Management Decision (Vol. 45, nº 3, 2007) Hierarchy of Strategy: The state of Play

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ISSN 0025-1747

Volume 45 Number 3 2007

Management Decision Hierarchy of strategy: the state of play Guest Editors: Abby Ghobadian, Nicholas O’Regan, Howard Thomas and David Gallear

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Management Decision

ISSN 0025-1747 Volume 45 Number 3 2007

Hierarchy of strategy: the state of play Guest Editors Abby Ghobadian, Nicholas O’Regan, Howard Thomas and David Gallear

Access this journal online ______________________________

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Editorial advisory board ________________________________

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Introductory chapter _____________________________________

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SECTION 1. THE CHANGING CONTEXT OF STRATEGY The problematic of strategy: a way of seeing is also a way of not seeing Kazem Chaharbaghi ____________________________________________

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SECTION 2. COMPETITIVENESS, TRADE-OFFS AND VALUE CREATION Hierarchical strategies and strategic fit in the keep-or-sell decision Ulrich Lichtenthaler ____________________________________________

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Firm value creation and levels of strategy Cliff Bowman and Ve´ronique Ambrosini ___________________________

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Corporate strategy and shareholder value during decline and turnaround Olivier Furrer, J. Rajendran Pandian and Howard Thomas ____________

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CONTENTS

CONTENTS continued

SECTION 3. COMPETENCIES, CAPABILITIES AND RESOURCES Core competency beyond identification: presentation of a model Urban Ljungquist ______________________________________________

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Strategizing through the capability lens: sources and outcomes of integration Jad Bitar and Taı¨eb Hafsi _______________________________________

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Resource margin accounting: an elucidation and preliminary empirical testing Peter Johnson and Howard Thomas _______________________________

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A swift response tool for measuring the strategic fit for resource pooling: a case study Kobe Naesens, Ludo Gelders and Liliane Pintelon ____________________

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SECTION 4. HIERARCHICAL STRATEGIES AND THE RESOURCE-BASED VIEW Enhancing the prescriptiveness of the resource-based view through Porterian activity analysis Norman T. Sheehan and Nicolai J. Foss ____________________________

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Driving a resource orientation: reviewing the role of resource and capability characteristics Danielle A. Chmielewski and Angela Paladino _______________________

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SECTION 5. HIERARCHICAL FIT Levels of strategy and performance in UK small retail businesses Phil Megicks __________________________________________________

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Organizational alignment and performance: past, present and future Ravi Kathuria, Maheshkumar P. Joshi and Stephen J. Porth ____________

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Balanced scorecard and hoshin kanri: dynamic capabilities for managing strategic fit Barry J. Witcher and Vinh Sum Chau______________________________

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SECTION 6. KNOWLEDGE Knowledge as a lens on the jigsaw puzzle of strategy: reflections and conjectures on the contribution of a knowledge-based view to analytic models of strategic management John McGee and Howard Thomas_________________________________

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Expatriates and corporate-level international strategy: governing with the knowledge contract Brian Connelly, Michael A. Hitt, Angelo S. DeNisi and R. Duane Ireland__

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From strategic fit to customer fit Matti Santala and Petri Parvinen _________________________________

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SECTION 7. PEOPLE IN THE HIERARCHICAL FIT More than friendship is required: an empirical test of cooperative firm strategies Ossi Pesa¨maa and Joseph Franklin Hair Jr__________________________

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A holistic framework for the strategic management of first tier managers Lola Peach Martins_____________________________________________

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SECTION 8. MOVING ON: FROM HIERARCHY TO HETERARCHY From a hierarchy to a heterarchy of strategies: adapting to a changing context Bala Chakravarthy and James Henderson ___________________________

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EDITORIAL ADVISORY BOARD Ali E. Akgu¨n Associate Professor of Science & Technology Studies and Technology Management, School of Business Administration, Gebze Istitute of Technology, Turkey David Ballantyne Associate Professor of Marketing, University of Otago, New Zealand Dr Mike Berrell Professor of Work Organization, Director Academic, Graduate School of Business, RMIT University, Melbourne, Australia David M. Boje PhD Department of Management, New Mexico State University, USA Mike Bourne Cranfield School of Management, Centre for Business Performance, Cranfield, UK Catherine Cassell Professor of Occupational Psychology, Manchester Business School, UK Professor Jason C.H. Chen, PhD Professor, Graduate School of Business, Gonzaga University, USA Prof. (Dr) Patrick Low Kim Cheng, PhD & Chartered Marketer MD BusinesscrAFT Consultancy (Asia Pacific), Associate, University of South Australia Mark Dodgson Director, Technology and Innovation Management Centre, University of Queensland, Brisbane, Australia Mario Emiliani Professor of Management, Rensselaer at Hartford Lally School of Management and Technology, USA Dr Check Teck Foo Professor & Honorary Chair of Competitive Strategy, School of Management, University of St Andrews, UK Stan Glaser Fred Emery Institute, Melbourne, Australia Christian Gro¨nroos Professor, Swedish School of Economics, Helsinki, Finland John C. Groth Professor of Finance, Texas A&M University, USA Professor Simone Guercini Department of Business Sciences, University of Florence, Italy Professor Angappa Gunasekaran Department of Management, Charlton College of Business, University of Massachusetts, North Dartmouth, USA Kristina L. Guo PhD, MPH Associate Professor, Public Administration/Allied Health Administration, University of Hawaii-West O’ahu, Pearl City, HI, USA William D. Guth Harold Price Professor of Entrepreneurship and Strategic Management, New York University, USA Eric Hansen Professor, Forest Products Marketing, Department of Wood Science and Engineering, Oregon State University, USA Douglas A. Hensler PhD, PE Dean and Sid Craig Endowed Dean’s Chair, Craig School of Business, USA Sam Ho Dean. Hang Seng School of Commerce, Hong Kong Jay Kandampully Ohio State University, Columbus, USA

Editorial advisory board

Magda Elsayed Kandil Senior Economist, International Monetary Fund, Washington DC, USA Tauno O. Kekale University of Vaasa, Finland Yoshio Kondo Professor Emeritus, Kyoto University, Japan William S. Lightfoot, PhD Professor of Management, Associate Dean, International University of Monaco Hao Ma PhD Professor of Management & EMBA Director, Peking University, People’s Republic of China Dr Robert K. Perrons Executive Coordinator of R&D, Shell International Exploration & Production, The Netherlands Nigel F. Piercy Professor of Marketing & Strategic Management, Warwick Business School, University of Warwick, UK Erwin Rausch President, Didactic Systems, Inc., and Adjunct Professor, Kean University, USA Michael A. Roberto Assistant Professor, Harvard Business School, Boston, MA, USA Jennifer Rowley School for Business & Regional Development, University of Wales, Bangor, UK Joseph Sarkis Clark University, Worcester, MA, USA William Schulte, PhD Associate Professor, Sam Walton Free Enterprise Fellow, Harry F. Byrd Jr School of Business, Shenandoah University, USA Wang ShouQing Deputy Head, Department of Construction Management, School of Civil Engineering, Tsinghua University, Beijing, China Amrik S. Sohal Department of Management, Monash University, Melbourne, Australia Mary-Beth Stanek General Motors, USA Ian Taplin Department of Sociology and International Studies, Wake Forest University, Winston Salem, USA and Bordeaux Business School, France David Tranfield Professor of Management, Director of Research and Faculty Development, Cranfield School of Management, Cranfield, UK Joao Vieira da Cunha MIT Sloan School of Management, Cambridge, USA Claus von Campenhausen Accenture, Mu¨nchen, Germany Ingo Walter Charles Simon Professor of Applied Financial Economics, New York University, USA Charlie Weir Aberdeen Business School, Robert Gordon University, Aberdeen, UK Ray Wild Principal, Henley Management College, Management Decision Henley-on-Thames, UK, 1990-2001 Vol. 45 No. 3, 2007 p. 317 Richard Wilding # Emerald Group Publishing Limited Cranfield School of Management, Cranfield, UK

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Management Decision Vol. 45 No. 3, 2007 pp. 318-326 q Emerald Group Publishing Limited 0025-1747

Introductory chapter Introduction There is broad support for the notion of a hierarchy of strategies within the extant strategy literature (Grant and King, 1982; Hax and Majluf, 1984; Hofer and Schendel, 1978). Hierarchical levels include: international, corporate, business, and functional (Hitt et al., 2007; Dess et al., 1995). This hierarchical categorisation is all too evident in the stream of theoretical and empirical publications across both strategy process and strategy content (Dess et al., 1995). The international strategy research focuses on the examination of factors that motivate organisations to diversify and the relationship between internationalisation and economic performance (Geringer et al., 1989; Kim et al., 1989, 1993). This stream of research is rooted in the theory of portfolio diversification (Kim et al., 1989) or transaction cost theory (Hennart, 1991). Geographic diversification is the international equivalent of domestic product diversification (Dess et al., 1995). As such it can be viewed as a component of corporate strategy. Strategy at a corporate level is primarily concerned with domain selection, that is to say, seeking the answer to the question – what business is the organisation engaged in or should be engaged in? It is viewed in terms of the pattern of linkages among the different businesses constituting the corporate profile (Rumelt, 1974). Alternatively, corporate strategy may be viewed as a grand strategy (Pearce et al., 1987). A grand strategy may be defined as a comprehensive general plan of major actions through which a corporation intends to achieve its long-term objectives (Pearce, 1982). Although there is no consensus as to the definitive set of alternative grand strategies, four options are commonly mentioned. These are: stability (concentration on the existing activities coupled with efficiency and effectiveness improvements), internal growth (innovation, market and product development), external acquisitive growth (vertical and horizontal integration, concentric and conglomerate diversification, joint venture), and retrenchment (turnaround, divesture, liquidation). Strategy at the business level (also referred to as business-unit or strategic business unit (SBU) strategy) is concerned with domain navigation, that is to say, how do we effectively compete in each of our chosen product market segment (Bourgeois, 1980). The focus of business strategy is the attainment of long-term competitive advantage (Porter, 1980, 1985) in a particular industry. Strategy at a functional level focuses on the maximisation of resource productivity within each of the specific functions, for example, operations and marketing (Hofer and Schendel, 1978). It is generally assumed that functional strategies are derived from the business level strategy (Fitzsimmons et al., 1991; Hayes et al., 1988; Skinner, 1969, 1985; Slack and Lewis, 2002; Wheelwright, 1984). Ghobadian and O’Regan (2002) proposed a model for developing business level strategy. This model is extended to demonstrate the relationship between business level and functional strategy (see Figure 1). According to this model, business strategy establishes an organisation’s strategic goals and its responses to environmental influences such as competitors’ moves, technological changes, entry and exit of competitors. The organisational goals are used

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Figure 1. The relationship between different business and functional level strategies

to determine functional objectives and each function determines how it meets these objectives in terms of structure (brick and mortars), infrastructure (policy), process, interface, and behaviours. The extant literature assumes linkages between different levels of strategy. For example, Wheelwright and Hayes (1994) argued that operations can support the business strategy by either developing “appropriate” operational resources to enable the organisation to effective compete in a product market or for the operations function to provide the foundation for competitive success. In the first instance, operations are “internal supportive” and in the second instance, operations are “externally supportive”. The difference is whether operations is geared towards achieving best in class or redefining the industry’s expectations. Similarly, Dess et al. (1995) argued that corporate strategy directly influences business level strategy because of its impact on SBUs’: market power, ability to understand market needs, ability to differentiate it product-service mix from those of competitors, cost structure, and earnings and cash flow stream. Implicit in most of these writings is a reciprocal relationship between the different levels of strategy (see Figure 2).

Figure 2. The relationship between different levels of strategy

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Given the importance of the concept of strategy hierarchy and the implied relationship between different levels of strategy, the aim of this special issue of Management Decision is to make a contribution to the strategy literature by addressing a number of key questions. These included: . What is the implication of hierarchical strategies for theories such as RBV, dynamic capabilities, and positioning? . What is the scope of strategies at different levels? . Who is responsible for making decisions at each level? . What is the implication of hierarchical level strategy for global/international firms? . What are the consequences of overlapping between each domain, coordination and planning? . What is the impact of the multiplicity of environmental and organisational factors that may lead to divergence rather than convergence? . How do coordination and dispute resolution mechanisms to ensure convergence rather than divergence between different levels of strategy? . How does the definition and measurement of the concept of fit differ between the various levels of strategy? . What is the direction of fit? While it is assumed that the fit happens top-down, is this necessarily the case? . What empirical evidence supports or rejects the hypothesis that fit between the different levels of strategy leads to better performance? . What strategies are available for attaining a close fit between different levels of strategy?

The structure of contributions The special issue generated a high level of interest, which was reflected in many excellent papers we received. Despite having an opportunity to publish a double issue we were left with no option but to reject many high quality papers. We have clustered the papers included in this special issue under the following headings: . “The changing context of strategy”; . “Competitiveness, trade-offs and value creation”; . “Competencies, capabilities and resources”; . “Hierarchical strategies and the resourced-based view”; . “Hierarchical fit”; . “Knowledge”; . “People in the hierarchical fit”; and . “Moving on: from hierarchy to heterarchy”. Table I shows the contributions clustered under each of these headings.

The changing context of strategy

Chaharbaghi

Competitiveness, trade-offs and value creation

Lichtenthaler Bowman and Ambrosini Furrer, Pandian and Thomas

Competencies, capabilities and resources

Ljungquist Bitar and Hafsi Johnson and Thomas Naesens, Gelders and Pintelon

Hierarchical strategies and the resource-based view

Sheehan and Foss Chmielewski and Paladino

Hierarchial fit

Megicks Kathuria, Joshi and Porth Witcher and Chau

Knowledge

McGee and Thomas Connolly, Hitt, De Nisi and Ireland Santala and Parvinen

People in the hierarchical fit

Pesa¨maa and Hair Martins

Moving on: from hierarchy to heterarchy

Chakravarthy and Henderson

An overview of papers Section 1. Changing context of strategy The first paper is by Kazem Chaharbaghi and examines the changing context of strategy. The paper is entitled, “The problematic of strategy: a way of seeing is also a way of not seeing”. It considers the emerging complex environment facing organisations and questions the post-rational observations and traditional constructions of strategy in terms of what they achieve and what they fail to achieve. It contends that while strategy is a multi-dimensional, dynamic concept, it is often a misused term. His paper shows that failure to understand the multidimensional aspect will result in an illusive strategy. He contends that managers can derive significant benefits from strategy by understanding the multiple dimensions and their interrelatedness. This understanding will in turn lead managers to align the corporate, business and functional dimensions more effectively in the pursuit of competitive advantage. Section 2. Competitiveness, trade-offs and value creation The next three papers broadly examine the competitiveness and trade-offs and value creation. Ulrich Lichtenhaler in his paper, “Hierarchical strategies and strategic fit in the keep-or-sell decision” takes the issue of strategic fit outside the firm and explores how firms exploit their knowledge assets by means of licensing out technology. The paper considers strategic fit from the perspective of buy-or-sell as a means of potential external knowledge exploitation. In particular, the paper conceptually explores how firms may respond to potential conflicts in the keep-or-sell decision by achieving strategic fit. Both approaches have attendant risks and inherent conflicts at distinct levels within the organisation in aspects such as knowledge and/or product strategies, potential conflict in the corporate and business unit strategies, and also at an

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Table I. Cluster of contributions

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operational level where R&D and marketing strategies potentially collide. This paper provides an examination of the strategic challenges in the realisation of competitiveness, from a hierarchical strategies and strategic fit. It concludes by suggesting that the decision to keep or sell will be determined largely by the degree of emphasis given to the following characteristics of a firm’s strategic approach: coordination, centralisation and collaboration. Bowman and Ambrosini in their paper “Firm value creation and levels of strategy” explore a value creation perspective and consider the implications for corporate and business (competitive) level strategy. They begin by identifying how value is created within a firm and consider the distinction between competitive and corporate strategy in considering the processes of value creation. They identify three main activities: current profit flows, creation of future value and activities that serve to reduce current profit flows. By distinguishing between the value-creating roles of these activities, they examine the usefulness of distinctions between corporate level and business level activity using the concept of loose or tight coupling of activities. They contend that when firms extend their scope beyond the single product situation “corporatising” issues arise concerning the integration or separation of value activities. Furrer, Pandian and Thomas in their paper “Corporate strategy and shareholder value during decline and turnaround” examine the impact of strategic conduct on shareholder value using beta excess return measures. They test the contention that this is more appropriate that case or event studies by comparing the performance of declining and non-declining firms. Their findings indicate that during decline, shareholder value is reduced largely as a result of a lack of efficiency. They also found that during the beginning of a decline phase, strategic actions focused on improving long-term competitiveness had a negative effect, where later in decline phase, they had a positive impact. Section 3. Competencies, capabilities and resources Ljungquist in his paper “Core competency beyond identification: presentation of a Model“ propounds empirical identifiers for core competences and their associated concepts. He found that core competences do not need empirical identification, as they can be identified by their contribution to consumers’ benefits from a product, are competitively unique and provide potential access to a wide variety of markets. The paper includes a comprehensive discussion on core competence as a concept including associated concepts (competence, capability and resource). Bitar and Hafsi in their paper “Strategizing through the capability lens: sources and outcomes of integration” examine the role of capabilities in the quest for competitive advantage. Their paper seeks to address aspects such as where do capabilities come from and how does capability development affect performance – aspects that are under researched in the extant literature. The importance of capabilities from a hierarchical perspective lies in bridging the gap between the internal and external environments gap through managers’ cognition. The authors contend that companies need to achieve first, better alignment between long-term objectives, short-term objectives and organisational design, second, a better coordinated management effort between identifying the types of capabilities that can support a new strategic initiative and the nurturing and development of these capabilities, and third, the increased

synergies among capabilities when new strategic initiatives are grounded in an organisation’s existing capabilities. Johnson and Thomas in their paper “Resource margin accounting: an elucidation and preliminary empirical testing”, outline a conceptual framework to measure cash-flow or resource valuation known as Resource Margin Accounting. They contend that economic performance, measured in terms of the economic profit derived from the consumption of economic resources, drives valuation. Resource margins are potentially of significant interest to strategists as it extends the current strategic approaches to individual firms. Naesens, Gelders and Pintelon in their paper “A swift response tool for measuring the strategic fit for resource pooling: a case study”, examine the reluctance to implement horizontal collaboration in business. Many firms are now faced with the choice of keeping various functions in-house, outsourcing or seeking cooperation with other companies to exploit synergies. Collaboration with others can be vertical, horizontal or lateral. Horizontal collaboration is an area that is currently under researched. Naesens et al. have developed a tool to help management ascertain initially if collaboration with a potential partner is feasible and determine if a further in-depth analysis should be carried out. Section 4. Hierarchical strategies and the resource-based view Sheehan and Foss consider approaches to “Enhancing the prescriptiveness of the resource-based view through Porterian activity analysis”. They contend that the resource-based view (RBV) of strategy does not clarify the link between resources and value creation as it lacks a full consideration of activities and their drivers. They conclude by suggesting that by formally including the concepts of activities and activity drivers, the RBV can significantly overcome its current lack of managerial guidance. Chmielewski and Paladino in their paper “Driving a resource orientation: reviewing the role of resource and capability characteristics”, examine the role of resource and capability characteristics as drivers of a resource orientation. They see RBV as a strategic orientation, which is the extent to which a firm practises a RBV and is oriented towards the development of valuable and unique resource bundles. In this study, they identify and define resource and capability characteristics and assess their relationship to resource orientation. Findings indicate that resource and capability characteristics are significant drivers of resource orientation. They conclude by stressing the need to further examine the characteristics that resources and capabilities possess that enable a firm to implement a RBV. Section 5. Hierarchical fit Megicks in his paper “Levels of strategy and performance in UK small retail businesses” looks at the way smaller retail firms face increasing competition. He investigates the way in which small retailer performance is influenced by strategy at both business and functional levels. His findings indicate that a hierarchy of effects exists in the relationship between strategy and performance. Business level strategies were found to be more important to success than functional level strategy as they enable small retailers to distinguish their business from competitors. Kathuria, Joshi and Porth in their paper “Organizational alignment and performance: past, present and future”, examine the concept of organisational

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alignment in the pursuit of performance and competitive advantage. The importance of coordinating the corporate, business and functional priorities and strategies of the firm is well established. While the concept of organisational fit is not new, the area of horizontal (cross-functional and intra-functional) alignment is under researched. The benefits of horizontal alignment are encapsulated in the success of Southwest Airlines and the failure of others to imitate their underling horizontal alignment. Their contention that the role of horizontal alignment is increasing as larger businesses are becoming more complex is timely. Witcher and Chau in their paper “Balanced scorecard and hoshin kanri: dynamic capabilities for managing strategic fit” propose the use of the balanced scorecard (longer term performance) and hoshin kanri (shorter term capabilities) to integrate dynamic capabilities for the strategic management process. The balanced scorecard is normally associated with achieving strategic performance over a period of time, whereas hoshin kanri is focussed on deployment of strategic initiatives. Both concepts use a limited number of attributes to drive and capture performance related activities. They propose a form of nested hierarchies of dynamic capabilities as a new strategic fit perspective. Section 6. Knowledge McGee and Thomas in their paper “Knowledge as a lens on the jigsaw puzzle of strategy: reflections and conjectures on the contribution of a knowledge-based view to analytic models of strategic management” focus on the growing interest in knowledge management and organisational learning and consider how knowledge can be captured, interpreted and used effectively. They consider knowledge from four perspectives: as an asset to safeguard, embedded in routines, achieved through learning and achieved through innovation. They propose the knowledge web to identify the ways that knowledge is used and aligned with strategic theories of the firm. Connelly, Hitt, De Nisi and Ireland in their paper “Expatriates and corporate-level international strategy: governing with the knowledge contract”, consider the relationship between expatriate managers and MNC headquarters from an agency perspective. So far there is no consensus on how to gauge the success of such assignments, with different measures of success at different levels of analysis. In addition, matters are further confused when some authors see success at the subsidiary level while others focus on the individual level. In line with the concept of hierarchical fit, the authors focus on organisational concerns and conclude that the distribution of decision making, in the forms of delegation and managerial discretion, is central to understanding opportunistic behaviour. The paper provides the basis for measuring expatriate effectiveness and success. Santala and Parvinen in their paper “From strategic fit to customer fit”, extend the strategic fit discourse by proposing a customer-based perspective and suggest that from a customer perspective, the firm and its activities are separate units of analysis, which have a fit-like relationship. The authors approach the issue from the perspective of changing customer level knowledge and seek to ascertain how this knowledge can be captured, interpreted and used effectively. The authors have developed a multidimensional contingency framework of the customer perception process.

Section 7. People in the hierarchical fit Pesa¨maa and Hair in their paper “More than friendship is required: an empirical test of cooperative firm strategies” consider the approaches to competitive advantage undertaken by smaller firms and in particular the role of personal relationships. Their findings indicate that smaller firms considering shared competitive strategies should also consider cooperative relationships as part of the relationship. They found that long-term orientation has a positive effect on friendship, loyalty, trust and commitment, with friendship associated with loyalty and commitment, and loyalty related to trust. The findings support a greater emphasis on establishing relationships using loyalty, trust and commitment to develop successful higher order strategies. But relationships based on friendship also can be an important consideration in strategy development. Accordingly, they have no hesitation in suggesting that firms should consider the role of loyalty, trust and cooperation in selecting business partners. Martins in her paper “A holistic framework for the strategic management of first tier managers” examines the key factors influencing the human resource management (HRM) performance of first tier managers (FTMs), and the vital importance that a holistic strategic framework can have in this regard. She focuses on the pivotal role of FTMs on the deployment of human resource practices and suggests that their performance is less than satisfactory largely due to conflicts with their primary responisbility to achieve operational targets. Nevertheless, employers are seeking to establish more devolved management structures that place more emphasis on local level managerial decision-making, with a resultant re-configuration of the role of FTMs to encompass a wider range of people management responsibilities. Her findings suggest that organisations need to adopt a holistic strategic approach to ensure effective coordination of strategic direction and HRM, to encompass both “vertical” and “horizontal” dimensions. Such an approach will include FTM empowerment, clear performance criteria, effective communications and appropriate reward systems. Section 8. Moving on: from hierarchy to heterarchy Chakravarthy and Henderson in their paper “From a hierarchy to a heterarchy of strategies: adapting to a changing context”, contend that the hierarchical view of strategies does not really reflect where decisions are made within the organisation. They contend that corporate, business and functional strategies are not hierarchical anymore, and instead are contemporaneous and interactive. Accordingly, they see decision making as more heterarchical than hierarchical. Increasing interactions both inter and intra firm will add a new dimension to strategy formulation and enhance the heterarchical orientation now emerging. Abby Ghobadian, Nicholas O’Regan, Howard Thomas and David Gallear References Bourgeois, L.J. (1980), “Performance and consensus”, Strategic Management Journal, Vol. 1 No. 3, pp. 227-48.

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Dess, G.G., Gupta, A., Hennart, J.F. and Hill, C.W.L. (1995), “Conducting and integrating strategy research at the international, corporate and business levels: issues and directions”, Journal of Management, Vol. 21 No. 3, pp. 357-93. Fitzsimmons, J.A., Kouvelis, P. and Mallick, D.N. (1991), “Design strategy and its interface with manufacturing and marketing: a conceptual framework”, Journal of Operations Management, Vol. 10 No. 3, pp. 398-415. Geringer, M., Beamish, P. and daCosta, R.C. (1989), “Diversification strategy and internationalisation: implications for MNE performance”, Strategic Management Journal, Vol. 10 No. 2, pp. 109-19. Ghobadian, A. and O’Regan, N. (2002), “The link between culture and strategy in manufacturing SMEs”, Journal of General Management, Vol. 28 No. 1, pp. 37-56. Grant, J.H. and King, W.R. (1982), The Logic of Strategic Planning, Little, Brown and Co., Boston, MA. Hax, A.C. and Majluf, N.S. (1984), Strategic Management, Prentice-Hall, Englewood Cliffs, NJ. Hayes, R.H., Wheelwright, S.C. and Clark, K.B. (1988), Dynamic Manufacturing, Free Press, New York, NY. Hennart, J.F. (1991), “The transaction cost theory of the multinational enterprise”, in Pitelis, C. and Sugden, R. (Eds), The Nature of the Transnational Firm, Routledge, London. Hitt, M.A., Ireland, R.D. and Hoskinson, R.E. (2007), Strategic Management: Competitiveness and Globalization, 7th ed., Thomson-Southwestern, Cincinnati, OH. Hofer, C.W. and Schendel, D. (1978), Strategy Formulation and Analytical Concepts, West Publishing, New York, NY. Kim, W.C., Hwang, P. and Burgers, W.P. (1989), “Global diversification strategy and corporate profit performance”, Strategic Management Journal, Vol. 10 No. 1, pp. 45-54. Kim, W.C., Hwang, P. and Burgers, W.P. (1993), “Multinationals’ diversification and the risk return trade-off”, Strategic Management Journal, Vol. 14 No. 4, pp. 275-86. Pearce, J.A. (1982), “The company mission as a strategic tool”, Sloan Management Review, Spring, pp. 15-24. Pearce, J.A. II, Robbins, D.K. and Robinson, R.B. Jr (1987), “The impact of grand strategy and planning formality on financial performance”, Strategic Management Journal, Vol. 8 No. 2, pp. 125-34. Porter, M.E. (1980), Competitive Strategy, Free Press, New York, NY. Porter, M.E. (1985), Competitive Advantage, Free Press, New York, NY. Rumelt, R.P. (1974), Strategy, Structure, and Economic Performance, Harvard University Press, Cambridge, MA. Skinner, W. (1969), “Manufacturing – missing link in corporate strategy”, Harvard Business Review, Vol. 47 No. 3, pp. 136-45. Skinner, W. (1985), Manufacturing: The Formidable Competitive Weapon, Wiley, New York, NY. Slack, N. and Lewis, M. (2002), Operations Strategy, Financial Times Prentice-Hall, London. Wheelwright, S.C. (1984), “Manufacturing strategy: defining the missing link”, Strategic Management Journal, Vol. 5 No. 1, pp. 77-91. Wheelwright, S. and Hayes, R. (1994), “Competing through manufacturing”, Harvard Business Review, Vol. 72 No. 5, pp. 115-25.

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SECTION 1. THE CHANGING CONTEXT OF The problematic of strategy STRATEGY

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Kazem Chaharbaghi University of East London, London, UK Abstract Purpose – The paper aims to question the post-rational observations and traditional constructions of strategy in terms of what they achieve and what they fail to achieve, and seeks to reconstruct strategy as a multi-dimensional, dynamic concept. Design/methodology/approach – For this purpose, the study uses and interrelates the dualities between continuity principle and discontinuity principle, knowledge and imagination, opportunity exploitation and opportunity exploration, and conformist innovation and deviant innovation. The paper makes explicit, through the notion of performance paradox, the context for the framework that results from the mutual relation of these four dualities. Findings – The paper finds that failure to understand these dualities and their interrelatedness will ensure that strategy will remain largely an illusive, unexplained and rhetorical concept. It demonstrates that the greatest benefit of understanding these dualities and their interrelatedness is that it can show how organisations should be by illuminating who they might be. Research limitations/implications – The paper identifies opportunities for innovation, research and reflection by establishing the need for balancing the seemingly conflicting opposites of these interrelated dualities and ways in which they can be located on their strengths. Practical implications – The paper suggests that the understanding that emerges from the treatment of strategy as a multi-dimensional, dynamic construct, allows organisations to align the corporate, business and functional dimensions more effectively in making progress and receiving more in terms of the results they want to achieve. Originality/value – The paper introduces a radical shift in thinking, arguing for a move away from simplified, unbalanced, static constructions of strategy that focus on one-dimensionality, asymmetry and post-rationalisation. Keywords Performance management, Corporate strategy, Change management, Innovation Paper type Conceptual paper

Introduction The conceptualisation of strategy in terms of corporate, business and functional strategies has gained widespread acceptance in the study and practice of strategy. There is also a growing recognition that organisations will achieve a greater performance if their corporate, business and functional strategies are aligned, supporting each other. For this purpose, the design and planning schools, for example, emphasise the notion of hierarchy of strategies in the process of alignment based on a top-down, rational approach. Such an approach, however, can potentially lead to a one-dimensional, mono-logical thinking in today’s multi-dimensional world that

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presents organisations with multi-logical problems which call for accommodating multiple perspectives. By treating multi-logical problems as though they were mono-logical, one-dimensional thinking reduces strategy to a meaningless concept thereby constraining organisations in making progress and achieving sustainable success. This can be illustrated by first examining the overuse and misuse of strategy in practice as an inert term and then questioning the post-rational observations and traditional constructions of strategy both in their virtues and failings. Such an examination and questioning will pave the way to rethink and reconstruct strategy as a multi-dimensional, dynamic construct that allows organisations to align the corporate, business and functional dimensions more effectively in making progress and receiving more in terms of the results they want to achieve. Strategy is a borrowed term from the military. The origin of this term is the Greek strategia, meaning the art of war. Within its original context, it was simply understood as a military means to political ends (Sun Tzu, 1981). Strategy has now become the new mantra of contemporary organisations, an inert term with no substance and meaning, incapable of producing any reaction from those who utter or hear it. It is taking over meeting rooms and corporate documents like a virus. The overuse and misuse of this term can be explained in terms of the presence of inherent contradictions that derive from the disjunction between the existing assumptions on which organisations are run and the reality that no longer fits these assumptions. In such circumstances, when organisations call for strategy they are simply acknowledging its felt absence rather than its presence. The crisis that follows is not only epidemic, but also endemic within the context in which these organisations find themselves. This is because the solutions that helped solve the old problems have created a new set of problems that cannot be solved by the same solutions that created them. Unfortunately, the purpose of using the term strategy in organisations that cannot divorce their past is not to create an alternative future but rather to justify and reinforce the old familiar solutions that maintain status quo. Huxley’s hypothetical world provides an interesting parallel. In Huxley’s (1989) brave new world, happiness is achieved through a repetitive message and a pleasure drug called “soma”. This drug enabled its users to experience any pleasure they could dream, while the repetitive message promoted pleasure as an end in itself, which must be pursued ad infinitum. Soma together with the repetitive message that promoted pleasure culminated in a form of social conditioning where the users accepted their inescapable social destiny and stopped questioning the way the world was. With no questions asked, thinking was curtailed and thereby social stability was maintained. In organisations that find themselves in a state of perpetual decline, strategy has become like Huxley’s soma where the constant call for it is providing a psychology of comfort. Such a comforting placebo, however, can only provide a false appearance of stability for these organisations. This is because, whilst in Huxley’s hypothetical world social stability could be imposed by soma and its associated repetitive message, the constant call for strategy in the real world of organisations provides little more than a vacuous belief to displace anxiety, a form of escapism from the recurrent crisis that remains unresolved. The problem of strategy also stems from the study of strategy itself, while its solution lies in how strategy emerges in practice. Although strategy is one of the most studied and taught of concepts, it is paradoxically one of the least understood. The reason for this is at least threefold. First, the studies and teachings of strategy only

focus on what can be studied and what is teachable respectively thereby ignoring what cannot be studied and taught. Second, and relating to the first, most studies and teachings of strategy assume that it is possible to condition what is essentially a matter of emergence in a way that creates an objective, linear world in which organisations can objectively plot some step-by-step course of action that turns them into innovative powerhouses over a short predetermined period of time. While such objective, linear representations of the world can provide some illusion of control, experience shows that the real world is structured by potent forces many of which cannot be controlled at all. Third, and following from the first and second, most studies and teachings of strategy assume that it is possible to rationalise observations of successful behaviours and transform these post-rational observations into a formula for success that ignores not only the crisis or overwhelming opportunity that led to it but also the experimental, iterative and non-linear process from which it emerged. Even more worrying is the dangerous assumption that a universal meaning can be generated from such observations, which are always changing and incomplete. Leading organisations, however, are strangely unconcerned by the availability of post-rational observations and formulas that claim to explain their behaviour. They probably realise that post-rationalisation embodies the past and not the future. It can only explain their last creativity, the sell-by-date of which is already passing. In any case, leading organisations are too busy replacing an obsolete formula with a new one based on a recent creativity. The irony is that it is precisely the unpredictable behaviour of leading organisations that forces post-rationalists to make further observations in order to create more formulas for success. A powerful example illustrating this problem can be found in the literary success of Peters and Waterman’s (1982) study of “best-run” companies where the authors pioneered a qualities approach based upon the content of generalisable observations that appeared to be common to several seemingly successful organisations, only for several key subjects within their study to fail publicly within months of publication. It is therefore not surprising to see Peters openly stating that “I decide to write a new book when I feel disgusted and embarrassed by my previous one” (Crainer, 1997). The exponential growth of literature, fuelled by the constant post-rational observations and abstract constructions that compete for attention, is reminiscent of the fashion industry whose audience are made to discard unfashionable clothes and replace them with the latest fashion. A cursory examination of the growing literature on strategy displays this in action with the following famed examples having already been paraded on the “cat-walk” of strategy, where it has been dressed up to be: . About differentiation and cost leadership (Porter, 1985); stretch and leverage (Hamel and Prahalad, 1994); vision (Mintzberg, 1995); choosing what not to do (Porter, 1996); revolution (Hamel, 1996); and, fit and scope (Johnson and Scholes, 1997). . Treated as a plan, a pattern, a position, a ploy and a perspective (Mintzberg, 1995). . Generic (Porter, 1980); rational or incremental (Johnson, 1988); deliberate or emergent (Mintzberg, 1994); and, prescriptive, descriptive, configurational, implicit or explicit (Mintzberg and Ansoff, 1994).

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Approached from either a classical, evolutionary, processualist or systemic framework (Whittington, 1993), and from a process, content or context perspective (De Wit and Meyer, 1994).

The breadth and abundance of literature together with the variability of the perspectives and vocabulary used make it seem that the central problem, that is, strategy, is a secondary issue. The exponential growth of literature on strategy is directing attention in different ways, is adding greater complexity and is provoking more and more uncertainty while communicating less and less meaning to its audience. This in turn gives rise to another set of problems: one-dimensionality and asymmetry. In competing for attention, each perspective places two concepts in opposition and attaches value to one over the other. For example, Porter (1996) argues that the essence of strategy is choosing what not to do, as without trade-offs there would be no need for choice, and thus no need for strategy. He concludes that improving operational effectiveness is a necessary part of good management, but it is not strategy. Using a similar line of argument, Hamel (1996), in advocating strategy as revolution, rejects incrementalism by considering it to be depressingly futile as a strategy, claiming that corporations around the world are reaching the limits of incremental improvements. This perspective, however, is not ill-conceived, just partial and unbalanced, obscuring the merits of the alternative. It is important to recognise that a way of seeing is also a way of not seeing and that a central emphasis on one alternative involves neglecting the importance or significance of the others. Within the context of strategy as revolution, for example, the advocates of incrementalism would argue that if continuity leads to a prosperous existence then incrementalism is highly pertinent as there is no context for revolution. Furthermore, they would assert that the impact of incrementalism should not be considered in incremental but in cumulative terms. Moreover, incrementalists would claim that incrementalism is necessary in any case if the fruits of revolution are to be reaped and enjoyed. In order to return organisations to the basic principles that provide the necessary direction to achieve sustainable success and in order to bring about the much needed clarity to the strategy field, this study reveals that four dualities, interrelated, offer a framework for understanding strategy as a multi-dimensional, dynamic construction and for evaluating different observations and perspectives of strategy available today. It is shown that these dualities drive and support these observations and perspectives of strategy and permeate the fundamental vocabulary. These are the duality between: (1) continuity principle and discontinuity principle; (2) knowledge and imagination; (3) opportunity exploitation and opportunity exploration; and (4) conformist innovation and deviant innovation. Before presenting the framework, however, it is useful to introduce, through the notion of performance paradox, the context that makes this framework valid, reliable and relevant.

Performance paradox Vilfredo Pareto (1848-1923), in developing his polemical essay Trattato di Sociologia Generale (Pareto, 1916), which was translated into English under the title The Mind and Society in 1935, investigated the patterns of wealth and income in nineteenth century England. In this investigation, he discovered that the distribution of wealth was predictably unbalanced as 20 per cent of the population owned 80 per cent of the usable land. The basic imbalance observed by Pareto over a century ago, also known as the 80:20 rule or the law of the trivial many and the critical few, can usefully be paralleled to a recurrent crisis in organisational life: the performance paradox, which manifests when a significant majority of effort leads to a minority of the results. This apparent contradiction can be explained through the decay of cause-and-effect models. Organisations are the product of an idea, a winning way of thinking and doing that their members want to repeat again and again because it generates similar results thereby making them feel like winners. Cause and effect are assumed through feedback loops and a process of intensification. A negative feedback loop is employed to focus effort through minimal deviation and maximum control whilst the amplification of effects indicates positive feedback. Thus, as intensified repetition increases conformity, it appears that its effect is growing. However, a cause-and-effect model is only effective within the original context that made it relevant and thus emerging contextual changes make the construction upon which such causality was founded increasingly irrelevant. This is because as a cause-and-effect model loses its relevance the amplifiers and reducers weaken the link between cause and effect. In this way, a crisis emerges both from within and outside as the contextually-misaligned organisation shows signs of diminishing returns. A common approach to deal with such a crisis is to work harder by conforming even more rigidly to the decaying cause-and-effect model in order to make it work. Although such an approach may prolong life, it cannot succeed as the nature of causality has changed which means that there is an emerging strategy vacuum. This implies that the only remaining alternative is to create another cause-and-effect model, which like its predecessor is initially powerful but decays over time. The problem for organisations with a decaying cause-and-effect model and no viable alternative cannot be underestimated. In such times of difficulty, organisations want more control and get less. They apply more of the same solutions to solve problems, and wonder why problems multiply, the effort for each problem solved inflates and the time between problems solved increases. They intervene and direct more only to receive less in terms of the results they want to achieve. However, what these organisations fail to notice is that, in increasing conformity through intensifying repetition, minimising deviation and maximising control, they have developed, through an unconscious process, a danger model, the aim of which is to identify divergence and destroy it through exclusion and rejection mechanisms. The implication of such a danger-model is at least twofold. First, it renders organisations unable to perceive the end for which conformity was emphasised, and as a result, obsessive conformity, originally conceived as a means, becomes transformed into an end-in-itself. Second, to keep on doing what worked in the past, even though it means steady decline, no matter how hard the organisation works, necessarily involves neglecting other alternatives. This is because the fixation on “what is” obscures “what is not” or “what might be”. As a result, when a cause-and-effect model that was once

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powerful starts to decay, in the absence of an alternative, there is a transitional period when work that used to generate results becomes symbolic work that produces no effect. Symbolic work is like running on a treadmill, all motion but no direction. It involves constructing appearances of “busyness”, examples of which included endless crisis meetings, creation of numerous corporate documents and the consumption of fashionable behavioural models of “success”, which if aped, symbolic workers assume, will deliver similar riches to those gained by their exemplars. Thus, symbolic work provides little more than a false hope, an unrealistic expectation based on a denial of reality. It is an expensive prescription for maintaining status quo. As symbolic work can only accelerate the rate of decline, organisations that find themselves in a state of perpetual crisis eventually come to realise that effort without the rejection of the prevailing cause-and-effect model and substitution of a new powerful cause-and-effect model, is fatal. In other words, they have to become their own creative destroyers. It is this fundamental recognition that transforms strategy from a rhetorical into a meaningful concept. Rethinking and reconstructing strategy Four interrelated dualities can account for resolving the performance paradox. These are the duality between continuity principle and discontinuity principle, the duality between knowledge and imagination, the duality between opportunity exploitation and opportunity exploration, and the duality between conformist innovation and deviant innovation. The interrelatedness of these four dualities, depicted in Figure 1, culminates in a framework that constructs strategy as a multi-dimensional, dynamic concept. Duality, as a key concept guiding the development of this framework, must not be confused with other bipolar concepts such as dilemmas and paradoxes. What is common across all bipolar concepts are mutual exclusivity and simultaneity. However, while dilemmas are viewed as an “either/or” scenario in which one attractive and or undesirable alternative must be selected or rejected vis-a`-vis its equally attractive and

Figure 1. A framework for constructing strategy as a multi-dimensional, dynamic concept

or undesirable counterpart, and while paradoxes are the apparent contradictions arising from the simultaneous presences of two seemingly conflicting forces, events, factors or tendencies that do not necessarily call for a choice between them, a duality within the context of this study is characterised as: . A distinction between two realms, each very different, valid, having a different tendency with differing influences, and of utmost importance in understanding organisational life in general and strategy in particular. . A never-ending concern of a divergent nature that grows out of the differences between two seemingly conflicting opposites that are both permanent and existing simultaneously. . An “and/both” scenario in which the principal task is not to eliminate but to balance such differences. . A way of accommodating two seemingly conflicting opposites which locates them on their strengths while avoiding their weaknesses. . An opportunity for making progress and receiving more in terms of the results organisations want to achieve. In capturing the above characteristics, the methodological underpinnings of this study have been based on what Chaharbaghi and Cripps (2006) term “metalectics”, the logic of which they state stems from: [. . .] the recognition that the world of values is inconsistent because it is made up of antagonistic elements; that full commitment to opposing perspectives simultaneously is impossible, yet each demands total acceptance; that this is not a case of logical contradiction because it involves human values; and that it represents a kind of contradiction that lies at the heart of divergent agendas and practices. Based on these recognitions, metalectics can be considered as a way of describing choice-making through three kinds of complimentary inquiries: namely, an empathetic enquiry, a sympathetic inquiry, and a dialectic inquiry applied dialectically. An empathetic inquiry attempts to understand as much as possible the value assumptions, hidden motivations and arguments of differing positions that support their rationale. A sympathetic inquiry does not deny the value assumptions of assertions, models or paradigms of others but nevertheless raises as many critical questions as possible about them. The idea is to play the devil’s advocate in the role of a critical friend and consider whether alternative arguments are more convincing. At the meta-theoretical level of exploration a dialectic applied dialectically goes beyond competing explanations to establish an alternative way of thinking about choice. A dialectic applied dialectically avoids the limitations of compromise that is reached by a dialectic that is applied objectively i.e. the weakening of polarised discourses through a process of denying the strengths of each position. This is an important point because where compromise between argument positions is reached, individuals have no rational or good reason to accept or reject it. In other words, compromise is founded on an individual’s or a group’s participation in the solution but weak engagement with the struggle. The artistry involved in metalectics is exposed where the individual perceiving extremes in conflict uses their emotional intelligences such as empathy and sympathy to enable engagement with the struggle without commitment to a particular position. The aim is to keep polarised positions in the struggle of opposition because only through this struggle can true dialectic survive. It is therefore necessary to ensure that each discursive theme is not destroyed. A metalectic discourse is thus one that masters the art of argument using the strengths of each of the diverse argument positions to transform understanding.

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In resolving the performance paradox, using metalectics, the continuity principle must first be delineated from the discontinuity principle. Although continuity and discontinuity represent two opposing tendencies, the former favouring the status quo and stability and the latter emphasising transformation and radical change, it is ultimately the relative orientation with regard to time that explains the basis of their conflict. If time can be can considered as a continuum in which events pass from the future through the present into the past, two assumptions concerning the future determines the way in which the world is considered to work. First, the past will repeat itself or the past trends will continue. In other words, the future is a simple extension of the past or an extrapolation of past trend lines. As a result, memory, that is, the ability of retaining and recalling past experience arising from actual observation of or practical acquaintance with historical facts or preceding events, is what should govern decision making and action. The second assumption considers the future to represent a radical departure from the past, shifting the emphasis from a single future to a range of alternative futures, including, for example, those deemed probable, those considered as possible, although not necessarily probable, and those viewed as the unintended consequences of past decisions and actions. The proponents of the continuity principle maintain that stability arising from, for example, norms, mores and routines, brings about certainty, safety, security and emotional comfort, and that it promotes and reinforces community. Those who emphasise the discontinuity principle, on the other hand, present transformation and radical change as a promise of a better future, ensuring survival and driving progress. Without discontinuities, they argue, human beings would still live in caves, miserable and naked, and that out of discontinuities in the past have come meaningful, beneficial advances. Although the continuity and discontinuity principles may appear to be opposites, they are not hostile to one another for at least three reasons. First, the strengths of each can be found in the weaknesses of the other and vice versa. Second and relating to the first, continuity is favoured when it contributes to well-being and prospering. However, when continuity leads to a miserable existence then discontinuity is preferred. This is because in such circumstances continuity helps preserve unsatisfactory life conditions while discontinuity helps escape them. Third and corresponding to the second, without periods of continuity it is not possible to enjoy the beneficial advances brought about by discontinuities. Thus, when the continuity and discontinuity principles are seen as complementing one another, that is, working together and supporting each other, a virtual spiral emerges where the emphasis on one increases the benefits of emphasising more of the other. A disturbed harmony between these two tendencies, on the other hand, results in a vicious circle in which the persistent domination of one, for example, weakens both as the dominator allows its weaknesses to outweigh its strengths by neglecting or playing down the strengths of the dominated. The duality between continuity principle and discontinuity principle provides the context for the duality between knowledge and imagination. A useful starting point for examining this duality is to consider the way in which Albert Einstein placed knowledge in opposition to imagination. In an interview, the poet and journalist George Sylvester Viereck asked Einstein, how does he account for his discoveries? He replied: I am enough of an artist to draw freely on my imagination, which I think is more important than knowledge. Knowledge is limited. Imagination encircles the world (Viereck, 1929).

Einstein’s words attach value to imagination over knowledge and point to two factors that lie at the heart of this asymmetry. First, knowledge is limited, that is, what is known cannot be otherwise and what is otherwise cannot be known whether it exists or not. Second, imagination is infinite, that is, it is without limits or boundaries. The question is not whether Einstein was right in thinking imagination is more important than knowledge, but under what condition was he right? When human beings first turned a stone into a tool, they demonstrated a fundamental part of human mental ability: imagination. Although imagination is unlimited and a privilege given by birth, very few use its powers in their daily life. As knowledge and imagination facilitate continuity and discontinuity respectively, when continuity is preferred, knowledge is emphasised to preserve it. On the other hand, when discontinuity is called for, imagination is favoured in order to respond to new life conditions, develop novel solutions, discover new possibilities and invent alternative realities. This, however, does not mean that knowledge is not supportive of the imaginative process and vice versa. Imagination is what extends the boundaries of knowledge while knowledge provides the criticality that is necessary for the evaluation of imaginative ideas. The insight that emerges from such a criticality unites hindsight and foresight in a way that provides a greater sense of anticipation while helping avoid the pitfalls of unintended consequences when imaginative ideas are introduced. This mutual relation between knowledge and imagination turns on a different but related recognition, which is, while Einstein’s words regard knowledge as limited and imagination as without limits, imagination is not bounded by that which is already within the current vision or field of knowledge such that an advance may surprise those who hold such knowledge, but does not completely confound them. In such circumstances, imagination enables them to see things differently within what might be considered as existing knowledge rather than opening the possibility of seeing different things of a kind never seen before. From this perspective, seeing things differently may alter practice radically, but it does not necessarily revolutionise “knowledge”. The duality between opportunity exploitation and opportunity exploration follows logically from the duality between knowledge and imagination. In this duality, exploitation stresses intensification through heightened repetition, minimal deviation and maximum control with a view to achieving greater reward and payback in milking an existing opportunity. Exploration, on the other hand, privileges diversification, emphasising variety by regarding regeneration deriving from having ample choices. While exploitation limits choice through retention and conservative play by focusing on options proven to work in the past, exploration increases the potential for choice by embarking upon journeys of discovery and invention in the hope of favourable outcome which cannot be known in advance and which often lead to multiple paths. Within the context of organisations, as exploitation and exploration efforts compete for resources, both at times of scarcity and plenty, the allocation of resources often favours exploitation over exploration. This is because the former is considered as having immediate payback while the latter is viewed as lacking significance given its uncertain outcomes. Such an imbalance, however, can spell certain death as in the absence or reduction of exploration the stock of opportunities to exploit will eventually be exhausted. This, however, does not mean that an imbalance towards exploration is desirable. Too much emphasis on opportunity exploration can result in too many costly journeys that cannot be afforded because of inadequate exploitation. It therefore

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follows that without opportunity exploitation there is no context for opportunity exploration and vice versa, and that a balance between them is necessary in order to meet the needs of today without compromising the ability of organisations to meet future needs. The duality between conformist innovation and deviant innovation brings together the three dualities considered above in a common cause to resolve the performance paradox. Conformist innovation emphasises continuity, knowledge and exploitation by recognising achievement as engaging in a conforming conduct. It implies adaptation of the individual practices to the requirements of minimising deviation though maximising control. It emerges from identifying ways in which organisations can conform more and more rigidly to a cause-and-effect model in order to make its effect grow. As the presence of a powerful cause-and-effect model is what makes increasing conformity effectual, there is no context for conformist innovation as soon as a cause-and-effect model starts to decay. In such circumstances, conformist innovation only becomes useful again to organisations after another powerful cause-and-effect model emerges out of deviant innovation. Deviant innovation emphasises discontinuity, imagination and exploration in rewarding deviance. It implies challenging the prevailing assumptions on which organisations are run. It emerges when organisations are refocused on doing something different or doing things differently. Thus, while the direction is defined by deviant innovation, the most appropriate way to move in that direction is mapped out by conformist innovation. The above four dualities together with their interrelatedness construct strategy in a way that makes it a valid, reliable, meaningful and significant concept. In this construction, strategy is neither the continuity principle nor the discontinuity principle, neither knowledge nor imagination, neither opportunity exploration nor opportunity exploitation, neither conformist innovation nor deviant innovation, but a third entity independent of the two. It is simply a link, a mental bridge that facilitates the seemingly conflicting opposites of these four dualities working together in harmony and in support of each other in resolving the performance paradox. Although such a mental bridge may not be immediately apparent, it nonetheless exists. It has an effect and one intuitively knows what it is when a movement from one end to the other takes place. This mental bridge as much as providing a means for such a movement, and as much as being a bearer of exchange, keeps both ends apart, making the best of both worlds by allowing each end to play to its strengths, and in doing so, preserves the four dualities. This has to be the case because a bridge ceases to exist unless both ends remain in place. From this perspective, both conformist innovation and deviant innovation, for example, although very different, are of utmost importance and strategy is what links or bridges them, allowing conformist innovators to receive and exploit what deviant innovators have delivered in the form of a powerful cause-and-effect model. The most important consideration is that although the conformist and deviant innovators see this same bridge and use the term strategy to refer to it, they attach a different meaning to it because their purposes are dichotomous. For conformist innovators, who sit at one end of the bridge, receiving and exploiting cause-and-effect models, strategy is what makes conformity effectual. For deviant innovators, who sit at the other end of the bridge, creating and delivering cause-and-effect models, strategy is what makes deviance valuable. For those who locate themselves on the bridge, strategy is a philosophy of running a dynamic

organisation in which the requirements for a chain of timely cause-and-effect models is understood. The purpose of this chain is to continually stock up cause-and-effect models emerging from deviant innovation, sequence and time their release both to succeed the decaying cause-and-effect models and to introduce opportunities of a kind never exploited before. In a dynamic organisation, such a task is never complete. Indeed it can never end. New cause-and-effect models are continuously introduced, powerful cause-and-effect models are intensified and decayed cause-and-effect models cease. The dynamic organisation is maintained by a strong corporate culture which facilitates the effective operation of the chain of timely cause-and-effect models. Implications and opportunities for corporate, business and functional dimensions In facilitating the effective operation of the chain of timely cause-and-effect models, the alignment of corporate, business and functional dimensions cannot be underestimated. Traditionally, the corporate dimension has been viewed as being concerned with the portfolio of businesses an organisation should be in, the business dimension has been considered as emphasising the way in which each business should compete while the functional dimension has been treated as serving the needs of the two higher levels. Such a view creates, in the name of efficiency, an asymmetry through a hierarchy that involves a vertical relation of subordination and superordination in the process of coordination. The word hierarchy derives from two Greek words, hieros, meaning “sacred”, and arkho, meaning “rule”, implying a system of ranking and organising things or people, where each element, except for the top element, is subordinated to a single other element. From this perspective, conflict is seen as a competition with an eventual winner and loser while peace is treated as the absence of conflict due to hierarchal domination. This approach often assumes that such a structure is flexible enough to allow each dimension perform the role it is best suited for. This, however, is only possible if original structure accepts it. It can be argued that a dependent relationship between corporate, business and functional dimensions can be made in both directions. One, in fact, can accept that the functional dimension follows the business dimension which, in turn, is led by the corporate dimension but equally one can accept that the corporate dimension follows the business dimension which in turn is driven by the functional dimension. One position would be to consider “unless the former and or the latter is the case inefficiency results” as meaning “unless the corporate dimension matches the business dimension and the business dimension matches the functional dimension inefficiency results, the disengagement cost of which can be high”. In practice, there is a constant interplay between the corporate, business and functional dimensions. These dimensions are locked together in a trilogy. In making the corporate dimension to match the business dimension and the business dimension to match the functional dimension it is useful to think of their alignment in terms of mobilisation. To mobilise is to think of those located in the corporate, business and functional dimensions as a mob wishing to become an army. From this metaphorical perspective, each dimension must contribute its force to the collective in a mobilised or directed way to make an impact. This metaphor of mobilisation is enlightening as the context within which the trilogy of corporate, business and functional dimensions is placed can cause them to

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play together in different, non-linear ways, with each dimension performing the role it is best suited for and or the role it is not suited for. The emerging context in which organisations find themselves points to two important considerations. First, the recognition that heterogeneity, and not just homogeneity, can be a productive way of doing business. Second, a complex world creates tricky problems that need intricate solutions beyond the wit of one dimension. Within this emerging context, it is necessary to make a distinction between heterogeneous communities of interest and homogenous communities of practice. Many examples of human achievements involve the collaboration between many individuals and groups, each with unique experiences, varying interests and different perspectives. Such heterogeneous communities of interest form naturally in order to meet a multi-faceted challenge of common concern that cannot be met individually. These communities differ markedly from and must not be confused with homogenous communities of practice whose members specialise and focus on undertaking similar work. This distinction implies that the collective does not diminish the importance of the individual and vice versa. New promising directions, for example, does not necessarily have to originate from the corporate dimension and can emerge from existing capabilities of a business function or new capabilities developed within a business function and even from the individual imagination of a lone genius working in isolation. The importance of the heterogeneous communities of interest lies in the benefits derived from differences that are balanced through horizontal alignment whereas the contribution of the homogenous communities of practice grows out of the benefits of normalising through vertical alignment. They exist in an “and/both” rather than in an “either/or” relationship. From this perspective, the effective operation of the chain of timely cause-and-effect models is not simply the sum of individual mental and physical efforts, but rather their intensification and multiplication through complementarities. It is such complementarities that provide direction, focus efforts and coordinate actions in meeting this challenge of common concern. Within the context of facilitating the effective operation of the chain of timely cause-and-effect models, corporate, business and functional dimensions render themselves ineffectual where diversity is treated as a constraint, the collective and individual are dichotomised in competition with one another and heterogeneous communities of interest are treated as homogenous communities of practice and vice versa. References Chaharbaghi, K. and Cripps, S. (2006), “Intellectual capital: direction, not blind faith”, Journal of Intellectual Capital, Vol. 7 No. 1, pp. 29-42. Crainer, S. (1997), “Tom Peters”, Management Today, May, pp. 74-5. De Wit, B. and Meyer, R. (1994), Strategy: Process, Content and Context, West Publishing, New York, NY. Hamel, G. (1996), “Strategy as revolution”, Harvard Business Review, July/August, pp. 69-82. Hamel, G. and Prahalad, C.K. (1994), Competing for the Future, Harvard Business School Press, Boston, MA. Huxley, A. (1989), Brave New World, Harper Perennial, New York, NY.

Johnson, G. (1988), “Rethinking incrementalism”, in De Wit, B. and Meyer, R. (Eds), Strategy: Process, Content and Context, West Publishing, New York, NY, pp. 61-9. Johnson, G. and Scholes, K. (1997), Exploring Corporate Strategy: Text and Cases, Prentice-Hall, London. Mintzberg, H. (1994), The Rise and Fall of Strategic Planning, Prentice-Hall, London. Mintzberg, H. (1995), “The entrepreneurial organisation”, in Mintzberg, H., Quinn, B. and Ghoshal, S. (Eds), The Strategy Process, Prentice-Hall, London, pp. 588-97. Mintzberg, H. and Ansoff, I. (1994), “A discussion on strategy paradigms”, in De Wit, B. and Meyer, R. (Eds), Strategy: Process, Content and Context, West Publishing, New York, NY, pp. 69-84. Pareto, V. (1916), Trattato di Sociologia Generale, Barbera, Firenze. Peters, T. and Waterman, R. (1982), In Search of Excellence: Lessons from America’s Best Run Companies, Harper & Row, New York, NY. Porter, M.E. (1980), Competitive Strategy: Techniques for Analysing Industries and Competitors, The Free Press, New York, NY. Porter, M.E. (1985), Competitive Advantage: Creating and Sustaining Superior Performance, The Free Press, Boston, MA. Porter, M.E. (1996), “What is strategy?”, Harvard Business Review, November/December, pp. 61-78. Sun Tzu (1981), The Art of War, Hodder & Stoughton, London. Viereck, G.S. (1929), “What life means to Einstein: an interview by George Sylvester Viereck”, The Saturday Evening Post, October 26, p. 117. Whittington, R. (1993), What Is Strategy – Does It Matter?, Routledge, London. Corresponding author Kazem Chaharbaghi can be contacted at: [email protected]

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Hierarchical strategies and strategic fit in the keep-or-sell decision Ulrich Lichtenthaler WHU – Otto Beisheim School of Management, Vallendor, Germany Abstract Purpose – Besides applying knowledge in own products and services, firms increasingly exploit their knowledge assets externally, e.g. by means of licensing out technology. The aim of this paper is to help firms achieve strategic fit in the keep-or-sell issue, which results from potential external knowledge exploitation. Design/methodology/approach – The keep-or-sell decision refers to the issue whether to commercialize knowledge assets externally in addition to exploiting them inside the organization. Because of the high opportunities and risks of externally leveraging knowledge, the keep-or-sell decision constitutes a major area of conflict between strategies at different levels, particularly knowledge vs product strategies, corporate vs business unit strategies and R&D vs marketing strategies. After detailing the keep-or-sell decision, the paper conceptually explores how firms may respond to potential conflicts in the keep-or-sell decision by achieving strategic fit. Findings – The paper identifies, in particular, three major characteristics of a firm’s strategic approach, i.e. coordination, centralization, and collaboration, which may help firms achieve strategic fit in the keep-or-sell issue. Originality/value – The keep-or-sell decision is a unique arena for studying hierarchical strategies and strategic fit. As a result, this paper has major implications for research into strategic fit, hierarchical strategies, knowledge management and open innovation. Achieving fit across a firm’s different strategies in the keep-or-sell issue is essential for firm performance in a knowledge-based economy. Keywords Corporate strategy, Strategic management, Knowledge transfer, Licensing, Innovation, Technology led strategy Paper type Research paper

Management Decision Vol. 45 No. 3, 2007 pp. 340-359 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710744990

Introduction External knowledge exploitation refers to commercializing knowledge assets either exclusively or in addition to their application in a firm’s own products or services, e.g. licensing-out transactions. The commercialization of knowledge assets is not a new phenomenon (Lamoreaux and Sokoloff, 1998; Lichtenthaler, 2005). However, it was considered an appropriate strategy only in some specific situations in the past because most industrial firms focused on their product business (March, 1991; Sanderson, 1998; Gallear and Ghobadian, 2004). A main reason for the traditional underutilization of the external mode of exploiting knowledge is the imperfections in the knowledge markets (Teece, 1981; Arora et al., 2001). Despite these imperfections, an active acquisition of external knowledge could be observed in many companies since the end of the 1980s

(Jones et al., 2001; Lichtenthaler and Lichtenthaler, 2004). As a result, firms are faced with the make-or-buy decision, i.e. the issue whether to develop knowledge in-house or whether to acquire it from external sources (Kurokawa, 1997; He and Nickerson, 2006). Only since the end of the 1990s, however, has the external commercialization of knowledge assets become a broader trend (Chesbrough, 2003a; Lichtenthaler, 2005; Gassmann, 2006). Various pioneering companies, such as Texas Instruments, Lucent Technologies, Dow Chemicals and DuPont, generate hundreds of million dollars in annual licensing revenues (Sullivan and Fox, 1996; Arora et al., 2001; Chesbrough, 2003a; Kline, 2003). Moreover, firms may realize major strategic benefits, such as gaining access to external knowledge or establishing own technologies as industry standards (Grindley and Teece, 1997; Rivette and Kline, 2000; Arora et al., 2001; Koruna, 2004). Besides these positive effects, the commercialization of knowledge assets contains substantial risks. Above all, external knowledge exploitation may strengthen competitors as a result of diffusing competitively relevant knowledge (Teece, 1986; Rivette and Kline, 2000; Arora et al., 2001). Therefore, firms are increasingly faced with the keep-or-sell decision, i.e. the issue whether knowledge should be applied in the firm’s own products and services or whether it is commercialized, additionally or exclusively, in disembodied form (Lichtenthaler, 2005). Despite the recent increase in external knowledge exploitation, prior research has largely neglected the keep-or-sell decision. The literature comprises mainly managerial works (e.g. Rivette and Kline, 2000; Davis and Harrison, 2001). As a result, the major strategic implications that derive from the keep-or-sell issue due to a potential active commercialization of knowledge assets have not been addressed. The strong need for research is underlined by the substantial managerial difficulties of many firms that contrast the enormous success of some pioneering companies (Escher, 2003; Lichtenthaler, 2006a). Moreover, prior research has shown that firms which actively commercialize knowledge assets are usually also deeply involved in acquiring external knowledge (Ford, 1985; Lowe and Taylor, 1998). One major reason for this finding may be the strategic approach to knowledge transactions in these firms (Ford, 1988; Grant and Baden-Fuller, 2004). Therefore, this article examines the role of different strategies in the keep-or-sell issue. As internal innovation constitutes the core business of most industrial firms, a basic volume of new products and services is developed independent of the specific strategic approach (Atuahene-Gima and Ko, 2001; Rigby and Zook, 2002; O’Regan et al., 2006). Regarding external knowledge exploitation, by contrast, there is not a substantial basic volume of knowledge transactions in most firms because their activities in this area are still limited (Tschirky et al., 2000; Elton et al., 2002; Koruna, 2004). Thus, the impact of the strategic approach likely is very high, and the examples of some pioneering firms underline the importance of a firm’s knowledge exploitation strategy (Chesbrough, 2002; Cohen, 2004; Shuchman, 2004). Moreover, the substantial revenues and the high risks inherent in external knowledge exploitation emphasize the importance of the keep-or-sell issue. In particular, the keep-or-sell decision constitutes a major area of conflict between strategies at different levels, e.g. corporate strategy vs business unit strategy. Thus, the keep-or-sell decision seems to be a unique arena for studying hierarchical strategies and strategic fit. Accordingly, this article addresses the following fundamental questions:

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What role do hierarchical strategies play in the keep-or-sell issue? What are major sources of conflict between different strategies in the keep-or-sell decision? How may firms achieve strategic fit in the keep-or-sell issue?

After detailing the keep-or-sell decision from a knowledge-based theoretical perspective, this article addresses the major areas of conflict between different strategies in the keep-or-sell issue. These conflicts may arise between strategies at distinct levels, particularly knowledge vs product strategies, corporate vs business unit strategies and R&D vs marketing strategies. Then, the paper explores how firms may respond to these challenges by achieving strategic fit in the keep-or-sell decision. To achieve strategic fit in the keep-or-sell issue, three major characteristics of a firm’s strategic approach to knowledge exploitation are identified: coordination, centralization and collaboration. These three principles may help firms avoid or overcome strategic conflict in the keep-or-sell issue. The implications of this analysis for theory and practice are discussed, and directions for future research are presented. Accordingly, this article offers several contributions. It constitutes the first work that examines in detail the strategic challenges of the keep-or-sell issue. Thus, this research deepens our understanding of realizing value from knowledge in open innovation systems (Chesbrough, 2003a; Laursen and Salter, 2006). Moreover, it addresses numerous emerging themes in knowledge management. By analyzing strategic issues in the decision to transfer knowledge assets to recipients outside the firm, it deepens our understanding of nonefficiency perspectives on organizational boundaries (Santos and Eisenhardt, 2005) and congruence between properties of contexts (Argote et al., 2003). In addition, the paper has major implications for research into hierarchical strategies and strategic fit. In the following section, a brief overview of the keep-or-sell decision is given from a knowledge-based theoretical perspective. The keep-or-sell decision Since the 1980s, corporate competition has changed, particularly with regard to the importance of knowledge in today’s economy. As competition has become increasingly knowledge-based (Lane and Lubatkin, 1998; Seely Brown and Duguid, 1998; Amesse and Cohendet, 2001), both firms and strategic management theorists have focused their attention in the context of corporate strategy upon knowledge. Many companies have started knowledge management initiatives and try to actively manage their knowledge bases (Nonaka and Takeuchi, 1995; Teece, 2000). Furthermore, there has been a substantial increase in the external acquisition and external exploitation of knowledge assets by which companies attempt to complement and capitalize their knowledge bases (Kurokawa, 1997; Rivette and Kline, 2000). Corporate strategy theory has reflected and stimulated these trends. By emphasizing the influence of knowledge and technology, researchers have tried to overcome the black box of the economist’s production function as well as the focus on transaction costs and on tangible resources of former theories (Grant, 1996; Spender, 1996). Some researchers have moved towards a distinctly knowledge-based theory of the firm (Grant, 1996; Spender, 1996), adopting a view on corporations as distributed knowledge systems (Tsoukas, 1996). Moreover, knowledge has a fundamental role in various other theories. Although knowledge is not the sole focus of these approaches,

the authors consider knowledge a crucial resource and emphasize the importance of knowledge creation and knowledge application. Among others, this is true for the evolutionary theory (Nelson and Winter, 1982), the resource-based view (Wernerfelt, 1984; Prahalad and Hamel, 1990; Barney, 1991), the dynamic capabilities approach (Teece et al., 1997; Eisenhardt and Martin, 2000) and the technology-based theory (Granstrand, 1998). As a result, there are various theoretical approaches, which are in many ways complementary and are aimed at explaining how companies may gain and sustain a competitive advantage against the background of an increasing importance of knowledge and a growing intensity and dynamism of competition. Apart from the importance of knowledge generation and its application and value appropriation inside the firm (Lichtenthaler and Ernst, 2006), these theoretical approaches underline that knowledge may be regarded as an economic good itself (Granstrand, 2000; Lichtenthaler, 2006b). Firms may be characterized as both product domain and knowledge domain, and an efficient use of a company’s knowledge requires congruence between these domains (Grant and Baden-Fuller, 2004). However, perfect congruence usually does not exist in reality (Grant, 1996) which gives rise to the markets for knowledge, in which a company may operate both as a buyer and supplier of knowledge (Teece, 1981). At the very least, the existence of these markets for knowledge expands the strategy space. Teece (1986) pointed out that if a firm cannot appropriate rents through commercializing knowledge assets, it should acquire complementary assets, which facilitate the internal application of the knowledge. Reductions in the transaction costs in the markets for knowledge, by contrast, increase the propensity of firms to externally exploit knowledge (Arora et al., 2001). In this context, Arora et al. (2001) have underlined that stronger intellectual property protection may be a mixed blessing for firms in knowledge-intensive industries. Although stronger intellectual property rights raise barriers against imitation by rivals, they may nonetheless ultimately result in more intense product market competition by facilitating knowledge transactions (Arora et al., 2001). Because of the possibility of internally and externally exploiting knowledge, a company generally has a choice between two options. In some situations, actual “either-or” decisions have to be taken (Lichtenthaler, 2005). Often, however, the internal and external modes of knowledge exploitation do not exclude one another (Ford, 1988; Brockhoff, 1998). Nevertheless, a company always has to decide whether to develop particular dynamic capabilities and internally exploit its knowledge assets or whether to build up different capabilities to be able to successfully manage the external commercialization of knowledge (Teece et al., 1997; Zack, 1999). Despite the complementary character of internal and external knowledge exploitation, a company therefore has to take keep-or-sell decisions, which refer to the question whether knowledge should be applied in the firm’s own products and services or whether it is commercialized, additionally or exclusively, in disembodied form (Lichtenthaler, 2005). The well-known make-or-buy decision in knowledge acquisition describes the question whether to develop knowledge in-house or whether to acquire it from external sources (Kurokawa, 1997; He and Nickerson, 2006). While internal R&D has traditionally been viewed as an important source of knowledge acquisition, an increasing inward transfer of knowledge may be observed in most companies since the 1980s (Veugelers, 1997; Gassmann and Reepmeyer, 2005). This has led to a more

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thorough analysis of the make-or-buy issue in many companies and to renewed scientific interest in this field of research (Pisano, 1990; Kurokawa, 1997; Veugelers, 1997; Veugelers and Cassiman, 1999). With regard to the keep-or-sell decision in knowledge exploitation, the traditional business strategies of large firms have focused on the internal application of knowledge assets (March, 1991; Chesbrough, 2003a). By contrast, external knowledge exploitation, e.g. out-licensing transactions, was used to a limited degree in the past (Elton et al. 2002; Koruna, 2004). In recent years, however, a considerable trend towards a more active commercialization of knowledge assets could be observed (Rivette and Kline, 2000; Lichtenthaler, 2005). As this development is a trend from practice rather than a movement initiated by academic research, scientific interest in external knowledge exploitation and in the keep-or-sell issue has grown only recently (Tschirky et al., 2000; Granstrand, 2004; Koruna, 2004). In particular, the keep-or-sell decision requires balancing the benefits and risks of commercializing knowledge assets. Apart from generating licensing revenues, external knowledge exploitation may be pursued to achieve a variety of strategic objectives. Among them are gaining access to external knowledge, setting industry standards, profiting from infringements of a firm’s intellectual property, realizing learning effects and guaranteeing “freedom to operate” (Grindley and Teece, 1997; Rivette and Kline, 2000; Lichtenthaler, 2005). Regarding the risks of commercializing knowledge assets, there is basically a trade-off between realizing the monetary and strategic benefits on the one hand and protecting a firm’s knowledge base and its idiosyncratic competencies on the other (Teece, 1986; Arora et al., 2001). These potential negative consequences and the resulting fear of giving away “corporate crown jewels” (Kline, 2003) are a main reason why most companies concentrated on internal knowledge exploitation and neglected the commercialization of knowledge assets in the past (Ford, 1985; Vickery, 1988; Elton et al., 2002). Despite the partial appropriateness of transaction cost theory (Coase, 1937; Teece, 1981; Caves et al., 1983; Seely Brown and Duguid, 1998), no detailed and comprehensive framework for the keep-or-sell decision in commercializing knowledge assets has emerged yet. While the role of the particular knowledge asset has been addressed in relative detail (Ford and Ryan, 1981; Lichtenthaler, 2005), other factors, especially the influence of the potential knowledge recipient, have mostly been ignored. Owing to the high complexity and context-dependency of the decision, it will be difficult or even impossible to develop a comprehensive framework as intended by Ford (1988). It appears to be more important that companies establish an overall external knowledge exploitation strategy, which is closely coordinated with the firm’s corporate strategy and with its internal knowledge exploitation strategies. On this basis, individual keep-or-sell decisions may be taken (Ford, 1988; Arora et al., 2001). In particular, an overall strategy will allow for responding to the potential conflicts of strategies in the keep-or-sell decision. These potential strategic conflicts in the keep-or-sell issue will be addressed in the following section. Conflict of strategies in the keep-or-sell decision The conceptualization of different hierarchical strategies constitutes a major approach to strategizing in theory and practice (Burgelman, 1983; Porter, 1987; Ensign, 1998; Frishammar, 2003; Grant, 2003; O’Regan and Ghobadian, 2004). Because of the

fundamental effect of external knowledge exploitation, i.e. transferring proprietary knowledge assets to recipients outside the firm (Lichtenthaler, 2005), the keep-or-sell issue bears major potential for conflict between different strategies. Basically, these conflicts may arise from different degrees of openness with regard to externally leveraging knowledge. As most industrial firms focus on applying their proprietary knowledge in own products, they are not necessarily open to external knowledge exploitation (Elton et al., 2002; Chesbrough, 2003a). Depending on their particular scope and direction, different strategies consider the commercialization of knowledge assets in an entirely different way. In particular, there are major differences regarding the openness to commercializing knowledge assets, which result in three major areas of conflict between different strategies: knowledge vs product strategy, corporate vs business unit strategy and R&D vs marketing strategy. In the following, the issue of knowledge vs product strategies is addressed. Knowledge strategy vs product strategy Knowledge may be regarded as an economic good (Granstrand, 2000). Firms may be characterized as both product domain and knowledge domain, and an efficient use of a company’s knowledge requires congruence between these domains (Grant and Baden-Fuller, 2004). As perfect congruence usually does not exist (Grant, 1996), firms have to decide whether the rents from their knowledge assets are commercialized best by integrating into related markets, by selling intermediate output or by selling the knowledge assets themselves (Teece et al., 1997). Accordingly, firms may simultaneously operate on the markets for products and services and on the markets for knowledge. With an increasing importance of knowledge transactions (Grant and Baden-Fuller, 2004), a firm’s knowledge strategy (Zack, 1999) does not only constitute a strategy that is subordinate to the firm’s product strategies in realizing value from knowledge through internal innovation. Instead, it represents a complementary strategy to a firm’s product strategies (Tschirky et al., 2000). While product strategies focus exclusively on the product business, external knowledge exploitation is mainly regarded as a potential avenue of diluting a firm’s competitive advantage in the product markets (Lorange, 1980). Knowledge strategy, by contrast, takes a broader approach to exploiting knowledge assets and is therefore more open to externally commercializing knowledge (Zack, 1999). After discussing the potential conflict between knowledge and product strategies, the following section deals with the issue of corporate vs business unit strategies. Corporate strategy vs business unit strategy While knowledge strategies take a broader approach to exploiting knowledge assets than product strategies, corporate strategy similarly takes an overall perspective on a firm’s business activities (Ansoff, 1965; Porter, 1987; Grant, 2003). The business unit strategies often tend to be relatively reserved with regard to externally leveraging knowledge although the commercialization of a particular knowledge asset might be appropriate from a corporate perspective. Because of incentive systems and other reasons, however, business unit strategies tend to focus exclusively on the local

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optimum for their particular business unit and not on the overall optimum for the whole company (Ansoff, 1965; Burgelman, 1983; Richter and Schmidt, 2005). A corporate-level strategy in external knowledge exploitation (Tschirky et al., 2000; Lichtenthaler, 2005) has to balance this focus by showing that external knowledge exploitation may be beneficial even if it negatively affects the competitive position of a particular business unit. From a firm-level perspective, it is appropriate to realize a knowledge transaction if its negative effects are overcompensated by the positive effects for the firm as a whole. For instance, a firm may decide to externally commercialize knowledge to generate licensing revenues, which overcompensate a decrease in the revenues and profit of a particular business unit. Besides potential conflicts between the corporate and business unit level, conflicts may arise between the functions of R&D and marketing, which are addressed in the following section. R&D vs marketing strategy As the focus of the marketing department is traditionally on a firm’s product or service business (Brockhoff and Chakrabarti, 1988; Tschirky et al., 2000; Escher, 2003), the marketing function in most firms is relatively reserved with regard to externally leveraging knowledge. The main reason for this reserved approach is the fear of strengthening competitors in the product business due to commercializing “corporate crown jewels” (Kline, 2003). As a result, the commercialization of knowledge assets is pursued much more proactively by the R&D department. Often, the R&D department is faced with the challenge of increasing the return on a firm’s R&D expenditures (Edler et al., 2002). Moreover, many firms have set up initiatives of organizing corporate R&D departments as profit centers (Lichtenthaler, 2005). Similar arguments apply to the approach of intellectual property departments or specialized external knowledge exploitation units, e.g. licensing functions (Tschirky et al., 2000), which are usually responsible for coordinating the external knowledge commercialization activities. As there is often a structural or hierarchical link of the intellectual property or licensing department to the R&D department (Tschirky et al., 2000; Escher, 2003), the conflict of functional strategies in the keep-or-sell decision basically boils down to coordinating the R&D and marketing functions. To cope with these potential conflicts and align the different strategies, firms may design their strategic approaches to the keep-or-sell issue. This alignment of strategies at different levels is addressed in the following section. Alignment of strategies in the keep-or-sell decision Successfully approaching the keep-or-sell decision requires in the first step a strategic approach to internal and external knowledge exploitation (Ford and Ryan, 1981; Lichtenthaler, 2005). However, prior research has shown that external knowledge commercialization is often still regarded as an ad hoc operation in practice (Fu and Perkins, 1995; Escher, 2003). Because of the imperfections in the markets for knowledge (Teece, 1981; Arora et al., 2001), networks and personal contacts have often played a key role in initiating knowledge transactions (Bidault and Fischer, 1994; Fu and Perkins, 1995). Although these imperfections support informal approaches to externally leveraging knowledge, they should be integrated into a more formalized knowledge exploitation strategy (Ford, 1988; Teece, 1998; Tschirky et al., 2000).

In internal knowledge exploitation, product-market strategies determine with which products a firm addresses which product markets (Lorange, 1980; Burgelman, 1983). An external knowledge exploitation strategy, by contrast, determines with which knowledge assets the firm addresses which knowledge markets (Koruna, 2004; Lichtenthaler, 2005). To reduce potential conflict of different strategies in the keep-or-sell decision, three major characteristics of a firm’s strategic approach could be identified: coordination, centralization and collaboration (Figure 1). While these characteristics facilitate the development of strategic fit in the keep-or-sell issue, they have implications for addressing hierarchical strategies to achieve strategic fit in general. The first issue of coordination is addressed in the following section.

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Coordination To realize the benefits of externally leveraging knowledge and reduce the potential conflict knowledge strategies vs product strategies, developing a specific strategy constitutes a first step. To make the external commercialization of knowledge a truly strategic activity, however, companies should take an integrated view comparing their current and future knowledge assets with both internal and external exploitation opportunities (Teece, 1986; Chesbrough, 2003b). Such an approach will facilitate an adequate use of the two complementary modes of knowledge exploitation, and it will permit a more effective integration of the firm’s knowledge about particular markets and applications. If external knowledge exploitation is an integral part of a firm’s overall business strategy, the identification of knowledge commercialization opportunities ideally does not only consider knowledge that has already been developed and is used or not used inside the company. Instead, it will already start during internal or external knowledge acquisition to take external knowledge exploitation into account in all major decisions regarding a company’s knowledge assets (Ford and Ryan, 1981). Thus, it seems beneficial to integrate the external knowledge exploitation strategy into the firm’s overall corporate strategy and to coordinate it with a firm’s knowledge generation and internal knowledge exploitation. Regarding the coordination of external knowledge exploitation with knowledge generation, companies should not only consider the commercialization of knowledge assets starting from their current knowledge base. Rather, it should already be taken into account in decisions on building up particular competencies and in the make-or-buy decisions on developing these competencies:

Figure 1. Strategic conflict and strategic fit in the keep-or-sell decision

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[A] company must not base its development decisions on the projected returns from product sales alone. Instead, it should consider potential returns from the technology as a whole (Ford and Ryan, 1981, p. 121).

