The Concept of First Mover Advantage, Essay Example

Introduction

First-mover advantage is an important concept found in economic and finance theory. Indeed, although the concept has different nuances depending on which field it is found in, it does share a common analytical thread: a country or firm, amidst uncertainty, decides to pursue a certain direction that has a palpable impact on how other economic participants react. This paper will look at first-mover advantage from the different academic fields of international trade and game theory. The concept of “first mover advantage” was first posited in New Trade Theory: New Trade Theory theorized that first movers in selected industries, particularly those associated with technology, would reap the gains of globalization faster than firms that followed later. First movers in game theory are more associated with the branch of economics known as “industrial organization.” Indeed, the focus of this concept is to understand how pricing and output are related in industries with duopolistic or monopolistic competition structures. While there are marked differences between how “first mover advantage” is conceptualized in the different fields of economics, the common analytic threads of benefits accruing to the first mover and influencing later behavior is consistent across the two fields.

Analysis

International Trade: First Mover Advantage

There are two notions of “first mover advantage” in the field of international trade: countries as first movers and firms as first movers, although the concept is used more in the latter context that in the former context. Thus, the context of first mover advantage of firms shall be treated first. The New Trade Theory broke with theoretical forefathers in a number of key areas. Proponents of the new trade theory posited that firms play a key role in the development of international trade. While this was not a novel invention, it did differ in emphasis from previous theories that emphasized the role of the state in international trade. Indeed, David Ricardo had set the trajectory of trade theory with his emphasis on a country’s competitive advantage in producing goods where it had a significant advantages in productivity.

This explanation held sway over international trade theory until Paul Samuelson and the Heckler-Olin model became ascendant in the field. While they still privileged the role of the country in trade theory, they propounded a different emphasis: the pattern of trade in the global economy was a function of different factor endowments that explained why countries produced one type of goods rather than another type. For example, Australia and Canada exported natural resources due to their rich (initial) resource endowment; resource-poor countries such as Japan and Korea produced electronics and other value-added devices due to the aggregation of capital and skilled labor. The focus, however, still remained on the country as the main unit of analysis.

New trade theory changed the existing explanation of what factors explained the pattern of international trade. New trade theory began with the work of Paul Krugman in the 1970s. Krugman had a different hypothesis regarding how international trade patterns arose: Krugman and his colleagues noticed that traditional trade theories predicted that trade between countries was a function of different comparative advantage (asymmetrical comparative advantage) ; however, a vexing puzzle still existed: countries with similar comparative advantages and factor resources traded heavily with each other. Indeed, the new trade theory changed the analytical locus of examination from why trade happened between different countries to why it occurred of countries of a similar economic profile.

The analytical tools to answer this question were different. Krugman and others round that trade increased due to a number of factors including returns to scale, imperfect competition, and first-mover advantage. Krugman hypothesized that two main points were important to understand the trade patterns in a globalized economy: 1) international trade can steadily increase through changes in production that include economies of scale; economies of scale will increase the variety of goods available, while also decreasing the price at which they are sold; 2) the world market for any product only has the capacity to support a certain number of firms. Thus, the pattern of trade will be influenced by those that were able to capture first mover advantages. Krugman and other economists have given several examples to buttress this point.

One example is firms in the electronics industry. The electronics industry is particularly susceptible to the “first mover advantage” due to the existence of standards and network effects of different products. Indeed, many economists posited that Japanese electronics and automobile firms were besieging the United States in the 1980s as a result of first mover advantage in a couple of areas. Most prominently, these firms had built up a substantial economies of scale advantage over counterparts in other countries due to greater productivity, use of resources, and overall management practices. Toyota and Sony were hailed as the new firms to beat as they produced the most innovative new products and gained market share away from traditional industry participants. In this case, the first mover advantage had to do with how firms produced their products in a way that was ahead of other companies. In hindsight, Japanese firms did have a first mover advantage, particularly vis-à-vis US and other firms that chose not to produce in a similar manner that improved output and cut production costs beyond the existing equilibrium.

There was another part of these firms strategy: they innovated in new products that other firms had to catch up with. Electronic firms are famous for building new innovational ecosystems that affords advantages over the competition: Sony was the first firm to mass market the VCR and Walkman stereos; Apple was the first firm to produce the IPod and Iphone. This is also an example of the first-mover advantage as it shut off the ability of competitors to come into the market, thereby preserving a handsome rent for the firms. There are numerous reasons why these firms succeeded: One reason is that they produced innovative products that were far ahead of the time and other firms had to scramble in order to produce anything like them. In the end, many could not and went out of business. There were, however, other reasons why it occurred including network effects. Once the base of consumers that use a certain technology expands to a tipping point, it can lead others to adopt the technology too and codify it among the leaders in the field. This is what happened for Sony and use of cassette tapes; this is also what happened to Apple with its strategy to build an innovative ecosystem that would chain users to the items purchased for their Ipod and Iphone, even if a better product came along.

The concept of first mover advantage in international trade is also synonymous with entrance into new markets. For example, after Deng Xiaoping decided to open China to foreign investment in the 1970s, there were a number of companies that established an immediate commercial presence. Countries such as Coca-Cola, Ford, and Motorola opened production factories and started to market to Chinese consumers. As a result, by the time many other multinational firms entered China in the 1990s and the 2000s, market share was already difficult to acquire. Indeed, in the areas of soft drinks and automobiles, these firms had established a first-mover advantage in that they were able to enter the country early, build a production and distribution network, and familiarize Chinese consumers with their products long before other firms were able to do the same. The first-mover advantage in this case was worth literally billions of dollars to the firms and their shareholders.

Overall, New Trade Theory put first-mover advantage on the map for international trade theory. The context is relevant to countries and firms; both firms that produce new products and innovate new production methods, as well as firms that enter new markets first in order to grab market share away from others.

