LINKING INTANGIBLE RESOURCES TO WAYS OF COMPETING*

Knut Haanes and Øystein Fjeldstad

Associate Professors

NORWEGIAN SCHOOL OF MANAGEMENT BI

PO Box 580
1301 Sandvika
NORWAY
Tel.: (47) 67.55.70.00
Fax: (47) 67.55.76.77

July 26, 1999

Forthcoming in European Management Journal

This is an extended version of a paper which was presented at the
18th Annual International Conference of the Strategic Management Society, Orlando, 1998.

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 ABSTRACT

Recent strategy literature suggests that intangible resources—in particular competencies and
relationships—are critical drivers of competitive advantage. However, there seems to be a
lacking understanding of when certain types of competencies and relationships are most critical.
This paper introduces a framework consisting of three fundamental levels of resource-
competition. The framework is illustrated through the pharmaceutical industry. We argue that (1)
biotech firms mainly engage in entrepreneurial competition; (2) traditional pharmaceutical firms,
here referred to as big-pharma, increasingly undertake contractual competition and, finally, (3)
generic drug makers compete predominantly operationally. The paper argues that intangible
resources contribute differently to competitive advantage depending on level of competition.

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 INTRODUCTION

Lately, there has been an increasing stream of strategy literature declaring the importance of
intangible resources in explaining firms’ competitive advantage (e.g., Itami, 1987; Barney, 1991;
Normann and Ramirez, 1993). A review of this literature concludes that competencies and
relationships are increasingly considered to be the most critical firm-specific resources, but also
finds a lack of elaboration of which types of competencies and relationships are most important
(Haanes and Fjeldstad, 1999). In this paper we link these observations to a framework consisting
of three fundamental levels of resource-competition, each respective level requiring specific
types of competencies and relationships. Then, we link our framework to the pharmaceutical
industry. This industry is suitable for illustrating the three levels of resource-competition due to
several factors, in particular the important role of patents as an isolating mechanism (Rumelt,
1984) which protects technical innovations from instant diffusion.

The paper argues that intangible resources contribute differently to competitive advantage
depending on level of competition. By elaborating the competitive nature of intangible resources
this approach may help managers better understand their firms’ resources, and thereby align
competitive moves with the firm’s dominant logic (Prahalad and Bettis, 1986). We draw attention
to the idea that all competencies and relationships are not equally important, and that the
importance to a large degree depends upon how it supports the way of competing. For instance,
according to this approach, a firm with competencies and relationships that support efficiency
(e.g., facilitating the flow of goods, «just-in-time» delivery of supplies, etc.) should be careful
about competing to create wholly new technologies. Conversely, a firm with competencies that
support innovative behavior is often well advised not to take its new product ideas to the point
where they compete head-on with specialized manufacturers. Developing appropriate resources
is an expensive and time-consuming effort (Dierickx and Cool, 1989), and the extant stock of
resources largely decides how the firm can compete in the short and medium term (Penrose,
1959). Our arguments thus follow the path dependent assumptions of the resource-based view
(Barney 1991).

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 THEORETICAL BACKGROUND

Two perspectives in strategic management are particularly relevant for understanding how firms
deploy scarce resources to create superior value. These are the resource-based (Wernerfelt, 1984;
Barney, 1991) and the activity-based (Porter, 1985; 1996; Stabell and Fjeldstad, 1998) views.
These perspectives are complementary in that the resource-based view focuses on what the firm
has, whereas the activity perspective focuses on what the firm does. The essence of strategy is to
combine the two foci, namely to create and appropriate value with scarce resources. Below, we
will look at each perspective in-turn and then at possible ways of bridging them.

The resource-based view

The underlying approach of the resource-based view is (1) to see the firm as a bundle of tangible
and intangible resources, and (2) to see some of these resources as costly to copy and trade.
According to Barney (1991), a firm’s resource position can lead to sustained competitive
advantage if it allows the firm to create value; if the resources are rare and imperfectly imitable,
and if the advantage is not subject to substitution. In order to become a source of sustained
competitive advantage, the resources also have to be organized, combined and deployed
appropriately. Resources may be difficult to imitate due to isolating mechanisms such as
historical conditions, time compression diseconomies, ambiguity in the relation between the
resources, or simply because the value created with the resource is socially complex (Dierickx
and Cool, 1989). This stream of research is influenced both by previous work illuminating firm
heterogeneity (e.g., Barnard, 1938; Selznick, 1957; Penrose, 1959) and by an economics-based
reasoning: firms are seen as rent seekers (Rumelt, 1984).