For instance, it might be beneficial to develop knowledge internally rather than to acquire it from external sources to realize external knowledge exploitation opportunities, which could not be achieved with knowledge that has been acquired from external sources. This type of systematic coordination of external knowledge exploitation strategy into corporate strategy is particularly important as there is a trend towards a closer linkage between the process of generating new knowledge and the process of exploiting knowledge (Brockhoff, 1998). In addition, the coordination of a firm’s knowledge exploitation strategy comprises the alignment of external knowledge exploitation with internal knowledge exploitation, especially with a firm’s product strategies and new product development programs. A close coordination is essential due to the interdependencies between the two modes of exploiting knowledge (Ford, 1988). On the one hand, external knowledge exploitation will usually limit the current and future internal knowledge exploitation opportunities. In many cases, it will not be beneficial to use internal and external knowledge exploitation simultaneously. Moreover, the diffusion of knowledge assets and the potential lack of developing the necessary complementary assets will influence the firm’s future internal knowledge exploitation potential. On the other hand, the external knowledge exploitation strategy will often only be successful if it is closely linked to the firm’s internal exploitation strategies and competitive strategies (Porter, 1980; Helms et al., 1997), which also demonstrates the high degree of interdependence. This is particularly true for many of the strategic functions of commercializing knowledge assets, such as setting industry standards, which are directed at both internal and external knowledge exploitation activities (Koruna, 2004). Accordingly, firms should not only formulate the well-known types of product-market strategies (e.g. Lorange, 1980), but they should widen the perspective of their corporate strategies to incorporate external knowledge exploitation and develop adequate “meta-strategies” to harmonize their knowledge management activities (Smothers, 1990; Brockhoff, 1998). Taking into account the requirement of complementary assets (Teece, 1986; Arora et al., 2001), the critical factor of such strategies may be seen in the goal of maximizing the rents derived from knowledge assets in the broader context of corporate strategy. To align corporate and business unit strategies, centralization is an important means, and it is described in the following section. Centralization To cope with the conflict corporate strategy vs business unit strategies, firms may establish a formal external knowledge exploitation strategy at the corporate level. Drawing on prior research into corporate strategy (Ansoff, 1965; Ensign, 1998; Chaharbaghi and Lynch, 1999; Bowman and Helfat, 2001; Richter and Schmidt, 2005), a firm’s corporate external knowledge exploitation strategy may be considered a company’s overall plan with regard to the commercialization of knowledge assets. Thus, this strategy is what makes a firm’s external knowledge exploitation add up to more than the sum of individual knowledge transactions, for example synergies due to learning effects, centralization or portfolio management (Burgelman, 1983; Porter,

1987; Lieberman, 1989). To understand how to formulate a corporate external knowledge exploitation strategy, the three essential criteria for developing successful corporate diversification strategies (Porter, 1987), i.e. internal knowledge exploitation strategies for the product and service markets, may be transferred to the level of knowledge markets. First, the particular knowledge markets that a firm addresses have to be structurally attractive or capable of being made attractive (Porter, 1979; Baysinger and Hoskisson, 1989). While this aspect is essential for diversification, it is less important for external knowledge exploitation due to the limited need to build up specific resources. However, attractiveness certainly matters if, for example, the decision is taken to continue developing knowledge to realize external knowledge exploitation opportunities. Second, the cost of entry into the knowledge markets must not capitalize all the expected future revenues from these fields (Porter, 1987; Lieberman, 1989; Root, 1994). Because of imperfections in the knowledge markets, entry costs may be substantial for a single knowledge transaction. Because of the multi-project perspective of the corporate-level view, however, initial entry costs may pay off if a sufficient return is achieved over numerous knowledge transactions. Third, the corporation as a whole must gain competitive advantage from external knowledge exploitation (Burgelman, 1983; Porter, 1987; Thomas and Pollock, 1999). While research into corporate diversification strategy emphasizes the advantages that a business unit may realize from being part of a corporation (Porter, 1987), the focus in externally leveraging knowledge is on the benefits that a particular knowledge transaction provides to the firm. A specific external knowledge exploitation strategy at the corporate level likely reduces the potential conflicts between the corporate and business unit level by giving directions and setting goals (Ansoff, 1965; Burgelman, 1983; Grant, 2003; Richter and Schmidt, 2005). This type of corporate-level strategy does not necessarily imply the centralization of external knowledge exploitation activities at the corporate level (Tschirky et al., 2000; Escher, 2003). Owing to the high diversity of the tasks along the external knowledge exploitation process, a decision for a more centralized or a more decentralized approach does not constitute an “either-or” decision. Rather, the situation may be interpreted as a continuum of organizational options with the purely centralized and purely decentralized approaches as the extreme cases. However, a relatively centralized organizational approach facilitates the implementation of an external knowledge exploitation strategy at the corporate level. Most pioneering and highly successful companies in external knowledge exploitation, such as IBM, DuPont and Texas Instruments, have chosen to carry out their activities in a centralized way (Sullivan and Fox, 1996; Arora et al., 2001; Cohen, 2004; Shuchman, 2004). As both centralized and decentralized organizational approaches involve the participation of employees from all levels, an external knowledge exploitation strategy at the corporate level needs to be accompanied by a close collaboration between the corporate and the business unit level (Mintzberg et al., 1998; Grant, 2003). As a firm’s knowledge is not resident at a particular organizational level, a close alignment of the tasks that are realized at the corporate level and at the business unit level appears to be essential. Because of interdependences between many tasks (Escher, 2003) and the complementary character of the relevant knowledge at the corporate and the business unit level, multiple interfaces have to be taken into account.

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The fact that many companies observe a relatively reluctant attitude of business unit managers with regard to externally commercializing knowledge (Shuchman, 2004) points to considerable problems in this area and to great opportunities for improving the current strategic approaches of many firms (Lichtenthaler, 2005). Above all, it seems necessary to balance the influence of both levels despite a possibly centralized strategic approach. While overriding the interests of the business units likely reduces the intention to initiate knowledge transactions at the business unit level, an overemphasis on business-unit objectives could lead to situations that are sub-optimal from the perspective of the whole company (Porter, 1987). A fair collaboration, by contrast, will lead to win-win situations, which will favor additional knowledge exploitation. Collaboration is also critical for aligning marketing and R&D strategy. This topic is addressed in the following section. Collaboration Owing to potential conflicts between functional strategies, in particular marketing strategy vs R&D strategy, a close collaboration between these units is essential in developing a firm’s strategic approach to the keep-or-sell issue. The interface between the R&D and marketing department may constitute a considerable communicational barrier (Brockhoff and Chakrabarti, 1988; Griffin and Hauser, 1996; Ernst and Teichert, 1998). Accordingly, firms should strongly rely on cross-functional integration mechanisms in developing knowledge exploitation strategies to reduce potential inter-functional conflicts (Sherman et al., 2005). Moreover, this approach helps combine the different knowledge bases of these departments by communicating the relevant knowledge and ideas across the organization, which may be regarded as a distributed knowledge system (Tsoukas, 1996). While the R&D department contributes the expertise in the particular knowledge assets, the marketing department possesses detailed insights into relevant markets for the knowledge assets. The market knowledge that is gained as a byproduct of own production and sales (Abernathy, 1978) may be useful to externally commercialize knowledge assets. Accordingly, a firm’s ability to externally leverage knowledge not only depends on its interface with the external environment but also on the knowledge transfers across and within organizational subunits (Cohen and Levinthal, 1990). If every subunit only makes use of its own knowledge, the great opportunities of communicating knowledge across different subunits, particularly in a diversified firm, will remain unrealized. For the level of both subunits and individuals, prior research has found considerable benefits of accessing external knowledge that may be facilitated by intra-firm communication and knowledge management systems (Szulanski, 1996; Hansen, 1999; Hoegl et al., 2003). Apart from ensuring close intra-organizational communication, it seems beneficial to establish a participatory strategic approach to the keep-or-sell issue that will result in a broader knowledge architecture (van den Bosch et al., 1999). An active participation of the employees from different departments appears essential to identify knowledge commercialization opportunities (Cohen and Levinthal, 1990; van den Bosch et al., 1999). A participatory strategic approach may be achieved by stimulating informal and autonomous activities of employees in parallel to their regular work. Above all, firms may benefit from the T-shaped skills of selected employees (Iansiti, 1993; Madhavan and Grover, 1998). In particular, it appears helpful to draw on the

knowledge of R&D employees, who have often developed new knowledge themselves and may have interesting ideas for its potential external commercialization, either exclusively or in addition to internal application. Although an active involvement of these persons is suggested, their limited resources for external knowledge exploitation are acknowledged, which usually does not constitute a firms’ core business. However, the identification of knowledge commercialization opportunities may be realized by these persons along with their ongoing work without major resource requirements (Allen, 1977; Cohen and Levinthal, 1990). After identifying three major characteristics of a firm’s strategic approach to overcome conflicts in the keep-or-sell issue, the implications of this analysis will be discussed in the following section. Discussion The three major characteristics of a firm’s strategic approach, i.e. coordination, centralization and collaboration, help a company achieve strategic fit in the keep-or-sell issue. In addition, however, these three principles may be applied to other fields, in which conflict of strategies and strategic fit play an important role. Coordination basically refers to activities of aligning different strategies that have been developed or currently are developed (Burgelman, 1983; Martinez and Jarillo, 1991). Centralization, by contrast, mainly refers to giving clear directions, which reduce coordination requirements a priori due to a variety of mechanisms, such as standardization of processes and limitations of the search space (Porter, 1987; Grant, 2003). Thus, centralization does not require the realization of all activities at the corporate level because it exclusively refers to strategizing. Finally, collaboration describes the possibility to reduce interface problems and potential conflict by aligning different strategies, e.g. R&D and marketing strategies, in the process of strategy development (Grant, 2003; Richter and Schmidt, 2005). While these three principles have been derived from an analysis of the keep-or-sell issue, which constitutes an excellent arena for studying strategic fit, they are likely helpful for deepening our understanding of strategic fit and interdependencies between hierarchical strategies in completely different fields. With regard to the keep-or-sell issue, the imperfections in the markets for knowledge have often led to relatively informal approaches to external knowledge exploitation (Fu and Perkins, 1995; Escher, 2003). However, these informal mechanisms should be complemented by a strategic approach to the keep-or-sell decision, which is aligned with a firm’s other hierarchical strategies (Ford, 1988). This strategic approach offers two major advantages. First, it will help firms realize the monetary and strategic benefits of commercializing knowledge assets (Ford, 1988; Davis and Harrison, 2001). Apart from providing direction for these activities, which may lead to gains in effectiveness and efficiency, a clear strategy will facilitate the coordination of knowledge transactions. Thus, it will allow for optimizing the results of the external knowledge exploitation program instead of optimizing individual transactions (Sullivan and Fox, 1996; Kale et al., 2002). Second, this strategic approach will facilitate the control of potential risks, which mainly refer to diluting the firm’s idiosyncratic competencies (Arora et al., 2001; Kline, 2003). These potential negative consequences will be limited by giving clear directions instead of regarding each knowledge transaction as an isolated action.

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Most firms considered external knowledge exploitation an ad hoc operation in the past (Escher, 2003; Lichtenthaler and Ernst, 2006). Therefore, their strategies likely emerged from the weakly coordinated decisions of multiple organizational members, following a “strategy as emergent process” view (Grant, 2003). Accordingly, a formal strategic approach may be regarded as an important strategic innovation (Mintzberg, 1994; Grant, 2003), and it may have a positive impact on a firm’s performance in commercializing knowledge assets (Ghobadian and O’Regan, 2002). However, earlier works have shown that overly formalized approaches may have negative effects because they may be a source of institutional inertia (Baden-Fuller and Stopford, 1994; Markides, 1998). Above all in dynamic environments, firms may easily plan more than they know. Thus, excessively formalized strategies may lead to inflexibility (Feurer and Chaharbaghi, 1995; Brown and Eisenhardt, 1998). As most firms focus on their product business, the external mode of knowledge exploitation has largely been neglected (Elton et al., 2002). Therefore, formal strategies will hardly lead to overly formalized “strategy as rational design” (Grant, 2003) planning processes at the moment. Rather, formal strategies will help firms arrive at an appropriate level of formalization, which facilitates “planned emergence” types of strategies (Grant, 2003). These strategies may help firms overcome the ad hoc approaches to commercializing knowledge assets that they often pursued in the past. Instead, external knowledge exploitation is considered an essential part of the firms’ knowledge strategies. The commercialization of knowledge assets is aligned with the firm’s internal innovation strategies in an integrated approach. The importance of strategic functions of commercializing knowledge assets and the interdependencies between internal and external knowledge exploitation (Arora et al., 2001; Koruna, 2004) have shown that firms need to develop integrated knowledge exploitation strategies. These strategies have to facilitate keep-and-sell approaches to knowledge exploitation instead of focusing on actual “either-or” decisions in the keep-or-sell issue. Accordingly, the emergence of the open innovation paradigm may lead us to fundamentally rethink traditional assumptions on the relationship between product business and external knowledge exploitation, e.g. out-licensing transactions. Product business and licensing appear to be complements rather than substitutes in knowledge exploitation. After discussing major implications of the analysis in this section, the final section concludes and underlines interesting avenues for further research. Conclusion The implications of the present article go far beyond the field of outward knowledge transfer. By analyzing how firms may capture value from knowledge assets, we have addressed a key topic of corporate strategy in knowledge-based companies. In the presence of markets for knowledge, external knowledge exploitation is not a marginal activity that may be managed exclusively by a dedicated licensing function. Instead, achieving strategic fit across a firm’s different strategies in the keep-or-sell issue is essential for firm performance in a knowledge-based economy. With the trend towards more open innovation systems, companies will increasingly commercialize knowledge assets. Thus, it will become more and more difficult for firms to completely refrain from externally leveraging knowledge assets. The external commercialization of knowledge will not merely be an option but rather a necessity in order to keep up with

the firm’s competitors. Refusing to commercialize knowledge assets may well result in a substantial weakening of a firm’s competitive position in the future. Accordingly, an appropriate strategic approach to the keep-or-sell issue will gain additional importance. The three major principles that have been identified, i.e. coordination, centralization and collaboration, will help firms achieve strategic fit in the keep-or-sell decision. In a first step, firms should consider external knowledge exploitation a strategic activity instead of merely regarding it as an ad hoc operation. Then, firms should coordinate their product business and external knowledge exploitation activities to harmonize their product and knowledge strategies. Furthermore, it is appropriate to sufficiently centralize the keep-or-sell decision to respond to potential conflict between strategies at the corporate and business unit level. Finally, emphasis should be put on cross-functional collaboration to achieve strategic fit between different functional strategies, above all R&D and marketing. In addition, the implications of the major characteristics of a firm’ strategic approach, i.e. coordination, centralization and collaboration, are not limited to external knowledge exploitation. Instead, they may deepen our understanding of strategic fit and hierarchical strategies in general. As a result, the present article has bridged major gaps in prior research, which is particularly important against the background of increasing knowledge commercialization in practice. Many companies have obviously become aware of the relevance of external knowledge exploitation. Others, however, have not yet recognized the importance and are in danger of missing the substantial monetary and strategic benefits that may be derived from an appropriate strategic approach to the keep-or-sell issue. By addressing strategic issues in the decision to transfer knowledge assets to recipients outside the firm, the present paper has addressed numerous emerging themes in knowledge management, e.g. organizational boundaries and congruence between properties of contexts (Argote et al., 2003). As much remains to be explored, there are great opportunities for further research into external knowledge exploitation strategies. The previous sections have shown that there are severe limitations of the existing literature on the keep-or-sell issue and on external knowledge commercialization in general. This lack of research becomes obvious if the literature on this topic is compared with the detailed findings of research into the internal exploitation of knowledge, i.e. new product development and innovation (Ernst, 2002), as the complementary exploitation mode and with research into the external acquisition of knowledge as the opposite direction of knowledge transactions (Veugelers and Cassiman, 1999). In particular, future studies may analyze the implementation of the strategies and the capabilities of firms to realize knowledge commercialization opportunities (O’Regan and Ghobadian, 2004). Thus, empirical research may contribute to validating the appropriateness of the three major characteristics of a firm’s strategic approach to the keep-or-sell decision that have been identified in this paper. Moreover, the importance of coordination, centralization and collaboration for reducing the potential conflicts between a firm’s strategies at different levels could be analyzed empirically. Accordingly, exploratory case studies and large-scale surveys are encouraged because they may lead to results that are equally relevant to research and practice and may help firms realize value from their knowledge assets. Beyond contributing to research into the keep-or-sell issue, these studies would considerably deepen our understanding of hierarchical strategies and strategic fit in general.

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Cliff Bowman and Ve´ronique Ambrosini Abstract Purpose – The paper aims to address the following questions: “How is value created within a firm?” and “Is the distinction between competitive and corporate strategy helpful in considering the processes of value creation?” Design/methodology/approach – The paper distinguishes five value-creating activities within the firm. Three are involved in the process of current value creation, one is directed at the maintenance of the firm and the other activity is concerned with the creation of future value. These processes of value creation are then explored from the perspective of corporate and business levels of strategy by considering whether these activities can be tightly or loosely coupled. Findings – The paper argues that decisions regarding loosely or tightly coupled value-creating activities should belong to the realm of corporate strategy and that this “corporatising” choice involves trade-offs in terms of responsiveness and cost. Practical implications – The arguments in this paper can be used by managers to help them think through the consequences of any corporate level strategy decisions they may envisage taking. Originality/value – This paper addresses traditional strategic management questions by building on a range of literatures, and proposes an original and meaningful way of examining the role of corporate and competitive strategy. Keywords Competitive strategy, Corporate strategy, Market value Paper type Conceptual paper

Our premise in this paper is that distinctions between corporate and business levels of strategy can usefully be explored from a value capture perspective. Given that firms exist to create value, we should be able to interrogate the utility of distinguishing between corporate level and competitive level strategy from this value perspective. The paper is structured around the following questions: . How is value created within a firm? . Is the distinction between competitive and corporate strategy helpful in considering the processes of value creation?

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To address these questions we first, explain what value means for the firm, and second, we examine the activities that create value within the firm. We consider the firm itself in the role of customer and supplier, and distinguish five activities inside the firm that reflect its motivations when these separate roles are performed. Three types of activities are involved with the process of current value creation: one is concerned with the creation of products/services, one with realising revenues from customers, and a third with minimising cost flows to suppliers. In addition there is activity directed at the maintenance of the firm, and another activity directed at the creation of future value. The core of the paper is dedicated to exploring what corporate and business (competitive) level strategy would mean when we take this value perspective. We consider the processes of value creation from the perspective of corporate and business

levels of strategy by considering whether these activities can be tightly or loosely coupled. We argue that decisions regarding how loosely or tightly coupled value creating activities should be belong to the realm of corporate strategy and that this “corporatising” choice involves trade-offs in term of responsiveness and cost. In essence we address traditional strategic management questions but we build on a range of literatures, and propose an original and meaningful way of examining the roles of corporate and competitive strategy. Specifically, in building the argument we draw on both the resource-based view (RBV) and on Porter’s (1980, 1985, 1987) industrial organisation economics-based (IO) contributions. Both the RBV and Porter address the issues of firm value creation. The RBV helps us to understand the unique resources that create value (Barney, 1991), and an IO perspective on bargaining power provides insights into who captures value. So the RBV provides insights into value creation, and insights into the power relationships between the firm and suppliers and customers can enable us to understand who captures value and why they are able to capture it. Hence we view the RBV and Porter as complementary rather than conflicting perspectives and we draw on them both in building our argument (Bowman and Ambrosini, 2000; Coff, 1999; Peteraf, 1993). We take the view that the firm is established to serve the interests of its equity owners, so production is undertaken in the pursuit of profit (Barney, 1986; Makadok, 2001). However, we recognise that firms do not “maximise” profits, they do not assume entirely opportunistic behaviour, rather they seek to optimise profits. Hence in what follows we reflect the broad aim of the pursuit of profit by using the term “optimise”. By using optimise we are acknowledging the problems of value creation in the real world. Value-creating activities The firm as an economic actor and a legal entity is both a customer for inputs from suppliers and a supplier of products or services to its customers. In acting as a customer the firm would seek to optimise its consumer surplus (or colloquially get “value for money”), and as a supplier, the firm would aim to optimise the revenues obtained from customers for a supplied product/service. If firms differentiate their product/service offerings in ways that are valued by the customer, they may be able to charge a premium price, or they could offer superior product/service utility at equivalent prices to competitors, and hence increase their market share (Porter, 1980). The availability of equivalent products/services or close substitutes will reduce the price that the firm can charge, thereby increasing consumer surplus, and reducing the firm’s ability to capture revenues from customers. The firm strives to reduce input costs, and seeks to generate revenue from sales to customers. To optimise the amount of revenue gained from customers the firm has to balance the prices charged with the volume of sales achieved. Price rises will normally reduce the total amount of consumer surplus, and hence result in lower sales volume, and vice versa. So the firm performs the roles of both customer and supplier for a purpose: to return an expanding stream of profits to investors. We can identify within the firm, activities that are involved in revenue appropriation from customers, and activities directed at reducing the cost of the inputs obtained from suppliers. We suggest that there are five main types of firm activity: type 1 activities create products and services; type 2 activities seek to generate revenues from marketing and

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selling these outputs; and type 3 activities are involved in procuring inputs into the firm. These three types of activity are involved in the creation of current profit flows. Type 4 activities are directed at the creation of future value, and would include R&D activity. Finally type 5 activities are support activities; they effect transactions between the firm and other parties. They are the necessary legal, tax and other activities required for the firm to continue to operate. Thus both type 4 and type 5 activities reduce current profit flows as they incur costs without any compensating revenue generation. These five types of activity have been distilled, inter alia, from Porter’s (1985) value chain. By distinguishing between the value-creating roles of these different activities we will be better able to subsequently debate the usefulness of distinctions between corporate level and business level activity. Product creation activities (type 1) These activities are involved in the production of products and services, and would include some primary activities of a value chain (Porter, 1985), e.g. production or outbound logistics. The worth or value of these activities can only be identified in retrospect, because unless the activity leads to a sale i.e. it ultimately results in the appropriation of revenues from customers, the activity cannot be judged to be productive. Value realisation activities (type 2) These activities are directed at realising revenues from the product outputs from type 1 activities. They would include marketing activity, customer relationship management, and direct sales activity. Input procurement activities (type 3) These activities are directed at reducing the amount paid to the input suppliers i.e. the aim of these activities is to obtain “value for money” for the firm. These activities reflect the firm’s motives as a customer, a customer of productive inputs like raw materials, electricity, and labour. This does not imply that the firm only seeks to procure the cheapest inputs. High quality inputs might be greatly valued by the firm’s procurement specialists, and even where a premium price was charged by the supplier, the consumer surplus perceived could be greater than with “cheaper” alternative inputs. These type 3 activities would include procurement, and line supervision activity, as well as activities designed to increase production efficiencies. The effect of these activities is therefore to moderate the cost flows incurred by all other activities. For instance artful procurement can result in a cost advantage where the firm pays less than rivals for equivalent inputs; one form of this activity could be “resource picking” (Makadok, 2001). Capital stock- vcreating activities (type 4) These activities such as market research, R&D, and training have to be funded either out of current streams of profits or directly by cash injections from investors. They can be understood as dynamic capabilities (Eisenhardt and Martin, 2000; Teece et al., 1997). They help to preserve the capital stock of the firm by, for example, ensuring that it adapts to changes in the market environment, and attempting to extend the capital stock through the creation of new resources.

These activities are intended to generate future streams of firm value. The dilemma is that these activities incur costs today for unknowable future benefits. Hence in the short term these activities reduce the current value retained by the firm, and as a result these activities are vulnerable to short-term pressures to cut costs as the value created by them can only be assessed ex post. Where these budgets are trimmed, the proportion of revenues used to fund these essentially speculative investments may be returned to investors in the form of increased dividends. However these activities potentially help to preserve and expand the stock of human and organisational capital by ensuring that activities are updated and refreshed in line with changes in the firm’s environment, and they can expand the firm’s capital with the introduction of new value creating activities. These may be discrete and deliberately managed support activities like R&D (Porter, 1985) or they could be co-produced with ongoing value creating activities. Co-produced activities would include learning from reflection or from interactions with clients (Argyris, 1990). Some capital creation activities may be undertaken without official sanction from management as individuals experiment with new ideas and approaches to their tasks. Firm maintenance activities (type 5) These activities are those necessary for the maintenance of the firm in a particular social context, and would include “infrastructure activities” (Porter, 1985) like accounts preparation, legal work, tax management, etc. They are necessary to conduct business, but they do not contribute to profit streams. Efforts will be made to perform these necessary activities at the lowest cost. Associated with this are related expenditures, which are not activities, but that have a similar impact, for example paying company taxes, training levies, etc. Some stakeholder models of the firm include a catch-all “society” stakeholder category (Clarkson, 1995), and these maintenance expenses could be viewed as payments to “society”. So it could be argued that maintenance activities and maintenance expenses are a response to societal pressures, but profit-seeking firms will act to reduce the impact of these expenses. Value creation and levels of strategy One of the questions that this special issue of Management Decision seeks to address is that of hierarchical strategies or strategy levels. Traditionally competitive strategy relates to how a strategic business unit (SBU), be it a stand alone firm or a division of a larger corporation, competes within a particular market, and corporate strategy relates to how a corporation manages a set of businesses (Grant, 2005). SBUs are directly engaged in the production of goods and services; the corporate centre typically is not. Its role is to oversee, support or augment the primary activities of the SBUs, and to facilitate the creation of value throughout the corporation via organic growth or external development (Goold et al., 1998). If we return to our five value activities and take the case of a firm engaged in supplying a single product to a clearly defined market, then all of these five activity types will be performed within the same integrated structure. The question of any distinction between corporate or competitive levels simply does not arise. Managers and employees will be engaged in all aspects of value creation, indeed the same individuals may well perform two or more activity types (e.g. in the small entrepreneurial firm).

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Corporate strategy emerges as a construct when we move away from this ideal-type single product/market firm, towards a firm with, for instance, two product lines, or that serves two distinct markets with the same product type. Then the managers of the firm are faced with an essentially structural question about how to organise the firm’s value creating activities. One simple solution to the development of an additional product line would be to re-create an entirely self-sufficient business unit, leaving the firm with two SBUs. However, this is likely to be an unattractive and expensive option, leading to duplication and under-utilised resources. A more typical response would be to utilise common resources wherever possible, to reap cost advantages, e.g. use one sales team to sell two lines, have a common accounts department, etc. If we consider that the “corporatising” problem originates where any diversion from the ideal-type single product business is undertaken, then the issue of corporate versus business level strategy is likely to be present in just about every firm and hence corporate decisions are likely to be made or at least considered by most managers, whatever the size of their firm. This means that it is critical to develop an understanding of what such decisions involve and what their consequences can practically be. In order to address this issue we propose that that different corporate value creating configurations should be considered from the perspective of the value creation activities we have explained and that we need to consider two questions regarding the five activity types we set out earlier. First, is the activity feasibly separable from other activities? Second, will separation confer any firm advantage i.e. will it generate more revenue for the investor? There will likely be both costs and benefits where activities are separated: net firm value may be created, but we expect that trade-offs will need to be negotiated. Moreover, these trade-offs will probably involve all types of activity. For example, we might choose to separate some type 1 activities in order to reap some benefits of task specialisation, but the longer-term effect may be a constraint on type 4 activities like R&D, due to the lack of interaction between the employees engaged in the separated type 1 processes. In what follows we develop our argument and examine levels of strategy from this value creation perspective. To do so we first introduce into our discussion the concept of loose or tight coupling of activities (Thompson, 1967; Weick, 1976). Loose and tight coupling of activities Weick (1976) defined loose coupling as a situation in which elements are responsive, but they retain evidence of separateness and identity. He later explained (Weick, 1982) that loose coupling occurs when elements affect each other suddenly rather than continuously, occasionally rather than constantly, negligibly rather than significantly, and eventually rather than immediately. If we apply this concept to activities involved in value creation we may be able to interrogate the entire value system of a firm with a view to identifying the relationships between activities. This would enable us to then identify the extent to which activities are loosely coupled, and which activities are tightly coupled together. Coupling could be construed as a necessary interdependence between activities. Generally, it is argued that the tight coupling of activities produces stability in the firm, whereas loose coupling enables it to be more flexible and therefore better able to adapt to a changing environment. However in line with Orton and Weick (1990, p. 205) we take the view that it is not helpful to simplistically categorise firms into being either

loosely coupled systems or tightly coupled systems, as all firms have activities that are distinct, and they may be required to interact or respond to varying degrees with other parts of the system: If there is neither responsiveness nor distinctiveness, the system is not really a system, and it can be defined as a non-coupled system. If there is responsiveness without distinctiveness, the system is tightly coupled. If there is distinctiveness without responsiveness, the system is de-coupled. If there is both distinctiveness and responsiveness, the system is loosely coupled. This general image is described . . . as the dialectical interpretation of loose coupling.

The value activities we have identified are distinct in relation to value creation. We would argue that although they are distinctive, the degree to which these activities need to be responsive will vary between firm contexts. Firm contexts will vary according to broad contingency variables like environmental dynamism and diversity, and task complexity (Emery and Trist, 1965; Mintzberg, 1979), and according to the nature of the particular products or services they produce, the competitive strategies they are pursuing (e.g. product differentiation, low cost), and the production technologies they employ, etc. “Corporatising” decisions and processes We suggest that decisions concerned with increasing or decreasing the distinctiveness of activities are corporate level issues. We could label these as “corporatising” decisions. Increasing distinctiveness can result from increasing specialisation, narrowing the scope of activity, fragmenting activities, and relocating activities. If we ignore agency issues, the motivations for increasing distinctiveness should be to increase firm value, and there are two generic ways that these value enhancements can be realised: improving efficiency, and/or improving effectiveness. Increasing distinctiveness implies an increased separation of value activities and increased task specialisation. This can be achieved by further fragmenting an existing value system, or by combining two or more related value systems within one hierarchy. The further separation of an existing value system may allow for specialisation, a sub-set of the overall task that may either enhance efficiencies or improve effectiveness (or both). The consolidation of activities across value systems may produce benefits from economies of scale or scope. With consolidation distinctiveness does not increase: the extent of differentiation across the activities in the system remains the same. What has changed is the degree of coupling: the benefit of activity consolidation is derived from a tighter coupling of activities. Where previously distinct activities have been consolidated, then distinctiveness or differentiation of activities is actually reduced. However, following Orton and Weick’s (1990) dialectic approach to loose coupling, we cannot consider the corporatising decision processes that increase or decrease distinctiveness without addressing the corresponding issue of responsiveness between activities. Generally, we would expect that decisions that increase the distinctiveness of value activities will call for, in turn, corporatising processes that address the demands for coordination between these activities i.e. addressing the responsiveness issue. Unless attention is paid to the issue of responsiveness it may be that the benefits of enhanced corporate distinctiveness and activity differentiation will be counteracted by the downside effects of inadequate activity coordination. Similarly, where distinctiveness has been reduced by, e.g. the consolidation of activities, this results

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in tighter coupling within these activities, but there may be a corresponding reduction in responsiveness between these consolidated processes and other value activities. In general we would expect that activity consolidation would increase the responsiveness of the consolidated activities. Thus consolidation enhances internal responsiveness between value activities, but, it is likely that internal responsiveness brought about by tighter coupling would also lead to a reduced ability of the corporation to respond to external changes. In contrast, we would expect that generally increasing fragmentation or distinctiveness of activities would increase the external responsiveness of the corporation i.e. it would be better able to sense and react appropriately to environmental changes. However, fragmentation and increased activity differentiation is also likely to reduce internal responsiveness. The early studies of differentiated organisations (e.g. Burns and Stalker, 1966; Lawrence and Lorsch, 1967) addressed similar issues posed by the requirements of increasing task specialisation, the need for adaptation to external changes, and the role of liaison and coordination devices. Here we are suggesting that corporatising decisions raise these same questions and that wherever activity and knowledge specialisation is encouraged by corporate decisions, this sets up a corresponding coordination or responsiveness requirement in the structure. Consolidation, fragmentation and the five activity types To summarise, activity types 1, 2, and 3 are involved in the procurement of inputs, the creation of products or services and the realisation of value through sales to customers. Type 4 activity is directed at the creation of future value and includes learning, training, and R&D activity, and type 5 activity is required for the maintenance of the firm. Types 1, 2, and 3 create current profit streams, and types 4 and 5 typically reduce current profit streams (we are not considering here the investor valuation of the company, but rather the creation of current profit). Based on our earlier argument we would expect that corporatising decisions to increase separation and distinctiveness of type 1, 2, and 3 activities would need to be compensated for by developing effective coordination/responsiveness processes to reduce the downsides of fragmentation, and that where consolidation reduces distinctiveness there may be consequent problems with internal or external responsiveness. For example, it might be decided that to achieve cost savings a sales force which was previously selling distinct product lines to more or less the same customer base should be consolidated, resulting in a reduced number of sales staff responsible for selling the whole product range. In effect here we have a corporatising decision to consolidate, with expected reductions in sales costs. A possible downside of this move would be a loss of sales effectiveness, as sales staff would have to master a greatly enlarged product range, need to form relationships with new customers, and become familiar with different industry contexts. To mitigate these reductions in effectiveness additional effort and resources would need to be committed. Similarly, if, for instance, procurement is consolidated across three related SBUs to increase leverage over key input suppliers, i.e. procurement is now more tightly coordinated or coupled across the three value systems, the expected outcome would be probable reductions in input costs. This action could once again have a downside, as a potential consequence of this consolidation would be a lack of responsiveness of the procurement function to the particular requirements of an SBU, possibly leading to

reduced effectiveness. Moreover where a type 1 production activity is consolidated to achieve the benefits of scale, there may be consequent reductions in the effectiveness of particular product lines that have been inappropriately standardised. Thus the consolidation has reduced external responsiveness. Where corporatising decisions lead to an increase in activity differentiation through enhancing specialisation we should expect the corporation to be better able to deal with changes in the external environment, thanks to the increased distinctiveness. However the increasing internal fragmentation can then create problems of internal coordination. If efforts are not made to address the internal coordination issues this presents, there may be reductions in overall corporate effectiveness. For example, a corporatising decision may lead to the establishment of dedicated sales teams to serve specific geographic regions. This should enhance the corporation’s ability to sense and respond to external changes in these different regional markets. The downside of such a decision might be a reduction in internal responsiveness, as these dispersed sales teams loose touch with staff and processes in type 1 and 2 activities, and indeed may find it difficult to liaise with each other. Where type 4 (e.g. R&D) activities are separated from types 1 and 2 there may be benefits of task specialisation enabling more effective innovation. Again the downside might be an increasing disconnection and lack of responsiveness to those enacting type 1 and 2 processes, leading to problems in “productionising” innovations (lack of responsiveness between types 1 and 4), or innovations that don’t seem to meet a market requirement (lack of responsiveness between types 2 and 4). Also it may be too costly, or unfeasible to attempt to detach capital stock creation activity from type 1 and 2 activities. For example, in knowledge intensive contexts future resources may be developed through experience, learning, and sharing ideas and insights. In these situations type 4 activity would be co-produced alongside the production of current products or services. Where it is technically feasible to detach developmental activity from the value delivery systems of the corporation there may be benefits not only of the development of a “critical mass” in R&D activity, it might be beneficial for the corporate centre to manage, and crucially fund these activities to ensure they take place. In this sense the separation of R&D has the effect of protecting these future orientated activities from short term performance pressures that might be felt by the SBUs. This then leaves type 5 firm maintenance or support activity. We would argue that in most firms these activities can feasibly be separated from the other four types of activity. These activities can be almost de-coupled from the operating core (types 1, 2, 3) with probably little impact on effectiveness of these type 1, 2 and 3 activities. Thus there is unlikely to be a problem in increasing the separation of these activities, and there may be positive cost and effectiveness benefits in uncoupling them from SBU value systems. These advantages might be scale and scope economies from better utilisation of specialised resources and capabilities, and the ability to appoint specialists to these roles. This means that the increasing distinctiveness of these maintenance or support activities may not need to be extensively compensated for by efforts to increase responsiveness between these type 5 activities and the SBU value systems. Unsurprisingly, therefore, type 5 maintenance activities seem to be the most corporatised activities in multi-SBU firms.

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Figure 1. Value activities and responsiveness

In Figure 1 we have summarised part of the argument. The vertical axis refers to the need for the firm to be responsive to external product markets, and the horizontal axis refers to the need for activities to be internally responsive to other activities. The location of each activity type reflects the arguments we have put forward. Thus there is a requirement for type 2 sales/marketing activities to be responsive externally, and they also have to be closely connected to other activities internally. In order to create value type 1 “operations” activities must be responsive to the external environment and to avoid internal inefficiencies they need to be internally responsive as well. Type 3 procurement activities need to be responsive to type 1 operations activities particularly, but we would suggest that procurement activities need not be so directly responsive externally, as they are not as customer oriented as type 2. If type 3 activities are responsive to type 1 and 2 activities, which in turn are in tune with the marketplace then this should help ensure that procurement activities are ultimately aligned externally. The oval incorporating types 1, 2 and 3 signifies the need for these core value-creating activities to be closely coordinated. Type 4 R&D activities need to be moderately internally and externally responsive and external responsiveness is likely to be mediated by activity types 1, 2 and 3. Hence, the type 4 oval should ideally overlap with activity types 1, 2 and 3. Figure 1 indicates that type 5 “maintenance” activity, relative to the other four types, need not be strongly internally or externally responsive. Thus with respect to “corporatising” decisions, we would expect firm maintenance activities to be readily de-coupled from other SBU activities, and if there were effectiveness or efficiency improvements from managing these centrally then there are unlikely to be extensive coordination or liaison cost penalties due to their relative loose coupling with other value activities. As we move away from the origin in Figure 1, the case for uncoupling activities becomes less straightforward. The costs involved in both the setting up and operating of liaison and coordination processes involved in effecting coordination between these activities, and the negative impacts of poor coordination become more significant the further we move northeast in the figure.

Concluding remarks Firm value creation should be the determining criterion in debating the utility of corporate “levels” of strategy. Strategy for profit-seeking firms should be directed at the creation of value. Here we have defined what “value” means for the firm, and have identified five different types of activity that are involved in value creation. We have argued that when firms extend their scope beyond the single product situation “corporatising” issues arise. These concern the integration or separation of value activities. Some activities, by their very nature can be readily separated from the other activities we have identified, e.g. maintenance activity. Other activities are tightly coupled and would resist separation, or, even if separation was feasible, the costs of doing this would outweigh the benefits. As there are both costs and benefits in separating activities, corporate level strategic activity should be directed at enhancing firm value from astute decisions regarding separation and integration, and reducing the costs of separation. Effective coordination of value activities would be one obvious way to reduce costs and therefore help to optimise firm value creation. Hence we could view corporate level strategy as having two essential roles with respect to value creation: (1) to enhance value creation through astute decision making with respect to the separation and integration of value activities; and (2) to establish appropriate processes to effect the required degree of coordination between value activities. If we follow the working assumption developed in the resource-based view (Barney, 1991, 2001) the core sources of sustained value generation are valuable, rare, difficult to imitate and non-substitutable (VRIN) resources that are embedded within firm activities. These resources do not necessarily sit neatly within specific functions or stages in the value chain (Porter, 1985). They are often complex, and are embedded throughout the SBUs, and may span various components of the value chain. Some VRIN resources may not be directly managed by those at the top of the SBUs, and hence: [. . .] the responsibility for creating, nurturing, and exploiting . . . [VRIN] resources . . . falls on every employee in a firm. To do this employees should go beyond defining their jobs in functional terms and instead define their jobs in competitive and economic terms (Barney and Hesterly, 2006, p. 103).

Hence functional distinctions are not overly relevant where the goal is to generate firm value. Some of the implications of this, and of considering SBUs as bundles of resources, are that it may not be relevant to consider businesses as hierarchies, as having different strategy levels, i.e. value creation permeates throughout the firm. Our argument suggests that it might be more useful to interrogate the firm’s operations using our five categories of value creating activities. Not only might these activities not align to traditional functional distinctions, embedded resources may span across departments and functional divisions. Indeed, some resources may exist in the form of interconnections between functions. Thus effective coordination processes to mitigate the effects of separating activities may themselves be a VRIN resource for the firm. Clarity about the role of an activity in the process of value creation must be helpful in determining how this activity needs to be developed strategically, and how

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the activity needs to coordinate with other value activities. So rather than concerning ourselves with strategy levels and the purpose of corporate centres, maybe the strategy conversation should focus on the five value creating activities in the system, and whether more value can be created by rearranging these five types of activity. References Argyris, C. (1990), Overcoming Organizational Defences, Allyn & Bacon, Boston, MA. Barney, J.B. (1986), “Strategic factor markets: expectations, luck and business strategy”, Management Science, Vol. 32 No. 10, pp. 1231-41. Barney, J.B. (1991), “Firm resources and sustained competitive advantage”, Journal of Management, Vol. 17 No. 1, pp. 99-120. Barney, J.B. (2001), “Is the resource-based view a useful perspective for strategic management research? Yes”, Academy of Management Review, Vol. 26 No. 1, pp. 41-56. Barney, J.B. and Hesterly, W.S. (2006), Strategic Management and Competitive Advantage, Pearson, Upper Saddle River, NJ. Bowman, C. and Ambrosini, V. (2000), “Value creation versus value capture: towards a coherent definition of value in strategy”, British Journal of Management, Vol. 11 No. 1, pp. 1-15. Burns, T. and Stalker, G. (1966), The Management of Innovation, Tavistock, London. Clarkson, M.B.E. (1995), “A stakeholder framework for analysing and evaluating corporate social performance”, Academy of Management Review, Vol. 20 No. 11, pp. 92-117. Coff, R. (1999), “When competitive advantage doesn’t lead to performance: the resource-based view and stakeholder bargaining power”, Organization Science, Vol. 10 No. 2, pp. 119-33. Eisenhardt, K.M. and Martin, J.A. (2000), “Dynamic capabilities: what are they?”, Strategic Management Journal, Vol. 21 Nos 10/11, pp. 1105-21. Emery, F.E. and Trist, E.L. (1965), “The causal texture of organizational environments”, Human Relations, Vol. 18, pp. 21-32. Goold, M., Campbell, A. and Alexander, M. (1998), “Corporate strategy and parenting theory”, Long Range Planning, Vol. 31 No. 2, pp. 308-14. Grant, R.M. (2005), Contemporary Strategy Analysis, Basil Blackwell, Oxford. Lawrence, P. and Lorsch, J. (1967), Organization and Environment: Managing Differentiation and Integration, Harvard University, Boston, MA. Makadok, R. (2001), “Toward a synthesis of the resource-based and dynamic capability views of rent creation”, Strategic Management Journal, Vol. 22 No. 5, pp. 387-401. Mintzberg, H. (1979), The Structuring of Organizations: A Synthesis of the Research, Prentice-Hall, Englewood Cliffs, NJ. Orton, J.D. and Weick, K.E. (1990), “Loosely coupled systems: a reconceptualization”, Academy of Management Review, Vol. 15 No. 2, pp. 203-23. Peteraf, M.A. (1993), “The cornerstone of competitive advantage: a resource-based view”, Strategic Management Journal, Vol. 14 No. 3, pp. 179-91. Porter, M.E. (1980), Competitive Strategy: Techniques for Analysing Industries and Competitors, Free Press, New York, NY. Porter, M.E. (1985), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, New York, NY. Porter, M.E. (1987), “From competitive advantage to corporate strategy”, Harvard Business Review, Vol. 65 No. 3, pp. 43-60.

Teece, D.J., Pisano, G. and Shuen, A. (1997), “Dynamic capabilities and strategic management”, Strategic Management Journal, Vol. 18 No. 7, pp. 509-33. Thompson, J. (1967), Organization in Action, McGraw-Hill, New York, NY. Weick, K. (1976), “Educational organizations as loosely coupled systems”, Administrative Science Quarterly, Vol. 21 No. 1, pp. 1-19. Weick, K.E. (1982), “Management of organizational change among loosely coupled systems”, in Goodman, P. et al. (Eds), Change in Organizations: New Perspectives on Theory, Research, and Practice, Jossey-Bass, San Francisco, CA, pp. 375-408. Further reading Makadok, R. and Coff, R. (2002), “The theory of value and the value of theory: breaking new ground versus reinventing the wheel”, Academy of Management Review, Vol. 27 No. 1, pp. 10-16. Corresponding author Ve´ronique Ambrosini can be contacted at: [email protected]

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Olivier Furrer Nijmegen School of Management, Radboud University, Nijmegen, The Netherlands

J. Rajendran Pandian Department of Management, University of Wollongong, Wollongong, Australia, and

Howard Thomas Warwick Business School, University of Warwick, Coventry, UK Abstract Purpose – The paper aims to assess the impact of corporate strategy on shareholder value in decline and turnaround situations. Design/methodology/approach – A sample of 45 turnaround firms was selected and matched against a control sample which did not face continuous decline over the time period studied. The impact of corporate strategy on shareholder value was tested using cumulative beta excess return measures to capture the long-term basis of corporate strategy. Findings – The paper finds that the beta excess return measures captured the hypothesized relationships between strategy and shareholder value for the sample firms studied. Practical implications – Beta excess return measures are superior to case studies or event studies for identifying the long-term effects of corporate strategy. Originality/value – Relatively few studies have compared the strategies of turnaround firms with a matched sample of non-declining firms. The use of cumulative beta excess returns to assess long-term valuation of corporate strategy is original. Keywords Corporate strategy, Shareholder value analysis, Turnarounds Paper type Research paper

Management Decision Vol. 45 No. 3, 2007 pp. 372-392 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745025

The aim of this paper is to assess empirically the impact of corporate strategy on shareholder value. Such an examination is of importance for several reasons: first, shareholders are undoubtedly the dominant stakeholders in a publicly quoted firm. They can affect the future of a firm by changing the management if the majority of shareholders are not convinced of the effectiveness of their strategies (Barker et al., 2001; Grinyer and Spender, 1979; Hedberg et al., 1976; Hofer, 1980; Nystrom and Starbuck, 1984; Ormerod, 2005; Pajunen, 2006; Slatter, 1984). Despite the increasing popularity of the shareholder value analysis (Rappaport, 1998; Doyle, 2000; McGee et al., 2005), there exists little empirical research supporting Rappaport’s conclusions. In fact, Woo (1984) concluded that the empirical findings did not provide support for the suggestion that basing strategic decisions on these models (e.g., constant growth model, two-stage model, etc.) would result in increased shareholder value. Woo felt that it was necessary to conduct more empirical tests of these models and to assess their validity in order to increase users’ (practicing managers’) confidence.

Rappaport and his colleagues have nevertheless provided a stream of research linking corporate strategy and the maximization of shareholder value (e.g., Blyth et al., 1986; Rappaport, 1998; Rappaport, 1981). However, much of this is case study based and difficult to generalize. Consequently, large sample studies based on multiple firms are essential to build users’ confidence. A further reason for conducting such empirical testing is that performance measurement is critical to the conduct of strategy research (Lubatkin and Shrieves, 1986). This has led strategic management researchers to examine the suitability of shareholder value and other financial market measures in assessing corporate performance. Most of these researchers have used event study methodology to examine the impact of corporate strategy on shareholder value (Chatterjee, 1986; Lubatkin, 1987; Woolridge, 1988; Woolridge and Snow, 1992; Chatterjee et al., 1992; Kelm et al., 1995). Such a methodology is adequate to study phenomena that occur in a narrow window (e.g., a few days at the most). However, in the case of measuring the impact of strategy, where the phenomenon has to be examined over a long period of time (a year to a few years), event studies are not suitable. In this study, therefore, we examine the impact of strategy on shareholder value using a large sample of firms over a long period of time in decline and turnaround situations in order to overcome the problems mentioned above. Two important elements focus the study: first, beta excess returns (Fama et al., 1969; Van Horne, 2001; Brearley and Myers, 2002; Petkova and Zhang, 2005), which are better suited for long-term examination of strategy than the abnormal return measures used in event study methodologies, are used to measure changes in shareholder value. Second, firms in decline situations are compared to non-declining firms over time so that easily detectable differences in corporate strategy and shareholder value can be identified and measured during the period of study. The paper is organized as follows: first, a brief review of empirical research on the impact of strategy on shareholder value and relevant literature on decline situations is provided. In the next section, hypotheses are developed about the link between corporate strategy and shareholder value. In the methodology section, the measurement issues related to capturing shareholder value over a long period of time and measuring strategy are presented and this is followed by a brief discussion of the sample and data sources. This is followed by an interpretation of the results. The implications of these results are also discussed, together with a review of the limitations of the present study. Suggestions of areas for future research are then proposed. Literature review Empirical examination of the impact of strategy on shareholder value Rappaport (1981) argued for the use of shareholder value to guide strategic investments. Rappaport’s objections to the use of efficiency of capital utilization measures (e.g., return on assets (ROA), return on invested capital (ROIC), and return on equity (ROE)) for such strategic decisions stem from the fact that these measures are generally based on accounting information which accounts neither for time value of money nor for the investment risks faced by the shareholders. He called his preferred decision-making framework Shareholder Value Analysis (SVA) (Rappaport, 1998; Doyle, 2000). Rappaport and others (e.g., Blyth et al., 1986; Rappaport, 1983, 1998; Rappaport and Friskey, 1986) presented a number of case studies to demonstrate how to use SVA successfully.

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However, it is difficult to generalize findings from such case studies. As a consequence, strategic management researchers directed their efforts to empirically test various theoretical hypotheses about the impact of strategy on shareholder value. For instance, Chatterjee (1986), Lubatkin (1987), and Chatterjee et al. (1992) examined mergers and acquisitions and how they created or destroyed shareholder value. This stream of research is an important part of work on diversification strategies where there are theoretical arguments that anticipate value creation due to synergy through mergers and acquisitions. Another stream of research concerns a firm’s research and development (R&D) expenditures or R&D progress announcements and the impact of such announcements on stock prices (Chan et al., 1990; Kelm et al., 1995; Woolridge, 1988; Woolridge and Snow, 1992). In a similar vein, other researchers have examined announcements regarding new product developments (Eddy and Saunders, 1980), capital expenditures (McConnell and Muscarella, 1985), marketing activities (Chauvin and Hirschey, 1993), and international joint ventures (Merchant, 2000; Merchant and Schendel, 2000) and assessed the impact on stock price. All these studies, however, used event study methodology and the measure of abnormal returns around the event (announcements) to test the relationship between corporate strategy and shareholder value. Findings from most studies were in a consistent and expected direction and confirmed that abnormal returns were positive (and statistically significant). This, in turn, suggested that investors took the actual strategies into account in valuing the firm. Therefore, one of the major advantages in examining such public announcements from a research viewpoint is that the investors are aware of a strategic change (“intended strategic change” in the case of expenditure announcements and “realized strategic change” in the case of progress announcements) and can assess its likely impact on the firm. In practice, however, many significant firm level strategic changes are “kept under wraps” in order to gain competitive advantage (i.e. in order to surprise rivals, most strategic changes are kept a secret) and are not captured in public announcements. The other drawback of these studies is that their findings tend to hold only for very short windows around the public announcement and when the window of examination is extended over ten days after the event, the stock price tends to fall (i.e. the abnormal return becomes negative) (e.g., Woolridge and Snow, 1992). Such a problem argues for the inadequacy of event study methodology for research related to longer-term corporate strategy. Indeed, to overcome these limitations, new methodologies and approaches are needed, involving large samples and longitudinal designs. For example, Lubatkin and Chatterjee (1991) studied the strategy-shareholder value relationship across market cycles using MANCOVA and logistic analyses and, in a recent paper, St John et al. (2000) used neural networks to investigate the relationship between corporate strategy and wealth creation. Firm decline During firm decline, shareholder value is destroyed. Research on firm failure and turnaround situations has viewed firm decline as a problem in organizational decision making and resulting adaptation processes (Argenti, 1976; Grinyer and Spender, 1979;

Hedberg et al., 1976; Starbuck and Hedberg, 1977; Starbuck et al., 1978; Mellahi and Wilkinson, 2004; Sheppard and Chowdhury, 2005). The central thesis is that firm decline is the result of managers’ failure to maintain the alignment of a firm’s strategy, structure, and objectives with an evolving and changing environment. Such failure may result from organizational inertia (Hannan and Freeman, 1977, 1984; van Witteloosstuijn, 1998), which is reflected in behaviors such as the need to be reliable (Hannan and Freeman, 1984), escalating commitment by management (Staw, 1981), blinded perception (Zajac and Bazerman, 1991), strategic paralysis (D’Aveni, 1989, 1990), and threat-rigidity (Staw et al., 1981). Other researchers (e.g., Grinyer et al., 1988; Hofer, 1980; Hofer and Schendel, 1978; Schendel et al., 1976; Schendel and Patton, 1976) have more objectively classified the causes of decline into either internal (or operational) problems or external (or strategic) problems. Indeed they found that management-related problems (or internal causes) outnumbered external environment-related problems (Bibeault, 1982; Slatter, 1984; Schendel et al. 1976; Grinyer et al. 1988; Lohrke et al., 2004; Filatotchev and Toms, 2006). They argue that the internal mechanisms of failing firms imply that their responses to environmental change are either too active or too passive: “Both inaction and hyperaction seem to typify firms in their years prior the failure” (Hambrick and D’Aveni, 1988, p. 15). Bankruptcy has been described as a “protracted process of decline” and a “downward spiral” (Hambrick and D’Aveni, 1988). Indeed, there is a considerable body of empirical evidence that shows significant differences between bankrupt and survivor firms as soon as five years prior to the bankruptcy filing itself (e.g., Aziz et al., 1988; Baldwin and Glezen, 1992; D’Aveni, 1990; D’Aveni and MacMillan, 1990; Hambrick and D’Aveni, 1992; Moulton and Thomas, 1993). These studies compared bankrupt firms with non-declining firms (e.g., Daily, 1996; Daily and Dalton, 1994a, b; D’Aveni, 1990; D’Aveni and MacMillan, 1990; Gales and Kesner, 1994; Hambrick and D’Aveni, 1988, 1992) with an emphasis on the bankrupt firms. However, decline is not irreversible and bankruptcy is not the only outcome (Cameron et al., 1988; van Witteloosstuijn, 1998). Successful turnarounds abound and are well documented. Early researchers on turnarounds (Grinyer et al., 1988; Hofer, 1980; Hofer and Schendel, 1978; Schendel et al., 1976; Schendel and Patton, 1976) suggested that to reverse a decline due to internal problems, a firm should focus on rectifying the internal causes. For example, if the cause of decline is inefficient operations, management should attempt to find ways of improving efficiency rather than trying to increase sales as long as the external environment has not changed. Such remedies are called operational remedies, whereas, if the decline is due to change in the external environment, then strategies should be changed/adapted. Accordingly, such remedies are called strategic remedies. That is, if the cause is internal, the solution should be operational and if the cause of decline is external, the action should be strategic. An important stream of research on the role of strategic change in the turnaround process was principally based on case studies (e.g. Chowdhury, 2002; Grinyer et al., 1988; Hofer, 1980; Hofer and Schendel, 1978; Lamberg and Pajunen, 2005; Schendel et al., 1976; Schendel and Patton, 1976). Further research (Arogyaswamy, 1992; Hambrick and Schecter, 1983; Ramanujam, 1984; Robbins and Pearce, 1992; Schendel and Patton, 1976; Thie´tart, 1988) based on large samples attempted to test the important role of strategic change on turnarounds but, in fact, provided little concrete

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Figure 1.

evidence. This lack of evidence supporting “strategic turnaround” even led some researchers to question whether turnarounds can be accomplished through strategic reorientations (Pajunen, 2005; Pearce and Robbins, 1993; Robbins and Pearce, 1992). It should be noted that the greater proportion of previous large-sample studies compared successful turnaround firms with unsuccessful turnaround firms (e.g., Hambrick and Schecter, 1983; O’Neill, 1986a, b; Schendel and Patton, 1976; Barker et al. 2001). And, the research studies reviewed above compare either bankrupt firms with non-declining firms, or turnaround firms with bankrupt firms. However, to the best of our knowledge, relatively few research studies have ever compared turnaround firms with a matched sample of non-declining firms. Such a comparison is of particular interest because, as it has been shown, decline may be of different types (D’Aveni, 1989; van Witteloosstuijn, 1998) and may not lead to bankruptcy. For example, during their decline, bankrupt firms have been shown to have severe pathologic strategic behavior such as inertia, hyperinitiative, or inconsistency (e.g., Hambrick and D’Aveni, 1988). Since the objective of this study is to investigate the relationship between strategy and shareholder value, not to focus on strategic failures or bankruptcy, these pathologic behaviors associated with bankruptcy are too extreme to be meaningfully compared with the strategies of non-declining firms. Therefore, we chose, in this study, to compare non-declining firms with declining firms that later successfully turnaround and avoid bankruptcy (in the rest of the paper, these latter firms are referred as turnaround firms). Using Figure 1, we clarify the distinction made in this study between bankrupt, turnaround, and non-declining firms. When a turnaround firm goes through decline and turnaround, three phases can be identified. First, the growth phase in which no decline is evident. Then, at a particular point due to some unexpected event (external or

internal) performance starts to decline. If the management’s action(s) (strategic or operational) do not arrest the decline, the firm continues the process of decline (the decline phase). Eventually, once the firm’s management (old or new) takes some other action(s) which are more appropriate, then the decline is arrested and performance starts to recover (recovery phase). Note that comparable non-declining firms in the same industry face the identical unexpected event if it is caused by a change in the external environment. Although the turnaround firms decline, comparable non-declining firms do not except in the rare situation of a short-term adverse effect when the extent of change is large and unpredictable. Even in such extreme cases, non-declining firms typically face decline just for that particular year, recover the following year and maintain a continued pattern of increase in performance. However, when the unexpected event is an internal matter, the turnaround firms will decline, but the non-declining firms will not since their internal situations differ and are unique. The three phases are depicted in Figure 1. Hypotheses Shareholder value destruction during decline Rappaport (1987, 1998) suggested that shareholder value should be measured as a product of the stock price and the number of shares outstanding. Since the number of shares outstanding rarely changes, shareholder value is directly related to the price of a stock. Since stock price movement is approximately a random walk, it is difficult even to imagine that there could be a link between strategy and such a measure of shareholder value. The random movement of stock prices confirms that the financial market is efficient. Cootner (1964) suggested that the random movements in stock price were around an “intrinsic value” (Graham et al., 1962). Graham et al. (1962) defined the “intrinsic value” of a firm as the net present value of the future stream of income. This is called the fundamental analysis model. Financial analysts who value stocks track a firm, its competition, the economy and other related factors which affect the future stream of income and then estimate its “intrinsic value”. If the price of a stock is beyond a given level above its “intrinsic value”, then the analyst would recommend a “sell” decision and vice versa. According to Cootner (1964), such profit-taking behavior combined with intense competition ensured that the random walk observed stays within a narrow band around the “intrinsic value”. In the fundamental analysis model, the “intrinsic value” of a firm depends on many factors and a firm’s strategy is only one of them. If we wish to capture the impact of strategy on shareholder value, then the measure used to capture shareholder value should control for the impact of other extraneous factors. Neither the cumulative returns to the investor (dividend plus price increase) nor the abnormal return measure control for such extraneous variables. Cumulative returns are the cumulative value of returns to shareholders and this does not exclude shareholder gains due to favorable environmental changes. Since abnormal returns do not control for the impact of factors other than an event under study, it can only be used to capture the impact of that event over a narrow window[1]. Thus, cumulative and abnormal return measures of shareholder value are not very useful for the purpose of assessing the impact of strategy on shareholder value. Lubatkin (1987) recognized this issue and attempted to use prior performance to control for these extraneous variables. However, this is not appropriate for two reasons: First, the extraneous variables could change between the

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period under study and the control period (when the abnormal returns prior to the event were estimated). Second, under the assumption of an efficient financial market, the abnormal returns over such long periods should be zero (or at least negligibly small) making such corrections useless. Therefore in this study, beta excess returns are used to capture changes in shareholder value attributable to firm specific factors (which could include dividend pay out, unexpected changes in income, retained earnings, and corporate strategy among many other firm specific factors). The fundamental analysis model suggests that shareholder value is the net present value of the future stream of income (Rappaport, 1987, 1998). This implies that a drop in income in the near future will be valued, and weighted, higher than similar drops in a more distant future. Hence, firms facing a decline in their income stream will have a sharp drop in shareholder value and this in turn will result in negative beta excess returns. In a perfect financial market, this re-valuation would occur in the first year of decline. But, according to previous research findings (e.g., Fama et al., 1969), it appears that as new information on the continued decline reaches the market, firm value (i.e. its stock price) would be adjusted to account for this continued drop in income. Therefore, if one measures beta excess returns every year during decline, it would be negative for turnaround firms. Since, non-declining firms continue to grow and since the corporate strategy of these firms would normally not be changed, their beta excess returns will be negligibly small. Hence the following hypotheses: H1. Cumulative beta excess returns over the decline phase for turnaround firms will be negative and will be less than those of non-declining firms. H2. Cumulative beta excess returns over each year during decline for turnaround firms will be negative and will be less than those of non-declining firms. In H1, we examined change in shareholder value over the complete decline phase whereas in H2, the same phenomenon is examined over each year during the decline phase to evaluate how the stock market adapts to new information. Link between strategy and shareholder value Shareholder value depends on the future stream of income and is affected by information on any factor that may affect the income stream. Such information may involve economic predictions, substitute technologies, movements in currency exchange rates, legal disputes, competitor’s moves, strategic investments, and so on. However, as long as such information affects all firms with similar risk to the same extent, the beta excess returns will not change but remain negligible. But, if the information affects one firm more adversely than the rest, the beta excess returns of such a firm will become negative. During decline, unanticipated changes coupled with inappropriate strategic conduct result in a decline in performance. Therefore, we examine the strategic conduct of such firms and compare them to those of non-declining firms, we can test the link between strategy and shareholder value, provided we control for changes in retained earnings or changes in income. In order to specify clearly the direction of impact of each of the conduct variables on shareholder value (on cumulative beta excess returns), it is important to examine each variable separately. Following previous researchers in the turnaround literature (Grinyer et al., 1988; Hofer, 1980; Hofer and Schendel, 1978; Schendel et al., 1976;

Schendel and Patton, 1976), these variables are grouped into operations related (near-term oriented) or strategic (long-term oriented). Operations-related variables invariably focus on improving efficiency and should have an immediate effect. Thus, if changes in operations related variables improve efficiency and hence improve profitability, then shareholder value will increase. That is, if efficiency improves, beta excess returns will be positive. Strategic variables focus on improving the competitiveness of a firm. They are long-term oriented and their effect on a firm profitability only accrues in the future. In this case, the improvement of a strategic variable will be discounted by the financial market and its impact on shareholder value will be smaller than that of operations-related variables. Manufacturing cost, accounts receivable, and accounts payable are classified to be operations related whereas capital expenditure is considered strategic. Marketing costs are more difficult to classify as purely efficiency related or strategic since their impact could improve both short term profitability through increase in volume of sales and long-term profitability through market development (Harker, 1998; Robbins and Pearce, 1992, 1993). If manufacturing expenses are controlled and decrease, manufacturing efficiency increases and shareholder value increases. In the case of marketing costs, the relationship is more ambiguous, though reductions in marketing costs may improve marketing efficiency in the short term, the long-term effect could be reduced sales and reduced brand image. In a similar vein, an increase in marketing costs may improve sales in the near term up to a point beyond which the sales may stagnate. In the case of a decline, we hypothesize that the short-term effect is more important than the long-term effect and an increase in marketing costs will have a negative impact on shareholder value. Accounts payable should be positively related to shareholder value since they reflect how effectively a firm utilizes trade credit to its benefit. Whereas, accounts receivable should have the opposite effect since it increases the firm’s cost of capital. As far as strategic (long-term oriented) variables are concerned, they should have a positive impact on shareholder value. However, in the case of a turnaround situation, their impact may be more difficult to predict. According to retrenchment theory (Robbins and Pearce, 1992; Pearce and Robbins, 1993), retrenchment, defined as a reduction in firm assets and costs, is strongly associated with a successful turnaround. This implies that during the decline phase of a turnaround, strategic variables such as capital expenditures would have a negative effect on shareholder value. However, retrenchment theory has been challenged by Barker and Mone (1994) and in some cases a change in strategy is needed to turnaround. Overall, we think that capital expenditures are likely to have a negative effect on shareholder value at the beginning of the decline phase and a positive effect later on. During the beginning of the decline, the stock market may consider that the firm is spending too much (and hence negative beta excess returns), but later in the decline phase, it may consider an increase in capital expenditures as a needed attempt to turnaround (and hence lead to positive beta excess returns). The following hypotheses are based on the above discussions: H3. The impact of manufacturing cost, marketing expenditures and accounts receivable on beta excess returns is likely to be negative whereas, the impact of accounts payable is likely to be positive.

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H4. The impact of capital expenditures on beta excess returns is likely to be negative during the first year of decline and positive in the years there-after. Methodology Sample Turnaround firms were selected on the basis of a survey of the business press from 1975 through 1985. Four business publications (Wall Street Journal, Business Week, Fortune, and Forbes) were searched for mention of decline or turnaround or any equivalent word. Firms that were covered in the business press as turnaround firms constitute the population of interest. This methodology for selecting the turnaround firms was selected because shareholder value was the focus of the study, and so it was important that information on turnaround firms was available to investors. From the firms identified by this phase, those publicly traded in manufacturing industries were retained in the sample because the nature of strategic change may be somewhat different then in service industries (Barker and Duhaime, 1997; O’Neill, 1981). Of these manufacturing firms, only firms that underwent at least three years of decline in operating cash flows were retained. Some previous studies (Barker and Mone, 1994; Robbins and Pearce, 1992) used a two-year decline as one of the criteria for their sample design. However, in this case because we wish to ensure that the need for strategic change is high (Barker and Duhaime, 1997), we think that a three-year period is more appropriate. Operating cash flows were used rather than the ROI or ROS measures, used by Barker and Mone (1994) and Robbins and Pearce (1992), because operating cash flows are directly related to shareholder value. In all, 58 turnaround firms satisfied all the requirements. We constructed a control group which consisted of a sample of firms which did not face continuous decline[2]. These firms were selected from the same industry as each of the turnaround firms and were of approximately similar size during the peak year (the year before the first year of decline, see Figure 1). Since industry conditions could have a strong impact on the future stream of income, it is necessary to control for industry conditions (Hambrick and Schecter, 1983; Robbins and Pearce, 1992; Schendel and Patton, 1976). Size could help a firm to sustain its decline; it is also an indicator of the extent of the firm’s resources that are available to reorient its strategy (Barker and Duhaime, 1997). There were industries (Porter, 1980) (e.g., the steel industry, SIC 3312) where every firm had faced decline in operating cash flows for over three years during 1975-1985 and hence turnaround firms from these industries could not be included in the sample. The resultant control sample contains 45 firms. Variables and data sources Measuring shareholder value. As mentioned earlier, we used beta excess returns to estimate changes in shareholder value. Fama et al. (1969) used beta excess returns in their examination of stock splits and the process of stock price adjustment to new information. Though there have been suggestions that beta excess returns capture the overreaction of the market, Chopra et al. (1992) have shown that such overreaction is small for medium and large firms. Chopra et al. (1992) concluded that beta excess returns could be used to assess the impact of firm specific factors on stock price over a long period of time if the estimation controls for changes in beta (the issue of nonstationarity). This can be achieved by re-estimating beta at appropriate intervals.

The daily return data tapes on the security prices maintained by the Center for Research on Security Prices (CRSP) at the University of Chicago contain the information on beta excess returns for each stock that satisfies the minimum requirements on data availability, trading, etc. These beta excess returns are estimated every year by estimating the beta for each stock, using all the daily returns data available and then grouping all the stocks into ten portfolios of the approximately same beta level. Beta excess returns for a firm are then calculated as the difference between the actual return for the day less the estimated return for a portfolio of similar beta level. Beta excess returns remain negligibly small and around zero if there are no firm specific unanticipated events leading to very steep changes in the stock price. If there is a industry-wide or economy-wide unanticipated event, all the stocks in the industry or the economy will be affected to the same extent and hence the return to the portfolio of similar beta level will reflect it and hence the beta excess return should still remain very small. But, if the unanticipated event is firm specific, then only this firm’s stock price will be revised and hence the beta excess returns will be different from zero (positive if the event is favorable and negative if the event is unfavorable). Thus, beta excess returns are better suited for capturing changes in shareholder value that are closely linked to firm specific events and not due to the impact of events common to most stocks. To assess changes in shareholder value over any period, daily beta excess returns are summed over that period. Such a measure is called the cumulative beta excess return[3]. Measuring corporate strategy. Strategy may be defined as a pattern in a stream of resource allocation decisions (Hofer and Schendel, 1978; Mintzberg, 1978; Mintzberg and Waters, 1982; Venkatraman and Prescott, 1990). Since there are a large number of resource allocation decisions, it is important to choose the most appropriate ones to capture strategy (Arend, 2004). The measures used in this study are based on the research by Prescott (1983) who used a set of 16 variables to capture the strategy of a firm. In his study, Prescott examined business units and developed a set of 16 variables based on the Profit Impact of Marketing Strategies (PIMS) database. These variables were subsequently used for several studies using the PIMS database (e.g., Prescott, 1986; Prescott et al., 1986; Venkatraman and Prescott, 1990). In this study, we used the COMPUSTAT database maintained by the Standard & Poors Co. Since data in the COMPUSTAT database are not available on all the 16 variables, we used a subset of five variables. These strategic conduct variables used are: (1) manufacturing costs; (2) marketing costs; (3) accounts receivable; (4) accounts payable; and (5) capital expenditure. Manufacturing costs, marketing costs, accounts receivable, and accounts payable are operations related variables (short-term oriented), and capital expenditures is a strategic variable (long-term oriented). Strategic conduct variables were calculated as the corresponding expenditure value divided by net sales so that all variables will be dimensionless and be within the range 0 and 1. The definition of these variables can be found in Table I.

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Control variables. There is strong empirical evidence to suggest that shareholder value is directly affected by unanticipated changes in income (Ball and Brown, 1968). Moreover, there is a strong feeling that the financial markets react strongly to changes in income and hence American managers are more concerned about increasing short-term profits than increasing long-term performance. Since decline is associated with a drop in performance, which is highly correlated to income, it could be argued that a change in shareholder value can result from a change in income and not from a change in strategy. Hence, it is important to control for changes in income. Following Cootner’s (1964) model, since both income and retained earnings are strongly correlated, we used the change in retained earnings as the control variable in this study. Results First, correlation analyses were carried out to assess the correlations between strategy conduct variables for turnaround firms and non-declining firms combined as one group. Then, multivariate regression analyses were used to assess the impact of strategy conduct variables on shareholder value. Regression analyses were conducted for every year over the decline period. The control variable used was change in retained earnings, which should capture the change in the “intrinsic value”. H1 has two parts: the first part related to the absolute value of cumulative beta excess returns of the turnaround firms whereas the second part related to comparing the beta excess returns of turnaround firms to those of non-declining firms during decline. The first part of H1 is tested by carrying out a t-test, while, the second part is performed by carrying out an analysis of variance (ANOVA). Both parts of the hypothesis are examined for the first year of decline, the first two years, and first three years. The results of the t-tests as well as those of ANOVA are found in panel A of Table II. Both parts of this hypothesis are strongly supported. The cumulative beta excess returns over the decline phase for the turnaround firms are negative and significantly smaller than those for non-declining firms. This means that, as hypothesized, turnaround firms faced a drop in their shareholder value and that non-declining firms did not. H2 essentially suggests that the valuation mechanisms will adjust shareholder value every year rather than during the very first year of decline. If shareholder value gets adjusted during the first year, cumulative returns during the latter years of decline will not be different from zero. Just as for testing H1, t-tests were carried out to test whether or not beta excess returns over every year were negative and ANOVA was used to test whether beta excess returns for turnaround firms differed from those for non-declining firms for every year of decline. The results are presented in panel B of Table II. Cumulative beta excess returns over every year during the decline phase were negative and significantly different from zero. The results confirm that shareholder

Table I. List of strategic conduct variables

Strategic conduct variables

Definitions

1. 2. 3. 4. 5.

Manufacturing costs/net sales Marketing costs/net sales Accounts receivable/net sales Accounts payable/net sales Capital expenditure/net sales

Manufacturing cost Marketing cost Accounts receivable Accounts payable Capital expenditure

Years A. One year of decline

Two years of decline

Three years of decline

B. 1st year of decline

2nd year of decline

3rd year of decline

t-tests turnaround firms Mean t-statistic (Pr . jTj) No. of observations

t-tests non-declining firms Mean t-statistic (Pr . jTj) No. of observations

ANOVA non-declining firms compared with turnaround firms Coefficient F statistic (Pr . jTj) No. of observations

20.175 24.221 * * * 0.000 33 20.371 29.897 * * * 0.000 33 20.483 212.24 * * * 0.000 33

20.033 20.832 0.411 35 20.078 21.337 0.190 35 20.121 21.789 * 0.082 35

0.142 6.191 * * 0.015 68 0.292 17.180 * * * 0.000 68 0.362 20.660 * * * 0.000 68

20.175 24.221 * * * 0.000 33 20.224 26.672 * * * 0.000 33 20.188 25.625 * * * 0.000 33

20.033 20.832 0.411 35 20.062 21.698 * 0.099 35 20.046 21.157 0.255 35

0.142 6.191 * * 0.015 68 0.162 10.514 * * * 0.002 68 0.142 7.422 * * * 0.008 68

Notes: Dependent variable: yearly beta excess return; Independent variable: turnaround ¼ 0; non-declining ¼ 1; * p , 0:10; * * p , 0:05; * * * p , 0:01

value gets adjusted as more and more information is made available and not on a single occasion. Also this evidence may be consistent with Ball and Brown’s (1968) finding that income declines in every year of the study period. The crux of the third hypothesis is that though shareholder value will depend on a large number of factors, there exists a direct link between strategic conduct and shareholder value. A series of regression analyses were carried out by regressing for every year the cumulative beta excess return against the yearly strategic conduct variables. This regression analysis was also carried out over a three-year period as well as a two-year period during the decline phase. The strategic conduct variables used were averaged over the corresponding period. The results are found in Table III. The direction of the impact of all the strategic conduct variables on the beta excess returns was as hypothesized. Manufacturing cost and marketing cost had a significant

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Table II. Results of t-tests and ANOVA

1.889 0.109 0.062 68

0.017 0.464 0.644 1.590 0.165 0.050 68 6.129 * * * 0.000 0.277 68

1.617 3.406 * * * 0.001 22.194 24.287 * * * 0.000 21.463 22.549 * * * 0.013 20.009 20.026 0.979 1.269 1.050 0.298 0.182 1.050 0.298 0.268 1.789 * 0.079 5.822 * * * 0.000 0.302 68

0.962 1.621 0.110 21.536 22.465 * * * 0.017 20.720 21.028 0.308 0.116 0.346 0.730 1.048 0.878 0.384 0.570 1.158 0.251

1.870 0.113 0.061 68

0.799 1.590 0.117 20.970 21.817 * 0.074 21.472 22.293 * * * 0.025 20.206 20.611 0.544 1.238 0.751 0.455 0.251 0.529 0.599 0.274 2.745 * * * 0.008 2.979 * * 0.013 0.151 68

0.399 0.797 0.428 20.516 20.966 0.338 20.889 21.375 0.174 20.373 21.141 0.258 0.759 0.481 0.632 0.486 1.057 0.295

Notes: Dependent variable: yearly beta excess return; * p , 0:10; * * p , 0:05; * * * p , 0:01

F statistic Prob . F Adj. R 2 Sample size

Change in retained earning

Capital expenditure

Accounts payable

Accounts receivable

Marketing cost

Manufacturing cost

2.015 2.789 * * * 0.007 22.271 22.858 * * * 0.006 22.158 22.516 * * * 0.015 20.393 20.824 0.413 0.218 0.132 0.896 21.405 21.916 * 0.060

5.347 * * * 0.000 0.245 68

3.868 4.328 * * * 0.000 24.565 24.763 * * * 0.000 23.867 23.678 * * * 0.001 20.366 20.690 0.493 0.799 0.412 0.682 22.042 22.232 * * 0.029

1.990 2.780 * * * 0.007 22.247 22.852 * * * 0.006 22.132 22.506 * * * 0.015 20.355 20.775 0.441 0.179 0.109 0.914 21.365 21.887 * 0.064

Intercept

Table III. Results of regression analyses 2 years of Without control Coefficient t-statistic (Pr . jTj)

0.076 0.827 0.412 4.547 * * * 0.001 0.241 68

3.865 4.315 * * * 0.000 24.563 24.749 * * * 0.000 23.861 23.663 * * * 0.001 20.404 20.757 0.452 0.865 0.444 0.659 22.069 22.254 * * 20.028

decline With control Coefficient t-statistic (Pr . jTj)

3.887 * * * 0.004 0.177 68

3.903 3.703 * * * 0.001 24.664 24.184 * * * 0.000 24.392 23.461 * * * 0.001 20.314 20.520 0.605 1.279 0.492 0.624 21.377 21.183 0.242

0.138 0.870 0.388 3.352 * * * 0.006 0.174 68

3.721 3.456 * * * 0.001 24.480 23.941 * * * 0.000 24.161 23.203 * * * 0.002 20.335 20.552 0.583 1.112 0.426 0.672 21.137 20.948 0.347

3 years of decline Without With control control Coefficient Coefficient t-statistic t-statistic (Pr . jTj) (Pr . jTj)

384

1 year after the peak year 2 years after the peak year 3 years after the peak year Without With Without With Without With control control control control control control Coefficient Coefficient Coefficient Coefficient Coefficient Coefficient t-statistic t-statistic t-statistic t-statistic t-statistic t-statistic Independent variables (Pr . jTj) (Pr . jTj) (Pr . jTj) (Pr . jTj) (Pr . jTj) (Pr . jTj)

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impact in the hypothesized direction right through the decline phase (i.e. the higher the manufacturing (marketing) cost, lower the beta excess return). Accounts receivable and accounts payable did not have significant impact but their impact was in the predicted direction (i.e. the higher the accounts receivable (payable), lower (higher) the beta excess return). The impact of capital expenditures was in the same direction as hypothesized, though its impact was significant in only the first year of decline. The impact of capital expenditures was negative (the higher the capital expenditure, lower the beta excess return) in the first year of decline, which was statistically significant. It was positive (the higher the capital expenditure, higher the beta excess return) in the second and third year of decline (but not statistically significant). Regressions were also separately run using a control for change in retained earnings. The regression analysis’ explanatory power increased but it did not affect the impact of strategic conduct variables. The impact change in retained earnings was significant and positive (i.e. as expected) in the second and third years of decline. Discussion In this study, our main aim was to empirically test the impact of strategic conduct on shareholder value in decline situations. Results of the hypothesis testing supported that value changes occurred incrementally – over the three years of decline under study. That is, investors adjusted the value of stocks as additional new information reached them. These findings are similar to those of Fama et al. (1969). As far as the impacts of strategy conduct variables were concerned, the impact of these variables was in the hypothesized direction though not all were statistically significant. Variables that have immediate impact on profits and profitability had an immediate impact on shareholder value as well. On the other hand, the variable, capital expenditures (a strategic variable) had a significant impact on shareholder value only during the first year of decline. During this first year of decline, capital expenditures were negatively and significantly associated with beta excess returns. During the latter years of decline, capital expenditures were positively associated with beta excess returns but not significantly. This means that investors may value retrenchment strategies (which presumably have immediate effect) highly in comparison to long-term strategies. This supports Robbins and Pearce (1992) argument that retrenchment strategies are a prerequisite for successful turnarounds. This is consistent with the argument of Bibeault (1982) and others who consider that arresting the “bleeding” by the required “surgery” is an important first step for a firm to successfully turnaround. As pointed out earlier, as long as an action taken by the management improves efficiency, such an action should have positive impact on shareholder value. To that extent, the positive link between manufacturing efficiency and marketing efficiency is empirically supported. The results also confirmed that the impact of changes in retained earnings did not affect the impact of these strategy variables. One interesting aspect of the findings is that the moderating variable included did increase the explanatory power of the model but did not in any way reduce the impact of the strategic conduct variables. Changes in retained earnings had a consistent positive impact on the beta excess returns as suggested by Cootner (1964). The lack of significant impact of some of these variables on shareholder value should not be interpreted to mean that investors were not sensitive to changes in strategy conduct variables. It may be that the impact of some of these variables on the income

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stream could be marginal and hence might not alter whether or not a firm successfully turns around. If a firm continued to operate inefficiently in manufacturing and marketing, it could fail to turnaround and hence investors weigh these strategy variables highly in comparison to accounts receivable and accounts payable. Also, contributions from savings in accounts receivable and accounts payable could be much less comparatively. In fact, it could also be argued that the relationship between these two variables (accounts receivable and accounts payable) and performance is not simple and direct. Because accounts receivable may lead to economies of scale, it could be used to increase sales and result in an improvement in manufacturing efficiency. Therefore, accounts receivable could be positively associated with shareholder value. However, if accounts receivable increase too much, it could be because of poor debt collection practices and hence, the impact of large accounts receivable could be negative. In the case of accounts payable, excessive use of trade credit could result in a strained relationship with suppliers and hence the transaction costs could increase reducing the efficiency. Also, firms performing poorly tend to fail to meet the credit terms of suppliers and hence may have higher accounts payable. Therefore, the higher the accounts payable, the lower the income stream and, hence, the lower the shareholder value. Limitations and directions for further research One of the major contributions of the results of this research is to empirically support the relationship between corporate strategy and shareholder value, as measured by beta excess returns. Our results also indirectly provide empirical support for Cootner’s (1964) model where stock price’s movements occur around the intrinsic value. In addition, the use of beta excess returns to measure shareholder value proved to be effective, suggesting that cumulative beta excess returns methods capture strategy changes very effectively. In future studies, it is possible that an excess return to an industry portfolio may prove to be a better measure, because it could highlight even more clearly the relationship between strategy and shareholder value. The measurement of corporate strategy could also be improved in future research. While the measures used were acceptable and consistent in terms of previous research studies, they could have been further assessed relative to industry norms. However, this was not possible because of the multi-industry nature of the study. It should be noted that, although this study used only a subset of variables which Prescott (1983) developed, it could perhaps be enhanced through the use of survey or interview data with top management personnel in the study firms, as suggested by Barker and Duhaime (1997). This, in turn, might lead to a set of “fine-grained” measures of corporate strategy. The trade-off is obviously between the depth of survey-type case study research and the more quantitative analysis offered here. It should also be stressed that, while the choice of decline situations as the area of study provided high-quality and easily detectable differences in strategy, it tended to limit the sample size of available firms and perhaps, to some extent, the quality of data. (This is because firms only report the minimum required information when they face situations of decline, crisis and constraints in resources.) An alternative sample design, perhaps involving random samples of firms, might have increased the sample size of firms studied but this would have been achieved at the expense of identifying a satisfactory number of changes in strategies and strategic postures taken by those firms.

Notes 1. That is, it is assumed that the extraneous variables do not change during that narrow window. 2. Some firms in this control group may, in some instances, have faced a one-year decline (the first year after the peak year) but were on the growth path the next year. 3. In this paper, we have used “beta excess returns” and “cumulative beta excess returns” interchangeably. When shareholder value changes over a period is under consideration, the measure used is “cumulative beta excess returns” over that period whatever the terminology used. References Arend, R.J. (2004), “The definition of strategic liabilities and their impact on firm performance”, Journal of Management Studies, Vol. 41 No. 6, pp. 1003-27. Argenti, J. (1976), Corporate Collapse: The Causes and Symptoms, McGraw-Hill, London. Arogyaswamy, K. (1992), “Organizational turnaround: a two-stage strategy-contingency model”, unpublished doctoral dissertation, University of Wisconsin-Milwaukee, Milwaukee, WI. Aziz, A., Emanuel, D.C. and Lawson, G.H. (1988), “Bankruptcy prediction: an investigation of cash flow based models”, Journal of Management Studies, Vol. 25 No. 5, pp. 419-37. Baldwin, J. and Glezen, G.W. (1992), “Bankruptcy prediction using quarterly financial statement data”, Journal of Accounting, Auditing & Finance., Vol. 7, Summer, pp. 269-89. Ball, R. and Brown, P. (1968), “An empirical evaluation of accounting income numbers”, Journal of Accounting Research, Vol. 6 No. 2, pp. 159-78. Barker, V.L. III and Duhaime, I.M. (1997), “Strategic change in the turnaround process: theory and empirical evidence”, Strategic Management Journal, Vol. 18 No. 1, pp. 13-38. Barker, V.L. III and Mone, M.A. (1994), “Retrenchment: cause of turnaround or consequence of decline?”, Strategic Management Journal, Vol. 15 No. 5, pp. 395-405. Barker, V.L. III, Patterson, P.W. Jr and Mueller, G.C. (2001), “Organizational causes and strategic consequences of the extent of top management team replacement during turnaround attempts”, Journal of Management Studies, Vol. 38 No. 2, pp. 235-69. Bibeault, D.B. (1982), Corporate Turnaround: How Managers Turn Losers into Winners, McGraw-Hill, New York, NY. Blyth, M.L., Friskey, E.A. and Rappaport, A. (1986), “Implementing the shareholder value approach”, Journal of Business Strategy, Vol. 6, Winter, pp. 48-58. Brearley, R.A. and Myers, S.C. (2002), Principles of Corporate Finance, 7th ed., McGraw-Hill, New York, NY. Cameron, K.S., Sutton, R.I. and Whetten, D.A. (1988), Readings in Organizational Decline: Frameworks, Research and Prescriptions, Balinger, Cambridge, MA. Chan, S.H., Martin, J.D. and Kensinger, J.V. (1990), “Corporate research and development expenditures and share value”, Journal of Financial Economics, Vol. 26 No. 2, pp. 255-76. Chatterjee, S. (1986), “Types of synergy and economic value: the impact of acquisitions on merging and rival firms”, Strategic Management Journal, Vol. 7 No. 2, pp. 219-39. Chatterjee, S., Lubatkin, M.H., Schweiger, D.M. and Weber, Y. (1992), “Cultural differences and shareholder value in related mergers: linking equity and human capital”, Strategic Management Journal, Vol. 13 No. 5, pp. 319-34. Chauvin, K.W. and Hirschey, M. (1993), “Advertising: R&D expenditures and the market value of the firm”, Financial Management, Vol. 22, Winter, pp. 128-40.

