FIRM SCOPE ADVANTAGES AND THE DEMAND SIDE
Jens Schmidt
Richard Makadok
Thomas Keil
Abstract
We use a formal model to demonstrate that, unlike competitive advantages in a single-market
context, multi-market scope advantages have different effects on performance depending upon
whether they arise from supply-side or demand-side factors. Our key finding is that, counterintuitively, a supply-side scope advantage becomes more valuable than an equivalent-size
demand-side scope advantage as customer preferences become positively correlated.
Consequently, the most attractive type of industry for a given firm depends upon which
particular type of scope advantage it has, and the best type of scope advantage for a firm to
develop depends upon characteristics of demand in its industry. We interpret these results as
having implications for the optimum scope of a firm, the boundaries of industries, and how
competitive advantage shifts between rival firms as their industry evolves.
Firm scope advantages and the demand side
INTRODUCTION
Research on how firms set their product market scope has offered numerous theoretical
explanations, including: mutual forbearance to restrain rivalry (Bernheim & Whinston, 1990;
Gimeno, 1999; Karnani & Wernerfelt, 1985), preemptive entry deterrence in product space
(Schmalensee, 1978), platform investments to achieve flexibility (Chang, 1996), opportunistic
risk reduction by managers at the expense of shareholders (Amihud & Lev, 1981), and
exploitation of firm-specific synergies to achieve competitive advantage (Montgomery &
Wernerfelt, 1988; Robins & Wiersema, 1995). Research on this last explanation has considered
both supply-side synergies due to proprietary resources or inputs that are shared across product
markets (Markides & Williamson, 1994; Markides & Williamson, 1996; Palich, Cardinal, &
Miller, 2000) or due to any other proprietary type of scope economies (Teece, 1980), as well as
proprietary demand-side synergies due to a superior ability to motivate customers to buy
multiple products from the same firm (Chatain & Zemsky, 2007; Tanriverdi & Lee, 2008; Ye,
Priem, & Alshwer, 2011). 1
While prior research has been valuable in identifying both supply- and demand-side sources
of synergy, it has relatively little to say about the circumstances under which these two types of
synergies are more or less valuable for a firm. In other words, we lack a theoretical account of
when it is optimal for a firm to focus on supply-side versus demand-side sources of synergy
when building a scope-based competitive advantage. Developing such a theory would have
implications for firms’ investment decisions and their decisions about product market scope, as
1
As a boundary condition, it is important to note that, by definition, such demand-side synergies can only occur
in situations where the markets for different products or services share the same set of customers. The two most
common scenarios where this might occur are when the products/services are universal or near-universal necessities
(e.g., utilities like water/sewer, electricity, and telecommunications) or when they are complements (e.g., hardware
and software, surgery and post-operative rehabilitation, health-care services and pharmaceuticals, architecture and
construction, or equipment and services needed to operate the equipment, such as installation, warranty, financing,
maintenance, training, or fueling).
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Firm scope advantages and the demand side
well as implications for both the boundaries and the evolution of industries.
In this paper we address this gap in the literature with the help of an analytical model.
Drawing upon concepts from the value-based strategy literature (Brandenburger & Stuart, 1996),
we examine how the relative value of supply-side versus demand-side firm-specific scope
advantages differs depending on the industry-wide structure of customer preferences. In
particular, compared to a proprietary supply-side synergy, a proprietary demand-side synergy is
relatively more valuable when customer preferences are more negatively correlated across
products– i.e. when customers have a weaker intrinsic preference (or a stronger intrinsic dislike)
for buying multiple products from the same firm.
This result is somewhat counterintuitive from the perspective of value-based strategy, which
views competitive advantage as a consequence of a firm’s proprietary ability to create more
economic value than its competitors, where economic value is defined as the difference between
the price that customers are willing to pay for its product and the cost that the firm must pay in
order to provide that product to those customers (Brandenburger & Stuart, 1996). In a scenario
with only a single product market, the magnitude of the competitive advantage is the same
regardless of whether the firm’s superior economic value is created on the demand side by
increasing customers’ willingness to pay for the product or created on the supply side by
decreasing the firm’s cost to provide that product, since an equal-sized shift in either case
increases the firm’s economic value creation equally. Assuming that the same “confidence
index” governs the price bargaining between firms and customers in either case (Brandenburger
& Stuart, 2007), the only difference between the outcomes of two cases is whether the negotiated
price goes up (as in the case of a proprietary demand-side increase in customers’ willingness to
pay for the product) or down (as in the case of a proprietary supply-side decrease in the firm’s
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Firm scope advantages and the demand side
cost to provide the product). In either case, the total amount of economic value created, and the
relative shares of economic value that are captured by the firm and its customers are the same.
However, once we consider a multiple-product scenario in which competitive advantage
comes in the form of a proprietary cross-product synergy, the outcomes of demand-side and
supply-side advantages diverge radically. This divergence occurs because, although both types of
synergies allow the advantaged firm to attract customers away from the disadvantaged firm, a
demand-side synergy allows the advantaged firm to attract a different type of customers than a
supply-side synergy does. In the supply-side synergy case, this attraction to the advantaged firm
is relatively stronger among customers who would intrinsically (i.e., in the absence of any
synergies) prefer consuming only products from the disadvantaged firm. Conversely, in the
demand-side synergy case, this attraction to the advantaged firm is relatively stronger among
customers whose intrinsic preferences (i.e., in the absence of any synergies) are split between the
two firms – i.e., preferring to consume some products from the advantaged firm and others from
the disadvantaged firm. Therefore, in environments where customers have a stronger intrinsic
preference to consume different products from the same firm, a firm with a supply-side synergy
will gain relatively more market share and profit than a firm with a comparable-size demand-side
synergy. Conversely, in environments where customers’ intrinsic preferences for different
products are more split between firms, a firm with a demand-side synergy will gain relatively
more market share and profit than a firm with a comparable-size supply-side synergy.
In other words, the relative profitability of supply-side versus demand-side synergies depends
critically upon the cross-product correlation of the intrinsic preferences of customers in the
market: When this cross-product preference correlation is more positive (indicating an intrinsic
preference for buying different products from the same firm), a proprietary demand-side synergy
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Firm scope advantages and the demand side
becomes relatively less profitable in comparison to a proprietary supply-side synergy.
Conversely, when it is more negative (indicating an intrinsic preference for buying different
products from different firms), a proprietary demand-side synergy becomes relatively more
profitable in comparison to a proprietary supply-side synergy.