The literature generally distinguishes between tangible and intangible resources (Itami, 1987).
Tangible resources are concrete and tradable, and include physical entities such as factories,
technology, capital, raw material and land. Intangible resources are more difficult to define and
measure, and includes skills, knowledge, relationships, culture, reputation and competencies.
Intangible resources are generally more difficult to transfer than tangible resources, as the value
of intangible resources is difficult to measure. Although both tangible and intangible resources
may be scarce and represent the input needed to create economic value (Lippman and Rumelt,

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1982), competencies have received particular attention as potential sources of sustained
competitive advantage in this literature. Competencies are the means by which a firm deploys
resources in a characteristic manner in order to compete. Thus, competencies are integrations of
skills and knowledge, and organizational competencies include the firm’s knowledge, routines
and organizational culture. In different ways, several authors have identified competence as the
crux to superior organizational performance. In particular Prahalad and Hamel’s (1990) notion of
core competence is important. Here, competence is seen as competitively important due to three
factors. First, a core competence potentially provides access to a wide variety of markets. Second,
it may make a significant contribution to the perceived customer’s benefits of the end products,
and third, it is difficult for competitors to imitate or otherwise substitute. In addition, the value of
competencies does not depreciate with use—the way raw materials and other more tangible
resources do—but rather increases. Competencies may lead to increasing returns and sustain
long-term economic growth. Other contributions that add to our understanding of competencies
in competition include the notions of absorptive capacity (Cohen and Levinthal, 1990),
architectural knowledge (Henderson and Clark, 1990), distinctive competencies (Selznick, 1957)
and dynamic capabilities (Teece, Pisano and Shuen, 1997).

The activity-based view

The activity based perspective was for a long time mainly concerned with seeing firms as value
chains (Porter, 1985), i.e. as systems where value is created by transforming a set of inputs into
more refined outputs. The strategic challenges associated with managing a value chain are
related to manufacturing products with the right quality at the lowest possible cost. The ways to
reduce costs—or increase value—are primarily found through economies of scale, efficient
capacity utilization, learning effects, product and information flows, and quality measures.
Critical drivers of value creation in chains also include the interrelationships between primary
activities, on the one hand, and product development, marketing and service, i.e., support
activities, on the other hand.

Today, this approach has been extend to also explain other ways of creating value, such as
through networks (Normann and Ramirez, 1993) and value systems (Porter, 1996). Stabell and
Fjeldstad (1998) formalized three types of value creations into a ”value configuration”

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framework. In addition to the value chain, they introduced the value network and the value shop.
Value networks create value by mediating products or services between customers. The value is
found in how the specific network gives buyers access to sellers of what they want, and vice
versa. The value shop creates value by solving unique problems for customers. Value is created
by mobilizing resources (Haanes, 1997)—essentially relevant competencies—to solve particular
problems. Problem solving involves developing solutions tailored to problems that the clients
will not—or more often cannot—solve themselves. In order to determine which type of value
creation takes place in a given firm, we need to look at what the firm gets paid for by their
customers.

 Value chains sell products that are the outcome of a transformation process. The customers
pay for the total quality of the product. Examples of firms that create value as chains include
producers of automobiles, clothing, electronics, food, computers, furniture and
pharmaceuticals.
 Value networks sell mediation between customers. The customers pay for access to and
interaction with other customers. Examples of companies creating value as networks include
commercial banks, airlines, postal agencies, insurers, brokers, stock exchanges and overnight
delivery companies.
 Value shops sell competencies and approaches to help solve certain unique problems. The
customers pay for solutions of—or effort spent on—their problems. The latter reflects the
fact that problem solving is uncertain, and that customers in many cases are willing to pay for
expected rather than realized value (Levitt, 1981). Examples of companies that create value
as «shops» include accountants, academics, investment bankers, physicians, designers,
lawyers, business consultants and consulting engineers.

Bridging the two perspectives

Resources per se do not create value (Penrose, 1959; Porter, 1991). Rather, value creation results
from the activities in which the resources are applied. Strangely, there is not yet an explicit link
between these two perspectives. Although researchers today have a deeper and more sophisticated
understanding of competencies and activities separately, there is still a need for a more developed
understanding of how and when certain competencies are most appropriate to obtain competitive

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advantage. One may make some general observations about the current status of these two
complementary perspectives:

 Resources are generally agreed to represent an appropriate unit of analysis for explaining
competitive advantage (Wernerfelt, 1984; Barney, 1991);
 Competencies and relationships are often considered to be the most critical types of resources
(Itami, 1987; Normann and Ramirez, 1993).
 Activity-based—or more precisely value configuration—analysis is a widely accepted tool for
determining on which basis the firm may build a competitive advantage (Porter, 1985; Stabell
and Fjeldstad, 1998).
 There is a need for a more developed understanding of the nature of resources in action
(Black and Boal, 1994; Haanes, 1997; Majumdar, 1998).