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Harker, M. (1998), “The role of marketing in the company turnaround process”, Industrial Marketing Management, Vol. 27, pp. 315-27. Hedberg, B.L.T., Nystrom, P.C. and Starbuck, W.H. (1976), “Camping on seesaws: prescriptions for a self-designing organization”, Administrative Science Quarterly, Vol. 21 No. 1, pp. 41-65. Hofer, C.W. (1980), “Turnaround strategies”, Journal of Business Strategy, Vol. 1 No. 1, pp. 19-31. Hofer, C.W. and Schendel, D. (1978), Strategy Formulation: Analytical Concepts, West Publishing, St Paul, MN. Kelm, K.M., Narayanan, V.K. and Pinches, G.E. (1995), “Shareholder value creation during R&D innovation and commercialization stages”, Academy of Management Journal, Vol. 38 No. 3, pp. 770-86. Lamberg, J.A. and Pajunen, K. (2005), “Beyond the metaphor: the morphology of organizational decline and turnaround”, Human Relations, Vol. 58 No. 8, pp. 947-80. Lohrke, F.T., Bedeian, A.G. and Palmer, T.B. (2004), “The race of top management teams in formulating and implementing turnaround strategies: a review and research agenda”, International Journal of Management Reviews, Vol. 5-6 No. 2, pp. 63-90. Lubatkin, M. (1987), “Merger strategies and stockholder value”, Strategic Management Journal, Vol. 8 No. 1, pp. 39-53. Lubatkin, M. and Chatterjee, S. (1991), “The strategy-shareholder value relationship: testing temporal stability across market cycles”, Strategic Management Journal, Vol. 12 No. 4, pp. 251-70. Lubatkin, M. and Shrieves, R.E. (1986), “Toward reconciliation of market performance measures to strategic management research”, Academy of Management Review, Vol. 11 No. 3, pp. 497-512. McConnell, J.J. and Muscarella, C.J. (1985), “Corporate capital expenditures and the market value of the firm”, Journal of Financial Economics, Vol. 14 No. 3, pp. 399-422. McGee, J., Thomas, H. and Wilson, D. (2005), Strategy: Analysis and Practice, McGraw-Hill, Maidenhead. Mellahi, K. and Wilkinson, A. (2004), “Organisational failure: a critique of recent research and a proposed integrative framework”, International Journal of Management Reviews, Vol. 5-6 No. 1, pp. 21-41. Merchant, H. (2000), “Event-studies of joint venture formation announcements: a synthesis and some possible extensions”, in Dahiya, S.B. (Ed.), The Current State of Business Discipline, Spellbound, Rohtak, pp. 1837-61. Merchant, H. and Schendel, D. (2000), “How do international joint ventures create shareholder value?”, Strategic Management Journal, Vol. 21 No. 7, pp. 723-77. Mintzberg, H. (1978), “Patterns in strategy formation”, Management Science, Vol. 24 No. 9, pp. 934-48. Mintzberg, H. and Waters, J.A. (1982), “Tracking strategy in an entrepreneurial firm”, Academy of Management Journal, Vol. 25 No. 3, pp. 465-99. Moulton, W.N. and Thomas, H. (1993), “Bankruptcy as a deliberate strategy: theoretical considerations and empirical evidence”, Strategic Management Journal, Vol. 14 No. 2, pp. 125-35. Nystrom, P.C. and Starbuck, W.H. (1984), “To avoid organizational crises, unlearn”, Organizational Dynamics, Vol. 12 No. 4, pp. 53-65.

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Further reading Brown, S.J. and Warner, J.B. (1985), “Using daily stock returns: the case of event studies”, Journal of Financial Economics, Vol. 14 No. 1, pp. 3-31. Christopher, M. and Ryals, L. (1999), “Supply chain strategy: its impact on shareholder value”, International Journal of Logistics Management, Vol. 10 No. 1, pp. 1-10. D’Aveni, R.A. (1989), “Dependability and organizational bankruptcy: an application of agency and prospect theory”, Management Science, Vol. 35 No. 9, pp. 1120-38. Foster, G. (1986), Financial Statement Analysis, 2nd ed., Prentice-Hall, Englewood Cliffs, NJ.

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Ginsberg, A. (1988), “Measuring and modeling changes in strategy: theoretical foundations and empirical directions”, Strategic Management Journal, Vol. 9 No. 6, pp. 559-75. Jacobson, R. (1987), “The validity of ROI as a measure of business performance”, American Economic Review, Vol. 77, June, pp. 470-8. Pandian, J.R. (1995), “Shareholder value and strategic action: a study of turnaround firms”, unpublished doctoral dissertation, University of Illinois at Urbana-Champaign, Urbana-Champaign, IL. Reiman, B. (1987), Managing for Value, Planning Forum, Oxford, OH. Seed, A.H. III (1985), “Winning strategies for shareholder value creation”, Journal of Business Strategy, Vol. 6 No. 2, pp. 44-51. Snow, C.C. and Hambrick, D.C. (1980), “Measuring organizational strategies: some theoretical and methodological problems”, Academy of Management Review, Vol. 5 No. 4, pp. 527-38. Srivastava, R.K., Shervani, T.A. and Fahey, L. (1998), “Market-based assets and shareholder value: a framework for analysis”, Journal of Marketing, Vol. 62 No. 1, pp. 2-18. Stewart, G.B. (1991), The Quest for Value, HarperCollins, New York, NY. Varaiya, N., Kerin, R. and Weeks, D. (1987), “The relationship between growth, profitability, and firm value”, Strategic Management Journal, Vol. 8 No. 5, pp. 487-97. Corresponding author Olivier Furrer can be contacted at: [email protected]

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SECTION 3. COMPETENCIES, CAPABILITIES AND RESOURCES

Core competency beyond identification: presentation of a model

Core competency beyond identification 393

Urban Ljungquist School of Management and Economics, Va¨xjo¨ University, Va¨xjo¨, Sweden Abstract Purpose – The purpose of this paper is to outline a model that is conceptually and empirically applicable by practitioners in contexts extending beyond mere core competence identification. Design/methodology/approach – This paper presents a conceptual review of a model. Findings – This paper demonstrates that the associated concepts (competence, capability, and resources) have characteristics that differ both conceptually and empirically. The findings also indicate that competencies are central to core competence matters; it is possible to distinguish them analytically by three criteria. Furthermore, the notions of hierarchy suggested in previous research could not be verified which implies that the associated concepts all reside at the same hierarchy level. Research limitations/implications – The findings advance core competence theories that better serve the needs of practicing managers and consultants, by initiating a specific research agenda in conceptual and empirical reviews and discussions. By proposing a model, the study provides a point of departure for core competency research that goes beyond matters of identification. Practical implications – The dissimilar characteristics of the associated concepts offer great opportunities to core competency management, by means of the different influences they have on core competencies. Their influence makes organizational change and rejuvenation not only comprehensible, but also manageable. This is of particular importance to organizations that need ongoing renewal of core competencies, for example, when facing dynamic business environments. Competence improvements manage and change core competencies; capability supports reinforce and create structure before, during, and after a change process; resource utilizations are operative, and need daily attention. Originality/value – The paper initiates a new research agenda for core competency matters by acknowledging specific features of the concepts associated with core competence. This makes a significant contribution to the existing literature in terms of practical and scholarly applicability. Keywords Competences, Change management, Corporate strategy, Organizational structures Paper type Research paper

Introduction The concept of core competence, as fundamental to organizational renewal and as a driving force behind strategic change, interests both managers and scholars. It is a complex and challenging concept: it is difficult to specify theoretically, to identify empirically as a phenomenon, and to apply in practice. Scholars have recently recognized these problems in general conceptual discussions (Hafsi and Thomas, 2005) and in core competence-specific empirical research (Wang et al., 2004).

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Identification is arguably the starting point of all core competence research (Clark, 2000) and is the matter on which most previous research has focused (e.g. Eden and Ackermann, 2000; Javidan, 1998). The process of identifying core competencies usually entails having employees identify core competencies by scanning and assessing company-critical resources, capabilities, and competencies (Prahalad and Hamel, 1990) – three factors commonly referred to as “associated concepts”. In the identification process these concepts often become conceptually and empirically merged, something that occurs in strategic management research too, when these associated concepts are defined interchangeably. For example, capabilities and competencies are defined interchangeably by Spanos and Prastacos (2004), resources and capabilities by Peteraf and Bergen (2003) and Ray et al. (2004), and skill, competence, and capability by Hamel and Prahalad (1994). Other scholars, however, have more usefully distinguished these associated concepts (Branzei and Thornhill, 2006; Makadok, 2001; Helfat and Peteraf, 2003; Amit and Shoemaker, 1993; Savory, 2006; Ljungquist, 2008). Although merging the associated concepts is occasionally justifiable, it normally makes sense to distinguish them by their characteristics. In fact, each concept is acknowledged to be substantial enough to have its own major research stream in the strategic management field, namely, the resource-based, competence-based, and dynamic capability-based streams (Barney, 1991; Sanchez, 2004; Teece et al., 1997). Although neglecting the associated concepts’ distinguishing characteristics may occasionally be useful in complex identification processes, for more advanced core competence matters doing so is unsatisfactory. The very diversity of the concepts enhances our understanding of core competence, and is relevant to research issues such as core competence management, a matter going far beyond mere identification. In this paper, we distinguish the associated concepts as clearly as possible using conceptual definitions and, in practical contexts, empirical definitions. Javidan (1998) has conceptually distinguished the associated concepts in a “competencies hierarchy”. This represents a combination of two types of hierarchy: a cumulative one, since the concepts are described as building on each other, and a qualitative one, since higher-order concepts are assumed to be of greater organizational value than lower-order concepts are. The hierarchy starts with resources at the bottom; next come capabilities, which build on resources, and then competencies, which build on both resources and capabilities (Javidan, 1998). Finally, core competencies reside on the highest level; they are of the greatest value to organizations, but are the most difficult to achieve. This hierarchy notion seems reasonable, although the definitions of the associated concepts are not explicitly presented. In fact, the hierarchy Javidan suggests seems to be valid only for structuring the concepts, for revealing that they have different organizational applications. In other words, the concepts’ differing characteristics as such are neither acknowledged in the hierarchy nor applied in practical matters. In this paper, the suggested hierarchy is scrutinized by acknowledging the differences between the concepts’ characteristics. The starting point for doing this is to differentiate the associated concepts, and to examine the characteristics and definitions by scrutinizing the identification of core competence (on which most existing research has focused) and exploring the extent to which the literature supports the hierarchy notion. This paper thus outlines a core competence model, conceptually and empirically applicable by practitioners to more than mere identification matters.

In the following, the associated concepts are first reviewed separately and their conceptual bases scrutinized. This leads to proposed methods for distinguishing between conceptual and empirical definitions, and to an assessment of their places in the hierarchy. The findings are summarized in a table and discussed in both individual and merged analytical terms. Conceptual fundamentals The core competence notion is evident in several major research streams in the strategic management field. Such streams include the resource- (Penrose, 1959; Wernerfelt, 1984), competence- (Sanchez et al., 1996), learning- (Senge, 1990), knowledge- (Grant, 1996), and dynamic capability-based views (Eisenhardt and Martin, 2000; Teece et al., 1997). Because of its diverse origins and applications, contemporary core competence issues are impossible to classify according to any one particular theory. Classification is further complicated by the fact that the “associated concepts” all have their own origins in the aforementioned “views”. For example, resources are the major focus of the resource-based view, in assessing organizations’ resources according to the valuable, rare, inimitable, and organizable categories (Barney, 1991). The knowledge-based view takes a different approach (Grant, 1996): a resource is defined as an input to the value process, and competencies and creating organizational knowledge are major focuses. The competence-based view, finally, also acknowledges resources, but mainly as deployable assets, governed by competencies (Sanchez et al., 1996). Core competence One of the best-known strategic management concepts is undoubtedly that of “core competence”. The concept was introduced in the early 1990s and is defined as “the collective learning in the organization, especially how to coordinate diverse production skills and integrate multiple streams of technologies” (Prahalad and Hamel, 1990, p. 82). Later, the definition was expanded to include “a bundle of skills and technology that enable a company to provide benefit to customers” (Hamel and Prahalad, 1994, p. 199). Though its basis is fairly clear, the concept is defined in vague terms, so the concept is difficult to apply in practical situations. Even so, it is crucial to keep referring to the concept’s premises when studying core competence, otherwise we will end up studying something else. Three criteria that distinguish a core competence from a competence are as follows (Prahalad and Hamel, 1990; Hamel and Prahalad, 1994): (1) A core competence must contribute significantly to customer benefit from a product. (2) A core competence should be competitively unique, and as such, must be difficult for competitors to imitate. (3) A core competence should provide potential access to a wide variety of markets. Accordingly, in this paper, a competence that satisfies the above three criteria is taken as a core competence. The criteria imply a hierarchy of quality between a core competence and a competence; the former is more advanced, but to determine the former we first need to define and identify the latter.

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Competence Competencies are commonly agreed to reside in individuals and teams of individuals, implying that the competence concept involves a cumulative hierarchy. This cumulative hierarchy notion is evident in many streams of research concerning the associated concepts: i.e. single-, double-, and triple-loop learning, which are based on competencies, capabilities, and dynamic capabilities, respectively, according to Savory (2006). Another researcher has adopted similar notions of hierarchy: i.e. first-order competence, which comprises customer and technological competencies; integrative competence, which is the ability to combine the previous competencies; and second-order competence, which is the ability to create first-order competencies (Danneels, 2002). Scholars also distinguish between “distinctive competence” and “core distinctive competence” (Eden and Ackermann, 2000). The two competencies involve a hierarchy: the former is a particular strength within a company that is difficult to imitate and may be used to generate sustainable profits; the latter are competencies “that primarily drive the aspirations system” (Eden and Ackermann, 2000, p. 16). A final example of a hierarchy involves three competence categories: distinctive competencies, which are the most important in a company; necessary competencies, which do not differ from those of competitors but which are needed for operational reasons; and protected competencies, which can hurt the company if misused (Heikkila¨ and Cordon, 2002). The first two examples can be assumed to involve qualitative hierarchy in terms of differences in importance. A competence has been defined as “a cross-functional integration and co-ordination of capabilities” (Javidan, 1998, p. 62), and as a set of skills and know-how resident in strategic business units. Another scholar has defined the concept as “the ability to sustain the coordinated deployment of assets in ways that help a firm achieve its goals” (Sanchez, 2004, p. 521). The first quotation is quite vaguely expressed, and since we do not know what the scholar means by “co-ordination” and “integration”, it is difficult to apply his definition. Accordingly, his definition is not useful in our attempts to develop empirical definitions. The second quotation is expressed differently, implying a capacity directed towards goals. Still, an expression such as “. . . sustain the coordinated deployment of assets . . . ” blurs the meaning, and makes it inapplicable to our concerns. We have already argued that a competence refers to a quality inherent in individuals or teams of individuals, a quality that develops and refines something (e.g. capabilities, resources), occasionally to a visionary end (e.g. to generate sustainable profits). Here, we apply the general notion and conceptually define a competence as developments made by individuals and teams. Furthermore, a competence as empirically identified and meeting the three criteria, most likely has one or several particular characteristics in line with the broader core competence notion. Furthermore, since core competencies are key contributors to organizational success, they must highly be developed, implying that minor competence developments are unlikely to have any impact on them. For empirical matters, we need to define a superior competence involving advanced forms of development. Here, we propose that a competence should have improvement as its main empirical characteristic; accordingly, a competence is here empirically defined as improvements. In an empirical study recently conducted by the author, empirical competencies having improvement as their main empirical characteristic involved, for

example, an R&D department’s competence to innovate, to develop products with external partners, and to adopt and create individual customer solutions. Customer and employee interviews verified the latter as a core competence. Capability A confusing aspect of the capability concept is that it seems to have two generic meanings (Collis, 1994). The first meaning is capacity, as adopted by Javidan (1998). One scholar has defined capability as “the capacity for a team of resources to perform some task or activity” (Grant, 1991, p. 119). The second meaning is coordination, consisting of a mix of routines, tacit knowledge, and organizational memory (Nelson and Winter, 1982). Contemporary research has also distinguished capabilities as being either operational or dynamic (Helfat and Peteraf, 2003). Operational capabilities include all the routines generally involved when performing an activity such as manufacturing, whereas dynamic capabilities (Teece et al., 1997; Eisenhardt and Martin, 2000) are those that build, integrate, and reconfigure operational capabilities. Winter (2003) also claims that capabilities are locally defined either as normal routines, or as “activities to support change”, the first being zero-level capabilities and the second being first-order dynamic capabilities. The distinction of capabilities as either operational or dynamic may invoke a notion of hierarchy, since the latter are considered as of higher organizational value. Several scholars support that interpretation. Savory (2006) does so when defining double- and triple-loop learning. Javidan (1998, p. 62) also cites the hierarchy notion when he suggests that a capability is of less organizational value and complexity than a competence is, defining a competence as the “cross-functional integration and co-ordination of capabilities”. I feel that both these arguments are essentially unsupported, because the researchers construct the hierarchy using the definitional expression; here we define a capability by its most generic characteristics – as systems and routines – regardless as to whether these characteristics are, for example, operational or dynamic. Thus, in this paper, capability is defined in accordance with Winter (2003), as systems and routines. The “capacity” concept is too vague and difficult to identify or measure empirically, so it is disregarded when considering the definitional issues. Systems play crucial roles in many company undertakings, such as structuring core competencies, and routines are also essential in organizing activities and processes. These crucial functions suggest the existence of a supporting link between a capability and a core competence. An empirical study recently conducted by the author found evidence for the existence of the supporting link, since empirical capabilities involved both internal systems (such as ISO certification) in quality and environmental issues, and decentralized efficiency in administrative routines. The main characteristic of the empirical capabilities identified was that they supported organizational activities and processes; accordingly, capabilities and core competencies are here proposed to be linked by support provided by routines and systems. Resources Resources are basic to an organization and are natural objects of study, since they form inputs to the value process (Grant, 1991; Eisenhardt and Martin, 2000). Resources are identified as sources of sustainable competitive advantage if they are valuable, rare,

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inimitable, and non-substitutable (Barney, 1991). Another definition includes capabilities as well as available assets (Sanchez et al., 1996). Javidan (1998) identifies resources as building blocks of competencies, the former being inputs to the organization’s value chain. It is easier said than done to construe that the resource concept belongs to a hierarchy. Here, I define resources in accordance with the general sense found in the literature reviewed (e.g. Grant, 1991), defined as inputs to the value process in an organization. With regards core competence, the empirical definition of a resource is that it utilizes core competencies. The author recently conducted an empirical study that identified empirical resources using the framework introduced here. In one case a core competence was utilized by the resources marketing expenses, manufacturing skills, and strong corporate finances; the last two items were found to have a major influence on the core competence studied. In concrete terms, customers were concerned about security issues; hence, the delivery security inherent in the company’s manufacturing skills and strong finances were utilized and strengthened the customer loyalty-creating core competence. Discussion Definitions The differences between the associated concepts were assessed with regard to conceptual definitions, empirical definitions, and hierarchical characteristics. The findings suggest that a core competence does not need to be identified empirically; rather, it can be analytically distinguished from a competence using three criteria, making competence the central concept in core competence identification matters. The definition of competence makes developments achieved by individuals and teams the conceptual focus, and improvements the empirical focus (see Table I). The definition of capability makes systems and routines the conceptual focus, and support the empirical focus. A resource is conceptually defined as an input to the value process, and is empirically defined as the utilization of core competencies. Single hierarchy From the literature review, it was possible to verify the hierarchical aspects of the concepts to only a limited extent. Competence is the only associated concept that involves both inter-concept and intra-concept notions of hierarchy (see Table I). The former are manifested by the three criteria, which hierarchically link a competence to a core competence in a qualitative way. The latter are manifested in the presence, in the competence concept, of characteristics embodying notions of hierarchy, for example, first- and second-order competencies (Danneels, 2002). The intra-concept hierarchy for competence cannot be fully assessed in this paper, as we first need comprehensive empirical studies to assess the hierarchical characteristics. With regards the capability and resource concepts, the literature review revealed disagreement concerning the de-verified hierarchies; however, any suggestions of hierarchy are mainly based on definitional factors, for instance in Javidan’s (1998) competencies hierarchy. Another example is Savory (2006), who defines competence, capability, and dynamic capability as single-, double-, and triple-loop learning, respectively, which by design constructs a hierarchy. Since this paper assumes a more basic definitional stance, trying to determine the concepts’ most generic characteristics, I have deliberately disregarded

Concept

Conceptual definition

Empirical definition

Hierarchy characteristics

Core competence

A competence that satisfies three criteria:

N/A

Inter-concept: hierarchically linked to competencies in a qualitative way

399

1. Contributes significantly to customer benefit from a product 2. Is competitively unique 3. Provides potential access to a wide range of markets Competence

Core competency beyond identification

Developments achieved Improvement by individuals and teams

Inter-concept: hierarchically linked to a core competence in a qualitative way Intra-concept: first-order and second-order; distictive and core-distinctive

Capability

System and routine

Support

N/A

Resource

Input to the value process

Utilization of core competencies

N/A

such constructions. Thus, from basic definitional factors we can both conceptually and empirically de-verify most of the notions of hierarchy pertaining to the particular concepts. We now move the discussion of hierarchy from the individual concepts to merged comparisons. Merged hierarchy The associated concepts do not limit each other’s scope. That is, the hierarchical link of the competence concept to the core competence concept does not imply that the capability and resource concepts are similarly linked. Resources, for example, may be of more value to some organizations than capabilities and competencies are. Accordingly, we cannot verify the qualitative aspects of the hierarchy of competencies that Javidan (1998) suggests. Furthermore, Javidan (1998) also suggests a cumulative hierarchy, though the findings of the review do not support that notion. On the contrary, the review made it obvious that the associated concepts have different characteristics, namely, improvement, support, and utilization. Accordingly it is essential to acknowledge the differences between them. Thus, we propose that the associated concepts all reside at the same hierarchical level. In a particular company, any one of the associated concepts could be of higher or lower organizational value than is typical. For example, as previously mentioned, in a

Table I. Conceptual and empirical definitions and hierarchical characteristics of core competence and the associated concepts

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case study company two particular resources were highly regarded by customers, and were thus of major value to the organization. We are now ready to outline a model of how the core competence and associated concepts are linked. The core competence concept resides at the top, separated from the associated concepts by a qualitative hierarchy based on its superior value to the organization (see Figure 1). Even though a single core competence has greater value to an organization than any single associated concept, its rarity implies that its value can be outweighed by the accumulated value of the associated concepts. Conclusions and implications This paper examines the core competence concept in three stages: unraveling the associated concepts’ fundamental aspects in conceptual and empirical terms, de-verifying the hierarchies, and outlining a core competency model. This examination has several purposes: First, to advance core competence theories to meet the needs of practicing managers and consultants. Second, to introduce a particular approach for use in conceptual and empirical reviews and discussions. Finally, to provide, in the proposed model, a point of departure for core competency research going beyond matters of mere identification. This paper makes a significant contribution to the core competence literature. Fundamental features of the associated concepts (competence, capability, and resource) are suggested, since the conceptual review showed them to have characteristics that differ both conceptually and empirically. In fact, the associated concepts convey information regarding the core competence concept, by means of the different influences they have on core competencies: competencies improve, capabilities support, and resources utilize core competencies. By means of these influences, organizational change and rejuvenation can not only be comprehended, but also managed. In particular, our findings indicate that a core competence does not need empirical definition, since it can analytically be distinguished from a competence by fulfilling three criteria; this makes competencies the central concept for core competence matters. Furthermore, the notions of hierarchy suggested in previous research, in particular the competencies hierarchy of Javidan (1998), could not be verified; accordingly, we conclude that the associated concepts all reside at same hierarchy level. The practical implications of this paper are that, unlike other discussions of core competency, it clearly reveals specific features of the associated concepts. By presenting these details, in conceptual and empirical definitions as well as in hierarchies, organizational core competencies can be identified, assessed, and managed. This is of particular importance to organizations in need of organizational

Figure 1. Outlined core competence model: associated concepts linked to the core competence concept

change, which face, for example, dynamic and harsh business environments, in which core competencies must be continually renewed. To advance core competence practice beyond mere identification, comprehensive organizational analysis is essential. Such analysis would preferably start with core competence identification, with the guidance of consultants and/or the existing literature. The core competencies empirically identified would be examined for the associated concepts, in line with the core competency model proposed here. That is, competencies are detected by means of improvements, capabilities by supports, and resources by core competence utilizations. Competence improvements are used to manage and change core competencies, capability supports reinforce and create structure before, during, and after change, and resource utilizations are operative and need daily attention. Further research is needed to test the suggested empirical definitions in order to refine their formulation and scope. Advancing this paper’s findings would also include updating the core competence determinants, i.e. the three criteria; in their current form, they are inaccurate and difficult to use in practical contexts. References Amit, R. and Shoemaker, P.J. (1993), “Strategic assets and organization rents”, Strategic Management Journal, Vol. 14 No. 1, pp. 33-46. Barney, J.B. (1991), “Firm resources and sustained competitive advantage”, Journal of Management, Vol. 17 No. 1, pp. 99-120. Branzei, O. and Thornhill, S. (2006), “From ordinary resources to extraordinary performance: environmental moderators of competitive advantage”, Strategic Organization, Vol. 4 No. 1, pp. 11-41. Clark, D.N. (2000), “Implementation issues in core competence strategy making”, Strategic Change, Vol. 9 No. 2, pp. 115-27. Collis, D.J. (1994), “Research note: how valuable are organizational capabilities?”, Strategic Management Journal, Vol. 15 No. 8, pp. 143-53. Danneels, E. (2002), “The dynamics of product innovation and firm competences”, Strategic Management Journal, Vol. 23 No. 12, pp. 1095-121. Eden, C. and Ackermann, F. (2000), “Mapping distinctive competencies: a systemic approach”, Journal of the Operational Research Society, Vol. 51 No. 1, pp. 12-21. Eisenhardt, K.M. and Martin, J.A. (2000), “Dynamic capabilities: what are they?”, Strategic Management Journal, Vol. 21 Nos 10-11, pp. 1105-21. Grant, R.M. (1991), “The resource-based theory of competitive advantage: implications for strategy formulation”, California Management Review, Vol. 33 No. 3, pp. 114-36. Grant, R.M. (1996), “Toward a knowledge-based theory of the firm”, Strategic Management Journal, Vol. 17, Winter, pp. 109-22. Hafsi, T. and Thomas, H. (2005), “The field of strategy: in search of a walking stick”, European Management Journal, Vol. 23 No. 5, pp. 507-19. Hamel, G. and Prahalad, C.K. (1994), Competing for the Future, Harvard Business School Press, Cambridge, MA. Heikkila¨, J. and Cordon, C. (2002), “Outsourcing: a core or non-core strategic management decision?”, Strategic Change, Vol. 11, June-July, pp. 183-93. Helfat, C.E. and Peteraf, M.A. (2003), “The dynamic resource-based view: capability lifecycles”, Strategic Management Journal, Vol. 24 No. 10, pp. 997-1010.

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Javidan, M. (1998), “Core competence: what does it mean in practice?”, Long Range Planning, Vol. 31 No. 1, pp. 60-71. Ljungquist, U. (2008), “Specification of core competence and associated components: a proposed model and a case illustration”, European Business Review, Vol. 20 No. 1. Makadok, R. (2001), “Toward a synthesis of the resource-based and dynamic-capability views of rent creation”, Strategic Management Journal, Vol. 22 No. 5, pp. 387-401. Nelson, R. and Winter, S. (1982), An Evolutionary Theory of Economic Change, Belknap Press, Cambridge, MA. Penrose, E. (1959), The Theory of the Growth of the Firm, Oxford University Press, Oxford. Peteraf, M.A. and Bergen, M.E. (2003), “Scanning dynamic competitive landscapes: a market-based and resource-based framework”, Strategic Management Journal, Vol. 24 No. 10, pp. 1027-41. Prahalad, C.K. and Hamel, G. (1990), “The core competence of the corporation”, Harvard Business Review, Vol. 68 No. 3, pp. 79-92. Ray, G., Barney, J. and Muhanna, W.A. (2004), “Capabilities, business processes and competitive advantage: choosing the dependent variable in empirical tests of the resource-based view”, Strategic Management Journal, Vol. 25 No. 1, pp. 23-37. Sanchez, R. (2004), “Understanding competence-based management: identifying and managing five modes of competence”, Journal of Business Research, Vol. 57 No. 5, pp. 518-32. Sanchez, R., Heene, A. and Thomas, H. (1996), “Introduction: towards the theory and practice of competence-based competition”, in Sanchez, R., Heene, A. and Thomas, H. (Eds), Dynamics of Competence-based Competition: Theory and Practice in the New Strategic Management, Elsevier Science, Oxford, pp. 1-35. Savory, C. (2006), “Translating knowledge to build technological competence”, Management Decision, Vol. 44 No. 8, pp. 1052-76. Senge, P. (1990), “The leaders’ new work: building learning organizations”, Sloan Management Review, Vol. 32 No. 1, pp. 7-23. Spanos, Y.E. and Prastacos, G. (2004), “Understanding organizational capabilities: towards a conceptual framework”, Journal of Knowledge Management, Vol. 8 No. 3, pp. 31-43. Teece, D.J., Pisano, G. and Shuen, A. (1997), “Dynamic capabilities and strategic management”, Strategic Management Journal, Vol. 18 No. 7, pp. 509-33. Wang, Y., Lo, H.-P. and Yang, Y. (2004), “The constituents of core competencies and firm performance: evidence from high-technology firms in China”, Journal of Engineering and Technology Management, Vol. 21 No. 4, pp. 249-80. Wernerfelt, B. (1984), “A resource-based view of the firm”, Strategic Management Journal, Vol. 5, pp. 171-80. Winter, S.G. (2003), “Understanding dynamic capabilities”, Strategic Management Journal, Vol. 24 No. 10, pp. 991-5. Corresponding author Urban Ljungquist can be contacted at: [email protected]

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Strategizing through the capability lens: sources and outcomes of integration Jad Bitar and Taı¨eb Hafsi

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HEC Montreal, Montre´al, Canada Abstract Purpose – This paper aims to explore the concept of capabilities and where they come from as well as their impact on integration and performance. Design/methodology/approach – The paper is presented in the form of a theoretical development and literature review. Findings – This paper proposes a theory of capability development and discusses the conditions under which a capability is effective. In particular, for a capability to be effective both local and global coherence are required. But a capability effectiveness and coherence has an inverted U shape. It increases with coherence up to a certain threshold then decreases. As a result, the development of capability is a powerful integration mechanism that crosses levels and functions. Research limitations/implications – This is a theoretical paper; the propositions offered have still to be empirically tested. Practical implications – Opening up the capability black box might help managers better grasp how to develop and shape organizational capabilities that are deemed to contribute to competitive advantage (e.g. the pricing capability). First, capabilities are not to be equated with competitive advantage. They may lead to a competitive advantage only where the context is favorable. Thus consistency with the environment challenges is an important factor to watch. This suggests that managers should give attention to the relationships between what they perceive to be their capabilities and the nature of the challenges faced by the organization. Further this research might promote the development of tools to measure coherence within a context and manage appropriate levels of dissent to trigger the re-shaping of existing capabilities or the emergence of new one. Originality/value – The paper bridges highly theoretical questions with practical considerations. Keywords Competences, Competitive advantage, Organizational development Paper type Conceptual paper

Introduction Strategic management’s fundamental issue revolves around the question of how organizations achieve competitive advantage. One of the most promising theoretical frameworks is the concept of capabilities. The capability view leads to a deconstructed perspective of strategy where capabilities are foundational components. What is interesting in this perspective is that the traditional dichotomy between thinking and doing (i.e. planning and implementing) fades away since they become intertwined and iterative at all levels of the organization. Instead of focusing managers’ energy only about the concept of strategy, managers at different levels, in the capability view, would focus on the sort and level of capabilities that their organization should (and can) acquire or develop to derive a competitive advantage. Since capabilities bridge the internal and external environments gap through managers’ cognition (Penrose, 1997), success will likely come from:

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a better alignment between long-term objectives, short-term objectives and organizational design; a better coordinated management effort between identifying the types of capabilities that can support a new strategic initiative and the nurturing and development of these capabilities; and the increased synergies among capabilities when strategic initiatives are grounded in an organization’s existing capabilities.

However, such a perspective also raises the importance of integration and differentiation to a whole new level by pushing such concerns, which were traditionally a top management issue, to all levels of the organization. Hence, adopting a capability’s perspective, although promising an increased effectiveness of strategy, will also require additional coordination and communication throughout the organization. Moreover, this should lead to new ways of organizing since it is argued that capabilities determine the configuration, coordination, integration and deployment of resources (Teece et al., 1997; Stalk et al., 1992). However, for a capability perspective to become valuable to practitioners, researchers need to go beyond the present conversation around capabilities which is mostly about the links between capabilities and performance, and try to describe better what capabilities are and how they can be developed. Most researchers approach capabilities as a black box, rarely defining them by what they are but rather by what they do (their effects). Moreover, they are often measured by proxies (Ethiraj et al., 2005; Ahuja and Katila, 2004; Gautam et al., 2004). For example, Miller and Shamsie (1996) measure the number of Oscars garnered by a studio as a proxy for capabilities while Ahuja and Katila (2004) adopt patents as a proxy measure for capabilities. The capabilities view as it stands today represents a paradox. It is often easier to define what a capability is not, than to define what it is. There are different reasons for such ambiguity: capability is a polysemic word that is used casually in every day’s life and in different disciplines where it possesses different meanings depending on the context. Most researchers describe capabilities as a key engine of competitive advantage but few define them (Spanos and Prastacos, 2004; Mascarenhas et al., 1998). Moreover, there is a lack of detailed empirical research that defines the concept from a practitioner’s perspective, and a gap of qualitative research that can shed some light on the practical nature of capabilities. Identifying what capabilities are can provide insights into how managers shape organizations in pursuit of competitive advantage (Barney et al., 2001). Looking at capabilities as a black box indicates that most “observed” links between them and performance are speculative. The literature, although fertile with research on capabilities, has a qualitative gap that can be filled by answering the following: . What are capabilities? . Where do they come from? . How does capability development affect performance? In other terms, what are the ingredients of a capability, how do they interact and what are the determinants of a capability’s link to performance? In this paper, we integrate existing research and we extend it with testable propositions that we intend to verify in

a coming work on the pricing capability, conducted through a qualitative research of five companies in five different industries. The first section is an attempt to clarify the language and propose avenues to answer the first question. In the next two sections we explore the other questions and offer a set of propositions to inform our qualitative inquiry. We argue finally that capability formation is an interesting heuristic when one thinks about integrating activities across functions and across levels.

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Capabilities: what are they? For Penrose, the distinction between resources and capabilities is the source of the uniqueness of firms versus markets. Although firms have access to common resources, it is their capabilities to configure and deploy these resources and to obtain distinct services from these resources, which leads to a differentiated offering, a real source of heterogeneity. This does not imply that resources cannot provide firms with rents, but it is capabilities that are a more consistent source of rent since they are more prone to market failure. Resources In this article we differentiate between two levels of analyses (see Figure 1) that are often intermingled in the literature, and distinguish between resources and capabilities. We adopt a similar position to Dierickx and Cool’s (1989) distinction between flows and stocks. In other words, a capability is usually firm specific whereas resources may be available to many competitors (Makadok, 2001) and while both a capability and a resource might lead to competitive advantage, a capability encompasses resources and expands their potential. Resources are made of tangible and intangible assets (Amit and Shoemaker, 1991) and are an important ingredient of capabilities. Problem-defining and problem-solving routines Although several definitions of capabilities have been suggested, we still lack a homogeneous understanding, from both a theoretical and empirical perspective, of what a capability is. For example, Winter (2000) considers a capability as a high-level routine that is coupled to “input flows”, and offers managers “a set of decision options for producing significant outputs of a particular type”. Sanchez (2004), on the other hand, describes a capability as a repeatable pattern of action: persistent in time and hence possible to observe. For Conner (1991), capabilities are historical products of strategic choices and resource commitments motivated by effectiveness and profitability, while for Oliver (1997) “capabilities are capacities to coordinate and

Figure 1. Resources as ingredients of capabilities

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deploy resources to perform tasks”. Dosi et al. (2000) suggest that they can be understood as the organisational know-how that permits firms to perform and extend their characteristic output actions. Finally, Collis’ (1994, p. 145) defines a capability as the “socially complex routines that determines the efficiency with which firms physically transform inputs into outputs,” and as such is an organization’s distinctive competence (Andrews, 1971). This diversity seems to stem from latent assumptions about the nature of capabilities. Most authors adopt an approach where a capability is measured by positive contributions to objectives pursued, e.g. Oscars won (Miller and Shamsie, 1996). However, as most definitions indicate, capabilities are neither inputs (resources) nor outputs (results/performance) but rather problem-defining and problem-solving routines that allow organizations to make sense of their environment, prioritize issues, and develop and implement solutions. What is critical in this definition is that capabilities are geared towards a solution. In other words, capabilities emerge from problem-solving routines directed towards some perceived constraints faced by the organization. Finally, this definition does not assume that capabilities are creating value for the organization (e.g. increase profits) as a whole, but in general emerge as a response to local constraints (e.g. reduce inventory). Problem-solving routines are an essential component of capabilities. The interweaving of routines, the embodiment of individual skills at an organizational level, into higher functional sets is described commonly as organizational processes (Simon, 1997). We suggest that processes, as complex chains of individual skills and organizational routines, are components of capabilities (see Figure 2). Structure and culture Capabilities are organizational elements having as components individual skills, routines and processes, and emerge from links across a mosaic of other organizational elements (Lewin and Volberda, 1999; Collis, 1994). For example, incentive and operating systems (Helfat and Lieberman, 2002; Henderson, 1994), corporate culture elements (e.g. loyalty) or behavior-shaping practices such as encouraging “mistakes” (Orlikowski, 2002) are essential for capability emergence. These organizational elements can be structural, cultural or cognitive (Miller, 2003; Collis, 1994; Amit and Schoemaker, 1991). Capabilities are thus not only an accumulation of know-how and skills, but are also the result of complex social processes integrating resources, knowledge and individual skills (Grant, 1991; Bhatt, 2000): they are a key “product of the organization as an entire system” (Collis, 1994, p. 145). Therefore, we suggest that

Figure 2. Processes and routines as ingredient of capabilities

capabilities are organizational elements emerging from the interactions of cultural and structural elements and have as ingredients processes and resources (see Figure 3). Knowledge and learning are necessary to build an organization’s core competence (Thompson, 1967). They reside in the interplay between individual levels and organizational levels (Nonaka and Toyama, 2002). As a direct product of problem defining and problem solving routines, they are drivers of capabilities, and this highlights the importance of multi-level analyses to grasp the complex facets of capabilities and help build competitive advantage. This complex view of capabilities sheds a light on the organizational elements that influence their emergence such as individual activities – skills and cognition – structural elements such as roles and responsibilities, cultural elements such as norms and values, resources such as budgets and tools, and processes of decision making and resource allocation, and more importantly interactions between individuals within the organization (e.g. communities of practice) or with external partners and clients (Kor and Mahoney, 2005; Miller, 2003). This leads us to our more complete definition of capability as:

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An organizational phenomenon emerging from resource deployment activities, undertaken by individuals and groups while defining and solving problems at different levels of an organization. It is driven by the learning and practices of these individuals and groups interacting within structural and cultural organizational elements, and with their environment.

It is useful to note that our definition does not make any assumptions about links between capabilities and competitive advantage and hence avoids the typical tautological trap. Capabilities lead to competitive advantage only when contextualized (Gautam et al., 2004). For example while R&D capability is posited as key for competitive advantage (Dutta et al., 2005; Henderson, 1994), it was shown that the Xerox PARC’s R&D capability, arguably one of the best in the industry, did not contribute to competitive advantage. We believe that our definition is more useful for researchers since it allows theorizing about and testing possible configurations of and contingencies under which capabilities are or are not valuable. This complex nature of capabilities also explains their idiosyncratic character, the difficulty to imitate them, and why they cannot be mechanically “built”, but rather develop over time through activities and learning. Where do capabilities come from? Capabilities emerge, develop, and dissolve as a result of several factors, of which the development cost and timing (Helfat and Peteraf, 2003; Bhatt, 2000). They seem to be shaped by managers (Montealegre, 2002) who can affect them positively or negatively.

Figure 3. Capabilities as product of organizational systems

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Moreover, capabilities may be an unintended by-product of organizational growth as Penrose suggested: slack managerial resources might lead to identifying problems that other busier managers may have either overlooked or to which they may have given a low priority. They can also help solve them, thus driving the emergence of new capabilities or reshaping existing ones.

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Perception: opportunities and failures The pursuit of new productive opportunity sets is driven either by the perception of failures to meet certain aspiration levels or by new identified opportunities (Cyert and March, 1963). Hence, capabilities seem to first take form at the cognitive level when individuals within an organizational context interpret “a failure to reach some aspiration level” (Cohen and Levinthal, 1990, p. 137) as an opportunity. They make sense of their environment in a way that allows them to redefine problems, interact with other organizational elements to marshal resources and engage in activities to solve these problems. Hence, at the core of capabilities’ emergence is a perception of a “problem” coupled to individual and organizational learning and doing dynamics. Such a process is cumulative and since it is driven by learning, it is path dependent. Capabilities then emerge from the pursuit of functional objectives in a context of uncertainty and characterized by collective action, interaction between different roles, knowledge coordination, a spectrum of tasks and constrained by cultural and structural contexts: P1.

Capabilities emerge over time through the activities of individuals, redefining and solving problems at different levels in the organization and reinterpreting them as opportunities.

Incremental learning: setting local objectives The identification of a problem is a necessary trigger for a capability emergence but is not sufficient. In a context of uncertainty and bounded rationality (Simon, 1997), learning and knowledge accumulation are essential ingredients. Capabilities allow an organization to “surmount the bounded rationality of particular individuals” (Teece et al., 1994, p. 16). Hence, engaging in activities to identify problems, implement solutions and evaluate them is a key driver of capability emergence. For example, setting objectives can be a catalyst for capability emergence since objectives become “problems” to be solved. In other words, organizations do not go about creating capabilities. Rather, they emerge when individuals identify problems, set local objectives, and try to achieve them by identifying and implementing new solutions, which over time become institutionalized. Refinement takes place as some problems gradually dissolve and past solutions become increasingly tacit. This process of capability maturation through solving and dissolving additional problems leads to the persistence of a capability configuration. As the components become more interconnected and institutionalized into routines, they increasingly shape the behavior of individuals: P2.

Problem defining and problem solving routines further refine the different components of a capability making them more tacit and making the overall configuration more persistent and more effective in shaping individual behavior[1].

This iterative and continuously refined model suggests that capabilities are not generic but rather firm specific. To be relevant they have to be contextualized. They evolve in response to problems defined in a specific context. Each organization develops its own configuration of capabilities shaped by its specific environment, history and future anticipations (Day, 1994). However, their complex nature and the pursuit of a functional goal suggest that they might be equifinal[2]. Hence, although two capabilities can emerge from different elements, they can have similar effects. Hence, the type of resources, the source of these resources and the method of acquisition and investment could lead to different capability configurations that have a similar functional objective: P3.

There is no single “recipe” with an established list of components for the formation of a specific capability, and different combinations of organizational elements can lead to equivalent capabilities.

Internal coherence: pursuing local effectiveness This complex nature of capabilities sheds a light on why minor variations can have a major impact on a capability’s effectiveness, and highlights the importance of coherence (Moorman and Miner, 1998; Teece et al., 1994) between the different constitutive elements of a capability. By coherence we mean an orderly and consistent relation between different components, similar to “synergy”. While Teece et al. (1994) suggest that “coherence is a measure of relatedness”, which is equivalent to the notion of fit; we suggest that it is subtly different. Fit suggests that two elements correspond to each other statically (Zajac et al., 2000) while coherence is a dynamic term. Coherence is similar to structural coupling. The more elements are structurally coupled to each other, the more the whole is coherent. Porter (1996) suggested that there are three types of coherence: (1) simple consistency between each activity and the overall strategy; (2) mutual reinforcement; and (3) optimization of effort across activities. Although these definitions are helpful, for our purposes we prefer to bring in two complementary types of coherence: (1) local or internal coherence; and (2) global or external coherence. We suggest that a capability’s effectiveness is determined by the synergistic interrelationships between its different components, local coherence, as well as by its interaction with other capabilities (Galunic and Rodan, 1998, p. 1200), global coherence. A high level of local coherence might indicate an increased capability’s local effectiveness and explain their uniqueness and their path dependence. For example, Helfat and Lieberman (2002, p. 741) suggest that Wal-Mart, when developing Walmart.com, had to install new “incentive and operating systems that were compatible with the internet operations, but were incompatible with Wal-Mart’s traditional brick-and-mortar retail business”. Woiceshyn and Daellenbach (2005) describe how increasing (decreasing) local coherence is akin to developing virtuous (vicious) circles where each component reinforces (weakens) the others leading to the emergence of a stable (unstable) configuration. Local coherence is highlighted by

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researchers such as Pitt and Clarke (1999) who talk about the importance of enabling “an appropriate fit of structures, processes and cultures” while Majumdar (2000) hints that a capability might crumble “under the weight of internal contradictions”. Hence, we suggest that: P4.

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A capability strengthens and persists as a result of interactions among its components. The higher the level of coherence among the components, the higher the capability effectiveness and the speeds with which it matures[3].

Aligning local and global objectives However, the pursuit of local coherence, pushed too far may lead a capability towards architecture of simplicity (Miller, 1993). This local imbalance could transform core capabilities into core rigidities (Leonard, 1998). For example Haas and Hansen (2005) found that a belief that high levels of knowledge acquisition enhanced performance led teams to become less performing the more they developed their knowledge acquisition capability. We suggest that capabilities can become rigidities if local coherence is pursued beyond a certain threshold that can be assessed. Moreover, problem identification is often based on individual initiative. Since individuals in an organization have different cognitions, context and motivations, their perceptions of possible problems can differ. For example, some individuals (e.g. sales or operations) might notice the failure of reaching sales objectives while others might not (e.g. marketing). Further, even if different individuals perceived the same problems, their solutions could be different, uncoordinated and hence end up not solving the problem or worse, exacerbating it. In a much cited example, Hau Lee tells the story of Volvo which had too many green cars: [. . .] marketing decided to discount them without telling the supply-chain folks. Over in Volvo’s supply-chain management system, demand for green cars suddenly took off, so the system quickly added more production to meet the new demand. This resulted in an even worse inventory problem (Greenbaum, 2003).

This supports the contention that capabilities can influence each other positively or negatively. Dutta et al. (1999) indicate that in high technology markets, R&D capabilities and marketing capabilities are synergistic, and Danneels (2002) showed that marketing and R&D work at cross purpose in shaping the evolution of a firm’s product development capability. Tripsas (1997) showed that while some capabilities might be essential for competitive advantage, their effectiveness is affected by other capabilities. We suggest that not only a capability’s elements need to be coherent (local coherence) but also a capability needs to be coherent with other capabilities (global coherence). Hence, while focusing on local coherence, by eliminating local problems, can increase a capability’s effectiveness it can also, if not balanced by global coherence, transform it into a rigidity. To avoid the traps that may be related to a focus on local doing and learning, it is important to complement local solutions with global ones. Hence, we suggest that balancing local and global coherence can increase a capability’s effectiveness: P5.

The relationship between a capability’s effectiveness and local coherence has an inverted U shape. Effectiveness increases with local coherence up to a threshold then decreases[4].

P6.

The threshold point at which the level of a capability local coherence leads to reduced effectiveness is affected by the level of global coherence[5].

Global coherence: pursuing global effectiveness Local coherence is essential for a capability’s emergence and development. However a capability’s effectiveness is also contingent on its relationship to a firm’s strategies (Barney, 1991; Selznick, 1957). As suggested above, capabilities and competitive advantage relationship is affected by the former’s contributions to a firm’s products and services in the market (Figure 4). Hobday et al. (2005, p. 1137) find that the “external environment has a strong shaping effect on the development of capabilities”. Most capabilities described in the literature have a component that provides a link with the environment such as “understanding the market” (Miller, 2003; Teece et al., 1997; Henderson, 1994), “monitor the environment” (Woiceshyn and Dallenbach, 2005; Spanos and Prastacos, 2004; Zahra and George, 2002; Grant, 1996; Mascarenhas et al., 1998; Day, 1994; Cohen and Levinthal, 1990), “customer intimacy” (Hobday et al., 2005; Kor and Mahoney, 2005; Knott, 2001; Prahalad and Ramaswamy, 1999; Capron and Mitchell, 1998; Mascarenhas et al., 1998; Tripsas, 1997; Iansiti and Clark, 1994), “supplier interaction” (McEvily and Marcus, 2005; Capron and Mitchell, 1998; Tripsas, 1997; Brown and Eisenhardt, 1998), and “external networks” (Smith et al., 2005; Baker et al., 2003; Orlikowski, 2002; Eisenhardt and Martin, 2000; Rindova and Khota, 2001; Lane and Lubatkin, 1998; Zander and Kogut, 1995). Global coherence arises as a firm’s capabilities, the potential value creation and capture activities that it engages in and the products and services it delivers to customers are all aligned. It is about shaping capabilities that contribute to deliver products and services for which customers are willing to pay a profitable price. Capabilities can contribute directly to a firm’s products or services such as product development capabilities or manufacturing capabilities, or indirectly such as R&D capabilities or customer support capabilities. Hence, the more capabilities are coherent with the external environment of the firm, the more they can contribute to a firm’s overall performance: P7.

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Increasing global coherence can increase a firm’s performance.

This external coherence can also be the trigger for a capability’s emergence. Many cases describe how firms identify a market opportunity and collaborate with early customers to create a new market by developing a suitable new product or service, and in so doing trigger the emergence of new capabilities. For example, Magnusson et al.

Figure 4. Capabilities and the link to competitive advantage

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(2005) describe how a power plant manufacturer starts by finding a “sympathetic customer” who will be offered incentives to compensate for its collaboration: P8.

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Pursuing global coherence triggers the emergence of new capabilities.

However, as described by Christensen (1997), the pursuit of external coherence can lead to an “Innovator’s dilemma”. Firms which focus exclusively on their customers’ needs and develop products and services to fulfill such needs, are rewarded as long as the current customers are representative of the needs of the larger market. However, environmental uncertainty, a result of disruptive technologies, and radical change, may lead markets to evolve in unexpected direction, thus investments could be lost and capabilities could become useless. Hence, we suggest: P9.

The relationship between a capability’s effectiveness and global coherence has an inverted U shape. Effectiveness increases with coherence up to a certain threshold then decreases.

P10. The threshold point at which a capability effectiveness starts decreasing is affected by environmental uncertainty. External and global coherence: the hierarchy of strategy The discussion above allowed us to identify several characteristics of organizational capabilities. The most important is that capabilities are geared towards local functional effectiveness. This highlights the difference between local (functional) performance and global (firm-level) performance. Hence while a capability can be effective, it does not necessarily contribute to competitive advantage; it might even have a negative impact on competitive advantage. This allows us to highlight two key concepts for managers pursuing competitive advantage: local coherence among an organizational capability components and global coherence among a firm’s capabilities. This suggests that the firm should be seen as a portfolio of capabilities which themselves are configuration of organizational components. Thus developing a competitive advantage is about managing an organizational capability local and global coherence. Capabilities as ingredients of competitive advantage require managers at all levels to be involved in shaping and developing them. Based on the above analysis, managers’ role cannot be limited to identifying the appropriate capabilities from a pre-existing set but should also cover nurturing, shaping, and possibly dissolving capabilities. We suggest that the roles of managers in capability development are multifaceted, depending on where they are in a structure. At the local level, managers’ role is to increase the effectiveness of current capabilities without falling into a competency trap where the capabilities become irrelevant or detrimental to the organization as a whole. Moreover managers at this level need to shape the meaning of local problems to help their teams make sense of the diversity and flow of events at the local level ensuring a minimum level of coherence. Sense-making activities cannot be only directed to building coherence around existing capabilities (e.g. customer service responding to customer complaints or questions) but also to sense the possible need for new capabilities emergence (e.g. the local Ritz Hotel does not wait for customers to call, rather it calls its customer to ensure satisfaction). This is a key role for managers at this level since their teams might be too focused on operational routines to perceive the need for new capabilities.

Middle managers’ role, linking senior and local managers, is to support local managers in their attempts not to fall into competency traps by ensuring the coherence among different functional capabilities or encouraging the development of cross-functional ones. For example, perceiving the inconsistency at HP between manufacturing and marketing, a middle manager’s role is to bridge the two “departmental thought worlds” (Dougherty, 1992) by helping them into a new understanding of problem identification and problem solving where a whole set of capabilities may be involved. Finally, we suggest that senior managers’ role is to engage in an innovative management of global coherence. Global coherence is based on perceiving problems at the firm level (e.g. new market opportunities, competitors’ strategy) and set appropriate objectives to stimulate the emergence of new capabilities (if needed) or the development and evolution of existing ones. Global coherence can be managed through setting and establishing a clear vision (Collins and Porras, 1997), which becomes a referential for all capabilities to contribute to. This passive element does not preclude senior managers from managing the firm’s portfolio of capabilities (Eisenhardt and Galunic, 2001). This involves developing new capabilities, modifying existing ones and dissolving others. Conclusion and implications The propositions that we have suggested in this article indicate some avenues of answers to the questions asked in the introduction. We suggested that capabilities are conceptual heuristics that allow managers to make sense of their organizations. A capability is a phenomena emerging from the interactions of different organizational elements such as structure, systems and values. They emerge through the activities – physical and cognitive – of individuals interacting with each other within a context. Hence, a capability is at the same time a collection of activities and a body of knowledge. Capabilities do not have a knowledge component and an activities component soldered together, but from a capability perspective knowledge is activities and activities are knowledge, as if they were fractal components of each other. We could also conceptualize a capability as a potential (knowledge) exercised through action. Individuals, trying to make sense of their world and acting within a specific context inside organizations, are the source of capabilities. Individuals able to make sense of their context (Bower, 1972) keep on perpetuating it and contribute, consciously or not, to the resilience of existing capabilities. In contrast, we expect individuals who have difficulties making sense of their context to tinker with it while solving the “problems” that they perceive. In so doing, they contribute to changing the existing capabilities or to developing new ones. In essence, capabilities emerge from the marshalling of knowledge and other resources within a specific context by boundedly-rational individuals acting to solve perceived problems. Hence, individuals are themselves components and drivers of capabilities. Capabilities, most often, deal with local issues and add value at a local level. This highlights the importance of framing when discussing capabilities since local is relative. Looking at the literature, we can see that some capabilities are very detailed such as “franchising” (Knott, 2001) while others are rather fuzzy such as “innovative capability” (Cohen and Levinthal, 1990). Where framing helps is by suggesting that

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however a capability is defined, there is always something beyond it with which it needs to interact. The point is that managers focusing on making a single capability effective are not necessarily contributing to their firm’s competitive advantage. A firm is a portfolio of capabilities that needs to be optimized both at the local level (functional) and at the global level (portfolio). This perspective echoes the traditional organization theory dilemma between differentiation and integration of work (Dougherty, 2001) as first highlighted by Lawrence and Lorsch (1967). Moreover, this local/global dynamics applied at the capability level can be used in a spatial dimension (two different capabilities can negatively/positively influence each other) or even in a time dimension where the development of one capability at a specific time will set the organization down one path enabling it or preventing it from developing another capability in the future. As described by Tripsas (1997), the success of the Fotosetter delayed the firm investments in capabilities in electronics and caused it to miss the new market. The implications of this work, as we foresee them now, can be numerous. From an academic perspective, the propositions offered in this work can be the basis of a more thorough theory development. This is now being undertaken by the authors. Through an interview, and case-based constructivist research (Mir and Watson, 2000), the development of what is now seen as a key capability, Pricing, is studied in detail in five companies of different industries. Such a work will help confirm the capability definitions proposed earlier, delineate the specific steps involved in capability development, and the conditions under which a capability can be more or less effective. From a practice perspective, opening up the capability black-box might help manager better grasp how to develop and shape organizational capabilities that are deemed contributing to competitive advantage (e.g. the pricing capability). First, capabilities are not to be equated with competitive advantage. They may lead to a competitive advantage only where the context is favorable. Thus consistency with the environment challenges is an important factor to watch. This suggests that managers should give attention to the relationships between what they perceive their capabilities and the nature of the challenges faced by the organization to be. Further this research might promote the development of tools to measure coherence within a context and manage appropriate levels of dissent to trigger the re-shaping of existing capabilities or the emergence of new one. Measurement of coherence is still to be developed in our coming research. However, for example, to avoid falling into local competency traps, managers could encourage a minimal level of inconsistencies among a capability’s components or with its relationship with other capabilities. This should increase its effectiveness and prevent it from becoming rigid. Specifically, they could pursue moderately conflicting objectives (e.g. increase revenues and margins) or deviate from accepted practices in activities that are not central to the actual competitive position. Another implication is that capability effectiveness could and should be monitored. It is affected by coherence among capability components, coherence among organizational capabilities, and coherence with overall vision and environmental position. The balance among these is the source of a capability effectiveness and ultimately of the firm’s competitive advantage. Finally, capabilities bridge levels within and with the environment. They can thus be seen as a tool to evaluate and build consistency and competitive advantage within an organization faced with competition.

Notes 1. In our research interviews on the pricing capability, we intend to identify the triggers that led to the emergence of the pricing capabilities and how it has evolved: the events/practices that shaped it. 2. Equifinality suggests that a system’s state can be reached from different initial states and in different ways. 3. In our research interviews, we look for events/practices that impeded the pricing capability, slowed its development or limited its effectiveness. 4. In our research interviews we look for evidence of how other capabilities such as sub components of pricing, marketing and manufacturing affect positively or negatively the pricing capability. 5. The differences among companies in different global coherence situations will help assess the link between threshold and global coherence.

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Further reading Dosi, G., Nelson, R. and Winter, S. (2002), “Introduction: the nature and dynamics of organizational capabilities”, in Dosi, G., Nelson, R. and Winter, S. (Eds), The Nature and Dynamics of Organizational Capabilities, Oxford University Press, Oxford. Dutta, S., Bergen, M., Levy, D., Ritson, M. and Zbaracki, M. (2002), “Pricing as a strategic capability”, MIT Sloan Management Review, Vol. 43 No. 3, pp. 61-6. Hamel, G. and Prahalad, C.K. (1994), Competing for the Future, Harvard Business School Press, Boston, MA. Johnson, G., Melin, L. and Whittington, R. (2003), “Micro strategy and strategizing: towards an activity-based view”, Journal of Management Studies, Vol. 40 No. 1, pp. 3-21. Mintzberg, H. (1979), The Structuring of Organizations, Prentice-Hall, Englewood Cliffs, NJ. Reed, R. and DeFillippi, R. (1990), “Causal ambiguity, barriers to imitation, and sustainable competitive advantage”, The Academy of Management Review, Vol. 15 No. 1, pp. 88-102. Tripsas, M. and Gavetti, G. (2000), “Capabilities, cognition, and inertia: evidence from digital imaging”, Strategic Management Journal, Vol. 21 Nos 10/11, pp. 1147-61. Wernerfelt, B. (1984), “A resource-based view of the firm”, Strategic Management Journal, Vol. 5 No. 2, pp. 171-80. Zollo, M. and Winter, S. (2002), “Deliberate learning and the evolution of dynamic capabilities”, Organization Science, Vol. 13 No. 3, pp. 339-51. Corresponding author Taı¨eb Hafsi can be contacted at: [email protected]

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MD 45,3

Resource margin accounting: an elucidation and preliminary empirical testing

420

Peter Johnson Said Business School, Exeter College, Oxford, UK, and

Howard Thomas Warwick Business School, Coventry, UK Abstract Purpose – The aim of this paper is to describe “resource margin accounting” (RMA) as a valuation framework in strategic analysis. Design/methodology/approach – The paper defines RMA as an improved framework for valuation in competitive strategy, relative to existing value-added and cash flow methods. The framework was tested on a sample of 300 US manufacturing companies between 1983 and 1998. Findings – The paper finds that the resource margin approach has greater explanatory power than traditional market-to-book valuation measures. Practical implications – The resource margin approach is methodologically and empirically superior to economic value-added (EVA) and cash flow models of valuation. Originality/value – The paper presents and tests a new valuation method: RMA. Keywords Cash flow, Economic value added, Resource management, Accounting, Strategic audit Paper type Research paper

1. Introduction The objective of the research presented in this paper is to introduce a robust performance measure that: . underpins a valuation model of companies and strategies which overcomes some of the deficiencies of current methods (discounted cash flow (DCF) and economic value added (EVA)); . has a sound theoretical foundation and sheds light on the debate between portfolio- and resource-based accounts of strategy; and . is validated by empirical investigation. The origins of this work lie in the consensus shared by senior managers, consultants and financial officers that existing cash-flow valuation methods are flawed and open to manipulation[1]. Such a theory would be of significant practical value to strategists, economists, and bankers. Management Decision Vol. 45 No. 3, 2007 pp. 420-433 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745052

The first author is grateful to Professors Colin Mayer, Kenneth Peasnell and John O’Hanlon for their support and guidance in carrying out this research, and to the Said Business School and the Rector and Fellows of Exeter College for funding it. He is also very appreciative of the hard work put in by his research assistants Neil Marson and Jane Tucker of Balliol College.

In Section 2, the conceptual approach that underlies resource margin accounting (RMA) is outlined and the paper develops certain resource margin performance measures and relates them to strategy and industrial economics. The relative merits of RMA in comparison with EVA are discussed in Section 3. In Section 4, the construction of the data set of US companies is described. The next section of the paper examines the links between resource margin performance and traditional measures of value using ordinary least squares (OLS) techniques. The paper concludes with a summary and a description of the further issues to be researched. 2. Resource margins Value-added, often called net output by economists, is an important factor in the determination of competitive success. Normally, value-added is taken to be defined as firm revenues minus the cost of raw materials and purchases[2]. The structure of an industry and how it evolves can be well captured by the analysis of the distribution of value-added between different industry participants and how this distribution shifts over time. Similarly, within what what academics call mobility groups, or strategy consultants call a strategic segment of an industry (see Grant, 1992), much competitor activity can be considered to be a struggle to control and safeguard profitable value-added through strategies based on relative cost position, superior price realisation through differentiation, or through technological advantage[3]. Within the firm, value-added corresponds to the competitively distinct resource base which managers control and which they use to implement strategies – it is the platform in which reside core competences[4]. Unfortunately, since the term “value-added” is much used, and gives rise to confusion between the value added to the net worth of a company beyond the contribution of rents towards the economic cost of book capital, and value-added as understood by tax authorities and economists, we will prefer to use the term resources rather than value-added to describe this notion. If the objective of strategy is to increase the value of the firm, then two key imperatives for competitive success are to grow the resources of the firm, and to achieve a satisfactory level of return (economic rent) on those resources. Let us represent the growth of resources of a firm by gR, and the return on resources by RM where: Resource margin ¼ RM ¼

Economic Profit : Economic Resources Consumed

The fundamental assertion made in this paper is that economic performance, measured in terms of the economic profit derived from the consumption of economic resources, drives valuation. As a consequence, strategists should pay particular attention to resource margins, as opposed to any other performance measure in the articulation of strategies. Many studies in industrial organisation (IO) have examined the relationship between profitability and resources in different structural contexts (for example, Fairburn and Geroski, 1993). These studies have shown that significant linkages exist between profitability, resources and industry structure. A measure often chosen for this research is the price-cost-margin or PCM, which is defined as: Net output 2 employee compensation : Net output

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If employee compensation represents a large majority of resource costs, then the numerator in the above expression will be approximately equal to profit and: RM < PCM:

422

Table I.

In other words, IO research, such the structure-conduct-performance model elucidated by Bain (1959) and others has revealed the relevance of resource margins to performance at the level of industries. The RM valuation framework proposed extends this IO approach (which relates structure to levels of performance) to individual companies and their competitive context. By focussing on growth and profitability in relation to resources, the RM framework can accommodate two approaches to business strategy which, while complementary, are often considered to represent opposing views: portfolio-based strategy, popularised by General Electric, McKinsey, the Boston Consulting Group and Porter; and the resource-based view of the firm as developed by Prahalad and Hamel (1990) and others. The performance of a firm depends both on the structural context in which it and its competitors find themselves, and on the individual firm’s ability to establish a competitive advantage relative to its competitors in that context. The context will determine the magnitude of resources over which firms compete, and the growth of those resources. Competitive advantage, on the other hand, will determine the profitability of resources for the individual firm relative to its competitors. In other words, the overall amount of economic rent achieved by a firm will depend on the attractiveness of the segments it operates in (the portfolio-based view), reflected in the growth available in resources, gR, as well as how well it uses its resources relative to competitors (the resource-based view), which is captured by RM. The resource margins approach integrates these two prevailing perspectives on strategy. RM also allows interesting and meaningful performance comparisons between businesses which have markedly different capital requirements or operating structures: contrast, for example, a hotel business, a contract catering business and a restaurant business (see Table I). Traditional measures of performance such as return on capital employed or return on sales (ROS) do not produce meaningful comparisons between each of these businesses. Even successful hotel businesses in spite of high returns on sales show low returns on capital because capital growth through property appreciation is not usually included in profits; restaurants, by contrast, are well captured by return on assets (ROA) and ROS measures, generating income on moderate levels of assets recorded as returns on capital or sales; contract catering, at the other end of the spectrum has paper-thin sales margins, but excellent cash characteristics often resulting in negative working capital. The use of resource margins can allow meaningful comparisons to be made within a common framework between these very different businesses for the purposes of resource allocation[5].

Hotels Restaurants Contract catering

Capital employed

Return on sales

Return on capital

RM

High Moderate Negative

High Moderate Very small

Low Good Nonsensical

Satisfactory Satisfactory Satisfactory

One may inquire as to the nature of the linkages between resource margins and investor rates of return. Consider the investment returns for a new equity funded business on a one-year basis. Imagine that investors provide funding sufficient to cover the cost of the business’ net output for one year. This means that the business can cover all its value-adding activities, but raw material and bought-in purchase costs are billed direct to the customer. If the business operates competitively, the return it achieves on the economic resources it consumes will be just sufficient to reward investors for the risk they have borne. This may be stated mathematically as: RM ¼ r i.e. the resource margin equals the required rate of return of investors. This normative result is a general prerequisite for financial and physical markets to be in equilibrium i.e. Tobin’s Q ¼ 1. More generally (Johnson, 2000a): Q¼1þ

1 r 2 gR X g 2t ðRMt 2 r Þ: r t¼1

In the case of gR ¼ 0, this simplifies to: Q¼1þ

1 X

R 2t ðRMt 2 r Þ

t¼1

where R is 1 plus the cost of capital r and whereg 2t ¼ ð1 þ g R Þt21 =R t . This equation states that for the idealised firm, the ratio of the market to book value of the firm is given by one plus the sum of the discounted marginal revenue products of the firm i.e. Tobin’s Q. If the resource margin generated equals the rate of return required by investors, then Q will equal one. The magnitude of Q is determined by RMt 2 r and gR making explicit the importance of excess resource margins and the growth in resources in the creation of shareholder wealth through competitive advantage. Those strategists familiar with more recent practitioner developments of the concept of EVA, may inquire how RM relates to EVA and whether it offers any advantages as a valuation concept. The next section looks at these issues in some detail, but may be summarised: . RM is entirely consistent with EVA; . RM avoids elements of accounting conventionalism which are problematic for EVA; and . RM does not conflate questions of economic efficiency with questions of the operational funding of the business cycle. 3. Advantages of RM relative to EVA While the resource-oriented nature of RM may meet with approval, it will perhaps be objected that we have failed to take account of the need to provide adequate returns to capital. This is traditionally done by deducting a charge for book capital from earnings to yield residual earnings, more popularly known as EVA: xat ¼ xt 2 ð R 2 1Þyt21

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where xat are residual earnings in period t, xt are earnings in period t, R is 1 plus the cost of capital r, and yt21 is the closing book value of the previous period. It can then be shown (Peasnell, 1982) that: P t ¼ yt þ

1 X

Et




  xtþt 2 ð R 2 1Þytþt21 R 2t

t¼1

424 and:

P t ¼ yt þ

1 X

  E t xatþt R 2t

t¼1

where Pt is the market value of a company at time t. E t ½A
represents the expected value at time t of variable A. (In general going forward Et[ ]will not be specified for the sake of clarity, unless expressly required). This expression states that the value of the company is equal to its book value plus the sum of discounted future residual earnings. The second sum on the right-hand side may also be considered to be unrecorded goodwill. What sits awkwardly in this equation is the book value of the company, which is determined by the conventions of accounting. The other terms appear to of convention. We shall return to consider this point further. Use of residual RM returns is not inconsistent with the fundamental notions that support EVA, and it may be shown that if the Peasnell equation is modified to accommodate RM measures of profitability, we obtain: P t ¼ y tþ1

1 X


 r y tþ1 gB g 2t RMtþt 2 r 2 yt r 2 gR r 2 gB t¼1

where RMtþt and y tþt are respectively the resource margin and the level of resources in period t þ t, and gB is the growth in book value yt (which reflects the historic funding of the firm, not the replacement cost of resources contracted by the firm). This equation is similar to the equation derived for the value of a firm which does not require subsequent injections of capital, and where assets are efficiently priced, together with an extra term which represents the capitalised stream of additional investment absorbed by the business to fund assets and working capital represented by yt. Hence: Value ¼ abnormal returns on resources þ normal returns on resources – additional capital to support application of resources: Note, in particular, that if there is no growth in book value, the value of the firm is independent of the value of starting capital yt depending only upon the pattern of resources consumed and the normal and abnormal returns on those resources. The associated Q ratio is given by: ! 1 r2g X gB 0 2t g ðRMt 2 r Þ 2 a Q ¼1þ r r 2 gB t¼1 where a is the ratio of book value yt to initial resources y tþ1 .

This equation highlights a difficulty with the EVA approach: EVA conflates questions of economic efficiency with questions of operational funding. Criticism along these lines has been voiced by Kwong et al. (1994). The capital yt is required to fund working capital and assets because of the operating cycle of the business. This need for capital has nothing to do with the efficiency of the use of resources by the firm in competitive markets[6]. To see that this is so, consider the case of a business which is newly established, where invoices are settled instantaneously, where all equipment is efficiently rented at a cost equal to the economic rate of depreciation of the assets involved, and where all profits are immediately paid over to the owners. In these circumstances, the question of the economic use of resources by the business still arises, but the book value of the company will be zero. EVA and residual earnings, in the case of this very fast turning business, are equal to earnings, but it is not possible to assess in the EVA framework whether the use of resources by this business amounts to an opportunity (utility) gain or loss. This is not the case with RM. A similar situation arises if we contemplate an extremely lengthy accounting period for a business (say 20 years) where what are customarily the capitalised unexpired costs of capital assets are treated as period expenses. Again, starting and ending book values would be zero. Consideration of these two extreme cases shows that EVA assessments of performance would appear to be subject to accounting conventions with regard to periods, and strongly influenced by the operating cycles of the business. As an alternative, we may separate conceptually the operational funding of a business from the contribution to the value of the firm that arises from the efficient or inefficient use of resources. This separation is similar to the separation of tax and financing effects from an all-equity valuation that arises in adjusted present value approaches to discounted cash flow (Brearley and Myers, 1981; Luehrman, 1997). Let us set aside the question of the funding of the operational cycle of the business: any capital which exists and is recorded on the balance sheet should be regarded, under this approach, as equivalent to cash or marketable investments, which do not feature in the valuation of the business as a going economic concern[7]. In other words, we may consider the value of the firm to be comprised of two elements: an investment component and an enterprise component. The investment component not only includes cash and marketable securities, but also working capital viewed as a largely involuntary or passive investment in the company reflecting its operating cycle. This component would also include any holding gain expected to arise from the retention of physical assets in excess of the purchase price of the asset. A risk-adjusted rate of return would be required on the investment component. The enterprise component of valuation would be determined by the level and development of resources and the margin generated on those resources, and would be independent of the book values of physical assets employed, once account had been taken of any expected holding gains. The value of the physical assets deployed would be entirely captured in the future economic rents in the business and no charge for recorded book capital would be made in the evaluation of the enterprise component. Note that in drawing a distinction between investment and enterprise components of value, the intention is not to diminish the practical importance of tight control of

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inventories and working capital, but to focus upon the microeconomic linkages that support the RM performance measures that have been introduced. By exclusively focussing on flows, resource margins thus avoid many of the complications introduced by incorporating a required return on book capital in the determination of excess returns. If a separation is also made between investment and enterprise components of value, resource margins also capture more convincingly the economic as opposed to the funding performance of the business. There will remain questions as to how to calculate economic depreciation in the assessment of resource margins, but these are also implicit in the EVA approach given the need to adjust abnormal returns for period changes in goodwill. By setting aside book values, resource margins avoid the conventionality issues of historic accounting procedures and allow us to focus on the economic determinants of value within a framework that is entirely consistent with microeconomics and competitive strategy. 4. Empirical validation for RM A preliminary investigation into the empirical validity of RM has been undertaken looking at available information on publicly quoted US manufacturing companies over a 20-year period and at the determinants of value. This data set was selected since it represented the largest available sample of consistent company information. 4.1. Data on resource margins The primary source of corporate data was Compustat Research Insight, among the most comprehensive databases available for the USA. This particular database was chosen because it was held to contain salary and payroll information, which would provide the means to calculate resource margins for a large number of companies, (initially expected to be several thousand), over many years (initially expected to be 20 years). In the event, it turned out that this information was only available for a very small number of companies over the expected time period, which was chosen to provide a suitable base for time-series methods. The first step was to define clean surplus and resource margin in terms of the elements of the database. Three definitions of resource margin were employed as a result of the emergent paucity of data. All three definitions shared a common numerator: clean surplus, but each employed a slightly different estimate of resources. The first added to the difference between sales and the cost-of-goods-sold a salary element which represented the proportionate allocation of known labour and related costs to the share of the cost structure represented by cost-of-goods-sold as opposed to total cost. The second definition adopted the definition often taken by economists: resources equal labour plus economic profit, which was estimated by clean surplus plus labour and related costs. The third definition extracted raw materials as a percentage of overall sales. None of these measures are entirely satisfactory, but the choice of definition was strongly influenced by considerations of tractability. In terms of the Compustat codes, these variables are defined as shown in Table II. Screens were constructed in order to identify for which companies 20 years of data were available for the different resource margin definitions. The relevant companies were then selected and data were compiled. At the same time excess resource margins were calculated using carefully matched beta and risk-free values, adjusting for the timing of fiscal year-ends. Five-year Treasury notes were used to determine the

Resource margin accounting

Concept

Monic

Formula

Clean surplus Resources no. 1 Resources no. 2 Resources no. 3 Resource margin no. 1 Resource margin no. 2 Resource margin no. 3 Excess RM no. 1 Excess RM no. 2 Excess RM no. 3 Residual income Residual return on equity

CX VA1 VA2 VA3 RM1 RM2 RM3 XSRM1 XSRM2 XSRM3 RI RESROE

ðCEQ 2 CEQ½21
Þ þ DV 2 SSTK þ PRSTKC SALE 2 COGS þ ½ðXLR*COGSÞ=ðSALE 2 OIADPÞ
CX þ XLR SALE 2 ðPRAWM*SALEÞ CX/VA1 CX/VA2 CX/VA3 RM1 2 ½GOVNOTES þ CALCBETA*0:09
RM2 2 ½GOVNOTES þ CALCBETA*0:09
RM3 2 ½GOVNOTES þ CALCBETA*0:09
Net income/book value Residual income/book value

427

Table II. Definitions

risk-free rate, but the results are not significantly sensitive to this assumption (as opposed to Treasury bills, for example). The use of clean surpluses over the 20-year period also had the effect of reducing the number of years of available data to 19 given the way the surplus is calculated. Average resource margins and growth in resources were also calculated on a five-year basis where possible. For a consistent data set averaging reduced the time series to 15 years in length. The data sets produced for the data screens were inadequate for all resource margin definitions except the third, which did not rely on Compustat for its primary data. The original definitions or resource margin only produced complete data for 23 companies from the universe of some 9,000 companies, increasing to 30 when all inactive companies were added. The subsequent analysis derives almost entirely from the third definition of resource margin, which relies on the extraction of raw materials from output using manufacturing census data (see Table III). In the rest of the paper, where we speak of the values of resource margins in an empirical context, we will mean resource margins computed according to this third definition. Included in this sample are a small number of companies with unusual resource margins that arise because of bookkeeping anomalies. These companies were eventually excluded from the analysis. The eventual series of excess resource margins extracted were predominantly negative. Substituting Treasury bill rates for note rates had little impact, giving 55 Data item/concept Clean surplus Resource margin 1 Resource margin 2 Excess resource margin 1 Excess resource margin 2 Raw materials percentage of sales Resource margin 3 Excess resource margin 3

Number of companies for which it is available 525 43 44 23 23 789 321 266

Table III. Data availability

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Table IV. Descriptive statistics for value relevant factors

companies out of 266 instead of 44 whose resource margins over 19 years summed to a positive value. It may simply be the case that these sectors of manufacturing were not producing sufficient returns for investors over this period. 4.2. NBER/Census Bureau Productivity Database This database is available on the National Bureau of Economic Research web site and gathers together data on 450 companies from 1958 to 1994, gathered from the Census Bureau’s Annual Survey of Manufacturers (ASM). This database provides, time series for raw materials expenditure and value of shipments, by four-digit SIC code, for manufacturing companies. (Codes 2011 to 2999). Materials cost was divided by value of shipments to get the percentage spent on raw materials for different SIC codes. The data were transposed to get horizontal time series and the years up to and including 1978 were removed. Values for the years from 1995 to 1998 inclusive were calculated using a five-year moving average. This gave the required timeframe for a 20-year series of raw material ratios by SIC code that matches up with Compustat company information. This series was imported into the Research Insight database, allowing the appropriate raw material ratio to be allocated to individual companies depending on their predominant SIC coding. This in turn allowed resource margins and excess margins to be calculated for these companies. These resource margin data, together with averages, excess margin data, and data on the

5 year average RM 5 year growth in resources M/B M/resources RM XSRM RI/B NI/B

No.

Range

Minimum

Maximum

Mean

Std dev.

3,945 3,945 3,945 3,945 3,945 3,945 3,945 3,945

40.85 366.83 865.93 23,943.5 116.14 116.03 180.97 155.40

2 39.62 2 42.15 2 37.41 0.000 2 108.75 2 108.81 2 89.22 2 55.22

1.23 324.69 828.53 23943.50 7.39 7.22 91.75 100.18

0.0362 8.3076 2.4315 15.5546 0.0454 20.0995 20.4164 0.1065

1.2647 14.5373 13.3451 509.140 1.8610 1.8595 4.2825 1.9056

Notes: RM, M, B, XSRM, RI and NI denote resource margin, market value, book value, excess resource margins, residual income after deducting a rent for book capital and net income respectively

Data item

Table V. Filtering criteria

Market value ($ m) Book value ($ m) Resources (value added) ($ m) Market value/resources Market value/book value Resource margins Average resource margins Excess resource margins Return on equity (NI/B) Residual return on equity (RI/B)

Criteria required to pass .10 .10 .2 0:1 , M=resources , 30 0:1 , M=B , 30 22 , RM , 2 22 , 5 year average RM , 2 22 , XSRM , 2 22 , ROE , 2 22 , ResROE , 2

growth of resources were then extracted for analysis in SPSS in order to carry out time-series modelling and regression analysis. 5. Testing the linkages between resource margins and value OLS regressions were used to investigate the linkages between market value variables and measures of resource margin and growth. Table IV records the descriptive statistics of the variables investigated.

5 year average RM 5 year growth in resources M/B M/resources RM XSRM RI/B NI/B

No

Range

Minimum

Maximum

Mean

Std dev.

3,357 3 3 3 3 3 3 3

2.24 352.37 20.27 28.31 2.71 2.79 3.57 3.19

2 1.01 2 27.69 0.35 0.12 2 1.10 2 1.24 2 1.96 2 1.55

1.23 324.69 20.62 28.43 1.61 1.55 1.61 1.65

0.1086 8.8133 2.2945 2.0768 0.1119 2 0.0385 2 0.0308 0.1189

0.1108 11.2002 1.7715 1.9141 0.1411 0.1495 0.2381 0.1387

Dependent/independent variables M/B vs RM M/B vs XSRM M/B vs 5 year average RM M/B vs 5 year growth M/B vs ROE M/B vs residual ROE M/ resources vs RM M/resources vs XSRM M/resources vs 5 year average RM M/resources vs 5 year growth M/resources vs ROE M/resources vs residual ROE

Model 1

F statistic

0.110 0.092 0.108 0.028 0.288 0.155 0.295 0.219 0.300 0.020 0.080 0.058

413.832 343.063 409.181 98.934 1,356.564 614.894 1,404.699 944.360 1,440.857 67.991 294.304 208.498

20.343 18.522 20.228 9.947 36.832 24.797 37.479 30.730 37.959 8.246 17.155 14.439

0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000

4.160 3.609 5.274 0.0267 6.854 2.928 7.370 6.001 9.473 0.0240 3.920 1.945

0.572 0.542 0.509 0.469 0.814 0.536 0.811 0.677 0.690 0.475 0.509 0.457

R square

Adjusted R square

Std error of the estimate

Durbin-Watson

0.614

0.377

0.376

1.5119

0.797

Regression Residual Total

429

Table VI. Descriptive statistics for value relevant factors (filtered data)

Durbin T statistic Significance Coefficient Watson

R

Model 1

Adj. R squared

Resource margin accounting

Sum of squares

df

Mean square

F

Sig.

4,639.099 7,657.111 12,296.211

6 3,350 3,356

773.183 2.286

338.269

0.000

Table VII. Regressions of value – relevant factors (filtered data)

Table VIII. Regression of value relevant factors against M/R (filtered data) – model summary

Table IX. Regression of value relevant factors against M/R (filtered data) – ANOVA results

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Because the variables contain a number of outliers, likely to affect the results of the regressions adversely, the sample was filtered in order to ensure that all variables lay within reasonable bounds. The criteria shown in Table V were used. The new statistics are shown in Table VI. As a first step, market to book and market to resources ratios were regressed against individual regressors to determine their value relevance. Growth refers to growth in resources. The results are shown in Table VII. If the normative assumptions that underpin OLS regression hold good, the analysis shows that resource margin, and resource growth are value-relevant factors not only for market to resource ratios, but also for market to book ratios. In fact the explanatory

Model 1 Table X. Regression of value relevant factors against M/R (filtered data) – coefficients of stepwise regression

Table XI. Regression of value relevant factors against M/B (filtered data) – model summary

Table XII. Regression of value relevant factors against M/B (filtered data) – ANOVA results

Model 1

(Constant) RM XSRM Average RM 5 year growth ROE RESROE

1

Standardised coefficients

t

Sig.

0.971 5.300 2 0.165 5.927 0.007 2 1.611 0.341

0.070 0.458 0.385 0.299 0.002 0.285 0.147

0.391 2 0.013 0.343 0.043 2 0.117 0.042

13.830 11.561 2 0.430 19.825 3.047 2 5.652 2.316

0.000 0.000 0.667 0.000 0.002 0.000 0.021

R square

Adjusted R square

Std error of the estimate

Durbin-Watson

0.567

0.321

0.320

1.4605

0.796

Regression Residual Total

Model Table XIII. Regression of value relevant factors against M/B (filtered data) – coefficients of stepwise regression

Std error

R

Model 1

Unstandardised coefficients

(Constant) RM XSRM Average RM 5 year growth ROE RESROE

Sum of squares

df

Mean square

F

Sig.

