Information Barriers to Competitive Strategy

Any use of market structure information as a guide to competitive strategy must address the challenge posed by measurement problems encountered in defining the magnitude and root cause of above-normal rates of return. To be sure, accounting profit data derived from a historical perspective give much useful information for operating decisions and tax purposes. However, these data sometimes measure economic profits only imperfectly. For example, advertising and research and development (R&D) expenditures are expensed for both reporting and tax purposes, even though each can give rise to long-term economic benefits. An expense-as-incurred treatment of advertising and R&D expenditures can lead to errors in profit measurement. Although current net income is depressed when advertising and R&D are written off before the end of their useful lives, intangible assets can be understated when they fail to reflect the value of brand names and other innovative products. Depending on the true rate of economic amortization for advertising and R&D and the rate of growth in expenditures for each, business profit rates can be either understated or overstated. In either event, reported business profit rates, such as ROE, can substantially misstate economic profits. At the same time, other imperfections in accrual accounting methods lead to imperfectly matched revenues and costs and, therefore, to some misstatement of economic profits over time.

Beyond these and other obvious limitations of accounting data, business practices are often expressly intended to limit the loss of valuable trade secret information. Why would anyone give competitors any more than the bare minimum of information? It is well-known, for example, that firms patent only what they cannot otherwise keep secret. Combined with the limitations of publicly available data on profitability, business practices create an information barrier that hides the true details about economic profit rates. At the same time, such obfuscation makes defining the scope of monopoly power difficult, as it hides the costs and benefits of entry into monopoly markets from both private and public decision makers.

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