STAKEHOLDER THEORY AND COMPETITIVE ADVANTAGE

JEFFREY S. HARRISON
Robins School of Business
University of Richmond
Richmond, VA 23173

DOUGLAS BOSSE
University of Richmond

ROBERT A. PHILLIPS
University of Richmond

ABSTRACT

Despite its influence on early development of the field, stakeholder theory is not widely
used by strategic management scholars to explain competitive advantage. Using some of the
central ideas of resource-based theory, we provide a fresh perspective on why firms that attend to
the needs of a broad group of stakeholders may enjoy competitive advantages that are not
available to other firms. The key is that these firms have a better understanding of their primary
stakeholders’ utility functions, which provides them with an enhanced ability to recognize value-
creating opportunities. Value appropriation issues are also addressed.

INTRODUCTION

A primary objective of the field of strategic management is to explain why some firms
outperform other firms (Rumelt, Schendel & Teece, 1994). Accordingly, much of the theory that
is applied to examining this question seeks to explain firm-level heterogeneity. Since many firm-
specific factors that provide temporary competitive advantage can be imitated by competitors,
strategic management researchers have begun to focus on the identification of factors that are
harder to imitate and thus more likely to lead to sustainable competitive advantage (Barney,
2001a; Barney & Arikan, 2001). Possibly because of some widely-held misconceptions,
stakeholder theory has not yet played a central role in this discussion. The primary purpose of
this paper is to bring stakeholder theory into the mainstream of thought in strategic management.
To do so, we examine competitive advantage through a stakeholder lens by integrating its core
propositions with those of resource based theory (Barney, 1991) and demonstrating how gaining
an understanding of individual stakeholders’ utility functions can allow a firm to take advantage
of market imperfections which, in turn, give rise to value creation opportunities.
We also examine the role of stakeholder theory in explaining the way value is
appropriated among stakeholders once it is created (Blyler & Coff, 2003; Coff, 1999). If high
value is created by a firm but that value is routinely distributed to non-shareholder stakeholders
such as managers and employees, or if it is extracted from the firm by strong customers,
suppliers or unions, then it will be hard to detect using traditional performance measures such as
return on investment or shareholder returns. A stakeholder perspective is useful not only in
examining how value is created, but in understanding how that value is allocated to stakeholders.
 CREATION AND APPROPRIATION OF VALUE

The stakeholder perspective envisions a firm at the center of a network of stakeholders, a

complex system for exchanging goods, services, information, technology, talent, influence,
money, and other resources (Freeman, 1984). The firm itself can be envisioned as a nexus of
formal and social contracts with its stakeholders (Jensen & Meckling, 1976). Freeman (1984)
and the authors of subsequent developments in stakeholder theory (e.g., Post, Preston, & Sachs,
2002; Phillips, 2003b) build their logic from an assumption of an efficient market and prioritize
the welfare of the firm. In an efficient market, firms that serve stakeholders purely for altruistic
purposes are not likely to survive. Stakeholder theory argues that firm value is created when the
firm meets the needs of the firm’s important stakeholders in a win-win fashion (Donaldson &
Preston, 1995; Jones, 1995; Walsh, 2005).
The core assumptions and propositions of resource-based theory provide a strong
foundation for extending stakeholder theory as a theory of competitive advantage. Resource-
based theory suggests a firm’s competitive position is defined by its unique bundle of resources
and relationships (Rumelt, 1984). It also identifies the attributes of those resources that may
provide a source of sustained competitive advantage: valuable, rare, and costly to imitate
(Barney, 1991). The focus of resource-based theory is on the resources and capabilities firms
control that are the cause of persistent differences in firm performance. We argue that specific
types of stakeholder-based resources (e.g., knowledge of stakeholders’ utility functions, a
reputation for respecting shareholders) and capabilities (e.g., continuously forming updated value
propositions for stakeholders) enable the firm to create and appropriate value. Further, we
examine the conditions under which stakeholder-based value creating processes should lead to
short- and long-term competitive advantage.