3,385.728 7,146.020 10,531.748

6 3,350 3,356

564.288 2.133

264.534

0.000

Unstandardised coefficients

Std error

Standardised coefficients

t

Sig.

1.358 2 2.121 0.489 3.128 0.013 6.302 0.407

0.068 0.443 0.372 0.289 0.002 0.275 0.142

2 0.169 0.041 0.196 0.084 0.493 0.055

20.012 24.789 1.316 10.832 5.712 22.889 2.865

0.000 0.000 0.188 0.000 0.000 0.000 0.004

power, measured by R-squared is better for the model comprising market to resource ratio; resource margin, than for the traditional model – market to book ratio; return on equity (ROE). We call these two models the M/R and the M/B models. It is noteworthy that resource margins are more relevant to the M/B model than ROE is to the M/R model. The t statistics are of limited significance because of large sample effects. The Durbin-Watson statistics also indicate a high level of auto-correlation in the data sample. Stepwise multivariate regressions were then undertaken first for the market value to resource ratio model, then the traditional market to book value model. The results for the resource margin model were of considerable significance as shown in Tables VIII-X. These results show that the resource margin model has high explanatory power if we assume that the conditions for reliable OLS regressions obtain. The t statistics are less significant than might first appear because of problems of large numbers and auto-correlation. Average and current resource margins have good explanatory power, whereas residual resource margins add little extra information. Surprisingly growth of resources is a less valuable regressor: in spite of some significance as measured by the t statistic, the coefficient is relatively small. ROE and residual equity returns have a small influence on the regression results for market to resource ratios. The negative coefficient for equity returns suggests it operates as a corrective factor to the basic resource margin model. By way of comparison, results were determined for the traditional market to book ratio model as shown in Tables XI-XIII. First, using OLS, the market value to resource model has greater explanatory power then the traditional market to book value model for this set of companies: the difference in adjusted R-squared (0.376 versus 0.321) is significant. Average resource margins contribute to the explanatory power of the traditional model, while current resource margins introduce a corrective element to the model. As a minimum this suggests including resource margins in standard M/B models. In spite of the limitations of OLS, the regressions lend general support to the resource margin approach, and suggest superiority to the traditional market to book model. Further analysis involving alternative samples and longer time periods is warranted. Further GLS research may also reveal the strength of the regression assumptions. It also remains to ask whether the models can be improved by introducing company- and year-specific effects in fixed effect and variable slope models. These aspects are covered in Johnson (2000b). 6. Conclusions In this paper a conceptual framework has been developed to substantiate the value-relevance of resource margins. It has been shown that resource margins have a good pedigree arising from research in industrial organisation, that they can be embedded in traditional microeconomic, accounting and finance frameworks, and are consistent with, but avoid some of the drawbacks of EVA. The combination of Compustat and US Census data has allowed the creation of a good data set of 266 US manufacturing companies for which resource margins may be determined over a 15-year period. OLS regressions on this data set, supported strongly the general linkages between resource margins and market values, and the M/R model compares favourably with M/B alternatives.

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Notes 1. For an optimistic modern account of cash-flow methods see Copeland et al. (1995). 2. Clearly there are questions of the value-added boundary of a firm. For instance, should factory electricity costs be included in value-added? The authors believe these questions might settled based on considerations of “returnability”. Where input factors might immediately be returned without price erosion, the factors may be held to be a purchase. Those inputs which are not returnable, or which suffer price erosion when returned, entail a degree of specificity to the firm in question which warrants their inclusion in the value-added structure. For example, under normal circumstances, imported factory electricity cannot normally be re-exported and hence would be included in value-added. 3. For instance see Porter (1980, 1985). 4. This is a simplification insofar as we overlook the need to achieve a competitive level of raw material and purchase prices through effective purchasing. 5. EVA fares no better, because: the hotel business is in fact a combination of an investment business and an accommodation renting business, (the former warrants a capital charge derived from the market value of the hotel property, whereas the latter does not); and the capital employed in contract catering is often negative because payables exceed the combined value of debtors, stocks and fixed assets. As we shall see later, separation of the operational and funding aspects of a business, allows us to develop a comparative measure which reflects the efficiency with which businesses use resources, capturing in a much sounder way the opportunity costs associated with the consumption of resources by particular businesses. 6. A specific difficulty for EVA as traditionally formulated, is that a capital charge is made against fixed operating capital and inventories, with no account taken of the other elements of working capital. 7. Assets other than cash should be valued by discounting their associated flows at a risk-adjusted rate r. If the rate of depreciation is equal to the economic rate of depreciation no bargain or loss will occur in relation to book asset values. References Bain, J.S. (1959), Industrial Organisation, John Wiley, New York, NY. Brearley, R. and Myers, S. (1981), Principles of Corporate Finance, McGraw-Hill, New York, NY. Copeland, T., Koller, T. and Murrin, J. (1995), Valuation: Measuring and Managing the Value of Companies, John Wiley, New York, NY. Fairburn, J. and Geroski, P. (1993), “The empirical analysis of market structure and performance”, in Kay, J. and Bishop, M. (Eds), European Mergers and Merger Policy, OUP, Oxford. Grant, R.M. (1992), Contemporary Strategy Analysis: Concepts, Techniques, Applications, Blackwell, Oxford. Johnson, P. (2000a), “Resource margin accounting: a theoretical perspective”, 2001-FE-16, working paper, Oxford Financial Research Centre, Oxford. Johnson, P. (2000b), “Resource margin accounting: empirical results for US manufacturing companies 1983-1998”, 2001-FE-17, working paper, Oxford Financial Research Centre, Oxford. Kwong, M.F.C., Munro, J.W. and Peasnell, K.V. (1994), “Commonalities between added value ratios and traditional return on capital employed”, Lancaster Working Papers in Accounting and Finance 94/007, Lancaster University Management School, Lancaster. Luehrman, T.A. (1997), “Using APV: a better tool for valuing operations”, Harvard Business Review, May-June, pp. 145-54. Peasnell, K. (1982), “Some formal connections between economic values and yields and accounting numbers”, Journal of Business Finance and Accounting, Vol. 9 No. 3, pp. 361-81.

Porter, M.E. (1980), Competitive Strategy, Free Press, New York, NY. Porter, M.E. (1985), Competitive Advantage, Free Press, New York, NY. Prahalad, C.K. and Hamel, G. (1990), “The core competence of the corporation”, Harvard Business Review, May-June, pp. 79-91. Further reading Box, G.E.P. and Jenkins, G.M. (1976), Time Series Analysis Forecasting and Control, Holden Day, San Francisco, CA. Edwards, J., Kay, J. and Mayer, C. (1987), The Economic Analysis of Accounting Profitability, OUP, Oxford. Ehrbar, A. (1998), Economic Value Added: The Real Key to Creating Wealth, John Wiley, New York, NY. Hill, R.C., Griffiths, W.E. and Judge, G.G. (1997), Undergraduate Econometrics, John Wiley, New York, NY. Johnson, P. (1999a), “An investigation of clean surplus value-added pricing models using time series methods for the UK 1983-1996”, 1999-FE-05, working paper, Oxford Financial Research Centre, Oxford. Johnson, P. (1999b), “Beyond EVA: resource margin accounting”, Mastering Strategy, p. 9. Johnson, P. (2003), “Strategy and valuation”, in Faulkner, D.O. and Campbell, A. (Eds), The Oxford Handbook of Strategy, OUP, Oxford. Kennedy, P. (1998), A Guide to Econometrics, Blackwell, Oxford. O’Hanlon, J. (1994), “Clean surplus residual income and earnings based valuation methods”, Lancaster Working Papers in Accounting and Finance 94/008, Lancaster University Management School, Lancaster. O’Hanlon, J. (1996), “An earnings based valuation model in the presence of sustained competitive advantage”, working paper, Lancaster University Management School, Lancaster. O’Hanlon, J. (1996), “The time series properties of the components of clean surplus earnings: UK evidence”, Journal of Business Finance and Accounting, Vol. 23 No. 2. O’Hanlon, J. and Peasnell, K.V. (1998), “Wall Street’s contribution to management accounting: the Stern Stewart EVA financial management system”, Management Accounting Research, Vol. 9 No. 4, pp. 421-44. Ohlson, J. (1995), “Earnings, book values and dividends in equity valuation”, Contemporary Accounting Research, Vol. 11 No. 2, pp. 661-87. Ramakrishnan, R. and Thomas, J. (1992), “What matters from the past? Market value, book value or earnings? Earnings valuation and sufficient statistics for prior information”, Journal of Accounting Auditing and Finance, Vol. 7 No. 4, pp. 423-64. Starck, A.W. and Thomas, H.M. (1998), “On the empirical relationship between market value and residual income in the UK”, Management Accounting Research, Vol. 9 No. 4, pp. 445-60. Wilcox, J.W. (1984), “The P/B-ROE valuation model”, Financial Analysts Journal, January/February, pp. 58-66. Corresponding author Howard Thomas can be contacted at: [email protected] To purchase reprints of this article please e-mail: [email protected] Or visit our web site for further details: www.emeraldinsight.com/reprints

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Kobe Naesens, Ludo Gelders and Liliane Pintelon Centre for Industrial Management, Katholieke Universiteit, Leuven, Belgium Abstract Purpose – A literature review, confirmed by in-depth interviews in industry, indicated a high level of reluctance to implement horizontal collaboration in business. One of the main reasons is the lack of a strategic decision support framework for the implementation of horizontal collaboration. An appropriate feasibility or fitness test could be helpful here. Two companies strategically ready to work together should first test whether any insurmountable practices (e.g. difference in culture) inhibit the collaboration. If such practices are present, the collaborative initiative will probably be a waste of time and effort. This paper therefore aims to present a method to check the strategic fit. Design/methodology/approach – By means of a general literature study, 300 performance indicators were collected. In a next step, they were reduced to 58 key elements by means of a focused literature study on partnerships and eight in-depth case studies in Belgian industry. Metrics have been assigned to each of these elements using the Supply Chain Operation Reference Model (SCOR). The elements are then combined into sub-criteria and criteria. Furthermore, the elements (both qualitative and quantitative) have been integrated through a multi-criteria decision-making method, namely analytic hierarchy process (AHP). Three different alternatives are considered: no-collaboration, informal collaboration, or partnership. By means of pairwise comparison of all criteria, sub-criteria and elements, an indication of the preferred form of collaboration is obtained and an improvement analysis per element can be performed. Findings – The paper suggests and tests a method for evaluating the strategic fit, incorporating key performance indicators. Research limitations/implications – The research assumes integrity of all partners. Practical implications – This paper presents a straightforward tool that demonstrates how to measure the strategic fit of inventory pooling in a horizontal collaboration between different organizations. Originality/value – The paper provides valuable information on measuring the strategic fit in horizontal collaboration initiatives. Keywords Supply chain management, Resource sharing, Analytical hierarchy process, Case studies, Belgium Paper type Literature review

Management Decision Vol. 45 No. 3, 2007 pp. 434-449 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745061

1. Introduction A new competitive landscape is taking shape. As Hitt et al. (1998) mention, managers and governmental policy makers are encountering major strategic discontinuities that are changing the nature of competition. A revolution in technology and globalization presents major challenges to firms’ ability to maintain their competitiveness. This leads to an escalating competition with an extreme emphasis on price, quality and satisfaction of customer needs and a focus on innovation (Hitt et al., 1998). When redesigning logistics processes, one should make a make/buy or ally choice or make a

choice between keeping logistics in-house, outsourcing or seeking cooperation with other companies to exploit synergies (Razzaque and Sheng, 1998). The need for collaboration has been mentioned by several authors (e.g. Lawton-Smith et al., 1991; Yoshino and Rangan, 1995). A collaborative supply chain simply means that two or more independent companies work jointly to plan and execute supply chain operations assuming greater success than when acting in isolation. Notice that although the partners have a common goal, they remain self-interested and their only focus is in long-term survival. Each member is searching for individual benefits such as lowering costs, increasing responsiveness, reducing transactions and the like (Simatupang and Sridharan, 2002). However, collaboration is about identifying and exploiting win-win situations and thus an opportunity for each partner. In general, one can identify four levels of working together. The most basic level is an “arm-length” relationship, which can grow into the second level or “cooperation” and later into the third level or “coordination”. “Partnership” is fourth on the continuum and it is as well called collaboration or strategic alliance. More specifically, it is called collaboration whenever the companies are working together on logistics and manufacturing related activities and called a strategic alliance whenever it involves more non-logistics activities and functions (Arabe, 2003). A collaborative supply network could be differentiated in terms of its structure: vertical, horizontal and lateral (Gill and Allerheiligen, 1996; Simatupang and Sridharan, 2002). Vertical collaboration can be defined as collaboration between parties performing complementary activities or services, i.e. when two or more organizations such as manufacturer, distributor, carrier and the retailer share their responsibilities, resources to serve similar end customers (e.g. vendor managed inventories (VMI)). Horizontal collaboration indicates the collaboration between parties performing the same type of activities and/or services, i.e. it occurs when two or more unrelated or competing organizations cooperate to share their private information or resources such as joint distribution centers. Lateral collaboration aims to gain more flexibility by combining and sharing capabilities in both vertical and horizontal manners (Simatupang and Sridharan, 2002; Naesens et al., 2004a, b). 2. Research focus Extensive academic research addressed the collaboration inside the supply chain or vertical collaboration. Most scholarly business journals (e.g. Operations & Production Management, Management Science, International Journal of Production Economics) published optimization models concerning this type of collaboration. See for example Lee et al. (1997); Cachon and Zipkin (1999); Balakrishnan et al. (2004); and Benjaafar et al. (2004). Academics agree on the advantages of horizontal collaboration (e.g. Contractor and Lorange (1988); Bowersox (1990); Mentzer et al. (2000); Nooteboom (2004)), but little attention has been given to the problems with horizontal collaborative initiatives. However, notice that 70 per cent of all strategic alliances fail (Zineldin and Bredenlo¨w, 2003). This results in a reluctance of companies to implement horizontal collaboration (Naesens et al., 2004a; Cruijssen et al., 2007). The first step in convincing industry is to present a framework for the implementation of horizontal collaboration.

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Figure 1. Decision support framework for horizontal collaboration

In this research, a framework for implementing horizontal collaboration was developed with the focus on resource pooling in inventory management (warehousing). By pooling the resources, the overhead and handling costs can be reduced due to economies of scale (Kleymann and Seristo¨, 2004; Toivonen et al., 2006). An example of this kind of pooling is found, e.g. when two companies, having different stock keeping units, are sharing one warehouse and therefore lowering the handling costs. Before the framework can be applied, the overall goal of the collaboration should be defined. In general, the goal is to diminish the total logistics costs. In-depth information concerning the total logistics costs can be obtained from, e.g. Melachrinoudis and Min (2007). Other possible goals are penetrating new markets, knowledge sharing and the like (Cruijssen, 2006). Once this goal has been clearly set, the first step of the framework, measuring the strategic fit on the possible partners, can be performed. By means of this test, the “as is” and “to be” situation and possible insurmountable practices are examined. Based on this, the potential partners with whom a partnership could succeed are determined. In a second step, strategic and tactical questions such as how to allocate costs and which items to pool should be taken. From this second level, the preferable partner(s) can be selected, i.e. the partners with whom in-depth (and time-consuming) negotiations are valuable. The third level gives the milestones when implementing the horizontal collaborative initiative in order to increase trust between the partners. Note that the levels are not strictly sequential, i.e. feedback and iterations are possible. Figure 1 depicts the different levels of the framework. Because it takes time and resources to establish, maintain and develop business relationships between firms (Anderson et al., 2001), performing a strategic fit test checking the compatibility of the two companies in advance is very important (first level of the framework). The focus of this paper is thus on the match or fit between two companies, having their own operations and environment. The scope is limited to resource pooling in inventory management (and thus decreasing total handling and overhead costs in warehousing). The concept of fit received considerable attention. Studies (Chandler, 1962; Lawrence and Lorsch, 1967; Thompson, 1967; Radder and Louw, 1998) defined this concept as the fit between the organizational structure, strategy, and/or the wider environment (external fit) and the fit among groups or units within the organization (internal fit). Furthermore, Smith and Reece (1999) refer to Skinner (1969) who described already in 1969 the need for companies to have the proper external fit when developing and implementing a manufacturing. To summarize, the deliverable of this part of the research (as described in this paper) is a practical tool for checking the strategic fit between two companies willing to

initiate resource pooling in inventory management. Notice that decision makers of both companies should separately test if the other possible partnering company fits. 3. Methodology General description Through a general literature study on performance measurement, 300 performance indicators have been determined. The main part of this literature study consisted out of literature on how to evaluate companies, e.g. Dindeleux et al. (1998); Beamon (1999); Veleva et al. (2001); Petroni and Panciroli (2002); Braam and Nijssen (2004); Camarinha-Matos and Afsarmanesh (2007); and Wang and Che (2007). Out of this literature study, it became clear that although financial indicators such as “Financial stability” are the conventional proxies of competitiveness, several non-financial performance indicators are also important and often neglected. According to several authors such as Kaplan and Norton (1992) and Nilsson and Kald (2002), the use of both financial and non-financial indicators creates a more accurate performance measurement system. Examples of non-financial indicators widely used are market share (Anderson and Sohal, 1999); overall competitiveness (Lau, 2002), productivity (Ross, 2002), market share growth (Tracey et al., 1999). In a next step, those 300 performance indicators were reduced to 58. In a first step, an in-depth literature specifically focused on partnerships such as Whipple and Frankel (2000); Harrison and New (2002); McCarthy and Golicic (2002); and Angerhofer and Angelides (2006). In a second step, eight in-depth case studies were performed. According to Yin (1994), case studies are appropriate for exploratory research such as this study. The primary resources of evidence are in this type of research systematic interviewing and direct observation. According to Yin (1994), the case study is an empirical inquiry that investigates a contemporary phenomenon within its real-life context. In this study, a multiple-case holistic design study is used which is more robust for replication of results. Design of the study – including data collection, analysis and quality – follows the procedures recommended by Yin (1994). First, the sample should be defined. The unit of analysis for this study is the organization or company. Within this context, each of the partners in a partnership could be considered a unit of the sample. The six selected companies, located in Belgium, were known a priori to engage in a collaborative partnership, i.e. each case study company had a partnership with a company in the same sector. They had different positions in a variety of supply chains and sectors: transportation (two firms), telecommunications, fast moving consumer goods (FMCG), chemicals and beverages. The interviewees were responsible for the partnership, they hold different functions, e.g. sales manager, procurement & logistics manager and customer business development manager. Two other cases from the so-called soft sector (i.e. the sector in which the main objective is not to make as much profit as possible) were added to check the generic character of the tool under development. All but one partnership were successful; the failed one was blamed on a lack of strategic fit. Second, the research design was determined. The research started with the two parts of the literature study described in detail above. Next, a questionnaire has been constructed. During the in-depth interviews, both a questionnaire with a Likert-scale and open questions have been used. The questionnaire has been structured around the three phases mentioned by Gray (1989): problem setting, direction setting and

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implementation. An extra phase was added concerning the partnership issues not taken up by Gray (1989). For data quality, the recommendations of Yin (1994) were followed. First, construct validity ensures that correct measures are used for the research concepts. This is obtained by the convergence of multiple data sources and having key informant reviews. Second, external validity was obtained by using multiple case studies and relevant literature as data sources. The above-described method resulted in 58 performance indicators, called elements. In a next step, metrics for each element were defined by using the Supply Chain Operations Reference Model (SCOR) (SCC, 2006). SCOR considers five main supply chain processes: “plan”, “source”, “make”, “deliver” and “return”. “Plan” defines the planning activities involved in running the other supply chain processes. It consists of, e.g. resource planning, demand planning, capacity planning and the like. “Source” relates to processes on the supplier side and consists of material acquisition and management of the sourcing infrastructure. “Make” relates to production execution and the production infrastructure. “Deliver” consists of order, warehouse, transportation and delivery. Finally “return” consists of the return of defective product, return of maintenance, repair or overhaul and return of excess product. (SCC, 2006) The SCOR model suggests for each of the processes some performance indicators and for each of the performance indicator a metric. Thus, for each of the 58 elements defined by the literature study and the in-depth case studies, a metric was defined based on the SCOR model. Furthermore, the elements (both qualitative and quantitative) have been integrated through a multi criteria decision making method namely analytic hierarchy process (AHP). The different elements were combined into different sub-criteria and criteria. The advantages of AHP include its ability to make both qualitative and quantitative decision attributes commensurable, and its flexibility with regard to the setting of the objective (Kangas, 1992). Furthermore, as Saaty (1990) states, it is an effective technique for analyzing a complex problem because it facilitates step-by-step cause-effect explanations and systematically accommodates the use of expert judgment. Therefore, these advantages make AHP the appropriate method for an analysis of competitiveness (Sirikrai and Tang, 2006). Three different alternatives have been determined (according to the previously described levels of collaboration): no-collaboration, informal collaboration or partnerships. By means of pairwise comparison of all criteria, sub-criteria and elements, an indication of the preferred form of collaboration is obtained and an improvement analysis per element can be performed. Finally, the tool has been tested by means of several case studies. It is not the purpose of this paper to provide a statistical overview of determining the 58 elements. This paper describes how the different elements are combined into a strategic fit test by using AHP and how strategic conclusions may be drawn out of this analysis. Therefore, the results of one of the validating case studies are described in detail. Principles of AHP When applying AHP, a hierarchical decision scheme is constructed by decomposing the decision problem into its decision elements as depicted in Figure 2.

The importance or preferences of the decision elements are compared in a pair-wise manner with regard to the element preceding them in the hierarchy. Pair-wise comparisons are quantified by using a scale (in this study the scale proposed by Saaty (1980)). An element aij of the comparison matrix is a one-to-one mapping between the set of discrete linguistic choices, and a discrete set of numbers, which represent the importance, or weight, of the previous linguistic choices. Furthermore, numerical techniques are used to derive quantitative values from verbal comparisons (Kurttila et al., 2000). The quantified judgment on pairs of criteria Ci to Cj are represented by an n-by-n matrix called A (Saaty, 1980):

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A ¼ aij with i; j ¼ 1; 2; 3; . . .; n: To obtain the weight of each alternative, Saaty applied the expression Ax ¼ nw where w is an eigenvector of matrix A with eigenvalue n. Thus to conclude, the AHP is based on three principles: (1) decomposition of the decision problem; (2) synthesis of the priorities; and (3) comparative judgment of the elements. The developed AHP structure is given in Table I. Notice that, as confirmed by case study companies G and H, only the elements in the “criterion internal process”, “subcriterion operational” should be reconsidered when measuring the strategic fit if another type of horizontal collaboration is considered, i.e. if no resource pooling in inventory management is tested. 4. Case study results Based on the above-described methodology, the different elements have been defined and structured into a hierarchical decision scheme (see Table I). Furthermore, the tool has been tested by several case studies of which one is described below. The company in the case study is a transportation company located in Flanders, Belgium. The company employs approximately 170 people and focuses on the transportation of chemicals. The collaborative initiative was started in 1990 with nine partners and currently consists of 14 partners (international). The current partnership between the case study company and one of the partners has been tested. Names are not mentioned due to confidentiality issues. The necessary data (weight and score per element) were provided by the staff member responsible for the collaborative initiative. First, as mentioned in the introduction, the general objective of the collaborative initiative should be defined. Because mainly hazardous and dangerous products are

Figure 2. The hierarchical decision problem

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Criteria

Sub-criteria

Elements

Company characteristics

Company structure

Scale Decision-taking structure Business performance Capital required/available General reputation Environmental reputation Level Scope Time-horizon Previous partnerships Partner – competitor? General culture Quality of products Quality of services Product life cycles Market share Customer loyalty Vertical integration Technological know-how Productivity Flexibility Control Lead-time Reliability Capacity utilization Total inventory cost No. SKU Product size Inventory turnover Quality product/service Service level Investments Communication ICT integration Decision-taking speed Collaborative planning Customer orientation Geographical issues Ease exit from market Outsourcing strategies Defensive/offensive Top management involvement Shareholder expectations Complementary Supplementary Demand variability Price elasticity Competitive pressure Entry barriers Technological change (continued)

Financial structure Image

440

General company characteristics

Competitive advantage

Product/service General competitive advantage

Internal processes

Operational

Tactical

Strategic

External parameters

Table I. Criteria, sub-criteria and elements

Product/service specific

Criteria

Sub-criteria

Elements

Industry-specific

Capital intensity Financial stability Growth potential Profit potential Resource utilization General business risk Inflation rate Juridical boundaries

General external parameters

transported by the considered companies, pooling of resources is necessary due to safety regulations (i.e. in case of severe problems having additional trucks to be able to react adequately) and to decrease the total logistics costs. Second, the AHP procedure is initialized. Step 1: the hierarchical structure In AHP, a problem is structured as a hierarchy. Therefore, the first step is to break down the multi-criteria problem into a hierarchical sequence with evaluation criteria and alternatives. The AHP structure is given in detail in Table I. Step 2: assigning weights Once the objective has been set and the AHP structure is known, the decision maker should give relative weights to the elements, sub-criteria and criteria. With AHP this requires a two-by-two comparison of each element, sub-criterion and criterion. Step 3: evaluating alternatives Next, the decision maker should evaluate the performance of the potential partner on the different elements. For each element, every possible combination of two alternatives is judged. The performance of the potential partnering company is given for each element and the decision maker should judge based on this score if no collaboration, informal collaboration or a partnership is more appropriate. This performance for each element is mostly easy to answer by middle or top management. This is of course a basic requirement for a swift strategic fit scan. The result of the case study for both steps 2 and 3 is given in Table II. In order to evaluate the different elements, the elements are ranked according to their weight. Subgroup A gathers the 10 percent most important elements, subgroup B the 10 percent to 30 percent next most important elements, subgroup C the following 40 percent to 70 elements and finally subgroup D the remaining 40 percent. Most focus will of course be given to subgroup A and B when evaluating the strategic fit. Step 4: selecting the appropriate alternative The most appropriate alternative is selected by means of a linear additive function, in which the relative priorities for an alternative are multiplied by the importance of the element, sub-criterion and criterion. In this case study, a partnership is preferred above informal collaboration or no collaboration (0.53 versus 0.40 and 0.06). From Table III, the decision maker can

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Table II. Elements ranked according to the weight

Ranking Elements 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 19 21 22 23 23 25 26 27 28 29 30 31 31 31 34 34 36 37 38 39 40 41 42 43 44 45 46 47 48 48

Informal No SubWeight Partnership collaboration collaboration group

Customer loyalty 148.96 Technological know-how 96.48 Reliability 86.37 Decision-taking structure 52.15 Service level 48.35 Quality product/service 47.68 Control 46.37 Quality of services 45.00 Flexibility 40.50 Lead-time 36.28 Size of products 36.17 Capacity utilization 32.42 Productivity 32.05 Time-horizon 30.12 Communication 26.65 Collaborative planning 25.95 Decision-taking speed 23.14 Previous partnerships 19.52 Business performance 12.22 Capital required 12.22 Level 8.88 Scope 8.82 Market share 8.49 Vertical integration 8.49 Demand variability 6.29 Price elasticity 6.22 General culture 6.02 Supplementary 5.25 Competitive pressure 5.07 Complementary 4.52 Total inventory cost 3.01 No. SKUs 3.01 Inventory turnover 3.01 Quality of products 2.78 Product life cycles 2.78 Partner/competitor 2.17 ICT integration 1.95 Investments 1.93 Technological change 1.38 Top management involvement 1.24 Customer orientation 1.16 Scale 0.81 General business risk 0.74 Profit potential 0.68 Financial stability 0.61 Growth potential 0.57 Entry barriers 0.52 General reputation 0.50 Environmental reputation 0.50

8.50 7.50 1.67 2.75 4.00 4.00 1.67 0.17 1.67 4.00 4.00 7.00 5.00 1.67 6.00 5.50 6.50 6.50 4.50 4.50 6.50 6.50 1.00 5.00 1.00 4.50 4.00 5.50 4.50 1.00 1.00 1.00 1.00 1.00 1.00 6.50 1.00 4.00 3.50 6.00 5.50 6.00 1.00 6.00 4.00 6.00 1.00 6.50 6.50

4.56 4.57 3.00 3.50 2.67 2.67 3.00 2.57 3.00 2.67 2.67 2.67 4.58 3.13 3.50 3.60 3.10 4.60 4.50 4.50 4.60 4.60 1.00 4.75 1.00 2.63 2.67 3.10 2.63 1.00 1.00 1.00 1.00 1.00 1.00 4.60 1.00 2.67 2.17 3.60 3.10 4.63 1.00 3.60 2.67 3.60 1.00 4.60 4.60

0.11 0.12 0.33 0.20 0.20 0.20 0.33 7.00 0.33 0.20 0.20 0.20 0.12 0.17 0.29 0.14 0.17 0.12 0.13 0.13 0.12 0.12 1.00 0.12 1.00 0.20 0.20 0.17 0.20 1.00 1.00 1.00 1.00 1.00 1.00 0.12 1.00 0.20 0.25 0.14 0.17 0.12 1.00 0.14 0.20 0.14 1.00 0.12 0.12

A

B

C

D

(continued)

Informal No SubWeight Partnership collaboration collaboration group

Ranking Elements 50 51 52 53 54 55 56 57 58

Resource utilization Juridical boundaries Defensive/offensive Outsourcing strategies Geographical issues Shareholders’ expectations Inflation rate Ease exit from market Capital intensity

0.36 0.29 0.27 0.21 0.12 0.10 0.10 0.08 0.06

1.00 4.50 3.50 1.00 1.00 1.00 1.00 1.00 1.00

1.00 2.63 2.17 1.00 1.00 1.00 1.00 1.00 1.00

1.00 0.20 0.25 1.00 1.00 1.00 1.00 1.00 1.00

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Table II.

Result

Partnership

Informal collaboration

No collaboration

Total

0.53

0.40

0.06

estimate if the possible partnering company does strategically fit or not. Notice that this method does not give the decision maker a “black or white” solution. The decision maker gets an indication how well the potential partnering company fits! Step 5: improvement analysis In a next step, it is possible to track down why a certain alternative is preferred above another. It is therefore possible to find the required improvements and determine if there are insurmountable practices making the partnership a finishing story. As can be seen in Figure 3 and Table II, four elements of group A (10 percent most important elements) are pointing to a partnership. Customer loyalty and technological know-how are scoring remarkably high. Service level and quality of product/service are also scoring well. On the other hand, the company prefers informal collaboration concerning reliability and decision taking structure. Main attention should be given to those two elements because they can endanger the collaborative initiative. As indicated by Figure 4 and Table II, for subgroup B (between 10 percent and 30 percent most important elements), for eight out of 12 elements a partnership is preferred: lead-time, size of products, capacity utilization, productivity, time-horizon, collaborative planning, decision taking speed and previous partnerships. A major problem has been noticed with the quality of the services. No collaboration has been preferred based on this element. The collaborative initiative could be clearly endangered by this and improvement is crucial. Finally, for the elements control, flexibility and communication, an informal collaboration is preferred. Those elements can thus endanger the partnership as well and therefore should be improved. The elements of subgroup C and D are analyzed in a similar way. Due to their relatively limited importance, this is not described in detail in this paper. The elements underperforming in those subgroups could generate certain frustrations about the partnership.

Table III. Selection of alternative

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Figure 3. Analysis of subgroup A

Figure 4. Analysis of subgroup B

Step 6: consistency check The consistency ratio of the judgments should be checked. Therefore, it is necessary to calculate the maximum eigenvalue lmax from Aw ¼ l max w
where w is the normalized eigenvector of A and l max $ n. The closer lmax is to n, the more consistent will be the judgments provided. The consistency index can be calculated as follows: CI ¼

l max 2 n : n21

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The consistency ratio (CR) is obtained by dividing the CI value by the corresponding random consistency index (ACI) evaluated by Saaty (1980) through the generation of a random matrix with different dimensions (n) (Saaty, 1980). A CR # 0:1 is mostly considered acceptable (see Table IV). The results of the consistency analysis are presented in Table V. As can be seen, most matrices are very consistent, however especially with internal processes and product/service specificity one should be careful to draw too fast conclusions. In order to improve the consistency even more, a new and easier interface was developed. Furthermore, the obtained results of the case studies were validated by the experience of the staff member of the case study company. 5. Conclusions and contributions The tool developed should help management in coping with the question if, based on a first swift analysis, collaboration with the potential partner is feasible and/or desirable. Current practice is to measure the strategic fit mostly based on maximum ten parameters. The resulting limited accuracy leads to inappropriate partnership decisions due to a lack of strategic fit. Notice that the swift scan tool is not intended to perform an in-depth analysis including the calculation of all the costs and benefits, but a tool to determine if a further in-depth analysis would be valuable. If there is a positive strategic fit for a partnership, the next steps of the framework such as determining and allocating the costs and benefits should be considered. n

ACI

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

0 0 0 0.52 0.89 1.11 1.25 1.35 1.4 1.45 1.49 1.51 1.54 1.56 1.57 1.58

Table IV. Random consistency index (ACI)

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Table V. Consistency analysis

Overview Criteria Company characteristics Competitive advantage Internal processes External parameters Company structure Financial strength Image General company characteristics Product/service General competitive advantage Operational Tactical Strategic Product-/service-specific Industry-specific General external parameters

CR 0.504 0.269 0.000 0.474 0.000 0.000 0.000 0.000 0.225 0.000 0.062 0.060 0.022 0.068 0.364 0.154 0.046

The framework is based on literature studies and in-depth interviews. A total of 58 key performance indicators (called elements) have been determined. By means of AHP, the desirability of a partnership can be measured. Furthermore, an improvement analysis may be performed. Next, this study describes in detail a case study for a transportation company pooling the resources. The results showed that a partnership was preferred above informal collaboration or no collaboration. However, the improvement analysis clearly indicated some major potential problems for the collaborative initiative. It is advisable to use a multi-disciplinary group of decision makers in order to avoid subjective bias of one decision maker. When the decision maker is able to evaluate the strategic fit between the two companies, less effort will be wasted in trying to set-up almost impossible partnerships, and therefore will save time and money.

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Enhancing the prescriptiveness of the resource-based view through Porterian activity analysis Norman T. Sheehan College of Commerce, University of Saskatchewan, Saskatoon, Canada, and

Nicolai J. Foss Center for Strategic Management and Globalization, Copenhagen Business School, Frederiksberg, Denmark and Department of Strategy and Management, Norwegian School of Economics and Business Administration, Bergen, Norway Abstract Purpose – Almost since the inception of the resource-based view (RBV), critics have complained that the view is weak in the prescriptive dimension. A recent statement of this critique is by Priem and Butler, who argue that the RBV does not address value creation. One aspect of this is that the link between resources and value creation is black-boxed. The paper aims to argue that a Porterian activity analysis with a focus on activity drivers can remedy this weakness, and how it brings into focus important implementation issues that are neglected in the RBV. Design/methodology/approach – The study extends Priem and Butler’s critique of the RBV by examining the RBV literature in light of Porter’s activity-based framework. Findings – The resource-based logic has been gainfully applied in many fields other than strategy. However, because it lacks the concept of activities, the paper argues that it has not reached its full potential in the field of strategy. Formally including the concept of activities and activity drivers addresses the prescriptive shortcomings of the RBV. Practical implications – Porter’s activity drivers are “levers” that managers can manipulate to improve firm value creation in two ways: The first method involves using activity drivers to improve the efficiency and effectiveness of individual activities. The second method involves improving the fit at the level of the firm’s activity set. Managers may identify potentially rewarding competitive positions and then use competitive data regarding rivals’ activities and drivers to gauge how successful their firm may be in capturing these positions. Originality/value – This is one of the first attempts to address the prescriptive shortcomings of the RBV using a Porterian activity lens. Keywords Resources, Organizational performance, Management strategy Paper type Conceptual paper

Management Decision Vol. 45 No. 3, 2007 pp. 450-461 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745070

Introduction Progress in the field of strategy is largely dependent on how well the field answers the question ”Why do some firms outperform others?” (Rumelt et al., 1994), as well as The authors are grateful to participants at the 2005 Strategic Management Society Conference in Orlando for comments on an earlier version of this paper.

corollary questions, such as, “How do firms get in a position where they can outperform others?”, “How can they maintain this position?,” etc. The resource-based view (RBV) offers critical and fundamental insights into why firms with valuable, rare, inimitable, and well organized resources may enjoy superior performance (Barney, 1995). Its current prominence is reflected not only by its dominance in the academic journals, by its inclusion in leading strategic texts[1] which warrants the conclusion that it is widely taught to students and practitioners in undergraduate, masters’ and executive programs. However, while the RBV is an excellent tool for (positively) describing why some firms outperform others, it offers limited (normative) guidance to managers, a critique recently and forcefully launched by Priem and Butler (2001). RBV analysis is phrased in very general terms and is in principle applicable to any resource anywhere in the firm. This wide generality is at the same time a strength and a weakness, the former because of the broad applicability of RBV analysis, the latter because the generality of the RBV also means a corresponding lack of specificity. Others have made similar claims and have suggested various valuable ways of taking the RBV in a more managerial direction. However, one important critique – namely that it is not sufficient clear in the RBV how resources contribute to firm-level value creation and that operationalization is therefore difficult (Priem and Butler, 2001) – has not in our view been satisfactorily answered. Recently, Ray et al. (2004, p. 35) acknowledged the role activities play in creating competitive advantage: Activities, routines, and business processes are the mechanisms through which resources and capabilities get exposed to market processes where their ultimate value and ability to generate competitive advantage are realized.

However, this paper goes beyond suggesting that resources be placed in activities to understand how firms sustain and create advantage (e.g., Duncan et al., 1998; Haanes and Fjeldstad, 2000; Porter, 1991; Ray et al., 2004; Stalk et al., 1992) to also include the concept of activity drivers. Adding activity drivers to the conversation makes two contributions: first, this paper extends Hoopes et al.’s (2003) argument that resource heterogeneity does not explain all firm level differences in performance by explicitly outlining the role of drivers. Second, we outline how activity drivers may be used by managers to improve their performance. The normative dimension of the RBV In one of the first statements of the RBV, Wernerfelt (1984, p. 12) argued that resources should be seen as “anything which could be though of as a strength or weakness of a given firm.” While agreeing with this, Barney (1991) shifted the focus to the characteristics of strategic resources, that is, those resources that are potential sources of sustained competitive advantage. However, these are formal criteria that in principle any resource might meet, depending on circumstances, and some critics (e.g., Miller and Shamsie, 1996) have therefore argued that RBV reasoning is “amorphous” in the sense that there is no explicit instruction concerning the respective contributions to sustained competitive advantage of different kinds of resources. In practice, however, research has tended to focus on single (stand-alone) intangible resources (Galbreath, 2004).

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The chief reason why it is difficult to apply the RBV in a prescriptive manner lies in the equilibrium orientation of the perspective. Economic equilibrium is an extremely useful device, because it lends discipline to analysis by allowing some and not other outcomes. However, it can also be constraining if used in a too heavy-handed manner. At a basic level, the RBV position that there can be “no rules for riches” (because such rules would be self-defeating) is an application of equilibrium thinking, that is, the notion that profit opportunities of any kind will be quickly discovered and exploited. Less obviously, equilibrium thinking of this kind lies behind the propositions that: most strategically relevant resources are either not available in the market, or, if they are, are highly likely to be priced so that no potential rent is left (Dierickx and Cool, 1989) (for a strong critique of this line of reasoning, see Denrell et al., 2003); and it may prove difficult to grow or copy strategic resources due to time compression economies and causal ambiguity (Barney, 1991; Dierickx and Cool, 1989). Finally, the equilibrium orientation of the RBV is manifest in the fact that it provides little insight into the “process black box” (Foss, 1996; Priem and Butler, 2001). The RBV is primarily an identification of the characteristics that resources must have to yield rents in equilibrium. This partially excludes concern with processes of building strategic resources through innovation and similar creative acts, or renewing such resources (see Matthews, 2006). Moreover, the neglect of the process black box also means that it becomes less transparent how resources contribute to value creation. How should resources be combined, in which proportions, amounts, sequences, etc. to yield value? These are highly important implementation issues that are currently outside the purview of the RBV. In a recent critique of the RBV, Priem and Butler (2001, p. 31) focus on the issue of value creation. They note the RBV’s rise in the field of strategy, and then proceed to play devil’s advocate by posing the question, “Is the RBV suitable for strategy research?”. Their key critique (Priem and Butler, 2001, p. 64) of the RBV is that while it provides a theory of sustainability, it is not a theory of value creation, which, if true, they rightfully argue limits its usefulness as a strategic tool. Barney (2001, p. 50) partially agrees with Priem and Butler’s (2001) critique. However, he does outline normative implications for managers (Barney, 2001; Barney and Arikan, 2001): First, he notes the RBV can be used to identify if the firm possesses any strategic resources which can be used to base the firm’s strategy on. If managers can identify these resources it allows them to nurture these resources. Second, managers in underperforming firms can use the RBV to identify resources that are lacking, and then examine if they can substitute or imitate these resources. Barney’s (2001) advice to managers is certainly helpful, yet does not fully address Priem and Butler’s (2001) critique. In particular, it does not open up the black box of understanding how resources contribute to value creation. We submit that this where the Porterian activity-based view may usefully complement the RBV. The activity-based view In 1980, Porter introduced the five forces framework and two generic strategies, low cost and differentiation. This is widely considered the Porter framework, which is evidenced by the fact it is the most cited work in the Strategic Management Journal in the period 1980-2000 (Ramos-Rodriguez and Ruiz-Navarro, 2004). However, Porter (1985) acknowledges a weakness with his 1980 work: while his 1980 work proposes

that the generic strategies are key to gaining competitive advantage, he does not outline how firms may achieve superior positions. Porter’s (1985) desire to rectify this leads him to develop the “other” Porter framework, the activity-based view, which adopts activities as the unit of analysis at the firm level. The activity-based view follows a logic that argues that firms are not paid for products per se, but rather they are reimbursed for the activities they perform to provide products consumers. The activity-based view also becomes an influential work in the field of strategy; although less prolific than Porter’s five forces, Porter’s 1985 work is the second most cited work in the Strategic Management Journal in the period 1987-2000 (Ramos-Rodriguez and Ruiz-Navarro, 2004). Porter (1980, 1985) argues there are just two generic strategies that lead to superior performance. The first is to produce at lower cost than competitors, while maintaining average quality and prices. The second is to induce customers to pay an above-average price without incurring costs that are larger than the price differential earned. But how do firms achieve superior positions based on being a cost leader or earning price premiums? The answer, Porter (1985, 1991) suggests, is at the activity level. Porter (1985) argues that we cannot understand a firm’s competitive potential by looking at a firm as a whole; rather a firm’s competitive position is determined by the activities it performs. The sum of the cost and value generated by each firm activity determines a firm’s relative cost and differentiation position relative to its rivals. To assist managers in understanding, improving, and implementing a low cost or differentiation strategy, Porter (1985) developed the value chain framework. The value chain is a generic activity template that is used to decompose the firm into the individual activities it undertakes to create value for the customer. A first level activity analysis involves comparing the activity breakdown to the firms’ rivals. Do the activities performed by rivals generate more value or incur less cost? Are they performing the similar activities more efficiently or are they performing activities differently? Porter (1991) then prods us further asking why firms’ activities generate lower cost or higher differentiation? He proposes that the answer to why some firms have lower cost or higher value delivered is due to activity drivers. While an activity level analysis will uncover some strategic insights, a second level analysis at the level of drivers is required to get a fuller picture of a firms’ competitive position (Porter, 1985). In Pearce and Robinson (2005)36, p. 104) words, “[d]rivers constitute the underlying source of competitive advantage, and make competitive advantage operational.” The link between activity drivers and firm performance is through positioning. Activity drivers are generic, structural factors that are more or less under management control, which impact the cost incurred or value delivered by an activity (Porter, 1985); they explain why a firm’s activity set generates more cost or value than its rivals. We extend Porter’s definition of drivers by clarifying the meaning of the term structural. We propose that activity drivers are structural in the sense that they represent abstract, relative or relational properties of activities, both in the context of the firm and in the context of the business value system the firm operates in. Consider scale and location, two potential drivers of cost or differentiation. The scale of an activity is implicitly defined relative to one or more of the following: The technology used to perform the activity (that is embodied in the way the activity is performed), the scale of other activities within the firm, the scale of the activity in

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competing firms, or the scale of the market for the product that the activity is involved in producing. Similarly, location is implicitly defined relative to one or more of the following: the source of inputs, the location of other activities in the firm, the market for products, and the location of competing firms. Drivers are also structural in the sense that they are abstract properties of activities. They need to be instantiated in firm-specific terms to be applied. Consider again scale and location. Scale is a driver of petroleum firms’ oil production activities, while the peak production rate of Norway’s Statfjord offshore oilfield (550,000 barrels of oil per day) is a concrete manifestation of the scale of an activity in a specific firm at a specific point in time. Similarly, location is a driver for a petroleum firms’ refining activities, while the location of a specific oil refinery in Norway is a concrete manifestation of location for a specific firm. Following his logic of two generic strategies, Porter (1985) proposes two types of drivers: Cost and differentiation. Cost drivers reduce activity cost by decreasing the cost of the inputs or reducing the amount of input required to produce the same output. For example, scale is a cost driver of a firm’s manufacturing activities if cost per unit fall as activity levels increase. Differentiation drivers influence the customer’s willingness to pay by increasing the value of the product itself, the value of the ancillary services that accompany the product, or the product’s image. A firm may also increase the buyer’s willingness to pay by reducing pre- and post-purchase costs. For example, location is a differentiation driver of marketing activities if the firm’s location induces consumers to pay a premium due to convenience. Successfully increasing the buyer’s willingness to pay involves knowing who the buyer is, how the product/service is employed, and what characteristics the buyer emphasizes (Porter, 1985). Cost and differentiation drivers have strong descriptive power to explain the total cost and value generated by a firm. Managers with a general knowledge of their competitors’ activity sets can use this information to analyze their position relative to its competitors (Ghemawat, 2006; Porter, 1985, 1991). Activities and activity drivers add prescriptiveness Activity drivers have strong descriptive power, but can they be used to increase value creation proactively? While it is not a straightforward process, the activity-based view does provide guidance as to how activities and drivers can be configured to achieve profitable positions. Activity drivers are “levers” that managers can manipulate to improve firm value creation in two ways: The first method involves using drivers to improve the efficiency and effectiveness of individual activities. For example, managers can improve their manufacturing costs by asking the following questions: . Scale. Should we increase or reduce the size of our manufacturing activities? . Accumulated learning. How can we leverage our knowledge-base and/or protect others from profiting from it? . Pattern of capacity utilization. Can we increase the utilization of manufacturing assets or reduce fixed costs? . Linkages. Can we improve coordination between related activities? . Interrelationships. Can we increase the level of coordination between the strategic business units? . Integration. Should we be outsourcing more or less?

. .

Location. Should we re-locate our manufacturing activities? Policy choices. If our manufacturing process is too complex can we lower costs by simplifying operations?

The second method involves improving the fit at the level of the firm’s activity set (Porter, 1985, Ghemawat, 2006). Managers can identify potentially rewarding competitive positions and then use competitive data regarding rival’s activities/drivers to gauge how successful their firm may be in capturing these (Porter, 1991; Ghemawat, 2006). Fortunately, the process of formulating and implementing firm strategy using the activity-based view is more complex than merely picking attractive positions and then manipulating the relevant drivers to achieve the desired position. Managers face two significant challenges when attempting to manipulate drivers: They must balance multiple drivers across multiple activities and they must operationalize the concept in the specific context of a firm. Drivers may counter-act each other within the same activity and/or may have different impacts across different activities (Porter, 1985). Therefore the benefit of an individual driver on an activity needs to be balanced with other drivers affecting that activity, between other firm activities, and relative to competitor activities. For example, the scale of manufacturing operations needs to be balanced with the other drivers of manufacturing operations (i.e. capacity utilization, policy choices, etc.), drivers of other activities (i.e. a larger manufacturing scale may adversely affect location as a driver of transportation costs), and relative to competitors (i.e. if all firms build large-scale plants then it is a potential no-win situation). Operationalization is a challenge for managers as drivers are defined relatively abstractly in order to make them generic and potentially applicable to all firms and industries. Part of the process of creating value is precisely choosing a position relative to the set of drivers that are critical in the firm’s industry. For example, it is not obvious at which level of the activity the driver applies to. Is it the scale of the smelter, the scale of the entire manufacturing process, or otherwise? Another point is which drivers are important will vary from industry to industry (and potentially over the life cycle of the industry). For example, the operationalization and role of scale varies with the industry. Scale in the automobile industry may be the number of cars produced per year. In the airline industry it may be the number of destinations or passenger miles flown per year. A further operationalization challenge for managers is that while drivers define the space of positioning alternatives, firms do not occupy all positions relative to an activity. Establishing the potential of unexplored positions is both difficult and uncertain, particularly when one also includes the potential responses of competitors. A related challenge is the fact firms do not have complete control over each of its activity drivers. The combined implication is that a position is not something that is directly and instantly captured, but rather it is something that the firm may evolve towards. The complex architecting of activities required to achieve a superior competitive position is challenging and therefore also potentially valuable as success may be difficult to understand and imitate. Given their importance in achieving competitive advantage, Rumelt et al. (1994, p. 421) write that: . . . [u]nderstanding drivers, which can range widely from environmental features to organizational ones, is of great importance to the manager.

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Are the RBV and activity-based view compatible? The objectives and underlying assumptions of the RBV and the activity-based view are compatible. The activity-based and RBVs share a goal of identifying and exploiting factors that lead to superior competitive positions. The activity-based view is best applied to improving a firm’s existing configuration of activities, as in the spirit of Porter (1985), while the RBV is best applied for the kind of assessment of a firm’s existing resource portfolio discussed by Barney (2001) or when exploiting the firm’s stock of resources to move into new product markets, as in the tradition of Penrose (1959) (e.g., Peteraf, 1993; Barney, 2001). The assumptions underlying each view are also similar. The RBV is based on the Chicago industrial organization perspective (Conner, 1991). And while Porter’s (1980) five forces is firmly rooted in the I/O perspective, Porter’s (1985) activity-based view is closer to the Chicago perspective as the rents earned are not due to exercising market power, but rather being more efficient than rivals (Foss, 1996). Further as Peteraf and Barney (2003) outline, both Porter and RBVs have similar definitions of competitive advantage and economic value. This level of compatibility is not surprising given that they offer complementary ways to explain firm level value creation. While they share a common objective of gaining and sustaining superior positions, the manner by which they are seen to “acquire” these is different. With the RBV it is the possession or control of strategic resources which allows firms to gain profitable positions. With the activity-based view, firms gain profitable positions by configuring their activities using drivers. However, activity drivers are not unique to the firm. They are generic, structural factors which are available to all firms in the industry in the sense that they are conceptualized as structural and relative properties of a firm’s activity set. Firms may “own” their positions, but only to the extent it is difficult for rivals to copy their activity/driver configurations. Have activities been implicitly subsumed by the RBV? Asking the question “Have drivers and activities been incorporated into the RBV?” is a fair question as combining stocks and flows of resources to study a firm’s internal situation has a long history. For example, Penrose (1959, p. 25) described the role of resources and the services derived from them and Rumelt (1984, p. 561) discussed the role of “resources and resource conversion activities”. Later, several authors join the discussion: Porter (1991) argues that resources and activities are duals of each other; McKelvey (1999, p. 296) lumps together Porter’s activities with resources, dynamic capabilities, and competencies; Ghemawat (2006) places resources and activities together to form integrative models of competitive advantage; Helfat and Raubitschek (2000, p. 975) discusses the key role which activities play in achieving competitive advantage; and Farjoun (2002, p. 574) labels activities as “work flow technology” and places them under the heading of resources. Given this, we need to discuss if activities and drivers have been implicitly adopted by the RBV. Indeed, one often finds mention of Porter’s activities in the RBV literature (somewhat in contrast with the widespread view of the RBV and the Porter view(s) as representing opposed positions). For example, Barney (1991, 2002), Grant (2005), and Duncan et al. (1998) recommend using the value chain as a tool to isolate those resources which may provide a competitive advantage, while Rumelt (1995, fn101) even argue that “[e]arly contributors to the RBV include Porter (1985), who made the

’activity’ the central element of this revised view.” But nowhere in our search of the literature did we find any reference to where the RBV had been explicitly extended to include Porter’s (1985) conception of activity drivers. Although the concepts of activities and drivers are not explicitly included, they may be implicitly included in the RBV literature. For example, the “O” in Barney’s (2002) VRIO framework implies that resources must be organized, although he does not discuss placing them in activities. What makes it more challenging is that there are terminological issues within the RBV that make it difficult to see if activities or drivers, in the Porterian (Porter, 1985) sense, are taken into account[2]. To be sure, we will first review if activities are the same as capabilities, and then if drivers are the same as resources. There is an overlap between activities and capabilities. Capabilities imply action, however, there is a subtle, yet key difference between the two. Activities are what firms actually do; they are actions the firm performs to create value (Porter, 1985). The RBV defines capabilities as the ability to execute (in a latent sense) (e.g., Amit and Schoemaker, 1993; Stalk et al., 1992), rather than the actual act of execution. While they are similar, there is a distinction between possessing the ability to do something and actually doing it, which Ray et al. (2004) acknowledge. Moreover, capabilities are typically (if not necessarily) broader in scope than activities; for example, firms may have “integrative” or “combinative capability,” that is, an overall, typically corporate-level, ability to integrate activities or bodies of knowledge (Kogut and Zander, 1992). Thus, capabilities may underlie activities (as in Richardson, 1972), but they are not the same thing. Are all activity drivers resources? Activity drivers and resources share many similarities: Both resources and drivers impact a firm’s cost/differentiation position, and both need managerial involvement in the sense that drivers must be made controllable, while resources must be organized. Given this similarity we should find examples of where a firm level factor may be a driver and a resource. For example, accumulated learning is a driver, which captures the increase in the firm’s stock of knowledge, which is a resource. Similarly, scale is seen as a driver by Porter (1985) and a resource by Barney (2002). Location can be seen as a driver or resource, while linkages and inter-relationships can be seen as elements of firm’s social capital or as drivers of activities. Barney and others argue that anything that improves a firm’s competitive position may be a resource (e.g., Barney and Arikan, 2001). We argue that while this definition makes the RBV of sustainability extremely robust, it hampers its ability to provide prescriptive guidance. While some drivers are resources, not all drivers are resources, unless we expand the definition of resources beyond the point where its usefulness may be questioned (e.g., Porter, 1991; Priem and Butler, 2001). There are two key differences between resources and drivers: First, resources are owned by the firm, while firms do not own drivers, as drivers are generic, structural properties of activities which are potentially open to all firms in an industry to take advantage of. Second, drivers influence the cost and differentiation of each activity or sets of activities, while resources typically relate to the business unit or corporation (Peteraf and Barney, 2003). In addition, there are some drivers which are difficult to conceive as resources. For example, high capacity utilizations (and its corollary low fixed costs) are not

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resources per se. The integration driver relates to “make or buy” decisions, which are not resources, but alternative ways of accessing the services of resources. Policy choices imply managerial choices rather than something firms possess. Timing is a driver, but not a resource as it relates to when the assets were purchased. And lastly, institutional factors are external to the firm and are not resources. While the line between activities and capabilities is thin (and potentially shifting over time), the difference between resources and drivers is tangible. We argue that if we desire the prescriptive benefit offered by activity drivers, we must explicitly integrate them into the RBV, rather then let them to continue to be encompassed under the broad heading of resources. Potential benefits of integration There are three key advantages of integrating the two views: (1) It addresses the prescriptive critique of the RBV (Priem and Butler, 2001). Including an activity-based decomposition of the firm as part of the analysis helps us understand the process by which resources contribute to firm value creation (Porter and Rivkin, 1998). Activities and activity drivers are the link between resources and performance (e.g., Porter, 1991). (2) It ameliorates many of the individual weaknesses of the two views. The activity-based view is weak in its assumptions about factor markets, which would be addressed by the RBV. The RBV, on the other hand, has been criticized for being static and introspective, which would be handled by inclusion of the concepts of activities and their drivers from the activity-based view. As well, RBV is criticized for not having a mechanism to endogenously create new resources and to analyze how changes in environment affect the value of resources. Adding activities to the picture relieves this, as well as the criticism that the resource-base view is too focused on individual resources, instead of bundles (e.g., Teng and Cummings, 2002). (3) Lastly, the activity-based view tackles implementation issues that are unresolved when using the RBV (Barney and Arikan, 2001). With the activity-based view strategies are formulated at the activity level and are generally easily translated into detailed implementation plans; activity-based strategic plans already outline who will do what, and when (Porter, 1998). The combined framework does not address all potential weaknesses. The main downside of incorporating the activity-based view is the level of detail and effort required to complete an activity-based analysis: Activity level data is typically not available in traditional accounting systems (Hergert and Morris, 1989; Porter, 1985). Conclusion The resource-based logic has been gainfully applied in many fields other than strategy (see Barney and Arikan, 2001 for a survey of resource-based research). However, because it lacks the concept of activities, we argue it has not reached its full potential in the field of strategy. Barney and colleagues (Ray et al., 2004, p. 35) appear to partially recognize this. As they argue:

[i]ndeed, the research reported here not only recognizes this common ground, but suggests that understanding the relationship between a firm’s resources and the effectiveness of its activities, routines, or business processes is particularly fruitful ground for analyzing the empirical implications of resource-based theory.

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While Barney and colleagues recognize the potential benefit of including activities when conducting empirical research, this paper goes one step further by arguing that by formally including the concepts of activities and activity drivers the RBV can significantly overcome its current lack of managerial guidance.

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Notes 1. Examples include Barney and Hesterly (2006), Dess et al. (2005), Ghemawat (2006), Grant (2005), Hitt et al. (2005), Pearce and Robinson (2005), Marcus (2005), Thompson et al. (2006), and Wheelen and Hunger (2004). 2. As an example of terminology issues which surround the RBV, Duncan et al. (1998, p. 10) quote from a research paper by Collis stating “there are as many definitions of organizational capabilities as there are authors on the subject.” See also Barney and Arikan’s (2001, pp. 139-40) discussion of the multitude of perspectives which purport to be different, yet share the same theoretical umbrella as the RBV. References Amit, R. and Schoemaker, P.J.H.S. (1993), “Strategic assets and organizational rent”, Strategic Management Journal, Vol. 14 No. 1, pp. 33-46. Barney, J.B. (1991), “Firm resources and sustained competitive advantage”, Journal of Management, Vol. 17 No. 1, pp. 99-120. Barney, J.B. (1995), “Looking inside for competitive advantage”, Academy of Management Executive, Vol. 9 No. 4, pp. 49-65. Barney, J.B. (2001), “Is the resource-based ‘view’ a useful perspective for strategic management research? Yes”, The Academy of Management Review, Vol. 26 No. 1, pp. 41-56. Barney, J.B. (2002), Gaining and Sustaining Competitive Advantage, 2nd ed., Prentice-Hall, Upper Saddle River, NJ. Barney, J.B. and Arikan, A.M. (2001), “The resource-based view: origins and implications”, in Hitt, M.A., Freeman, R.E. and Harrison, J.S. (Eds), The Blackwell Handbook of Strategic Management, Blackwell, Oxford. Barney, J.B. and Hesterly, W.S. (2006), Strategic Management and Competitive Advantage, Pearson Prentice-Hall, Upper Saddle River, NJ. Conner, K. (1991), “A historical comparison of resource-based theory and five schools of thought within industrial organization economics: do we have a new theory of the firm?”, Journal of Management, Vol. 17 No. 1, pp. 121-54. Denrell, J., Fang, C. and Winter, S.G. (2003), “The economic of strategic opportunity”, Strategic Management Journal, Vol. 24 No. 10, pp. 977-90. Dess, G.G., Lumpkin, G.T. and Taylor, M.L. (2005), Strategic Management: Text and Cases, McGraw-Hill Irwin, Boston, MA. Dierickx, I. and Cool, K. (1989), “Asset stock accumulation and sustainability of competitive advantage”, Management Science, Vol. 35 No. 12, pp. 1504-11. Duncan, W.J., Ginter, P.M. and Swayne, L.E. (1998), “Competitive advantage and internal organization assessment”, The Academy of Management Executive, Vol. 12 No. 3, pp. 6-16.

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Farjoun, M. (2002), “Towards an organic perspective on strategy”, Strategic Management Journal, Vol. 23 No. 7, pp. 561-94. Foss, N.J. (1996), “Research in strategy, economics, and Michael Porter”, Journal of Management Studies, Vol. 33 No. 1, pp. 1-24. Galbreath, J.T. (2004), “Determinants of firm success: a resource-based analysis”, PhD thesis, Curtin University of Technology, Sydney. Ghemawat, P. (2006), Strategy and the Business Landscape, 2nd ed., Pearson Prentice-Hall, Upper Saddle River, NJ. Grant, R.M. (2005), Contemporary Strategy Analysis, 5th ed., Blackwell, Oxford. Haanes, K. and Fjeldstad, Ø.D. (2000), “Linking intangible resources and competition”, European Management Journal, Vol. 18 No. 1, pp. 52-62. Helfat, C.R. and Raubitschek, R. (2000), “Product sequencing: co-evolution of knowledge, capabilities, and products”, Strategic Management Journal, Vol. 21 Nos 10/11, pp. 961-79. Hergert, M. and Morris, D. (1989), “Accounting data for value chain analysis”, Strategic Management Journal, Vol. 10 No. 2, pp. 175-88. Hitt, M.A., Ireland, R.D. and Hoskisson, R.E. (2005), Strategic Management, 6th ed., Thomson South-Western, Mason, OH. Hoopes, D.G., Madsen, T.L. and Walker, G. (2003), “Guest editors’ introduction to the special issue: why is there a resource-based view? Toward a theory of competitive heterogeneity”, Strategic Management Journal, Vol. 24 No. 10, pp. 889-902. Kogut, B. and Zander, U. (1992), “Knowledge of the firm, combinative capabilities, and the replication of technology”, Organization Science, Vol. 3 No. 3, pp. 383-97. McKelvey, B. (1999), “Avoiding complexity catastrophe in coevolutionary pockets: strategies for rugged landscapes”, Organization Science, Vol. 10 No. 3, pp. 294-321. Marcus, A.A. (2005), Management Strategy: Achieving Sustained Competitive Advantage, McGraw-Hill Irwin, Boston, MA. Matthews, J. (2006), Strategizing, Disequilibrium, and Profit, Stanford University Press, Stanford, CA. Miller, D. and Shamsie, J. (1996), “The resource-based view of the firm in two environments: the Hollywood film studios from 1936 to 1965”, Academy of Management Journal, Vol. 39 No. 3, pp. 519-43. Pearce, J.A. and Robinson, R.B. (2005), Formulation, Implementation, and Control of Competitive Strategy, 9th ed., McGraw-Hill Irwin, Boston, MA. Penrose, E.T. (1959), The Theory of the Growth of the Firm, Basil Blackwell, London. Peteraf, M.A. (1993), “The cornerstones of competitive advantage: a resource-based view”, Strategic Management Journal, Vol. 14 No. 3, pp. 179-91. Peteraf, M.A. and Barney, J.B. (2003), “Unravelling the resource-based tangle”, Managerial and Decision Economics, Vol. 24 No. 4, pp. 309-23. Porter, M.E. (1980), Competitive Strategy, Free Press, New York, NY. Porter, M.E. (1985), Competitive Advantage, Free Press, New York, NY. Porter, M.E. (1991), “Towards a dynamic theory of strategy”, Strategic Management Journal, Vol. 12 No. 6, pp. 95-117. Porter, M.E. (1998), Competitive Advantage, 2nd ed., Free Press, New York, NY. Porter, M.E. and Rivkin, J.W. (1998), “Activity systems as barriers to imitation”, working paper 98-066, Harvard Business School, Boston, MA.

Priem, R.L. and Butler, J.E. (2001), “Is the resource-based ‘view’ a useful perspective for strategic management research?”, The Academy of Management Review, Vol. 26 No. 1, pp. 22-40. Ramos-Rodriguez, A.-R. and Ruiz-Navarro, J. (2004), “Changes in the intellectual structure of strategic management research: a bibliometric study of the Strategic Management Journal, 1980-2000”, Strategic Management Journal, Vol. 25 No. 10, pp. 981-1004. Ray, G., Barney, J.B. and Muhanna, W.A. (2004), “Capabilities, business processes, and competitive advantage: choosing the dependent variable in empirical tests of the resource-based view”, Strategic Management Journal, Vol. 25 No. 1, pp. 23-38. Richardson, G.B. (1972), “The organisation of industry”, Economic Journal, Vol. 82 No. 327, pp. 883-96. Rumelt, R.P. (1984), “Towards a strategic theory of the firm”, in Lamb, R.B. (Ed.), Competitive Strategic Management, Prentice-Hall, Englewood Cliffs, NJ, pp. 556-70. Rumelt, R.P. (1995), “Inertia and transformation”, in Montgomery, C.A. (Ed.), Resource-based and Evolutionary Theories of the Firm: Towards a Synthesis, Kluwer Academic, Boston, MA, pp. 110-30. Rumelt, R.P., Schendel, D.E. and Teece, D.J. (1994), Fundamental Issues in Strategy: A Research Agenda, Harvard Business School Press, Boston, MA. Stalk, G., Evans, P. and Shulman, L.E. (1992), “Competing on capabilities: the new rules of corporate strategy”, Harvard Business Review, Vol. 70 No. 2, pp. 57-69. Teng, B.S. and Cummings, J.L. (2002), “Trade-offs in managing resources and capabilities”, Academy of Management Executive, Vol. 16 No. 2, pp. 81-91. Thompson, A.A., Gamble, J.E. and Strickland, A.J. (2006), Strategy: Winning in the Marketplace, 2nd ed., McGraw-Hill Irwin, Boston, MA. Wernerfelt, B. (1984), “A resource-based view of the firm”, Strategic Management Journal, Vol. 5, pp. 171-80. Wheelen, T.L. and Hunger, J.D. (2004), Strategic Management and Business Policy, 9th ed., Pearson Prentice-Hall, Upper Saddle River, NJ. Further reading Barney, J.B. (1986), “Strategic factor markets: expectations, luck and business strategy”, Management Science, Vol. 32 No. 10, pp. 1512-34. Foss, N.J. (1998), “The resource-based perspective: an assessment and diagnosis of problems”, Scandinavian Journal of Management, Vol. 14 No. 3, pp. 133-49. Corresponding author Norman T. Sheehan can be contacted at: [email protected]

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Danielle A. Chmielewski and Angela Paladino Department of Management, The University of Melbourne, Melbourne, Australia Abstract Purpose – This study seeks to introduce the role of resource and capability characteristics as drivers of a resource orientation (RO) and to examine empirically these relationships in different market conditions. Design/methodology/approach – This study was conducted using a nation-wide survey distributed to key informants of multiple business units. Multiple regression was used to assess the relationships. RO is used as a proxy for the implementation of the resource-based view (RBV). The RO is also tested against performance outcomes to examine the robustness of the model that has been examined. Findings – Findings showed significant relationships between resource and capability characteristics and RO. These relationships were shown to be robust across various market conditions. RO also depicted significant, positive relationships with all four performance indicators that were assessed. Industry conditions were found to strengthen some of these relationships. Research limitations/implications – The results are limited to cross-sectional data that prevent the determination of causality. In addition, it is a nation-specific study that may not be generalisable to alternative settings. This presents an opportunity for further research to replicate this study in other nations and/or industries. The research presents implications for further theory development and suggests that management can focus on developing unique resource bundles to improve company performance; however, they will need to be attentive to the competitive environment in which they compete. Originality/value – This is the first study that empirically evaluates drivers of an RO and further tests the scale that was applied by Paladino. Additionally, this study illustrates that the RBV can be empirically tested through the use of an RO to have a demonstrable impact on financial and non-financial elements of performance. Keywords Resources, Organizational performance Paper type Research paper

Management Decision Vol. 45 No. 3, 2007 pp. 462-483 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745089

Introduction The resource-based view (RBV) has dominated economic and management thinking for the past two decades (Foss and Knudsen, 2003). Only recently have researchers recognised that it may also be classified as a strategic orientation that managers may apply to their firms to achieve superior performance. Referred to as the resource-based theory of strategy, resource-based strategic management or the RBV of strategy (e.g., Grant, 1991), we have only just recognised the theory’s “considerable potential” for extension into strategic and management (Mowery et al., 1998). Note: Both authors contributed equally to this manuscript.

The RBV satisfies all components of “strategy”. It enables a company to identify and develop its valuable resources by assisting it to identify pertinent business interrelationships and forming the basis for strategy formulation (Collis, 1991; Grant, 1991; Hitt et al., 1995, Barney and Zajac, 1994; Paladino, 2006). Moreover, the RBV satisfies key characteristics of strategy such that it is a long-term view, and it requires an understanding of the external environment to be applied and leveraged. As research has evolved, the RBV has come to encompass not only a firm’s resources, but also its capabilities (Helfat and Peteraf, 2003; Henderson and Cockburn, 1994). As Makadok (2001) argues, firms are likely to use a combination of resources and capabilities in the pursuit of a sustainable competitive advantage. Capabilities are a special type of resource, in that they are firm-specific and enhance the productivity of a firm’s other resources (Makadok, 2001). While there has been much research that examines the premises and consequences of the RBV, there is not a comparable emphasis on understanding its drivers. Consequently, assessing whether company behaviours are consistent with the tenets of the RBV has been difficult. Possession of certain resources does not automatically confer a competitive advantage (Wernerfelt, 1984). Rather, resources and capabilities need to possess certain characteristics before they can contribute to a competitive advantage (Barney, 1991; Mahoney, 2001; Teece et al., 1997; Vicente-Lorente, 2001). What this suggests is that it is not the resources and capabilities per se that drive a firm’s practice of a RBV, but rather it is the unique characteristics that resources and capabilities possess that are the key drivers. While there has been a flood of research that measures specific types of capabilities (see, for example, Dutta et al., 2005; Hansen and Lovas, 2004; Henderson and Cockburn, 1994; Nerkar and Roberts, 2004), no such research has focused on quantifying the drivers of a resource-based strategy. As the RBV is a wide-reaching theory of the firm, it cannot be assessed in its current form. This has also been acknowledged by Foss and Knudsen (2003), who claim that the RBV is lacking analytical precision. Hence, a resource orientation (RO) was applied as it uses the precepts of the RBV to assess empirically whether a firm applies the RBV (Paladino, 2006). RO describes the degree to which a firm practices a RBV and is used to assess the extent to which a firm is oriented towards the development of valuable and unique resource bundles (Paladino, 2006). It is these resource bundles that create superior value for the firm and, thus, continuous superior performance for business. To facilitate the study of the drivers of RO, this paper introduces two key characteristics of a firm’s resources and capabilities. The empirical evaluation of these characteristics addresses a criticism of the RBV literature that there is a lack of empirical research conducted on the RBV (Priem and Butler, 2001a, b). Another key criticism of the RBV is concerned with the lack of research regarding the interaction between a firm’s resources and its competitive environment (Barney, 2001). An additional purpose of this study is to examine the relationships between resource and capability characteristics and RO under different market conditions. Both firm- and market-based factors impact on a firm’s strategic decision making and profitability (McGahan and Porter, 1997). Recently, Cockburn et al. (2000) and Priem and Butler (2001a) have all called for strategy research to incorporate firm- and market-based factors. This study addresses this call by examining whether market conditions affect the interplay between resource and capability characteristics and RO.

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The RBV assumes that a better understanding of a firm’s idiosyncratic resources and capabilities leads to an improved understanding of the relationship between a firm’s strategy and performance. This allows it to achieve a competitive advantage (Barney, 1991; Vicente-Lorente, 2001). The RBV focuses on the heterogeneity of firms. It addresses and looks at how these differences determine not only a firm’s choice of a particular strategy, but also how successfully the firm is able to implement and execute the strategy (Barney, 1991). While a considerable number of studies have examined the unique characteristics of resources and capabilities (see, for example, Amit and Schoemaker, 1993; Barney, 1991; Brush and Artz, 1999; Capron and Hulland, 1999; Eisenhardt and Martin, 2000; Makadok, 2001; Rouse and Daellenbach, 1999; Verona, 1999; Vicente-Lorente, 2001), only one has measured resource and capability characteristics and assessed their impact on the RBV (Chmielewski and Paladino, 2006). This is important, because as Spanos and Lioukas (2001, p. 910) state, the “resource-based perspective posits that the essence of strategy is or should be defined by a firm’s unique resources and capabilities”. This paper aims to address this by identifying and defining these resource and capability characteristics, based on an extensive review of the literature, and then assessing their relationship to RO, a proxy measure for the RBV applied in this study. Hence, this study seeks to: . examine the role of resource and capability characteristics as drivers of a RO; . examine the relationships between resource and capability characteristics and RO under two different industry conditions; . assess the relationship between RO and performance; and . assess the relationship between RO and performance in different industry conditions. Research and hypotheses The RBV identifies those resources that provide firms with the opportunity to develop an advantage over their competitors (Barney, 1991; Rao and Stekel, 1998). The RBV requires firms to leverage their resources in order to develop a sustainable competitive advantage. Firm resources will only provide this advantage if they are capable of yielding revenue (Barney, 1991; Dierickx and Cool, 1989). The RBV is now recognised as a strategic tool in that it allows management to exercise “their ability to work creatively with the raw material presented by the firm and their environment; to respond appropriately when their firm’s organisational structure finds ‘good’ strategies; and to create decision structures and procedures that allow a firm to respond to its environment adaptively” (Cockburn et al., 2000, p. 1128). There has been considerable debate concerning the role of resources and capabilities in the formation of marketing strategies (Hart, 1995). According to Rao and Stekel (1998, p. 270), the RBV “sees companies as a unique collection of assets and capabilities (or skills and resources in our language) that allow them to outperform their competitors over a sustained period of time”. Its foundation rests on the premise that competitive advantage originates at the firm (rather than the industry) level (Capron and Hulland, 1999). It also assumes that resources are imperfectly mobile and heterogeneous (Barney, 1991; Mata et al., 1995).

As the RBV is a theory of the firm, it cannot be tested in its current form. Thus, a construct that applies the tenets of the RBV was used. The RO scale assesses the extent to which a firm is oriented towards the development of valuable and unique resource bundles (Paladino, 2006). RO is defined as the organisational orientation that creates the necessary behaviours to identify, apply and accumulate unique and valuable resource bundles that create superior organisational value and a sustainable competitive edge (Paladino, 2006). A RO focuses on how firms create and deploy firm-specific resources when making strategic decisions and is intent on leveraging existing resources to enhance performance. A RO therefore describes the degree to which a firm practices a RBV. Thus, it is assessed at the same level of alternate strategic orientations that are applied in the strategy and market literatures such as market orientation. The Paladino (2006) study assessed RO relative to market orientation, an alternate strategic orientation used in the marketing literature. This study demonstrated similar findings with respect to the effects of RO on financial outcomes, thereby proving the viability of RO as a legitimate strategy. Firm resources and capabilities must have distinct characteristics to enable a firm to implement a RO and respond to changes in market conditions. The adoption of a RO is dependent on whether resources and capabilities possess essential qualities. These qualities act as determinants or essential prerequisites for the adoption of a RO. Using the extant RBV literature as a basis of investigation, we now turn to reviewing these key characteristics. The RBV is built around the internal attributes of a firm that incorporate its competencies and assets (Russo and Fouts, 1997). Not only is it important to own such resources, but it is also imperative that the “stocks” of assets and capabilities that a firm owns are recognised by the firm (Dierickx and Cool, 1989). The RBV emphasises firm-specific resources as a means of explaining one firm’s position in the market relative to others (Cockburn et al., 2000). Many terms have been used to describe the attributes that resources are required to possess in order to enable a firm to achieve superior performance. These terms are all variations of Barney’s (1991) original four resource characteristics, and include scarcity, appropriability, durability, uniqueness, non-transferability, firm-specificity, opacity, idiosyncratic, specialised, and rent-generating (see Amit and Schoemaker, 1993; Capron and Hulland, 1999; Mahoney, 1995; Priem and Butler, 2001a; Rouse and Daellenbach, 1999; Vicente-Lorente, 2001). These have been incorporated into the resource sustainability measure. Resource sustainability involves an accumulation of unique resources which will impede present and potential competitors from quickly replicating the firm’s resource base. Barney (1991) summarises the four key characteristics that resources need to possess to confer a competitive advantage: value, rarity, inimitability, and non-substitutability. These four characteristics arguably refer to the sustainability of a firm’s resources, because they determine the extent to which a firm’s resources confer a sustainable competitive advantage. As Barney (1991, p. 102) argues, a firm has a sustained competitive advantage “when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitors and when these other firms are unable to duplicate the benefits of this strategy”. Hence, we posit that the greater the resource sustainability, the more a firm will be able to defend its resource base and effectively implement a RO: H1. The greater the resource sustainability, the greater the RO.

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When examining resource characteristics, it is also necessary to look at a firm’s capability characteristics, because capabilities determine the way in which resources are reconfigured and redeployed to work together to add value to the firm (Prahalad and Hamel, 1990; Vicente-Lorente, 2001). In fact, some contend that resource and capability characteristics are in fact one in the same (e.g., Amit and Schoemaker, 1993; Barney, 1991; Peteraf, 1993). Capabilities are firm-specific, embedded in the organisation and enhance the productivity of a firm’s other resources (Makadok, 2001). Capabilities “enhance the firm’s capacity to deploy resources to effect a desired end” (Brush et al., 2001, p. 68). Capabilities enable firms to respond and adapt to industry challenges (Day and Wensley, 1988). Capabilities possess a number of distinct characteristics, such as being firm-specific, idiosyncratic, tacit, causally ambiguous, dynamic, adaptable, path dependent, and invisible assets (see Eisenhardt and Martin, 2000; Hart, 1995; Helfat, 2000; Karim and Mitchell, 2000; Makadok, 2001; Schilling, 1998; Verona, 1999). These attributes have been incorporated into the capability dynamism measure. This literature shows that some capabilities are deemed to be ordinary while others are in fact dynamic (see Winter, 2003). This allows firms to exploit and redeploy resources to respond to changing environments and markets (Teece et al., 1997). Specifically, dynamic capabilities have been defined as: [. . .] the organisational and strategic routines by which firms achieve new resource configurations as markets emerge, collide, split, evolve and die (Eisenhardt and Martin, 2000, p. 1107).

This definition captures an essential component of the RBV, this being the ability to generate new sets of resources or new applications for resource bundles, in the face of changing or turbulent environments. Research has recognised that dynamic capabilities themselves are not direct sources of long-term competitive advantage (Eisenhardt and Martin, 2000). Rather, they tend to assist a firm to implement a RBV. Similarly, Sharma and Vredenburg (1998, p. 735) state that a firm’s capabilities: [. . .] are the coordinating mechanisms that enable the most efficient and competitive use of the firm’s assets, whether tangible or intangible.

Hence, capability dynamism allows a firm to be flexible and adapt its resources to changing conditions, thereby assisting in the effective implementation of RO. Therefore, if capability dynamism is high, this suggests that capabilities are more flexible and adaptable throughout the firm. This may also be contingent on the nature of the environment in that dynamism may be present more in turbulent or virulent environments as compared to stagnant or stable ones. We assess this through the moderating effects in the discussion that follows: H2. The greater the capability dynamism, the greater the RO. Performance is often assessed from a purely financial perspective. However, as recognised by Combs and Ketchen (1999), performance is a multi-dimensional construct that is reflected in a number of outcomes and daily operations. As a result, multiple measures should be examined to capture a number of dimensions of firm performance (Venkatraman and Ramanujam, 1986; Combs and Ketchen, 1999). Most research has used an array of financial measures to represent performance, ranging

from return on capital (ROC), return on sales (ROS), to market share growth. While there is conflicting evidence, the majority of work that applies specific capabilities and resources to outcomes provide evidence of a positive relationship between RO and performance outcomes (e.g., Henderson and Cockburn, 1994; Makija, 2003). Consistent with the extant literature, a number of financial indicators are applied here. While there is no empirical support for such a relationship for RO, RBV theory suggests that a positive relationship between RO and overall performance should ensue (e.g., Barney, 1991; Henderson and Cockburn, 1994; Sharma and Vredenburg, 1998). Customer satisfaction has been defined as: [. . .] the favourableness of the individual’s subjective evaluation of the various outcomes and experiences associated with buying [a product] or using it (Babin and Griffin, 1998, p. 128).

Companies must have systems in place that allow them to monitor the marketplace and disseminate this information across all functions to develop and maintain a strong market position. This enables the company to use its internal resources to be responsive to consumer needs. Customer value and thus satisfaction will only be created when a firm is able to exploit and leverage its critical resources fully. In this sense, value will be achieved when it is created for the firm and its customers (Slater and Olson, 1996). This has implications for RO. Firms need to establish and develop resources that are required to understand these customer requirements and deliver the promised value (Slater, 1997). Few have analysed the impact of unique firm resources on customer-related variables such as customer satisfaction. It is critical that a company understands where its key resources lay and where further developments need to occur (Webster, 1994). Distinctive resource bundles will allow a company to define where it is “uniquely capable” among all of its competitors. The value of such a strategy increases if competitors find it difficult to emulate these distinct offerings (Heskett et al., 1990; Webster, 1994). Thus, if a company continually invests in its resource base, we expect it to be able to achieve customer satisfaction. Therefore: H3. The greater the RO, the greater the (a) ROC, (b) ROS, (c) Market share growth, and (d) Customer satisfaction. Moderating market conditions Changes in customer requirements and competitor actions invariably impact a firm’s strategy (Walley and Thwaites, 1996). As the competitive environment evolves, companies must continue to monitor their unique bundle of resources to ensure they continue to be relevant (Webster, 1994). Research demonstrates that environmental characteristics constitute the foremost contingency that firms must confront and have a considerable impact on strategy and performance (Goll and Rasheed, 1997; Morgan and Piercy, 1998). While McGahan and Porter (1997) acknowledged the importance of the RBV, they did advise that ignoring the effects of the competitive environment would prove detrimental to the firm. According to Doyle (2000, p. 157), a firm’s “success or failure can be explained by (i) external factors – the attractiveness or otherwise of the market in which the firm is operating and (ii) internal factors – the specific capabilities the business has inherited or developed, which allow it to develop a competitive

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advantage”. Furthermore, according to Priem and Butler (2001a) a firm’s market environment (i.e. opportunities and threats) ultimately determines the value of a firm’s resources and capabilities (i.e. strengths and weaknesses). A number of factors influence the attractiveness of the market, including market turbulence and competitive intensity (Gatignon and Xuereb, 1997; Glazer, 1991; Jaworski and Kohli, 1993; Narver and Slater, 1990; Porter, 1980). This paper thus also reviews the relationship between market turbulence and RO, as well as between competitive intensity and RO. The RBV is appropriate to apply in a dynamic and turbulent environment characterised by diverse customers, workforces and environmental conditions. In these environments, managers’ cognitive frameworks place emphasis on the development of new competencies and resources (Collis and Montgomery, 1995; Chakravarthy, 1997; Grant, 1996; Higgins, 1996; Grant, 1998): A definition of a business in terms of what it is capable of doing may offer a more durable basis for strategy than a definition based upon the needs which the business seeks to satisfy (Grant, 1991, p. 116).

Hence, resources and capabilities provide a stable basis on which a firm may define itself (Grant, 1991). Grant (1998) argues that the more turbulent the environment, the greater the number of changes that take place within the market place and the greater the number of differences in firm resources. He contends that this will enable a company to be responsive to change and anticipate change over time. Market turbulence “represents the changes in composition of customers and their preferences . . . [and] implies changing strategies in the face of changing customer needs” (Slater and Narver, 1994, p. 51). As Slater and Narver (1998, p. 1003) argue, in a turbulent environment: [. . .] the more enduring advantage is an ability to anticipate evolving customer needs and to generate new value-creating capabilities based on that knowledge.