Hence, one may argue that the current perspectives in strategic management have the
shortcoming that intangible resources, such as competencies and relationships, are not yet linked
to how firms create value and to how they compete in their industries. Consequently, there is not
yet a distinction explaining when certain competencies and relationships are most critical.

THREE LEVELS OF RESOURCE-COMPETITION

The study of how firms compete is the essence of the academic field of strategy. This framework
helps better understand how resources can be mobilized to compete. There are many other useful
dimensions of competition in addition to the one presented here, such as price competition,
technology competition, service competition, etc. We will, however, argue that this specific
approach complements and extends other approaches by specifically linking types of resources to
ways of competing.

Resource-competition may be classified into three different levels. First, operational competition
is concerned with efficiency in the production process (Porter, 1996). This can be gained through
scale and experience, as well as by substituting capital for labor. At the other extreme of the
competitive spectrum lies entrepreneurial competition. This implies the more Schumpeterian

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sources of performance advantage, which result from the formation and implementation of
entirely new combinations (Schumpeter, 1934). Both the operational and the entrepreneurial
level of competition are well captured by the activity-based perspectives in strategy (e.g.,
Porter’s distinction between cost leadership and differentiation), and by other organizational
theories (e.g., the distinction between exploration and exploitation [March, 1991]). Moreover, the
resource-based perspective (e.g., Wernerfelt, 1984; Barney, 1991) helps us distinguish a third
type of resource-competition. This implies the effective appropriation and mobilization of certain
imperfectly traded resources. We here label this contractual competition. This level of
competition has previously been alluded to by Miles and Snow (1978) as the activities associated
with the “analyzer”, a type of firm that screens the environment for interesting ideas and then
moves relatively early to realize these commercially. However, whereas the approach of Miles
and Snow was to create a typology of firms, our focus is to identify levels of competition and
types of intangible resources.

The three levels of resource-competition are distinctly different:

 Entrepreneurial competition implies performance in the creation of new technologies or

entirely new solutions;
 Contractual level competition implies performance in expanding the available set of non-
freely traded resources that can be applied to a given technology;
 Operational competition implies efficiency in the actual transformation of freely traded input
factors into products and services.

At each level of resource-competition, distinct categories of associated competencies contribute

to superior performance. However, the differences between the three levels are a matter of
degree, and we do not pretend that the boundaries between these can be easily defined. Most
firms will to some extent engage in resource-competition on all three levels. Nevertheless, one
level will often be dominant.

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Entrepreneurial level competition
At the entrepreneurial level, the creation and modification of technologies and products
departing from past solutions is the meta-activity. This implies exploration (March, 1991).
Exploration is associated with the long-term, and implies experimentation and search for new
opportunities, technologies, strategies and competencies. The returns to exploration are distant in
time and space. It takes time to create value with a new exploration, and even if a new product is
realized the value may be appropriated by other organizations (Teece, 1986). Applying a short
time perspective to exploration makes all new ideas look bad, whether they are good or bad. A
firm that only explores puts itself at a short-term risk, as it neglects present opportunities.
Entrepreneurial level competition changes the pattern of resource deployment on two levels
simultaneously. An emerging industrial logic is formed on both a new architecture and new
components (Henderson and Clark, 1990). The architecture refers to the way components are put
together in the industry, whereas the components refer to each specific portion of the product.
Both change dramatically in the early stages of the industry, as different companies experiment
with new combinations. As noted by Mansfield (1977), products in an emergent industry do not
emerge fully developed. Neither do the commercial aspects of the industry, as experimentation
with different business models takes place. Hence, it may eventually create great difficulties for
established firms (Utterback, 1994) which offer close substitutes. Entrepreneurial competition is
made difficult by the “failure trap”. The firm comes up with new ideas, but does not have the
necessary patience to wait for the payback. This may lead to a vicious circle, where the firm
continuously creates new concepts but where the ideas spill over to competitors who manage to
appropriate their value.