In order to understand the practical meaning of this result, we must interpret the real-world
conditions under which the cross-product correlation of customers’ intrinsic preferences would
be higher or lower. For example, it would be higher in situations where the market’s preference
for “one-stop shopping” is higher due to higher search costs or more time-constrained customers
– e.g., supermarkets displacing butcher shops, greengrocers, and dry-goods stores (Klemperer &
Padilla, 1997). Similarly, the correlation would also be higher in industries where all competitors
offer customer-loyalty incentives (e.g., the nearly ubiquitous airline frequent-flyer program). On
the other hand, it would be lower or negative in factor markets where businesses are more
vulnerable to “hold-up” problems from their suppliers, in which case those businesses might
prefer to reduce suppliers’ bargaining power by sourcing different inputs from different
suppliers. Likewise, there may be some markets (e.g., in entertainment or fashion) where
customers have an intrinsic preference for variety, which would imply a negative correlation.
Another factor that would affect this correlation is the degree of difficulty that consumers face
when trying to combine products from different suppliers. For example, in technology products,
the correlation would be lower in situations where there is a universal standard interface for
connecting products, or higher in situations where each company has its own idiosyncratic and
proprietary interface. Likewise, in situations where customers have less experience in using the
products, they will know less about how to combine them and will therefore rely more on the
seller to combine them, which would raise the correlation (Spiller & Zelner, 1997). Similarly,
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Firm scope advantages and the demand side
markets composed of professionals or experts who use the products frequently would have a
lower correlation than markets composed of amateurs who use them only rarely.
Although our model is static rather than dynamic, it could possibly be interpreted as applying
to a scenario where the same product is purchased at several different times (instead of several
different products being purchased at the same time), in which case the cross-product preference
correlation would simply represent the intensity of switching costs, brand loyalty, or some other
type of inertia in customers’ purchasing behavior. It can also be interpreted in terms of a
dynamic shift of an industry where customers become more competent over time at combining
products themselves and less dependent upon the seller to do so, which would lower correlation.
Our study advances strategic management theory on several fronts. In particular, we add to a
growing stream of studies that explores the impact of demand-side factors on strategic issues
such as technology development paths (Adner & Levinthal, 2001; Adner, 2002), resource
repositioning (Adner & Snow, 2010), the sustainability of competitive advantage (Adner &
Zemsky, 2006), knowledge embedded in existing customer relationships (Chatain, 2011) or
corporate diversification decisions (Ye, Priem, & Alshwer, 2011). In particular, we show how
the correlation of preferences across product markets can influence the value of a scope
advantage. In terms of the literature on firm scope and diversification, our findings identify
conditions where demand-side synergies may have (or should have) a relatively larger influence
over firm scope decisions than supply-side synergies. Our findings are also relevant for
explaining the interaction of firm-level scope advantages with industry-level variables, such as
entry of firms with different types of scope advantages into an industry or the change of industry
structure as a consequence of firms pursuing their scope advantages. Finally, our study may also
contribute to research about the consequences of any phenomenon that affects the cross-product
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Firm scope advantages and the demand side
correlation preference, which may include, as noted in the previous paragraph, the literatures on:
search costs, customer time constraints, supplier “hold up” problems, universal standard
technical interfaces, customer learning and experience, switching costs, and brand loyalty.
Our study proceeds as follows. In the next section we provide an overview of the extant
literature on supply-side and demand-side scope advantages. Next we introduce and solve the
model. Then we discuss the implications of our key results for strategic management theory.
Finally we provide conclusions and some suggestions for further study.
TYPES OF FIRM SCOPE ADVANTAGES
Supply-side and demand-side synergies
There is an extensive literature on the mechanisms and rationales for firms setting their
product market scope to exploit cross-product synergies. Both supply-side and demand-side
rationales for synergies have been identified. While a large part of this literature seeks to explain
the optimal scope of the firm, e.g. by considering the relatedness of industries and product
markets (Hoskisson & Hitt, 1990; Palich, Cardinal, & Miller, 2000), our paper is concerned with
how firms gain competitive advantage through diversification.
The rationale for building competitive advantage by exploiting superior proprietary supplyside synergies requires that organizations for providing different products or services exhibit
similarity in their operating logic (Prahalad & Bettis, 1986) and draw upon common firmspecific resources (e.g., Farjoun, 1994; Robins & Wiersema, 1995). To the extent that these
proprietary resources are superior to rivals’ resources in improving the effectiveness of the joint
production, distribution, marketing, or selling of different products or services, they give the firm
a supply-side scope advantage – for example, through superior scope economies. In addition, a
small stream of research on diversification suggests that there may also be advantages to be
7
Firm scope advantages and the demand side
gained from entering product markets that share the same customers (Chatain & Zemsky, 2007;
Cottrell & Nault, 2004; Nayyar, 1990; Nayyar, 1993). Just as firms can sometimes enjoy
synergistic benefits from co-producing, co-distributing, co-marketing, or co-selling different
products or services, consumers can also sometimes enjoy synergistic benefits from copurchasing or co-consuming different products or services from the same firm. One might think
of these demand-side synergies as economies of scope in consumption or in purchasing. To the
extent that one firm has a proprietary ability to increase the synergistic benefits enjoyed by its
customers to a higher level than rival firms can, this ability gives the firm a demand-side scope
advantage. In effect, its customers would have stronger scope economies in consumption or in
purchasing than its rivals’ customers.
A number of demand-side factors have been identified that contribute to firms achieving
demand-side scope advantages. Some of these give customers superior economies of scope in
purchasing, while others give them superior economies of scope in consumption. Let us consider
each of these categories in turn.
Superior knowledge and familiarity of customers with the firm (Nayyar, 1990; Nayyar, 1993;
Priem, 2007) can reduce their search costs or other transaction costs in order to give them
superior economies of scope in purchasing. For example, by collecting a unique database on the
reputations of sellers, eBay reduces its customers' search costs and risk of fraud by letting them
make purchases from multiple sellers with confidence, even when those sellers are tiny,
relatively unknown companies. Likewise, online service and game companies like Facebook and
Zynga that offer several different services and games simplify transactions by creating “virtual
currencies” that are conveniently used to pay for all of their paid services or games. Similarly,
PayPal service gives its customers the convenience of paying for multiple transactions to
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Firm scope advantages and the demand side
different sellers with a “single sign-on” which eliminates the need to re-enter credit card numbers
and expiration dates for each purchase, as well as the added security of keeping their credit card
and bank account information out of the hands of sellers (whose identities may be unknown).
PayPal is able to do this for a wider range of different sellers than competing services because its
parent company eBay made PayPal the default payment method for its auctions and other
transactions. Besides secure payment, another transaction cost is delivery, which is where
Amazon.com has a scope advantage. By virtue of superior bargaining power over overnight
delivery companies, Amazon.com offers its customers two forms of superior scope economies in
purchasing. First, it offers free “Super Saver” (i.e., slow) shipping on orders over twenty-five
dollars, which may include products from a variety of different categories. Second, its “Amazon
Prime” service gives its customers an unlimited number of free fast (two-day) product deliveries,
across a wide variety of different product categories, for a flat annual fee of $79 – and even
refunds $1 of that fee for each shipment that an Amazon Prime member chooses to take by a
slower delivery method.