Value Creation, Stakeholder Welfare and Utility Functions

A firm creates value when the price its customers are willing to pay for its offerings
exceeds the firm’s opportunity cost. In order for managers to make well-informed decisions
regarding actions that will create more value, they need to understand what shapes customers’
willingness to pay and what affects the firm’s opportunity costs. This understanding is based on
knowledge of customers’ welfare and the welfare of all other stakeholders of the firm. The need
to develop this level of understanding about stakeholders provides a primary motivation for
stakeholder theory.
Welfare refers to the well being of an individual or group and is often conceptualized by
a utility function. In this paper the relevant “utility function” of a stakeholder specifies that
stakeholder’s preferences for different combinations of tangible and intangible outcomes
resulting from actions taken by the firm. A stakeholder’s utility function incorporates the
opportunity costs incurred by that stakeholder contingent upon each potential action the firm
could reasonably consider.

The Role of Uncommon Knowledge in Value Creation

The strategic management literature often implicitly assumes information about

stakeholder preferences regarding cost, time and quality is common knowledge. This assumption
is related to the notion that prices convey all relevant information about all economic actors’

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utility functions and that information about prices is common knowledge. While this logic has
been helpful in developing theory regarding the efficiency of the price system, it is unhelpful for
building theory about value creation because it ignores the fact that value creation opportunities
are, by definition, uncertain and connected to the possession of unique information or resources
(Rumelt, 1984). For example, when a prospective customer or employee rejects a take-it-or-
leave-it offer, the firm often does not gain detailed knowledge of that actor’s utility function. It
would be helpful for the firm to know in what ways it could change the offer to get the opposite
reaction from that actor. Differences in individual stakeholders’ utility functions give rise to
market imperfections which, in turn, give rise to value creation opportunities. The common
knowledge assumption overlooks the importance to value creation of understanding the details of
stakeholders’ utility functions.
The fields of bargaining and conflict resolution offer helpful language for explaining how
stakeholder theory contributes to our understanding of value creation. Like integrative bargaining
theory, stakeholder theory assigns the less tangible concerns about self-image, fairness, process,
precedents, or relationships the same analytic standing as the “harder” or “objective” interests
such as cost, time, and quality (Sebenius, 1992). This treatment is consistent with the concept of
utility functions that specify the relative impact on stakeholder welfare from actions taken by the
firm. Theories that seek to explain value creation (beyond arbitrage) must allow for the situation
where some information about stakeholders’ utility functions is excluded from the market price
(Rumelt, 1984.). In resource-based theory, for example, the condition of ex ante limits to
competition (Peteraf, 1993) explains why expectations of future resource value can differ from
market price.
The first step to creating value with a stakeholder is to probe deeply for interests,
distinguish them from issues and positions, and to carefully assess tradeoffs (Sebenius, 1992).
This is what we mean by seeking to understand stakeholders’ utility functions. When a firm
seeks to understand a broader set of stakeholders’ utility functions, it increases the likelihood that
it will be able to use unexpected events, such as changes in technology, changes in relative
prices, changes in consumer tastes, and changes in law, tax, and regulation, to create value
(Freeman & Evan, 1990; Rumelt, 1984). Building on this type of knowledge, managers can
envision potential resource combinations that will exploit the potential to create value.
The bargaining literature also offers a parallel with stakeholder theory in describing how
firms and their stakeholders interact when creating value. Firms that manage for stakeholders
exhibit cooperative behavior such as openly sharing information, communicating clearly,
spurring creativity, emphasizing joint problem solving, and channeling hostilities productively.
When both parties take an integrative approach their joint problem becomes inventing alternative
agreements that increase their utility. This often requires the firm to share its own utility function
– the relevant tradeoffs that would increase and decrease its welfare – with its stakeholders.
When a firm shares its own underlying interests with stakeholders it helps facilitate trust that
many stakeholders seek before revealing potentially sensitive details of their own utility
functions (Jones, 1995).
The process of inventing alternative agreements that increase utility is a creative
envisioning process that requires entrepreneurial intuition and imagination. The process itself
entails analyzing the similarities and differences between the firm’s utility function and the focal
stakeholder’s utility function. For example, value can be created in exchanges when firms
identify differences in factor values or market access that suggest greater potential gains from
trade, complementary technical capabilities that can be profitably combined, differences in risk

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tolerance that suggest contingent agreements, or differences in time preference that suggest
altering schedules of payments (Sebenius, 1992). This type of knowledge about stakeholders also
makes it possible to envision other outcomes such as new products or services, new product or
factor markets, new ways of producing or delivering, and new ways of obtaining resources.
Firms use this process for creating value with stakeholder groups (e.g., a labor union) and
individual stakeholders (e.g., a key customer).
Firms that create value tend to identify and understand how the welfare of their
stakeholders is affected by their actions. Separating this discussion from a discussion of value
distribution is difficult because the firm’s behavior during the discovery phase (when seeking to
understand their utility functions) can send strong signals about how it will behave during the
value distribution phase. The resource-based perspective does little to address how economic
value is or should be distributed once it is created (Barney & Arikan, 2001).