Contractual level competition

On the contractual level, firms compete on the appropriation of scarce resources used by a given
technology in an imperfect resource market. In order to mobilize imperfectly traded resources,
the contractual challenges are to identify and understand market potential where it is not yet
developed and then to fast build a commercial structure. Contractual competition is about
building systems to commercialize new technologies, many of which have been introduced
outside the company. Contractual competition consists of two main activities. First, screening the
environment for interesting novelties with a commercial potential, and second, establishing a set

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of contracts to actually commercialize the selected novelties. In order to develop contractual
level competitive advantage, support activities such as procurement, human resource
management and marketing can be critical. Performance advantage is not related to superior
implementation and execution of the given technology, but rather to its extension to a larger
market domain than the initial innovators. This means finding a market potential that has not yet
been realized. For instance, it is well known that many of the basic concepts of Apple’s Mac
computer (such as the mouse and the user interface) first originated in Xerox Parc, but that
Xerox were not capable of commercializing these (and many other) ideas. The ability to build a
commercial structure upon the introduction of a new technology is a competence that may be
more difficult to imitate and substitute than the ability to develop fundamentally new
technologies. The contractual competitors can build a sustained competitive advantage through
their ability to see commercial opportunity and construct the system where value is created and
appropriated. This requires that the firm has an ability to contract and mobilize resources that at
that time tend not to be widely available. Thus, if a commercial system can be built the resources
cannot easily be copied or substituted by other firms (Barney, 1991).

Operational level competition

In operational level competition, firms are seen to obtain competitive advantage through superior
execution of activities, based on established technologies. We distinguish two such sources of
superior execution. The first deals with intrinsic properties of the technology. Performance
differences related to scale and scope are intrinsic and relate to the domain of application of a
technology. The second deals with the procedural implementation of an established technology.
Drivers of the latter include learning effects, capacity utilization, vertical integration and links
between activities (Porter, 1985). Whereas the fundamental activities in entrepreneurial and
contractual competition were exploration and expansion, respectively; it is exploitation in
operational competition (March, 1991). Exploitation refers to the short-term improvement and
refinement of present knowledge, opportunities and technologies. A firm that puts too much
emphasis on exploitation risks not surviving in the long-term, because it neglects building
knowledge to seize new opportunities. The success trap is associated with too much exploitation,
i.e., the firm being satisfied with the returns on exploiting present knowledge and technologies.

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Present recipes will easily lead the firm to continue exploiting at the neglect of exploration,
which is necessary in the long term.

The figure below is meant to illustrate the three levels, not to suggest that all firms fit neatly into
one. Some firms actually succeed in all three. Intel in microprocessors in an example of this,
having gone from the early discovery to today also being the most efficient producer.

INSERT FIGURE 1 HERE

The three types of resource-competition will tend to have a chronological sequence for a given
technology. A new industry emerges through entrepreneurial action, implying experimentation
and the discovery of a technological opportunity. Often, many competitors with similar motives
—but with different technologies—emerge at the same time. These firms are often small and
purely technology oriented, and incumbents often overlook them. Their competencies are often
more advanced when it comes to the possibilities with the technology than when it comes to
grasping the commercial opportunity—or more correctly; understanding how to develop the
commercial opportunity. Then, contractual activity develops the commercial industry, which
often results in a dominant design (Abernathy and Utterback, 1978), both in terms of technology
and markets. Finally, when the industry is well defined and a factor market established, there is
room for operational activity. This is about winning the head-on competition through lower costs
and efficiency.

For the purpose of this paper it is important to note that the competencies required to compete
efficiently varies with level of resource-competition. This has important implications for strategy.

COMPETITION IN THE PHARMACEUTICAL INDUSTRY

The pharmaceutical industry provides a interesting illustration of this framework for several
reasons. First, this is an intensely competitive and global industry with a strong focus on
innovation. The fundamental challenge in the industry is to create patented drugs that can be
commercialized internationally. The companies in the industry average R&D investments of

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more than 20%, and the total research and development investment is expected to hit $ 24 billion
in 1999 (Hess, 1999). Second, the patent protection and the required medical approval create
well defined isolating mechanisms. These make each product imitation difficult, but on the other
hand facilitate technology diffusion. Finally, this is an industry with extensive competition and
cooperation between both small and large companies. This article merely presents an overview
of the industry for illustrative purposes. For a richer and more detailed description of the
pharmaceutical industry, see Thomas and Bogner (1996). For more in-depth accounts of the
research and development processes in the industry, see Henderson and Cockburn (1994) and
Cockburn and Henderson (1998).

