibalism: introducing a new product designed to supersede and hence destroy its own current bestseller before a rival does. Particular attention is given to the payoffs of various superseding product strategies and, given these strategies, whether the leading firm can be expected to invest at least as much in innovation as a challenger. A patent‐race game with a stochastic invention process is presented. The result is that when the leading firm deliberately decides to forgo being first‐mover in the new market, developing and then ‘shelving’ its new product until the current bestseller is challenged successfully by the rival, the leading firm may spend more than its challengers on R&D, thereby retaining a competitive advantage in innovation of new‐generation products. The paper concludes with a discussion of the practical implications of the model.

Software piracy by users is generally believed to harm both software firms (through lower profits) and buying customers (through higher prices). Thus, it is thought that perfect and costless technological protection would benefit both firms and consumers. The model developed here suggests that in some circumstances, even with significant piracy, not protecting can be the best policy, both raising firm profits and lowering selling prices. Key to the analysis is joining the presence of a positive network externality with the fact that piracy increases the total number of program users. The network externality exists because consumers have an incentive to economize on post-purchase learning and customization costs.software, computers, piracy, strategy, network externality