Industrial Organization: First Mover Advantage

While first-mover advantage was part of a larger corpus of work associated with trade theory, the concept also arose in the context of game theory. There is some controversy over whether first-mover advantage, at least in its current form, was first used in the context of international trade or game theory. There is little controversy, however, that it emerged before both of these disciplines in the initial analysis of duopoly and oligopolistic firms.

Cournot and others were the first economists (some would argue microeconomists) to develop the concept of first-mover advantage in the context of firm-level competition. Indeed, while the classical system of Adam Smith gave clear implications on what the price level and quantity level would be for firms in a market with perfect competition, the same was not true where the market was not perfectly competition, which is likely 99% of the markets in existence. Indeed, the existence of market power in firm-level competition fundamentally changed the dynamics of how firms interacted with each other. Rather than relying on a mythical “invisible hand” that would clear the market at equilibrium price and quantity, firms in non-competitive markets dealt with the dynamic of pricing based on what other firms signaled in the market.

The French economist Cournot worked extensively with these types of market problems to understand how firms would react in an uncertain environment. Cournot established the “Cournot duopoly” model that offered the view of how two firms competed over time based on the following assumptions: 1) Firms produced the same goods and don’t collude with one another;2) each firm assumes that its rivals make decisions that maximize profits. Overall, the Cournot model uses these assumptions to understand how firms set prices, set output levels, and generally deal with strategy vis-à-vis other firms.

This is a main difference between the concept of first-mover advantage used in international trade versus that used in game theory. In the context of international trade, the main analytical locus is on understanding how firm behavior explains international trade patterns; the key is in understanding how firms achieve economies of scale and use first mover advantage to codify this advantage. In game theory, however, the focus is more on understanding how the firm makes decisions in pricing and output (level not product) to learn how firms operate in the market.

Indeed, different types of game theory games show how first-mover advantage can or cannot be an advantage for firms. Many typically posit that first-mover advantage is an insuperable competitive advantage; that is, it is better to move first because the firm has the ability to set the stage for what type of competition will occur and can react faster. This assumption, however, often times proves to be wrong: some strategists have shown that while the first mover has the advantage to set price and equilibrium, if done poorly, the strategy can hem in the initial mover so that it cannot recover over the long-run. This is the point of the book, The Strategy Paradox, that showed how firms that had the initial decision to set strategy were ultimately harmed by it in the long-run. This is because: firms that have an aggressive first mover decision tend to expend greater resources and commitment to ensure that the strategy succeeds. This leaves the firm unable to revise the strategy and compete with firms if they react in a different way that is not compatible with the strategy chosen by the first mover firm.

Game theory is worried about the connection about this strategy and how it ultimately results on the competitive battlefield.

Conclusion

Overall, there are numerous differences and similarities between how the first mover advantage function in the context of international trade and game theory. For international trade, the concept of first-mover advantage signaled a sudden departure from the previous analytical framework: Classical trade theory posited that countries were the main unit of analysis and productivity in different countries established international patterns of trade; although the innovations of Samuelson and Hecker Ohlin changed the focus to resource endowments, the focus on country-level analysis persisted.

The New Trade Theory, theorized by Paul Krugman and his acolytes, posited that while country-level factors were important, the fact that countries with similar comparative advantages illustrated that something was happening at the firm-level. Indeed, the New Trade Theory posited that firm-level analysis was the key in understanding expanding world, particularly focusing on economies of scale and first-mover advantage. First mover advantage played a key role in the emerging theory as firms needed some type of advantage to build economies of scale over other firms. Some firms focused on building innovative new ways to produce goods, such as the production systems at Toyota. They boosted productivity, decreased the cost of production, and created new innovative products that consumers wanted. This was also the case with Apple: they exercised first-mover advantage in Ipod and other products that led to a sustainable competitive advantage.

First mover advantage was also exercised by firms entering new countries: Coca Cola and Ford entered China before other firms in their industries; as a result they were able to build competitive advantage and increase their ability to compete vis-à-vis other firms.

First mover advantage was also explored in the context of game theory. Game theory arguably has a longer history than that in international economics. Cournot in the eighteenth century focused on exploring the competitive dynamics between firms in non-competitive markets; that is, markets in which market power exists. Game theory later moved onto institutionalize some of these assumptions in order to understand how firms behave. Unlike international trade theory, however, which wanted to understand why firms produced certain products, a question that explained larger trading patterns, game theory focused on how firms wanted to set prices and produce output. This analysis is important for a number of reasons that includes the ability to understand which markets are competitive, and perhaps how firms maximize profits and make strategy decisions moving forward.

While some have posited that first-mover advantage is usually the decider of a commercial contest, the concept is important but not demonstrative in deciding economic completion. Indeed, as cited throughout the paper, first mover advantage does open up opportunity that otherwise might not have existed for a particular firm. However, the opportunity is also a threat, particularly to the extent that a firm chooses the wrong strategy or makes an over commitment trying to establish competitive advantage vis-à-vis other firms. Thus, one should be careful to put too much stock in the concept of first-mover advantage, instead of focusing on how the phenomenon affects the dynamic competitive equilibrium in different fields. First mover advantage can explain why technology firms may have longer lead times once they establish dominance, but also why they fall faster once a new paradigm is established. In the field of game theory it may explain how market power affects the way firms set prices and quantity.

References:

Fudenberg, Drew and Tirole, Jean. 1991. MIT Press.

Krugman, Paul. 1994. International Economics. Wiley Press.

Krugman, Paul. 1986. Strategic Trade Policy and the New International Economics. Harvard University Press.

Raynor, Mike. 2006. The Strategy Paradox. Wiley Press.