One way a firm can give its customers superior economies of scope in consumption is by
exploiting existing customer relationships or superior knowledge about customers to provide
product combinations that are best suited to their specific needs (Chatain & Zemsky, 2007;
Zander & Zander, 2005). A firm may also gain proprietary customer synergies or switching costs
by facilitating customers’ economies of learning (Cottrell & Nault, 2004) as a form of economies
of scope in consumption. For example, unlike its main competitor Boeing, Airbus makes all of
its cockpits look identical and work identically across all of the different aircraft they produce,
which makes it much easier for pilots to qualify to operate different Airbus aircraft than for
different Boeing aircraft. Consequently, the reduced training costs and greater flexibility of labor
9
Firm scope advantages and the demand side
gives airlines superior economies of scope in “consuming” Airbus aircraft than they would have
with Boeing aircraft. Similarly, Google gives its users the convenience of a “single sign-on” to
obtain access to a superior range of different personal information services working together in
tandem, including e-mail, calendar, task list, social networking, web site hosting/editing,
personalized virtual newspapers/magazines, and portfolio tracking, as well as on-line storage,
sharing, and editing of documents, spreadsheets, presentations, and photos. Superior economies
of scope in consumption may also be created by having a customer loyalty program that is
superior to those of competitors – for example, an airline frequent-flyer program that offers a
superior choice of destinations.
Superior supply-side synergies are known to motivate a firm to gain competitive advantage by
diversifying across businesses that employ common resources, even if they are unrelated in terms
of the customers they serve (Li & Greenwood, 2004; Siggelkow, 2003; Stern & Henderson,
2004); likewise, superior demand-side synergies may also motivate a firm to gain competitive
advantage by diversifying across businesses that serve a common set of customers even if they
are unrelated in terms of the resources they employ (Nayyar, 1993; Tanriverdi & Lee, 2008).
While prior research has identified the importance of both supply-side and demand-side
advantages in understanding the performance consequences of product-market scope choices, we
know relatively little under what circumstances each factor may have a stronger effect. The
limited research that has incorporated both demand- and supply-side factors has been conducted
in the highly idiosyncratic software industry (which is subject to strong network externalities)
and found that in that context demand-side factors may dominate supply side factors (Nayyar,
1993; Tanriverdi & Lee, 2008). In the following we will go beyond these limited findings in
developing a more general model that helps us explain under what circumstances supply- and
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Firm scope advantages and the demand side
demand-side scope advantages may have stronger performance implications.
Value creation, competitive advantage, and scope advantage
Following the value-based strategy literature (Brandenburger & Stuart, 1996), we distinguish
between value creation (defined as difference between customers’ willingness to pay for a
product and the firm’s cost to provide that product) and value capture (defined as that part of
value creation that can be appropriated by a firm or a customer), and we also define competitive
advantage as superior value creation, i.e. a higher spread between customers’ willingness to pay
and firm costs than competitors (Adner & Zemsky, 2006; Peteraf & Barney, 2003). Value-based
logic incorporates both the supply and demand sides of value creation, and also makes explicit
the two types of competitive advantage identified by Porter (1985): cost advantage (having lower
costs than competitors at comparable customer willingness to pay), and differentiation advantage
(having higher customer willingness to pay than competitors at comparable costs). By combining
the supply-side and demand-side scope advantages with cost and differentiation advantages, we
can distinguish between four scope advantages, since either supply-side or demand-side scope
advantages can affect either cost or differentiation. The underlying mechanism works through a
firm-specific factor that the firm can exploit across product markets. This factor can be a
resource or capability that resides inside the firm, such as human expertise (Farjoun, 1994) or
customer-specific knowledge (Chatain, 2011), but can also be external to the firm, such as
customer experience in dealing with a firm (Nayyar, 1993). Table 1 lists examples for each of the
four resulting types of advantage.
-------------------------------Insert Table 1 about here
-------------------------------We define a scope advantage as a firm’s ability to create more economic value than its
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Firm scope advantages and the demand side
competitors by participating in a particular combination of different product markets. Defined in
this way, a scope advantage is a special case of a competitive advantage – i.e., a competitive
advantage that materializes if and only if the firm participates in the right combination of
different markets. The scope advantage is profitable if the firm captures some portion of this
extra economic value created. Superior performance would additionally require a firm to capture
more value than its competitors. Diversification literature usually hypothesizes and tests the
direct link from resources (which it aims at measuring) to performance (which is more directly
observable than resources) without analyzing the intermediate step of scope advantage. A benefit
of our model is that it also opens up the intermediate step and thus sheds additional light on the
mechanism by which firm-specific factors enable scope advantages and thereby allow firms to
enjoy superior performance.
MODELING DEMAND-SIDE VERSUS SUPPLY-SIDE SCOPE ADVANTAGES
Our model serves two purposes: First, it demonstrates a difference between the outcomes of a
single-market competitive advantage and the outcomes of a multi-market scope advantage.
Second, it demonstrates a difference between the outcomes of a supply-side scope advantage and
a demand-side scope advantage of equivalent size. Let us consider each of these results in turn.
In comparing the single-market case to the multi-market case, we show that the difference
between a supply-side advantage and a demand-side advantage has little impact on the outcomes
of the single-market case, but substantial impact on the outcomes of the multi-market case. In the
single-market case, all of the important outcome variables – including the aggregate amount of
economic value created, the amount of economic value captured by each firm and by their
customers, and the distribution of market shares between firms – are unaffected by whether the
competitive advantage comes on the supply side or the demand side (and the only outcome that
12
Firm scope advantages and the demand side
differs is whether the advantaged firm raises or lowers its price). By contrast, in the multi-market
case, a firm with a demand-side scope advantage attracts a different set of customers than a firm
with a supply-side scope advantage of equal magnitude, and this difference between the types of
customers served has a substantial impact on the important outcome variables.
The second purpose that our model serves is to examine the conditions under which a supplyside scope advantage or a demand-side scope advantage will have a greater impact on firm
performance. In particular, we identify the market-wide cross-product correlation of customer
preferences as an important contingency factor that influences the relative benefits of supply-side
versus demand-side scope advantages.
The remainder of this section is organized as follows: First, as a baseline for comparison, we
describe how supply-side and demand-side competitive advantages of equivalent size affect the
outcomes of a well-known classic single-market model. Second, we extend this classic model to
capture a two-market context. Third, we examine how this two-market version of the model
behaves differently under a supply-side scope advantage than under a demand-side scope
advantage of equivalent size. Fourth, we examine how these differences are affected by changing
the market’s cross-product preference correlation. For the purposes of this abbreviated draft, we
present the results of all of these models through graphical illustration. 2
The single-product case
We start with the classic Hotelling single-market linear model (D'Aspremont, Gabszewicz, &
Thisse, 1979; Hotelling, 1929) of competition between two horizontally differentiated firms,
such as Coca-Cola and Pepsi-Cola. Assume that customers are uniformly distributed along a line
segment from −1 to +1, and that the two firms are positioned at the opposite endpoints of this
2
In order to comply with the Academy of Management’s page limit on manuscripts, we have omitted the full
mathematical derivation of our results. This lengthy derivation will be included as an appendix to future drafts of
this paper.