A turbulent, dynamic market requires a firm to be responsive and adapt to changes in its environment (Rajagopolan and Spreitzer, 1997). This suggests that market turbulence influences both strategic decision making and the selection of a firm’s strategy. Competitive intensity is defined as “the behaviors, resources and ability of competitors to differentiate” (Jaworski and Kohli, 1993, p. 60). In essence, it refers to the extent to which the composition of the market and competitive actions change over time (Gatignon and Xuereb, 1997; Kohli and Jaworski, 1990; Slater and Narver, 1994). We argue that RO should be robust across different market conditions as long as the firm possesses both capability dynamism and resource sustainability. There is an absence of past research that examines the effects of industry moderators on RO. Consequently, we are unable to compare these relationships between market conditions, RO, capability dynamism and resource sustainability to past research. Given this, we contend: H4. The relationship between RO and (a) resource sustainability and (b) capability dynamism will remain unchanged under conditions of market turbulence and competitive intensity.

H5. The higher the rate of market turbulence, the stronger the relationship between RO and performance. H6. The higher the rate of competitive intensity, the stronger the relationship between RO and performance. Figure 1 illustrates our conceptual premise and the relationships under investigation. It shows that we expect capability dynamism and resource sustainability to have a positive and direct relationship with RO. We recognise that individual firms may have either characteristics and still be able to attain superior performance. These underlying factors are posited to drive the implementation of RO, regardless of market conditions. The RBV posits that unique and sustainable resources should provide a firm with value and a sustainable competitive edge in most of the market conditions (e.g., Barney, 1991). Hence, our model incorporates performance outcomes and the role of the environment. It examines the two market conditions of competitive intensity and market turbulence to assess their influence over the relationships between resource sustainability and RO, capability dynamism and RO, as well as RO and performance.

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Methodology Data collection The unit of analysis is the business unit. The sampling frame consisted of 2,894 consumer goods firms. The study employed an online survey. While the response rate for online surveys is typically lower than for mail surveys (see Tse, 1998; McDonald and Adam, 2003; Schuldt and Totten, 1994), an online survey generally “produces an acceptable response rate at a lower cost per returned questionnaire than mail” (Tse, 1998, p. 353). This research adopted a key informant strategy: the online survey was e-mailed to one key informant within a business unit. This allowed researchers to target those informants who possess knowledge of tacit organisational processes that are difficult to observe and document (Chen et al. 1993). The key informant approach is particularly

Figure 1. Conceptual model

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useful when there exists a lack of archival data on organisational level constructs (Kumar et al., 1993). It is used regularly in research that examines organisational processes and strategies (e.g., Fredrickson, 1984; Heide and John, 1995; Phillips, 1991). The key informant within the business unit was someone who held a position equivalent of divisional general managers. As Heide and John (1995) point out; middle-to-senior level managers possess the ability to answer the range of questions being asked of them due to their specific knowledge about their business unit’s operations, functions, and strategies. According to Kumar et al. (1993), the key informant method is restricted by informant bias and random error. To overcome the problem of informant bias, respondents were selected who held similar or comparable organisational roles across the sample. To overcome the problem of random error, respondents were assured of the confidential nature of the research. This ensured that respondents were more likely to give unbiased, accurate answers (Heneman, 1974). E-mail invitations containing a hyperlink to a web site with the online survey were sent to senior executives in our sample firms. The initial e-mail was followed by two subsequent follow-up e-mails. After taking into account ineligible and/or unreachable respondents, 149 usable surveys were received. While the response rate is low, it is not unusual. Alreck and Settle (1995) note that it is not uncommon for direct mail data collection response rates to fall within the range of 5 to 10 per cent. Indeed, our response rate (6 per cent) was consistent with the 7 per cent response rate obtained by Tse (1998) in his study comparing response rates when using e-mail versus mail data collection methods. For the purposes of this study, a high internal validity is more important than external validity, which is consistent with the view put forth by Wittink (2004) in his editorial statement of the Journal of Marketing Research. We nonetheless controlled for a possible non-response bias in three ways by testing whether any differences of various independent, dependent and control variables existed between responses of the first-wave and second-wave, first-wave and third-wave, and second-wave and third-wave. First, we evaluated non-response bias using Armstrong and Overton’s (1977) method whereby the data were divided into thirds using the three response waves as the grouping variable. The t-tests between mean responses of first-wave and second-wave, first-wave and third-wave, and second-wave and third-wave responses indicated no statistically significant differences (p , 0:05) across two independent variables (resource sustainability and capability dynamism), the dependent variable (resource orientation), and a control variable (business unit size). Second, we conducted one-way between-groups analysis of variance to explore the impact of response wave on resource sustainability, capability dynamism, resources orientation and business unit size. Respondents were divided into three groups according to the response wave. There were no statistically significant differences (p , 0:05) in the means scores of first-wave, second-wave and third-wave responses. Third, we used the Mann-Whitney U Test to compare the median responses between first-wave and second-wave, first-wave and third-wave, and second-wave and third-wave responses across resource sustainability, capability dynamism, resource orientation and business unit size. No statistically significant differences (p , 0:05) were found. These findings indicate that non-response bias was not a problem with these data.

The measures The study used existing scales to measure resource sustainability, capability dynamism market turbulence, competitive intensity, resource orientation, the control variables and the performance outcomes. Capability dynamism refers to a firm’s ability to rapidly respond to changing environments by reconfiguring, integrating, and redeploying resources. Resource sustainability is defined as the extent to which a resource’s attributes confer a sustainable competitive advantage to a firm (Chmielewski and Paladino, 2006). These two scales contained five items each. They were assessed on a seven-point Likert-type scale ranging from 1 ¼ strongly disagree to 7 ¼ strongly agree. Market turbulence refers to the extent to which the composition of a business unit’s customers and their preferences change over time, while competitive intensity refers to the extent to which the composition of a business unit’s market and competitive actions change over time (Jaworski and Kohli, 1993). These two scales contained six items each. They were assessed on a seven-point Likert-type scale ranging from 1 ¼ strongly disagree to 7 ¼ strongly agree. Resource orientation refers to the extent to which a firm creates behaviours that are required to identify, apply and accumulate unique and valuable resources that create sustainable and superior value for the firm. The scale was applied from Paladino (2006). As a result of its relative novelty, more details are provided regarding this scale than the alternate measures that were applied in this study. The RO scale was developed from a behavioural perspective to assess the extent to which a firm pursues a RBV. It assesses what organisations do with regard to developing and deploying resources. Drawing on the literature and following extensive pretests, 21 items were used to measure RO. Three factors emerged from the tests as significant and consistent with the literature. These were: (1) uniqueness; (2) synergy; and (3) dynamism. The scale was assessed on a seven-point Likert-type scale ranging from 1 ¼ strongly disagree to 7 ¼ strongly agree. The scale satisfied all exploratory factor, confirmatory factor analysis (CFA) and reliabilities analyses, with results complementing those of the pilot testing that was used. These lend support to the contention that RO is well measured by the three factors. Examples of the scale items that were used for the dimensions of uniqueness, synergy, and dynamism, respectively, include: “We constantly strive to ensure that our resources cannot be easily identified by competitors,” “We work to ensure our resources span (provide benefits) to several departments,” and “We work to ensure our resources act as triggers for collaborative problem solving with stakeholders”. Four performance outcomes were evaluated. Three objective and frequently-used measures of performance were employed in this study: ROC, ROS, and market-share growth. These single-item scales were adapted from McDougall et al. (1994), and were assessed on a seven-point Likert-type scale ranging from 1 ¼ much worse than competitors to 7 ¼ much better than competitors. Customer outcomes are often neglected in such studies. As a result, customer satisfaction was incorporated in the study using a scale adapted from Jap and Ganesan (2000). This scale comprised three

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items, and was assessed on a seven-point Likert-type scale ranging from 1 ¼ much worse than competitors to 7 ¼ much better than competitors. Consistent with past research, control variables were used to examine their effects on firms across a cross section of industries (e.g., Narver and Slater, 1990; Jaworski and Kohli, 1993). Doing so also responds to Foss and Knudsen (2003) who attest that control variables are necessary to include in empirical research. They claim that “a regression that omits a control for additional conditions will typically show biased and weaker effects” (Foss and Knudsen, 2003, p. 299). Hence, the inclusion of control variables “provides a more precise specification of the causal chain through which a sustainable competitive advantage is expressed” (Foss and Knudsen, 2003, p. 299). Two control variables were used in this study. The first was quality, which is defined as the extent to which the business units’ products meet the needs and wants of customers relative to its competitors (Ittner and Larcker, 1997). This single-item scale was adapted from Keller and Aaker (1992), and was assessed on a seven-point Likert-type scale where 1 ¼ lower quality, and 7 ¼ higher quality. The second control variable used was business unit size. This refers to the number of employees in the business unit, and was adapted from Schoenecker and Cooper (1998). It was measured using a ratio response format. This variable was log transformed. A pretest was first conducted to determine face validity. We then assessed measure reliability and validity using exploratory factor analysis (EFA) and CFA using LISREL. The results supported both discriminant and convergent validity for all constructs. We subjected resource orientation, capability dynamism and resource sustainability, competitive intensity and market turbulence, and customer satisfaction to CFA to test the underlying structure identified (Gerbing and Anderson, 1988). Briefly, the following results were attained: . for RO, the goodness-of-fit ðGFIÞ ¼ 0:95, root mean square error of approximation ðRMSEAÞ ¼ 0:07, comparative fit index ðCFIÞ ¼ 0:97; . for capability dynamism and resource sustainability, GFI ¼ 0:91, RMSEA ¼ 0:10, CFI ¼ 0:94; . for market turbulence and competitive intensity, GFI ¼ 0:91, RMSEA ¼ 0:09, CFI ¼ 0:90; and . for customer satisfaction, GFI ¼ 0:91, RMSEA ¼ 0:00, CFI ¼ 1:00. The fit indices indicate a good fit and meet the benchmarks suggested by the literature (Baumgartner and Homburg, 1996). Table I reports the correlations, Cronbach’s alpha, composite reliability and average variance extracted of all variables. The Cronbach alpha’s for the six constructs ranged from 0.70 to 0.94, with composite reliability ranging from 0.69 to 0.94, and average variance extracted from 32 per cent to 65 per cent. Discriminant validity was assessed using two different techniques. First, following the recommendations put forth by Bagozzi and Yi (1988), we constrained and then freed the phi coefficients for all possible pairs of constructs under study. Then, the difference between the x 2 of the constrained model and the x 2 of the unconstrained model (with one degree of freedom) was calculated. For instance, a significant x 2 difference (10.74) was obtained for the pair of constructs resource sustainability and capability dynamism. For all pairs of constructs, the x 2 difference was significant,

Resource orientation Competitive intensity Market turbulence Resource sustainability Capability dynamism ROC ROS Market share growth Customer satisfaction

4.57 3.15 3.49 3.86 4.73 4.84 4.94 4.84 4.94

Mean 1.04 1.21 1.07 1.33 1.09 1.32 1.22 1.62 1.23

SD 0.94 0.82 0.69 0.86 0.90

0.80

0.83

CR

0.84 0.82 0.70 0.85 0.90

a

0.58

0.65 0.49 0.32 0.60 0.64

AVE 1 0.04 2 0.28 * * 0.46 * * 0.47 * * 0.33 * 0.17 0.26 * 0.41 * *

1 1 0.24 * * 0.19 * * 0.10 20.33 * 20.06 20.04 * 0.01

2

1 0.02 0.01 2 0.10 2 0.04 0.15 2 0.09

3

1 0.26 * * 0.24 0.18 0.29 * 0.38 * *

4

1 0.32 * 0.14 0.23 0.42 * *

5

CR ¼ composite reliability; AVE ¼ average variance extracted

8

1 0.60 * *

7

1 0.75 * * 0.58 * *

1

9

a ¼ Cronbach’s Alpha;

1 0.68 * * 0.50 * * 0.042 * *

6

Notes: * Correlation is significant at the 0.05 level (one-tailed); * * Correlation is significant at the 0.01 level (one-tailed);

1. 2. 3. 4. 5. 6. 7. 8. 9.

Descriptive statistics

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Table I. Descriptive statistics

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falling above the critical value of 3.84, despite the loss of one degree of freedom. The constructs with the free (unconstrained) phi coefficient were all found to fit the data far better than those with a fixed coefficient. This supports the presence of discriminant validity. Discriminant validity was also assessed by comparing the squared correlations for all pairs of constructs under study with the AVE for each construct (Fornell and Larcker, 1981). In all cases, the AVE for each construct exceeded the squared correlation between construct pairs, thus indicating discriminant validity. Results Moderated regression analysis was conducted on the hypothesised relationships. Table II provides a summary of the moderated regression results for the antecedents of RO. H1 predicted that the greater the resource sustainability, the greater the RO. Resource sustainability is significantly and positively related to RO (b ¼ 0:383, p , 0:01). H1 is supported. H2 predicted that the greater the capability dynamism, the greater the RO. Capability dynamism is significantly and positively related to RO (b ¼ 0:384, p , 0:01). H2 is supported. H4 predicted that the relationships between resource sustainability and RO and between capability dynamism and RO would remain robust across different market conditions (namely competitive intensity and market turbulence). None of the four moderated relationships were significant, so H4 is supported. Also, neither of the control variables were significant. Table III provides a summary of the moderated regression results for the consequences of RO. H3 predicted that RO will have a positive effect on performance. Resource orientation Independent variables

Table II. Moderated regression analysis: standardised regression coefficients

b

t

Control variables Quality Business unit size

2 0.03 0.07

2 0.35 1.011

Direct effects Resource sustainability (A) Capability dynamism (B) Market turbulence (C) Competitive intensity (D)

0.383 0.384 0.299 2 0.018

5.305 * 5.225 * 4.080 * 2 0.248

Interaction effects A£C B£C A£D B£D R2 Adjusted R 2 F

0.046 2 0.019 2 0.005 0.062 0.442 0.398 10.122 * *

0.666 2 0.262 2 0.073 0.892

Notes: * p # 0:01; * * p # 0:05 (one-tailed test)

0.69 1.29 2 0.78

0.13 0.30 2 0.15 0.216 0.054 1.34

0.48 20.05 0.309 0.163 2.110 * *

0.19

0.20 20.27

2.42 * * 2 0.66

0.38 2 0.13

b 0.42 20.17

t 1.31 * * * 2 0.57

ROC

0.22 2 0.10

b

Notes: * p # 0:01; * * p # 0:05; * * * p # 0:10 (one-tailed test)

Competitive intensity (C) Interaction effects A£B A£C R2 Adjusted R 2 F

Control variables Quality Business unit size Direct effects Resource orientation (A) Market turbulence (B)

Independent variables

ROS

0.07 0.17 0.13 0.226 0.067 1.419

2.13 * * 20.26

0.26 0.01

0.35 20.16

0.71 0.66

0.36

1.69 * * 0.04

2.08 * * 20.93

Market share growth b t

1.09

1.38 * * * 21.43 * * *

2.64 * 21.07

t

2 0.67 2 0.14 1.49 * * * 20.03 0.24 0.429 0.315 3.761 *

3.61 * 0.66

3.34 * 0.43

20.10

0.47 0.11

0.46 0.06

Customer satisfaction b t

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Table III. Moderated regression analysis (performance outcomes): standardised regression coefficients

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The results across a range of performance outcomes indicate that RO is significantly and positively related to performance (ROC: b ¼ 0:38, p , 0:05; ROS: b ¼ 0:20, p , 0:10; market share growth: b ¼ 0:26, p , 0:05; and customer satisfaction: b ¼ 0:47, p , 0:01). H3 is thus supported. H5 and H6 predicted that market turbulence and competitive intensity would strengthen the relationship between RO and performance. The results show that market turbulence strengthened the relationship between RO and only one indicator of performance, ROS (b ¼ 0:48, p , 0:05). H5 is thus partially supported. The results also show that competitive intensity had a marginally significant positive moderating effect on the relationship between RO and customer satisfaction (b ¼ :24, p , 0:10). Therefore, H6 is only partially supported. Of the two control variables, only quality was significant across the range of performance outcomes (ROC: b ¼ 0:22, p , 0:10; ROS: b ¼ 0:42, p , 0:01; market share growth: b ¼ 0:35, p , 0:05; and customer satisfaction: b ¼ 0:47, p , 0:01). Discussion The principal purpose of this research was to examine the relationships between resource and capability characteristics and RO. Our study has shown that capability dynamism and resource sustainability are two of these characteristics that suggest that a firm has a RO. Resources and capabilities are seen as the heart of a firm’s competitive position (Collis and Montgomery, 1995). Firms use a combination of both resources and capabilities when making strategic decisions (Eisenhardt and Martin, 2000; Makadok, 2001). The RBV focuses on the heterogeneity of firms, and looks at how these differences determine not only a firm’s choice of a particular strategy, but also how successfully the firm is able to implement and execute the strategy (Barney, 1991). Our results show that the characteristics of a firm’s resources and capabilities influence its ability to implement RO (i.e. practice a RBV). In fact, these were consistent with our hypotheses that predicted a positive and direct relationship between capability dynamism, resource sustainability and RO. Hence, all of our hypotheses were supported in this research. We recognise that there may be alternate factors that may impinge on this relationship and anticipate that this study may prompt further research and replication. An additional purpose of this research was to examine the relationships between resource and capability characteristics and RO under different market conditions. Moreover, we sought to assess the relationships between RO and performance in different market conditions. Barney (2001) admits that a valid criticism of his 1991 RBV article is its lack of analysis on the interaction between a firm’s resources and its competitive environment. Research has generally shown that a RBV is robust under different market conditions (Barney, 1991; Henderson and Cockburn, 1994). In fact, ever since Penrose (1959), unique resource bundles have been shown to confer a performance advantage to firms experiencing market conditions that are constantly changing. This ability to withstand these changing conditions has been attributed to robust resource bundles that depict distinct characteristics. This is in accordance with Cockburn et al.’s (2000) finding that a firm’s resources and capabilities enable a firm to armour itself against environmental changes and provide the necessary ammunition to shape their external environment. Consistent with our expectations, this study has shown that the relationships between capability dynamism, resource sustainability

and RO are robust in two of the major market conditions often shown to change the nature of resources in firms (Grant, 1998). The concepts tested in this study are central to the field of strategy. While we expected these results to emerge based on our comprehensive review of past research, it is rare that all hypotheses are empirically validated in the one study. While such results may simply be an artefact of the sample used, they still do provide an important basis from which further studies may emanate. Future research may also take a micro-view of the concepts tested in the study. Specifically, rather than test RO in its entirety, its dimensions (such as dynamism), could be assessed to determine their impact on performance. Alternatively, the relationship between the drivers and the dimensions of RO could also be evaluated. This would enable researchers to determine, for example, whether firms that possess resources with low imitability enjoy higher returns[1]. In doing so, the results would also enable senior managers to determine appropriate strategies to implement within the firm. Our research has been limited by a few elements that are common across many quantitative studies. The use of questionnaires as the sole method of data collection has been argued to be a contributor to common method variance. Ideally, a combination of methods, incorporating both quantitative and qualitative techniques should be used. Cross-sectional research enables us to only examine relationships at one point in time. As a result, we are unable to determine the development of relationships and therefore, causality. Only the use of longitudinal data would enable us to do so and to assess the robustness and generality of the model. Another limitation has to do with the use of a key informant approach. Some researchers argue that it is more beneficial for research conducted at the business unit-level to use a multiple informant approach (see Chen et al., 1993; Kumar et al., 1993). Using multiple informants within a business unit can enhance researchers’ understanding of the mechanisms, processes, and outcomes of the business unit’s strategy (Chen et al., 1993). Using multiple informants can also reduce informant bias, particularly on subjective performance-related questions (Kumar et al., 1993; Phillips, 1991). While there are no past studies on which to compare these findings, this study is a significant one in that it provides a benchmark upon which future studies can be based. While we have examined two of the dominant characteristics of resources in this study based on a comprehensive literature review, future research would be well served to examine if there are further characteristics that influence RO. In addition, examining all constructs under different settings would be beneficial. This could be a review of either different industries or country settings. Conclusion Our study sought to accomplish four objectives. First, we introduced and empirically examined the role of resource and capability characteristics as significant drivers of a RO (used as proxy for the implementation of the RBV). Building on this, the second objective of the paper was to analyse the effect of market conditions on the relationships between resource and capability characteristics and RO. Next., we assessed the relationship between RO and performance. Finally, we empirically tested the effects of RO on performance in different environmental settings. The results

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provide evidence of the significant role that characteristics play as drivers of RBV implementation. What was also of particular note was the robust nature of the relationships between capability dynamism and RO and resource sustainability and RO, which did not change in the presence of differing market conditions. The performance effects also presented noteworthy results demonstrating significant effects with all outcomes under investigation. Environmental conditions were also evaluated demonstrating a significant effect in some market conditions. These findings challenge the idea that specific resources and capabilities drive the implementation of the RBV and suggest that we need to examine further the characteristics that resources and capabilities possess that enable a firm to implement a RBV. Our results imply that these findings would be generalisable across industries. These characteristics enable the identification of unique resources and capabilities, something that has been an obstacle for the practice of the RBV (e.g., Conner, 1991). This study provides statistically significant findings that further enhance our knowledge of what is required to implement a resource-based strategy within an organisation. It goes further to demonstrate that there are significant financial and non-financial consequences as a result of the pursuit of a resource-focused strategy. Managers must be able to monitor industry conditions to evaluate their effects on these outcomes. This is pertinent for firms such as multinational enterprises, whose trade often takes place across multiple industries. To advance knowledge in this broad field of study, studies need to move away from analysing industry-specific capabilities and move towards industry-wide studies that assess resource/capability characteristics under turbulent conditions. It is only when this takes place that we can move towards truly assessing whether the RBV assists a firm to achieve a sustainable competitive advantage that is independent of industry effects. Note 1. The authors would like to thank the anonymous reviewers for this insight. References Alreck, P.L. and Settle, R.B. (1995), The Survey Research Handbook, Irwin, New York, NY. Amit, R. and Schoemaker, P.J.H. (1993), “Strategic assets and organizational rent”, Strategic Management Journal, Vol. 14 No. 1, pp. 33-46. Armstrong, J.S. and Overton, T.S. (1977), “Estimating nonresponse bias in mail surveys”, Journal of Marketing Research, Vol. 14 No. 3, pp. 396-402. Babin, B.J. and Griffin, M. (1998), “The nature of satisfaction: an updated examination and analysis”, Journal of Business Research, Vol. 41 No. 2, pp. 127-36. Bagozzi, R.P. and Yi, Y. (1988), “On the evaluation of structural equation models”, Journal of the Academy of Marketing Science, Vol. 16 No. 1, pp. 74-89. Barney, J. (1991), “Firm resources and sustained competitive advantage”, Journal of Management, Vol. 17 No. 1, pp. 99-119. Barney, J. (2001), “Is the resource-based ‘view’ a useful perspective for strategic management research? Yes”, Academy of Management Review, Vol. 26 No. 1, pp. 41-56. Barney, J.B. and Zajac, E.J. (1994), “Competitive organizational behavior: toward an organizationally-based theory of competitive advantage”, Strategic Management Journal, Vol. 15 No. 1, pp. 5-9.

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SECTION 5. HIERARCHICAL FIT

Levels of strategy and performance in UK small retail businesses Phil Megicks University of Plymouth, Plymouth, UK Abstract Purpose – This study aims to investigate the way in which small retailer performance is influenced by strategy at different levels. It also aims to propose that business level strategy is more important to success than functional level strategy in small retail firms, as this is what enables them to distinguish their business from competitors and effectively set about competing in their markets. Design/methodology/approach – Data were collected from a mail survey of 305 independent retailers in the UK. Multivariate statistical methods were used to develop appropriate variables and explore the relationships between level of strategy and performance. Findings – The results indicate that business level strategy variables have a significant influence on performance whereas functional levels do not when their combined effects are analysed using hierarchical regression modelling. Research limitations/implications – The caveats normally associated with survey methods apply, as do those related to the use of cross-sectional, self-report, and managerial perceptions data. Implications for retail strategy theory and small retailers’ performance are addressed. Practical implications – The importance of business level strategy generally and its specific elements are considered with a view to providing guidance to management decision makers and policy advisors. Originality/value – Reliable measures for retail strategy variables are developed in the paper. The research distinguishes the performance effects of retail business strategy from retail functional strategy and supports the view that business strategy decisions are superior in their market significance over operational retail mix decisions. Keywords Corporate strategy, Small enterprises, Retailers, Business performance, United Kingdom Paper type Research paper

Management Decision Vol. 45 No. 3, 2007 pp. 484-502 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745098

Introduction At the beginning of the twenty-first century the challenges facing small retail businesses in the UK have never been so daunting. The increased threat of the powerful multiple chains across all product sectors, changing demographic and technological conditions, and the evolution of customer purchasing patterns has meant that a strategic imperative exists for all businesses operating in this context to assess their business position. This has been highlighted by a recent parliamentary investigation of the future of the high street (APPSSG, 2006), which suggests that the landscape of retailing in the UK will change significantly if current trends pertain, and that the future existence of many small shops is threatened. Yet against this backdrop of well-documented problems for small retailers it is clear that many small shopkeepers run successful businesses and that such achievement is likely to stem from the

adoption of strategies appropriate to the market conditions that they face and their own unique capabilities or distinctive competences (McGee and Petersen, 2000). Of particular concern therefore to small retailer decision makers and policy advisors to the sector is the extent to which different strategies may influence performance. Indeed the very nature of strategy in these small enterprises has encountered only limited previous interest from researchers especially in the UK (e.g. Byrom et al., 2001; Megicks, 2001), and particularly with regard to how the strategy at different levels (Hofer and Schendel, 1978) might be influential in determining success or failure. It is our contention that given the competitive intensity of the retail industry and their limited resource base, smaller shops may have a tendency to focus attention on implementing operational “functional” level strategies revolving around the retail mix when faced by the day-to-day necessity to attract, satisfy, and keep customers. However this may be to the detriment of more medium and long-term thinking about how to compete in their markets which requires attention to “business” level strategies, and which may ultimately determine future performance outcomes (Conant and White, 1999). This paper investigates the proposition that business level strategy is essential to small retailer success by initially reviewing the extant literature on retail strategy, its relationship with performance and its specific application in a small retailer context. It then moves on to develop a classification of functional and business level strategy variables relevant to retail competition using data from small retail enterprises in the UK. Next the relationship between variables at the different levels and measures of store performance is analysed. The results of the study are then discussed and particular attention is given to implications of the research for theory and practice. Finally the limitations of the research are noted and areas for future investigation identified. Theoretical considerations Strategy in retailing A review of the retail strategy literature identifies only a relatively limited number of studies that have examined strategic behaviour in firms from an empirical standpoint (e.g. Park and Mason, 1990; Alexander and Veliyath, 1993). Within the existing body of work, researchers have tended to utilise approaches that concentrate on a particular aspect or level of strategy to form strategic types and in many instances examine their relationship with business performance (e.g. Conant et al., 1993; McGee and Petersen, 2000). The greater bulk of studies have adopted inductive approaches based around clustering techniques to identify post hoc strategic types (e.g. Hawes and Crittenden, 1984; Lewis and Thomas, 1990) and a small number of studies have used a priori approach to identifying pre-existing conceptual strategic types in retailing (e.g. Segev, 1987; Moore, 2005). In both instances however, establishing retail strategies has, in the main, been guided by the application of strategic positioning theory drawn from outside the retail sector at the business level, and its adaptation to a retail context at the functional level through the retail mix. This line of development is evidenced in some of the early inductive studies of retail business strategy where Porter’s (1980) generic strategy framework has been used as a basis for classification. A number of researchers have considered retailers’ strategic options in terms of differentiation, low cost and focus strategies (e.g. McGee, 1987; Wortzel, 1987; Dwyer and Oh, 1988; Helms et al., 1992). Consequent variations on

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generic strategy have emanated from such work including sales service and merchandise differentiation, and price leadership, together with combined low-cost and differentiation strategies. Others (e.g. Doyle and Cook, 1980; Walters and Knee, 1989; Park and Mason, 1990) on the other hand have broadly adapted the Ansoff (1957) product market approach to retailing which has given rise to business strategy options relating to productivity improvement, integration, consolidation, repositioning, market development, penetration, and diversification. In a more recent study by Moore (2005), the researcher applied the Miles and Snow (1978) theoretical typology to the retail sector and found some evidence to support the presence of three of the four strategic business level archetypes in the retail industry and a link with retail performance. Functional level strategy in retailing was investigated in a study by Hawes and Crittenden (1984) who derived competitive strategy types using cluster analysis of retail marketing activities and identified differences in performance between the groups. Furthermore, an alternative stream of research on retail strategy, which predominantly identifies variations in functional level retail strategy and performance, considered strategic groups of retailers in industry structure studies based on their scope of activities and resource allocation (e.g. Lewis and Thomas, 1990; Carroll et al., 1992; Flavian and Polo, 1999). Small retailer strategy Conventional normative assessment of strategy within the small retail business sector, particularly in the UK, has been developed against a backdrop of the limitations of the business form (see Kirby, 1986). Thus it is proposed that strategies should be adopted that avoid the low price and differentiation domain of the large retailer and emphasise a focused offer (Watkin, 1986). This is consonant with the accepted wisdom of small business strategists who propose customer service and product specialisation or customisation as appropriate strategic positions (Covin and Covin, 1990). Moreover, some commentators such as Berman and Evans (1989) have identified small retailers as having a strategic advantage in being able to adapt speedily to changing market conditions. Thus it is argued that configuring and implementing targeted strategies as a basis for success with no predetermined positioning being deemed preferential is a particular capability of these enterprises. Results of the sparse number of studies that provide empirical evidence of the strategies adopted by small retailers and their effects on performance tend to concur with this view in as much as they identify wide-ranging inductive strategic types at the functional level. This is indicated by the work of Fiorito and LaForge (1986), which considered the strategic use of retail marketing mix variables and identified differences in strategic type on this basis. Similarly Conant et al. (1993) adopted functional marketing strategies to define strategy types among small retailers and concluded that firms that choose to compete in clearly defined ways generally achieve superior levels of performance. This study was extended by McGee and Rubach (1996) to take account of environmental conditions in the retail strategy and performance relationship. Finally in a study by Megicks (2001), both business and functional level retail strategy variables were combined to define competitive strategy types amongst small retailers and draw associations with store performance. In so doing, although it was possible to identify strategies at different levels that distinguished better performing small retailers, it was not possible to assess their relative importance.

Research questions Drawing on the research to date it is clear that, although there have been a number of attempts to identify the way that strategy is shaped in the retail sector and to judge the extent to which performance relates to types of strategy adopted, the relative significance of different levels of strategy has yet to be evaluated. Variation in research design and the market sector studied has led to equivocal results in defining the hierarchy of retail strategies and their importance in terms of business success. In the small retailer segment of the market, where the vast majority of firms compete and where the pressure of competition is at its peak, there is a gap in the research to define strategy at the business as well as the functional level and evaluate the extent to which performance is influenced by their relative effects. Following previous lines of investigation presented above the current research adopts an approach that considers comprehensive business-level strategies within the small retail sector which focus on how firms compete in their chosen business in conjunction with functional-level strategy that focuses on the operational aspects of delivering those strategies in the market. The nature of small retail businesses requires that success is dependent on delivering value to customers and at the functional-level this is encapsulated in the retail marketing mix strategies adopted. The emphasis is therefore on the marketing dimension of strategy in the retail mix at the operational level which dominates competitive behaviour and subsumes all other functional areas in the way that offers are configured and delivered to customers in support of the specific business-level strategies pursued (see Park and Mason, 1990). Thus given the need to examine the nature of strategy in a small retailer context along with the way in which strategy influences the performance of small retail businesses, this research develops measures for retail strategies at different levels and assesses their relative impact on store performance. It specifically addresses the following two research questions: (1) Within the context of small retail firms, what strategic alternatives are available at the functional and business level? (2) What is the relationship between retail strategies at the different levels and small retailer performance? Research methodology Sample and data collection A postal survey of 2,000 owner-managers of a cross-section of independent retail businesses in urban in rural locations in the UK was administered using a two-wave mailing regime. A random sample of retail businesses with fewer than ten outlets (the UK definition of independent retailers) across a range of product market sectors was drawn from a Dun & Bradstreet MarketPlace database. Standard approaches to maximising responses were adopted including a covering letter explaining the significance of the study to understanding the factors affecting small retailer performance and the promise of a copy of the study results to each respondent. Survey instrument and measures The research instrument used to elicit retail strategy in respondent firms was based on an adaptation of two previous studies which explored operational methods of retail competition and small retailer strategic types: Conant et al. (1993) and Megicks (2001). The

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questionnaire included multiple item batteries of statements relating to retail functional strategy (31) and retail business strategy (20) measured on 1 to 7 Likert-type scales assessing the degree of emphasis placed on each within the business. In addition four separate subjective self-report business performance measures for overall performance, change in turnover, change in return on investment (ROI) and change in customer retention were employed which were adapted from past research in the small retailer field (Conant et al., 1993; Kara et al., 2005). Additional data were collected for descriptive analysis and control purposes relating to business and respondent characteristics. The adoption of this approach is in harmony with many previous studies of this type and permits the multivariate analysis of the nature and effects of strategy using the large data sets that self-report measures permit (Hambrick, 1980). Previous research also supports the use of subjective managerial assessments of retail performance based on the understanding that they are quite consistent with secondary published performance data external to the business (Venkatraman and Ramanujam, 1986) in addition to objective performance data internal to the business. Analysis and results Response rates and descriptive statistics In total 305 usable questionnaires were obtained representing an effective response rate of 16.6 per cent (returned survey packets, incomplete questionnaires, and businesses reporting themselves ineligible/no longer trading were discounted). Comparison of key study variables between mailings using appropriate comparison tests at the 0.05 level indicated no significant differences between the two waves, which satisfied concerns of non-response bias as suggested by Armstrong and Overton’s (1977) extrapolation technique. Nearly half of the respondents (49 per cent) described themselves as proprietors, 30 per cent as partners, 16 per cent as directors, and only 5 per cent as managers of the retail businesses surveyed. Approximately 31 per cent were female and 69 per cent male, and the average age of respondents 50 years. The mean number of outlets was 1.2 with 70 per cent of all respondents operating from a single outlet. Annual sales turnover averaged around £410,000; responding businesses employed over five staff and had been running for approaching 16 years on average. Data analysis Survey data were analysed in a two-stage approach which initially involved classifying retail strategy variables at the functional and business level by means of factor analysis and reliability evaluation. Subsequently the relationship between retail strategy and performance was investigated using multiple regression analyses to assess the relative impacts of retail strategies at different levels. Distinguishing retail strategy variables In order to clarify the nature of strategic retailing behaviour at different levels amongst small retailers, factor analysis was adopted to identify distinct aspects of retail functional and retail business strategy. Analysis was undertaken separately for the two different levels of strategy using 31 and 20 items respectively adopting a principal components method with varimax rotation in both cases. Factors were extracted using scree plot inspection and identifying factors with eigen values greater than 1.0. Further

refinement of the variables was undertaken using criteria for scale reliability analysis assessing Cronbach’s alpha coefficients for the resultant scales with items deleted, item-to-total correlations, and the cross-loading of items on different factors (Hair et al., 1998). Consequently items were dropped from further analysis if the reliability of the resultant factors were improved. The results of these analyses are presented in Tables I and II; deleted items are indicated in italics. A total of seven separate internally consistent functional strategies were identified for small retailers and were labelled accordingly based on the nature of the items loaded on each. High quality merchandise and service (RFS1) defines an operational focus on top-end product and full service support for customers. The second factor, store operations and product uniqueness (RFS2), puts an emphasis on the internal feel

Retail functional item Customer service Links with suppliers After-sales service Pre-sales advice High quality merchandise Higher priced lines Ordering service Returns and exchange Card payment facilities Layout and merchandise presentation Lighting and sound Staff training Store location Stocking different products Lower priced lines Range of products High stock levels Selection in range Traditional merchandise Internet-based promotion Computerised sales and purchasing Direct mail advertising Credit terms Promotional offers Sales Advertising in press Involvement in community Sponsorship of local events Supplier merchandising support Stocking recognised brands Up-to-date lines

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Retail functional strategy factor loadings (n ¼ 305) RFS1 RFS2 RFS3 RFS4 RFS5 RFS6 RFS7 0.690 0.678 0.633 0.605 0.578 0.475 0.453 0.388 0.371 0.743 0.728 0.668 0.638 0.522 0.673 0.641 0.625 0.576 0.562 0.732 0.686 0.623 0.562 0.767 0.665 0.526 0.734 0.679 0.638 0.573 0.493

Notes: The extraction method was principal components analysis with Varimax rotation and Kaiser normalisation. The total variance explained was 57.47 per cent. Loadings under 0.35 have been suppressed. The Kaiser-Meyer-Olkin measure of sampling adequacy was 0.791. Bartlett’s test of sphericity Approx. Chi-square = 3,404.624 (significance = 0.000). Communalities range from 0.347 to 0.751

Table I. Factor analysis results for retail functional strategy variables

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Table II. Factor analysis results for retail business strategy variables

Retail business item Grown from high quality service Grown from serving new customers Retain customer loyalty through service Clear view of customers and what is offered Consolidated by closing outlets Grown by integration Grown by opening new stores Grown by introducing mail order Consolidated by increasing efficiency Consolidated by cutting costs Clear positioning compared with competitors Compete through a specialist range Compete through a unique range Compete through exclusive distribution Low costs from supplier relations Low costs from efficiency Cut prices to improve competitiveness Expanded by diversifying Grown by widening range Changed with customer needs

Retail business strategy factor loadings (n ¼ 305) RFS1 RFS2 RFS3 RFS4 RFS5 RFS6 0.861 0.809 0.698 0.637 2 0.411 0.794 0.738 0.643 0.815 0.804 0.488 0.783 0.693 0.639 0.825 0.722 0.664 0.770 0.668 0.503

Notes: The extraction method was principal components analysis with Varimax rotation and Kaiser normalisation. The total variance explained was 64.47 per cent. Loadings under 0.35 have been suppressed. The Kaiser-Meyer-Olkin measure of sampling adequacy was 0.884. Bartlett’s test of sphericity Approx. Chi-square ¼ 2,082:939 (significance ¼ 0:000). Communalities range from 0.493 to 0.781

of the store, its location, and the difference of its products. Product range and low price (RFS3) conveys a functional strategy that concentrates on the availability of standard products at prices set below the competition. Factor four, online and direct marketing (RFS4), reflects a combination of computerised selling, purchasing, and direct marketing, and indicates more innovative strategic operations amongst small retailers that have adopted internet-based activities. Sales promotion (RFS5) is a standard combination of marketing communications methods in retail businesses. The sixth factor, local involvement (RFS6), indicates that the retailer is engaged with the local community particularly through sponsorship opportunities. The final factor brand merchandising (RFS7), highlights an emphasis on the provision of up-to-date, branded products which are supported through in store merchandising by suppliers. The refined variables achieved Cronbach’s alpha coefficients ranging from 0.65 to 0.78 which are above the acceptable threshold of 0.60 (Finkelstein, 1992) for assessing internal consistency in research of this type where scale development is not the primary intention of the study (McDougall and Robinson, 1990). Retail business strategy amongst small retailers may be characterised in six ways according to the analysis undertaken in this research. Customer service focus (RBS1) indicates an emphasis on growth through a targeted high quality retail service provision resulting in retaining existing and capturing new customers. The second retail business strategy factor, channel expansion (RBS2), identifies the business

growing through managing its channels including integrating activities, new store openings, and mail order. Third, consolidation (RBS3) emphasises cost reductions and efficiency savings as a strategic option. Specialisation (RBS4) suggests a focus on the uniqueness and specialist nature of merchandise provided by a retailer. The fifth factor, low cost (RBS5), indicates striving for lower costs and a low price competitive positioning based on efficiency and supplier relations. The last retail business strategy to be revealed is diversification (RBS6) through expanding the range of merchandise offered and changing the business in line with evolving customer needs. Cronbach alpha results for these variables varied from 0.63 to 0.84 and were similarly deemed internally consistent on the same basis as the functional strategy variables.

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Retail strategy and performance The models used to establish associations between retail strategy and performance were based on ordinary least squares regression using the enter method to identify independent effects and a hierarchical regression routine to identify combined effects of the two sets of variables. Descriptive statistics for the independent and dependent variables that formed a basis for the regression undertaken are provided in Table III. Pearson’s product moment correlation coefficients between the main study variables and the performance measures are presented in Table IV. The pattern of correlations Number of items

Cronbach’s a coefficient

Mean

SD

Retail functional strategy variables RFS 1: high quality merchandise and service RFS 2: store operations and product uniqueness RFS 3: product range and low price RFS 4: online and direct marketing RFS 5: sales promotion RFS 6: local involvement RFS 7: brand merchandising

9 5 5 3 3 2 3

0.78 0.78 0.72 0.69 0.73 0.65 0.67

5.21 5.26 5.22 2.67 3.41 4.26 4.94

1.12 1.16 1.10 1.63 1.69 1.60 1.46

Retail business strategy variables RBS 1: customer service focus RBS 2: channel expansion RBS 3: consolidation RBS 4: specialisation RBS 5: low cost RBS 6: diversification

4 3 2 2 3 3

0.84 0.65 0.74 0.71 0.63 0.66

5.72 2.93 4.12 4.66 3.64 4.55

1.09 1.04 1.57 1.81 1.42 1.40

Performance measures Overall performance Change in turnover Change in ROI Change in customer retention

1 1 1 1

– – – –

5.18 4.94 4.39 5.08

1.24 1.51 1.43 1.35

Control variables Years running business Number of staff Number of outlets

– – –

– – –

15.70 5.20 1.22

11.26 7.21 0.90

Table III. Regression variable definition and statistics

Table IV. Correlations of strategy and performance variables (n ¼ 305)

RFS 1 RFS 2 RFS 3 RFS 4 RFS 5 RFS 6 RFS 7 RBS 1 RBS 2 RBS 3 RBS 4 RBS 5 RBS 6 Overall performance D turnover D ROI D Customer retention 0.16 * * 0.15 * * 0.19 * *

0.20 * * * 0.28 * * * 0.28 * * * 0.29 * * *

0.15 * * 0.21 * * * 0.21 * * *

0.30 * * *

0.18 * *

0.16 * * 0.31 * * * 0.27 * * * 0.45 * * * 0.32 * * * 0.09 0.16 * * 0.10 0.26 * * * 0.38 * * *

3

0.47 * * * 0.46 * * * 0.47 * * * 0.34 * * * 0.23 * * * * * * 0.33 0.33 * * * 0.37 * * * 0.30 * * * 0.48 * * * 0.43 * * * * * * 0.54 0.38 * * * 0.03 0.04 0.20 * * 0.08 0.40 * * * 0.26 * * * 0.07 20.03 0.37 * * * 0.35 * * *

2

0.03

0.07 0.09 0.16 * *

0.43 * * * 0.13 * 0.28 * * * 0.14 * 0.19 * * 0.15 * 0.10 0.06 0.17 * *

4

0.13 *

0.12 * 0.14 * 0.20 * *

0.28 * * * 0.47 * * * 0.19 * * 0.17 * * 0.11 * 0.03 0.28 * * * 0.29 * * *

5

7

8

0.15 * *

0.12 * 0.15 * * 0.11 0.09

0.13 * 0.15 * * 0.16 * *

0.48 * * *

0.33 * * * 0.43 * * * 0.37 * * *

0.34 * * 0.18 * 0.25 * * * 0.36 * * * 0.13 * 2 0.07 0.08 0.08 0.29 * * * 0.05 20.04 0.40 * * * * 0.08 0.14 0.14 * 0.26 * * * 0.28 * * * 0.51 * * *

6

10

11

20.02

0.14 * 0.04 0.04

0.04

0.03 0.02 0.04

0.23 * * *

0.08 0.13 * 0.20 * * *

0.17 * * 0.03 0.14 * 0.15 * * 0.30 * * * 20.10 * * 0.17 0.22 * * * 0.33 * * *

9

0.03

0.08 0.07 20.01

0.22 * * *

12

14

15

0.26 *

16

0.44 * * * 0.70 * * * 0.58 * * *

0.18 * * 0.31 * * * 0.54 * * * 0.25 * * * 0.50 * * * 0.64 * * *

13

Notes: * Correlation is significant at the p , 0:05 level (two-tailed); * * Correlation is significant at the p , 0:01 level (two-tailed); * * * Correlation is significant at the p , 0:001 level (two-tailed). Correlations between control variables and other variables are not shown

15. 16. 17.

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14.

1

492

Variable

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shows associations between variables at the same level and at different levels and also relationships between the strategy variables and the performance measures. Although there are some instances of quite significant correlations between variables they are not indicative of multicollinearity (. 0.8 as proposed by Field (2005)). Moreover such patterns provide insights into the way in which functional level strategies and business level strategies are inter-related and how they separately and jointly contribute to small retailer performance, which is further examined in the regression analyses that follow. Independent effects. In the first run of regression models separate analyses were undertaken for the effects on the four performance measures of the retail functional and retail business strategy variables; three business descriptor variables were also included in the models as control variables. The results of the analyses at the different levels of retail strategy are outlined in Table V. Independent effect models for the functional strategy variables are distinguished by their low levels of explanation of variance in the dependent variable (as depicted by the adjusted R 2) with only the customer retention model displaying a respectable level of explanation (0.132); the other three models all explain less than 10 per cent of the variance in their respective dependent variable. The models for the business strategy variables are however more robust and explain a greater proportion of variance in the dependent variables. The adjusted R 2 values range from 0.125 to 0.233 and can be considered acceptable indicators of relationship in exploratory research of this type. The limited explanatory power of the overall models is reflected in the independent effects of the functional level variables on performance with only five independent effects being significant across all the models. The RFS2 variable is significant in the models for turnover (b ¼ 0:181, p , 0:01), ROI (b ¼ 0:173, p , 0:01), and customer retention (b ¼ 0:172, p , 0:01). In addition in the customer retention model the RFS1 (b ¼ 0:288, p , 0:001) and RFS7 (b ¼ 20:149, p , 0:05) variables are also significant, the latter being negatively related to performance. Summarising these effects, there is a generally positive effect of store operations and product uniqueness on small retailer performance. Furthermore, there is also a significant positive association between high quality merchandising and service and customer retention and a negative effect of brand merchandising and customer retention. In the business strategy models, however, although substantially more variance is explained, only two more significant effects are present but higher b values are apparent. In all four of the models the RBS1 variable is highly significantly associated with performance: overall (b ¼ 0:400, p , 0:001), turnover (b ¼ 0:409, p , 0:001), ROI (b ¼ 0:333, p , 0:001), and customer retention (b ¼ 0:458, p , 0:001). In addition RBS2 varies significantly with overall performance (b ¼ 0:178, p , 0:01), and both overall performance and turnover are significantly and negatively affected by RBS3. From these results there is clear evidence to suggest that customer service focus is strongly and positively associated with the performance of small retailers. Channel expansion strategy is also positively related to the overall performance measure, and a Consolidation business strategy appears to be negatively associated with overall performance and the turnover measure. The contrast in the capability of the two separate sets of strategy factors to assess variation in the dependent variables is apparent when the R 2 values are compared for

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Table V. Regression results (independent effects): retail functional and business strategies and performance (n ¼ 305) 0.041 0.074 2 0.021 0.400 0.178 2 0.121 2 0.052 0.028 2 0.018

0.742 1.254 2 0.347 5.827 * * * 3.074 * * 2 1.997 * 2 0.840 0.481 2 0.277 5.824 * * * 0.125 0.101 32.896 * * *

1.081 0.139 0.311 0.643 1.788 0.855 2 0.394 0.363 0.578 0.109 1.755 0.024 20.131 0.129 20.008 0.409 0.046 20.118 20.035 0.017 0.122

20.148 0.126 0.013 0.119 0.181 0.004 20.037 0.021 0.041 20.007

t

22.495 * 2.317 * 20.141 6.333 * * * 0.849 22.075 * 20.607 0.304 1.953 10.714 * * * 0.223 0.133 54.545 * * *

2.640 * * 2.019 0.212 1.650 2.637 * * 0.060 20.576 0.312 0.668 20.100 4.018 * * * 0.090

D turnover

20.053 0.129 0.001 0.333 0.048 20.073 0.070 20.037 0.066

20.069 0.085 0.020 0.095 0.173 0.058 0.030 0.083 20.014 20.039

b

t

20.967 2.211 * 0.009 4.914 * * * 0.830 21.230 1.158 20.643 1.006 6.789 * * * 0.146 0.067 30.187 * * *

21.220 1.361 0.336 1.309 2.508 * * 0.846 0.460 1.215 20.233 20.543 3.613 * * * 0.079

D ROI

Notes: Standardised regression coefficients are displayed in the table; Significance: * p , 0:05, * * p , 0:01, * * * p , 0:001

Retail business strategy Running Staff Outlets RBS1 RBS2 RBS3 RFS4 RFS5 RFS6 F-value Adjusted R 2 Difference in R 2 F-value for difference in R 2

0.008 0.070 0.019 0.048 0.127 0.060 2 0.027 0.025 0.037 0.008

b

2 0.166 0.049 0.009 0.458 0.004 2 0.091 0.065 0.002 0.027

2 0.142 0.052 0.028 0.288 0.172 0.032 2 0.124 0.074 0.025 2 0.149

2 2.213 0.891 0.168 7.125 * * * 0.078 2 1.614 1.129 0.036 0.443 11.245 * * * 0.233 0.101 37.228 * * *

2 2.594 0.855 0.477 4.088 * * * 2.571 * * 0.488 2 1.957 1.117 0.414 2 2.153 * 5.625 * * * 0.132

D customer retention b t

494

Retail functional strategy Running Staff Outlets RFS1 RFS2 RFS3 RFS4 RFS5 RFS6 RFS7 F-value Adjusted R 2

Overall performance b t

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each of the models and the performance outcomes. The F-value test of the difference between the R 2 for the business and functional strategies regression models in each instance indicates highly significant results which suggests that the business level strategy is superior in explaining differences in performance. Combined effects. To ascertain the combined effects of the two sets of variables, hierarchical regression analysis (Neter et al., 1996) was employed which involved initially entering the retail functional strategy variables in the four performance models. The retail business strategy variables were then also entered in a separate run of the same four models. The result of this type of analysis enables the effects of the two sets of variables to be evaluated in a combined model and also assesses the extent of the relative influence of the two sets of effects through identifying the significance of the change in R 2 between the first and second models. Table VI presents the results of the combined regression and hierarchical analysis for the four performance dependent variables models. In all instances the analysis reveals a major distinction between the influence of the functional level variables and the business level variables on retail performance. When combined with the business level variables none of the functional level variables have a significant effect on performance for any of the outcome measures. In contrast a number of business level variables have significant effects in the various models. Indeed all the significant effects remain the same as in the independent models for the business level variables and the independent effects previously apparent in the functional models, have now been superseded by the business level effects. Further, the change in the R 2 value for all four hierarchical models is highly significant (p , 0:001) which indicates that adding the business level variables into the regression after the functional level variables has a significant impact on the models’ explanatory power. In assessing the combined effects there is potential for the previously significant effects displayed at the functional level to have been eliminated due to multicollinearity with the business level factors, thus not enabling the separate effects of all variables to be distinguished. However in the analysis undertaken here advanced diagnostics methods used to investigate the existence of multicollinearity in regression models detected no such problem. The variance inflation factors and tolerance levels were inspected for all variables in the combined effect models and came within the accepted bounds proposed by Neter et al. (1996). The tolerance levels for each variable were well within the recommended cut-off value (0.10), with the minimum value at 0.416. The variance inflation factors were also all far below the recommended cut-off value (10), with the highest value at 2.406. Discussion and implications The purpose of this study was to identify strategies adopted at different levels by small retailers and investigate the comparative effects on business performance in this context. The findings of the analysis undertaken suggests that a hierarchy of effects exists in the relationship between strategy and performance with business level strategy providing a superior basis for understanding small shop performance compared with functional strategy. This is supported through a comparative analysis of the independent effects of strategies at the different levels on performance, but more importantly by an analysis of the combined effects, which affords greater explanation of variation in performance when the business level strategies are included. Therefore

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Table VI. Regression results (combined effects): retail functional and business strategies and performance (n ¼ 305) 0.943 1.086 20.370 20.904 1.429 0.444 20.339 0.199 20.321 0.149 5.369 * * * 2.909 * * 21.912 * 20.630 0.444 20.605 3.478 * * * 0.115 0.106 * * * 5.185 * * *

2 0.114 0.119 2 0.006 2 0.067 0.121 2 0.047 2 0.004 2 0.008 0.031 0.007 0.410 0.036 2 0.114 2 0.031 0.037 0.109

t 22.121 * 2.041 * 20.107 20.849 1.807 20.706 20.064 20.118 0.507 0.104 5.810 * * * .604 21.993 * 20.493 0.632 1.668 6.938 * * * 0.216 0.137 * * * 7.600 * * *

D turnover 20.038 0.094 0.001 20.105 0.089 0.063 0.047 0.096 20.009 0.006 0.332 0.034 20.071 0.086 20.061 0.019

b

t 2 0.677 1.551 0.022 2 1.287 1.287 0.912 0.730 1.408 2 0.147 0.086 4.522 * * * 0.545 2 1.190 1.296 2 0.985 0.282 4.420 * * * 0.153 0.089 * * * 4.451 * * *

D ROI

Notes: Standardised regression coefficients are displayed in the table; * p , 0:05, * * p , 0:01, * * * p , 0:001

0.054 0.067 20.023 20.076 0.102 0.031 20.022 0.014 20.021 0.011 0.403 0.186 20.117 20.043 0.028 20.042

b

2 0.109 0.052 0.017 0.071 0.099 0.017 2 0.092 0.070 0.044 2 0.116 0.420 0.001 2 0.084 0.030 2 0.003 0.005

22.054 * 0.908 0.305 0.913 1.504 0.258 21.507 1.090 0.712 21.713 6.037 * * * 0.022 21.479 0.479 20.050 0.084 6.938 * * * 0.278 0.131 * * * 7.459 * * *

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Running Staff Outlets RFS1 RFS2 RFS3 RFS4 RFS5 RFS6 RFS7 RBS1 RBS2 RBS3 RBS4 RFS5 RFS6 F-value Adjusted R 2 Change in R 2 Change in F-value

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from undertaking the hierarchical analysis it is possible to substantiate the view that business level strategy is an essential contributor to success in small retail businesses. This is very much in keeping with the belief that if small shopkeepers have a clear understanding of how to compete in their markets and distinguish themselves from competition then they will reap the performance benefits (Robinson et al., 1986; Conant and White, 1999). Notwithstanding this overall conclusion it is also possible to assess the specific effects of individual strategies at the two levels considered, albeit that in the case of retail functional strategy this can only be regarded as indicative of a situation where decisions are made in isolation from business strategy. At an operational level therefore it is worth noting the positive effects of store operations and product uniqueness on all-round performance, and the positive and negative effects of high quality merchandising and service and brand merchandising on customer retention respectively. The business level results are however much more meaningful as they are consistent across independent and combined effect models. It is clear that a customer service focus business strategy is an important factor in influencing small retailer performance across the board. This supports both the conventional view that growth and success can be derived from a focused approach, together with a pragmatic understanding of small retailer capabilities enabling the provision of high-level service quality. There also appears to be some support for the positive effect of channel expansion strategy on overall performance, which may satisfy the motivation of retailers to grow their business in this way. Interestingly results also suggest that consolidation is negatively associated with performance overall and change in turnover which may reflect the difficulties of operating under a tight cost and efficiency regime, and could preclude expansion and reduce sales growth opportunities. In addressing the two research questions there are a number of important implications for researchers, practitioners, and policy advisors. From a retail strategy research viewpoint, this study develops a set of functional and business level strategies that are indicative of competitive behaviour in the small retailer sector in the UK and in so doing makes a significant contribution to understanding levels of strategy in the UK small retail business sector which has not been examined empirically hitherto. Theoretically this provides a basis for further examination of retail activity across the sector particularly in terms of identifying the applicability of these strategies to individual retail product markets. Furthermore they may offer insights into whether such strategic distinctions are relevant to small retailers in different economies at varying stages of development, with perhaps less hostile and dynamic environments to cope with. This research also makes a contribution to understanding the relationship between strategy and performance in small retail businesses, and presents a clear indication of the superiority of business level strategy over functional level strategy in influencing business success. Within this it also suggests that hybrid business strategies which are defined by prevailing market circumstances and the firms’ capabilities to enable a distinctive positioning are likely to provide a platform for success. The managerial implications of this research are important as they offer small retail owner-managers insights into the nature of the strategic options that they potentially have at their disposal at the different levels and the way that these might contribute to their business performance. It indicates to decision makers in these small enterprises the importance of developing business level strategy which addresses the question

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“How do we compete in our markets?”, and the need to reflect on strategic direction rather than simply focusing in on operational aspects of their retail business functions. In the competitive retail environments that small shops reside it is all too easy to forego the big issue of business strategy for the expediency of day-to-day affairs, and consequently overlook the major determinant of long term success. Owner-managers must be aware of this and spend time and resource on understanding and enacting their business position based on clearly defined segmentation and targeting policies. The need for essential planning mechanisms are therefore apparent, which should stem from knowledge of the catchment area’s consumer behaviour and competitive conditions, and a clear vision of the particular benefits the store provides to its customers. Small shop decision makers should note that high performing businesses have grown through both attracting and keeping customers, and that superior service quality is a major factor in their success. Indeed it would appear that this is a prerequisite for success in the small shop sector as customers expect this to be a distinguishing feature in comparison with multiple operators, and that every effort should therefore be made to ensure that it is consistently delivered throughout the business. From this perspective there is a strong requirement for staff training in customer care, product knowledge, and in particular individualised customer attention. Moreover there may be opportunities to match the traditional skills of the shopkeeper in these respects with innovative approaches afforded by new information technologies when providing service, and also when planning the development of the future direction of the business. In so doing the significance of building relationships with customers over time should be underscored along with the complementary necessity of ensuring that good relationships with suppliers are maintained. The findings are also of significance to policy advisors including trade associations, business networks, government departments, and training agencies who offer guidance and support to the small retailer sector. Prominence should be given to an understanding of the superiority of business level strategies over those implemented at the functional level, and embedding this principle in business support mechanisms. The importance of a focus on satisfying specific customers” needs and service quality should also be stressed. The opportunities presented by channel expansion should also be highlighted to practitioners, as should the possible shortcomings of consolidation. In practical terms an integrated and accessible training programme for small shop owner-managers is required that replaces the current fragmented provision in the UK. National, regional, and local support agencies should provide funding for training current decision makers which ensures that they have the skills to enact business strategies through market knowledge processes, and implement them through relevant operational skills. In particular the importance of market research to clarify target customer groups and identify the dimensions of service quality that they value should be included in the skills development agenda of small shop managers. Similarly, as the independent retail sector is regarded as having low barriers to entry and therefore offers a relatively easy start-up opportunity for many potential entrepreneurs, there is a need for a programme of awareness building among this audience that concentrates on the significance of business strategy in future success. Given the time pressures on small shop managers and decision makers there is scope for informal support initiatives to be encouraged that enable networks of small retailers to be established

and business strategy to be facilitated. Such groups which at a local level can share market knowledge to enable better strategy development, can also promote operational effectiveness through exchanging good practice in key areas such as customer service and supplier relationship management. They may also provide a stimulus for innovative approaches to fulfilling customer needs through the merchandise and service offers that small shops use as a basis for distinguishing themselves from their larger rivals. With this in mind there appears to be an opportunity to share insights into the potential strategic response of small shops to an increasingly complex milieu of values that shape the retail environment which combine social, sustainable, and ethical proposes in addition to economic ones. In light of the recent parliamentary report into the future of small shops in the UK, this research may offer some direction to the continued debate as to the best way forward for small retailers, particularly as it may be possible to learn from those businesses in the sector that reap the rewards of clearly defined business level strategy. Equally, within the bounds of the constraints presented below, there are comparable lessons to be learned for small shop decision makers in other countries and the appropriate policy making bodies that mirror those of the UK. Whatever the stage of development of the retail sector in terms of its polarised structure and the growth of multiple players, the main findings of this research relating to the imperative of business strategy are likely to have relevant implications for the future success of small retail businesses in any nation. Limitations and directions for further research As with all empirical studies adopting this form of research design and analysis techniques there are methodological caveats that need to be added. In the first instance the limitation of the perceptual measures used and the collection of data from single informant in each organisation should be noted and future research would be strengthened by the surveying of multiple informants and the use of objective measures, particularly when gauging firm performance. Furthermore, because of the cross-sectional data used, causality between the performance and strategy measures cannot be firmly established which would require a future longitudinal study. The nature of the sample is that it covers all retail businesses but in a single geographical market limits generalisability of the findings to specific product markets in the sector and other national markets. In these cases the measures that we have derived may not be a valid representation of competitive activity and thus future research in particular product markets and in different countries may offer further evidence of the appropriateness and comprehensiveness of the scales developed. The results are also limited in their ability to explain variability in performance, which suggest the inclusion of additional explanatory variables in the models. One such set of factors could be the interaction effects of the strategies at the different levels on each other which have not been included in this research, and could be incorporated in a further study. As business environmental conditions are generally regarded as a key factor in influencing success and failure in small retail businesses further research should also be undertaken to understand the effects of the intensity of competition and the dynamics of the market. Moreover, the fit between strategy, environment, and performance is a potentially significant area for additional research especially the investigation of whether the identified relationships between strategy and performance are moderated by environmental conditions. It may be that there are variable effects of

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the levels of strategy on performance under different conditions, not only across the UK sector, but also in specific product and national small-scale retailing industries. This research focuses on the measurement of different types of strategic behaviour undertaken by small retailers and in that regard is presenting a derivative picture of the outcomes of the strategic process within these firms. Research to investigate how strategy at different levels is developed within small retailers would appear to be immensely important and in particular, given the findings presented here, understanding how business level strategy is formulated and put into practice in different environmental circumstances. Thus further routes of study are presented in the way that resources and capabilities, planning processes, information and knowledge management, and decision-maker orientation shape strategy internally and facilitate its effective implementation in the market. References Alexander, L. and Veliyath, R. (1993), “Matching competitive strategy with grocery store format: an investigation of the performance implications”, Journal of Strategic Marketing, Vol. 1, pp. 3-19. All-Party Parliamentary Small Shops Group Shops (APPSSG) (2006), High Street Britain: 2015, All-Party Parliamentary Small Shops Group Shops (APPSSG), House of Commons, London. Ansoff, H. (1957), “Strategies for diversification”, Harvard Business Review, Vol. 35, September-October, pp. 113-24. Armstrong, J. and Overton, T. (1977), “Estimating non-response bias in mail surveys”, Journal of Marketing Research, Vol. 14 No. 3, pp. 396-403. Berman, B. and Evans, J. (1989), Retail Management: A Strategic Approach, Macmillan, New York, NY. Byrom, J., Medway, D. and Warnaby, G. (2001), “Towards a typology of rural retailing strategies: evidence from the Uists, Proceedings of the Academy of Marketing Conference, Cardiff. Carroll, C., Lewis, P. and Thomas, H. (1992), “Developing competitive strategies in retailing”, Long Range Planning, Vol. 25 No. 2, pp. 81-8. Conant, J. and White, J. (1999), “Marketing programme planning, process benefits, and store performance: an initial study among small retail firms”, Journal of Retailing, Vol. 75 No. 4, pp. 525-41. Conant, J., Smart, D. and Salano-Mendez, R. (1993), “Generic retailing types, distinctive marketing competencies and competitive advantage”, Journal of Retailing, Vol. 69 No. 3, pp. 254-79. Covin, J. and Covin, T. (1990), “Competitive aggressiveness, environmental context and small firm performance”, Entrepreneurship Theory and Practice, Vol. 15 No. 2, pp. 35-50. Doyle, P. and Cook, D. (1980), “Marketing strategy, financial structure, and innovation in UK retailing”, Journal of Business Research, Vol. 12, March, pp. 37-50. Dwyer, F. and Oh, S. (1988), “A transaction cost perspective on vertical contractual structure and interchannel competitive strategies”, Journal of Marketing, Vol. 52, April, pp. 21-34. Field, A. (2005), Discovering Statistics Using SPSS, 2nd ed., Sage, London. Finkelstein, S. (1992), “Power in top management teams: dimensions, measurement and validation”, Academy of Management Journal, Vol. 35 No. 3, pp. 505-39.

Fiorito, S. and LaForge, R. (1986), “A marketing strategy analysis of small retailers”, American Journal of Small Business, Vol. 10 No. 4, pp. 7-17. Flavian, C. and Polo, Y. (1999), “Strategic groups analysis as a tool for strategic marketing”, European Journal of Marketing, Vol. 33 Nos 5/6, pp. 548-69. Hair, J., Anderson, R., Tatham, R. and Black, W. (1998), Multivariate Data Analysis, 5th ed., Prentice-Hall, Englewood Cliffs, NJ. Hambrick, D. (1980), “Operationalising the concept of business-level strategy in research”, Academy of Management Review, Vol. 5, October, pp. 567-76. Hawes, J. and Crittenden, W. (1984), “A taxonomy of competitive retailing strategies”, Strategic Management Journal, Vol. 5 No. 3, pp. 275-87. Helms, M., Haynes, P. and Cappel, S. (1992), “Competitive strategies and business performance within the retailing industry”, International Journal of Retail & Distribution Management, Vol. 20 No. 5, pp. 3-15. Hofer, C. and Schendel, D. (1978), Strategy Formulation: Analytical Concepts, West, St Paul, MN. Kara, A., Spillan, J. and DeShields, O. (2005), “The effect of market orientation on business performance: a study of small sized service retailers using MARKOR”, Journal of Small Business Management, Vol. 43 No. 2, pp. 105-18. Kirby, D. (1986), “The small retailer”, in Curran, J., Stanworth, J. and Watkins, D. (Eds), The Survival of the Small Firm 1 – The Economics of Survival and Entrepreneurship, Gower, Aldershot, pp. 162-79. Lewis, P. and Thomas, H. (1990), “The linkage between strategy, strategic groups, and performance in the UK retail grocery industry”, Strategic Management Journal, Vol. 11 No. 5, pp. 385-97. McDougall, P. and Robinson, R. (1990), “New venture strategies: an empirical identification of eight archetypes of competitive strategies for entry”, Strategic Management Journal, Vol. 11 No. 6, pp. 447-67. McGee, J. (1987), “Retailer strategies in the UK”, in Johnson, G. (Ed.), Business Strategy and Retailing, Wiley, London, pp. 89-106. McGee, J. and Petersen, M. (2000), “Toward the development of measures of distinctive competencies among small independent retailers”, Journal of Small Business Management, Vol. 38 No. 2, pp. 19-33. McGee, J. and Rubach, M. (1996), “Responding to increased environmental hostility: a study of the competitive behaviour of small retailers”, Journal of Applied Business Research, Vol. 13 No. 1, pp. 83-94. Megicks, P. (2001), “Competitive strategy types in the UK independent business sector”, Journal of Strategic Marketing, Vol. 9 No. 4, pp. 315-28. Miles, R. and Snow, C. (1978), Organizational Strategy, Structure and Process, McGraw-Hill, New York, NY. Moore, M. (2005), “Towards a confirmatory model of retail strategy types: an empirical test of Miles and Snow”, Journal of Business Research, Vol. 58 No. 5, pp. 696-704. Neter, J., Kutner, M.H., Nachtsheim, C.J. and Wasserman, W. (1996), Applied Linear Regression Models, Irwin, Homewood, IL. Park, M. and Mason, J. (1990), “Toward an integrated model of the determinants of business performance”, Research in Marketing, Vol. 10 No. 2, pp. 157-202. Porter, M. (1980), Competitive Strategy, Free Press, New York, NY.

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Robinson, R., Logan, J. and Salem, M. (1986), “Strategy versus operational planning in small retail firms”, American Journal of Small Business, Vol. 10, Winter, pp. 7-16. Segev, E. (1987), “Strategy, strategy making and performance – an empirical investigation”, Strategic Management Journal, Vol. 8 No. 6, pp. 565-77. Venkatraman, N. and Ramanujam, V. (1986), “Measurement of business performance in strategy research: a comparison of approaches”, Academy of Management Review, Vol. 11 No. 4, pp. 801-14. Walters, D. and Knee, D. (1989), “Competitive strategies in retailing”, Long Range Planning, Vol. 22 No. 6, pp. 74-84. Watkin, D. (1986), “Toward a competitive advantage: a focus strategy for small retailers”, Journal of Small Business Management, Vol. 24 No. 1, pp. 9-15. Wortzel, L. (1987), “Retailing strategies for today’s mature marketplace”, The Journal of Business Strategy, Vol. 7, pp. 45-56. About the author Phil Megicks is Associate Dean of the Faculty of Social Science and Business at the University of Plymouth, and Head of the Small Business and Services Research Unit at the Plymouth Business School. He has published widely on small business management and strategy, particularly in the retailing and service industries. To complement this work he is also actively engaged in consumer shopping research and the ethical dimension of buying. Phil Megicks can be contacted at: [email protected]

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Organizational alignment and performance: past, present and future Ravi Kathuria

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Argyros School of Business and Economics, Chapman University, Orange, California, USA

Maheshkumar P. Joshi School of Management, George Mason University, Fairfax, Virginia, USA, and

Stephen J. Porth Erivan K. Haub School of Business, Saint Joseph’s University, Philadelphia, Pennsylvania, USA Abstract Purpose – The purpose of this paper is to identify and define the types of organizational alignment – vertical and horizontal; to examine the evidence for the alignment-performance relationship, and propose research questions and practical implications to advance the theory and practice of managing alignment. Design/methodology/approach – The study is a conceptual examination based on a thorough review of both theoretical and empirical research. Findings – The paper finds that vertical alignment has received considerably more attention in the literature. Studies of horizontal alignment within organizations are less common. When horizontal alignment is studied, the focus tends to be dyadic – between two functional areas. The limitations posed by the dyadic approach suggest gaps in the research and opportunities for future research. As firms grow and diversify, becoming multi-business organizations, the importance of horizontal alignment will be elevated. Research limitations/implications – Research on vertical alignment should focus on developing larger sets of moderating variables, such as the morale of the workforce, or the life cycle of the firm or industry. Research on horizontal alignment should explore multi-point horizontal alignment. Practical implications – Managers in organizations with multiple strategic business units could use the application questions in the study to assess the state of alignment in their respective units and the organization as a whole. Originality/value – The paper documents existing literature on the concept of organizational alignment and identifies new opportunities to continue to build and expand the research stream. It also provides a list of application questions that may be used to assess organizational alignment in organizations. Keywords Strategic alignment, Business performance, Organizational performance, Operations management Paper type Conceptual paper

Introduction The concept of fit or alignment is a central theme in the field of strategic management (Venkatraman and Camillus, 1984; Venkatraman, 1989; Tan and Tan, 2005). For instance, Porter (1996, p. 73) contends:

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Strategic fit among many activities is fundamental not only to competitive advantage but also to the sustainability of that advantage. It is harder for a rival to match an array of interlocked activities than it is merely to imitate a particular sales-force approach, match a process technology, or replicate a set of product features.

When formulating corporate strategy, researchers have emphasized the importance of fitting or aligning the organization’s strategy with an internal appraisal of the firm and an external assessment of environmental opportunities and threats (see Ansoff, 1965; Andrews, 1971). Alignment is important in formulating strategies as well as in their implementation. Implementation is fostered by aligning and adjusting key systems, processes, and decisions within the firm (Galbraith and Nathanson, 1978; Lorange and Vancil, 1977; Stonich, 1982; Kaplan, 2005). The idea of fit has been promoted in the strategy literature from various perspectives. For instance, In Search of Excellence (Peters and Waterman, 1982), the 1982 best-selling book, proposed that when firms achieve an integrated harmony among three “hard” “Ss” of strategy, structure, and systems, and four “soft” “Ss” of skills, staff, style, and super-ordinate goals, they tend to become higher performing or excellent firms. Similarly, in examining high performing firms, Miller (1986) argued a firm’s strategy, structure and environment often coalesce or configure into different types that are predictable and hence manageable. Linking his argument with fit, Miller (1986, p. 236) further states: [. . .] configurations (or Gestalts, or archetypes, or generic types) are said to be predictively useful in that they are composed of tight constellations of mutually supportive elements.

The mutually supportive elements that lead to fit can become sources of competitive advantage (Miller, 1996). Alignment requires a shared understanding of organizational goals and objectives by managers at various levels and within various units of the organizational hierarchy. A firm’s ability to seek and maintain a competitive advantage rests on its ability to acquire and deploy resources that are coherent with the organization’s competitive needs (Porter, 1996). However, some strategy researchers have argued that too much alignment may result in firms with components that are very tightly coupled and lead to problems with adapting to a dynamic external environment. For instance, Hagel and Singer (1999) argue that fit should be considered in light of the interaction costs faced by a firm. They contend that if the interaction costs of performing an activity within the confines of the firm are higher than the costs of performing it externally, then it ought to be performed externally rather than attempting to create a fit within the tightly couple bounds of the firm. Similarly, Pascale (1999) argues that if the fit in an organization leads to equilibrium, it can actually be counterproductive. He contends that the firm should strive for adaptive systems rather than equilibrium. In the same vain, Hamel and Prahalad (1994) have argued that if fit is achieved by paring down organizational ambition, the firm will not achieve its strategic potential. Thus, they argue: This is why the genesis of the strategy process must be a purposefully created misfit between where the firm is and where it wants to be (Hamel and Prahalad, 1994, p. 147).

To overcome this dilemma between fit and flexibility, Miller (1996) argues that configurations (through fit) can provide competitive advantage only if they are dynamic and flexible. Forms of alignment The literature distinguishes between two types of organizational alignment – vertical and horizontal or lateral. Vertical alignment refers to the configuration of strategies, objectives, action plans, and decisions throughout the various levels of the organization. The conceptualization of strategy at three levels – corporate, business, and functional (which we refer to as levels 1, 2 and 3, respectively in Figure 1) – has gained widespread acceptance in the literature. In addition to coordinating activities and priorities across each of these three levels, vertical alignment depends on coordination at a fourth level – the decision areas within each function (Kathuria and Porth, 2003). Figure 1 shows this hierarchy of relationships. Strategic management is an iterative process that starts with the development of an overall strategy at the corporate level to guide the entire organization. Strategy implementation is effectively carried out in a bottom-up fashion, with an aim to make lower level decisions consistent with the decisions at the upper levels. When this consistency is achieved, vertical alignment has been realized. Horizontal alignment refers to coordination of efforts across the organization and is primarily relevant to the lower levels in the strategy hierarchy. Horizontal alignment can be defined in terms of cross-functional and intra-functional integration. Cross-functional integration connotes the consistency of decisions across functions (e.g., level 3) so that activities and decisions across marketing, operations, HR, and other functions complement and support one another. Intra-functional coordination is achieved through coherence across decision areas (level 4) so as to achieve synergy within each function. For successful implementation, decisions within a function (level 4) should be aligned vertically with that function’s strategic objectives, as well as, laterally – across decision areas within a function (Kathuria and Porth, 2003). The process of horizontal alignment requires exchange and cooperation among various functional activities. The notion of intra-functional coordination is also referred to as internal fit. Internal fit is, in part, due to the consistency between a function-specific task and that function’s policies and practices. In the case of manufacturing strategy studies, it means the

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Figure 1. Hierarchy of alignment

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consistency between manufacturing task and manufacturing policies and practices (Skinner, 1974). For example, Kathuria and Partovi (1999) focused on the internal fit between manufacturing priorities, in their case flexibility, and work force management practices used by manufacturing managers.

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Alignment: the early research and the measurement challenges Early works on the topic were conceptual and theoretical. As early as 1961, Likert emphasized the importance of coordinating the corporate, business and functional priorities and strategies of the firm, using the notion of a “linking pin.” Hofer and Schendel (1978) also underscored the need to link strategies at the three levels. Likewise, the “vertical linking process” was stressed by Hrebiniak and Joyce (1984, p, 113) who argued that: [. . .] successful implementation of strategy depends on this integration and the development of short-term operating objectives that relate to strategic plans.

The need to link strategies at the three levels is also widely accepted in functional areas, such as the manufacturing literature (see Skinner, 1969, 1978, 1985; Hayes and Wheelwright, 1984). Skinner (1978, 1985) argues that the levels of strategy operate in a hierarchical way. Corporate strategy (level 1) provides direction and guides business strategy (level 2), which, in turn leads to strategies in the functional areas (level 3). Subsequently, researchers started to test empirically the notion of alignment. Swamidass (1986) observed that executives at different levels in a firm, chief executive officers (CEOs) and manufacturing managers (MMs), emphasized different priorities. Findings revealed the existence of a mismatch of manufacturing priorities between CEOs and MMs, raising the concern that decisions at the manufacturing and operations level could be undermining business strategy. The above conclusion is consistent with the literature which indicates that manufacturing is poorly understood, and missing from, or inconsistent with business strategy (Skinner, 1969; Wheelwright, 1978; Hayes and Wheelwright, 1979). Schroeder et al. (1986), however, found that the mission of manufacturing was usually consistent with the business strategy. They identified elements of manufacturing mission as: quality and reliability, customer service, economic performance, flexibility, resource and equipment utilization, technology, organizational development, employee and community relations, and inventory control. Based on an exploratory study of manufacturing managers, their conclusion was that the manufacturing mission was usually aligned with business strategy. The conflicting findings of the above-mentioned empirical studies could be attributed to the lack of a refined measure of alignment. Vickery et al. (1993, p. 436) tested a refined measure of production competence, which they define as “the degree to which manufacturing performance supports the strategic objectives of the firm”. They claimed their measure better captured the notion of alignment compared to earlier measures of alignment, such as the one used by Richardson et al. (1985) that deployed a binary classification (1,0) based on the perceived match between the corporate mission and manufacturing capabilities. Contemporary researchers deploy not only refined measures of alignment, but also have extended this research to include its impact on performance under varying situational contingencies. With increased awareness of managers due to greater

dissemination of knowledge over time, one might expect to find increasing evidence of and support for alignment in recent studies. Contrary to expectations, however, some studies have found various levels of disagreement on competitive priorities between functional managers and their business unit managers. For example, based on a study of 98 manufacturing units in the USA, Kathuria, Porth and Joshi (1999) noted that differences between general managers (GMs) and MMs about the competitive priorities of their units were still prevalent. Kathuria, Porth and Joshi (1999) collected data from matched pairs of individuals from each participating organization, a functional manager and the business unit manager, such as a general manager, and they deployed the matched response approach to arrive at the degree of alignment between the two. This marked an improvement in the measure of alignment previously deployed. Researchers (see Joshi et al., 2003) also started using more refined measures of alignment, such as the Euclidean distance measure of alignment that was originally proposed by Venkatraman (1989). Venkatraman (1989) proposed six different perspectives on operationalizing the concept of fit in strategy research. In some recent studies, such as Joshi et al. (2003) and Tarigan (2005), the fit is viewed as the opposite of the level of disagreement between managers. Because of to GMs’ relatively senior position in any organization and correspondingly higher involvement in strategy formulation, both studies considered their perception of priorities as “ideal” profiles relative to their MMs. The Euclidean distance was calculated as a square root of the sum of squared differences between the two managers on the competitive priorities in question. Subsequently, the disagreement score was then converted to an alignment score for each pair of GMs and MMs by subtracting their respective disagreement score from the maximum disagreement score among all matched pairs. The example below illustrates the process of calculating the alignment scores: In this example, GMs and MMs rate their organization’s competitive priorities (e.g., quality, flexibility, delivery, and price) on a scale of 1-5. Consider, for example, the GM’s emphasis in a given unit on the four competitive priorities was as follows: price ¼ 3:50, quality of conformance ¼ 4:00, delivery ¼ 2:75 and flexibility ¼ 3:25. The MM of that same unit, however, rated the four priorities as follows: price ¼ 3:00, quality of conformance ¼ 4:34, delivery ¼ 3:33 and flexibility ¼ 4:80. Based on the above scores, misalignment (as Euclidean distance) for the given unit is calculated as ¼ SQRTðð3:50 2 3:00Þ2 þ ð4:00 2 4:34Þ2 þ ð2:75 2 3:33Þ2 þ ð3:25 2 4:80Þ2 Þ ¼ 1:76: Theoretically, the maximum misalignment score would be 8 if all items were emphasized by a GM at 5 and all items were emphasized by MMs at 1, or vice versa). The misalignment score is then converted into an alignment score as follows: Alignment score for the given pair ¼ ðMax misalignment score from the sample 2 Misalignment score of the responding pair).

Vertical alignment and performance Lingle and Schiemann (1996, p. 59) state that: Effective organizations are organic, integrated entities in which different units, functions and levels support the company strategy – and one another.

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Researchers in strategic management have examined this issue of coherence or alignment and its impact on performance. For example, by studying a firm’s overall business strategy and relating it to different functional areas, Nath and Sudharshan (1994) developed a measure of coherence. They found a monotonic relationship between coherence and performance among their sample of acute care hospitals. Nath and Sudharshan (1994) urged researchers to examine the relationship between a firm’s environment, organizational structure, business strategy and the coherence or fit between a firm’s business strategy and its functional strategies. Whipp et al. (1989) found that alignment between strategic and operational aspects is more “visible” in successful firms. This is consistent with Day (1984), who suggested that business strategy should be integrated with functional strategies to achieve a sustainable competitive advantage. These studies lend credence to the fact that when various levels of strategy, and strategic priorities are consistent, linked, and mutually supporting, the performance of the organization would be higher than otherwise. In an empirical study, Smith and Reece (1999) found that the fit between business strategy and decision categories or operational elements (e.g., inventory and logistics decisions, workforce issues, and organization structure), leads to improved business performance. Further, focus on the vertical alignment between manufacturing and business strategy is evident in an empirical study (Sun and Hong, 2002) to examine the alignment between manufacturing and business strategies. Using data obtained from across 20 countries, they concluded that as alignment between manufacturing and business strategies increases, firm performance increases. Additionally, the incremental contribution to performance due to the manufacturing function increases as the alignment increases. Examining strategic capabilities of small and medium sized firms, O’Regan and Ghobadian (2004) concluded that when a fit is obtained between generic capabilities and strategic planning the resultant organizational performance is at a higher level. For them, generic capabilities consisted of organizational abilities such as the ability to promote the product or service, ability to offer a broad product range, wide distribution, responsiveness to changes in demand, ability to compete on price and provide after sales service, ability to maintain delivery schedule, quality levels and organizational ability to obtain involvement of both top management as well as line managers in organizational activities. Similarly, Papke-Shields and Malhotra (2001) found that the influence and involvement of manufacturing executives does affect alignment, which, in turn, affects business performance. Edelman et al. (2005), using data from 192 firms concluded that small firms fit their strategies to the available resource profiles in order to achieve higher performance. Using a sample of 206 global firms Xu et al. (2006) examined if the interrelationships among strategy, structure, and processes influence firm performance. They concluded that the fit among strategy, structure, and processes is positively linked with performance. Horizontal alignment and performance In the case of horizontal alignment, some work has been conducted in linking two functional areas, such as operations management and marketing management. For instance, using data obtained from US banks, Rhee and Mehra (2006) found that strategic fit between operations and marketing was more critical in understanding organizational performance as compared to the choice of competitive strategies alone.