The creation and manufacturing of drugs has become one of the largest and most profitable
industries worldwide. The annual sales of medical drugs total $ 300 billion, with a profit margin
that has been estimated at 30% (Economist, 1998). The traditional actors in the industry, namely
the integrated pharmaceutical firms, have been undergoing large changes during the last decade
as a consequence of (1) increased buyer pressures (particularly from Governments and HMO’s),
(2) harder price competition from generic drug makers, and (3) innovative pressures from
biotech companies. The industry is here divided into three levels of competition, that undertaken
by: (1) traditional pharmaceutical firms, (2) biotech firms, and (3) generic drug makers. This
division into different ways of competing is not clear-cut with regards to all firms, however, as
many corporations undertake all three forms of competition. For instance, the big-pharma firm
Roche owns over 80% of Genentech, a major biotech firm. Similarly, both Novartis and Merck,
large traditional pharmaceutical companies, are also producers and distributors of generic drugs.
In addition, there are numerous alliances between biotech firms and big-pharma firms. These
collaborations seem to affect innovation positively, and there is often a mutual dependency
between these two types of firms (Shan, et. al., 1994).

Time pressures have accelerated the division of labor in the industry for at least two reasons.
First, it takes a long time to develop a new drug and second, once developed, the company needs
to break even fast in order to be profitable before the patents run out. On average it takes fifteen
years to develop a new drug, and it costs more than $400 million. Although firms that produce a
successful drug are protected through their patents (normally for 20 years), there is a high

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pressure to save time in commercialization. Only 30% of all drugs introduced ever break-even
(Gilmartin, 1998). High R&D investments—as well as marketing costs—have to be recouped
before a given drug becomes profitable. Hence, most biotech firms simply do not have the time
or resources to grow organically, even if they have developed a drug with a high market
potential. It often turns out that traditional pharmaceutical firms—which often themselves face
declining returns to scale in terms of innovation (Graves and Langlowitz, 1993)—have
competencies and relationships that make them better suited for efficient commercialization.
Below, we will look at the three types of competition in the pharmaceutical industry.

Entrepreneurial competition – Biotech firms

Biotechnology can be defined as the integration of natural science and engineering science in
order to develop products and services based on the application of organisms, cells and
molecular parts. Biotechnology is, however, not a narrowly constituted technology. It is
comprised of many interdisciplinary skills and techniques, with wide-ranging applications.
Biotechnology can also be described as an enabling technology capable of affecting many areas
of industrial, medical, and agricultural activity. The term biotechnology is often used for «genetic
engineering», which has emerged during the last decades. This includes recombinant DNA
techniques, established enzyme technology, monoclonal antibodies, as well as instrumentation
technology for the automated sequencing of DNA, proteins and the synthesis of peptides. The
biotech industry has from its inception been closely linked to the pharmaceutical industry, and
there are today more than 2,000 «biomedicine» firms. As of 1999, more than 2,200 biotech-based
medicines are in various stages of clinical testing, and some 350 drugs are in the process of
seeking approval by the U.S. Food and Drug Administration (FDA). Of these, 30% are in the late
stages of this process. Biotech firms are important technical innovators. They are generally
smaller than traditional pharmaceutical companies, and they are often spin-offs from universities
and research entities (Powell, et. al., 1996). Only three biotech firms—Amgen, Chiron and
Genentech—have turnovers that exceed $1 billion. Many biotech firms function almost as basic
research labs, utilizing their small size and targeted competencies to develop new ideas and to
produce technical breakthroughs.

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Producing innovation requires certain competencies, such as an advanced understanding of the
basic technology underlying the respective biotech firm’s area of activity. Successful
biotechnology firms live on the innovation edge, and need to master the state-of-the-art in their
chosen activity. Furthermore, they need the ability to learn from formal and informal
collaboration. Typically, many such partnerships are found with universities. As seen by the
manager of a biotechnology company we studied: «We were really very fortunate because we
could start cooperating with researchers on the cellular applications for the future. In this way we
evolved with our customers.»

Biotechnology firms typically have the willingness to experiment with new designs. Their raison
d’etre is prototyping entirely new concepts. In essence, the competence that distinguishes a
successful biotechnology firm is its ability to grasp and diagnose new, unique problems and to
come up with solutions. Advanced problems are often accessed through the research network.
Participating at the frontier of research provides the biotech firms leverage to access, assimilate,
and exploit additional ideas and information. R&D collaboration is both an admission ticket to
an information network and a vehicle for the rapid communication of news about opportunities
and obstacles (Kreiner and Schutz, 1993). Hence, successful biotech firms have intangible
resources that assist in the identification of—and inquiry into—new problems, including a
network to access relevant technological competencies and access to advanced know-how.