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Firm scope advantages and the demand side
line segment, with firm 1 located at the −1 endpoint and firm 2 at the +1 endpoint. Each firm
produces one product, which is sold in indivisible units, and each customer purchases and
consumes exactly one unit from exactly one firm. A customer’s willingness to pay for a given
firm’s product is reduced in direct proportion to her distance from that firm. 3 Customers who are
located close to one of the line segment’s endpoints exhibit a strong intrinsic preference for the
product of whichever firm is located at that endpoint, so it would take a very large price discount
to induce them to switch their purchase to the opposite firm’s product. Conversely, a customer
located at the line segment’s midpoint (at the origin) is intrinsically indifferent between the two
firms’ products, so even a very small price discount would induce her to switch. In the soft-drink
industry, this corresponds to the fact that some consumers are brand-loyal to Coke regardless of
price, other consumers are brand-loyal to Pepsi regardless of price, and still others are pricesensitive and simply purchase whichever cola is cheaper. Both firms have constant marginal
costs regardless of the quantities of output they produce, and no fixed costs. Each firm sets its
own price in competition with its rival, with no opportunity for collusion or price discrimination.
-------------------------------Insert Figure 1 about here
-------------------------------As a starting point, we assume symmetry between the two firms, so that neither firm has any
cost or quality advantage. Both firms share the same marginal cost per unit produced, and
customers’ willingness to pay for their respective products are an exact mirror image of each
other across the origin. As a result of this symmetry, both firms set the same price, and the
customer located at the origin is exactly indifferent between the two firms’ products. The
3
This distance-related decline in willingness to pay can be interpreted as a cost of transportation in the case
where the horizontal dimension is geographic. Or, in the case where the horizontal dimension represents a product
attribute, it can be interpreted as a cost of tailoring to adjust the product closer to the customer’s ideal preference, or
as a simple disutility from consuming a product that does not exactly match her ideal preference.
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Firm scope advantages and the demand side
outcomes of this scenario are as illustrated by the Case 1 graph in the left-side panel of Figure 1:
Each firm captures its respective half of the market on its own side of the origin, so their market
shares are equal; and since their costs and prices are equal as well, it follows that they also
capture equal amounts of economic value as profits. Likewise, their respective customer groups
also capture equal amounts of economic value as consumer surplus.
Next we consider how this equilibrium is altered if the symmetry is broken by giving one firm
a competitive advantage. Without loss of generality, let the advantaged firm be firm 1 located at
the −1 endpoint, and let the disadvantaged firm be firm 2 located at the +1 endpoint. We first
consider a supply-side cost advantage in the form of reduced marginal cost, and then a demandside differentiation advantage in the form of increasing the overall market’s perception of
product quality (i.e., vertical differentiation). In Figure 1, the supply-side cost advantage scenario
is illustrated by the Case 2 graph in the middle panel, and the demand-side differentiation
advantage scenario is illustrated by the Case 3 graph in the right-side panel.
In the supply-side cost advantage case, the advantaged firm must choose the price that will
best exploit its lower marginal cost. At one extreme, it could reduce its price by the full amount
of the cost reduction, which would maximize its gain in market share while keeping its margin
unchanged. At the opposite extreme, it could leave its price close to the symmetric-case pricing
level, which would maximize its margin improvement while keeping its market share unchanged.
Since profit in this model equals the product of margin and market share 4, neither of these
extreme options is optimal. Rather, in order to maximize the product of its margin and its market
share, the advantaged firm instead reduces its price by an intermediate amount, which increases
both its margin and its market share by an intermediate amount. As a defense against this
4
In this model, since all customers always buy exactly one unit of output, the overall market size is kept fixed.
Therefore, each firm’s market share is always directly proportional to its output sold.
15
Firm scope advantages and the demand side
incursion by the advantaged firm, the disadvantaged firm mitigates its loss of market share by
reducing its price as well, but by a smaller amount than the advantaged firm. As the Case 2 graph
in the middle panel of Figure 1 shows, the advantaged firm enjoys higher margin (height of its
profit rectangle), higher market share (width of its rectangle), and higher profit (area of its
rectangle) than in the symmetric case, while the disadvantaged suffers a reduction in margin,
market share, and profit from the symmetric case. The total economic value captured by
customers as a consumer surplus is higher than in the symmetric case.
For the demand-side differentiation advantage case, rather than reducing the advantaged
firm’s marginal cost, we instead raise all customers’ willingness to pay for its product (as Pepsi
attempted with its Pepsi Challenge marketing campaign), and we do so by the same amount as
we had previously reduced its marginal cost. Here again, the advantaged firm must choose the
price that will best exploit this quality advantage. At one extreme, it could raise its price by the
full amount of the increase in customer willingness to pay, which would maximize its increase in
margin while keeping its market share unchanged. At the opposite extreme, it could leave its
price close to the symmetric-case pricing level, which would maximize its market share gain
while keeping its margin unchanged. For the same reason as before, neither of these extreme
options is optimal. Instead, the advantaged firm raises its price by an intermediate amount, which
increases both its margin and its market share by an intermediate amount, and the disadvantaged
firm defends against this incursion by reducing its price to some degree, which mitigates its loss
of market share. As the Case 3 graph in the right-side panel of Figure 1 shows, the advantaged
firm enjoys exactly the same increase in margin, market share, and profit that it would obtain in
the cost advantage case, while the disadvantaged firm suffers exactly the same reduction in
margin, market share, and profit that it would in the cost advantage case. Likewise, customers
16
Firm scope advantages and the demand side
also gain the same amount of consumer surplus as they would in the cost advantage case. The
only outcome that differs between the cost advantage case shown in the middle graph of Figure 1
and the differentiation advantage case shown in the right-side graph of Figure 1 is whether the
advantaged firm’s prices go up or down. Indeed, even the magnitude of its price change is the
same in both cases, with only the directions differing. So, the two graphs are identical except for
the direction of their vertical shift.
The multi-product case with uniform customer distribution
Next, we demonstrate that the equivalence between a supply-side cost advantage and a
demand-side differentiation advantage under a single-market scenario (as shown above in the
previous sub-section) does not occur under a multi-market scenario where competitive advantage
comes in the form of a proprietary cross-product synergy – i.e., a scope advantage, as defined
earlier. We add a second dimension to the Hotelling linear market to create a two-market
“Hotelling square,” which has been applied elsewhere to address a different set of research
questions than we examine here. 5 As in the single-market scenario, we start with the symmetric
case where neither firm has a competitive advantage, and we then compare this symmetric case
to the cases of a supply-side scope advantage and a demand-side scope advantage.
