In the perfectly competitive market, firms cannot sustain the long-term profitability as the entrance of potential competitors can drive down the price to the point where economic profits are zero. But in reality, some firms persistently enjoy profits that are higher than its rivals. Resource-based theory (RBV) is used to explain this phenomenon by stating that ‘the unique bundle of resources that some firms have obtained help to shape the firms’ value-creating strategies which are implemented to gain a competitive advantage’. This essay will firstly examine the characteristics of the resources which are the basis of a competitive advantage, then analyze the isolation mechanism which help to maintain firms’ competitive advantage. Finally limitations of this theory will be discussed.

According to McGahan and Porter’s research, 31.71% of the factor influencing business profitability is suggested to be firms’ resources and capabilities. These resources and capabilities have to be heterogeneous and imperfectly mobile because they can be inherently non-tradable, firm-specific, and co-specialized. Moreover, resources should fulfill VRIN criteria to enjoy a competitive advantage and sustainable performance. Firstly, resources must be valuable enabling a firm to exploit opportunities and neutralize threats by improving its efficiency and effectiveness. Secondly, resources must be difficult to find among the existing and potential competitors of the firm. Hence resources must be rare or unique to offer competitive advantages. Additionally, resources should be inimitable, which means other firms either cannot obtain them or have to obtain them at a much higher costs. Fourthly, key resources need to be non-substitutable. If not, competitors will use strategically equivalent substitutes for these resources to form similar competencies (Barney, 1991).

Scarcity, immobility and non-substitutability of valuable resources are necessary to sustain the advantageous position but not sufficient. Therefore, the isolating mechanism, can be treated as barriers preventing rivals to duplicate the competitive advantages that owned by the resource and capability owner. It consists of two aspects: impediments to imitation and first mover advantage. The former impedes the potential entrants from duplicating the resources and capabilities of the incumbent firm.

There are four types of impediments to imitation. Firstly, legal restriction, such as patents, copyrights, trademarks as well as government regulation through licensing and certification can impede imitation. For instance, a certain drug of a pharmaceutical firm is always protected by its patent. However, this resource can also be mobile since it can be sold and bought, though it is scarce. The second aspect is superior access to inputs and customers. A firm which is easier to get access to high-productivity inputs, such as raw materials and information, or secures access to the best distribution channels or the most productive retail locations will be able to sustain cost quality advantage and will outcompete its rivals for customers. Also, market size and scale economy is another type of impediments. If a giant company has acquired a large percentage of the market share and its minimum efficient scale is large vis-à-vis market demand, the imitation can be blockaded. The final one is intangible barrier to imitation, which consist of causal ambiguity, dependence on historical circumstances and social complexity.

Causal ambiguity is a consequence of the tacit knowledge, thus the causes of a firm’s outstanding value-creating capabilities are obscure and only imperfectly understood. Therefore forms an efficient barrier. However the negative effect is it might also prevent the firm from translating the operational success in one of its plants to another. Barney (1991) argued that the dependence on historical circumstances of a firm makes it very difficult for competitors to replicate its distinctive competence since it is developed from the company’s history and development process. The third intangible barrier is social complexity, such as personal relationship or trust, which leads to the result that the firm’s advantage becomes really hard to imitate.

The other aspect of isolation mechanism is first-mover advantage. As Wernerfelt (1984) suggested, it refers to the situation that the first-moving companies have already sustained some resource adversely affects the later acquirers’ profits. For example, Amazon was the first major online bookstore, seizing a head start on later entrants. Established book retailers Barnes & Noble and Borders were quick to develop their own Web sites. Four factors fall under the category of first-mover advantage. The first factor is learning curve, which indicates that firms with greater experience are able to increase volume and enhance their cost advantage over rivals. Moreover, reputation buyer uncertainty can make a brand a powerful isolating mechanism. For example, Mattel which is famous for Barbie recovered from its close to bankruptcy in 1990s by adopting core brand strategy. Thirdly, entrants have to deal with substantial customer switching costs. Finally, positive network effects, such as strong brand recognition and word of mouth, can be a powerful advantage to an early mover. Unfortunately, first-movers may be confronted disadvantages. According to Grant’s research in 1998, 11 first movers have been knocked down by followers, out of 15 product markets. The reasons might be the following four points: relatively high R&D expenses, undeveloped supply and distribution channel to develop marketable products, uncertainty of customer demands, and immature technologies and complements. Accordingly, the recommendation for established firms is to implement a fast second strategy in the case of radical innovation.

The function of RBV is considerable in a firm environment. However, there are several limitations of this economic theory also should be taken into account. Firstly, its ambiguity definitions, such as valuable, rare, inimitable, are quite vague concept. Secondly, RBV only concerns about the firm’s internal resources and capabilities but ignore external factors at the industry-level which are suggested by Porter’s Five Forces. In addition, RBV is static as it does not tell how resources can develop and change over time in its original formulation. Accordingly, the concept of dynamic capabilities, which can be defined as ‘the capacity of an organization to purposefully create, extend or modify its resource base’, is a strategic extension of RBV. The final point is that RBV is to a certain extent tautological but it misses an independent and efficient selection mechanism to explain which resources are valuable and which are not.

In conclusion, this essay firstly introduces the unique resources should be heterogeneous and imperfectly mobile with four characteristics: they must be valuable, rare, inimitable and non-substitutable. Apart from that, firms should adopt isolation mechanism to maintain its advantageous position. It is comprised of impediments to imitation and first-mover advantage. In terms of impediments, four types are mentioned including legal restriction, superior access to inputs and customers, market size and scale economies, as well as four kinds of intangible barriers. Furthermore, first-mover advantage consists of four aspects as follows: learning curve, reputation and customer uncertainty, switching cost and network effects. In the last part, some limitations of this theory are examined, which are argued as ambiguity definition, ignorance of external factors, lack of dynamics and redundance of this theory.