What is the concept of economic rent?

To help understand the role of resources in competitive advantage, it is necessary to consider the concept of economic rent. This was first developed by the English economist, David Ricardo (1772-1823). Economic rent is defined as any excess that a factor earns over the minimum amount needed to keep that factor in its present use.

There are three main types of economic rent:

1. Ricardian rents – derive from the resources of the organisation; they are rents generated from resources that possess some real competitive advantage, allowing the company to generate significant additional returns;
2. Monopoly rents – derive from the markets in which the organisation operates. They are the rents associated with a company’s unique position in the market place that allows it to earn exceptional returns.
3. Schumpeterian rents – these derive from a new and innovatory product or service that allows the organisation to charge considerably above its costs of production.

So, why is the concept of economic rent important? It has two significant implications for resource strategy:

1. Scarcity of resource. It identifies this concept and raises the possibility of developing resources that are so scarce that they can earn substantial economic rent;
2. Alternative use for resources. This concept explores other and more profitable uses for any resource beyond the one that is currently being pursued. Specifically, it considers the possibility that using the resource for another purpose might produce more rent.

Having understood the concept of economic rent, it is worth noting how it relates to accounting profit. The latter is the difference between total revenue and the explicit costs of generating this in a given time period. Economic rent is the difference between total revenue and the opportunity cost of the factors of production. It is not concerned with the accounting profit that will arise from the current strategy, but the extra that might be earned beyond the current profit if the resources were to be used elsewhere. It explores strategic concepts related to the organisation’s possession and use of resources or its dominance in the market place. Accounting profit does not.

Economic rent has several difficulties:

• it is difficult to estimate because of the conceptual problem of ensuring that all alternative uses have been considered and accurately valued;
• it makes the simplistic assumption that every option can always be implemented, without regard for the human resource implications;
• it provides few insights on how to identify new Ricardian or monopolistic rent opportunities at the commencement of strategy analysis. It is useful after the event but is not strategy is being formulated.