In fact, biotech firms need to build relationships that support entrepreneurial competition. These
relationships include (1) access to leading customers, and (2) access to technical knowledge.
These relationships are usually of both a formal and an informal nature. Both types of networks
facilitate new idea generation, in terms of new market solutions or new technical solutions. For
instance, having links to other knowledge-intensive firms may help the firm pick up new ideas
and stimulate to think in new ways (Porter, 1990). Such relationships might include cooperation
with research centers, etc. This requires that the firm is open to learn from customers and
suppliers. As argued by Powell, et. al., (1996: 121) in a study of inter-firm collaboration between
biotech firms:

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 “…once a firm begins collaborating, it develops experience at cooperation and a
reputation as a partner. Over time, firms develop capabilities for interacting with
other firms. Experience with collaborative networks proves a fertile ground for
both further formal partnerships and an expanding array of informal
relationships. A broader range of collaborative efforts provides greater
opportunity to refine organizational routines far cooperating and render them
more versatile.”

The relationships of successful biotech firms generally include links to «idea rich» surroundings,
such as research institutions, other biotech firms and advanced pharmaceutical companies. These
allow the firms to pick up new ideas, to think in new ways, and to put an intense research
commitment behind new technological innovations. In addition, they represent «reservoirs» of
available competencies that may be mobilized when new opportunities are seen.

Contractual competition – (Big Pharma”) Traditional pharmaceutical firms

The traditional pharmaceutical industry has been very profitable and R&D intensive, and this
trend is predicted to continue due to ongoing advances in technology and an aging population in
the largest markets. The traditional pharmaceutical firms (here called “big-pharma”) encompass
some of the world’s largest and most profitable firms altogether. For instance, Merck, Roche,
Glaxo and Novartis each has a turnover exceeding $7 billion. The high risks and increasing costs
of product development, nevertheless, does affect how the large pharmaceutical companies
organize innovation. Although they still undertake extensive research and development
internally, increasingly the discovery of entirely new solutions originate in biotech firms and
research laboratories. Therefore, we see more joint ventures with biotech companies with
interesting technologies. In fact, many large pharmaceutical companies seem to prefer
cooperation to acquisition, even if the take-over price is no hindrance (Bower, 1993). This is
partly due to the fact that biotechnological innovation is foreign to pharmaceutical firms, which
have traditionally based their research on organic chemistry.

The current focus of big-pharma firms is to identify promising discoveries and then to take these
through testing and approval onto the market. The approval process requires a large investment,
where the big-pharma firms possess internal laboratories, links to clinical hospitals and
experience in managing the FDA approval procedure. These are critical resources in the

15
commercialization process. Once a drug is accepted, the big-pharma firms use their global sales
and marketing networks to commercialize it. Increasingly, the big-pharma firms also have a
contracting approach to leverage their know-how in generic drugs towards the end of the patent
life-cycle. The critical competencies for big-pharma firms include their ability to screen and
understand potential commercial breakthroughs (often made in research-intensive companies,
e.g., biotech firms). This requires competitive intelligence and a blend of technological and
commercial knowledge, i.e., an absorptive capacity (Cohen and Levinthal, 1990). Contractual
competition requires an understanding of the potential market and an ability to organize a web of
internal and external contracts. The relationships that are important for big-pharma firms include
a large set of contacts into research settings in order to screen new opportunities. Moreover, it is
an advantage to have an established reputation as a serious collaborative partner. Finally, in order
to sell and market new products, the big-pharma firms need good relations to physicians,
pharmacies and other large customer groups, as well as a brand name that facilitates the
introduction of new products. In sum, two important resources of big pharma firms are
contactability, an ability to access and manage contacts in many areas, and contractability, a
reputation for trustworthiness.

Operational competition – Generic drug manufacturers

Generic drug manufacturers produce generic drugs. A generic drug is called by its basic chemical
name instead of a registered brand name, which are usually held by big-pharma. In general,
generic drug makers do not undertake R&D themselves. Rather, they start producing “me too”
products once the patents of original products have run out. Generic drugs have the same active
ingredients as brand-name drugs. If a physician prescribes a generic drug instead of a brand-
name product, good standard practice and most countries’ laws require that it be therapeutically
equivalent. In addition to not having a brand name, the generic drugs are often priced much
lower. Today, managed care organizations affect the pharmaceutical business in every significant
market segment. As those organizations have continued to grow in size and influence, they have
increasingly demanded discounts from pharmaceutical companies. This has provided the generic
drug makers, such as Mylan Laboratories, Teva Pharmaceuticals, Barr Laboratories, Ivax, etc.
with a market opportunity. Also, in many countries the generic drug makers have been helped by
an increasing reluctance by Governments to pay high prices for original drugs. Moreover, some

16
big-pharma firms have also entered into generic drug manufacturing in order to expand their
volumes and capitalize on already incurred plant investments.