Similarly, in an effort to examine the horizontal alignment between marketing and manufacturing, Alegre and Chiva (2004) examined two cases studies and concluded that for the successful firm a fit between product innovation and manufacturing competitive priorities was necessary. Youndt et al. (1996) examined the horizontal alignment relationships between human resources (HR) systems, manufacturing strategy, and firm performance. They found certain types of HR systems were directly related to operational performance measures, such as employee productivity, equipment efficiency, and customer alignment. Further they found that certain competitive priorities or manufacturing strategies moderated this relationship. For example, they found that the interaction effect of a cost strategy with an administrative HR system was positive on equipment efficiency, whereas that of a delivery flexibility strategy was positive on customer alignment. Additionally, they observed the interaction effect of a quality strategy with the human-capital enhancing HR system was positive on all three operational performance measures noted above. Compared to the research of vertical alignment and linkages, the work on horizontal alignment is sparse. For instance, let us revisit the quote by Porter (1996) used in the introduction of this article. In his paper explaining the concept of strategy and how a firm sustains competitive advantage over time, Porter emphasizes the importance of horizontal alignment across many activities of the firms rather than one or two key activities. In that vein, Kathuria and Igbaria (1997) presented an integrated framework for aligning information technology applications across various functional areas, such as product design, demand management, capacity planning, distribution, etc., with manufacturing strategy – competitive priorities and process structure, in particular. Let us explore this distinction further, using Southwest Airlines as an example. Currently in the USA, Southwest is one of the few major airlines that is profitable and the only airline to report 33 years of consecutive profits. Many competitors have been frustrated in their attempts to imitate Southwest. This is due in part to the difficulty of imitating Southwest’s underlying horizontal alignment among many aspects of its strategies and operations. It is well documented that Southwest is a no-frills, low priced carrier. Others who have tried to replicate the Southwest model have not succeeded because they were unable to achieve other horizontal components of the strategy. This includes HR practices such as non-union workers, and a vibrant corporate culture, operational practices such as flying only one kind of aircraft and serving mostly smaller metropolitan areas, and Southwest’s supply chain management of parts and supplies. In addition, Southwest’s choice to not become part of any industry-wide reservation system allowed it to sell through the internet much earlier than others (an IS function) combined with many e-mail/internet based promotion approaches (a marketing function) again show many levels of horizontal alliances not easily replicated by any one single competitor. Our assertion is that while ample research exists to suggest that vertical alignment leads to higher levels of business unit performance, the empirical research to support a similar relationship between horizontal alignment and performance needs to be buttressed. The anecdotal evidence of Southwest Airlines would suggest that performance at the corporate level may improve as horizontal alignment is achieved as conceptualized in the arguments by Porter (1996).

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Factors affecting the alignment-performance relationship The need to examine these linkages continues because not all studies are able to support a direct relationship between alignment and performance. For example, Joshi et al. (2003) reported the lack of a direct relationship between alignment and performance, but under certain moderating conditions found the relationship was significant. West and Schwenk (1996), Homburg et al. (1999), and Lindman et al. (2001) reported similar findings. For example, Lindman et al. (2001) did not find consensus among managers on the firm’s business-level strategy to influence manufacturing performance. Homburg et al. (1999) also did not find support for the alignment-performance relationship in the case of a cost leadership strategy for any of their three performance dimensions. Similarly, West and Schwenk (1996) found no significant relationship between consensus among top management teams and any of the three performance measures. All of the above studies, however, found alignment or strategic consensus to influence performance indirectly, either through a mediating variable (see Lindman et al., 2001) or in the presence of some moderating variables. In the paragraphs below, we examine the influence of contextual factors on the alignment-performance relationship. Joshi et al. (2003) integrated the strategy and operations literature to focus on the alignment-performance relationship in the wake of certain organizational factors. Based on a sample of matched pairs of MMs and GMs, they found that organizational factors (such as organizational tenure of MMs and length of association of MMs with GMs) moderate the relationship between alignment of manufacturing priorities and manufacturing performance. Their study showed that alignment is especially critical when the managers are relatively new to the organization. Similar to Joshi et al. (2003), Tarigan (2005) focused on the perceptions of GMs and MMs concerning manufacturing priorities of their business units as a representation of the alignment to evaluate manufacturing unit performance. His focus was on managers from Indonesia (Joshi et al. (2003) focused on US managers) and the moderating organizational factor of decentralization. Tarigan (2005) found that alignment of priorities between MMs and GMs is positively related to manufacturing performance. In addition, his results show a negative moderating effect of decentralization on the alignment-performance relationship. The importance of aligning the information systems (IS) function with other business functions is widely examined in the IS literature (Luftman and Brier, 1999). In a special issue of the Decision Sciences journal that focused on the interface between operations and information systems, Kathuria, Anandarajan and Igbaria (1999) presented an intelligent decision support systems approach to align information technology applications with manufacturing strategy. Similar to manufacturing and business strategy vertical linkages, studies have found IS strategic alignment to positively affect business performance (Jarvenpaa and Ives, 1993). Specifically, in an effort to examine the fit between IS strategies and business strategy of the firm, Sabherwal and Chan (2001) linked Miles and Snow’s (1978) typologies to IS strategies and found that prospectors and analyzers (two of the four typologies proposed by Miles and Snow) showed a positive performance relationship when examining business strategy and IS strategy. In a further effort to explore subtle aspects of IS fit and performance, Chan et al. (2006) concluded through an empirical examination that the effect of alignment on performance varies across different industries and for

different business strategies. This is consistent with a finding in the manufacturing strategy literature by Kathuria et al. (1998), who noted that the alignment on some (not all) competitive priorities was influenced by industry membership. In the marketing literature, Olson et al. (2005) focused on relationships between business strategy, marketing strategy, and organizational performance. They argued that different business strategies (using the Miles and Snow (1978) model) will require a different focus on marketing activities (such as customer, competitor, innovation, and cost control on behalf of the marketing department) in the presence of structural characteristics of the organizations such as formalization, centralization, and specialization. Using responses from 228 senior marketing managers, Olson et al. (2005) conclude that each strategy type requires different combinations to be used by marketing function in terms of the organizational structural characteristics as well as different marketing activities. Other contextual variables that have been found to affect the alignment-performance relationship include the type of business environment (Homburg et al., 1999), human capital in the form of prestige of partners and tacit knowledge gained through experience (Hitt et al., 2001), among others. Conclusions and implications We set out to examine the evolution of the concept of organizational alignment over the past several decades in the management literature. Our survey of the literature reveals that management sub-fields such as manufacturing, operations, marketing, information systems, human resources, and business strategy have focused on the concept of vertical alignment across different levels of the organization as a starting point in this research stream. Initially the focus was on whether vertical alignment existed. Over time, the discussion shifted to the impact of alignment or non-alignment on the performance of a specific set of functional activities or on overall business unit performance. More recent studies have taken this idea one step further to examine the moderating effects of various contingencies in explaining the alignment-performance relationship. This survey of the literature provides us with several insights about organizational alignment as well as some gaps and questions to be addressed. Of the two types of organizational alignment – vertical and horizontal – it is clear that vertical alignment has received considerably more attention in the literature. Perhaps this is because studies of vertical alignment are easier to conceptualize and allow researchers to study questions within their fields of functional expertise. For example, a researcher specializing in marketing investigates the alignment of marketing activities within the business unit, emphasizing the importance of the marketing function in the success of the business unit. A similar focus has emerged from researchers in the fields of operations management, HR management and information systems, who investigate questions of vertical alignment between strategies and activities within their respective functional areas and the business strategy of the firm. Studies of the concept of horizontal alignment within organizations are less common. Furthermore, our literature review suggests that when horizontal alignment is studied, the focus tends to be dyadic. That is, horizontal alignment studies tend to examine relationships between two functional areas, such as marketing and operations, or manufacturing and HR, or IS and operations. In studies of horizontal alignment, the operational definition of the concept of fit across functions becomes

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critical. Based on Venkatraman’s (1989) work, many researchers have developed measures of alignment that mirror some form of Euclidean distance measures that work very well in the form of a dyadic measurement of either vertical alignment or horizontal alignment. The limitations posed by the dyadic approach suggest gaps in the research and opportunities for future research. These gaps are critical to understand for both researchers and managers from any perspective. We also contend that as firms grow and diversify, becoming multi-business organizations, the importance of horizontal alignment will be elevated. Grant (2005) reported that over a period of 70 years from 1930 to 2000, the 100 largest industrial companies increased their share of the US economy from less than 35 percent to 65 percent. This shows that larger businesses are indeed becoming more complex and suggests the need to further understand the role of horizontal alignment in organizational performance. As mentioned earlier, researchers may find that present measures of horizontal alignment using dyadic approaches are not sufficient to capture emerging requirements for multi-point alignment. There is, however, some work done in the field to overcome these limitations, such as the profile deviation method proposed by Venkatraman (1989). Hill’s (1994) profile analysis in operations strategy may also be adapted to measure horizontal alignment across several functions within an organization. Our survey of the alignment literature has implications for both researchers and practitioners. Researchers interested in further understanding vertical alignment might do well to focus on developing larger sets of moderating variables beyond individual factors (e.g., years of association) and organizational characteristics such as formalization or decentralization. These new factors may include the morale of the workforce, or the life cycle of the firm or industry for instance. On the other hand, researchers interested in exploring alignment might find fertile ground in focusing more on horizontal alignment. This will entail exploring new and exciting areas of multi-point horizontal alignment more so than the dyadic studies that currently exist. This multi-point approach, studying fit in several functions of an organization simultaneously, may necessitate a deeper understanding of profile analysis and require statistical methods that also allow for moderating variables. The implications of this study for practitioners are highlighted in the example of Southwest Airlines. Managers need to understand and explore both multi-point horizontal alignment and vertical linkages in their organization. Ways to measure and manage both types of alignment are needed as well as studies that clarify the contextual nuances and moderating variables of the alignment-performance relationship. For these studies to have value for decision makers, research methods that are focused on qualitative data as well as quantitative data might become critical and methods such as ethnographic approaches will have to be explored. The contribution of this study is that it documents the existing literature on the concept of organizational alignment and identifies new opportunities to continue to build and expand the research stream. While we appreciate and acknowledge the contributions of many researchers from a variety of sub-fields of management, we also strongly feel that in the new hypercompetitive, global marketplace, the time has come for a renewed focus on certain aspects of vertical alignment and, perhaps more importantly, a new focus on horizontal alignment. Our review identifies opportunities for fruitful research on the topic of organizational alignment.

Application questions Managers in organizations with multiple strategic business units could use the following questions to assess the state of alignment in their respective units and the organization as a whole: . Are business unit managers in agreement with corporate managers on their organizational priorities? Are they in agreement with functional managers? Are functional managers in agreement with corporate managers? . Are functional managers from areas, such as marketing, operations, finance, in agreement with one another regarding their functions’ priorities? . Are decisions within a function, such as operations management, aligned so as to support the functional strategy? For example, are decisions related to capacity planning, location, manufacturing planning and control systems, etc. aligned so as to support core competencies of the operations function? References Alegre, J. and Chiva, R. (2004), “Alignment between product innovation and competitive priorities”, International Journal of Business Performance Management, Vol. 6 Nos 3/4, pp. 287-97. Andrews, K.R. (1971), The Concept of Corporate Strategy, Irwin, Homewood, IL. Ansoff, H.I. (1965), Corporate Strategy: An Analytical Approach to Business Policy and Expansion, McGraw-Hill Book Company, New York, NY. Chan, Y.E., Sabherwal, R. and Thatcher, J.B. (2006), “Antecedents and outcomes of strategic IS alignment: an empirical investigation”, IEEE Transactions on Engineering Management, Vol. 53 No. 1, pp. 27-47. Day, G.S. (1984), Strategic Market Planning: The Pursuit of Competitive Advantage, West Publishing, St Paul, MN. Edelman, L.F., Brush, C.G. and Manolova, T. (2005), “Co-alignment in the resource-performance relationship: strategy as mediator”, Journal of Business Venturing, Vol. 20 No. 3, pp. 359-83. Galbraith, J.R. and Nathanson, D.A. (1978), Strategy Implementation: The Role of Structure and Process, West, New York, NY. Grant, R.M. (2005), Contemporary Strategy Analysis, Blackwell Publishing, Malden, MA. Hagel, J. and Singer, M. (1999), “Unbundling the corporation”, Harvard Business Review, March-April, pp. 133-41. Hamel, G. and Prahalad, C.K. (1994), Competing for the Future, Harvard Business School Press, Boston, MA. Hayes, R.H. and Wheelwright, S.C. (1979), “Link manufacturing process and product life cycles”, Harvard Business Review, January-February, pp. 133-40. Hayes, R.H. and Wheelwright, S.C. (1984), Restoring Our Competitive Edge, John Wiley & Sons, New York, NY. Hill, T. (1994), Manufacturing Strategy: Text and Cases, Richard D. Irwin, Homewood, IL. Hitt, M.A., Bierman, L., Shimizu, K. and Kochhar, R. (2001), “Direct and moderating effects of human capital on strategy and performance in professional service firms: a resource-based perspective”, Academy of Management Journal, Vol. 44 No. 1, pp. 13-28. Hofer, C.W. and Schendel, D. (1978), Strategy Formulation: Analytical Concepts, West Publishing, St Paul, MN.

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Homburg, C., Krohmer, H. and Workman, J.P. Jr (1999), “Strategic consensus and performance the role of strategy type and market-related dynamism”, Strategic Management Journal, Vol. 20 No. 4, pp. 339-57. Hrebiniak, L.G. and Joyce, W.F. (1984), Implementing Strategy, Macmillan Publishing, New York, NY. Jarvenpaa, S.L. and Ives, B. (1993), “Organizing for global competition: the fit of information technology”, Decision Sciences, Vol. 24 No. 3, pp. 547-80. Joshi, M.P., Kathuria, R. and Porth, S.J. (2003), “Alignment of strategic priorities and performance: an operations perspective”, Journal of Operations Management, Vol. 21 No. 3, pp. 353-69. Kaplan, R.S. (2005), “How the balanced scorecard complements the McKinsey 7-S model”, Strategy & Leadership, Vol. 33 No. 3, pp. 41-6. Kathuria, R. and Igbaria, M. (1997), “Aligning IT applications with manufacturing strategy: an integrated framework”, International Journal of Operations & Production Management, Vol. 17 No. 6, pp. 611-29. Kathuria, R. and Partovi, F.Y. (1999), “Work force management practices for manufacturing flexibility”, Journal of Operations Management, Vol. 18 No. 1, pp. 21-39. Kathuria, R. and Porth, S.J. (2003), “Strategy implementation: managing the organizational issues”, in Porth, S.J. (Ed.), Strategic Management: A Cross-functional Approach, Prentice-Hall, Englewood Cliffs, NJ, pp. 205-36. Kathuria, R., Anandarajan, A. and Igbaria, M. (1999), “Linking IT applications with manufacturing strategy: an intelligent decision support system approach”, Decision Sciences, Vol. 30 No. 4, pp. 959-91. Kathuria, R., Joshi, M.P. and Porth, S.J. (1998), “Misalignment of managerial priorities affecting OM: has it changed?”, International Journal of Operations and Quantitative Management, Vol. 4 No. 1, pp. 43-54. Kathuria, R., Porth, S.J. and Joshi, M.P. (1999), “Manufacturing priorities: do general managers and manufacturing managers agree?”, International Journal of Production Research, Vol. 37 No. 9, pp. 2077-92. Lindman, F.T., Callarman, T.E., Fowler, K.L. and McClatchey, C.A. (2001), “Strategic consensus and manufacturing performance”, Journal of Managerial Issues, Vol. 13 No. 1, pp. 45-64. Lingle, J.H. and Schiemann, W.A. (1996), “From balanced scorecard to IS management”, Management Review, Vol. 85 No. 3, pp. 56-61. Lorange, P. and Vancil, R.F. (1977), Strategic Planning Systems, Prentice-Hall, Englewood Cliffs, NJ. Luftman, J.N. and Brier, T. (1999), “Achieving and sustaining business-IT alignment”, California Management Review, Vol. 42 No. 1, pp. 109-22. Miles, R.E. and Snow, C.C. (1978), Organization Strategy, Structure and Process, McGraw-Hill, New York, NY. Miller, D. (1986), “Configurations of strategy and structure: towards a synthesis”, Strategic Management Journal, Vol. 7 No. 3, pp. 233-49. Miller, D. (1996), “Configurations revisited”, Strategic Management Journal, Vol. 17 No. 7, pp. 505-12. Nath, D. and Sudharshan, D. (1994), “Measuring strategy coherence through patterns of strategic choices”, Strategic Management Journal, Vol. 15 No. 1, pp. 43-61.

Olson, E.M., Slater, S.F. and Hult, G.T.M. (2005), “The performance implications of fit among business strategy, marketing organization structure, and strategic behavior”, Journal of Marketing, Vol. 69 No. 3, pp. 49-65. O’Regan, N. and Ghobadian, A. (2004), “The importance of capabilities for strategic direction and performance”, Management Decision, Vol. 42 No. 2, pp. 292-313. Papke-Shields, K.E. and Malhotra, M.K. (2001), “Assessing the impact of the manufacturing executive’s role on business performance through strategic alignment”, Journal of Operations Management, Vol. 19 No. 1, pp. 5-22. Pascale, R.T. (1999), “Surfing the edge of chaos”, Sloan Management Review, Spring, pp. 83-94. Peters, T. and Waterman, R. (1982), In Search of Excellence: Lessons from America’s Best Run Companies, Harper & Row Publishers, New York, NY. Porter, M.E. (1996), “What is strategy?”, Harvard Business Review, Vol. 74 No. 6, pp. 61-78. Rhee, M. and Mehra, S. (2006), “Aligning operations, marketing, and competitive strategies to enhance performance: an empirical test in the retail banking industry”, Omega, Vol. 34 No. 5, pp. 505-15. Richardson, P.R., Taylor, A.J. and Gordon, J.R.M. (1985), “A strategic approach to evaluating manufacturing performance”, Interfaces, Vol. 15 No. 6, pp. 15-27. Sabherwal, R. and Chan, Y.E. (2001), “Alignment between business and IS strategies: a study of prospectors, analyzers, and defenders”, Information Systems Research, Vol. 12 No. 1, pp. 11-33. Schroeder, R.G., Anderson, J.C. and Cleveland, G. (1986), “The content of manufacturing strategy: an empirical study”, Journal of Operations Management, Vol. 6 No. 4, pp. 405-15. Skinner, W. (1969), “Manufacturing: the missing link in corporate strategy”, Harvard Business Review, Vol. 47 No. 3, pp. 136-45. Skinner, W. (1974), “The focused factory”, Harvard Business Review, May-June, pp. 113-19. Skinner, W. (1978), Manufacturing in the Corporate Strategy, Wiley & Sons, New York, NY. Skinner, W. (1985), Manufacturing: The Formidable Competitive Weapon, Wiley & Sons, New York, NY. Smith, T. and Reece, J.S. (1999), “The relationship of strategy, fit, productivity, and business performance in a service setting”, Journal of Operations Management, Vol. 17 No. 2, pp. 145-61. Stonich, P.J. (1982), Implementing Strategy: Making Strategy Happen, Ballinger, Cambridge, MA. Sun, H. and Hong, C. (2002), “The alignment between manufacturing and business strategies: its influence on business performance”, Technovation, Vol. 22 No. 11, pp. 699-705. Swamidass, P.M. (1986), “Manufacturing strategy: its assessment and practice”, Journal of Operations Management, Vol. 6 No. 4, pp. 471-84. Tan, J. and Tan, D. (2005), “Environment-strategy co-evolution and co-alignment: a staged model of Chinese SOEs under transition”, Strategic Management Journal, Vol. 26 No. 2, pp. 141-57. Tarigan, R. (2005), “An evaluation of the relationship between alignment of strategic priorities and manufacturing performance”, International Journal of Management, Vol. 22 No. 4, pp. 586-97. Venkatraman, N. (1989), “The concept of ‘fit’ in strategy research: toward verbal and statistical correspondence”, Academy of Management Review, Vol. 14 No. 3, pp. 423-44. Venkatraman, N. and Camillus, J.C. (1984), “Exploring the concept of ‘fit’ in strategic management”, Academy of Management Review, Vol. 9 No. 4, pp. 513-25.

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Vickery, S.K., Droge, C. and Markland, R.E. (1993), “Production competence and business strategy: do they affect business performance?”, Decision Sciences, Vol. 24 No. 2, pp. 435-55. West, C.T. and Schwenk, C.R. (1996), “Top management team strategic consensus, demographic homogeneity and firm performance: a report of resounding nonfindings”, Strategic Management Journal, Vol. 17 No. 7, pp. 571-6. Wheelwright, S.C. (1978), “Reflecting corporate strategy in manufacturing decisions”, Business Horizons, February, pp. 57-66. Whipp, R., Rosenfeld, R. and Pettigrew, A. (1989), “Managing strategic change in a mature business”, Long Range Planning, Vol. 22 No. 6, pp. 92-9. Xu, S., Cavusgil, S.T. and White, J.C. (2006), “The impact of strategic fit among strategy, structure, and processes on multinational corporation performance: a multimethod assessment”, Journal of International Marketing, Vol. 14 No. 2, pp. 1-31. Youndt, M.A., Snell, S.A., Dean, J.W. Jr and Lepak, D.P. (1996), “Human resource management, manufacturing strategy, and firm performance”, Academy of Management Journal, Vol. 39 No. 4, pp. 836-66. Further reading Anand, G. and Ward, P.T. (2004), “Fit, flexibility and performance in manufacturing: coping with dynamic environments”, Production and Operations Management, Vol. 13 No. 4, pp. 369-95. Decoene, V. and Bruggeman, W. (2006), “Strategic alignment and middle-level managers’ motivation in a balanced scorecard setting”, International Journal of Operations & Production Management, Vol. 26 No. 4, pp. 429-48. Likert, R. (1961), New Patterns of Management, McGraw-Hill, New York, NY. Mintzberg, H. (1981), “Organization design: fashion or fit?”, Harvard Business Review, Vol. 59 No. 1, pp. 103-16. St John, C. and Rue, L. (1991), “Research notes and communications co-ordinating mechanisms, consensus between marketing and manufacturing groups, and marketplace performance”, Strategic Management Journal, Vol. 12 No. 7, pp. 549-55. Venkatraman, N. and Ramanujam, V. (1987), “Measurement of business performance in strategy research”, Academy of Management Review, Vol. 11 No. 4, pp. 801-14. Wheelwright, S.C. (1981), “Japan – where operations really are strategic”, Harvard Business Review, July-August, pp. 67-74. Wheelwright, S.C. (1984), “Manufacturing strategy: defining the missing link”, Strategic Management Journal, Vol. 5 No. 1, pp. 77-87. About the authors Ravi Kathuria is Associate Professor of Operations Management at the Argyros School of Business and Economics, Chapman University located in Orange, California, USA. He worked in the industry and as operations consultant for over eight years. His work has been published in several leading journals, such as Journal of Operations Management, Production and Operations Management, Decision Sciences, Journal of Management Education, Journal of Quality Management, International Journal of Production Research, Omega, and International Journal of Operations & Production Management. He has received many teaching and research awards, including the 2005 Chan Hahn Prize for the Academy of Management Best Paper Award in the Operations

Management Division. He serves on the editorial review boards of the Journal of Operations Management and Production and Operations Management. Ravi Kathuria is the corresponding author and can be contacted at: [email protected] Mahesh P. Joshi is Associate Professor of Entrepreneurship and Global Strategic Management at the School of Management, George Mason University, Fairfax, Virginia, USA. Mahesh received his PhD in Strategic Management and International Management from Temple University, Philadelphia, Pennsylvania. Dr Joshi’s research interests include corporate entrepreneurship as well as technology management and global strategic change. Dr Joshi has published articles in journals such as Strategic Management Journal, Long Range Planning, Journal of Operations Management, Corporate Governance: An International Review, Competitive Intelligence Review, Journal of International Management, and Journal of Management Education. Stephen J. Porth is Professor of Management and Associate Dean of the Haub School of Business at Saint Joseph’s University, Philadelphia, Pennsylvania, USA. His research and teaching interests are in the areas of strategic management, leadership, management consulting, and business ethics. He has received several awards for excellence in teaching and research. Dr Porth also has experience as a management consultant, specializing in leadership development and strategic management programs. He has written three books and published extensively in management journals, including Journal of Operations Management, Journal of Management Education, Journal of Organizational Change Management, International Journal of Production Research, and International Journal of Operations & Production Management.

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Barry J. Witcher and Vinh Sum Chau Norwich Business School, University of East Anglia, Norwich, UK Abstract Purpose – The paper seeks to combine the uses of the balanced scorecard and hoshin kanri as integrative dynamic capabilities for the entire strategic management process. It aims to posit a model for the combination of these long- and short-term organisational activities as a framework for a senior level to manage a firm’s strategic fit as an integrated organisation-wide system that links top management goals to daily management. Design/methodology/approach – The resource-based view of strategy is explored for its relevance to how a combined balanced scorecard and hoshin kanri approach serves as a high-order dynamic capability. Examples are given from Canon, Toyota and Nissan, of how core capabilities are managed to show how strategy is executed cross-functionally across a firm’s functional hierarchy. Findings – The study finds that strategic management of the organisation should consider the long-term strategy as well as the short-term capability. Important to this are core capabilities and core competences, cross-functional management, and top executive audits, which, when managed properly, explicate a new view of strategic fit, as a form of nested hierarchies of dynamic capabilities. Originality/value – The paper is the first exposition of how balanced scorecard and hoshin kanri practices may usefully complement each other in strategic management. It is a useful framework for dynamically managing sustained competitive advantage. Keywords Corporate strategy, Hoshin kanri, Balanced scorecard, Competences Paper type Conceptual paper

Management Decision Vol. 45 No. 3, 2007 pp. 518-538 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745115

Introduction The aim of this paper is to explicate the role performed by the balanced scorecard and hoshin kanri as integrative dynamic capabilities for strategic management. This involves understanding how a senior level may strategically fit together strategy and operational effectiveness as components of a firm’s total strategic management. The scorecard and hoshin kanri are integrative cross-functional approaches used for managing strategic priorities across the functional hierarchy of the firm. They provide firms with an overall capability for sustaining strategic management over time. The scorecard’s strength lies in its ability to clarify long-term statements of corporate purpose. Hoshin kanri, on the other hand, is strong as a management system for the deployment and execution of purpose as short-term actions. In fact the balanced scorecard was originally developed from hoshin kanri (Kaplan and Norton, 1993). This paper represents the first exposition of how they might usefully complement each other in strategic management. As a subject for research investigations, this is likely to be a rich and rewarding source for new ideas about how practice can be improved. This is This paper is an outcome from research sponsored by the Economic and Social Research Council (UK) as part of its Innovation Programme (grant number L-125-25-1059).

especially so for firms and organisations which seek to mobilise total effort on key cross-functional objectives across the whole organisation. One important concern is how to effectively link top management goals to change programmes at an operational and daily management level. Our exposition begins with a brief introduction to the balanced scorecard, hoshin kanri, and their similarities to each other. We posit a new strategic management model (Figure 1) for understanding the elements of the scorecard and hoshin kanri. This makes a distinction between the scorecard as a dynamic capability for longer-term strategy, and hoshin kanri as one for managing its implementation and execution. The components of the model are outlined and discussed finally in relation to wider thinking about strategic management and, in particular, strategic fit.

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The balanced scorecard Within the scorecard cannon, the writings of Robert Kaplan and David Norton are paramount. Their original work (Kaplan and Norton, 1992, 1993) proposed the scorecard as a reference framework for performance management. Later work (1996 and afterwards) emphasised its role as a central part of strategic management. Survey evidence suggests the scorecard is widely used (Rigby, 2003), although it remains uncertain whether it is primarily used for performance management or strategic management (Drury and El-Sishini, 2006; Mackay, 2005). Kaplan and Norton (2001a) make a distinction between two kinds of scorecard in use. These are a strategic form, which concerns corporate level objectives and measures, and an operational form, which applies to a sub-unit level. They note that there is sometimes confusion between what can be taken as a truly strategic measure, and what should really be operational. The design of the scorecard is the same for corporate and other levels. It is composed of a limited number of strategic objectives and measures grouped into four perspectives. These are financial, customer, internal business process, and learning

Figure 1. Two dynamic capabilities for strategic management

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and growth based. Traditionally, measures of performance are primarily centred on financial indicators. These are typically based on past performance and do not take into account future performance, nor do they necessarily take full account of the improvement of (more intangible) strategic assets. The scorecard offers the opportunity to take these other indicators of performance into account while still allowing managers to retain a focus on short-term financial needs. Even so, some of the scorecard literature has questioned the limited number and the scope of the perspectives (Mooraj et al., 1999), but Kaplan and Norton (1996b) argue that the design is robust enough to serve the balanced requirements of most firms and organisations. The scorecard objectives must be considered and managed as an inter-related single set. The coupling of all the objectives with measures is important, since without measurement the non-financial objectives may be ignored in practice. Hoshin kanri The words “hoshin kanri” translate as policy management, where “policy” refers to a statement of a strategic objective and its strategies – sometimes called guidelines. The Chinese kanji characters for “ho” used in the Japanese language suggest method, while for “shin” they suggest the light that reflects from a compass needle to show the way. So together they signify a business methodology for direction and alignment. Hoshin kanri developed in Japanese firms as a strategic management approach to enable the corporate level to manage strategic objectives across the functional hierarchy of the firm. It is particularly useful where it is necessary to achieve an organisation-wide collaborative effort in key areas of a business (Witcher and Butterworth, 2001). The principle is that every employee should incorporate into their routines a contribution to key corporate priorities. Then, within a relatively short period the firm concerned will have achieved a significant step forward than would have been possible through normal (typically functionally-based) working. Hoshin kanri as a recognisable form emerged during the 1960s in Japan (Akao, 1991). During the time of the transfer of Japanese quality technologies to the West in the late 1980s and 1990s, a small number of Western firms and organisations adopted the ideas; the most emulated is Hewlett-Packard’s “hoshin planning” (see Witcher and Butterworth, 2000). The balanced scorecard and hoshin kanri Arthur Schneiderman developed the first balanced scorecard in 1987, while vice-president of Quality and Productivity at Analog Devices Incorp, a semi-conductor company based in the Boston area (Kaplan and Norton, 1993). There are strong associations between the balanced scorecard in its role as a strategy framework and hoshin kanri. Schneiderman had spent time in Japan and was in touch with people at Hewlett-Packard, and he used what Kaplan and Norton (1993) acknowledge as a “prototype for the balanced scorecard” to integrate scorecard metrics with hoshin planning, which Kaplan and Norton describe as “a procedure that concentrates an entire company on achieving one or two key objectives each year” and hoshin objectives “included customer service and new product development, for which the measures” existed on the Analog scorecard (142). In other words, Analog was documenting strategic objectives and measures on a scorecard, which was then used to derive and deploy hoshins through the organisation.

The idea of the balanced scorecard’s four perspectives is similar to one used within hoshin kanri. This is the QCDE grouping of objectives used in hoshin kanri, where quality objectives and measures (Q), are comparable to those in the scorecard’s customer perspective, because customers ultimately define what quality means; cost (C), similarly covers financial objectives and measures; delivery (D), covers process objectives in a similar way to the internal business perspective, and education (E), objectives resemble learning and growth and cover people-based objectives and measures. This similarity of objective categorisation is unacknowledged in the scorecard and hoshin kanri literatures. However, according to Schneiderman (2001), the key to linking strategy to action is not the balanced scorecard itself but the underlying processes that make it work. Elsewhere, he points to a lack of an obvious hoshin kanri type system, which can serve to deploy and manage objectives at a level in the organisation where improvement in operational performance is managed (Schneiderman, 1999). Kaplan and Norton (1996a, b) offer a strategic management system, but this stops short of a methodology for the implementation and management of strategic objectives into short-term priorities at a daily management level. Instead they suggest a corporate scorecard will provide a point of reference for other hierarchical levels to design their own scorecards. So, for example at Mobil, they explain that each business unit developed its own scorecard in light of its local situation. Measures at the individual business levels did not have to add up to a divisional measure, and while unit managers did choose local measures to influence the measures on the divisional scorecard, the measures were not a simple decomposition of the higher-level scorecard (Kaplan and Norton, 2001a, b). However, while the activities involved, such as a deployment system for this, are unclear, Kaplan and Norton do argue for establishing common and high-level management processes. They maintain this is especially necessary for effective deployment, feedback and review, or it is likely that any success a local balanced scorecard has will not be sustained (Kaplan and Norton, 2001a, b). Strategic management The balanced scorecard and hoshin kanri are core capabilities in the sense that each is an approach that is central to the strategic management of the firm. Strategic management is the overall and general management of a firm’s, or an organisation’s, long-term purpose. This definition is usefully broad enough to encompass competitive firms and non-profit organisations, including public sector agencies. Figure 1 illustrates the balanced scorecard and hoshin kanri as complementary capabilities. These sit side-by-side as dual frameworks: the former is represented as long-term strategy, while hoshin kanri is the management of longer-term strategy as its short-term implementation and execution. The balanced scorecard and hoshin kanri are, hierarchically, high order capabilities, which are dynamic in the sense they give to the corporate level a capacity to manage and influence strategic management activities through the organisation over time. An effective strategic management system provides the longer-term stability for the firm as a whole to manage and control change in the short-term. Combining the balanced scorecard with hoshin kanri makes this possible. The scorecard in this representation is a corporate level and longer-term component of strategic management. Hoshin kanri,

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on the other hand, is used to translate corporate level strategy into short-term components across the functional levels of the firm and organisation. Vision, mission, and values The central point of reference for all strategic management is the clarity of the overall and long-term purpose of the firm and organisation. This concerns the rationale or reasons for existence and management. Figure 1 shows three kinds of purpose statement, and each provides a different but inter-linked perspective on the overall rationale. Vision is a desired set of circumstances or a future goal. It is typically aspirational and inspirational and is used to condition the overall sense of direction for the whole organisation. Mission is a statement of purpose in terms of what the firm does, typically for its primary stakeholders, and this defines the nature and boundaries of its activities. Values include statements about codes of behaviour, such as ethical standards and responsibilities. Increasingly, firms use values to state the core business philosophies and management methodologies, which everybody should use to carry out their work effectively and properly. Vision, in its role for determining the direction of change, is made central to most of Kaplan and Norton’s work on the balanced scorecard, when strategic objectives are typically defined in terms of a need to sustain a competitive position. Only occasionally do the authors refer to non-profit organisation when they suggest mission may be as important as vision for its role in articulating stakeholder interest (Kaplan and Norton, 2001a). In fact all three forms of purpose statement should influence the nature of a scorecard’s corporate objectives and measures. There is no generally accepted science to guide this influence, nevertheless, purpose statements should be used together to provide the overall context to continuously examine the basic assumptions of the business and the relevance of the scorecard objectives. Balanced objectives Kaplan and Norton originally envisaged that a consensus on the content of a scorecard would emerge through discussion. In later work (Kaplan and Norton, 1996a, b) introduced the strategy map as a discussion framework, and to help identify cause-and-effect elements on the objectives and measures. The idea is to visually map the routes a firm might take in achieving its purpose. Corporate executives start building a scorecard by a review of the mission statement and values, and from these, develop a strategic vision to clarify the firm’s overall goal (Kaplan and Norton, 2001a). Kaplan and Norton (1996b) see the strategy map as a set of hypotheses, which a senior level tests through strategic review. The number of objectives and measures for a corporate scorecard should be limited only to those that progress strategic vision and competitive advantage. This limits the scorecard to between 16 and 28 measures: any more than this makes if difficult for an organisation to absorb a strategy (Kaplan and Norton, 1996b). This rules out diagnostic objectives and measures, which monitor if the firm is under control, and which signal when and where non-routine events require immediate managerial attention (Kaplan and Norton, 1996b). To illustrate the difference between what is strategic and what is diagnostic, Kaplan and Norton contrast how an individual will diagnostically monitor health, getting involved only if something like low blood pressure signals that something is wrong; with a need to strategically develop a career, when an individual must proactively take the initiative

to develop their work experience. Diagnostic measures involve managers in reactive and corrective behaviour, which involves single-looped learning, while strategic measures involve managers in more fundamental and double-looped learning (Argyris and Schon, 1981). This separation of strategic and diagnostic objectives is dangerous if it distances a senior level understanding from the strategic implications of the core business areas to result in simple-minded strategies that are incongruent with the capabilities of the wider organisation (Mintzberg, 2004). It can also confuse understanding about what is really strategic and what is really operational. Deciding the difference is important for effective strategic management and its resolution lies in the difference between what is meant by a strategy and what is meant by a business model. The business model: core capabilities and competences For the balanced scorecard, in terms of furthering vision, strategy is an overall policy to achieve the scorecard objectives. While accepting this as sensible, strategic management should incorporate the firm’s business model (Magretta, 2002): that is, a statement of those critical core capabilities that have to be managed effectively if long-term purpose is to be achieved. It is necessary to identify those business areas, typically cross-functional business processes, which are core to the effectiveness of the firm or organisation in achieving its longer-term purpose. These core capabilities can be defined as long-term critical success factors, following Daniel (1961) and Rockart (1979), or strategic risk statements (Sharman and Smith, 2004), or as a value chain, including the primary and support activities that create customer value (Porter, 1985). The important point to note for strategic management is that a business model supplies the framework for identifying the overall structure for the senior level to manage the operational effectiveness of strategy. It is important to know the health of the business in order to understand how it can accommodate change. This requires more than leaving the monitoring to other levels of management. Following Yip (2004) by recognising that strategy can be used to change an underlying business model, we additionally argue, however, that the senior level must take a proactive part in a strategic management of operational effectiveness. Within firms and organisations that apply lean production the specification of core business processes is an important early design stage for the elimination of activities that do not contribute to value (Hines et al., 2002). However, many firms go further and specify their core processes as managing capabilities. So, for example, Nissan uses a more developed corporate business model that comprises 13 core capabilities (Witcher et al., 2007a). These are: cross-functional activities that include hoshin kanri, daily management (nichijo kanri ), production maintenance, standardisation establishment, productivity improvement activity, inspection, production control and logistics, personnel and labour management, cost management, quality control (including just-in-time management, process control), engineering capability, parts localisation, and purchasing. Nissan also specifies seven corporate core competences, which it calls its business methodologies and philosophies. These are: daily control, the determination of hoshins (the review of hoshin-related work and set up activity), the coordination of hoshin development and deployment for hoshin/business plan and control items, the establishment of control items, analytical and problem-solving abilities, check and action taken, leadership and participation by high-ranking personnel. The important

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thing here is that everybody is expected to sustain and develop their abilities in managing the core areas of the firm. These competences constitute an important strategic resource to Nissan, and the senior level involves itself in an annual audit of proficiency across the Nissan group (see “Review”, below). In relating strategy and the business model to overall purpose, vision is primarily associated with competitive strategy to sustain change; while mission is primarily a concern for specifying the core capabilities that control operational effectiveness, while values relate primary to core competences and how strategy and operational effectiveness are managed. Seen in these terms corporate purpose serves to provide a firm and organisation with its overall theory of the business (Drucker, 1955). Thus the long-term components of strategic management serve to give a platform of stability for managing change through the shorter-term components of planning and execution of strategically-linked actions. Medium-term objectives Hoshin kanri involves the implementation and execution of strategic objectives. It starts at the senior level with a medium-term plan, designed in the form of objectives set for three successive years. These are normally grouped as QCDE objectives in a similar manner to the four perspectives of the scorecard (see above). The grouping of objectives in this way began in Japan during the early-1960s when cross-functional management committees were established at Toyota and Komatsu. This reflects a high level of involvement of senior managers in the management of objectives across the organisational hierarchy. The idea is to sustain a senior level management system that actively oversees continuous actions in all the functional areas of the firm on the QCDE objectives (Toyota, 1999). Cross-functional management teams in each of the four objective areas take responsibility for strategic review and report to the full senior management team. This structure drives review through the planning cycle (Koura, 1993). The QCDE scheme, if not the full use of a management committee structure, is universal in Japanese and many Western hoshin kanri companies. Its use creates a harmony of objectives (Soin, 1992), which is practically the same thing as “balance”. However, the QCDE scheme is less about setting longer-term objectives and measures than to provide the firm as a whole with a common language to facilitate transparency and cross-functional problem solving. Medium term objectives are based on the longer term ones, but also take into account the current status and condition of the core capabilities specified in the business model. There is no reason why at this point the perspectives and QCDE language of objectives should not be linked together directly to use the same labels and language. However, the medium-term plan must not be based solely on the needs of the scorecard, but should also take account of the need to progressively improve the business model and the core capabilities of which it is constituted. In a general sense the scorecard, particularly where a strategy map is used to articulate cause-and-effect issues, provides the desired strategic outcomes, which can be written into a medium-term plan under a strategic theme or challenge (Hamel and Prahalad, 1989). The plan provides the signposts for the firm’s near future, which will serve as a basis for setting the annual priorities to execute at the functional levels of the firm. The execution of priorities is shown in Figure 1 as a descending sequence of four distinct phrases: focus, alignment, integration, and review (FAIR). These are now considered in turn.

Focus The focus phase involves the senior level in setting at the centre its priorities for the coming planning cycle (depicted in Figure 1 as “short-term priorities”). This normally involves a senior management team made up departmental and functional heads. The priorities are based on the needs of the strategic themes and medium-term plans, which are reviewed against current status and an analysis of the external environment. The priorities are translated as two kinds of annual cross-functional objective: hoshin and improvement objectives. These are designed to progress the medium-term plan and take into account the weak points of departmental and corporate cross-functional management. The senior management team considers the firm’s functional strengths and weaknesses in relation to the firm’s core capabilities. In Figure 2, the needs of departments (shown at top of the matrix) are considered, for example, in relation to core activities defined by a value chain. The idea is to gauge the implications of cross-functional objectives and strategies for their impact on functional objectives and vice versa. The improvement objectives are specified within the QCDE groups (in Figure 2, the scorecard perspectives are represented in brackets) as incremental targets, typically representing annual changes of a few percentage points. The hoshins are more complex since they typically involve innovatory change and a greater organisational effort. A hoshin can be determined to correct a significant weakness across the hierarchical levels of the firm, but more likely they reflect a strategic theme designed to significantly advance the competitive position of the firm. Hoshins are crafted to

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Figure 2. The determination of annual objectives at the senior level

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encourage new thinking about the reasons for existing ways of working. The linking of hoshin objectives with thinking about how objectives can be achieved is important since change should not be effected in ways that are generally dysfunctional to routine functional and operational effectiveness in daily management. On the other hand, hoshin-related activity must not be crowded out by operational expediency. For this reason, the improvement targets are managed as a check not just on the health of operational effectiveness, but also on the hoshin activity. The QCDE targets are determined to ensure that at any one time the core capabilities are known and are under the control of those managing them. Some Japanese firms refer to QCDE targets as control items. However, they are also active as a powerful lever for maintaining the momentum of continuous improvement. Unlike the hoshins, which are very few in number, perhaps less than half a dozen, the QCDE targets are numerous, perhaps amount to several dozens, and are set without any specification of strategies. The manipulation of cross-functional objectives by senior management establishes a proactive strategy-linked form of change management called kaizen (Imai, 1986). Its importance to the execution of strategy in daily management is largely unappreciated in Western strategic management (Dean and Bowen, 1994), and it was never fully appreciated in the transfer of total quality management (TQM) to Western firms (Lillrank, 1995; Cole, 1998). Alignment The hoshins and QCDE targets are given to the other levels of the firm to use as priorities in a participative form of business planning called catchball. This is an iterative activity involving passing draft action plans to and fro among the participating parties (Tennant and Roberts, 2001). It involves agreeing plans at every level of the organisational hierarchy, where teams and individuals have to agree their contributions to the hoshins and QCDE targets. This activity aligns other functional priorities and control systems (including budgets and staff appraisals) to the strategically-linked priorities. Hoshin objectives and the QCDE targets are accepted as given below the level of the senior management team. Catchball activity is centred on working out the ways of how to achieve them. The emphasis is on the self-management of means rather than a top-down linked set of activities associated with management by objectives (MbO). Throughout catchball, the Pareto principle and other management methodologies (or core competences) are used to lever scarce resources at points where they will have the most impact. This involves its own level of prioritisation and keeps sub-objectives and means to a low number for practical working. Some hoshins may be too difficult to translate easily into operational plans. These are typically managed as change projects, which can run for extended periods. Typically a hoshin-project takes a complex path through time and involves people from up and down the organisational hierarchy, who may otherwise never work together (for an example of a hoshin project, see Chau and Witcher, 2005). The aim of these projects and of the catchball planning activity generally is to break the hoshins and QCDE targets down into daily management activity that can be managed routinely within normal functionally-based working. Integration Typically, hoshin and QCDE related activity is integrated in a form of daily management through PDCA-conditioned TQM. PDCA is the Deming Cycle principle

for managing a process of work: where “P” is plan, “D” is do, “C” is check, and “A” is action (Deming, 1986). The cycle applies to every level of a business process. This is represented in Figure 1 by turning of a review wheel: a firm-wide system of review where checks on the progress of objectives and targets in daily management provide data for monthly operational meetings, which in turn provide further information for quarterly strategic reviews, which provide data used in annual reviews. PDCA management is sometimes wrongly referred to as a closed loop or negative feedback system (Simons, 1995), and contrasted with a double-looped (even deutero) based learning system (Argyris and Schon, 1981). Similarly, Benner and Tushman (2003) see TQM as a form of exploitative learning rather than exploratory learning system. This literature is perhaps over-mindful that strategic management is focused on strategic change, rather than the role operational effectiveness has in executing change. It ignores how strategy-linked forms of daily management activities may bring about significant change, not only in the operational processes, but also in medium-term plans and occasionally to longer-term strategy. Review The review phase of FAIR is the annual input into the review wheel. It is a senior level review of how the firm as a whole is managing its core capabilities (including hoshin kanri ). The most advanced forms are found in Japanese hoshin kanri and involve executives and board members as auditors (Witcher et al., 2007b), and are referred to for such applications as a top executive audit (TEA). It is primarily used to establish what action on strategy is required by top management (Kondo, 1988). Thus, a TEA is the senior level’s check, following the PDCA-cycle principle, on its execution cycle, and provides feedback to the following year’s focus phase (shown in Figure 1 by a reversed pecked line), when the senior management team take follow-up action and set new hoshins. The “plan” and “do” stages correspond to the alignment and integration phases respectively (Witcher, 2002). The educational character of a TEA for the senior level is considerable as it offers the best chance for senior managers to grasp systematically those facts that reflect on themselves. It serves as a vehicle to stimulate mutual discussions between senior managers and those who execute strategy at functional and daily management levels and helps to clarify operational needs. This goes deeper than an understanding of corrective action to solve immediate issues, which should be dealt with in daily management. Rather, the audit is centred on the use and development of the firm’s core competences: that is, the organisation-wide business methodologies and management philosophies, and how they are employed to manage the core capabilities or core areas of the firm. TEAs vary for different firms. In general the activity begins with a short checklist of subjects and issues. This is based on the experience of the pervious audit, as well as on issues picked up during the quarterly strategic reviews, and from preliminary surveys designed to test stakeholder perceptions of current conditions. The checklist is a guide for the senior level only, since the actual process is essentially exploratory. It takes in plant tours and walkabouts to give auditors and employees opportunities to examine and reflect on their daily work. This is an activity that helps mutual understanding and employee relationships to an extent that routine meetings and reports by themselves are unlikely to achieve. Typically, a TEA makes use of a strategic theme taken from the medium-term plan to differentiate the current audit

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from previous ones, to keep a degree of freshness in the activity. Finally, a report with recommendations is issued with recommendations that can be followed up in a subsequent audit. At Nissan each of its seven core competences are used as audit items, which are explicitly examined for the level of practice and learning in each of the 13 core capabilities. A two-page summary is issued across the corporate group, which compares how different units manage (Witcher et al., 2007a). This includes how people manage hoshin kanri, which at Nissan is specified as a core capability. The seven competences are judged using a set of criteria based on five stages of competency development. The following is an example of the five-step criteria for the core competence of hoshin development, where step 1 rates as no competence, while step five represents full competence: (1) 1st step: . Hoshins are contained in slogans meant for everybody. . Measures are not determined even though objectives exist. (2) 2nd step: . Hoshins resulting from precise definition of desired objectives. . Not concentrated to the vital subjects in this year. . Objectives and measure have been determined. . Measures determined without understanding present situation. (3) 3rd step: . Accurate formation of aim through distillation of the year’s important points. . Annual plan and mid-term plan (three years) are not matched. . Understanding is present related to objectives, establish measures. . No analysis done, but have decided measures through experience. (4) 4th step: . Emphasis placed on the formulation of hoshins with solutions, based on review. . Annual plan and mid-term plan are matched. . Set up measures using QC method for grasping problem. . Procedure of policies determination has been laid down as rule. (5) 5th step: . Formulation of the year’s hoshins, which bear a relation to middle-term plans. . Understood present situation, make clear contribution rate for each factor. . Revision of hoshins is being done appropriately. The functional areas, teams and individuals, are expected to understand what a hoshin is for, its link to the medium-term plan, and be able to clarify their contribution. The process is visible and sends messages that confirm top-level commitment to core

competences as common ways of managing, especially the importance of strategy to daily management. TEAs in hoshin kanri resemble quality audits, which are used more generally in business and management to check compliance with advanced quality management standards. So, for example, the certified standard used in the USA for suppliers of telecommunications (QuEST, 2001) is one of the best and most comprehensive of these, and this covers best practice management methodologies, including planning and review. However, it is not the same thing, since this and quality standards generally are used to specify and maintain services and product standards; they are not used (directly) to develop strategic competences and capabilities. Typically, quality systems are used by specialist personnel, and there is no necessary involvement of the top management team and general senior managers. Performance excellence models are widely used in Western-owned firms for benchmarking best and good practice management. These can be used to specify a firm’s core capabilities and competences. A good example is at Xerox, which uses a management framework (which is similar to the European Excellence Model) as part of its hoshin kanri to audit how the firm’s is being managed in relation to its overall strategic goals (Witcher and Butterworth, 1999). The feedback from the auditing activity has been used at Xerox to design hoshins explicitly to develop the firm’s core competence in multi-skilling. However, evidence from the UK suggests this example is an exception, and that the auditing activity associated with performance excellence models is rarely linked to strategic management (Aydin, 2006). The review wheel (strategic control) Other strategic management frameworks are offered in the literature: notably Simons’ (1995) four levers of control, and Kaplan and Norton’s (1996a, b) strategic management framework. However, these fail to make a clear distinction between the relationship of the longer-term strategic components (purpose, objectives and a business model) and operational effectiveness in the short-term (the implementation and execution of strategic management). This is a question of strategic control. Classically strategic control is associated primarily with managing the implementation of a long-term strategic plan (Ansoff, 1965). In contrast, in Figure 1, strategic control is shown as a review wheel. It is recognised that this is an idealised representation of review in that activity is ongoing, and much of its associated activity is informal and similar to the catchball activity used during the alignment phase. In principle, however, organisation-wide review may be conceptualised as a multi-levelled set of hierarchical activity that works bottom-up. It begins with PDCA in daily management involving routine working, monthly operational management reviews, and periodic (typically quarterly) strategic reviews, and finally, involves TEAs. Data are rolled up continuously from one hierarchical level to another. The perspective at each level is different, but the important thing is that the wheel should be strategically managed so that the following conditions hold: . senior management is able to use review data to test the assumptions and conditions of longer-term purpose, the strategic objectives (especially the cause-and-effect of the scorecard), and the business model; and . review must work as an interactive learning framework for the firm as a whole to incorporate exploitative and explorative learning (March, 1991).

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Goodness of fit The success of the scorecard is, in one sense, a result of Kaplan and Norton’s achievement in removing its ideas from its hoshin kanri roots. Hoshin kanri takes time to develop in any organisation. The present appeal of the scorecard is that it appears to be a straightforward approach and therefore tempting to busy career mobile managers who wish to see early business results. It is relatively easy for a level to establish its own scorecard and strategy map (although it is more difficult to link it meaningfully to corporate level strategy). The scorecard and hoshin kanri may represent two alternative ways for ensuring that strategic plans are implemented if they (in the end) represent two fundamentally different cultures: a Western one centred on selecting and monitoring the right measures to drive change (an “ends justifying the means” approach) and a Japanese culture centred primarily on the capability of a firm’s organisational processes in delivering value to the customer (the means contributing towards the ends). The balanced scorecard is strong on the content of strategy, or in other words, things that must be achieved, but it has little to say on how it should be done. In their early work, Kaplan and Norton seem to assume that firms will have the processes, knowledge and organisational structures, that enable a successful deployment and implementation of strategic objectives (Berkeley-Hill, 2002). The history of the adoption of TQM in Western firms seems to support the idea that Japanese management methodologies and philosophies are difficult to apply properly. Generally, TQM has taken many bewildering forms in Western firms (Cole, 1998; Witcher, 1995), so that many Japanese-owned subsidiaries distinguish for their employees a Japanese form of TQM they call total quality control, a TQM that is involved with both the management of improvement and hoshin objectives (Witcher and Butterworth, 2001). Confusion may be a major reason why effective TQM seems to be difficult for rival firms to emulate effectively (Powell, 1995; Douglas and Judge, 2001). This may be changing. Some observers, particularly from the resource-based view of strategy, see TQM as an established management competence for managing changes and transformations and which helps to sustain competitive difference over time (Doz, 1996). There is also evidence that TQM is undergoing a resurgence (Rigby, 2003), which may be partly the result of an increased popularity for six-sigma. It may be that firms are now beginning to understand quality management as a fully integrated management system, and not as a partial approach that many of the early applications seemed to involve (Witcher and Wilkinson, 1991). If this leads to more participative forms of goal deployment it may have positive results for the management of scorecard objectives (Dinesh and Palmer, 1999). In early work on the transfer of Japanese practices to Western companies, Oliver and Wilkinson (1988) argued it is not just a question of how particular elements of Japanese business strategy (such as production methods, personnel practices and so on) transfer to a different culture which is important, but how functional strategies and practices fit together as elements of a firm’s total strategy. They argue what is noteworthy about successful Japanese firms is the goodness of fit between strategies. The distributed and hierarchical nature of the firm works against the tightness of fit, since different functions and units, particularly in overseas markets, have different interests and represent the purpose of the firm differently. The coordination of activity within firms is an important theoretical area for strategic management, especially in

areas of structure, management control systems, and shared organisational culture (classic work includes March and Simon (1958); Chandler (1962); and Mintzberg (1979)). Conventional top-down and sequenced forms of long-term strategic planning is difficult in terms of its effective implementation and execution (Quinn, 1980; Mintzberg and Waters, 1985). However, an over-whelming proportion of firms employ some form of strategic planning (Rigby, 2003). There is evidence that some of the most peer-admired firms are focusing more on enterprise-wide objectives than on local initiatives and effectively align the organisation around a common strategic vision, which is linked to a centralised performance management system focused on enterprise-wide objectives (HayGroup, 2006). These objectives give to managers clear performance targets and provide a focused space for creativity and flexibility at a local level. This echoes Kanter (1983), that firms should not so much as strategically plan their futures as plan their organisations to be strategically capable in the face of uncertain external change. Porter et al. (2000), however, see corporate control in Japanese organisations as overbearing and a barrier on innovative thinking, and only effective in pursuing operational improvement. Ironically, this view of Japanese corporate management could have helped prevent the spread of enabling capabilities such as hoshin kanri to the West. At the time when the Japanese were first introducing cross-functional structure, Western firms were moving away from management by committee towards devolved and divisional forms of corporate control (Jantsch, 1967), and this may have contributed to a neglect of cross-functional management in Western firms. The importance of cross-functional management is likened by Ishikawa (1990) to the use of woof in making cloth: only when woof and warp (the horizontal and vertical structures) are intertwined will cloth be manufactured, and without woof, warp remains only a thread. So, similarly, only when cross-functional management intertwines with the management by divisions will a firm’s organisation fit together strongly enough to achieve its overall strategic purpose. Porter (1996) observes that the importance of the strategic fit of the functional areas of the firm is one of the oldest ideas in strategic management. He argues that a total view of the firm has been supplanted by partial concepts: he names core competences, critical resources, and key success factors. Classically, fit concerns how a firm matches its internal capabilities to the external opportunities in its environment. Pettigrew et al. (2003) contrast different views of fit from different organisational theory perspectives. In particular they support a view of complementarity theory (Milgrom and Roberts, 1990, 1995) that strategic fit is about how complementary resources work together to reinforce and sustain competitive advantage. They suggest this is compatible with Porter’s (1996) use of fit to explain how sets of strategy related activities together build up a position of competitive strength, which also acts to preclude doing other (non-strategic) activities. Porter introduces the idea of mapping these activities, which is similar to the strategy map, and which could be used to take account of Porter’s activities and to identify cause-and-effect trade-offs. Pettigrew et al. (2003) maintain that a systems perspective is necessary to understand the process of managing strategy and change. They cite the early example of the McKinsey 7-S model (Pascale and Athos, 1982) as a good example. Much of this work was inspired by Japanese examples. The weakness of the complementarities perspective is that there is no one (obvious) way for the management of strategic activities to achieve effective

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performance. Rather the synergic interaction of capabilities differs between firms because of the way competences vary, and for contextual reasons that give a firm its uniqueness. Some observers maintain there is now widespread evidence to indicate there is no one best fit or best organisational model, but that practices should be firm specific and relevant to the firm’s strategic and environmental contingencies (Edwards et al., 2004).

532 The resource-based view Over the last ten or 15 years the most influential school of strategy to emerge has been the resource-based view of the firm. This understands a strategic approach to be based on the development of firm-specific strategic resources and the internal capabilities to manage them. A central issue has been the rigidity of core competences: core in the sense that they sustain competitive advantage. These develop at least in part from organisational learning and involve complex working and the development of specialist problem solving and knowledge. However, they lock a firm into a trajectory that puts it at risk if it proves difficult for the firm to respond quickly to sudden external change (Tushman and Anderson, 1986; Dierickx and Cool, 1989; Leonard-Barton, 1992). Prahalad and Hamel (1990) argue, however, that risk is manageable if core competences are used to serve unrelated markets. They define core competences as the abilities of employees to learn how to develop and manage strategic capabilities, especially how to integrate different technologies through cross-functional management and collaborative working. (This is very similar to how Nissan define their business methodologies and philosophies as core competences; see above.) Prahalad and Hamel (1990) argue that core competences can be used to build a core product, such as Canon’s expertise in optics to serve markets as diverse as cameras, copiers, and semi-conductor equipment. Canon’s competitive advantage is thus an internal capability not easily seen or understood by its rivals. While Prahalad and Hamel (1990) do not explain how collaborative forms of cross-functional management are managed, this is done through hoshin kanri, and in this sense it is Canon’s strategic capabilities rather than core competences that constitute the higher order activity. In Prahalad and Hamel (1990), the core competences (collaborative learning) manage core products (the technological expertise), and it how Canon dynamically manages these capabilities that really counts (Stalk et al., 1992). In their article, Teece et al. (1997) define a dynamic capability as a capacity to renew competences to achieve congruence with a changing business environment. Strategic management as a dynamic capability adapts to, integrates, and reconfigures internal and external organisational skills, resources, and functional competences, so they strategically fit the requirements of change. This capability is necessarily a high-order one, in that it is a whole firm activity that influences other hierarchical, but partial, capabilities and competences. For Figure 1, strategic management is shown comprised of two high-order dynamic capabilities: the balanced scorecard, and hoshin kanri. As an example, Teece et al. (2000) give a detailed description of Fujimoto’s (1994) account of production activities in the Japanese auto industry. This identifies the Toyota Production System (TPS), an advanced form of lean production, as a high-order dynamic capability. This is not the only dynamic capability at Toyota. Hoshin kanri is used to manage and integrate not only the TPS, but also other important dynamic

capabilities, notably Toyota’s integration of its supply chain (Kurogane, 1993; Monden, 1998; Hines, 1998). In this way, hoshin kanri is a higher order dynamic capability, within which second-order dynamic capabilities are nested (Winter, 2003). Teece et al. (1997) argue a dynamic capability is difficult for outsiders to fully understand and that it cannot transfer between firms in a complete sense. So a similar application will always be different in different firms and this is more likely with complexity. However, intangibility is likely to vary with the complexity. Eisenhardt and Martin (2000) define dynamic capability more simply as any cross-functional routine used to reconfigure combinations of strategic resources as conditions change. Dynamic capabilities are cross-functional business processes such as strategic decision making, product development routines, co-ordination processes for internal collaborations, knowledge creation, alliance and acquisition processes, and market exit routines. We regard these examples, taken from Eisenhardt and Martin (2000), as lower order capabilities, in that they nest within the Teece et al. (2000) definition of strategic management as a dynamic capability, and in the terms in which we define strategic management for this paper. Eisenhardt and Martin (2000) maintain that common features exist that can be benchmarked and shared as best practice between firms: just as there are better and worse ways to hit a golf ball, there are more or less effective ways to execute dynamic capabilities. In this paper we hold to the Teece et al. (2000) view of dynamic capability, with the emphasis they place on the capacity to renew competences. We argue that a combined strategic management of the scorecard and hoshin kanri is a high order dynamic capability, because they enable a senior level to manage cross-functional processes, including those that Eisenhardt and Martin describe as dynamic capabilities. Here is a new view of what is meant by strategic fit: this is the fit of a hierarchy of nested dynamic capabilities. This is touched on in several places in the literature (notable, Winter (2003)), but it has still to be examined. This is especially so in relation to complementarities, where the notion of inter-linked capabilities in understanding a senior level’s strategic management would, in our view, be a major advance. It would, at the very least, help colleagues to better understand a difficult (even hidden) phenomenon like hoshin kanri. The literature has still to properly explore its empirical foundations and explicate in more detail its theoretical implications for general practice. Conclusion In summary, this paper argues for a complementary use of the balanced scorecard and hoshin kanri. The balanced scorecard is a valuable approach for the translation of longer-term purpose into strategic objectives and strategic themes. These can be managed alongside the firm’s model of its core capabilities and competences. These are concerned with the management of longer-term operational effectiveness and do not typically appear on a “strategic” scorecard. Hoshin kanri is used as an implementation and execution system. This is used to translate scorecard objectives and the needs of the business model firstly into medium term plans and challenges, and then as short-term priorities within the annual planning cycle. Hoshin kanri brings advantages to execution that include the specification of a vital few hoshins, and the determination of incremental targets to drive and sustain the momentum of change; participative planning; a PDCA cycle-based learning approach for the management of objectives,

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and a senior level involvement for understanding for developing competences in core operational capabilities. A key aspect of hoshin kanri is its insistence on only a very few hoshins to focus attention on those cause-and-effect relationships at an operational level that require breakthrough in performance. Following the Kaplan and Norton cannon, the scorecard is primarily about the longer-term strategic objectives and measures. The issue is how to ensure that people understand longer-term strategy so they are able to understand how strategy can inform their activities in daily management, and how operations inform strategy. The resource-based view of the firm was used to portray dynamic capabilities in the light of such examples from Canon, Toyota and Nissan, to argue the synergistic combination of the balanced scorecard and hoshin kanri as nested forms of dynamic capabilities for the organisation-wide management of the strategic fit of strategy to operations. References Akao, Y. (Ed.) (1991), Hoshin Kanri: Policy Deployment for Successful TQM, Productivity Press, Cambridge, MA (originally published in 1988 as Hoshin Kanri Catsup No Jissai ). Ansoff, H.I. (1965), Corporate Strategy: An Analytic Approach to Business Policy for Growth and Expansion, Pelican, London. Argyris, C. and Schon, D. (1981), Organizational Learning, Addison-Wesley, Reading, MA. Aydin, A. (2006), “An exploratory investigation of the self-assessment implementation process using the EFQM Excellence Model”, unpublished PhD thesis, University of East Anglia, Norwich. Benner, M.J. and Tushman, M. (2003), “Exploitation, exploration, and process management: the productivity dilemma revisited”, Academy of Management Review, Vol. 28 No. 2, pp. 238-56. Berkeley-Hill, O. (2002), “Is the balanced scorecard concept compatible with policy deployment?”, unpublished paper, Lean Operations, Cardiff Business School, Cardiff, January. Chandler, A.D. Jr (1962), Strategy and Structure, MIT Press, Cambridge, MA. Chau, V.S. and Witcher, B.J. (2005), “Longitudinal tracer studies: research methodology of the middle range”, British Journal of Management, Vol. 16 No. 4, pp. 343-55. Cole, R.E. (1998), “Learning from the quality movement: what did and didn’t happen and why?”, California Management Review, Vol. 41 No. 1, pp. 43-73. Daniel, D.R. (1961), “Management information crisis”, Harvard Business Review, September-October, p. 111. Dean, J.W. Jr and Bowen, D.E. (1994), “Management theory and total quality: improving research and practice through theory development”, Academy of Management Review, Vol. 19 No. 3, pp. 392-418. Deming, W.E. (1986), Out of the Crisis: Quality, Productivity and Competitive Position, Cambridge University Press, Cambridge, MA. Dierickx, I. and Cool, K. (1989), “Asset stock accumulation and sustainability of competitive advantage”, Management Science, Vol. 35 No. 12, pp. 1504-11. Dinesh, D. and Palmer, E. (1999), “Management by objectives and the balanced scorecard: will Rome fall again?”, Management Decision, Vol. 36 No. 6, pp. 363-9. Douglas, T.J. and Judge, Q. (2001), “Total quality management implementation and competitive advantage: the role of structural control and exploration”, Academy of Management Review, Vol. 44 No. 1, pp. 158-69.

Doz, Y. (1996), “Managing core competency for corporate renewal: towards a managerial theory of core competences”, in Dosi, G. and Malerba, F. (Eds), Organization and Strategy in the Evolution of the Enterprise, Macmillan Press, London, pp. 155-78. Drucker, P.F. (1955), The Practice of Management, Heinemann Butterworth, London. Drury, C. and El-Sishini, S. (2005), Divisional Performance Measurement: An Examination of the Potential Explanatory Factors, research report, CIMA, London. Edwards, T., Battisti, G., McClendon, W.P. Jr, Denyer, D. and Neely, A. (2004), “How can firms in the UK be encouraged to create more value? A discussion and review paper”, Advanced Institute of Management Research, London, February. Eisenhardt, K.M. and Martin, J.A. (2000), “Dynamic capabilities: what are they?”, Strategic Management Journal, Vol. 21 Nos 10/11, pp. 1105-21. Fujimoto, T. (1994), “Reinterpreting the resource-capability of the firm: a case of the development-production systems of the Japanese automakers”, a draft working paper, Faculty of Economics, University of Tokyo, Tokyo. Hamel, G. and Prahalad, C.K. (1989), “Strategic intent”, Harvard Business Review, May-June, pp. 63-76. HayGroup (2006), “‘Going global’, the world’s most admired companies”, Fortune, pp. 4-5. Hines, P. (1998), “Benchmarking Toyota’s supply chain: Japan vs UK”, Long Range Planning, Vol. 31 No. 6, pp. 911-18. Hines, P., Silvi, R. and Bartolini, M. (2002), Lean Profit Potential, Lean Enterprise Research Centre, Cardiff Business School, Cardiff University, Cardiff. Imai, M. (1986), Kaizen: The Key to Japan’s Competitive Success, McGraw-Hill, New York, NY. Ishikawa, K. (1990), Introduction to Quality Control, Chapman & Hall, London. Jantsch, E. (Ed.) (1967), Technological Forecasting in Perspective, OECD, Paris. Kanter, E.M. (1983), The Change Masters – Corporate Entrepreneurs at Work, Allen & Unwin, London. Kaplan, R.S. and Norton, D.P. (1992), “The balanced scorecard – measures that drive performance”, Harvard Business Review, January-February, pp. 71-9. Kaplan, R.S. and Norton, D.P. (1993), “Putting the balanced scorecard to work”, Harvard Business Review, September-October, pp. 134-42. Kaplan, R.S. and Norton, D.P. (1996a), “The balanced scorecard as a strategic management system”, Harvard Business Review, January-February, pp. 78-85. Kaplan, R.S. and Norton, D.P. (1996b), The Balanced Scorecard: Translating Strategy into Action, Harvard Business School Press, Boston, MA. Kaplan, R.S. and Norton, D.P. (2001a), “Transforming the balanced scorecard from performance measurement to strategic management: part 1”, American Accounting Association, Vol. 15 No. 1, pp. 87-104. Kaplan, R.S. and Norton, D.P. (2001b), The Strategy-focused Organization: How Balanced Scorecard Companies Thrive in the New Business Environment, Harvard Business School Press, Boston, MA. Kondo, Y. (1988), in Juran, J.M. and Gryna, M. (Eds), Juran’s Quality Control Handbook, 4th ed., McGraw-Hill, London, pp. 35F1-35F30. Koura, K. (1993), “Administrative aspects and key points of cross-functional management”, in Kurogane, K. (Ed.), Cross-functional Management: Principles and Practical Applications, Asian Productivity Organization, Tokyo, Ch. 3.

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Kurogane, K. (Ed.) (1993), Cross-functional Management: Principles and Practical Applications, Asian Productivity Organization, Tokyo. Leonard-Barton, D. (1992), “Core capabilities and core rigidities”, Strategic Management Journal, Vol. 13 No. 5, pp. 111-25. Lillrank, P. (1995), “The transfer of management innovations from Japan”, Organization Studies, Vol. 16 No. 6, pp. 971-89. Mackay, A. (2005), A Practitioner’s Guide to the Balanced Scorecard, research report, CIMA, London. Magretta, J. (2002), What Management Is, How It Works and Why It’s Everyone’s Business, The Free Press, London. March, J.G. (1991), “Exploration and exploitation in organizational learning”, Organization Science, Vol. 2 No. 1, pp. 71-87. March, J.G. and Simon, H.A. (1958), Organizations, John Wiley, New York, NY. Milgrom, P. and Roberts, J. (1990), “The economics of modern manufacturing”, American Economic Review, Vol. 80 No. 3, pp. 511-28. Milgrom, P. and Roberts, J. (1995), “Complementarities and fit: strategy and organizational change in manufacturing”, Journal of Accounting and Economics, Vol. 19 Nos 2/3, pp. 179-208. Mintzberg, H. (1979), The Structuring of Organizations, Prentice-Hall, London. Mintzberg, H. (2004), “Management as life’s essence: 30 years of the nature of managerial work”, Strategic Organization, Vol. 2 No. 2, pp. 205-12. Mintzberg, H. and Waters, J.A. (1985), “Of strategies, deliberate and emergent”, Strategic Management Journal, Vol. 6 No. 3, pp. 257-72. Monden, Y. (1998), Toyota Production System: An Integrated Approach to Just-in-Time, 3rd ed., Engineering and Management Press, Norcross, GA. Mooraj, S., Oyon, D. and Hostettler, D. (1999), “The balanced scorecard: a necessary good or an unnecessary evil?”, European Management Journal, Vol. 17 No. 5, pp. 481-91. Oliver, N. and Wilkinson, B. (1988), The Japanization of British Industry, Blackwell Publishers, Oxford. Pascale, R.T. and Athos, A.G. (1982), The Art of Japanese Management, Penguin, London. Pettigrew, A.M., Whittington, R., Melin, L., Sanchez-Runde, C., van den Bosch, F., Ruigrok, W. and Numagami, T. (2003), Innovative Forms of Organizing: International Perspectives, Sage, London. Porter, M.E. (1985), Competitive Advantage: Creating and Sustaining Superior Performance, Free Press, New York, NY. Porter, M.E. (1996), “What is strategy?”, Harvard Business Review, November-December, pp. 61-78. Porter, M.E., Takeuchi, H. and Sakakibara, M. (2000), Can Japan Compete?, Macmillan, London. Powell, T.C. (1995), “Total quality management as competitive advantage: a review and empirical study”, Strategic Management Journal, Vol. 16 No. 1, pp. 15-27. Prahalad, C.A. and Hamel, G. (1990), “The core competence of the corporation”, Harvard Business Review, May-June, pp. 79-91. QuEST (2001), TL 9000 Quality Management System Requirements Handbook, Quality Excellence for Suppliers of Telecommunications Forum, American National Standards Institute, New York, NY.

Quinn, J.B. (1980), Strategies for Change – Logical Incrementalism, Irwin, Homewood, IL. Rigby, D. (2003), Management Tools 2003: Global Survey Results Find Companies Using More Tools than Ever to Make Headway in Tough Times, strategy report, Bain and Company, Boston, MA. Rockart, J.F. (1979), “Chief executives define their own data needs”, Harvard Business Review, Vol. 57, March-April, pp. 81-93. Schneiderman, A. (1999), “Why balanced scorecards fail”, Journal of Strategic Performance Management, Vol. 2 No. 1, January, pp. 6-11. Schneiderman, A. (2001), “How to build a balanced scorecard, part 3: selecting scorecard metrics”, available at: www.schneiderman.com Sharman, R. and Smith, D. (2004), “Enterprise risk management”, Enterprise Governance: Getting the Balance Right, Professional Accountants in Business Committee (PAIB) report, International Federation of Accountants, New York, NY, Ch. 6. Simons, R. (1995), Levers of Control: How Managers Use Innovative Control Systems to Drive Strategic Renewal, Harvard Business School Press, Boston, MA. Soin, S.S. (1992), Total Quality Control Essentials, McGraw-Hill, New York, NY. Stalk, G., Evans, P. and Shulman, L.E. (1992), “Competing on capabilities: the new rules of corporate strategy”, Harvard Business Review, May-June, pp. 57-69. Teece, D.C., Pisano, G. and Shuan, A. (1997), “Dynamic capabilities and strategic management”, Strategic Management Journal, Vol. 18 No. 7, pp. 509-33. Teece, D.C., Pisano, G. and Shuan, A. (2000), “Dynamic capabilities and strategic management”, in Dosi, G., Nelson, R.R. and Winter, S.G. (Eds), The Nature and Dynamics of Organizational Capabilities, Oxford University Press, Oxford, pp. 334-62. Tennant, C. and Roberts, P. (2001), “Hoshin kanri: implementing the catchball process”, Long Range Planning, Vol. 34 No. 3, pp. 287-308. Toyota (1999), Ensuring the Achievement of the Second Action Plan (FY2000) and Taking Actions for the 21st Century, company document, Toyota Environment Management, Toyota City. Tushman, M. and Anderson, D. (1986), “Technological discontinuities and organizational environments”, Administrative Science Quarterly, Vol. 31 No. 3, pp. 439-65. Winter, S.G. (2003), “Understanding dynamic capabilities”, Strategic Management Journal, Vol. 24 No. 10, pp. 991-5. Witcher, B.J. (1995), “The changing scale of total quality management”, Quality Management Journal, Vol. 2 No. 4, pp. 9-29. Witcher, B.J. (2002), “Hoshin kanri: a study of practice in the UK”, Managerial Auditing Journal, Vol. 17 No. 7, pp. 390-6. Witcher, B.J. and Butterworth, R. (1999), “Hoshin kanri: how Xerox manages”, Long Range Planning, Vol. 32 No. 3, pp. 323-32. Witcher, B.J. and Butterworth, R. (2000), “Hoshin kanri at Hewlett Packard”, Journal of General Management, Vol. 25 No. 4, pp. 70-85. Witcher, B.J. and Butterworth, R. (2001), “Hoshin kanri: policy management in Japanese-owned UK subsidiaries”, Journal of Management Studies, Vol. 38 No. 5, pp. 651-74. Witcher, B.J. and Wilkinson, A. (1991), “Fitness for use? Barriers to full total quality management in the United Kingdom”, Management Decision, Vol. 29 No. 8, pp. 46-51. Witcher, B.J., Chau, V.S. and Harding, P. (2007a), “Top executive audits and hoshin kanri at Nissan South Africa”, paper, Norwich Business School, UEA, Norwich.

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Witcher, B.J., Chau, V.S. and Harding, P. (2007b), “Top executive audits: strategic reviews of operational activities”, Managerial Auditing Journal, Vol. 22 No. 1, pp. 95-105. Yip, G.S. (2004), “Using strategy to change your business model”, Business Strategy Review, Vol. 15 No. 2, pp. 17-24. Further reading Dosi, G. and Malerba, F. (1996), “Organizational learning and institutional embeddedness: an introduction to the diverse evolutionary paths of modern corporations”, in Dosi, G. and Malerba, F. (Eds), Organization and Strategy in the Evolution of the Enterprise, Macmillan Press, London, pp. 1-24. Hamel, G. and Prahalad, C.K. (1994), Competing for the Future, Harvard Business School Press, Boston, MA. Kano, N. (1993), “A perspective on quality activities in American firms”, California Management Review, Vol. 35 No. 3, pp. 12-31. Koura, K. (1991), “Control items for hoshin kanri”, in Akao, Y. (Ed.), Hoshin Kanri: Policy Deployment for Successful TQM, Productivity Press, Cambridge, MA, Ch. 3. Lorange, P., Scott Morton, M.F. and Ghoshal, S. (1986), Strategic Control Systems, West Publishing, St Paul, MN. Mills, A.E. (1966), The Dynamics of Management Control Systems, Business Publications, London. Otley, D. (1999), “Performance management: a framework for management control systems research”, Management Accounting Research, Vol. 10 No. 4, pp. 363-82. Corresponding author Barry J. Witcher can be contacted at: [email protected]

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SECTION 6. KNOWLEDGE

Knowledge as a lens on the jigsaw puzzle of strategy Reflections and conjectures on the contribution of a knowledge-based view to analytic models of strategic management

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John McGee and Howard Thomas Warwick Business School, Coventry, UK Abstract Purpose – The purpose of this paper is to demonstrate how to incorporate knowledge concepts into analytical models of strategy formulation and the strategic theory of the firm. Design/methodology/approach – The paper examines four different perspectives of the elusive concept of “knowledge”, namely, “knowledge as assets”, “knowledge through innovation”, “knowledge embedded in routines” and “knowledge through learning”. The study attempts to specify and interrelate the concepts of a knowledge-based strategic theory of the firm. Findings – The “knowledge web” is seen as a partial framework, capturing from a strategic perspective how both specific and organisational knowledge build the competences necessary for the value-creating activities of the firm. Practical implications – The paper provides frameworks for understanding how knowledge can reinforce the strategic core competences of the firm. Originality/value – The paper addresses knowledge as a key element in the development of an enhanced strategic theory of the firm, incorporating the knowledge-based viewpoint. Keywords Competences, Competitive strategy, Knowledge management, Resources, Corporate strategy Paper type Conceptual paper

1. Introduction There is increasing interest in the nature of “knowledge” in the field of strategic management (Spender, 1996). In information management, the burgeoning areas of intellectual capital (Pike et al., 2006), knowledge management (Nonaka and Takeuchi, 1995) and organisational learning (De Geus, 1988; Senge, 1990) examine the role of knowledge in the enactment of strategy. New preoccupations of economists with organisational economics, and emergence of the resource-based (Wernerfelt, 1984) – and, perhaps, knowledge-based (Eisenhardt and Santos (2001) – view in strategic management provide alternative lenses for exploring how knowledge links to strategy development. This raises questions such as: “Is ‘knowledge’ a variable that can be operationalised in our theory making and hypothesis testing, or is it, like the economist Robert Solow’s famous articulation of ‘technical change’, a residual that soaks up huge amounts of variance without offering greater depth of understanding?”; and “Is knowledge better framed in asset terms involving such key strategic assets as intellectual capital (Amit and Schoemaker, 1993) or is it better captured in a dynamic framework where learning is the variable of interest?”

