So we've been discussing and analyzing capabilities and we've talked about these three steps to do so, identifying capabilities, using the value chain, assessing alignment both internally and externally. And then ultimately assessing the sustainability of any advantage thinking in particular about imitability and durability. So let's go back to Southwest Airlines. When I talk about Southwest in my classrooms, usually I'll get some enterprising student who raise their hand and ask me a pretty important question, which is, this is great, we can analyze them and identify that they have a sustainable competitive advantage. But how do you build this in the first place? How do you build these types of capabilities? A few years back I had an opportunity to sit with the then president Collin Bard of Southwest Airlines and ask her if you had to do it all over again could you build the capabilities that you had? And she reflected on the moment and actually though it might have been very difficult to do so. So how do you build capabilities? Let's think about one first alternative here. Well, you could go out and acquire them from others. There are in fact markets for resources out there. There's markets for labor and talent. There's markets for technology. As I mentioned before, there are markets for patents and the like. There are other ways you can acquire capabilities as well. When those capabilities are maybe have a higher order here that are embedded in the organization. Perhaps you go and acquire it outright through a merger and acquisition as a way to get capabilities. Now, it's interesting to think about some of the challenges of using this approach to acquire a capability. Think about Southwest Airlines and their unique culture. If they were bought by another airline would that new airline be able to maintain that culture they have after that acquisition? The last thing they'd want to do is to buy a capability in this way and then destroy the very capability that they were seeking to buy. There are other mechanisms as well, in which firms might gain access to capabilities that they don't posses. Things like alliances, R and D alliances, bringing two firms together to maybe share knowledge and resources. Various types of associations and partnerships. Corporate venture capital refers to efforts by larger corporations to invest in essence venture capital into small upstart ventures. Often to gain a window onto technology or window on the various capabilities that firms might have. If you look at for example, the pharmaceutical industry they are often very active in partnering with and maybe ultimately licensing technology from other biotech companies, biotech startups in the like. So what are the limitations of this idea of just going out and buying capabilities? Well, first of all, it's only viable if there are in fact factor markets here, that there is a market for these things to buy and sell. And you need those factor markets to be imperfect. But what do we mean here? Well, this goes back again to our fundamental principle business strategy. If there is a perfectly competitive factor market, then the price one would end up paying to acquire that factor would end up exceeding or at least equaling the value that it creates for the organization. So consider yet another sports example here, and going back to basketball. LeBron James, arguably the best player in the world right now. He was recently on a free agent on the market. So multiple teams were bidding for his services. And if this was a true perfectly competitive market, one could imagine that the price paid to acquire his services actually exceeds or at least equals the value he creates. Otherwise someone else would be willing to step in and pay him a little more. So this idea that there needs to be an imperfection in the factor market to be able to acquire it better than others. So what does this mean? It means ultimately that firms must either have superior information or some preexisting complimentary capability to be able to access that capability for less than the value it creates. A few years back there was a book written by Michael Lewis called Moneyball was made into a popular movie starring Brad Pitt in more recent years. In that book, they tell the story of the Oakland Athletics, a US baseball team that has been successful despite the fact that they come from what they call a small market with limited revenue, limited resources. They've been able to succeed in part because they leverage information to their advantage. They unlock secrets to competitive success for individual players, individual talent that others weren't able to see. They leverage superior information to acquire factors, in this case human capital, for less than others might see their value. Another way to think about build to do acquire these types of factors is to preexisting complementary capability. So for this, let's go back to a sports team again. If you're a basketball team and you're looking to acquire LeBron James, you might argue that he's more valuable to you given the complimentary set of players you have to surround him with than they are for another team. As long as you're willing to pay just a little bit more than that other team, you can abstract value from acquiring that talent. So again, you need either superior information or preexisting complementary capability to be able to get this assets for less than their value. Alternatively, of course, you could just have luck, you could just be lucky and find one of these assets when others don't want to see them. But that's less interesting to us at the end of the day. So let me show this graphically to kind of illustrate this point. Imagine two companies. A leader and a laggard here. They both have some performance metric that they position themselves on. Let's call that maybe the quality of their products, if you like, and they use to create a certain amount of value for their costumers in the markets that they operate. An information story would be one where they're both on basically the same distribution here and the leader is exiting the laggard. And the laggard from simply doesn't know as well as the leader as the best way to position themselves on the performance. In essence, they need to increase their quality to increase value here. You'll note, by the way, that if you can over quality here in my example, you could have more quality than is valued, and therefore you see value go down. Complementarity is a slightly different argument. It's in essence that the curves faced by different firms are different. So it's not that the laggard is not as intelligent or not as informed as the leader is that they have a different set of circumstances that makes their position the best that they can do for who they are, but it is inferior to someone else. Again, you need either an information advantage or complementarity advantage to be able to arguably build and acquire one of these capabilities, just you can acquire one of these capabilities. So that gets me to alternative two here. What if we just develop these internally over time? And this is what we normally think about when we think about a company or an organization, building up their capabilities. This is why companies invest heavily in new product development, internal research and development, just their ability to create innovative new products and services and capabilities. Firms also spend a lot on knowledge management and training again, to build their capabilities and they leverage their superior leadership hopefully, to do so. I would argue though, that the limitations I just articulated for acquiring capabilities are actually the same for developing internally over time. And this gets back again to a fundamental principle. If everybody knows this is valuable and they know how to develop that valuable capability, then arguably everyone will develop that capability and it will not be a source of competitive advantage. So, to be successful and developing a capability that provides you a competitive advantage, you either need, again, superior information. You know why, you know what to do. Or a preexisting complimentary capabilities that you have better know how to do it. You can actually execute on this better than others. Or again, we're back in the world of luck where something happens within your history that allows you to have this capability that others aren't able to develop. So again, to build your capabilities, you can either go and purchase those capabilities, you can develop them internally over time. But in either case, you need to either have better information or a better set of preexisting complementary capabilities that allow to acquire those capabilities for less than they value they create.