Consider a Hotelling square that extends from −1 to +1 in both dimensions, as shown in
Figure 2, with firm A located at the lower-left corner (−1,−1) and firm B at the upper-right
corner (+1,+1). Each firm produces two products, with the characteristics of product 1
represented along the horizontal dimension and the characteristics of product 2 represented along
the vertical dimension. As in the single-product scenario, we continue to assume that each
5
In industrial organization economics, the mix-and-match literature uses a Hotelling square to examine the
desirability of standardization for providers of complementary products (Boom, 2001; Denicolò, 2000; e.g., Matutes
& Regibeau, 1988; Matutes & Regibeau, 1992). More recently, a Hotelling square model has also been used in
strategy research on platform bundling (Eisenmann, Parker, & Van Alstyne, 2011).
17
Firm scope advantages and the demand side
product is sold in indivisible units, and that each customer purchases and consumes exactly one
unit of each product from exactly one firm. A customer’s horizontal position in the square
represents her ideal preference for the first product’s characteristics, and her vertical position in
the square represents her ideal preference for the second product’s characteristics. Customers
with a stronger preference for firm A’s version of product 1 have a horizontal position closer to
the left side of the square, while customers with a stronger preference for firm B’s version of
product 1 have a horizontal position closer to the right side of the square. Likewise, customers
with a stronger preference for firm A’s version of product 2 have a vertical position closer to the
bottom edge of the square, while customers with a stronger preference for firm B’s version of
product 2 have a vertical position closer to the top edge of the square. Consistent with the singlemarket scenario, we capture the strength of these preferences by assuming that a customer’s
willingness to pay for a firm’s version of product 1 is reduced in direct proportion to her
horizontal distance from that firm in the square, and that a customer’s willingness to pay for a
firm’s version of product 2 is reduced in direct proportion to her vertical distance from that firm
in the square. 6 As a baseline for easy comparison to the single-market case, we start with the
assumption that customers are distributed uniformly across the entire square, but this uniformity
assumption is highly limiting because it requires customers’ intrinsic preferences to be
independent across the two products. Accordingly, in a later section, we will relax this
uniformity assumption in a way that allows for the possibility that customers’ preferences may
be correlated across products. As in the single-market case, we continue to assume that both
firms have constant marginal costs regardless of their output quantities, no fixed costs, and no
opportunity for collusion or price discrimination.
6
Again, as in the single-market case, this distance-related decline may be interpreted as a transportation cost, a
tailoring cost, or a disutility.
18
Firm scope advantages and the demand side
-------------------------------Insert Figure 2 about here
-------------------------------First, consider the outcome in the symmetric case where neither firm has any scope
advantage. In that case, both firms will offer their respective versions of product 1 at the same
price, and both firms will also offer their respective versions of product 2 at the same price.
Consequently, customers on the vertical line through the origin will be indifferent between the
two firms when buying product 1, so the two firms will split the market for product 1 evenly,
with firm A serving all customers in the left half of the square, and company B serving all
customers in the right half of the square. Likewise, customers on the horizontal line through the
origin will be indifferent between the two firms when buying product 2, so the two firms will
split the market for product 2 evenly, with firm A serving all customers in the bottom half of the
square, and company B serving all customers in the top half of the square. Therefore, in this
symmetric case shown in Figure 2, the four quadrants of the square exactly correspond to the
four possible combinations of customers’ product choices: Customers in the lower left quadrant
buy both products from firm A, while customers in the upper right quadrant buy both products
from firm B. Customers in the upper left quadrant buy product 1 from firm A and product 2 from
firm B, and the reverse is true for customers in the lower right quadrant.
Next, we consider how the distribution of customers’ product choices changes when one firm
has a scope advantage. Without loss of generality, let A be the advantaged firm and B be the
disadvantaged firm. To illustrate the two-product case, we use the example of a telephone
connection (product 1) and TV broadcasting (product 2) as two product markets. The
overwhelming majority of households consume both products. Many telecom operators in recent
years have expanded their business into delivering TV content (IPTV). Conversely, some TV
19
Firm scope advantages and the demand side
broadcasters, e.g. cable networks, are also offering telephone and internet services. Firms in
these two markets are able to exploit both supply- and demand-side scope advantages, which
makes this example ideally suited for our illustration purpose. There is technical infrastructure
(which may be used for a supply-side scope advantage) as well as an established customer
relationship (which may be leveraged as a demand-side scope advantage).
-------------------------------Insert Figure 3 about here
-------------------------------We start with a supply-side scope advantage scenario. For the purposes of our model, we treat
a supply-side scope advantage as a proprietary way that the advantaged firm can reduce its
marginal costs on the portion of its outputs that are provided to customers who purchase both
products from that firm. 7 An example is the usage of the existing infrastructure and workforce by
a telecom operator for delivering TV content, or vice versa. Both services can be sold
simultaneously by the same salesperson, installed simultaneously by the same installer, and
repaired simultaneously by the same technician. Furthermore, the network of equipment
infrastructure is a fixed resource that, when used for delivering both types of content, is spread
over a larger base and thereby exploits economies of scope. If one competitor has a superior way
of managing these scope economies in workforce and infrastructure, then it would gain a costbased supply-side scope advantage. As in the single-product scenario, the advantaged firm
reduces its price by an intermediate amount in order to balance the increases in both its margin
and its market share, while the disadvantaged firm also reduces its price, but by a lesser amount,
7
As Table 1 suggests, an alternative differentiation-based form of supply-side scope advantage may also occur if
all of the advantaged firm’s customers for each product (regardless of which firm they bought the other product
from) experienced an increased willingness to pay in direct proportion to the number of customers who buy both
products from the advantaged firm. For example, in our telephone/TV broadcast example, a differentiation-based
supply-side scope advantage may occur if combining the two services increases the overall efficiency of the
infrastructure in a way that allows higher traffic rates to distribute more content and thereby leads to an increased
willingness to pay by all customers for each service, no matter which firm they buy the other service from.
20
Firm scope advantages and the demand side
in order to mitigate its loss of market share. The outcome of the supply-side scope advantage
scenario is shown in the left-side panel of Figure 3. Compared to the symmetric case shown in
Figure 2, firm A gains the same amount of market share across both products from customers
who would otherwise have bought both products from firm B (i.e., in the upper-right quadrant)
as it does from customers who would otherwise have bought only one product from firm B (i.e.,
in the lower-right and upper-left quadrants).