Management Decision Vol. 45 No. 3, 2007 pp. 539-563 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745124

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In responding to its acknowledged heritage from economics and the theory of the firm strategic management has created a rod for its own back by claiming that its purpose is to explain the performance differences between firms. But there has been little progress in achieving this in much the same way as successful specification and estimation of performance models has eluded economists. In our viewpoint, strategy is generally concerned with varieties of firm-specific imperfections where contexts are highly idiosyncratic, and causal ambiguity often prevails. Accordingly it is not surprising that quantitative explanations of differential performance are elusive. In the same vein it is equally unsurprising that some progress has been made in advancing theories of behaviour that contribute to parts of the strategy picture, e.g. the positioning (market-based) view (MBV) and the resource-based view (RBV). These have been judged by their a priori validity and by their power to explain parts of the behaviour of firms – hence they are partial models. We think that a knowledge-based view (KBV) might follow this (useful) approach in providing an enhancement of existing partial models and in doing so might enable us to add some more connected pieces to solve the jigsaw puzzle that is the essence of strategy in a complex environment. Therefore, the primary purpose of the paper is to demonstrate how to incorporate knowledge concepts into the analytical models of strategy formulation and the strategic theory of the firm. 2. Knowledge, strategy formulation and the strategic theory of the firm The argument of this paper addresses four different perspectives on knowledge from an economic and analytic viewpoint: knowledge as assets for protection, knowledge through innovation, knowledge embedded in routines, and knowledge through learning. Finally we set up criteria to judge the arrival of an emerging, integrative, KBV of strategy seen from an analytic, theoretical viewpoint, not from the more practical perspective of knowledge management and the “enactment” of strategy. We begin with some important underpinnings from an economics perspective. “Boundaries” are central to an understanding of any theory of the firm. The key economic mechanism (going back to Adam Smith) is that the size of the market drives the degree of (knowledge) specialisation which itself then determines the extent of the horizontal and vertical boundaries through the effect on economies of scale and scope, and on the nature of transactions costs (Williamson, 1981) and the contractual and other costs of using markets. The traditional, comparative statics, positioning model (Porter, 1980) treats knowledge as implicit – neither explicit nor decisive in its contribution to analysing competition. The need for “sustainability” opens up the static model to a dynamic view. The RBV (Penrose, 1959) provides the stickiness, embeddedness, tacit, path dependent characteristics of knowledge as a differentiating and defensible resource. This takes us into our first knowledge theme – “knowledge as asset” thinking – the search for inimitable distinctive assets or core competences. However, this only goes so far as to characterise “knowledge as protection” for competitive position. We then appeal to Schumpeterian ideas (Christensen, 1997; Hamel, 2000) and to the literature on innovation to see – critically – how expansion of the frontiers of knowledge serves as the genesis of advantage, “knowledge as innovation”. The economic rationale concerns the nature and effect of the incentives to innovate. From a strategy perspective we are interested in the consequences of innovation for different types of firms, small versus

large, incumbents versus entrants, and for the impact on industry structure. Evolutionary economics brings an organisational lens through a mixture of Darwinian natural selection together with adaptive feedback mechanisms (Vronen, 1995). This leads to an organisational perspective in the form of organisational routines (see the seminal work by Nelson and Winter (1982)) – through mechanisms of knowledge embeddedness plus a learning perspective. This is a dynamic perspective on routines sometimes described as organisational genetics (Vronen, 1995, pp. 74-8) – “knowledge embedded in organisational routines”. Dynamic capabilities thinking (Teece et al., 1997) adds learning to the RBV approach and emphasises the central role of dynamic efficiency – “knowledge as learning”. We then set up the criteria for an effective KBV of the firm and comment on the well-known papers by Grant (1996) and Spender (1996). Our first conclusion is that we are (surprisingly) quite far along in specifying and inter-relating the concepts of a KBV, and can thus offer a reinterpretation of the field in terms of “strategy as knowledge”. The nub of this argument is that a KBV impacts directly on all aspects of strategy – the interconnectedness of knowledge acts not just as a metaphor for strategy but as a meta-level analysis of strategy, i.e. the glue that binds different forms of strategic thinking together. Second, however, since knowledge is an abstract concept (Spender, 1996) – an intellectual construct – and is rarely observable directly, the empirical record is currently quite patchy. This, therefore, positions the KBV as intuitively appealing conceptually but empirically elusive (in fact very typical of strategic management generally). Third, we offer final observations on the further development of the KBV. 3. The economics of the firm and the theory of competitive advantage We begin with an important review of the theory of the firm and a competitive advantage from an analytical and economic perspective. This review sets the framework for the examination of the KBV from the viewpoint of the theory of the firm (see also McGee et al., 2005). The well-known shapers of the horizontal (product range and market segment) boundaries of the firm are economies of scale and economies of (narrow) scope[1] (Chandler, 1990; Teece, 1980). The central economic concept is “specialisation” driven by scale and scope where specialisation occurs as a function of market size[2]. This is a prime link between the market and specialisation within the firm and is the driver for recent fascination with deconstruction among consulting firms (Evans and Wurster, 1997, 1999). The logic of vertical integration rests on the economics of “make versus buy” coupled with transactions cost economics, especially the Williamsonian (Williamson, 1981) notion of “economising” (essentially a mixture of technical efficiency and agency efficiency). The rush towards cooperative strategies suggests that firms think the agency problems are soluble – hence the fascination with the “virtual corporation” and the Boston Consulting Group (BCG) “Blown to Bits” examples of deconstruction and orchestration (Evans and Wurster, 1997, 1999). These are powerful economic mechanisms: the argument is that knowledge (driven by expansion and economic growth) is a fundamental driver of specialisation and of the balancing act between technical and agency costs. The rationale for the horizontally and vertically extended company rests on the tacit knowledge that allows internal coordination to be less costly

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Figure 1. Disintermediation

than external contracting through markets. However, the contemporary, running argument is that the increasing size of global markets permits greater knowledge specialisation that in turn shifts the balance between the firm’s valuation of internal tacit knowledge and externally held explicit knowledge. Figure 1 is an example of disintermediation through outsourcing. The rate of expansion of large, global markets allows for new knowledge specialisation opportunities. These allow for the arrival of new firms that convert tacit, coordinative corporate knowledge (“corporate glue”) into explicit, codified, and saleable knowledge-based products. This changes the balance from internal co-ordination to external market contracting and – taken as a trend – leads simply to outsourcing and more generally to disintermediation. Note how common standards and interfaces allow pieces of knowledge to be snapped together like LEGO thus reducing internal co-ordination costs. As outsourcing proceeds and individual islands of corporate tacit knowledge are dismantled what happens to competitive advantage and to entry barriers? The reduction of barriers based on tacit knowledge places more burdens on explicit knowledge assets and on the assets that underpin cost-based strategies. The ability to control the supply chain is known as “orchestration” by Evans and Wurster (1997, 1999) and by McGee (2003). Orchestration enables one or a few firms to determine the standards and operating rules by which a supply chain operates. In effect the smaller, “orchestrated” firms adopt the standards set by the orchestrators, the owners of the competitive advantages. For example, Microsoft and Intel through the Wintel standard orchestrate the personal computer supply chain. Firms such as Unilever and Procter and Gamble seek to orchestrate their supply chains through strong brand names supported by product development. The effect of deconstruction is to open up the market to new firms and to create the possibilities of newly orchestrated forms of advantage. This is the traditional heart of strategy – the analysis of markets and the structure of industries (Porter, 1980, 1982). It is, however, an industry level of analysis showing how profits arise from imperfections using competitive advantage as the intermediating construct. We call this the MBV. In this MBV knowledge is largely implicit being either tacit in nature or captured in terms of its effects (such as patents)

rather than in its resource characteristics. Thus, knowledge is reflected in differential positioning and in a knowledge production function whose inputs are simply cash and whose outputs are characterised in economic terms. There are two useful amendments to this view. An early addition was the use of game theory in situations where advantages were held to be weak or transient and competition was oligopolistic. Advantage might be gained by out-strategising the opponent following game theoretic principles. Of interest to us are those situations where uncertainty prevails and the value of information becomes essential for the analysis. Much later came the co-operative model advanced by Brandenburger and Nalebuff (1995) – co-opetition. Their approach is to conduct a co-operation analysis on the Five Forces, calling it the value net. Under this approach complementarities can be exploited through a co-operative mode – but it does require the existence of distinctive sets of assets protected by barriers in some way. Figure 2 is a simple schematic to show how the MBV concentrates on product market choices leaving the internals of the firm to a mysterious but highly efficient maximisation process based on an ability to shop the world for the relevant factors of production. Note that there is no resource language here. The traditional economic approach, therefore, treats knowledge as an implicit argument albeit an important one. Knowledge affects the nature of the economic equilibrium, like so many other variables, but does not feature as a central player with regularity of effects on the competitive outcome. As we move towards placing knowledge at the centre of strategy theory we argue that there are four distinct approaches (perhaps theories) of how knowledge works. The first is the RBV that provides us with the “knowledge as asset” metaphor. A second view is Schumpeterian (Schumpeter, 1934) in origin picturing knowledge as innovation and as an essential element in the general theme of creative destruction. Third, evolutionary economics[3] moves us away from a decision orientation towards a focus on internal organisation and the role of organisational routines. The use of a Darwinian natural selection process coupled with adaptive feedback mechanisms explains the nature of organisational routines in large organisations. Such routines and their adaptation over time require embedded knowledge, acquisition of knowledge, and transfer and integration of knowledge within organisations. Finally, the Teece et al. (1997) approach to dynamic capabilities adds the elements of learning and other dynamics to the RBV and suggests paths by which both RBV and evolutionary approaches can take place in practice. The progenitors of these approaches did not place knowledge per se at the centre of their writing so to a large degree what follows is a reinterpretation of existing theory in terms of a knowledge perspective.

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Figure 2. Market-based view

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Figure 3. Resource-based view

4. Knowledge as assets Figure 3 restates the MBV shown in Figure 2 in resource-based terms. The internals of the firm are now fleshed out in terms of resources and capabilities, the conventional description that permits discrimination between assets based on knowing and skills based on experience and actions. We do not summarise the key tenets of the RBV here. They are familiar enough (see Wernerfelt, 1984; Barney, 1991; Grant, 1991). Instead we suggest some conclusions in the language of “core competences” (Prahalad and Hamel, 1990; Hamel and Prahalad, 1993; McGee et al., 2005). First, core competences can have a very significant impact by their effect on scope (boundaries), and by the (long) time scales over which they exist and change. They arise typically through collective learning – very much in the economics tradition of “objectified knowledge” (Spender, 1996). Also, their impact is to create a meta-level on which we can view competition. At the meta-level competition is about contests for the acquisition of distinctive skills, in which competition in product markets is a “superficial expression” of the more fundamental competition over competences. Therefore the dynamics of the strategic theory of the firm focus on learning because it is logically prior to product market evolution. Figure 4 is a simple expansion of the range and nature of asset positions[4]. The broad categories give some idea of the differing demands on internal processes and on the challenge for integration of these different positions through some form of corporate glue. Many authors have provided classifications and explanations of the language of resources, assets, capabilities and competences. A common terminology has not emerged although much of the commentary has been illuminating. Grant (1991), for example, distinguishes between resources as inputs and capabilities as those intermediate processes derived within the production function that are the main source of competitive advantage. Both are hard to define objectively and indeed Grant (1991) goes as far as to say that capabilities are organisational routines. Amit and Schoemaker (1993) also deploy the language of resources and capabilities but seek to draw links with the industry analysis framework. Resources for them are intermediate goods (in contrast to Grant), and capabilities are “based on developing, caring, and exchanging information through the firm’s human capital”. They are built by combining physical, human, and technological resources at the corporate level. The link with industry (or product-market) arises when certain resources and capabilities become the prime determinant of economic rents. This can only occur if these resources and capabilities are subject to market failure and their possession can therefore be firm-specific. Amit and Schoemaker (1993) refer to these as “strategic

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Figure 4. Resource positions (expanded)

assets”. This enables a distinction to be drawn between those resources and capabilities that are generally attainable and those that are asymmetrically distributed between firms, and difficult to trade and imitate. Prahalad and Hamel (1990) have made famous the language of core competence and avoid using the language of resources and capabilities. For them “core competences are the collective learning in the organisation, especially how to co-ordinate diverse production skills and integrate multiple streams technologies”. Just as Amit and Schoemaker (1993) extend their notion of strategic assets towards product markets with a concept of strategic industry factors, so also do Prahalad and Hamel (1990) in making core competences the foundation for core products. For them the insight is not what is a core competence and how to build one, but a view of the strategic architecture of the firm by which they mean “a road map of the future that identifies which core competences to build and their constituent technologies”. For these and other authors writing in the same vein, the common characteristic is the appeal to economic reasoning in the form of asymmetric distribution of assets to support economic rents. But the mainspring of firm-specific resources can lie anywhere between inputs and outputs with alternative scenarios about the contributory roles of organisation structure and process, and managerial culture. All these arguments can be criticised as lacking quantifiability. Our own approach in Figure 4 is more modest in intent. We seek only to distinguish between some categories of resources and capabilities so that we can see different roles that knowledge can play. The distinction between tangibles and intangibles comes prior to any distinction between resources and capabilities. We divide intangibles into three parts. The first is those assets that are relational in character and mediate the relationship of the organisation with the outside world. The second is more explicitly concerned with knowledge and know-how and includes such intellectual capital themes as patents, trademarks, copyright and registered designs. Although some entries under this heading suggest explicit knowledge (such as patents) they are

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surrounded by or produced by know-how that is essentially tacit. Our term competences can be used interchangeably with capabilities without any loss of meaning. These are, following Grant, intermediate processes some of which are explicit in their design but many are likely to display characteristics of organisational routines. Indeed, McGee et al. (2005) point out that Sony’s core competence in miniaturisation allows it to make everything from the Sony Walkman to digital cameras. In the same vein, Honda’s core competence in engines allows it to offer lawnmowers, motorcycles and passenger cars. 5. Knowledge as innovation Thus, the RBV framing “knowledge as assets’provides a theory of protection and sustainability. For an understanding of the genesis of advantage we have to turn elsewhere. The Schumpeterian approach (Christensen, 1997) offers innovation as the medium through which creative destruction takes place. The element of destruction depicts intuitively and vividly but also convincingly how the old is replaced by the new. But it also sets these mechanisms in waves and floods of change suggesting that the benefits of change and innovation are overwhelmed by the magnitude of the opportunities on offer. Thus Schumpeter suggested there were patterns of change and ferment interspersed with stability. In this way Schumpeter emphasised dynamic efficiency above static efficiency. Some recent writings clearly have their origins in Schumpeter. See for example, d’Aveni’s (1994) approach to hypercompetition where he argues that the sources of competitive advantage are being created and destroyed at an increasingly rapid rate. Hamel and Prahalad (1993) use the language of dominance to assert a doctrine of strategic intent and define the gap between ambition and resources as strategic stretch. But the Schumpeterian world of enormous opportunity is not the only context for innovation. Firms may wish to create their own shocks or, more modestly, may seek to calculate finer pieces of sustainable advantage. But who innovates? Economists such as Kenneth Arrow have formulated models to explain whether new entrants have advantages over incumbents, whether monopoly can innovate more readily than competitive markets, and whether potential entrants can outwit monopolists. Of course, the answers depend on the situation but the above effects provide us with good reason for thinking that incomers may often provide the wellspring of innovation – eventually. The behaviour to be explained is not that of the innovator who rationally examines the balance between costs and revenues in the light of prevailing competition and makes innovations when the return-risk ratio looks promising. The more difficult behaviour to explain is the reluctance of incumbents to refrain from innovating in the light of expected innovation from new entrants. The two rational economic reasons for this are the sunk-cost effect and the replacement effect. The former arises when the incumbent assesses his existing technology by comparing his contribution margin to no new costs of investment beyond that of simple replacement. By contrast a new technology has a stiffer hurdle because the contribution margin (assuming for simplicity the same revenue stream from both technologies) has to cover new investment as well (see Besanko et al., 2000, pp. 488-9). The replacement effect was first formulated by Arrow (1962) in considering who has the greater propensity to invest, the monopolist or the new entrant. The incentive for the monopolist to invest in a radical new technology requires a comparison of the new stream of monopoly profits with the existing stream. However, for the new entrant

who, if successful, will become the new monopolist, the incentive is simply the new stream of monopoly profits. Through innovation an entrant can replace a monopolist but a monopolist can only replace himself, hence this is called the replacement effect. Thus established firms under this thinking are less willing to stretch themselves to innovate. However, where the monopolist anticipates that new entry is likely then the incentives reverse to favour the monopolist. The incentive for the monopolist to innovate in the teeth of potential competitive intrusion is that of retaining monopoly profits from successful innovation versus sharing the market with a new entrant as a duopoly within which prices will be lower due to competition. This is greater than that of the new entrant who expecting the monopolist to defend by innovation can only anticipate the profit streams from sharing a competitive duopoly. Arrow called this the efficiency effect. The balance between these three effects depends on the probability of successful innovation by potential entrants. Where this is low the sunk cost and replacement cost effects will dominate and the monopolists will prefer to maintain their existing cash flows. Where the probability is high then the efficiency motives will dominate and monopolists will seek to maintain their market position even if it is less favourable in absolute terms. This analysis of innovation competition focuses on the payoffs to innovation. There is also a literature on the choosing the right levels of research and development (R&D) under market uncertainty and under uncertainty about the response of rivals. The analysis of first-mover advantage is well known. It asserts that the first mover gains advantage by establishing explicit knowledge protected by patents and trademarks and goes on to build advantages of scale, experience and scope so that later movers can never erode the early advantage (see Ghemawat’s (1991) description of Du Pont in titanium chloride). There is also an interesting empirical literature on technology races and patent races (Gottinger, 2003). These races describe the battles between firms to complete a successful R&D programme and to be the first to market with an innovation with all the benefits of first mover advantage. A race is an interactive pattern of competition characterised by firms constantly trying to get ahead of their rivals, or trying not to fall too far behind. Like the dominant design literature (Anderson and Tushman, 1990), racing behaviour is also a dynamic story of how technology unfolds in an industry recognising the fundamental importance of strategic interactions between competing firms. A simple race between two firms might involve the following. The leader may consider further investment to outdistance its rival and get to the winning post first. But it is aware of the diminishing marginal productivity of research for itself and the uncertainty of innovation for its rival. It therefore has to balance the risks and expenditures associated with pressing on with the benefits of delay in terms of consolidating its own knowledge and the difficulty for its rival of catching up. By contrast the follower is faced with the need to catch up, but has the same concerns about the productivity of research offset to some degree by at least some knowledge about the successful path followed by its rival. The leader has considerable incentives to be cautious whereas the follower might be more inclined to plunge ahead. Clearly the variables are many and imponderable given the uncertainty of success in R&D and the difficulty of predicting the responses of rivals. Gottinger (2003, pp. 37-8) summarises the implications:

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At one level, racing behaviour has implications for understanding technology strategy at the level of the individual firm and for understanding the impact of policies that aim to spur technological innovation. At another level, racing behaviour embodies both traditions that previous writings have attempted to synthesise: the “demand-pull” side emphasised by economic theorist and the “technology-push” emphasised by the autonomous technological innovation school.

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Gottinger (2003, p. 51) observes from his research on telecommunications and computer industries the apparent inability of technology-oriented companies to maintain leadership in fields that they pioneered. These failures might be due to agency problems or other sub-optimal managerial behaviour. But of more interest to our thesis here is the existence of market asymmetries that affect racing behaviour: risk- and resource-driven asymmetries. The latter are clearly linked to the replacement effect (above). All this literature (Abramowitz, 1986, Gottinger, 1998, 2001; Lerner, 1997, Scherer, 1991) carries implications for knowledge in terms of its creation, how it is accessed, transferred and integrated, and who has the incentives for these activities. This suggests the need to examine organisational processes and the routines that shape its future orientation. 6. Knowledge embedded in routines Recently the strategy literature has paid attention to the organisational processes that form the basis for the development of the firm’s strategy (Teece et al., 1997; Johnson and Huff, 1998, Eisenhardt and Martin, 2000). These scholars, along with others, focus on the routines[5], competences and capabilities of the firm that shape its development in the long run. This approach shifts the focus of attention from the market positioning view (described earlier) to a more micro analytic approach that aims to go even deeper than the RBV, aiming to understand the way in which competitive advantage is actually developed (Johnson and Bowman, 1999). Our interest here is in the routinised elements of strategy making. This is well grounded in the literature (March and Simon, 1958; Nelson and Winter, 1982; Cyert and March, 1963; Teece et al., 1997). Less well known and certainly less commonly cited alongside the above scholars is the long-standing preoccupation of economists with evolution[6]. Veblen (1898, p. 397) talks about “the process of cumulative change”. Marshall (1920, p. xiv) used the term “economic biology” and argued that the “the key-note is that of dynamics rather than statics”. These represent early arguments about economic evolution. Although economists have spent considerable time developing the neo-classical theory of the firm (a misnomer for a theory of markets), the notion of “evolutionary economics” has gained considerable momentum. Some of the impetus for this derived from the long controversies about “marginalism”[7]. This led to the breaking open of the black box of the firm and the onset of the new theory of the firm. The essence of this is to throw light on the internal organisation of the firm. Whereas the traditional theory is concerned with prices and output, the new theory is interested in how transactions are organised. The intellectual progress of this strand of economics is marked by Coase’s (1937, 1988) path-breaking paper on the nature of the firm, new approaches to understanding the nature of ownership bringing inn property rights (Alchian and Demsetz, 1972) and agency costs (Jensen and Meckling, 1976), and Williamson’s (1985, 1987) transaction cost economics. Coase (1937, 1988) anticipated all of this in pointing out that the essential differentiating feature of intrafirm

transactions, as opposed to interfirm transactions, is authority and hierarchy. This stream of thinking does reinforce the idea of “efficiency management” – Williamson (1981) expressed it as the strategy of “economising”, and this has strong resonance with the idea of cost minimisation from neo-classical theory. But more important than this it opens the door to ideas about the evolution of efficient organisational forms. Vronen (1995, p. 2) maintains that evolutionary economics is inspired by the new institutional economics. This analyses processes through which institutions evolve (Langlois, 1986). Similarly the sociologist Granovetter (1985, p. 488) argues that: [. . .] social institutions and arrangements previously thought to be the adventitious result of legal, historical, social or political forces are better viewed as the efficient solution to certain economic problems.

The central part of evolutionary theory is the selection argument that argues that competitive markets select for the most efficient organisational forms. Although there are considerable debates about the precise forms and implications of this process, the selection argument is the hard core of evolutionary theory. Evolution is a form of organisational ecology where firms engage in behaviour that is routine rather than purposive. Adaptation takes place by mimicking the survivors who are accidentally well adapted. Managers get little credit in this view. Scholars like James Brian Quinn have argued for processes that are typically fragmented, evolutionary and intuitive. He describes this as logical incrementalism (Quinn, 1978) in which minor changes in strategy take place as a response to changes in the external environment in an evolutionary and adaptive manner. Nelson and Winter’s (1982) approach (drawing heavily on Winter (1964)) is a sustained argument that selection is not an ad hoc or involuntary response, but is systematic and purposeful firm behaviour. They – famously – argued for collections of routines based on tacit knowledge supplemented by organised search behaviour for modifications or substitutes. This allowed for the evolution of economic thinking (over many decades) to map onto the newer thinking from management theorists attempting to understand and map organisational processes. The essential link is purposive behaviour of managers and we shall argue that this is characterised by asset and knowledge accumulation and by learning processes that allow knowledge to be transformed from tacit to explicit. Thus we see Burgelman (1983) arguing that the intellectual basis for activist and explicit roles for top managers is based on complex organisations that are subject to both evolutionary and planned processes. Nelson and Winter (1982) introduced us to evolutionary economics but much is owed to Simon (1955, 1959, the concept of satisfying and bounded rationality) and Penrose (1959 (theory of the growth of the firm)). Although Nelson and Winter’s (1982) tone is somewhat hostile to traditional economics, their approach can be seen as a rehabilitation of the theory of the firm by providing (far more) realistic assumptions but in the process not disturbing the orthodox neo-classical conclusions (although some may argue this point). They shift attention away from decision calculus (how can one continually make these complex trade-offs about everything?) to internal organisation where organisational routines regularly and automatically make “decisions” based on the knowledge and best practice embedded in those routines. The argument for routines that make “good decisions” is based on two points: one, a Darwinian natural selection process at an organisational level that ensures that only

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the “best” routines are kept in operation, and two, on an adaptive feedback mechanism at the individual level that permits new knowledge to be accessed and then diffused through the organisation to be eventually embedded in routines. Routines are thus embodiments of organisational memory – better called organisational genetics. The evolutionary approach is saved from ecological sterility by the learning process (based on Simon). Through this we can see the essential elements and characteristics of a KBV starting to take shape: tacit versus explicit knowledge; relative roles of individuals, groups and organisations; sourcing and accessing of knowledge, transfer and integration of knowledge (note the classic formulation by Nonaka and Takeuchi (1995)). 7. Knowledge as learning Nelson and Winter’s second set of routines are those that determine the long run changes in the firm’s stock of capital – hence they are called strategising routines. Attention has been paid to the contribution of planning and budgeting processes to the accumulation of fixed assets over time. But more central to our argument are the product and technology development processes. For example Henderson and Clark (1990, p. 15) developed the concept of “architectural knowledge” explaining how the dominant organisational design “incorporates a range of choices about the design that are not revisited in every subsequent design”. They go on to link this architectural knowledge to the development of innovation processes. These strategising routines contribute to strategy and strategy making as they store the firm’s experience in such a way that it can use it in a new context. They channel the structure of decision-making processes into the type of behaviour that has brought success in the past. However, such routines have a negative side. Over time as the environment changes new forms of organisation become appropriate and gaps emerge between environmental requirements and existing capabilities. These gaps cause routines to become dysfunctional (Teece et al., 1997, Leonard-Barton, 1992) and inhibit future development of the firm (Levitt and March, 1988; Henderson and Clark, 1990; Leonard-Barton, 1992; Teece et al., 1997). This leads to the processes by which routines are modified over time, organisational learning. The literature makes many references to types of organisational learning. Cyert and March’s (1963) view of organisations as complex adaptive systems suggest modes of learning. Levitt and March (1988) refer to change processes at several nested levels. Cohen and Baclayan (1994) illustrate the role of experimental learning. Bettis and Prahalad (1995) suggest that firms unlearn ineffective routines. Hedberg (1981, p. 18) suggests that unlearning is “a process through which learners discard knowledge”. All of these notions build on the idea that routines flow from history and serve as the organisational memory in which knowledge about best practice is stored. The propositions about learning fall into two camps. The cognitivists (Huff, 1994; Porac et al., 1989) focus on learning at the individual level and individual mental maps. Structuralists suggest that learning is an organisational phenomenon based on the firm’s routines and that these are subject to formal change processes. Nonaka and Takeuchi (1995) combine these two views into their knowledge creation spiral. This begins with a distinction between tacit and explicit knowledge and maps how tacit knowledge starts with the individual and proceeds through socialisation and integration processes so that knowledge becomes a key ingredient in the organisation’s

capital stock. More generally, such learning can be described as a “sense-making” process (Weick, 1979, 1995) through which the members of the organisation construct a “common reality” that influences the way they seek to achieve an “objective economic reality”. Teece et al. (1997) in their well-known paper on dynamic capabilities may have intended to add primarily to the RBV but they also provide a sense of the internal mechanisms by which learning and adaptation may actually take place. Their definition of dynamic capabilities is “the sub-set of the competences and capabilities which allow the firm to create new products and processes and respond to changing market circumstances” (Teece et al., 1997, p. 270). In some ways this is a restatement of Nelson and Winter’s (1982) strategising routines, but inherent in their discussion is recognition of learning. They identify three characteristics that permit learning. The first is the nature of the internal processes: co-ordination/integration (a static notion), learning (dynamic), and reconfiguration (a renewal or transformational concept). Second, they are specific about the variety of resource positions that might need to be addressed. Finally, they pay attention to the paths by which developments can take place. It has to be said that these concepts can be very slippery. Path dependency, for example, is celebrated only as an idea. However, they are on more firm ground in outlining the ways in which technological opportunity can shape the future. The hints they provide on the nature of increasing returns are suggested here. We revisit our schematic again in the form of Figure 5. This time the resource side is further elaborated by the inclusion of learning and dynamics. Note, however, that the resource (knowledge) element defies construction in linear form – we begin here to see it as an interconnected whole (via the multiple arrows). Learning, moreover, creates multiple feedback effects.

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8. Towards a KBV We have reviewed four different perspectives on knowledge in strategy and in strategy making: knowledge as assets for protection, knowledge through innovation, knowledge embedded in routines, and knowledge through learning. In doing this we have touched on a wide variety of themes in strategic management, competitive

Figure 5. Dynamic capabilities view

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Figure 6. Spiral of organisational knowledge creation

advantage, the RBV, strategy making, and strategising routines. We have also commented on developments in economic thinking ranging from neo-classical theory, through Schumpeter to evolutionary economics with a hint also of institutional economics. In doing this we have progressed from market positioning and the firm as a black box to serious consideration of internal organisation and those processes that underpin competitive advantage. Knowledge makes its entry as an asset, albeit largely invisible, that protects competitive position. But we have moved to a more subtle position where knowledge is embedded in individuals and by complex processes is socialised and reintegrated into the organisation at large. Do these various perspectives on knowledge enable us to articulate a KBV of strategy whose implications allow us to draw inferences about strategy and strategy making that are either absent from other theories or in contradiction to them? What are the essential ingredients of a KBV? Grant (1996) and Spender (1996) in a special issue of SMJ in 1996 have two much quoted papers that step outside conventional economic approaches. Grant (1996) sees the firm as an institution for integrating knowledge where knowledge is individually held and is typically tacit. The organisation’s role is to access, transfer, and integrate that tacit knowledge within and throughout the organisation. His approach is very similar to that of Nonaka and Takeuchi (1995 (see Figure 6)). In Grant’s view, the firm is a co-ordinating mechanism with implications for organisational design and for the nature of organisational process. Spender sees knowledge as too contentious a concept to easily bear the weight of a theory. The biggest problem, he sees, is the multitude of types and definitions. He therefore argues (as Grant does implicitly) for a pluralistic epistemology and advances the idea of interplay between explicit and tacit knowledge, and between different units within the organisation (from individuals through to collectives). This leads to different Weberian ideal types (see Figure 7). He moves from this to knowledge as activity and argues eventually for a Penrosian view – a historical,

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Figure 7. Different types of organisational knowledge

path dependent process in which the individual rather than machine bureaucracies are the important strategists. It is useful to start with Spender’s (1996, p. 48) view (Figure 7) that our concepts of knowledge are highly varied and in many ways inconsistent or incapable of being inter-related: Knowledge is a highly contentious concept, far too problematic to bear the weight of a useful theory of the firm without a clear statement of the epistemology which gives it meaning.

He then proceeds by making three points: (1) Knowledge is the interplay between the tacit/implicit and the explicit, the horizontal dimension in Figure 7. (2) This distinction allows for several different adaptation mechanisms – for example, Nelson and Winter’s (1982) own use of adaptive feedback mechanisms where the interplay between tacit and explicit takes place through individual choices that are eventually embedded in organisational routines (“organisational genetics”), but note that “eventually” is highly under identified in this and most other models. (3) Many theorists, starting with Polanyi (1966) and famously in Nonaka and Takeuchi (1995), see the origin of all knowledge in individual intuition. So the third element is the transformation and communication of what is known tacitly by individuals into collective or social knowledge. Hence the second dimension in Figure 7. Therefore Spender advances four ideal types connected by an adaptation mechanism. He observes that the organisational intent is to transform tacit, individual knowledge into collectively owned, objectifiable knowledge – this is the world of standards, procedures, practices, patents, science, training, but still recognisably a world that remains dependent on the knowledge held by individuals although, in this diagram, the adaptation mechanisms of transformation and conversion process operate in silence. Given different types of knowledge are there different types of knowledge-based theory, Spender asks. A theory of conscious knowledge would have to solve agency

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problems – how can inventors be persuaded to pass on their codified knowledge to an organisation? A theory based on automatic knowledge also has agency problems where the brilliant man must be persuaded to stay with the firm (see work-out clauses for entrepreneurs when they sell their businesses). A theory of objectified knowledge raises problems of imitability in a world where knowledge is explicit. A theory based on inherently immobile collective knowledge (this is where Nonaka and Takeuchi would wish to take us and where Nelson and Winter go with their extra rational learning processes) leads to a conclusion that this is the most secure and strategically significant kind of organisational knowledge. Nonaka and Takeuchi’s (1995) knowledge spiral (Figure 6) predates Spender by some three years. Their arena (matrix) has become a standard framework of its kind. Their focus is on a knowledge spiral, an adaptation mechanism through which knowledge is converted and then transferred between the tacit and the explicit (it can go either way) and among individuals, groups, and the whole organisation. Socialisation is the sharing of experiences so that tacit knowledge is shared between individuals, from individuals to the organisation through the development of culture and shared mental models, and from the organisation to individuals. Externalisation is the conversion of tacit into explicit knowledge through its articulation and systematisation within the organisation. Combination involves the conversion of explicit knowledge held by individuals and groups into explicit knowledge at the organisational level, and subsequent conversion of organisational knowledge back to the individual in different form. This is the key role of information systems within the firm. Internalisation is conversion of explicit knowledge back into tacit knowledge in the form of individual know-how and organisational routines. The knowledge spiral is the dynamic process by which knowledge is translated through separate but related stages, through socialisation to combination and externalisation, and back to internalisation. Thus individual creativity can be linked to the growth of collective knowledge[8]. Spender’s contribution relates to the different types of organisational knowledge whereas Takeuchi and Nonaka use the same intellectual space to portray the adaptation mechanisms that organisations can use to convert and transfer various kinds knowledge to inimitable and therefore rent-earning organisational knowledge. The value chain, popular for its simple and robust character, can be restated first, in the language of core competences and the RBV but more fundamentally in this language of knowledge. This characterisation creates a liner chain of activities that can be readily restated as a similar chain of core competences. The activities of the value chain might be dispersed across different owners but in any event they are controlled in economic terms through the operation of core competences. Thus economic power is operated through the conjunction and interaction of core competences. However, the linearity of the chain metaphor is uncomfortable where the empirical record suggests knowledge is multi-faceted and capable of being attached to other pieces of knowledge in a variety of expected and unexpected ways, particularly as interface standards are developed and “knowledge as Lego” becomes more and more possible. The notion of a web is intuitively appealing (Figure 8). At the centre is the corporate glue, that organisationally held tacit knowledge that cannot readily be imitated – the “collective” knowledge according to Spender, and the knowledge architecture according to Henderson and Clark (1990). This is characteristically a collective concept but also a tacit and sticky concept meaning that the organisation can be

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Figure 8. The knowledge web

readily and sustainably differentiated by it. This corporate glue supports and is supported by a set of core competences within which elements of objectifiable knowledge may be evident[9]. These are buttressed by closely held partnerships where ability to control the agency costs becomes really important. More remotely managed are the sub-contract relationships where market contracting suffices. The value is a meta-level concept within which the activity sets formerly given pride of place in the value chain are replaced by knowledge concepts. Inherent in a KBV and also in an economist’s concept of a knowledge production function are the linkages between knowledge as assets, knowledge embedded in processes, and the pathways to competitive advantage. In the Teece et al. (1997) formulation, knowledge processes can be divided into entrepreneurial (creative), coordinative and integrative (static), learning (dynamic), and reconfigurational (transformational). In asset or resource terms we see knowledge as embedded in many different classes of assets such as technology, complementary, financial, reputational, structural, institutional, and market structure. For example, Amit and Schoemaker (1993) provide an excellent description of strategic assets and their linkage to organisational rent (competitive advantage). Following but not replicating Teece et al. (1997) we express the linkages to competitive advantage in terms of dynamic pathways. Whereas Amit and Schoemaker (1993) and Peteraf (1993) only assert the relationship between assets and rents, in this approach the linkages, dynamic pathways, are defined in terms of path dependency (which allows us to call on an evolutionary perspective) and technological opportunities (which allows for returns to scale[10], first/early mover advantage, and oligopolistic gaming). The strength of this approach lies in its organisational inclusivity, ranging from internal process to asset positions, linked over time through management of the pathways. Empirical support here is patchy but attracting research interest. This approach follows the approach of Teece in style but our additions to Teece are the inclusion of entrepreneurial (creative) processes and a more explicit characterisation of paths as dynamic links. This literature enables us to see that there are elements of knowledge that can be related to sustainable competitive advantage. These knowledge concepts lie deep behind the well-known notions of strategic positioning and the RBV and are powerful in that they in a fundamental sense are the drivers behind core competences and competitive advantage. So, is it possible to draw this thinking together into a

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Figure 9. Element of the knowledge-based view

Figure 10. Elements of specific knowledge

perspective that we might call the KBV of strategy? Our approach is to suggest three categories (Figure 9) called specific knowledge, organisational knowledge, and the knowledge web[11]. Specific knowledge (Figure 10) relates to the knowledge production function and links as inter-related activities knowledge, production, access to knowledge, knowledge diffusion, connections between elements of knowledge, and knowledge renewal (including the discarding of knowledge). The foundations of this are highly dispersed. There is a considerable economic literature on innovation competition and R&D and in the scientific and social science literature on innovation processes. There is also some considerable mystery about creativity usually captured under the heading of serendipity. Organisational knowledge (Figure 11) is the process by which various elements of specific knowledge are taken into the organisation, transformed into social/collective knowledge and through dynamic pathways linked into other organisational activities. The key elements (Figure 11) are characterised as types of organisation knowledge, the

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Figure 11. Organisational knowledge

knowledge creation process, and dynamic pathways. The inheritance from Spender, Takeuchi and Nonaka, and Teece et al. are self-evident. The knowledge web (already shown in Figure 8) represents the way in which specific knowledge and organisational knowledge is captured into value creating activities within the firm (discussed above) (see also Winter (1987) for an earlier exposition of this point). Both specific and organisational knowledge feed into the knowledge web. The notion of corporate glue or knowledge architecture stems directly from the conjunction of tacit and social knowledge. But specific knowledge is also evident from its role within core competences and within the core competences of strategic partners. The knowledge web is also dynamic in that incentives to innovate and to create new linkages between knowledge components are created here and therefore provide the link back to the knowledge production function that is captured within the category of specific knowledge. This approach allows us to connect three strands. The first concerns the ways in which knowledge is produced, accessed, diffused, renewed, and discarded. The second concerns the notion of organisational knowledge an essentially invisible asset fostered and conditioned by visible and defined organisational routines and ad hoc processes. The third is a strategic theory of the firm in which positioning and resourced based approaches are recast in the form of knowledge[12]. Again, knowledge is the invisible asset but captured here in the form of specific activities on which management focuses attention. This does not answer all the questions but perhaps does allow us to define a set of interesting questions and permit the formation of some conjectures which link our analytic approach to the “enactment” approach offered in the literature of knowledge management. We suggest the following provides a useful linkage agenda: . How is knowledge produced and accessed? This includes the imponderable of “knowledge creation” as well as the more prosaic “knowledge conversion” (a word used by Grant (1996) and by Nonaka (1994) and has a parallel to the economists’ idea of a production function. We know more about the processes of innovation and we also know quite a lot about the economic analysis of new technology decisions.

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How does knowledge fit into supply chain and value chain thinking – in other words, how does it link and co-ordinate with the other activities of the firm to produce competitive advantage? The knowledge web is a useful Gestalt but much needs to be done to identify the specifics. How do pieces of knowledge connect up? How do they change the nature of the corporate “glue” – the integrative strategic architecture? What difference does any of this make for the analysis of strategic decisions such as diversification and acquisition? Does this have anything to contribute to economists’ thinking about increasing returns industries - another arena where the “new economy” appears to be challenging basic assumptions behind traditional thinking (McGee and Sammut-Bonnici, 2002, 2003)?

These are not simply issues for shaping and assessing a theory, but they are also conjectures. They are conjectures about the nature of knowledge itself, whether such a multi-faceted concept can be marshalled into the constraints inherent in a normative, organisationally focussed theory. 9. Conclusions Taking a reasonably broad view of the writings in and around knowledge and strategy we made a number of observations about extant thinking, relative to the enriched development of a strategic theory of the firm: . Whereas knowledge was only implicit in the MBV of the firm it is a central element of the RBV. . Dynamic theories of the firm cannot operate without some clear and operational concepts of knowledge. For example: tacit and explicit; and a knowledge production function incorporating innovating, accessing, transferring, integrating, and codifying. . However, we sympathise with assertions that knowledge is a highly contentious concept. For example: know-how vs know-what; explicit vs implicit, individual vs. collective; knowledge as knowing, as learning, as activity, etc. . Nevertheless, our conjectures about the applicability of knowledge as a significant explanatory variable may be supported empirically: for example see the wide range of citations in Eisenhardt and Santos (2001). . The writing on organisational knowledge has shown it as the lynchpin between internal organisational structures and processes and the capture of economic rents. . More controversially, there is a case for an evolutionary theory incorporating dynamic pathways as the external manifestation of organisational knowledge. Our own approach to this has not been to attempt to provide “a unified theory of absolutely everything”[13]. Rather, we have attempted to find a way of incorporating knowledge variables into the explanation of the long run performance of firms and their long run sustainable competitive advantages from an analytic and economic perspective. To do this we offer a simple categorisation that links three types of literature, on specific knowledge – a very dispersed literature, on organisational

knowledge – which made considerable progress in the 1990s, and on the strategic theory of the firm. These strands we suggest are mutually reinforcing and interconnected. In particular, from a managerial perspective we can see how knowledge “issues” have a very direct economic content via the knowledge production/diffusion function, and a very organisational and individual element through the analysis of organisational knowledge. These do not stand, however, as separable issues although elements of the problem can be treated in isolation. Rather the system wide characteristics of knowledge are evident particularly in the knowledge web through which value creation activities are composed. In a subsequent paper, we shall attempt to marry analytic, economic and “enactment” views of knowledge into an enhanced framework for a strategic theory of the firm. Notes 1. The use of the word narrow is to differentiate from economies of broad scope – the difference being the nature of the resource “hook”, narrow being located typically within functions to explain product range scope, broad being wider and more generic in kind to support business diversity. 2. For a concise explanation see Besanko et al. (2000, pp. 117-9). 3. Nelson and Winter (1982) are most commonly identified with evolutionary economics. But the roots run deeper: see Veblen (1898) on cumulative change, Marshall (1920) on “economic biology” and his well-known appreciation of dynamic analysis, and Alchian (1950, 1963) on the implications of selection for the economic system. 4. See the teaching notes in De Wit and Meyer (1999) for a practical illustration. Also see Barney (1991) and Grant (1991) for similar deconstructions of resources. 5. The approach adopted in this section owes much to Menuhin (2001) and Menuhin and McGee (2003). 6. This is described and analysed in great detail by Vronen (1995). 7. See for example the antimarginalist critique exemplified by the Oxford Research Group in the 1930s, especially Hall and Hitch (1939) and the American economist Lester (1946). 8. The authors are indebted to Rob Grant for this articulation of Nonaka and Takeuchi’s model. 9. An alternative description would be to describe the corporate glue as supported by elements of objectifiable knowledge and the conjunction of the two being core competence. This has the merit of defining core competence explicitly in terms of knowledge concepts. 10. Especially network externalities where “winner takes all” strategies are possible (McGee and Sammut-Bonnici, 2002, 2003). 11. Alternatively knowledge in action. 12. A link here could be made with Rumelt (1984) by developing the argument that our use of knowledge as corporate glue is directly analogous to his use of isolating mechanisms. 13. See the debates that have taken place in theoretical physics. References Abramowitz, M. (1986), “Catching up, forging ahead, and falling behind”, Journal of Economic History, Vol. 46 No. 2, pp. 385-406. Alchian, A.A. (1950), “Uncertainty, evolution and economic theory”, Journal of Political Economy, June, pp. 211-21.

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Alchian, A.A. (1963), “Reliability of progress curves in airframe production”, Econometrica, No. 31, pp. 679-93. Alchian, A.A. and Demsetz, H. (1972), “Production, information costs, and economic organisation”, American Economic Review, Vol. 62 No. 5, pp. 777-95. Amit, R. and Schoemaker, P.J. (1993), “Strategic assets and organisational rent”, Strategic Management Journal, Vol. 14 No. 1, pp. 33-46. Anderson, P. and Tushman, M.L. (1990), “Technological discontinuities and dominant designs”, Administrative Science Quarterly, Vol. 35 No. 4, pp. 604-33. Arrow, K. (1962), “Economic welfare and the allocation of resources for inventions”, in Nelson, R.R. (Ed.), The Rate and Direction of Economic Activity, Princeton University Press, Princeton, NJ. Barney, J. (1991), “Firm resources and sustained competitive advantage”, Journal of Management, Vol. 17 No. 1, pp. 99-120. Besanko, D., Dranove, D. and Shanley, M. (2000), Economics of Strategy, 2nd ed., John Wiley & Sons, New York, NY. Bettis, R. and Prahalad, C.K. (1995), “The dominant logic: retrospective and extension”, Strategic Management Journal, Vol. 16 No. 1, pp. 5-15. Brandenburger, A.M. and Nalebuff, B.J. (1995), Co-opetition, Doubleday, New York, NY. Burgelman, R.A. (1983), “A model of the interaction of strategic behaviour, corporate context, and the concept of strategy”, The Academy of Management Review, Vol. 8 No. 1, pp. 61-70. Chandler, A.D. Jr (1990), Scale and Scope: The Economics of Industrial Competition, Harvard University Press, Cambridge, MA. Christensen, C.M. (1997), The Innovator’s Dilemma, HBS Press, Boston, MA. Coase, R. (1937), “The nature of the firm”, Economica, Vol. 4 No. 16, pp. 386-405. Coase, R. (1988), “Lecture on the nature of the firm, III”, Journal of Law, Economics and Organisation, Vol. 4 No. 1, pp. 33-47. Cohen, M.D. and Baclayan, P. (1994), “Organisational routines are stored as procedural memory: evidence from a laboratory study”, Organisation Science, Vol. 5 No. 4, pp. 554-68. Cyert, R.M. and March, J.G. (1963), A Behavioral Theory of the Firm, Prentice-Hall, Englewood Cliffs, NJ. D’Aveni, R.A. (1994), Hypercompetition: Managing the Dynamics of Strategic Manoeuvring, Free Press, New York, NY. De Geus, A. (1988), “Planning as learning”, Harvard Business Review, Vol. 66 No. 2, pp. 70-4. De Wit, R. and Meyer, R. (1999), Strategy Synthesis: Resolving Strategy Paradoxes to Create Competitive Advantage, Thomson, London. Eisenhardt, K.M. and Martin, J.A. (2000), “Dynamic capabilities: what are they?”, Strategic Management Journal, Vol. 21 Nos 10-11, special, pp. 1105-21. Eisenhardt, K.M. and Santos, F.M. (2001), “Knowledge-based view: a new theory of strategy?”, in Pettigrew, A.M., Thomas, H. and Whittington, R. (Eds), The Handbook of Strategy and Management, Routledge, New York, NY. Evans, P. and Wurster, T. (1997), “Strategy and the new economics of information”, Harvard Business Review, Vol. 75 No. 5, pp. 70-82. Evans, P. and Wurster, T. (1999), Blown to Bits: How the New Economics of Information Transforms Strategy, Harvard Business School Press, Boston, MA. Ghemawat, P. (1991), Commitment: The Dynamics of Strategy, Free Press, New York, NY.

Gottinger, H.-W. (1998), “Technological races”, Annual Review of Economics (Japan), Vol. 38, pp. 1-9. Gottinger, H.-W. (2001), “Stochastic innovation races”, Technological Forecasting and Social Change, Vol. 68 No. 1, pp. 1-18. Gottinger, H.-W. (2003), Economics of Network Industries, Routledge, London. Granovetter, M. (1985), “Economic action and social structures”, American Journal of Sociology, Vol. 91 No. 3, pp. 481-510. Grant, R.M. (1991), “The resource based theory of competitive advantage: implications for strategy formulation”, California Management Review, Spring, pp. 119-45. Grant, R.M. (1996), “Toward a knowledge-based theory of the firm”, Strategic Management Journal, Vol. 17, Winter, special issue, pp. 109-22. Hall, R.L. and Hitch, C.J. (1939), “Price theory and business behaviour”, Oxford Economic Papers, Vol. 2, Oxford University Press, Oxford. Hamel, G. (2000), Leading the Revolution, HBS Press, Boston, MA. Hamel, G. and Prahalad, C.K. (1993), “Strategy as stretch and leverage”, Harvard Business Review, March-April. Hedberg, B.L.T. (1981), “How organisations learn and unlearn”, in Nystrom, P.C. and Starbuck, W.H. (Eds), Handbook of Organisational Design, Vol. 1, Oxford University Press, New York, NY, pp. 2-27. Henderson, R.M. and Clark, K.B. (1990), “Architectural innovation: the reconfiguration of existing technologies and the failure of established firms”, Administrative Science Quarterly, Vol. 35 No. 1, pp. 9-30. Huff, A.S. (1994), “Mapping strategic thought”, in Huff, A.S. (Ed.), Mapping Strategic Thought, 2nd ed., John Wiley & Sons, Chichester, pp. 11-52. Jensen, M.C. and Meckling, W. (1976), “Theory of the firm: managerial behaviour, agency costs, and ownership structure”, Journal of Financial Economics, Vol. 3 No. 4, pp. 305-60. Johnson, G. and Bowman, C. (1999), “Strategy and everyday reality: the case for study of micro-strategy”, working paper presented at the 15th EGOS Colloquium, Warwick, 2-14 June. Johnson, G. and Huff, A.S. (1998), “Everyday innovation/everyday strategy”, in Hamel, G., Prahalad, C.K. and Thomas, H.T. (Eds), Strategic Flexibility: Managing in a Turbulent Economy, John Wiley & Sons, Chichester. Langlois, R.N. (1986), “Rationality, institutions, and explanation”, in Langlois, R.N. (Ed.), Economics as a Process: Essays in the New Institutional Economics, Cambridge University Press, Cambridge, pp. 225-55. Leonard-Barton, D. (1992), “Core capabilities and core rigidities: a paradox in managing new product development”, Strategic Management Journal, Vol. 13, special issue, pp. 111-26. Lerner, J. (1997), “An empirical exploration of a technology race”, The Rand Journal of Economics, Vol. 28 No. 2, pp. 228-324. Lester, R.A. (1946), “Shortcomings of marginal analysis for wage-employment problems”, American Economic Review, Vol. 36 No. 1, pp. 63-82. Levitt, B. and March, J.G. (1988), “Organisational learning”, Annual Review of Sociology, Vol. 14, pp. 319-40. McGee, J. (2003), “Strategy as knowledge”, in Wilson, D. and Cummings, S. (Eds), Images of Strategy, Basil Blackwell, Oxford.

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McGee, J. and Sammut-Bonnici, T. (2002), “Network industries in the new economy”, European Business Journal, Vol. 14 No. 3, pp. 116-32. McGee, J. and Sammut-Bonnici, T. (2003), “Emerging strategies for new industry structures”, European Business Journal. McGee, J., Thomas, H. and Wilson, D. (2005), Strategy: Analysis and Practice, McGraw-Hill, Maidenhead. March, J.G. and Simon, H. (1958), Organisations, John Wiley & Sons, New York, NY. Marshall, A. (1920), Principles of Economics, 8th ed., Macmillan Press, London. Menuhin, J. (2001), “Strategising routines: the emergence of strategic initiatives”, unpublished PhD thesis, University of Warwick, Coventry. Menuhin, J. and McGee, J. (2003), “Strategising routines in HSBC (UK)”, unpublished working paper, University of Warwick, Coventry. Nelson, R.R. and Winter, S.G. (1982), An Evolutionary Theory of Economic Change, Belknap Press, Cambridge, MA. Nonaka, I. (1993), “On a knowledge creating organization”, paper presented at the AIF National Congress, Posma, October. Nonaka, I. (1994), “A dynamic theory of knowledge creation”, Organization Science, Vol. 5 No. 1, pp. 14-37. Nonaka, I. and Takeuchi, H. (1995), The Knowledge-creating Company: How Japanese Companies Create the Dynamics of Innovation, Oxford University Press, New York, NY. Penrose, E.T. (1959), The Theory of the Growth of the Firm, Basil Blackwell, London. Peteraf, M.A. (1993), “The cornerstones of competitive advantage: a resource-based view”, Strategic Management Journal, Vol. 14 No. 3, pp. 179-91. Pike, S., Boldt-Christmas, L. and Roos, G. (2006), “Intellectual capital: origin and evolution”, International Journal of Learning and Intellectual Capital, Vol. 3 No. 5, pp. 233-48. Polanyi, M. (1966), The Tacit Dimension, Anchor Day Books, New York, NY. Porac, J.F., Thomas, H. and Baden Fuller, C. (1989), “Competitive groups as cognitive communities: the case of the Scottish knitwear manufacturers”, Journal of Management Studies, Vol. 26 No. 4, pp. 397-416. Porter, M.E. (1980), Competitive Strategy, Free Press, New York, NY. Porter, M.E. (1982), Competitive Advantage, Free Press, New York, NY. Prahalad, C.K. and Hamel, G. (1990), “The core competence of the corporation”, Harvard Business Review, May-June, pp. 79-81. Quinn, J.B. (1978), “Strategic change: logical incrementalism”, Sloan Management Review, Fall. Rumelt, R.P. (1984), “Towards a strategic theory of the firm”, in Boyden Lamb, R. (Ed.), Competitive Strategic Management, Prentice-Hall, Englewood Cliffs, NJ. Scherer, F. (1991), “International R&D races: theory and evidence”, in Mattsson, L.-G. and Stymme, B. (Eds), Corporate and Industry Strategies for Europe, Elsevier Science Publishers, New York, NY. Schumpeter, J. (1934), The Theory of Economic Development, Harvard University Press, Cambridge, MA (originally published in 1911, republished 1968). Senge, P. (1990), “The leader’s new work: building learning organisations”, Sloan Management Review, Fall, pp. 7-23. Simon, H.A. (1955), “A behavioural model of rational choice”, Quarterly Journal of Economics, Vol. 69 No. 1, pp. 99-118.

Simon, H.A. (1959), “Theories of decision-making in economics and behavioural science”, American Economic Review, Vol. 49 No. 3, pp. 253-83. Spender, J.-C. (1996), “Making knowledge the basis of a dynamic theory of the firm”, Strategic Management Journal, Vol. 17, Winter, special issue, pp. 45-62. Teece, D.J. (1980), “Economics of scope and the scope of the enterprise”, Journal of Economic Behaviour and Organisation, Vol. 1 No. 3, pp. 223-47. Teece, D.J., Pisano, G. and Shuen, A. (1997), “Dynamic capabilities and strategic management”, Strategic Management Journal, Vol. 18 No. 7, pp. 509-33. Veblen, T. (1898), “Why economics is not an evolutionary science?”, Quarterly Journal of Economics, Vol. 12 No. 4, pp. 373-97. Vronen, J.J. (1995), Economic Evolution, Routledge, London. Weick, K.E. (1979), The Social Psychology of Organising, McGraw-Hill, New York, NY. Weick, K.E. (1995), Sensemaking in Organisation, Sage, Thousand Oaks, CA. Wernerfelt, B. (1984), “A resource-based view of the firm”, Strategic Management Journal, Vol. 5 No. 2, pp. 171-80. Williamson, O.E. (1981), “Strategizing, economizing, and economic organization”, Strategic Management Journal, Vol. 12, Winter, special issue, pp. 75-94. Williamson, O.E. (1985), The Economic Institutions of Capitalism, Free Press, New York, NY. Williamson, O.E. (1987), “Transactions costs economics”, Journal of Economic Behaviour and Organisation, Vol. 8 No. 1, pp. 617-25. Winter, S.G. (1964), “Economic natural selection and the theory of the firm”, Yale Economic Essays, Vol. 4 No. 1, pp. 225-72. Winter, S.G. (1987), “Knowledge and competence as strategic assets”, in Teece, D.J. (Ed.), The Competitive Challenge – Strategies for Industrial Innovation and Renewal, Ballinger, Cambridge, MA. Further reading Argyris, C. and Schon, D. (1978), Organisational Learning, Addison-Wesley, Reading, MA. Brown, J.S. and Duguid, P. (1991), “Organisational learning and communities-of-practice: toward a unified view of working, learning and innovation”, Organization Science, Vol. 2 No. 1, pp. 40-57. Kogut, B. and Zander, U. (1992), “Knowledge of the firm, combinative capabilities, and the replication of technology”, Organisation Science, Vol. 3 No. 3, pp. 383-97. Tsoukas, H. (1996), “The firm as a distributed knowledge system: a constructionist approach”, Strategic Management Journal, Vol. 17, Winter, special issue, pp. 11-25. Corresponding author Howard Thomas can be contacted at: [email protected]

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Brian Connelly and Michael A. Hitt Texas A&M University, College Station, Texas, USA

Angelo S. DeNisi Freeman School of Business, Tulane University, New Orleans, Louisiana, USA, and

R. Duane Ireland Texas A&M University, College Station, Texas, USA Abstract Purpose – This paper proposes a methodology for governing expatriate assignments in the context of corporate-level objectives. Design/methodology/approach – The approach taken is to envisage expatriate managerial assignments within the theoretical framework of agency theory and the knowledge-based view of the firm. The paper begins with the view that knowledge acquisition and integration is a primary goal for most expatriate assignments. The relationship between expatriate managers and multinational corporation (MNC) headquarters from an agency perspective are considered and the notion of a “knowledge contract” as a means of governing that relationship is discussed. Four corporate-level international strategies available to MNCs (global, international, transnational, and multidomestic) are then examined and the extent of agency problems under each strategy is discussed. Findings – The paper makes specific predictions about the type of knowledge contract that is most likely to address agency problems for each corporate strategy. Originality/value – This research extends agency theory by introducing the knowledge contract as a means of managing agency concerns. This offers a broader range of contract alternatives, moving researchers beyond traditional agency theoretic prescriptions. The research also contributes to the literature on expatriate management by integrating assignment success with research on corporate-level international strategy. Few authors have recognized organizational strategy as an important unit of study in international human resource management. Doing so, however, has yielded a unique set of contingency relationships that would otherwise be obscured. Keywords Expatriates, International business, Corporate strategy, Knowledge management Paper type Conceptual paper

Management Decision Vol. 45 No. 3, 2007 pp. 564-581 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745016

Introduction Multinational corporations (MNCs) invest more in a single expatriate manager than perhaps any individual in the organization other than the chief executive officer (CEO) (Selmer, 2001). In spite of this, organizations rarely consider expatriate assignments from a strategic perspective. One indicator of this problem is the lack of consensus regarding how to gauge the success of these assignments. In fact, scholars have considered different measures of success at different levels of analysis, and these indicators are often inconsistent with one another (Edmond, 2002). For example, some scholars have considered success at the level of the subsidiary, and suggested that it is primarily a function of financial objectives such as growth and profitability (Fey and Bjorkman,

2001). Others have considered success at the level of the individual employee (Tung, 1987), suggesting that successful assignments are those that do not end prematurely (Hogan and Goodson, 1990). These indices of success are inconsistent, increasing the difficulty of relating them to success considered at the level of the organization. A primary goal of this work is to consider how MNCs can govern expatriate managers in view of corporate-level objectives. We believe that our conceptualization of these processes offers a more comprehensive measure of expatriate success. To accomplish our research objective, we first discuss how expatriate managers can contribute to the competitive advantage of MNCs through their role in the knowledge transfer process. We then present a framework for discussing corporate-level international strategy, consisting of four basic types. Drawing on agency theory (Jensen and Meckling, 1976), we consider the extent to which agency problems exist in the relationship between expatriate managers and MNC headquarters under each type. We describe the potential conflict of interest that exists between MNC headquarters and expatriate managers and examine how to align their interests using what we refer to as the “knowledge contract.” Finally, we make specific predictions about the best kind of knowledge contract to use to successfully address agency problems under each strategy. This work makes three contributions to the literature. First, it provides a new mechanism for gauging expatriate success. Whereas, previous analyses have focused mainly on individual and subsidiary levels, this paper explores organizational level concerns. We address individual and subsidiary level factors only to the extent that they are related to corporate-level strategy. Second, in regard to governing and managing expatriate assignments, this research moves the emphasis from traditional measures of compensation and promotion to that of knowledge management. This represents a significant shift from current practice and from the dominant prescriptions emerging from the expatriate literature. Finally, our analysis of expatriate managerial assignments by type of corporate-level international strategy provides a useful typology of expatriatism with the potential to facilitate future research efforts to explore more fully the concept of expatriate types. Knowledge and the agency problem The knowledge-based view of the firm is one of the most commonly used strategic lenses for evaluating organizational actions and outcomes (Grant, 1996). Knowledge-based logic suggests that the most important objective facing MNCs today is the transfer and exploitation of knowledge in a manner that is more effective and efficient compared to external market structures (Ghoshal, 1987; Grant, 1996; Jackson et al., 2003; Teece, 1977). As external markets become more open and efficient, MNCs experience pressure to design increasingly efficient knowledge transfer strategies (Gupta and Govindarajan, 2000), and expatriate managers serve at a critical point in the knowledge management chain. Specifically, the MNC’s capacity to transfer knowledge within its boundaries efficiently and effectively hinges on its global network of expatriates (Bender and Fish, 2000). Therefore, it is imperative that firms pay close attention to the mechanisms that govern expatriate managers in the knowledge management process. Expatriate managers play a crucial role in the knowledge integration process and are important to efforts undertaken to effectively leverage knowledge resources (Downes and Thomas, 2000; Zahra et al., 2000). This process involves both acquiring knowledge and diffusing that knowledge throughout the organization. In fact, Gupta and Govindarajan (1991, p. 473) suggested that “the primary reason why MNCs exist is

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because of their ability to transfer and exploit knowledge more effectively and efficiently in the intra-corporate context than through external market mechanisms”. Although knowledge integration may be a major goal in expatriate assignments, there are some reasons why this integration may not occur. Expatriate managers have little incentive to share knowledge they have acquired because, to the extent that they harbor a monopoly of locally developed knowledge, they gain bargaining power in the MNC by controlling an important asset (Coff, 2003). Further, it is impossible for the organization to be aware of all the knowledge expatriates gain during their assignments or to monitor the extent to which expatriates share that information. This results in a basic agency problem. Agency theory is commonly used to examine governance mechanisms in a relationship where one party delegates control to another party (Jensen and Meckling, 1976). A fundamental concept in agency theory is that of a contract that governs the principal-agent relationship in a situation where both parties act according to their economic self-interests (Fama, 1980; Jensen and Meckling, 1976). The “agency problem” refers to conflicts between the two parties that the contract is meant to address. The extent to which agency problems exist revolves around the dual issues of information asymmetry (i.e. the agent has information that is not available to the principal, and it is difficult for the principal to verify the agent’s intentions or behavior) and opportunism (i.e. agents may act according to their own preferences, at the cost of other goals that are important to the principal) (Eisenhardt, 1989). Although these two concepts are related such that information asymmetries increase the potential for opportunistic behavior, the literature has historically viewed information asymmetry and the threat of opportunism as distinct variables (Conner and Prahalad, 1996). Thus, MNCs need mechanisms to ensure that the information for which they sent expatriates overseas to acquire will actually be shared and integrated into the rest of the firm, either within the host country or in the home country. The managerial expatriate assignment results in a classic principal-agent structure in which a principal (MNC headquarters) delegates control to an agent (the expatriate manager). Information asymmetries and a threat of opportunism are products of this structure. A conflict of interest between principal and agent is a fundamental assumption of agency theory (Jensen and Meckling, 1976). Information asymmetries and the threat of opportunism are not problems unless such a conflict exists. In fact, solutions to the agency problem often try to avoid the conflict by aligning the interests of principal and agent. Scholars have established that a conflict of interest exists between MNC headquarters and their subsidiaries, owing to different goals, motivations, and roles (Bjorkman et al., 2004; Nohria and Ghoshal, 1994). Roth and O’Donnell (1996) suggested that this conflict of interest existed between MNC headquarters and subsidiary managers. We agree, and further extended it to the relationship between MNC headquarters and expatriate managers. The primary interest of expatriate managers is likely to be advancement of their own career. In pursuit of such interests they may make themselves more valuable to the firm by harboring knowledge and skills rather than institutionalizing them. Thus, their own interests conflict with those of headquarters. Yan et al. (2002, p. 380) describe this in more detail: According to agency theory, because of the low verifiability of what the expatriate manager is actually performing in a foreign environment, it is likely that he or she will leverage this performance and engage in activities such as cultivating local networks that increase his or her marketability, jockeying between companies for better job offers, or withholding strategic information from the focal firm to increase individual bargaining power.

This conflict of interest between MNC headquarters and expatriate managers lies at the heart of differing perspectives about expatriate success. Under agent opportunism, the experience described above may be highly successful from the individual’s perspective but not at all successful from the organization’s perspective. To address these divergent perspectives, we suggest that firms align the success metrics of headquarters with those of the expatriate manager by settling in advance common objectives for knowledge integration. The knowledge contract We introduce a “knowledge contract” between expatriate managers and the MNC to describe explicit arrangements about integrating locally acquired and developed knowledge. Organizations may use the knowledge contract to resolve agency problems that exist between the two parties. We define the knowledge contract as the governance mechanisms, or rules of the game, by which organizations monitor and reward expatriate managers for how they acquire, synthesize, and share local knowledge with the subsidiary, other subsidiaries, or the firm’s headquarters. Although the knowledge contract will have both explicit (written) and implicit (psychological) forms, we focus here on the written component. Organizational knowledge goals drive the written knowledge contract, which Yan et al. (2002) characterize in three components: retention, transfer, and utilization of expatriate manager expertise. The focus of retention is on keeping the expatriate manager’s knowledge by keeping the manager within the organization’s boundaries (Bender and Fish, 2000). The written knowledge contract may seek to retain expatriate managers, for example, with guarantees of employment or promotion upon repatriation (Fey and Bjorkman, 2001). Knowledge transfer here refers to moving knowledge from the expatriate manager into another knowledge repository in the organization (Teece, 1977). In the written knowledge contract, this may take the form of expressly designated mentor or co-worker relationships with other expatriates or with host country nationals (Chiesa and Manzini, 1996). Alternatively, knowledge transfer may occur because of written mandates for the institutionalization of knowledge via requirements for documentation or reports. Organizations may address the utilization of knowledge from expatriate managers in two directions. First, they may guard against knowledge utilization toward opportunistic ends using the knowledge contract (Mudambi and Navarra, 2004). For example, expatriate managers may be prohibited from engaging in competing businesses in the local market for some period of time. Second, they may provide incentives for leveraging expatriate knowledge for strategic competitive advantage (Cantwell and Mudambi, 2005). For example, expatriate managers may be rewarded with additional compensation for innovations developed at their subsidiary (Bonache and Fernandez, 1997). Researchers have also identified a psychological contract that specifies beliefs about reciprocal and promised obligations (Rousseau, 1989). Although it is implicit, unwritten, and informal, the psychological contract may include important expectations that, if left unmet, can adversely affect the employment relationship and its outcomes (Morrison and Robinson, 1997). For example, Feldman and Thomas (1992) argue that perceived violations of international managers’ psychological contract can contribute to high turnover rates. For the expatriate manager, the focus of the psychological contract is on rewards such as continued development, attractive future assignments, and promotion (Yan et al., 2002). For the organization, the psychological contract revolves around the significant financial investment that it has made in the individual (McNulty and Tharenou, 2004). We recognize the psychological contract and the written knowledge

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Figure 1. Specificity of the knowledge contract

contract are not entirely independent. However, we are mainly concerned in this research with the governance mechanisms of the written knowledge contract rather than the unstated and implied expectations of the psychological contract. The MNC can employ various governance mechanisms within the knowledge contract to either encourage or enforce knowledge integration (Chiesa and Manzini, 1996). Prior research has considered the means necessary to ensure knowledge transfer between MNC headquarters and subsidiaries (Bjorkman et al., 2004). However, the knowledge contract is mainly concerned with mechanisms for integrating knowledge into the organization, or transferring knowledge from the expatriate manager to local managers or other expatriates. Mechanisms for knowledge integration may include incentives such as promotion guarantees, contingent financial rewards, or enlargement of responsibility. The knowledge contract may incorporate monitoring and control mechanisms, such as documentation and reporting requirements, or compartmentalizing routines such that complete knowledge does not rest in a single individual. It may also include structures designed to promote knowledge sharing, such as mentoring or co-worker relationships with a view toward knowledge transfer. Managing with the knowledge contract assumes an intentional approach toward understanding knowledge that emerges from expatriate assignments and incorporating mechanisms back into the individual’s contract to ensure its retention, transfer, and utilization. The more mechanisms that firms employ, the more specific the knowledge contract becomes, aligning the interests of principal and agent and attenuating potential agency problems. Although it might seem that MNCs should always move toward increased specificity of knowledge contracts to better align the interests of principal and agent, this specificity is not without cost (Jones, 2001). Transaction costs of the knowledge contract are the summed costs, direct and indirect, associated with the rules and routines designed to monitor and reward expatriate managers for knowledge integration behavior. As MNCs move from broad, nonspecific contracts to very specific, binding contracts they also increase the transaction costs involved in administering and monitoring that contract. Thus, when agency problems are severe, firms will likely employ specific knowledge contracts to mitigate the potentially high costs associated with their agency problems. However, when agency problems are not significant, firms are more likely to make use of nonspecific knowledge contracts to reduce overall transaction costs. Therefore, we posit the following (see Figure 1):

P1.

The threat of opportunism by expatriate managers and the degree of information asymmetry between expatriates and MNC headquarters is negatively related to specificity of the knowledge contract.

The seriousness of the principal-agent problem, and the utility of different types of knowledge contracts, also depends on the specific international strategy the MNC is implementing. This is because different corporate-level international strategies leverage different kinds of knowledge and impose different knowledge-development concerns. These relationships are described next. International corporate-level strategies Corporate-level international strategy types, and how to choose a suitable one, have received much attention in the popular press (Mankin and Cohen, 2004), mainstream business literature (Hout et al., 1982), and academic literature (Harzing, 2000). Firms that operate internationally typically face two types of competitive pressures: pressure to reduce costs and pressure to be locally responsive to the markets in which they operate (Bartlett and Ghoshal, 1991). These pressures place conflicting demands on subsidiaries. To minimize costs, firms may need to base their core businesses and productive resources at the most favorable low-cost location and offer standardized products to a global marketplace. To accommodate diverse demands arising from market differences, firms may also need to differentiate product offerings and marketing strategies from country to country, which raises costs. Carrying out a specific strategy to balance these competing demands allows firms to develop ownership advantages, or firm-specific advantages (FSAs), associated with internalization (Rugman and Verbeke, 2001). When an MNC reaches a certain level of product complexity across multiple industries and countries, it becomes increasingly burdensome to operate without an international strategy at the corporate level (Hitt et al., 1994). The academic literature features a wide variety of dimensions and prescriptions for corporate-level international strategy, resulting in some conceptual ambiguity about the substance of an “international strategy.” One often used typology is that prescribed by Bartlett and Ghoshal (1998), who identified four main strategies for the MNC: global, international, transnational, and multidomestic. A global strategy is one that centralizes strategic and operating decisions in the home office, which is responsible for integrating interdependent strategic business units worldwide. Firms following this strategy try to standardize their product offering and marketing strategy so they can reap maximum benefits from economies of scale. This strategy is most suitable to situations in which there are strong pressures for cost reductions and demand for local responsiveness is low, such as that found in many industrial goods industries (Hitt et al., 2007). Because of the need to coordinate strategies and operating decisions across country borders, these firms require a high degree of resource sharing and cooperation, leveraging innovations and core competencies developed at or with the home office. A multidomestic strategy, on the other hand, seeks to achieve maximum local responsiveness (Hout et al., 1982). Customization is at a premium, and firms design products and strategies to meet the specific needs and preferences of local customers. Consistent with customization is an accordingly high cost structure where firms develop a set of value creation activities for each major national market in which they do business, rather than leveraging resources and distinctive competencies from the home office. As the organization decentralizes strategic and operating decisions to business units, each national subsidiary operates in a largely autonomous manner.

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The international strategy bears similarity to a global strategy in that it creates value by transferring core competencies and resources from MNC headquarters to foreign markets. However, the international strategy is distinct in that the firm decentralizes resources and capabilities outside the core to subsidiaries. Firms carrying out an international strategy will typically undertake some level of customization of product offering and marketing to leverage core competencies within local markets, but customization is usually limited in scope. This strategy is common among firms that control a valuable core competence at headquarters that is lacking or insufficient in the foreign market, and is only useful when pressures for local responsiveness exist but are fairly weak. Finally, the transnational strategy involves a firm simultaneously seeking to lower its costs while being responsive to local demands. The difficulty in implementing a transnational strategy lies in reconciling conflicting goals: . the demand for low cost, which requires global coordination; and . the demand for local responsiveness, which requires flexibility and local control. Firms seek to resolve this conflict by creating an integrated network of subsidiaries with shared vision and common commitment. The core distinction of a transnational firm is that competencies and resources do not reside solely in a single country, but instead may develop in any of the company’s worldwide operations. Knowledge, therefore, is decentralized and knowledge transfer occurs between subsidiaries as much or more than between headquarters and subsidiaries. Extent of the agency problem under each strategy The agency problem differs across the four types of MNC strategies discussed above. Within the context of a global strategy, for example, expatriate managers are likely to take on an institutionalized role with little managerial discretion. Because coordination occurs mostly from the home office, the organization does not imbue expatriates with power to make independent decisions for the subsidiary. Instead, expatriate managerial decisions are interdependent with headquarters and with other subsidiaries (Roth and O’Donnell, 1996). Because the emphasis is on cost reduction and worldwide standardization, it is important to centralize strategic decision making at the home office. Expatriate managers therefore have fewer occasions to act opportunistically. As a result, we propose the following: P2a. The threat of opportunistic behavior by expatriate managers is low in firms carrying out a global strategy. Further, the specialized knowledge needed to manage a firm exercising a global strategy is based at headquarters. This requires visibility on the part of expatriate managers worldwide for the strategy to work effectively. Information that is available to expatriates is also available to the home office. In fact, under this strategy, most of the core knowledge needed for high-level expatriate managers to do their job originates from the home office. Because knowledge is centrally located and shared with subsidiaries throughout the world, it needs to be both codifiable and transferable (Kogut and Zander, 1993). The emphasis, then, is on explicit knowledge that headquarters disperses from a central repository and makes widely available throughout the firm. There is relatively little need to develop local knowledge because the primary objective of expatriate managers becomes one of implementing strategies established by the parent company (Bartlett and Ghoshal, 1998). Thus, we propose:

P2b. Information asymmetry between expatriate managers and MNC headquarters is low in firms implementing a global strategy. Expatriate managers working under a multidomestic strategy typically control research and development, production, and marketing activities with a great deal of autonomy, often with host country nationals. These firms do not centralize decision making at headquarters, but instead delegate authority so that expatriate managers can customize products and services and add value. As a result, monitoring their work is increasingly difficult (Rajagopalan and Finkelstein, 1992). The goal of expatriate managers becomes a complex one of sensing and exploiting local opportunities (Bartlett and Ghoshal, 1998). This is a highly nonprogrammable task, and it is important for expatriate managers to gain the necessary knowledge to develop innovations locally. Expatriate managers in the multidomestic firm will acquire knowledge that is region-specific and is nontransferable. Thus, expatriate managers in multidomestic firms will incur risk as they gain information that, in large part, is not valuable in other settings. These expatriates are likely to reduce that risk by engaging in various forms of opportunistic behavior. Thus, we propose: P3a. The threat of opportunistic behavior by expatriate managers is high in firms carrying out a multidomestic strategy. Similarly, as the role of expatriate managers becomes more autonomous, they increasingly lose the ability to transfer skills and knowledge to the home office or to other subsidiaries (Hill and Jones, 2004). A significant portion of the expatriate manager’s knowledge stock under a multidomestic strategy is highly localized, so there is little incentive to transfer that knowledge back to the home office because it may not be generalizable to other markets. Neither the incentive system nor the structure is in place to promote knowledge transfer. As expatriate managers in the multidomestic firm develop local knowledge through intricate social relationships with host country nationals (Toh and DeNisi, 2003), they are likely to build tacit knowledge that is not readily transferred to the MNC. Furthermore, expatriate managers may purposely inhibit knowledge transfer to leverage that knowledge in future bargaining with the MNC and make themselves more valuable to the firm. Because the success of expatriate managers in multidomestic firms is tied to local responsiveness, it is important that they both acquire local knowledge and leverage that knowledge for firm growth. There are, however, several factors inhibiting transfer of that knowledge to the home office. Expatriate managers in firms following this strategy create information asymmetries between themselves and MNC headquarters, so we propose that: P3b. Information asymmetry between expatriate managers and MNC headquarters is high in firms carrying out a multidomestic strategy. The goal of expatriate managers in firms carrying out an international strategy is one of adapting and leveraging headquarters’ competencies (Bartlett and Ghoshal, 1998). Organizations necessarily provide expatriate managers with some degree of decision-making authority so they can adapt products and services locally; ultimately though, the head office retains tight control over strategic decisions (Hitt et al., 2007). The knowledge base developed by expatriate managers leverages core competencies in the local market, and is therefore partially region-specific. However, skills developed in leveraging core competencies from headquarters are more readily transferable to other markets, in contrast with expatriate managers in multidomestic firms who deal primarily with locally developed core competencies. Therefore,

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personal asset specificity (and its associated risk) incurred by expatriate managers in international firms is less of a problem than it is for multidomestic firms, but more common than for global firms, where local knowledge and responsiveness are not highly valued. There is less need for expatriate managers in international firms to engage in opportunistic behaviors as ways of reducing risk, leading us to propose that: P4a. The threat of opportunistic behavior by expatriate managers is low in firms carrying out an international strategy, but not as low as that found in global firms. Firms carrying out an international strategy centralize core competencies at headquarters, so they generally develop knowledge at the home office and transfer it to expatriate managers (Bartlett and Ghoshal, 1998). Expatriates in these firms transfer valuable competencies and products to a market where indigenous competitors lack those competencies and products. As expatriate managers receive core competencies from headquarters, the emphasis is again on explicit knowledge that can be codified. However, because these firms are not innovating locally and local responsiveness is limited to rudimentary customization, there is less emphasis on acquiring local knowledge. The international strategy attends to language differences and basic cultural norms from a marketing standpoint, but does not attempt to adapt core competitive advantages to local needs. The international strategy may involve more tacit knowledge development than that found in the global strategy because expatriate managers must adapt and leverage core competencies locally. The tacitness and complexity of knowledge development does not approach that found in multidomestic firms that focus on local innovation and value creation. Therefore, information asymmetries in international firms are relatively low, such that: P4b. Information asymmetry between expatriate managers and MNC headquarters is low in firms carrying out an international strategy, but not as low as that found in global firms. The role of expatriate managers in a firm using a transnational strategy is unique because these firms differentiate contributions of subsidiaries (Bartlett and Ghoshal, 1998), and managers therefore take on specialized functions. Expatriate managers assume global responsibility for a set of value creating activities associated with a specific product or service, resulting in a laterally coordinated organizational structure (Roth and O’Donnell, 1996). The complex nature of such a role mandates a certain degree of managerial discretion, which in turn increases the number of decision options available to the expatriate (Hambrick and Finkelstein, 1987). This laterally coordinated form bears similarity to multidomestic organizations because the role of expatriate managers is multi-faceted, nonprogrammable, knowledge intensive, and concerned with local innovation. At the same time, the degree to which skills and knowledge developed by expatriate managers in transnational firms are region-specific is tempered by an emphasis on information sharing and resource interdependence. The transnational strategy has at least two main effects on expatriates’ motivation to share knowledge. First, expatriate managers have incentives to share locally developed innovations and knowledge with the home office and other subsidiaries, making that knowledge less region specific and more useful on a global scale. Second, expatriate managers in transnational firms have at their disposal a developing knowledge base from a broad variety of subsidiaries, making each manager’s

knowledge base inherently more global. Armed with a personal asset base that is less region specific than that found in multidomestic firms, expatriate managers in transnational firms incur less personal risk and are therefore less likely to seek risk aversion strategies. The significant degree of managerial discretion that organizations ascribe to them is counterbalanced by their risk tolerance. Therefore, the threat of opportunism by expatriate managers in transnational firms will be high, but not as high as that found in multidomestic firms. Specifically, we propose that: P5a. The threat of opportunistic behavior by expatriate managers is high in firms carrying out a transnational strategy, but not as high as that found in multidomestic firms. The nature of the transnational strategy requires expatriate managers to acquire, leverage, and transfer specialized knowledge, but the transferability of knowledge in transnational firms is limited by at least three issues. First, expatriate managers working under this corporate strategy face a vast array of information originating from diverse sources across multiple geographic boundaries with associated language, time zone, and cultural barriers. This information is far more complex and multidimensional than that found in firms following global or international strategies and expatriate managers are unlikely to be capable of processing and transferring all the information that is available to them. Second, knowledge transfer in the transnational firm is checked by the competing demand of local responsiveness. Local responsiveness raises costs, reduces the ability (and willingness) to share knowledge, and increases, to some degree, the personal asset specificity of expatriate managers as they seek to meet the customization needs of a particular market. Local responsiveness also results in a higher degree of tacitness because locally developed knowledge is wrapped up in culture, customs, and relationships. Third, lateral centralization of core competencies contributes to information asymmetries between expatriate managers and the MNC because the network of subsidiaries does not transfer all knowledge efficiently. Multiple subsidiaries generate core competencies and value-added activities. As such, either headquarters or expatriates may gain information that is salient to the expatriate’s task without the other party being aware that such knowledge even exists. Unlike the other three strategies, where one of the two parties in the principal-agent relationship creates knowledge, the transnational firm introduces third-party innovation to which either the agent or the principal may not be privy. These three issues together create information asymmetries between the home office and expatriate managers in transnational firms. Because the transnational MNC focuses on shared knowledge, the effect of these asymmetries should not be as severe as that found in multidomestic firms. Thus, we propose: P5b. Information asymmetry between expatriate managers and MNC headquarters is high in firms carrying out a transnational strategy, but not as high as that found in multidomestic firms. We summarize our arguments about information asymmetries and the threat of opportunism for each of Bartlett and Ghoshal’s (1998) four corporate-level international strategies in Table I. These two dimensions, information asymmetry and the threat of opportunism, will in turn determine the extent to which the potential for agency problems exist.

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Table I. Threat of opportunism and information asymmetry in corporate-level strategies

Agency problems and the knowledge contract Given the preceding propositions, we may use the knowledge contract to develop agency theoretic prescriptions for situations involving specific corporate-level strategies. We argued earlier that a more specific knowledge contract will result in higher transaction costs as firms impose rules, routines, and procedures designed to bind expatriate knowledge to the MNC at large. These transaction costs include not only negotiating, but also monitoring and enforcing the knowledge contract (Hennart, 1988). Organizations have several means of enforcement at their disposal, including coercion, sanction, and withholding of rewards. The transaction costs of enforcement depend in large part on the form of enforcement, which is likely to be affected by the degree to which the organization has invested in the expatriate. A countervailing force is the transaction cost associated with the threat of opportunistic behavior on the part of expatriate managers and with information asymmetries between expatriate managers and MNC headquarters. To avoid or resolve problems, organizations can design the most efficient knowledge contract by balancing these two broad, competing costs. It is also important to consider the utility of knowledge integration to the organization. Prior research has often examined bidirectional knowledge transfers between MNC headquarters and their subsidiaries (Foss and Pedersen, 2002; Gupta and Govindarajan, 2000). However, the knowledge contract is more concerned with unidirectional knowledge integration, alternatively described as knowledge transfer from the expatriate manager to organizational routines, local managers, or other expatriates. Therefore, the utility of the knowledge contract will be directly proportional to the amount of locally developed knowledge held by expatriate managers, because such knowledge is valuable to the firm (Bonache and Fernandez, 1997; Very et al., 2004). A multidomestic strategy is likely to bring about the most locally developed knowledge as firms decentralize value creation activities and expatriate managers take on complex roles. The same logic applies to the transnational strategy as expatriate managers seek to develop local knowledge that they may share with managers in other subsidiaries. Knowledge development in the transnational strategy may be tempered, however, because expatriate managers are less autonomous than in the multidomestic strategy and benefit from knowledge creation from various sources. A global strategy, on the other hand, will result in the lowest amount of knowledge creation. Products and strategies are standardized worldwide, making expatriate managers more likely to remain socialized into the parent company and less likely to engage in local knowledge development. An international strategy will also result in minimal local knowledge creation, although we may expect this strategy to yield some potentially important developments about local product offerings or marketing tactics. Thus, similar to the threat of opportunism and information asymmetry, utility of the knowledge contract will differ across the corporate strategies, with the lowest existing in the global strategy to highest in the multidomestic strategy.

Global International Transnational Multidomestic

Threat of opportunism

Information asymmetry

Lowest Low High Highest

Lowest Low High Highest

Consistent with Eisenhardt (1989), we believe it is helpful to conceptualize an agency-related contract as being on a continuum of specificity. Thus, we suggest the most efficient governance mechanism for the relationship between expatriate managers and MNC headquarters will be an increasingly specific knowledge contract as we move from centralized firms (global) to decentralized firms (multidomestic). As explained here, global strategy firms present the lowest amount of information asymmetries and a minimum potential for opportunistic behavior by expatriate managers. Therefore, the most efficient knowledge contract is one minimizing overall transaction costs. Strict governance mechanisms, and their associated costs, are likely to introduce inefficiencies in the globally managed firm. Therefore, firms exercising a global strategy should employ nonspecific knowledge contracts for maximum efficiency (Figure 1). On the other end of the spectrum, firms exercising a multidomestic strategy are burdened with the highest degree of information asymmetry and the highest potential for opportunistic behavior. These firms need more strict governance and more specific agency contracts to mitigate the potentially severe costs of the agency problem. Although specific knowledge contracts have higher transaction costs for monitoring and enforcing the terms of the contract, these costs are offset by the potentially high costs of opportunism. Multidomestic firms, then, will find specific knowledge contracts to be the most efficient form of governance for the principal-agent relationship. Between these two extremes, international firms experience little in the way of opportunistic behavior from expatriate managers and generally do not have significant information asymmetries, but more so than global firms. Therefore, firms carrying out an international strategy will find maximum efficiency in nonspecific knowledge contracts with correspondingly low transaction costs, although they will require more specificity than that found in global firms. Firms exercising a transnational strategy, on the other hand, have a higher degree of information asymmetry and significant potential for opportunism by expatriate managers, but not as much as that found in multidomestic firms. Transnational firms therefore need a specific knowledge contract to address agency problems. However, the most efficient agency contract for transnational firms will not be as specific as that found in multidomestic firms because the agency problem is less severe for transnationals. Therefore, we propose that: P6.

The most efficient governance mechanism between MNC headquarters and expatriate managers takes the form of a specific knowledge contract in firms carrying out a multidomestic strategy and a nonspecific knowledge contract in firms carrying out a global strategy. Between these two extremes, the most efficient form of knowledge contract for the transnational strategy is more specific than that of the international strategy.