VALUE APPROPRIATION

The phenomena of creating and appropriating value are two aspects of an integral
structure, and they are not separable. Managers exercise at least some discretion with regard to
how firm value is distributed (Berman, Phillips & Wicks, 2005; Hambrick & Finklestein, 1987;
Shen & Cho, 2005). In firms that create a large amount of value, this discretion is increased. For
this discussion, it is important to disassociate the value that a firm creates from its bottom-line
profitability. A firm with low profitability may create a lot of value but allocate most of it to
stakeholders such as customers, suppliers or employees during the normal course of business
(Coff, 1999). Alternatively, a firm with high profitability may either have a lot of value to
distribute, or may be under-allocating value to particular stakeholders, a situation that could lead
the organization to lose opportunities for future value creation in the future. Value appropriation
is influenced by the power of particular stakeholders, by moral/ethical considerations and/or as a
result of strategic choice.
Stakeholder power can be defined as “the ability to use resources to make an event
actually happen (Freeman, 1984: 61)”. Several authors have identified characteristics that give
stakeholders power. Freeman (1984) divides stakeholder power into three broad types: formal
power, economic power and political power. Coff (1999), in turn, outlined four primary
determinants of bargaining power, based on the negotiation and bargaining literatures
(Marburger, 1994; Pfeffer, 1981; Porter, 1980). Stakeholders have power if they 1) have the
ability to act in a unified manner, 2) have access to superior information, 3) are difficult or
impossible to replace and 4) face low costs if they decide to move to another firm. Power also
plays a prominent role in Mitchell, Agle & Wood’s (1997) stakeholder typology. They maintain
that the salience of stakeholders to managers is a function of urgency, power and legitimacy.
Value distribution decisions also involve moral considerations of justice and fairness that can
affect the behavior of stakeholders in future periods (Donaldson & Preston, 1995; Friedman &
Miles, 2006; Jones & Wicks, 1999; Mitchell, Agle & Wood, 1997; Phillips, et al., 2003) Phillips,
2003b; Post, Preston & Sachs, 2002). Justice and fairness are core considerations in managing
for stakeholders and that firms that allocate both value and decision-making voice more widely
across their stakeholder network than a direct, short-term shareholder wealth maximization
objective function would prescribe tend to experience more sustainable competitive advantages
(Friedman, 1962; cf. Jensen, 2001). Procedural justice and reciprocity are both essential to these
arguments (Phillips, et al, 2003).

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 Stakeholder power and moral considerations of justice and fairness influence, but do not
completely determine, the way a firm allocates the value it creates. Managers can make a
strategic decision to allocate more time, effort and other organizational resources to a particular
stakeholder as a part of a deliberate strategy to understand better that stakeholder’s utility
function, as a prelude to finding new ways to create value (as described earlier).