Next, we turn to the demand-side scope advantage scenario. For the purposes of our model,
we treat a demand-side scope advantage as a proprietary way that the advantaged firm can
increase customer willingness to pay among those customers who would actually buy both
products from the advantaged firm. 8 An example in telecom is the “last mile” (connection to the
customer household) or the actual customer relationship. Clearly, a firm that has an established
customer relationship and the ability to provide services to a particular customer can leverage
that to also deliver other services to this customer. Therefore there is a cost advantage due to
lower costs of acquiring new customers, which can, e.g., be based on customer familiarity and
trust with the service provider (Nayyar, 1993). Furthermore, due to knowledge about customer
behavior and needs (arising from the established customer relationship) a firm is able to tailor its
offering to these customers, resulting in an increased willingness to pay (Chatain, 2011). As in
the single-product scenario, the advantaged firm raises its price by an intermediate amount in
order to balance the increases in both its margin and its market share, while the disadvantaged
firm reduces its price, but by a lesser amount, in order to mitigate its loss of market share.
However, the outcome from a demand-side scope advantage, as shown in the right-side panel of
Figure 3, is much different than the outcome under a supply-side scope advantage, as shown in
8
Alternatively, it could also decrease the costs incurred by those customers who buy both products from the
advantaged firm.
21
Firm scope advantages and the demand side
the left-side panel of Figure 3. It is still true that firm A gains some market share in all three of
its “non-home” quadrants (top-left, top-right, and bottom-right quadrants), but this time the vast
majority of its market share gain comes from customers who would otherwise buy one product
from firm B (top-left and bottom-right quadrants), and much less of its market share gain comes
from customers who would otherwise buy both products from firm B. This occurs because firm
A’s demand-side scope advantage gives customers who would otherwise have bought one
product from firm B have a much stronger incentive to buy that product from firm A. Therefore,
a demand-side scope advantage attracts a different set of customers than a supply-side scope
advantage, as shown in Figure 3. Also, in the case of a demand-side scope advantage, the
disadvantaged firm actually gains some customers that would otherwise buy one product from
the advantaged firm. This is due to the advantaged firm pricing in a way that induces joint
purchasing, which leads customers that otherwise only weakly prefer to buy one product from
the advantaged firm but strongly prefer to buy the other product from the disadvantaged firm to
buy both products from the disadvantaged firm. Nevertheless, in the aggregate, the advantaged
firm gains more customers from the disadvantaged firm than the reverse.
In Figure 3, the amounts of market share gain for both types of scope advantage are
approximately equal, but this is only because we have assumed a uniform distribution of
customers across the entire square. Because a demand-side scope advantage gets a larger
proportion of market share gain comes from the off-diagonal (top-left and bottom-right)
quadrants, we can expect the results between the two types of scope advantage to differ more
dramatically if we relax the uniformity assumption and allow the number of customers in each
quadrant to differ. We will explore this in the next section.
22
Firm scope advantages and the demand side
The multi-product case with preference correlation
In the following, we relax the assumption of uniformly distributed customers and instead
allow the relative number of customers to vary across the Hotelling square. More specifically, we
assume that preferences may be correlated between the two product markets by using a customer
density function with a different number of customers in each quadrant. For mathematical
simplicity, we accomplish this goal by assuming that customers are distributed in a piecewiseuniform fashion across the Hotelling square, with the uniform distribution allowed to differ in its
density across quadrants, as shown in Figure 4. When preference correlation is negative,
customers tend to be located at the off-diagonal quadrants, whereas with positive preference
correlation relatively more customers are at the diagonal quadrants. At the extremes, all
customers are located only at the off-diagonal quadrants (negative correlation) or only at the
diagonal quadrants (positive correlation). Figure 4 shows the distribution of customers for
positive and negative correlation as well as independence.
-------------------------------Insert Figure 4 about here
-------------------------------A negative preference correlation means that customers tend to dislike purchasing both
products from the same supplier. As we have stated above, this can be due to customers
preferring variety, avoiding dependence on particular suppliers, being inherently disloyal, or
suppliers having a reputation as specialists. Preferences are positively correlated if there is
difficulty in jointly using the products from different suppliers, e.g. due to the lack of
standardized interfaces, a general lack of knowledge about products, or the existence of large
shopping costs. Furthermore it can be the case that customers perceive that it is natural that one
firm supplies both products (i.e. generalists are preferred).
23
Firm scope advantages and the demand side
As can be seen from Figure 3 above, when a firm has a demand-side scope advantage, a
higher proportion of customers that will switch over to buying from the advantaged firm (market
share gain) tends to be located at the off-diagonal quadrants as compared to the case of a supplyside advantage (note: Figure 3 shows the case of uniform preference distribution). Thus, when
preferences are negatively correlated, there is a total higher number of customers on the offdiagonal quadrants (see the left graph of Figure 4). Therefore, a demand-side scope advantage
should lead to a higher market share gain and higher total performance than an equal supply-side
advantage when preferences are negatively correlated. Conversely, when customer preferences
are positively correlated, the market share gain and performance increase of a supply-side
advantage should be higher as compared to the market share and performance impact of a
demand-side advantage.
The result that a demand-side advantage is more valuable compared to a supply-side
advantage when preferences are negatively correlated and less valuable when they are positively
correlated at first seems counterintuitive. However, these findings highlight the role of fringe
customers. A competitive advantage is especially valuable if it allows the firm to induce a lot of
customers that are close to indifferent between different firms. This is particularly true of
customers that are inherently disloyal. For example, a superior loyalty program (a source of
demand-side scope advantage) will be more valuable when customers are disloyal than when
customers anyway prefer buying from the firm. This is all the more important if there is
diminishing marginal utility (further increases in product quality have a lesser impact on
customers’ willingness to pay) or diminishing marginal efficiency (further investments in
efficiency have a lesser effect on variable costs), which we have not assumed in our paper. In
these cases, competitive advantages have much less of an effect on customers that would anyway
24
Firm scope advantages and the demand side
buy from the firm than on fringe customers that are close to indifferent.
DISCUSSION
Above we have demonstrated that a single-market competitive advantage and a multi-market
scope advantage differ in their respective outcomes. We have further shown that a supply-side
scope advantage leads to a different outcome than a demand-side scope advantage of equal
magnitude, depending on the intrinsic correlation of customer preferences in the market. In the
following, we discuss the implications of these core findings for literature in strategic
management focusing on the role of the demand side in determining competitive advantages, the
role of the demand side in determining firm scope decisions and performance, and the role of
scope advantages as drivers of industry structure.
Competitive advantages, scope advantages and the demand side
A key finding of our study is that, while in a single-market setting supply-side and demandside competitive advantages are symmetric and equal in their magnitude, they differ substantially
in a multi-market setting. The symmetry of the single-market solution, where a decrease in costs
or an equal increase in customer willingness to pay have the same effect does not carry over to a
situation when firms have scope advantages, i.e. competitive advantages that only apply when
the firm is present in several product markets. As we have shown, the difference stems from the
interaction of the scope advantage with the demand side, as a supply-side scope advantage
induces a different set of customers to switch their consumption to the advantaged firm than a
demand-side scope advantage does.