The focus of generic drug manufacturers is on efficiency (in order to compete on price). The
competencies required to compete operationally are mainly linked to efficiency in production.
This includes the ability to identify a scope for economies of scale and capacity utilization, as
well as for better linkages between the different activities. They are also connected to an efficient
flow of goods. This implies the ability to gradually improve the logistics connected to a very
complex flow of people, technologies and materials. Another critical competence is negotiations
skills, allowing the firm to continuously reduce the costs of suppliers by (1) making sure they
reduce costs, and (2) reducing both transaction and linkage costs. Furthermore, the relationships
needed for generic drug makers to compete operationally include a set up with suppliers and
customers that facilitate an efficient flow of information and products. Also, close contacts to
customers and a limited number of suppliers may limit transaction costs. The relationships
developed by successful generic drug makers are largely aimed at cutting cost and improving
flows. This may imply reducing the number of suppliers and increasing the business with the
remaining partners.

We will argue that the three ways of competing, as illustrated above, require different
competencies and different relationships. These are summarized in the table below.

INSERT TABLE 1 HERE

DISCUSSION AND CONCLUSION

To summarize, how competencies and relationships may contribute to competitive advantage

differs with the competitive level. With respect to competencies we distinguish the exploration-
related competencies needed for successful entrepreneurial action; the expansion-related
competencies needed for successful contractual action, and finally; the exploitation-related
competencies needed for successful operational action.

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Developing the market commercially is done through contractual competition (here by “big-
pharma” firms), often undertaken by larger firms diversifying into the industry or the new
market. These are not usually first movers, but rather early movers, who have a different focus
than the one competing entrepreneurially (here biotech firms). Whereas companies competing
entrepreneurially explore product and technology opportunities, the company competing
contractually is concerned with developing the actual market. The companies that are successful
in contractual competition are innovators when it comes to understanding and exploiting the
market opportunity. This framework introduces contracting as a way of competing that has not
been discussed sufficiently in the literature. However, aspects of the contractual competition has
been discussed by Chandler (1990) and Miles and Snow (1978). Chandler, for instance, found
that the most successful industrial firms were the first to build management (p. 131).: ”The
dominant companies are those whose founders and senior executives understood…the logic of
managerial enterprise, that is, the dynamic logic of growth and competition that drives modern
industrial capitalism.” Similarly, Miles and Snow identified the analyzer as a competitive
archetype, alongside the defender (focused on efficiency), the prospector (innovation) and the
reactor (follower). According to Miles and Snow (p. 68) the analyzer is: ”…an organization that
minimizes risk while maximizing the opportunity for profit, that is, an experienced Analyzer
combines the strengths of both the Prospector and the Defender into a single system”. These
observation, in addition to more recent studies documenting that the early movers—as opposed
to first mover—are the most successful (Tellis and Golder, 1996) seem to suggest that the
contracting is a significant level of competition. It undertaken by the company that understands
the potential of resources that are not yet commercially recognized. It is not the one that develops
the technology, but often the one to appropriate (Teece, 1986) much of its potential value.

This discussion has implications for our understanding of competition and competencies. There
are different ways of competing and, consequently, different types of competencies that support
each way of competing. This can be stated through a set of propositions about resource-
competition in the pharmaceutical industry.

Proposition #1:

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There are systematic differences in the properties of competencies and relationships leading to
superior performance in the pharmaceutical industry. These depend on whether firms compete to
(1) create new technologies (potential products), (2) create new business systems based on newly
introduced technologies, or (3) compete on price/quality with established technologies within
established business systems. These ways of competing are closely associated with the biotech
firms, large pharmaceutical firms and generic drug makers, respectively.