STAKEHOLDER MANAGEMENT INFLUENCE ON COMPETITIVE ADVANTAGE

Competitive advantage implies more than merely creating value. Rather, the key is to
create more value than competitors are able to create. A firm is said to have a competitive
advantage if it creates and appropriates more value than the least efficient rival capable of
breaking even. Simply extending the prior logic, this occurs when the firm drives a wedge
between the willingness to pay it generates among buyers and the costs it incurs and then collects
returns in excess of its own opportunity costs. Stakeholder theory argues that managing for
stakeholders is one way to achieve competitive advantage. We now examine this issue from a
resource-based perspective.
Resource-based theory argues that differences in firms’ resource endowments cause
performance differences. “Resources” in this context refer to anything that enables the firm to
conceive of and implement strategies that improve its efficiency and effectiveness (Barney,
1991). When a firm has resources that are valuable and rare those resources may be a source of
temporary competitive advantage (Barney, 1991). A potential source of temporary competitive
advantage, for example, is having superior knowledge of stakeholders’ utility functions and a
enjoying a reputation of showing respect for stakeholders (a “stock” resource). Knowledge is a
widely accepted resource in the resource-based literature. Simply having a stakeholder network
does not explain why a firm might have a competitive advantage. All firms have such a network.
The potential for advantage comes from the valuable and rare knowledge possessed by the firm
about the utility functions of the most critical members in its stakeholder network. Knowledge
about a stakeholder’s utility function gives the firm potential to envision actions it can undertake
to create value.
Acquiring superior knowledge about stakeholder’s utility functions may be accomplished
via strong stakeholder relationships enjoyed by firms that have both a pattern of and reputation
for respecting stakeholders. However, it can sometimes be acquired via other sources, at least on
a case-by-case basis. Examples of possible sources of this knowledge include research firms and
consultants. Thus, our arguments regarding knowledge of utility functions and value creation
may explain short-term, but not necessarily longer-term competitive advantage. The difference
between a short-term and a sustained competitive advantage is that a sustained competitive
advantage persists even after rivals have attempted to imitate it. Therefore valuable and rare
resources that are also difficulty or costly to imitate can be a source of sustained competitive
advantage (Barney, 1991).
The issue of sustainability can be addressed by an examination of whether the resources
created in a firm that manages for stakeholders are difficult or costly to imitate, since we have
already determined that they are not impossible to imitate, at least on a limited basis. Resources
that are difficult or costly to imitate are characterized by isolating mechanisms that adhere them
to the firm (Rumelt, 1984). A firm’s reputation is an example of a resource that is unique to each
firm. Firms with a strong reputation for managing for stakeholders can enjoy advantages that are
difficult to imitate by competitors. Social complexity also makes a resource difficult to imitate

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(Barney, 1991). Relationships, such as those between a firm and its stakeholders, are resources
characterized by the isolating mechanism of social complexity. Research firms and consultants
do not have the same social relationship with a stakeholder as the focal firm; thus, the quality of
information provided by these third parties regarding utility functions is reduced.
Given the dynamic nature of a firm’s stakeholder network – with continuous changes in
the relative bargaining power of stakeholders and even changes affecting network membership –
a potential source of sustainable competitive advantage is having the capability to continuously
develop strong stakeholder relationships. Sustaining a firm’s competitive advantage requires
management to continuously adjust and renew the firm’s unique bundle of resources as time,
competition, and change erode their value (Rumelt, 1984). These relationships, in turn, provide
the firm with continuously updated superior knowledge of stakeholders’ utility functions (a
“flow” resource/capability). The firm’s ability to continuously create value with stakeholders
given an assumption of market efficiency (where prices continuously adapt to reflect updated
values) depends on its ongoing investment in understanding the utility functions of its
stakeholders and treating them with respect.
One of the caveats associated with this analysis is that the benefits of managing for
stakeholders must exceed the costs if taking a stakeholder approach is to result in competitive
advantage, an outcome that is vital to the resource-based view and this discussion. A
comparison of costs and benefits is useful at both the individual stakeholder and the network
level. The costs of managing for stakeholders include allocations of managerial time spent in
communicating and managing relationships with stakeholders as well as the direct allocation of
financial and other firm resources to them. The key to managing for stakeholders in such a way
as to enhance organizational performance is to determine which stakeholders to include and how
much to invest in those stakeholders, from a utility function perspective.
In general, a firm should invest in relationships with stakeholders that have high power,
to whom the firm has a moral obligation, or with whom the firm sees potential for new value
creation (strategic choice). Furthermore, the amount of investment is partially a function of these
three factors. However, two other variables also help to determine the amount of investment.
They are the cost of acquiring knowledge about the stakeholder’s utility function and the
frequency with which that utility function is expected to change. Change in a utility function may
represent either a new opportunity to create value or a threat to existing operations.
Consequently, if a stakeholder’s utility function is expected to change frequently, the firm may
invest to develop a capability to continuously update the firm’s knowledge of this stakeholder’s
evolving utility function so it can to take actions that reduce the likelihood of that stakeholder
adversely affecting the firm’s performance or increase the likelihood of that stakeholder
positively affecting the firm’s performance.
This paper integrates stakeholder theory and resource-based theory and, in doing so,
extends both perspectives. At the intersection is a stakeholder’s utility function, defined as the
stakeholder’s preferences for different combinations of tangible and intangible outcomes
resulting from actions taken by the firm. Differences in individual stakeholders’ utility functions
create market imperfections which, in turn, give rise to value creation opportunities. Managing
for stakeholders increases the probability that a firm will understand a broader group of
stakeholders’ utility functions, which increases the firm’s ability to discover new ways to create
value.

REFERENCES AVAILABLE FROM THE AUTHORS

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