This result highlights the role of demand-side factors in determining performance outcomes of
competitive advantages. In a single-market setting, the demand side plays a role when customers
differ in their preferences between the different suppliers’ products, as in the Hotelling setup in
25
Firm scope advantages and the demand side
this paper. Then also a pure cost advantage will lead some customers to switch, as firms will
adjust their prices and some customers will switch to purchasing from the advantaged firm (as
illustrated in the Pepsi-Coke example in the previous chapter). However, the outcome is
symmetric between a supply-side and a demand-side competitive advantage. In the multi-market
setting, however, the set of customers that are induced to switch differs between the two types of
scope advantages. Demand-side scope advantages are thus of a different nature than supply-side
scope advantages. While supply-side scope advantages are located within the boundaries of the
firm, such as a resource or capability that is shared across markets (e.g. managerial
understanding), demand-side scope advantages are often located at the firm-customer interface
(Dyer & Hatch, 2006) or at the customer side (Nayyar, 1993; Priem, 2007) (e.g. the knowledge
or familiarity of customers with a firm’s products, as in the above Airbus/Boeing example). As
argued by Priem (2007), firms can purposefully build such demand-side advantages by
strategically influencing customers’ knowledge and perception.
Since demand-side advantages are not necessarily located within the boundaries of a firm, an
interesting question concerns the sustainability of such advantages. One may wonder if isolating
mechanisms exist to sustain the advantage or if such advantages are inherently temporary in
nature. Several arguments suggest that also demand-side scope advantages can be sustainable. As
noted above, a key factor contributing to demand-side scope advantages is the existence of a
lock-in situation that can be exploited by a firm. As an example, an airline that has trained its
pilots on Airbus planes will incur lower costs in re-training when purchasing different Airbus
planes than Boeing planes, due to the similarity of the cockpits. A similar sustainable demandside advantage exists if a firm is able to exploit a superior location, reducing customers’
shopping costs (Klemperer & Padilla, 1997). In yet other cases, firms may have an advantage at
26
Firm scope advantages and the demand side
a particular product combination level. Such an advantage exists if there is superior integration
of products, as in the above-mentioned example of Google services that are tightly integrated,
e.g. providing single sign-on (Stremersch & Tellis, 2002). Such integration can lead to customers
deriving additional benefits from joint consumption due to cost savings or increased
convenience.
Scope advantages and the firm scope decision
Our study has found a significant difference between supply-side and demand-side scope
advantages. In particular, we have found that their outcome depends on the level of correlation of
the intrinsic customer preferences across markets, which is a characteristic of an industry or a set
of industries. Assuming that different firms have different types of scope advantages, we can
therefore expect that the decision to enter an industry or market depends on the question if the
firm is able to match its competitive advantage with the characteristics of the market and the
preferences of customers therein.
Above we have identified several conditions that give rise to differences in the correlation of
intrinsic customer preferences across markets. The correlation is high when there are benefits of
one-stop shopping, e.g. due to search or transaction costs (as in the case of supermarkets), when
there is little standardization or no established interfaces and customers cannot be sure whether
products purchased from different vendors work together, or when there is little experience in
using the products. Conversely the correlation is negative when customers wish to reduce their
dependence on suppliers or have a preference for variety (as in fashion or entertainment) or a
tendency to be disloyal, as well as when firms have a reputation as specialists. Our results
suggest that firms that have a demand-side advantage should enter markets where the preference
correlation is negative, i.e. markets where customers have a tendency to not buy products from
27
Firm scope advantages and the demand side
the same firm. For instance, Microsoft has been able to reap benefits of a common interface and
superior product integration in multiple software application markets where customers have had
a strong preference to deal with category specialists.
These results are counterintuitive, as firms with demand-side scope advantages can be seen as
generalists that enter an industry that prefers specialist firms. However, as our results suggest, it
is exactly a market with a preference for specialists where a firm that has a demand-side scope
advantage (which effectively makes it a “superior generalist”) is able to break up the market
structure. This is due to the existence of fringe customers, as discussed above. In a market that
prefers specialists, a superior generalist can attract a proportionally higher number of new
customers than a superior specialist. The same is true also in the opposite setting: A firm that has
a supply-side scope advantage will fare better in a market setting where customers prefer to buy
from generalists (i.e. a market where there is high legitimacy for suppliers of bundles as well as
low levels of knowledge about individual products). Our findings thus imply a pattern of market
entry decision based on the type of scope advantage (a firm-level characteristic) and the
preference of customers to buy from generalists or specialists (an industry- or market-level
characteristic).
While our model is static in nature, we can also apply our above argument to a dynamic
context. In particular, we might expect the correlation of preferences to change over time and
over the lifecycle of an industry. Preference correlation may decrease over time, which can, e.g.,
be the case when customers become more knowledgeable about the products. It may also
increase, e.g. when more and more firms enter an industry, which leads to a decrease in the
bargaining power of suppliers. Thus we can expect the direction and speed of change in
preference correlation to be industry-specific. In any case, our above results then lead to the
28
Firm scope advantages and the demand side
conclusion that different firms with different types of scope advantages will enter an industry at
different stages in its lifecycle. This may help explain early vs. late mover advantages as well as
entry patterns into industries (see, e.g., Franco, Sarkar, Agarwal, & Echambadi, 2009).
Furthermore our results also explain how different firms will exhibit competitive advantages at
different stages of an industry lifecycle, and the mechanisms how competitive advantages may
shift between firms as the industry evovles.
Scope advantages as drivers of industry structure
A further conclusion that can be derived from our findings is that different advantages lead
not only to entry into different types of industries, as described in the previous section, but that
the pursuit of competitive advantages in itself can also alter the structure and boundaries of
industries over time. The above example of a telecom operator expanding into delivering TV
content to its customers is an example of a phenomenon prevalent in technology industries
known as “convergence” (Han, Chung, & Sohn, 2009). However, this phenomenon also exists in
other types of industries. For example, many durable goods manufacturers also sell service
contracts, competing with specialist service providers (or forcing them into a subcontractor role).
A firm that exploits a demand-side scope advantage in effect connects the two markets over
which the advantage is exploited.
The existence of an increasing number of firms that are present in the same two industries
leads to these two industries becoming more related over time (Li & Greenwood, 2004).
Therefore, if a firm with a demand-side advantage enters an industry in order to exploit its scope
advantage and others follow suit, these two markets eventually converge. The key driver of the
industry-level convergence noted above is thus the pursuit of a firm-level competitive advantage
in the form of a demand-side scope advantage and subsequent attempts at imitation by
29
Firm scope advantages and the demand side
competitors. It should be noted that above, we have assumed that preference correlation is
exogenous to firms, i.e. firms cannot change the preference correlation. However, a sequence of
firm decisions to pursue scope advantages and the subsequent increase in relatedness of
industries over time also alters how consumers perceive combinations of products and therefore
also preference correlation. In extreme cases, one dominant firm that pursues a scope advantage
might be able to alter preference correlation. This might help it to exploit its advantage, but at the
same time might pave the way for competitors to enter the industry as well.