We will deal with these levels in turn below. First, entrepreneurial level competencies allow the
development of new solutions. This may include intimate knowledge of state-of-the-art in basic
research, or a deep knowledge about the market. Relevant competencies are correlated with
innovative efficiency (Cohen and Levinthal, 1990). This includes attracting creative people, the
ability to manage innovation, the ability to motivate people, and the will to take risks on
unproved solutions. One may create the following proposition about biotech firms:

Proposition #2:
Superior performance as a biotech firm in developing new product or process technologies
requires:

 Competencies and relationships that allow the firm to gain unique insights into a technology,
and to combine technological knowledge in new ways.
 Competencies and relationships that allow the firm to learn continuously from
experimentation.
 Competencies and relationships that facilitate unique problem solving.

The competencies that are key to contractual level competition are those that allow the firm to
expand rapidly on the basis of existing technologies. To accomplish this the firm needs superior
resources that support procurement, resource management and marketing when facing imperfect
factor and output markets. The competencies that support contractual competition encompass (1)
the ability to see commercial opportunities in the market for existing technologies, and (2) the
ability to access the resources to seize the opportunities. Accessing (imperfectly traded and
imitated) resources requires both the ability to manage a variety of contractual mechanisms

19
simultaneously and a broad network reach. For instance, when operating in imperfect output
markets, the firm needs competencies to build brands, trust and loyalty to all parties, including
the suppliers of competence (i.e., the employees and other contractual parties). These
relationships must allow the firm an extensive reach within the relevant domain.

Proposition #3:
Superior performance in the pharmaceutical industry for drug firms in terms of developing new
business systems requires:
 Competencies and relationships that allow the firm to understand the potential of a not yet
fully developed product (that may well have been developed elsewhere).
 Competencies and relationships that allow the firm to organize a nexus of contracts in order
to build the business system and develop the market.
 Competencies and relationships that allow the firm to access technologies and mobilize the
resources that allow commercial exploitation of the technology.

Finally, operational level advantages stem from the efficient implementation of primary
activities. The intangible resources that are key at this level facilitate resource acquisition
efficiency, with the aim of cost reduction. This requires competencies in manufacturing, logistics,
negotiations, as well as the ability to retain quality and improve incrementally. Sustaining
operational level advantages require competencies that optimize the use of resources and, thus,
give an advantageous cost position in the chosen segment (Porter, 1980). Therefore, “the
operator” (the firm that competes operationally) needs competencies to build relationships to
support operational level performance. Such relationships are linked to efficient resource
acquisition. Examples of such relationships include just-in-time set-up with suppliers and
customers, and the establishment of bargaining power vis-à-vis vendors.

Proposition #4:
Superior performance within generic drug production requires:
 Competencies that allow the firm to produce efficiently
 Competencies and relationships that allow the firm to get an optimal flow of inputs and
outputs.

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 Competencies and relationships that minimize transaction costs.

Both contractual and entrepreneurial competition means combining resources in new ways
(Schumpeter, 1934). The company competing entrepreneurially combines resources to create
new products, whereas the company competing contractually takes these new product ideas and
develops new markets. Companies competing operationally (here generic drug makers) take both
products and markets for granted and focus purely on efficiency. They innovate in terms of
building a system that outcompetes the two others on costs (through economies of scale, capacity
utilization, flow of goods management, etc.). This requires competencies that support efficient
operations, and these types of competencies are different from both those required for contractual
and entrepreneurial competition.

This framework may have interesting implications for managers. First, it helps us better
understand which intangible resources are most critical for our firm. Second, it may help
managers clarify what kinds of competitive activities their firm is actually engaged in. It is
clearly important to distinguish creation (of new industries) from operational competition.
Finally, this framework helps us link the three main levels of strategy, namely competencies,
companies and competition. So far, most theories have been concerned with one of these.

21
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FIGURE 1: THREE LEVELS OF COMPETITION

High
Operational
Mobility of critical

competition
resources

Contractual
competition

Entrepreneurial
competition

Time
Low
Industry development over time

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TABLE 1: THE COMPETENCIES AND RELATIONSHIPS RELATED TO LEVEL OF COMPETITION
Level of competition Supporting competencies
Entrepreneurial  Know-how in basic
competition technology
 Ability to learn
 Ability to experiment
 Ability to solve new
problems
Contractual competition  Understanding of
markets, actors and
resources
 Ability to see commercial
opportunity
 Ability to organize
contracts
 Ability to mobilize new
resources
Operational competition  Efficiency
 Quality management
 Flow of goods
 Negotiation skills
Supporting relationships
 Networks to access
relevant technological
competence
 Network to access
advanced problems
 Contractability –
reputation for
trustwortiness
 Contactability – many
potential relationships
 “Just-in-time”
 Low transaction costs
 High bargaining power
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