An interesting question in this respect is that when two industries converge, from which
original industries the “winners” come from. In the telco and TV broadcaster example, the
question thus is that when both telephone and TV move towards internet technology, will the
dominant firms in the new industry be the telcos, the TV broadcasters, or some other party (such
as Apple or Google). This also shows that there is a potential asymmetry that may favor firms
from one industry over another. As an example, digital cameras have become a standard feature
of mobile phones, hurting camera producers. However, while digital camera producers might not
have an advantage from venturing into the mobile phone industry and include such features into
their phone, they might do well by neglecting fringe customers and focusing on customers that
have a preference for high quality for digital cameras.
In sum, our theory contributes to explaining how industry boundaries may shift as a
consequence of firms pursuing competitive advantages, in particular scope advantages.
Especially the pursuit of demand-side scope advantages is a potentially major source of changes
in industry boundaries and therefore also warrants further empirical study. In particular, our
above assertion that it is the pursuit of competitive advantages that drive industry structure
changes should be subjected to an empirical test.
30
Firm scope advantages and the demand side
CONCLUSIONS
In an interview with Newsweek, Jeff Bezos, founder and chairman of Amazon.com, made the
following statement (Newsweek, 4th of January, 2010):
There are two ways that companies can extend what they're doing. One is they can take an
inventory of their skills and competencies, and then they can say, ‘OK, with this set of skills
and competencies, what else can we do?’ And that's a very useful technique that all
companies should use. But there's a second method, which takes a longer-term orientation. It
is to say, rather than ask what are we good at and what else can we do with that skill, you
ask, who are our customers? What do they need? And then you say we're going to give that to
them regardless of whether we currently have the skills to do so, and we will learn those skills
no matter how long it takes.
As this quote suggests, practitioners are very clear that firms can decide firm scope based on
supply-side and demand-side sources of advantage. In this paper we have built on this insight
and asked the follow-on question under what circumstances a supply-side or a demand-side
scope advantage is more valuable. We have demonstrated a difference between single-market
competitive advantages and multi-market scope advantages. We have further shown that in
multi-product settings the outcome of supply-side and demand-side scope advantages differs
substantially. In particular, when customer preferences are negatively related, a demand-side
scope advantage is more valuable than a supply-side scope advantage, whereas supply-side
advantages are more valuable when customer preferences are positively related. Our model,
which we, due to space limitations, have illustrated through examples as well as a graphical
solution, allowed some novel insights on the value of different types of scope advantages, in
particular when explicitly accounting for demand-side factors. Our formal treatment of the
31
Firm scope advantages and the demand side
subject allows us to add granularity, in particular in terms of considering how demand-side
variables, such as intrinsic preference correlation in our setting, interact with firm-level
variables, such as different types of competitive advantages and subsequent decisions on product
market scope.
As in every study, a number of limitations need to be acknowledged. Given that we ground
our theorizing in a mathematical model, we make certain simplifying assumptions, such as the
distribution of customers, that are an abstraction of real-life settings. While our assumptions and
model have enabled us to derive interesting and counterintuitive insights into the relationship
between demand-side factors and firm-level factors, further work might relax some of these
assumptions. One could, for instance, modify the level of customer heterogeneity on the product
markets or allow firms to choose their positions. We have also limited our model to two markets,
whereas firms may be present at several markets with differing levels of correlation. A
simulation study might fruitfully explore different types of scenarios where firms with different
scope advantages employ different bundling strategies. Furthermore, as mentioned above, our
model is static in nature, but we have partly used it to explain dynamic phenomena. A dynamic
model could lead to additional insights, e.g. into the conditions and timing of entry of firms with
different types of scope advantages into different types of industries, which might explain
observed patterns of diversification and scope expansion.
In conclusion, our findings add to the literature on firms’ product scope and the emerging
demand-based view of strategic management that seeks to explain how demand-side factors,
such as the structure of customer preferences, contributes to strategic level performance
outcomes like technology development paths (Adner & Levinthal, 2001; Adner, 2002), resource
repositioning (Adner & Snow, 2010), the sustainability of competitive advantage (Adner &
32
Firm scope advantages and the demand side
Zemsky, 2006), knowledge embedded in existing customer relationships (Chatain, 2011) or
corporate diversification decisions (Ye, Priem, & Alshwer, 2011). We find that the correlation of
customer preferences across product markets has an impact on the value of different types of
scope advantages, that these firm-level advantages interact with industry- or market-level
characteristics to explain entry into an industry as well as the development of industry
boundaries over time, and that demand-side scope advantages, just like supply-side advantages,
can be sustainable through being protected by isolating mechanisms (Klemperer & Padilla,
1997).
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TABLE 1
Examples of Synergies and Their Underlying Resources
Supply-side
Similarity of human expertise
reduces costs of applying same
skills in other markets (Farjoun,
1994)
Cost
advantage
Differentiation Customizable product due to
unique value chain creates higher
advantage
willingness to pay (Rivkin &
Porter, 1999)
Demand-side
Client-specific knowledge leads to
lower costs of retaining customers
(Chatain, 2011)
Experience of using a service of a
firm leads to lower customer
acquisition costs (Nayyar, 1993)
Familiarity with software user
interface leads to higher willingness
to pay due to a lock-in effect
(Cottrell & Nault, 2004)
FIGURE 1
Equivalence of Supply-Side and Demand-Side Advantages
in the Single-Product Case
customer value surplus
customer value surplus
-1
firm 1 profit
firm 2 profit
customer value surplus
1
1
-1
firm 1 profit
Case 1: No advantage
firm 1 profit
firm 2 profit 1
firm 2 profit
Case 2: Supply-side cost
advantage
37
-1
Case 3: Demand-side
differentiation advantage
Firm scope advantages and the demand side
FIGURE 2
The Hotelling Square (No Firm Has Any Advantage)
(-1,1)
(1,1)
B1A2
B1B2
A1A2
A1B2
(-1,-1)
(1,-1)
FIGURE 3
Supply-Side Versus Demand-Side Scope Advantages in the Two-Product Model
(Left: Supply-Side Advantage, Right: Demand-Side Advantage)
(-1,1)
(1,1)
B1A2
(-1,1)
(1,1)
B1A2
B1B2
B1B2
IV
II
A1A2
I
A1B2
A1B2
A1A2
III
(-1,-1)
(1,-1)
(-1,-1)
38
(1,-1)
Firm scope advantages and the demand side
FIGURE 4
Cross-Product Correlation of Intrinsic Customer Preferences
ρ =0
negative correlation
independence
39
positive correlation