Discussion One of the main contributions of this analysis is introducing the knowledge contract as a primary means to manage agency concerns. Grant (1996) envisaged that the knowledge-based theory of the firm had important implications for the distribution of decision-making authority in organizations. Distribution of decision making, in the forms of delegation and managerial discretion, are central to understanding opportunistic behavior. At the same time, agency theory researchers have also called for developing a broader range of agency contract alternatives to produce a greater variety of agency theoretic remedies (Eisenhardt, 1989; Wright et al., 2001). Our application of the knowledge-based view to a knowledge contract between principal

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and agent represents such an extension and provides a unique understanding of how organizations might address agency concerns. Another contribution of this work is to integrate corporate-level strategy and expatriate managers. Few authors have recognized organizational strategy as an important unit of study in international human resource management. Our multilevel analysis moves in this direction, yielding a unique set of contingency relationships that would otherwise be obscured. Specifically, the corporate-level international strategy employed has a significant effect on the degree to which information asymmetries and the threat of opportunism surface in expatriate assignments. These in turn affect the knowledge management roles that both expatriate managers and MNC headquarters may be expected to fulfill. This is a significant conclusion because firms are better able to evaluate the success of expatriate assignments when they evaluate them based on organizational level objectives, rather than individual or subsidiary level objectives. For example, an individual expatriate manager may believe that he/she had a successful assignment based on personal criteria such as factors of adjustment or compensation. Subsidiaries, on the other hand, may judge success based on business-level criteria such as growth, profits, or market share. Organizations have their own set of criteria for success that, according to the knowledge-based view of the firm, includes retaining, integrating, and utilizing knowledge for sustained competitive advantage (Gupta and Govindarajan, 1991). Finally, the ideas advanced herein also contribute to research on repatriation. Much of the literature on expatriate assignments concerns itself with issues of selection, training, adjustment, the assignment itself and matters prior to departure. Repatriation literature, on the other hand, addresses adjustment back to the home country, career management, and retention (Baruch and Altman, 2002). The knowledge contract holds the potential to alleviate repatriation concerns, therefore making expatriate assignments more attractive to managers. Organizations may anticipate common problems associated with repatriation, such as career development and role uncertainty (Black et al., 1992), and fold them back into the knowledge contract to reduce managerial uncertainty about repatriation. This, in turn, positively affects expatriate managers’ willingness to accept overseas assignments and their ability to perform in those assignments (Feldman and Thompson, 1993). Implications for managers For the practitioner, there are at least two applications of our arguments. The first relates to compensation and risk. Research on expatriate assignments has focused much attention on the issue of compensation (Reynolds, 1997). Agency theory has often emphasized compensation as a means to influence behavior (Bonache and Fernandez, 1997). Roth and O’Donnell (1996) infer that expatriate managers in decentralized firms (corresponding to transnational and multidomestic firms in our analysis) receive high compensation packages and a high proportion of contingent pay. This is consistent with our analysis because expatriate managers in transnational and multidomestic firms take on a greater amount of risk due to personal asset specificity. However, instead of reducing the agency problem by seeking to align behavior with contingent pay and paying a premium to expatriates for personal risk, we propose that firms consider risk reduction strategies by using the knowledge contract. There are several ways MNCs may use the knowledge contract to reduce expatriate risk. For example, the knowledge contract may contain employment or promotion guarantees. Thus, if expatriate managers develop knowledge that is specialized to a

particular culture, they do not run the personal risk of not being employable outside that market. Instead, the knowledge contract effectively shifts risk back to the MNC, obviating the need for risk-oriented premiums. Another example works in the reverse direction, recognizing that expatriate managers assume the risk of assignment failure and therefore risk becoming personally less valuable to the organization and to the market. The knowledge contract may address this problem by explicitly defining mentoring, co-worker and knowledge transfer mechanisms that reduce the risk of assignment failure. Although there will be transaction costs associated with a more specific knowledge contract, it will also yield reduced risk for expatriate managers and, correspondingly, reduced premiums paid for assuming such risk. Another area where this research informs management practice is that of expatriate effectiveness and success, as shown in Table II. When firms apply the appropriate knowledge contract given a particular corporate-level strategy (i.e. QI and QIV), it results in clear objectives for expatriate assignments from an organizational perspective. The knowledge contract aligns goals for expatriate managerial assignments with corporate objectives, so both the MNC and the expatriate have a clear understanding of what constitutes success. Expatriate managers are likely to be more comfortable and more successful in an environment where objectives are clearly defined and aligned with the MNC. For example, expatriate managers in a multidomestic firm will likely prefer a more specific knowledge contract because this will reduce information asymmetries. They can be confident that the MNC understands the need to acquire region-specific knowledge and capabilities and will not penalize them for that specificity in subsequent assignments or repatriation.

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Limitations and future research The arguments offered in this paper are subject to limitations. We recognize that our examination of the agency problem for the relationship between expatriate managers and MNC headquarters is limited in scope. We believe the influence of corporate-level international strategy will explain a sufficient amount of variance in expatriate assignments to warrant exclusive attention. An interesting area of future research would be to consider more in-depth typologies. How do business-level strategies affect the knowledge contract? How do industry trends affect the knowledge contract? As more and more companies strive to be transnational, how can they use the knowledge contract to ease their transition? How does the need to integrate business- and corporate-level strategies affect the knowledge contract? Degree of agency problem

High

Specificity of knowledge contract Low

High

QI. Success High threat of opportunistic behavior due to information asymmetries demands close monitoring of knowledge development and transfer

QII. Failure Risk is high for the MNC. Expatriate managers may capitalize on their position at the expense of the MNC

Low

QIII. Failure Transaction costs are unnecessarily high

QIV. Success Emphasis is on knowledge flow from the MNC to the subsidiary. Transaction costs may be kept to a minimum

Table II. Using the knowledge contract to gauge expatriate success

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Further, we found that introducing the knowledge contract as a means to attenuate agency concerns forced us to consider moderating influences only insofar as they have a significant impact on the knowledge contract. However, moderators to the relationship between expatriate managers and MNC headquarters may affect our conclusions. For example, how does a firm’s geographical portfolio and experience with expatriatism affect its use of the knowledge contract? How might the knowledge contract affect expatriate training and selection (Caligiuri et al., 2001; Selmer, 2001)? Future research should incorporate such moderators and compare agency theory remedies with remedies from alternative strategic lenses, such as social network theory or resource dependence theory. Entry mode and cultural distance are two important moderators that could influence specificity of the knowledge contract. Firms have various means available to them to expand internationally, ranging from licensing arrangements to joint ventures to wholly owned subsidiaries. Firms may employ expatriate managers under any of these arrangements. So, an important research question is: “how does the mode of entry into a country affect how the knowledge contract should be employed?” (Malhotra, 2003). Do more resource intensive forms of entry (e.g., subsidiary) result in more potential for agency problems and therefore more specific contracts? Also, the cultural distance between home and host countries is very important to expatriate assignments (Barkema et al., 1996). Greater cultural distance requires expatriate managers to assume more risk, providing opportunity for firms to use the knowledge contract to transfer that risk to themselves. Also, the literature would benefit from applying a more general agency theoretic approach to the relationship between expatriate managers and MNC headquarters that could potentially consider firm-level and environmental factors (Lubatkin et al., 2001). For example, how do corporate governance and ownership structures influence the knowledge contract? How do national and professional institutions influence the knowledge contract? Although our research suggests a new means of gauging expatriate effectiveness and success, we have not discussed specific metrics of implementing this approach. An important area for future research revolves around discovering how the organization measures knowledge development. How will firms decide when expatriate managers should share knowledge? Managing expatriates with the knowledge contract assumes an intentional approach toward understanding knowledge that emerges from expatriate assignments, so characterizing and measuring this knowledge is important to the process. Finally, we developed our arguments from the perspective of western firms and western expatriates. The degree to which agency theory findings are generalizable to other cultures and countries warrants further study. To extend the arguments presented herein to expatriates originating from other countries, scholars will have to examine the underlying foundations of agency theory for generalizability. It is possible that different conclusions will surface based on different assumptions when the actors are changed. References Barkema, H.G., Bell, J.H. and Pennings, J.M. (1996), “Foreign entry, cultural barriers, and learning”, Strategic Management Journal, Vol. 17 No. 2, pp. 151-66. Bartlett, C.A. and Ghoshal, S. (1991), “Global strategic management: impact on the new frontiers of strategy research”, Strategic Management Journal, Vol. 12 No. 4, pp. 5-17. Bartlett, C.A. and Ghoshal, S. (1998), Managing across Borders: The Transnational Solution, 2nd ed., Harvard Business School Press, Boston, MA.

Baruch, Y. and Altman, Y. (2002), “Expatriation and repatriation in MNCs: a taxonomy”, Human Resource Management, Vol. 41 No. 2, pp. 239-60. Bender, S. and Fish, A. (2000), “The transfer of knowledge and the retention of expertise: the continuing need for global assignments”, Journal of Knowledge Management, Vol. 4 No. 2, pp. 125-37. Bjorkman, I., Barner-Rasmussen, W. and Li, L. (2004), “Managing knowledge transfer in MNCs: the impact of headquarters control mechanisms”, Journal of International Business Studies, Vol. 35 No. 5, pp. 443-55. Black, J.S., Gregersen, H.B. and Mendenhall, M.E. (1992), “Toward a theoretical framework of repatriation adjustment”, Journal of International Business Studies, Vol. 23 No. 4, pp. 737-60. Bonache, J. and Fernandez, Z. (1997), “Expatriate compensation and its link to the subsidiary strategic role: a theoretical analysis”, International Journal of Human Resource Management, Vol. 8 No. 4, pp. 457-75. Caligiuri, P., Phillips, J., Lazarova, M., Tarique, I. and Burgi, P. (2001), “The theory of met expectations applied to expatriate adjustment: the role of cross-cultural training”, International Journal of Human Resource Management, Vol. 12 No. 3, pp. 357-72. Cantwell, J. and Mudambi, R. (2005), “MNE competence-creating subsidiary mandates”, Strategic Management Journal, Vol. 26 No. 12, pp. 1109-28. Chiesa, V. and Manzini, R. (1996), “Managing knowledge transfer within multinational firms”, International Journal of Technology Management, Vol. 12 No. 3, pp. 462-77. Coff, R. (2003), “Bidding wars over R&D-intensive firms: knowledge, opportunism, and the market for corporate control”, Academy of Management Journal, Vol. 46 No. 1, pp. 74-85. Conner, K.R. and Prahalad, C.K. (1996), “A resource-based theory of the firm: knowledge versus opportunism”, Organization Science, Vol. 7 No. 5, pp. 477-501. Downes, M. and Thomas, A.S. (2000), “Knowledge transfer through expatriation: the U-curve approach to overseas staffing”, Journal of Managerial Issues, Vol. 12 No. 2, pp. 131-49. Edmond, S. (2002), “Exploring the success of expatriates of US multinational firms in Mexico”, International Trade Journal, Vol. 16 No. 3, pp. 233-56. Eisenhardt, K.M. (1989), “Agency theory: an assessment and review”, Academy of Management Review, Vol. 14 No. 1, pp. 57-75. Fama, E.F. (1980), “Agency problems and the theory of the firm”, Journal of Political Economy, Vol. 88 No. 2, pp. 288-308. Feldman, D.C. and Thomas, D.C. (1992), “Career issues facing expatriate managers”, Journal of International Business Studies, Vol. 23 No. 2, pp. 271-94. Feldman, D.C. and Thompson, H.B. (1993), “Expatriation, repatriation, and domestic geographical relocation: an empirical investigation of adjustment to new job assignments”, Journal of International Business Studies, Vol. 24 No. 3, pp. 507-29. Fey, C.F. and Bjorkman, I. (2001), “The effect of human resource management practices on MNC subsidiary performance in Russia”, Journal of International Business Studies, Vol. 32 No. 1, pp. 59-76. Foss, N.J. and Pedersen, T. (2002), “Transferring knowledge in MNCs: the role of sources of subsidiary knowledge and organizational context”, Journal of International Management, Vol. 8 No. 1, pp. 49-67. Ghoshal, S. (1987), “Global strategy: an organizing framework”, Strategic Management Journal, Vol. 8 No. 5, pp. 425-40.

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Morrison, E.W. and Robinson, S.L. (1997), “When employees feel betrayed: a model of how psychological contract violation develops”, Academy of Management Review, Vol. 22 No. 1, pp. 226-56. Mudambi, R. and Navarra, P. (2004), “Is knowledge power? Knowledge flows, subsidiary power and rent-seeking within MNCs”, Journal of International Business Studies, Vol. 35 No. 5, pp. 385-406. Nohria, N. and Ghoshal, S. (1994), “Differentiated fit and shared values: alternatives for managing headquarters-subsidiary relations”, Strategic Management Journal, Vol. 15 No. 6, pp. 491-503. Rajagopalan, N. and Finkelstein, S. (1992), “Effects of strategic orientation and environmental change on senior management reward systems”, Strategic Management Journal, Vol. 13 No. 2, pp. 127-41. Reynolds, C. (1997), “Expatriate compensation in historical perspective”, Journal of World Business, Vol. 32 No. 2, pp. 118-32. Roth, K. and O’Donnell, S. (1996), “Foreign subsidiary compensation strategy: an agency theory perspective”, Academy of Management Journal, Vol. 39 No. 3, pp. 678-703. Rousseau, D.M. (1989), “Psychological and implied contracts in organizations”, Employee Responsibility and Rights Journal, Vol. 2 No. 2, pp. 121-39. Rugman, A.M. and Verbeke, A. (2001), “Subsidiary-specific advantages in multinational enterprises”, Strategic Management Journal, Vol. 22 No. 3, pp. 237-50. Selmer, J. (2001), “Expatriate selection: back to basics?”, International Journal of Human Resource Management, Vol. 12 No. 8, pp. 1219-33. Teece, D.J. (1977), “Technology transfer by multinational firms: the resource cost of transferring technological know-how”, The Economic Journal, Vol. 87 No. 6, pp. 242-61. Toh, S.M. and DeNisi, A. (2003), “Host country national reactions to expatriate pay policies: a model and implications”, Academy of Management Review, Vol. 28 No. 4, pp. 606-21. Tung, R.L. (1987), “Expatriate assignments: enhancing success and minimizing failure”, Academy of Management Executive, Vol. 1 No. 2, pp. 117-27. Very, P., Hebert, L. and Beamish, P. (2004), “Exploring the limitations of the knowledge projection model in MNCs: the impact of expatriate managers on subsidiary survival”, in Hitt, M. and Cheng, J. (Eds), Theories of the Multinational Enterprise: Diversity, Complexity, and Relevance, Vol. 16, JAI Press, Greenwich, CT. Wright, P., Mukherji, A. and Kroll, M.J. (2001), “A reexamination of agency theory assumptions: extensions and extrapolations”, Journal of Socio-Economics, Vol. 30 No. 5, pp. 413-29. Yan, A., Zhu, G. and Hall, D.T. (2002), “International assignments for career building: a model of agency relationships and psychological contracts”, Academy of Management Review, Vol. 27 No. 3, pp. 373-91. Zahra, S.A., Ireland, R.D. and Hitt, M.A. (2000), “International expansion by new venture firms: international diversity, mode of market entry, technological learning, and performance”, Academy of Management Journal, Vol. 43 No. 5, pp. 925-50. Corresponding author Brian Connelly can be contacted at: [email protected]

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From strategic fit to customer fit Matti Santala and Petri Parvinen Department of Marketing and Management, Helsinki School of Economics, Helsinki, Finland

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Abstract Purpose – The purpose of this paper is to extend the strategic fit discourse by proposing a customer-based perspective. Design/methodology/approach – The paper develops a conceptual framework based on a theory and literature review. Findings – The paper proposes that, from a customer perspective, the firm and its activities are separate units of analysis that have a fit-like relationship. Practical implications – A fit-like relationship, here coined “customer fit”, has the potential to explain determinants of performance differentials in marketing practice, guide the analysis and dissemination of customer knowledge in organisations and provide grounds for strategic marketing resource allocation. Originality/value – The paper proposes that the concept of customer fit can be employed to analyze, formulate and coordinate the potential of a firm’s value proposal. Keywords Corporate strategy, Consumer behaviour, Strategic marketing, Perception Paper type Conceptual paper

Management Decision Vol. 45 No. 3, 2007 pp. 582-601 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745133

Introduction The concept of strategic fit is based on the contingency perspective, facilitated by strategic management pioneers Chandler (1962) and Ansoff (1965). It reflects the open systems approach, which sees organisations as a set of interdependent parts that form a whole, which in turn is interdependent with larger environments (Zeithaml et al., 1988). The theoretical framework postulates that fit, match or congruence between a firm’s strategy and environmental or organisational contingencies leads to enhanced business performance (Andrews, 1971; Zajac et al., 2000). The strategic fit has been established as a superior conceptualisation of a framework under which various bivariate relationships of different strategic fit categories and their impact on third variable, usually performance (contingency), has been researched (Venkatraman and Camillus, 1984). The fit has been defined as an internal consistency or alignment (Ensign, 2001), but has been difficult to conceptualise and measure empirically. Despite these methodological and conceptual challenges, strategic fit has been an important building block in the development of strategic management theory (Venkatraman and Camillus, 1984; Drazin and de Ven, 1985). Recently, interest towards strategic fit has reduced and it has received less explicit attention in strategy literature (Kraatz and Zajac, 2001). According to Zajac et al. (2000), this can be caused by three central reasons: the static time frame of traditional fit research, the lack of multidimensionality in conceptualisations and the need to develop normative frameworks for further testing. As a research agenda, he proposes that multivariate relationship of contingencies must be acknowledged, the fit is largely unique in every organisation, and that there is a need for normative, a priori suggestions to develop the fit discourse (Zajac et al., 2000). Extending the presented research agenda, we argue that also the categories of strategic fit are lacking research

interest, as they fail to resonate with current views on organisational success factors that create competitive advantage. Stemming from the works of Penrose (1959) and Wernerfelt (1984), the dominating research stream in strategic management is the resource-based view, which purports that rare, valuable, inimitable and non-substitutable resources are the primary drivers of competitive advantage (Barney, 1991). As an extension of this view, it is proposed that knowledge is the most strategically significant resource of the firm (Grant, 1996). This is based on the view that processes, practices and routines – not resources per se – are subject to inimitability and causal ambiguity, and as they are context-specific, they are the critical differences that offer value solely to the organisation that makes use of them (MacDuffie, 1995). This view, based on skills, ability and learning capacity, is often referred to as the knowledge-based view (Grant, 1996) or dynamic capabilities, which refers to the specific knowledge or routines that enable organisational change and adaptation (Teece et al., 1997). Following this development, the focus is turning to the mechanisms that contribute to the development of valuable processes and resources. Aside from organisational knowledge, a growing number of scholars are arguing on the importance of customer level knowledge for organisational decision making in process development, resource allocation and in the coordination of change and renewal (e.g. Lusch et al. 2006; Kim and Mauborgne, 1998; Christensen, 1997). The latest development in this discourse has turned the focus towards the nature of customer value and exchange, suggesting that the way the organisation sees its buyers defines the way it performs (Vargo and Lusch, 2004). Adapting to this line of thought, we propose that in the contemporary environment the development of managerially relevant “strategic” fit concerns primarily the contingencies that influence customer perception. We refer to this as a shift from strategic fit to customer fit. The paper approaches this research agenda by focusing on the challenges of managerial perspective on customer level knowledge and seeks to answer how customer perspective can be conceptualised and cognitised for research and practice. The predominant concentration is put on customer perception process and on acknowledging the impact of internal processes (e.g. affects) and context (e.g. situation). We proceed in a priori nature to present a multidimensional contingency framework of customer perspective which aims to propose a further research initiative for scholars and an alternative view for managers to approach customer value perception and marketing resource allocation. In this paper, all buyers, institutional or individual, are referred to as customers in order to reflect the view that all perceivers are individual decision-makers and potential customers. The paper is structured as follows. First, we contextualise our perspective by presenting theoretical developments that assert customer knowledge as a source of competitive advantage. Second, we present the principles of constructive decision-making theory and discuss the implications of the recent findings on affects and unconscious processing. Third, we proceed to conceptualise terminology for customer perception after which we turn to propose the customer fit framework, issues of further research and managerial implications. Theoretical grounds According to Firat and Dholakia (2006), the contemporary environment is characterised by two fundamental drivers of change:

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(1) cultural transformations; changing the way world is seen, what is valued and how subjects interact; and (2) unprecedented technological development; changing the way things are done, the tempo in which they are done and the way information is perceived and exchanged.

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In this environment, firms are facing empowered buyers who are becoming increasingly critical towards value proposals. This progress is reflected in customer tastes and it is argued that as functional quality has commoditised, buyers are emphasising more emotional issues in decision making and are looking for value adding “partners” who offer superior value through brand, processes, design or other elements relevant to buyer. This submits the fundamental principles of marketing, the concepts of value and exchange as well as their development and nature, under re-examination. The concept of customer value is central to all theorising in strategic management and marketing as it determines the foundational logic of business thinking. For conceptualisation, we refer to a definition purported by Morris Holbrook, a noted pioneer of customer value research. According to his current view, customer value is not just economic value, but rather an “interactive relativistic preference experience” (Holbrook, 1999, 2006). “Interactive” refers to a relationship of a subject and object (or subject), which is never fully objective nor subjective. “Relativistic” refers to the comparative, situational and personal nature of an evaluation. “Preference” refers to the plehotra of viewpoints that can be adapted (e.g. affect, attitude, evaluation). “Experience” refers to the fact that value does not reside in an object, product or possession, but rather in the experience and in the fulfilment of a need. A similar experiential view on customer value is also emerging in marketing context. The value-in-use perspective is purported by the propositions of service dominant logic (S-D logic (Vargo and Lusch, 2004)) which combines advances of different schools of marketing thought into a new perspective or “logic”. As the name indicates, S-D logic argues that all products and services are essentially masked value propositions that merely convey a promise of the value-in-use. This view positions products primarily as service enablers which, in accordance with the Holbrook’s propositions, create value evaluations as subjective, personal interpretations of all the elements of the experience. This broader perspective turns focus towards the role of perception, as value is seen as a situation-specific and context-specific interpretation of personal or organisational benefits. According to Simonson (2005), the objective value of the value proposition is not of primary relevance and instead, the managerial focus of analysis should be put on the elements that constitute the value perception as customers are not able to distinguish the “real” value. Consequently, skills and applied knowledge in presenting, developing and leveraging resources for holistic value perception is suggested to be a managerial view that purports the creation of competitive advantage in the contemporary environment. A more comprehensive presentation on theoretical grounds for this view is provided in Table I. From customer knowledge to customer insight The rational decision-making approach has been the standard view in economics and strategy. It embeds a view that preferences are primitive, consistent and immutable,

Value and exchange

Service dominant logic (Vargo and Lusch, 2004, 2006)

Coevolution (Baum and Singh, 1994; Lewin and Volberda, 1999; Murmann, 2003)

Nature of progression of competition – Interdependency – Mutual adaptation

Resource advantage theory (Hunt, 2001, Nature of competition Hunt and Duhan, 2002, Hunt and Madhavaram, 2006)

Phenomenon

Adapted perspective

Performance is not the result of managerial adaptation or environmental selection but rather the joint outcome of intentionality and environmental effects Organisations evolve in relation to their environments while at the same time these environments evolve in relation to them

Modes of transaction are embedded

The role of management is to recognise, understand, create, select, implement, and modify strategies Demand is heterogeneous across industries, heterogeneous within industries, and dynamic Different market offerings are required for different market segments in the same industry The firm’s objective is superior financial performance

Organisations exist to combine specialised competences into complex service that is demanded in the marketplace The enterprise can only make value propositions. Marketplace feedback enables firms to learn how to improve the offering to customers and consequently improve firm performance Firm’s objective is to identify and develop core competences, the fundamental knowledge and skills of an economic entity that represent potential competitive advantage

Meaning

Competition is dynamic and relative in all levels of analysis – no equilibrium exists Resource characteristics are heterogeneous and imperfectly mobile. Information is imperfect and costly Consumers’ tastes and preferences are dynamically changing

Renewal of knowledge is the fundamental source of competitive advantage

Value is always determined by the customer (value-in-use). It cannot be embedded through manufacturing (value-in-exchange)

The application of specialised skill(s) and knowledge, i.e. service is the fundamental unit of exchange

Central premise(s)

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Table I. Theoretical grounds

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and that cognitive processes are evaluations that compare alternatives for preference maximisation (McFadden, 2001). This line of thought is captured by a categorisation of approaches to customer knowledge presented by Gibbert et al. (2002) (see Table II). In Table II, three different perspectives on customer knowledge are summarised. Two of the presented research orientations emphasise knowledge on existing preferences, while Gibbert et al. (2002) propose that a fuller comprehension about drivers of buyer behaviour would be beneficial. This aim for a holistic view on customer reality aims to comprehend the drivers of behaviour instead of preferences. It is often referred to as customer knowledge but, for the purposes of this paper, it will be termed customer insight to distinct it clearly from other orientations. The importance of customer insight is purported by many scholars (e.g. Kotro, 2005), but a pioneer of marketing performance research, Andy Neely provides a relevant managerial perspective on the issue. He states that access to customer knowledge is not the managerial problem anymore, but that the central problems are: . the managerial perspectives on how to perceive and interpret the information; and . the development of knowledge dissemination processes that determine how information is utilised in organisations (Neely and Najjar, 2006). These challenges are based on empirical research and further support the previous argument that strategic management research and practice appears to lack coherent and adaptable approaches to conceptualise the customer perspective and the way value is perceived. From rational utility to perceived value The traditional view on value in economics and strategy is based on rational, utility-maximising behaviour that provides a sound logic for the analysis of market

Table II. Challenges of customer knowledge

Knowledge management

Customer relationship management

Customer knowledge management

Knowledge sought in

Employee, team, company, network

Customer database

Customer experience, creativity, satisfaction level and environment

Rationale

Unlock and integrate organisational knowledge

Mining the knowledge

Gaining knowledge from customer, as well as sharing and expanding this knowledge

Objectives

Efficiency, cost savings, Database nurturing and Joint value creation with leveraging customers avoidance of re-inventing

Problem

Indirect understanding Knowledge from the of what customers want customer and value

Note: Modified from Gibbert et al. (2002)

Knowledge utilisation in decision making

transactions and managerial role in organisations. From the rational perspective, the managerial quest is to discover customer preferences and design a value proposal accordingly. Questions of quality control, pricing and segmentation are central in this perspective. The view enables to subject the complexity of customer heterogeneity under rational analysis and provides a straightforward, comprehensive and intuitively appealing principle of customers as rational, me-like buyers. The shortcomings of the view are explained by cognitive biases, understood as mental errors caused by our simplified information processing strategies. The research concludes that cognitive biases in managerial decision making exist (Schwenk, 1984; Bateman and Zeithaml, 1989; Wright and Goodwin, 2002), and that they limit the quality of business decisions (e.g. Hodgkinson et al., 1999) as managers are making decisions based on perceptions of the environment instead of objective variables (Weick, 1979), which consequentially harms organisational performance (e.g. Bourgeois, 1985; Voyer, 1993; Boyd and Richerson, 1993; Barr and Huff, 1997). Taking a further look into the issues of managerial perceptions, Mezias and Starbuck (2003) review the past 20 years of research in this area and conclude that even experienced managers have significantly biased perspectives of their organisations’ business environment. As a conclusion, they suggest that some other explanatory factors must be present, as the managerial perceptions of the business environment seem to provide no explanatory power on the performance differentials between firms. Until recently, there has been little “hard” evidence to disprove the rational logic of decision making. However, lately the broadening interests towards neuroscience and supporting technological developments have revealed new insights into the way the mind works. As a central keypoint, the view on the importance of affects in decision making has gained widespread support. D’amasio (1994) argued, based on brain-damaged patients, that affects are preconditions for all decision making and that the principles of rational decision making need to be reconsidered. This has invigorated an ongoing discourse about the meaning of affects, or emotions for buying behaviour (Thompson et al., 2006). So far, it has been argued that emotions are non-conscious elements that influence the buyer perception process, cognitive evaluations, attitudes and eventually buying behaviour. Neuroscientific research has demonstrated that emotions can occur without awareness (Berns et al., 1997; Morris et al., 1998; Whalen et al., 1998) and interact with, for example, attitudes and preferences. Further research on the topic has found support on the importance of affects and unconscious processing. The following keypoints capture the current view: . Instead of cognition, it appears that we are driven by affects, and especially by emotions. Whenever thinking contradicts with emotions, emotions win (Franzen and Bouwman, 2001). . Emotions are physiologically based, usually automatic responses to stimuli, which either unconsciously lead to behaviour or, in issue of relevance, determine the level of attention and the need for conscious processing (D’amasio, 2000; Van Raaij and Ye, 2005). . Unconscious processing of external stimuli takes place and influences our actions without our conscious awareness. For example priming, unconscious establishment of goals, has been shown to influence subsequent behaviour in multiple experiments.

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.

.

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The relevance of stimuli is a challenging topic of research. It can be inferred from behaviour that there has been an influence, but it is not easy to predict in advance whether, and which, stimuli and cues (e.g. marketing interventions) will have the desired scale and nature of effect. Memory is dynamic – what we remember is not laid down as a permanent record. Memories can be distorted or changed. Every time we remember, we reconstruct the memory depending on place, context, situation and other influencing factors. What this means is simply that people do not remember accurately, no matter how asked. Most of our actions are unconsciously determined. Indeed, Bargh and Chartrand (1999) argue that up to 95 per cent of our actions can be determined unconsciously.

The presented findings challenge many modes of thinking and decision-making that economics has embraced. The view of the rational decision-maker is proving to be overtly limited as the issues that managers are interested in, such as how brand experiences and communications influence people, are likely to happen unconsciously unless there is a particular event that creates a crystallised memory to recover. The perception process – how stimuli and its cues are conceived, especially unconsciously – appears to be far more important than previous research has indicated. It seems that the perception process has a fundamental influence on what results in a distinctive memory trace, what is the attached association and how learning, or reforming of the influence, takes place over time. Advancing the understanding of this process can potentially be an important contribution to strategic decision making. Information processing The question of customers’ information processing has been approached in consumer behaviour research, where an alternative for rational decision-making approach has been introduced. Instead of taking preferences as existing, stable constructs, the information-processing approach views decision making as a constructive process in which preferences are built or formed according to situation and context (Bettman et al., 1998). The information processing approach is based on two different empirical traditions: the perceptual tradition (Kahneman and Tvesky, 1979), which emphasises how value exists not in the objective stimulus presented but in the way people represent that stimulus; and the adaptive decision-making tradition (Payne et al., 1993), which focuses on the effort-accuracy trade-off that decision-makers face and stresses the alternative strategies that can be adapted for controlling the effort needed. The perceptual tradition is described to be more concentrated on affects and unconscious processes, whereas adaptive tradition is more concerned with the cognitive work on decision process strategies. Aside these, another approach to information processing is presented by MacInnis and Price (1987) who argue that “imagery”, the creation of mental representations, is a type of processing mode used by individuals to integrate information about an object (or event) into a Gestalt. Further, they propose that modes of information processing and learning are determined by personal interests which also define the interpretations and construct a hierarchical structure out of them. For example, at the top of the personal hierarchy could be “the country of origin” image (e.g., Australia, Germany), salient aspect of brand image, concrete functions, price, or

any other cue, depending on the perceiver and situation. This suggests that there is a multivariate relationship between different cues that form constructs, or “Gestalts”. Based on recent empirical research, it is proposed that no clearly dominating cues exist, and that the importance of an individual cue depends on its saliency and consistency in relation to other cues (Miyazaki et al., 2005). Approaches to processing value proposals as personally formed “Gestalts” form an established research area, but the interrelatedness of Gestalts has lacked attention. Previous research streams provide support for the existence and influence of different “Gestalts”. For example, the country of origin research has reported that some countries have a positive or negative image, depending on the context, which affects the assessment of the value proposal characteristics (Steenkamp, 1990). It is argued that the perceived qualities or deficiencies of a firm’s country of origin are transferred to the firm’s value proposals if the origin is known (Hamzaoui and Merunka, 2006). A related topic is the firm-activity relationship (Chauvin and Hirschey, 1994) which, from an ethical perspective, discusses the impact of corporate layoffs or other “firm” activities to brand image and customer behaviour. It appears that corporate activity is often interpreted in multidimensional way, as consumers might criticise a firm’s activities but praise its products immediately afterwards (Miles and Covin, 2000). However, the impact on consumer behaviour is yet to be proven. The emerging importance of customer-firm interaction has also been proposed by Ambler et al. (2002) who argue that it is a result of the decline in meaningful product differentiation (e.g. Peters 1994) and the availability of company information that was until recently only for internal use. Ambler et al. (2002) also credit the human need for social learning, making sense of oneself in relation to the environment, to be explanatory of the firm’s importance to customers. Surprisingly, it appears that branding literature is only starting to consider multibrand dynamics whereby consumer attitudes towards one brand within the consideration set is not only influenced by the evaluation of that particular brand, but also by context, other competing brands and personal issues (Ballantyne et al., 2006). The role of Gestalts in information processing seems to be an approach that is emerging in importance and has direct managerial relevance. It can be observed that identical value propositions with almost equal brands have inconsistent outcomes in terms of marketing performance and financial performance. For example, teleoperators are currently running very similar marketing campaigns with very similar offerings. Performance differentials, however, seem to be substantial as different operators enjoy very different customer success in terms of growth rates, returns to marketing investment and bottom-line financial performance in the same markets. According to the teleoperator image studies, for example, retail customer perception is run increasingly by the attributes of the firm, proposing that firm is a “master” gestalt that influences the interpretation of the value proposal and marketing activity (see GfK Marketing Services, 2006). Yet, on a more concrete level, the existence of multiple “Gestalts” is supported by findings of a Finnish national youth study (n . 1,000, conducted by 15/30 research company, 2006) which reports that younger consumers are critical towards all elements of marketing communication and emphasise the “meaning” of the value proposal in their buying behaviour. Interestingly, many respondents explicitly mention firms as separate units of “meaning” assessment in their open-ended answers. This leads us to

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Figure 1. Customer perspective

propose that the customer perspective can be categorised as a multivariate relationship between an offerer, its activity and the personal interpretation of it, driven by the perception process as outlines. The customer perception process – an embodiment Merging the previously presented findings on customer insight, perceived value and information processing, we purport that the “offerer” and its “activity” are two different Gestalts that are analysed according to personal preferences, situation and context (see Figure 1). Further, we propose that embodiments are interrelated and alignment is required to create a “fit” which is formed by various contingent factors. At first, we consider the nature of “Gestalts” in the light of the perception process, unconscious processing and elements that influence this processing. According to recent knowledge, the perception process can be articulated as an unconsciously engaged, haphazardly proceeding process of information attainment, in which individual interpretation of cues is determined and filtered by respondents’ internal (for example goals, motives, attitudes) and external (for example situation, context, social influence) factors. We see that the dynamic and procedural nature of perception process is of central relevance and should be communicated also through terminology. We find that the term embodiment, as a partial concretisation that proceeds and changes all the time, is appropriate for this use. Thereby the two “Gestalts” are termed as embodiments, and we refer to them as firm embodiment (the “offerer”) and marketing embodiment (the “offering”). In following, we present the proposed conceptualisations for both embodiments. Firm embodiment refers to a broad conceptualisation of all the characteristics that the perceiver attributes to the “offerer”. This is subjected to saliency of characteristics, but commonly firm’s name, origin and perceived specialty are acknowledged and form a ground for the value proposition evaluation. The type of firm embodiment is highly dependent on the type of business, value proposal, and its context. In addition, it is dependent on the personal history with the firm, or lack of it. For example, in business-to-business contexts, a firm embodiment before engaging in business is often influenced by previous customers, established projects and articulated capabilities. In time, there is a “learning” effect as various forms of interaction reflect the qualities of the firm and the embodiment changes accordingly. Also, the involvement (high-commitment/low-commitment) on the transaction and its tendency (utilitarian/hedonic) determine the attention and the depth of the information processing that influence the perceived firm embodiment. For example, in case of every-day consumer goods, firm embodiment can be confirmatory and refer to the

distributor (e.g. Disney or Marks & Spencer). Firm embodiment is the constellation of managerial activity or inactivity as activities, in a sense “feed the embodiment”. When a firm develops from start-up venture towards a bigger firm, it establishes natural characteristics that reflect its orientation, capabilities and culture, which are then compared to the marketing embodiment and its match to personal preferences. The firm embodiment adapts characteristics from marketing embodiment which then become “established” characteristics of the firm. These characteristics can be used deliberately to “feed” the perceived embodiment through communications and activity, or they can be left without articulation. The power of characteristics is based on human tendency to categorise. It is well known that based on previous experiences, attitudes and beliefs people “draw a picture”, i.e. have tendency to create assumptions of missing information based on existing “knowledge” (also described as “halo-effect” (see Reynolds, 1965)). In practice, this refers to the fact that firms carry a weight of general industry and people related beliefs, which influences the way all firms’ activity is perceived. As a distinction of the firm embodiment, marketing embodiment is the “activity” of the firm aiming to establish a value proposal to the perceiver. This makes it the “realisation” or “actualisation” of the value proposition. In this context, the term marketing embeds broad array of activities, from new product development to marketing strategy (see Gro¨nroos, 2006a). As such, marketing embodiment is an umbrella for various contingent factors that are dependent on their relative saliency and the intentionality of their communication. An example of intentionality in marketing embodiment is to influence the category in which the value proposition is seen to belong. Similarly to halo-effect, people categorise, or “frame”, information to decrease their cognitive effort by automatically including a perceived Gestalt into category with previously established attitudes and assumptions. This influences the interpretation of perceived stimuli and, as such, the marketing embodiment is essentially a personal perception of the value experience in relation to perceived promise and offerer, filtered by established attitudes. The performance of marketing embodiment can be dependent on the firm embodiment or it can by itself become the “dominant” embodiment when customers are attracted by the perceived superior value of the value proposal and do not subject it to any comparison with the firm. Sometimes it is vice versa, and from customer perspective, this resembles a question of simple trade-off: either a more reliable value proposition (established firm embodiment), or something new and/or appealing (nonexistent, or unreliable firm embodiment). The proposed views on embodiments are summarised in Table III. Aligning the embodiments: customer fit The ideological roots of customer fit can be traced to Barnard (1938) and Selznick (1957), who suggested that top management’s job is to establish and convey “organizational meaning”, and to maintain institutional integrity. Approaching the mystery of cognitising the “meaning”, we propose that firm embodiment and marketing embodiment have a fit-like relationship which influences the way value proposal is perceived and experienced. Relying on Holbrook’s view on customer value, customer fit can be defined as a preference experience, resulting from a personal, dynamic and relational perception process that evaluates the offering (marketing embodiment) in relation to offerer (firm embodiment) to establish expectations (unconscious and conscious) about goals that

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Gestalt

Firm embodiment

Marketing embodiment

Nature

“Static” – characteristics/possession

“Dynamic” – activity

Principle

Firm demographics Personalisations (e.g. leaders) Previous product/service experiences Corporate actions

Product and service experiences Marketing communications Other users The “meaning” of use

Examples

Orientations Established capabilities Processes of resource utilisation Portfolio of value proposals Previous and existing customers Partners, culture, governance Point of sales

Processes of customer interaction Functionality Design Distribution partner(s) Framing Partners 4Ps

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Table III. Embodiments

Customer perspective (1) The perceived characteristics of the firm (2) Facts that position the firm in market space in relation to other firms (3) The portfolio of different value proposals, and (4) The corporate decisions that describe the firm like personnel policy, investment decisions and public statements

(1) Perception of the value proposition and related activity (2) Interpretation of the characteristics of the offering and its use (3) Interpretation of the “meaning” of the value proposition

can and should be achieved with the value proposal. The salient aspects of embodiments influence and guide value perception by illuminating the key promises (e.g. safety with Volvo). During interaction or use, the personal “value” of the proposition is revealed when learning alters the perception of the customer fit as, for example, a technological device reveals relevant functionality that enables use beyond expectations. As such, the customer fit factors are different according to the level of the personal embodiment process. This view is backed by recent research which suggests that the impact of affects is of critical importance when engaging into a new customer relationship and decreases in importance over time as cognitive, well-grounded opinions of the value proposition are constructed (Homburg et al., 2006). However, in general, the literature concerns in great extent the determinants of customer value, but has only little to say about how it changes and evolves (Flint et al., 2005). Modifying Gro¨nroos’ (2006b) argument, we propose a four-level approach to customer fit dynamics. At the first level, emotions are important and customer fit often manifests as an interest or as an inexplicable “feeling”, positive (e.g. trust, appeal) or negative (e.g. distrust, uncertainty), that influences the intensity and emotional ground of subsequent information processing mode. An example is appealing aesthetics, which has been proven to influence customer behaviour. At the second level, in the value-of-use situation, the customer fit is perceived partially based on the first phase fit, which also influences the value experience and goal expectations as well as their interpretation. An example would be a guitar teacher who does not know his subject but has such convincing behaviour that pupils attribute their poor progress to their

own lack of ability. At the third level, the customer fit creates commitment through processes that enable customers to experience benefits that go beyond the value proposition. For example, the customer communities built around the value proposition or symbolic features that enable person to accomplish “secondary” objectives, like convey certain image or find new acquintances. At the fourth level, the customer fit constitutes of the strategic renewal of the buyer perception of the firm by altering firm embodiment or marketing embodiment, either permanently or temporarily. People need change to remain interested, which, however, does not mean changing the core of the value proposition. In some cases, however, the similarity needs to be essentially total, but this occurs mostly for products and services that are “iconic”. An illustrative picture of the phases presented above is provided in Figure 2. The customer fit is thereby a process of “meaning” creation, based on the view that individuals have different interests and tastes, which determine the way value is perceived. Different customer fit’s are needed as customer tastes are heterogeneous and constructed under situational and contextual (e.g. cultural and social) influences. The heterogeneity of tastes is supported by recent empirical research, which suggested that no clearly dominating cues (e.g. price) exist, and that the importance of an individual cue depends on its saliency and consistency in relation to other cues (Miyazaki et al., 2005). This reflects the decision-making tendency to search for something special in value proposal, while at the same time assessing its riskiness and trustworthiness. The controlling of risks seems to be an integral part of all decision making, as it is argued that when observed, a negative cue (or contradicting cues) dominates the quality assessments of value proposals (Ahluvalia et al., 2002; Anderson, 1981; Campbell and Goodstein, 2001). Acknowledging the previously presented findings on unconscious processing, we propose that customers have a tendency to automatically process the existence of negative cues in value proposals by comparing marketing embodiment and firm embodiment. Therefore the “meaning” creation can be seen as an internal consistency or alignment (Ensign, 2001) of characteristics between firm and marketing embodiment that resonate with the customer on all levels of the embodiment process.

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Figure 2. Categorisation of the levels of embodiment process

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Measuring the customer fit The operationalisation and measurement of conceptualisations has been a central challenge of contingency perspective (Venkatraman, 1989). Inconsistent theoretical underpinnings, simplified research constructs and the dynamic nature of real-life relationships have hampered the building of the body of knowledge. In the case of customer fit, a further challenge is proposed by the unconscious processes and their cognitising for research use. Therefore, to further approach the operationalisation of customer fit, we suggest adapted approaches to capture the “meaning” of value propositions in research settings. One approach is to view the changes between customer fit levels and the factors that contribute to the interest to change the level of commitment. Aside the levels, the unifying context, or “meaning” in research settings can be constructed by drawing hypothesises from existing literature (see, e.g. Christensen et al., 2005; Holt, 2004; Gro¨nroos, 2006b). Aside the adapted research approach, the methodological issues are a key concern. We propose that multiple, complementary methodologies and research settings are required to establish the grounds for customer fit phenomenon. For methodological approaches we propose at least the following. First, a case study on issues that distinct high-performers and low-performers, which helps to identify processes and concretisations that contribute to different performance (see Flyvbjerg, 2006). Second, research on managerial cognitions of firm-marketing relationships that can be used to reveal determinants of perceptions. Third, an approach to view the customer value-in-use and its evolvement in the extended case method which helps to overcome the interviewer bias by adapting researcher as a part of value formation in practice, essentially interacting and understanding the social and cultural implications that influence the experience of value (see Burawoy, 1998). Fourth, the implications of unconscious processes can be researched by measuring the changes in autonomic nervous systems caused by hypothesised customer fit characteristics (see Winkielman et al., 2001). Finally, the existence and “strength” of the fit can be approached through brain imaging that reveals processing and activated areas. The paper proposes following key propositions as a ground for further research settings: P1.

There is no one best way to organise firm-activity relationship, activities are not equally effective between firms, and the impact of activity depends on the fit between firm and realised activity evaluated from the customer perspective.

P2.

The customer view on a value proposal is a perception of the reality, conceptualised through various anchors (e.g. contextual, situational, affective) that create their “meaning”.

P3.

There is a co-evolutionary development between contemporary market environment, firms and customers perception, which has atuned perception process and created an automatic, unconscious and, when relevant, conscious processing of cue consistency between offerer and offering.

P4.

Process-realisation dynamics can be subordinated to a set of factors and characteristics that contribute to performance and are potentially generalisable.

Managerial implications This paper provides managers an approach to view the complexity of the customer perspective. The proposed conceptualisations can be used to better capture the procedural and multidimensional nature of customer perception in strategic customer analysis and the development of value proposals. The customer fit framework provides an approach to marketing resource allocation by categorising firm embodiment and marketing embodiment as different challenges that can be concentrated on. Managers should use the framework to discuss and decide whether to prioritise advancing firm embodiment, marketing embodiment or the fit. Marketing investment and practical activities should follow this evaluation. The discussion of the paper can be summarised in following implications for managerial problem setting and analysis: . Managerial and customer perspectives on the value proposal are inconsistent – customer perception captures only fractions of the reality, which are perceived representative of the whole. Understanding these perceptions of reality is more important than the reality itself. . Adaptation to buyer perspective is often critically challenging as managers are, among other issues, biased by far greater insight on the firm and its activity, and the relative strengths and weaknesses in regard to competitive propositions. . The managerial view on customer value perceptions is a strategic choice that influences the consequential problem statements and decision making. . The customer perception on value is like an embodiment process that has different determinants according to the level of process, focus and processed information. . Organisational view on customer value, otherwise stated as customer insight, is an increasingly important determinant of lasting performance in contemporary environment where sustainable competitive advantage seems to have become elusive. An example of these implications in customer fit development can be depicted through the strategic turnaround of Wataniya Telecom. Wataniya Telecom was the first commercial mobile phone operator in Kuwait when it was launched in 1999. In 2004, the competition started to accelerate and Wataniya hired executives from Scandinavia, the telecommunications pioneer of 1990s. This led to a strategic change and Wataniya chose to profile itself as the most customer-oriented company in the market. To establish this customer fit, Wataniya Telecom realised multiple complementary activities. The process proceeded by establishing a new marketing embodiment to feed the firm embodiment and onwards to realise the intended customer fit. This was done through three central elements: (1) positioning through cultural associations (see Holt, 2004); (2) focusing on a neglected customer group; and (3) investing in new technology. First, the Wataniya established itself as the red carpet company, which resonated strongly with the cultural traditions of the area and evoked an immediate emotional response that could be leveraged to get customers to become familiar with Wataniya and try it. The realisation of the new positioning was holistically carried out and every

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customer actually walked on a red carpet when entering the Wataniya service point. Second, Wataniya choose to focus on workers that originated from abroad. In Kuwait most of the work is done by immigrants who come from abroad to work in short periods. However, the workers, who used substantial amount of their pay for communication with people back home, were not acknowledged or well served by any market actor. The quality of sound in long distance calls was poor because of network technology and all contracts were mainly targeted for the needs of the natives. In order to capture this group, Wataniya offered prepaid solutions, which were popular, and proactively approached potential worker customers by establishing a commission system that, for example, incentived car drivers to promote Wataniya to female housekeepers otherwise unreachable. Third, Wataniya bought a new roaming network that was, at the time, the most advanced technology available. This technology enabled Wataniya to offer superior value and new applications that concretised the intentioned perception of customer-orientated customer fit. The adaptation to new technology was also used as an experience creation as customers were required to change their sim cards and Wataniya offered a walk on red carpet for every customer. Technical advances, proactive approach, use of powerful symbolism and innovative distribution resulted in a strong increase in customer base and in the ability to increase prices while at the same time competitors were cutting theirs. The Wataniya case can be summarised by reflecting the managerial implications with the factors of the carried out embodiment process (see Table IV).

Key propositions

Feeding the firm embodiment

Managerial and customer perspectives on the value proposal are inconsistent

Hiring outside talent, who have industry insight and fresh perspective – ability to question the markets and ways of operation

New view on customer value; creating an affective marketing embodiment through powerful symbolism

Value is realised in use

New technology that delivers superior sound quality, customisation possibilities and a channel to interact with customers and collect information

Clear sound, new services, ability to use abroad. A holistic solution from customer perspective – makes using easy

Customer tastes and preferences Constant renewal and expansion of services and are relative and constantly solutions changing Technology enables to customise solutions and to offer dynamically renewing value-added services Customer insight is important for sustained superior performance Table IV. Wataniya customer fit

Realisation of marketing embodiment (customer perspective)

Knowledge about customers, their context of use and behaviour habits enables to customise the most appealing solutions

Constant development of solutions, which indicates customer focus and commitment

Personalised customisation possibilities and communication (dialog)

Discussion Intuitively, managers and researchers tend to believe that customer perceptions can be captured by approaching them with rational logic. Consequently, the analysis of customer value has concentrated on determinants of quality, leaving the affective and contextual elements with less attention (Gordon, 2006). Also, the imperfect nature of customer information on value propositions has received less explicit attention. In this paper, we have proposed that both of these issues are important aspects to further understand the consumer behaviour in research and practice. As a research initiative, we have approached the complexity of customer perspective in a priori nature by conceptualising a multidimensional contingency framework of customer perception process. This was carried out with distinct aims for both research and practice. First, for managerial practice the goal was to cognitise the procedural nature of customer perception, and to propose an alternative perspective to approach the determinants of marketing resource allocation. Second, for research the aim was to extend strategic fit discourse and propose that with further work the firm-activity dynamics analysis might become an important addition to marketing and strategic management research. References Ahluvalia, T., Kenworthy, L., Wagner, A., Wallace, G., Gilotty, L. and Towbin, K. (2002), “Working memory in high-functioning autism and Asperger Syndrome”, Journal of the International Neuropsychological Society, Vol. 8, p. 224. Ambler, T., Bhattacharya, C., Edell, J., Keller, K.L., Lemon, K.N. and Mittal, V. (2002), “Relating brand and consumer perspectives on marketing management”, Journal of Service Research, Vol. 5 No. 1, pp. 13-25. Anderson, N.H. (1981), Foundations of Information Integration Theory, Academic Press, New York, NY. Andrews, K.R. (1971), “New horizons in corporate strategy”, McKinsey Quarterly, Vol. 7 No. 3, pp. 34-43. Ansoff, H.I. (1965), “The firm of the future”, Harvard Business Review, Vol. 43 No. 5, pp. 163-78. Ballantyne, R., Warren, A. and Knobbs, K. (2006), “The evolution of brand choice”, Journal of Brand Management, Vol. 13 No. 4, pp. 339-52. Barnard, C. (1938), The Functions of the Executive, Harvard University Press, Cambridge, MA. Barney, J.B. (1991), “Firm resources and sustained competitive advantage”, Journal of Management, Vol. 17 No. 1, pp. 99-120. Bargh, J.A. and Chartrand, T.L. (1999), “The unbearable automaticity of being”, American Psychologist, Vol. 54, pp. 462-79. Barr, P.S. and Huff, A.S. (1997), “Seeing isn’t believing: understanding diversity in the timing of strategic response”, Journal of Management Studies, Vol. 34 No. 3, pp. 337-70. Bateman, T. and Zeithaml, C. (1989), “The psychological context of strategic decisions: a model and convergent experimental findings”, Strategic Management Journal, Vol. 10 No. 1, pp. 59-74. Baum, J.A.C. and Singh, J.V. (1994), “Organization-Environment coevolution”, in Baum, J.A.C. and Singh, J.V. (Eds), Evolutionary Dynamics of Organizations, Oxford University Press, Oxford, pp. 379-402. Berns, G.S., Cohen, J.D. and Mintun, M.A. (1997), “Brain regions responsive to novelty in the absence of awareness”, Science, Vol. 276 No. 5316, pp. 1272-5.

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More than friendship is required: an empirical test of cooperative firm strategies Ossi Pesa¨maa Department of Management, Lulea˚ University of Technology, Lulea˚, Sweden, and

Joseph Franklin Hair Jr Department of Marketing, Coles College of Business, Kennesaw State University, Kennesaw, Georgia, USA Abstract Purpose – The purpose of this paper is to examine a proposed six-construct theoretical model of factors influencing successful cooperative relationships and strategy development. Design/methodology/approach – A theoretical model of strategy development and cooperative relationships was tested. Qualitative research among key experts identified 15 successful regional tourism networks. Two successful cooperative networks were selected based on annual revenues. A sample of 254 small and medium-sized members were surveyed from the two networks in Northern Minnesota, USA. Findings – Strong support was obtained for the proposed model. Hypothesized relationships were tested and the findings were consistent with previous research. Long-term orientation has a positive effect on friendship, loyalty, trust and commitment. Friendship is related to loyalty and commitment, and loyalty is related to trust. Ultimately, trust and commitment engender successful cooperation. The model can be used as a guide to strategy development at different levels in an organization. Research limitations/implications – Large firms select between higher and lower order functional strategies. Small and medium-sized firms sometimes address commitment and cooperative strategies through shared goals and decisions in order pursue higher order strategies. This paper research supports a greater emphasis on establishing relationships using loyalty, trust and commitment to develop successful higher order strategies. However, relationships based on friendship also can be an important consideration in strategy development. Practical implications – Strategic implications for developing relationships that can be used as a planning component of hierarchical strategies. Originality/value – The paper maintains that loyalty is more important than friendship in developing successful strategies based on cooperation. Keywords Corporate strategy, Strategic alliances, Trust, Channel relationships, United States of America Paper type Research paper Management Decision Vol. 45 No. 3, 2007 pp. 602-615 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745142

Introduction When they have a choice companies pursue a strategy of locating in regions where the likelihood of success is high (Park and Russo, 1996; Baum and Haveman, 1997). But a

large number of small and medium-sized companies are located in remote geographical regions where success is more difficult. These companies must choose strategies that enable them to compete more effectively. Cooperation has been proposed as one strategy likely to improve companies’ competitiveness. Being located in a remote geographical area makes it more difficult to compete. Relatively small local markets minimize the number of businesses with similar product strategies (e.g., two bakeries with the same pastry products). But when businesses are too dissimilar this hampers their ability to develop a strong shared strategy (too much difference eliminates the possibility of cluster proximity) and eliminates the possibility of long-term product development. This is frequently because lack of determination is widespread and negative attitudes discourage new ideas. Moreover, decisions often are based on underdeveloped resources with inadequate competencies, such as higher transportation costs or a smaller customer base, creating challenges to improving products or services and how they should be marketed. Operating under these challenges presents many problems for businesses, whether developing corporate, business or functional strategies. But, changing just one of the characteristics could stimulate the development of a more positive vision and innovative ideas, thus leading to a more successful hierarchy of strategies. Formation of cooperative networks has been posed as one solution. Indeed, networks have been used as a strategy but often the networks have been unsuccessful. What can lead to success in networks between firms? One possibility is suggested by social exchange theory. This theory is applicable at different hierarchical levels, such as between individual firms, both large and small, as well as between networks of different firms’ (Zaheer et al., 1998; Bignoux, 2006). In this paper we propose and test a model of cooperation based on social exchange theory that could be used by firms to enhance their competitive position, and thereby more effectively coordinate corporate, business and functional strategies. Theoretical framework Social exchange theory suggests that when there is a long-term orientation (LTO), loyalty, trust and commitment can be the result of personal relationships, and that these relationships will engender cooperation and discourage opportunism (Blau, 1964, Zaheer et al., 1998). Personal relationships are thus a consequence of individuals cooperating within an organization, or between groups or firms. Some researchers have challenged this theory (Levinthal and March, 1993; Edquist, 1997) by assuming a more rational selection of goals, locations, decision making, organization, market and administrative routines as major determinants of success (Rumelt et al., 1991). Similarly, studies based on agency theory (Zajac, 1990), transaction cost economics (Williamson, 1981), resource differentiation (Teece et al., 1997) and diversification of industry (Porter, 1980) assume accurate and unbiased selection which results in high performing firms. The embeddedness literature (Granovetter, 1985; Uzzi, 1997) merges these two fields by assuming that personal relationships such as friendship, loyalty, trust and commitment will diminish opportunism and encourage cooperation, limiting choices but positively effecting both personal and firm performance. The embeddedness view has therefore become a bridge between traditional sociological approaches (Blau, 1964) and the role of indirect relationships (e.g. friendship and other social activities) in establishing cooperation. Relationships between firms are thus a

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rational selection entered into when they are beneficial for the firm and terminated when benefits are not evident. Blau (1964) claims non-formal relationships, such as friendships, have a strong effect on the formal terms of contracts that regularize cooperation. He concludes an increased presence of inter-firm relationships results in consensus regarding assumptions about forming relationships. This consensus considers how individual relationships are formed as well as whether they have direct or indirect effects in establishing cooperation. Relationships have been explored empirically in strategic management (Gulati, 1995) as well as in other fields such as marketing (Morgan and Hunt, 1994) and sociology (Rodriguez and Wilson, 2002). The studies have shown that cooperative relationships can emerge in situations involving competitor interactions (Ingram and Roberts, 2000), international exchanges (Mavondo and Rodrigo, 2001), business-to-business contacts (Morgan and Hunt, 1994; Gulati, 1995; Doz, 1996; Holm-Blankenburg et al., 1996, Zaheer et al., 1998; Mavondo and Rodrigo, 2001; Varama¨ki, 2001; Rodriguez and Wilson, 2002), buyer-seller dyads (Dwyer et al., 1987; Garbarino and Johnson, 1999; Ylimaz and Hunt, 2001; Ekelund, 2002), online banking (Mukherjee and Nath, 2003), and supplier-to-supplier contacts (Nicholson et al., 2001). These findings enable us to better understand the emergence and functioning of relationships leading to successful cooperation. Social exchange theory illustrates how bonds between groups are initially formed and function over time. The theory suggests that friends, families and other groups are not considered organizations, but treated as valuable input in reaching goals (Rodriguez and Wilson, 2002). Moreover, value systems are never perfectly implemented because of the difficulty in determining an individual’s values. Finally, bonds become an important part of an organization only after members begin sharing goals. Literature on success assumes individuals are goal oriented (Edquist, 1997) and more so than others plan their time, tasks and relationships based on anticipated gains. Establishing relationships is a cost that can be calculated in money since it consumes time, effort and resources from other parts of the business. Relationships therefore may depend more on expected gains than on the type of bond. In business-to-business commitments these gains could be a shared understanding that operates daily or obligations that lead to future benefits. These obligations could lead to commitments in which replacing the partner is too expensive. In achieving cooperation, time is a relevant consideration since developing relationships requires a long period of time and may increase expenses in the relationship investment. The time requirement motivates individuals to consider other alternatives or situations likely to result in a positive experience (Gulati, 1995). Cooperation is a skill that some individuals develop naturally. Others, however, find it difficult to understand the benefits of working together and may therefore not pursue cooperative relationships. In some situations cooperation appears very technical and personal relations are like inputs designed to gain a certain outputs. Moreover, cooperation can be conditioned by culture and some cultures are more inclined to establish long-term relationships (Nohria and Eccles, 1992). Ylimaz and Hunt (2001) used transaction costs and game theory to explain cooperation based on providing greater benefits than costs. In fact, cooperation diminishes the need to assess risks such as economic pitfalls (Axelrod, 1984) and personal issues (Blau, 1964).

Different perspectives necessitate different approaches to cope with associated risk. Blau (1964) believes cooperation is based on personal relations while Gulati (1995) argues that firms balance available choices in terms of their importance and that choices emerge from previous experiences. Hence, resources are required to maintain the current relationship or to develop another competing relationship. This paper examines strategy development and cooperation between businesses. Strategies are chosen based on a LTO that pursues relationships through loyalty and friendship, enhanced by trust and commitment. Cooperation assumes relationships are strengthened by shared goals, decisions, understanding, flexibility in overcoming difficulties, and communicating to reduce difficulties. Mavondo and Rodrigo (2001) reinforce this view and include other propositions. First, individuals do not pursue cooperative relationships if there is no current or future value. Second, social skills are necessary to establish cooperation. Finally, as cooperation increases common goals are accepted and implemented. Thus, goals no longer predict the relationship itself, but how the relationship is likely to influence cooperation and ultimately strategy development across all levels of the firm. The model in Figure 1 is an extension of Gulati (1995) and Morgan and Hunt (1994). It poses that in strategy development firms prefer an LTO to build personal relationships (friendships) and develop loyalty. Friendships and loyalty lead to trust and personal commitment, and ultimately have a positive effect on cooperation and the success of strategies. The constructs and their proposed relationships are discussed in the following paragraphs.

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LTO In developing strategies, successful cooperation hinges on a LTO based on positive experiences involving cooperation (Wetzels et al., 1998; Gulati, 1995; Gulati and Gargiulo, 1999) and the belief that cooperation will lead to positive results (Axelrod, 1984). These realities reflect the fact that firms are not likely to pursue strategies based on relationships that offer few benefits. Thus expectations are based on positive experiences and anticipated future value. Managers pursue long-term strategies even if no immediate benefits are promised because they believe it is important for the performance of their organization. This

Figure 1. Strategy model constructs and hypotheses

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perspective assumes managerial approaches are based on more than just daily contact and require time and effort to develop (Gundlach et al., 1995; Wetzels et al., 1998; Gounaris, 2005). However, an LTO can have negative outcomes. For example, opportunities may be lost because of obligations to remain loyal. Furthermore loyalties can hamper creativity and encourage routine patterns because thinking outside the box challenges the fundamentals the relationship is based on. Contextual circumstances can discourage an LTO and lower trust (Gounaris, 2005) and the need to control all decisions makes the situation more difficult. The absence of an LTO becomes crucial in situations where firms pursue complicated tasks requiring more time. Even if there is an LTO management of the situation may be poor. Relationships involving high personal and collectivistic investments also demand maintenance. One consequence of long-term friendships is they produce more dependencies because one must consider the impact of loyalty. For example, pursuing actions without considering others’ feelings typically terminates relationships (Ingram and Roberts, 2000) or discourages future sharing of common benefits. Empirical evidence supports a relationship between LTO and commitment (Gulati, 1995). Moreover the frequency of interaction depends on the length of the relationship (Nicholson et al., 2001) and repeated success leads to trust (Gulati, 1995). This explains the high cost to replace relationships developed over a long period of time. Based on these findings, we propose the following four hypotheses: H1. LTO is related to friendship. H2. LTO is related to loyalty. H3. LTO is related to commitment. H4. LTO is related to trust. Friendships Personal relationships based on friendships are consequences of individuals, within or between firms, working together and sharing their leisure time. Friendships can stimulate good communication, increase loyalty, trust and commitment but discourage opportunism (Zaheer et al., 1998). That is why relationships often are considered as important as the product or services a company sells. When customers choose products or services the qualities might be similar, but the organizational reputations different. Organizational reputation extends to operational levels where coordinating tasks through invisible friendships can be decisive in winning customers (Ingram and Roberts, 2000). As an example, when a customer first becomes aware of an invisible friendship network they might say “So this is how it works.” Thus, relationships can be as important as product or service qualities. Friendships, however, involve more than being aware of the other friends’ feelings and the significance they have for the future development of the relationship (Mavondo and Rodrigo, 2001). Friendships, therefore, must be considered from a broader perspective. Being a friend does not necessarily include knowledge of what constitutes the friendship, because we may simply like each other. A consequence of developing friendships is that persons socialize outside work and therefore also have access to information and how decisions are made (Mavondo and Rodrigo, 2001). This access

directly affects the ability to talk openly as friends and to consider the partner’s feelings before making an important decision. Friendships recognize that when partners change friends are lost. Thus, a negative side is that friendships as in any relationship involve conflicts and disappointments. The negative side also includes situations where someone feels pressure when one person exerts control over another because of their stronger position. Clearly this influences relationship development and results in conflicts and disappointments. However, friendship also leads to positive situations such as better ideas and improved discussions. This bundled construct of friendship is important in examining cooperation as a strategy. Cooperation between friends is effective in completing demanding tasks such as radical product change (Johannisson, 1990) and in coordination of sales activities (Ingram and Roberts, 2000). In fact, the lack of friendships results in poor access to resources and information (Maslyn and Uhl-Bien, 2001). If cooperation and information sharing is important to continuing the relationship, then loyalty, trust and commitment must be considered. We propose the following hypotheses: H5. Friendship is related to loyalty. H6. Friendship is related to commitment. H7. Friendship is related to trust. Loyalty Personal relationships are the outcome of individuals cooperating on goals and decisions in which friendships stimulate interpersonal communicative skills. Although friends are enthusiastic about other individuals’ ambitions, loyalty protects relationships. Loyalty is more task-related in the sense that the situation or action in itself becomes more important. Therefore, loyalty in personal relationships increases trust and commitment (Uzzi, 1997) and discourages opportunism (Zaheer et al., 1998). Companies develop strategies to create loyal customers and more successful companies have loyal employees. Replacing employees or customers may not be negative in the long run but can be risky and costly in a short run. Loyalties are always difficult, and being loyal is based on enjoying the relationship and the context in which it takes place (Gounaris, 2005). In practice, loyalty protects and gives security to current relationships. However, loyalties may also discourage change. Loyal individuals are faithful during winds of change and continuously attempt to improve their shared contexts through cooperation. Thus, cooperation enables individuals to “save face”, avoid conflicts, and find mutually beneficial solutions. Loyalty is therefore critical in the process of cooperation, especially in achieving trust and commitment. Loyalty means that during cooperation individuals avoid embarrassing situations or spontaneously confronting friends or partners, and try to minimize difficulties and find agreeable solutions to conflicts. Thus, solving conflicts and finding solutions is central to a loyalty. Tjosvold and Sun (2002) reported that loyalty deepens personal friendships based on trust and strengthens cooperative goals, thus avoiding dysfunctional conflicts. Similarly, Morgan and Hunt (1994) found that shared values are important in developing communication, trust and commitment, so that conflicts that do arise are resolved in a functional manner.

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In light of these findings, we propose the following hypotheses: H8. Loyalty is related to trust. H9. Loyalty is related to commitment.

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Trust If commitment leads to giving up resources and operations, or sharing more decisions, then the risk must be controlled by assessing whether the other individuals in the relationship are trustworthy. Trust is based on inherently risky experiences involved in relationships (Mayer et al., 1995) and operates to exclude risky situations that threaten or otherwise jeopardize competitive advantages. At a personal level trust enhances social control and facilitates reciprocity and empathy (Axelrod, 1984). Trust is therefore considered an experience of mutual honesty and confidence that includes few negative surprises and is established on the basis of similar values. The assumption of few negative surprises with trust results in a feeling of fairness when decisions are made on new goals and opportunities. Positive experiences from working together in previous projects and frequent interactions engender trust (Powell, 1990; Gulati, 1995, Garbarino and Johnson, 1999). Thus, trust is based on loyalty and cooperation and takes a long time to develop with friendship as a precursor (Mavondo and Rodrigo, 2001). Trust is a key mediator to cooperation and directly effects both commitment and cooperation (Morgan and Hunt, 1994; Wetzels et al., 1998; Garbarino and Johnson, 1999; Ylimaz and Hunt, 2001; Wong and Sohal, 2002). Other studies corroborate the importance of trust in achieving successful cooperation (Axelrod, 1984; Rousseau et al., 1998; Wildeman, 1998; Varama¨ki, 2001). Trust is a governing mechanism used to facilitate cooperation. It is achieved based on reliability, honesty, fairness, responsibility, helpfulness and confidence (Morgan and Hunt, 1994). Trust establishes a state of belief that the more mutual trust exists the less likely the relationship will result in undesirable actions, hence reducing risk. Trust is therefore a matter of experience, which often takes a long time to develop and when damaged is difficult to repair. In light of these findings, we propose the following hypotheses: H10. Trust is related to commitment. H11. Trust is related to cooperation. Commitment Commitment is based on how loyal a person or persons are to a social unit (Gundlach et al., 1995). Commitment means individuals intend to continue their relationships (Gundlach et al., 1995). Future intentions are therefore central to this concept along with social or professional values. Commitment includes future intentions to exchange information and transactions on a professional level, as well as more shared decision making. Successful long-term relationships contain highly committed parties. Therefore, a major reason for failed cooperation is lack of commitment (Wildeman, 1998). In light of these findings, we propose the following hypothesis: H12. Commitment is related to cooperation.

Methodology Unit of analysis The unit of analysis must be considered in studies of relationships between firms in order to avoid organizational level conclusions being based on personal perspectives (Oliver and Ebers, 1998; Mavondo and Rodrigo, 2001). However, relationships between firms typically involve both the personal and organizational levels. Figure 2 shows how personal relationships are likely to effect business-to-business reputations as well as interpersonal and inter-organizational relationships (Zaheer et al., 1998). The boundaries of the unit illustrate how firms often develop strategies. Relationship strategies are assumed to affect not just a single unit, but also the whole firm. Thus, simple tasks such as voicemail or e-mail often can influence overall business performance. Furthermore, personal relationships can directly affect firm performance. This study focused on relationships between individuals in firms that belong to a network and the consequences these relationships may have on company performance.

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Questionnaire The questionnaire included six multi-item constructs adapted from Mavondo and Rodrigo (2001), Morgan and Hunt (1994) and Ingram and Roberts (2000). The six constructs were: LTO, friendship, loyalty, commitment, trust and cooperation. The constructs were measured using a five-point Likert scale with the endpoints labeled 1 ¼ unimportant and 5 ¼ very important. The initial instrument was developed and pretested with knowledgeable experts. It was then further pretested on a sample representative of those who would ultimately complete the survey. Based on the pretests individual items were revised or deleted from the questionnaire. The final questionnaire consisted of 31 items representing the six constructs plus demographic questions. Respondents were asked to complete the questionnaire and return it in the pre-addressed, stamped envelope. Construct reliabilities based on Cronbach alpha exceeded the required standard of 0.7. Sample Questionnaires were given to 254 businesses in the northern part of the USA. The businesses represented a broad cross section of different types, including banks, restaurants, real estate companies, retailers, hotels, transportation, and related services. All were knowledgeable about cooperative networks based on several years of experience of either participating in or working with such organizations. A total of 99 completed questionnaires were returned, representing a 39 percent response rate.

Figure 2. Relationships and organizational success

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Results An initial examination of the results was developed by calculating the means of the six constructs. The means were based on the summated scores of the individual items for each of the constructs. Table I presents the means for each of the constructs. The means illustrate that respondents perceive trust, cooperation, loyalty and long-term orientation as being the most important to the success of their businesses. This suggests that respondents believe pursuing cooperation through loyalty and trust is relatively more important than through friendships. To confirm this relationship, we examined the actual relationships between the constructs. To test the relationships, including the proposed hypotheses, the data was further analyzed using structural equations modeling. The overall model demonstrated acceptable fit (x 2 ¼ 8:568, df ¼ 3, p ¼ 0:0036, x 2 =df ¼ 2:856, NFI ¼ 0:965, IFI ¼ 0:977 and CFI ¼ 0:975). Other than the Chi-square value, all of the goodness of fit measures met or exceeded recommended cutoff values. Individual items exhibited significant and substantial loadings on their intended construct indicating good convergent validity. Structural equations modeling enabled an examination of all relationships simultaneously instead of separately, as would have been true with path analysis. Figure 3 shows the model and hypotheses. The hypotheses were examined by focusing on the size and significance levels of the path coefficients. The first four hypotheses relate to long-term orientation and its affect on four constructs – friendship, loyalty, commitment and trust. Results indicate that long-term orientation Construct

Table I. Constructs and means

Figure 3. Strategy model relationships and findings

Long-term orientation Friendship Loyalty Commitment Trust Cooperation

Means 3.58 2.94 3.65 3.13 4.28 3.82

is positively and significantly related to both friendship (H1, r ¼ 0:251; p , 0:05) and loyalty (H2, r ¼ 0:255; p , 0:05). Similarly, LTO is a positive significant predictor of both commitment (H3, r ¼ 0:296; p , 0:01) and trust (H4, r ¼ 0:257; p , 0:01). Thus, the first four hypotheses are accepted. The next three hypotheses relate to friendship. H5 and H6 are statistically significant showing that friendship is positively related to loyalty (H5, r ¼ 0:339; p , 0:01) and to commitment (H6, r ¼ 0:237; p , 0:05). In contrast, there is not a statistically significant relationship between friendship and trust (H7). Thus, are accepted, and H7 is rejected. H8 and H9 relate to loyalty. H8 is statistically significant showing that loyalty is positively related to trust (H8, r ¼ 0:564; p , 0:01). However, loyalty is not significantly related to commitment (H9). H8 is therefore accepted and H9 rejected. The remaining three hypotheses examine trust and commitment. Trust is significantly and positively related to commitment (H10, r ¼ 0:250; p , 0:05) as well as cooperation (H11, r ¼ 0:572; p , 0:01). Moreover, there is a significant positive relationship between commitment and cooperation (H12, r ¼ 0:355; p , 0:01). Therefore, H10, H11 and H12 are accepted. Discussion This paper proposed and tested a model of cooperative strategies among small and medium-sized companies. The model hypothesized that successful strategies based on cooperation (i.e. sharing strategic goals and decisions) begin with an LTO. The importance of a LTO was hypothesized based on previous studies. The studies conclude that both earlier experiences and future cooperative decisions are important to successful cooperation. Axelrod (1984) studied cooperation from an individual perspective based on the assumption that repeated cooperative actions, motivated by self-interest, must include improved outcomes for all. But the lack of shared goals in shared decision making will hamper the overall cooperative strategy. Gulati (1995) studied LTO based on shared experiences and demonstrated how earlier experiences enhance trust and eventually result in more future cooperation. This study found that LTO engenders cooperation via friendship, loyalty, trust and commitment. Cooperative relationships involving friendship, loyalty and trust were examined by Ingram and Roberts (2000). They found that such relationships enhanced competitiveness by enabling firms to better serve their customers. Our results are similar in that they indicate friendships motivate individuals to consider the feelings of others before making decisions, thus leading to both loyalty and commitment. This suggests friendships play an important role in forming loyalty and commitment. Ingram and Roberts (2000) also found that friendships facilitate trust and that relationships can be effective even if there are gaps in the network. However, they cautioned that friendships may also cause free-riding issues, which in turn affect trust. For example, friendships provide access to partners but if information is not shared this lowers trust resulting in reduced future benefits. Similarly, inappropriate use of information such as giving information to individuals outside the network will cause partners to question the benefits of the network. Our results indicate no relationship between friendship and trust. But there is a significant relationship between friendship and loyalty as well as friendship and commitment. This suggests friendships should focus on building loyalty and commitment more so than trust.

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Previous research shows loyalty is related to cooperation when the relationship has perceived benefits (Holm-Blankenburg et al., 1996). The current study found that loyalty is related to trust and ultimately to cooperation. Trust also is related to commitment, which involves social and professional values in addition to trust, and our study confirmed this. Our findings are consistent with Mavondo and Rodrigo (2001) and Nicholson et al. (2001), who found similar links between loyalty, trust and commitment. When loyalty leads to trust and commitment, partners are more likely to cooperate because it reduces risk. Previous research has also shown that trust is related to commitment and cooperation and that commitment encourages cooperation (Morgan and Hunt, 1994; Mavondo and Rodrigo, 2001; Ekelund, 2002; Mukherjee and Nath, 2003). This study’s findings are similar providing further evidence of the importance of relationships between loyalty, trust, commitment and ultimately cooperation. Conclusions Large firms select between higher and lower order functional strategies. Small and medium-sized firms sometimes address functional cooperative strategies through shared goals and decisions in order pursue higher order strategies. In an effort to be successful, small and medium-sized firms in remote areas developing shared competitive strategies should consider cooperative relationships as part of both business and functional strategies. This paper relies on social exchange theory advocating personal relationships based on trust (Blau, 1964; Rodriguez and Wilson, 2002). The findings support an embeddedness perspective suggesting rational decision making combined with personal relationships involving social aspects such as friendship, loyalty, commitment and trust can lead to successful strategies based on cooperation (Granovetter, 1985; Uzzi, 1997). The overall model demonstrates that given an LTO, strategy development should consider the role of loyalty, trust and cooperation in selecting partners. Implications This paper has demonstrated the importance of personal relationships and the role they can play in the success of strategies at all levels in the organization. Successful cooperation requires a long-term perspective as well as establishing friendships and building loyalty, trust and commitment. Furthermore, personal relationships can be as important as the transactional value provided. The emerging global economy stresses efficiency and effectiveness in technical and service qualities. But in strategy development cooperation among firms through better relationships is also important. Service-oriented industries have recognized the impact good relationships can have on reputation, including providing credibility for their services and products (Gounaris, 2005). However, product-oriented industries can also benefit through better planning and cooperation on R&D projects, new product development, market strategies, international exchanges, and local community development. Limitations The current study is based on a cross-sectional study. The proposed relationships are represented as sequential but “return loops” are also possible. For example, trust may lead to commitment, but commitment can enhance trust. Future studies of the proposed

relationships, both in terms of magnitude and direction, could benefit from a longitudinal study.

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Lola Peach Martins Middlesex University, Hendon, UK Abstract Purpose – The intention of this research paper is to shed light on the key factors influencing the human resource management (HRM) performance of first tier managers (FTMs), and the vital importance that a holistic strategic framework can have in this regard. Design/methodology/approach – The research paper uses an up-to-date historical approach and, additionally, draws on detailed case study evidence from an aerospace manufacturing/engineering company via manually and electronically analysed in-depth semi-structured interview and company documentation. Findings – The case study findings reveal that the FTM’s HRM performance is greatly influenced by a group of four key factors, and their interrelationships. Research limitations/implications – The literature survey was mainly industry-specific (manufacturing), and the sample was restricted to one sector (aerospace), as well as one case study organisation. Furthermore, the views of FTMs’ staff are not directly represented. Originality/value – The FTMs’ HRM role shows no signs of abating; in addition, questions regarding their performance of this role have increasingly emerged. This has become more evident as organisations have continued to expand the FTMs’ role by devolving greater HRM responsibilities to them, and their performance of the role demonstrates that many FTMs are ill equipped to perform their HRM duties to the required standard. However, the vital importance that a holistic strategic framework (which encompasses the four key factors influencing their performance) can have on their performance of this role is not acknowledged. The present research paper, gives an empirical example of a case study, and therefore provides a springboard to address the weakness in the literature. Keywords Junior managers, Strategic management, Human resource management, Aerospace industry, Change management Paper type Research paper

Management Decision Vol. 45 No. 3, 2007 pp. 616-641 q Emerald Group Publishing Limited 0025-1747 DOI 10.1108/00251740710745151

Introduction The strategic management[1] of first tier managers (FTMs) is crucial for various reasons: first, there is a burgeoning importance attached to the role due to human resource management (HRM) devolution, which shows no signs of abating; second, to manage the uncertainties that tend to arise about the FTM’s HRM role; and third, in order to manage effectively the problems associated with their performance of this devolved role. According to Brewster and Larsen (2000), and Budhwar (2000), the raison d’eˆtre of HRM devolution to FTMs can be put down to the following: . the complexities of some issues which top management find difficult to comprehend; . it helps in terms of reducing costs; . FTMs are faster when it comes to responding to frontline state of affairs;

the experiential learning of FTMs acquired through devolution of core HRM activities propels them towards promotion for future managerial positions, which requires higher level decision-making skills; and it results in creating a motivational environment, as well as effective control, as line managers are in constant contact with frontline staff.

Strategic management of FTMs

Regarding the uncertainties attached to this role, several pertinent views are highlighted. Renwick (2003) states that FTMs have always been involved in managing human resources, however, according to research carried out by Thurley and Wirdenius (1973), Child and Partridge (1982), Lowe (1995), Renwick (2003), and Hales (2005) the nature of this role and the importance attached to it has varied, and has not always been clear. Core debates linked to this variation tends to stem from uncertainties about whether they are managers or not, and where to place the responsibility of people management (Renwick, 2003) – with senior managers, middle managers, HRM professionals, or with FTMs. Notwithstanding these reservations, Cooper (2001), Storey and Sisson (1993), and Cunningham and Hyman (1999) have revealed that FTMs are in the best position to adopt and deliver the most appropriate human resource management styles and practices, as they are the closest to frontline staff. Whittaker and Marchington’s (2003) study, have also suggested that FTMs are in a good position to take on the role, but in partnership with human resource professionals. The Chartered Institute of Personnel and Development (Crail, 2004) have revealed that while some FTMs accept this “new” role, and are able to perform the HRM tasks very well, at the same time, other studies show that FTMs frequently fall short of discharging their HRM responsibilities effectively, therefore, pointing a “rhetoric and reality” gap (Cunningham et al., 2004). A number of factors have been identified as contributing to this problematic performance. These include an unwillingness on the part of the FTMs to take on such people management tasks (Roffey Park, 2000), the lack of relevant training provided to them (Gwent TEC, 1999/2000, Priestland and Hanig, 2005), and the absence of supportive surrounding management culture, systems and structures (Purcell, 2001 cited in Storey, 2001; Guest and Conway, 2004; Hartog and Deanne, 2004; Priestland and Hanig, 2005). According to Earnshaw et al. (2000) and Renwick (2000), the FTM’s HRM role or rather, the performance of it has been problematic because their primary responsibilities are in meeting service or production goals. Generally speaking, the people management role of FTMs is well documented (Renwick, 2003), and has long history, stretching from the early factory system of production to the present era (Hales, 2005; Kraut et al., 2005; Crail, 2004; CIPD, 2005; Cunningham et al., 2004; Whittaker and Marchington, 2003; Larsen Holt and Brewster, 2003; MacNeil, 2003; Gibb, 2003; Renwick, 2003; IDS, 1991). However, while the various studies point out disparate HRM performance deficiency factors, very little is said about the contribution a more holistic strategy can make to the HRM performance of FTMs, if adopted. It is nonetheless clear that, together, the various explanations draw attention to the essence of managing FTMs strategically as human resources; that is, an approach that takes a broader range of integrated strategic factors that are beneficial to FTMs and the organisation, into consideration.

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In summary, the historical literature on devolution implies that the way organisations manage change, including the way the discharge of the FTM’s HRM responsibilities have taken place, requires due attention. In other words, as suggested by Christiansen, 1997 (cited in O’Regan and Ghobadian, 2004), “there is something about the way decisions get made in successful organisations that sows seeds of eventual failure”. To date, however, relatively few integrated (in-depth, and systematic) studies of HRM devolution to FTMs associated with decision making have been undertaken that seek to address the performance of FTMs in the context of the way they, as human resources, are strategically managed. Aim of the research Evidentially, employers have sought to increase the responsibilities of FTMs for a range of soft and hard hHRM activities and issues (Whittaker and Marchington, 2003; Hutchinson and Purcell, 2003; Larsen Holt and Brewster, 2003; Crail, 2004; Hales, 2005). However, the historical legacy vis-a`-vis the people management role is scarcely considered, when determining their suitability for the role and planning an effective HRM strategy for the successful implementation of devolution. A historical perspective sheds light on pertinent issues that need to be well thought-out when an attempt is being made to solve an organisational dilemma (Thurley and Wirdenius, 1973; Child and Partridge, 1982; Meshoulam and Baird, 1987). In the case of this study, the historical perspective sheds light on four interrelated key factors vis-a`-vis the strategic management of FTMs and their HRM performance: (1) the perceptions and attitudes of primary stakeholders (including FTMs) of the role; (2) the degree to which their new role is adequately defined and clearly communicated; (3) the extent to which they receive appropriate training and the overall development opportunities made available; and (4) how far broader organisational systems and structures serve to facilitate or hinder role/performance. The broad aim of the case study was three-fold. First, the examination of how the company was seeking to change the people management role of its FTMs: to determine what factors were considered in doing so. Second, the exploration of how well the FTMs were performing this revised role: to determine their ability to handle their devolved HRM responsibilities. Third, the identification of what key factors were acting to shape the way in which they performed this role. Here, however, attention is focussed on the findings obtained in this last area and, in particular, their relationship to previous findings regarding the factors that influence the way in which they perform the people management responsibilities devolved to them. This introduction provides the background for this article, which is based on research conducted in 2003 at a company I have named AeroCo. The case study participants (CSPs) were asked to comment on factors acting to enhance or hinder the FTMs performance, and actions, which they felt, could be taken to support FTMs in the undertaking of this role, to operationalise the four-factor framework (see Figure 1). Additionally, the CSPs were asked to indicate the extent to which they understood the

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Figure 1. FTM’s four factor framework by L.P. Martins

four-factor framework vis-a`-vis the HRM performance of FTMs. Therefore, the testing of the validity and usefulness of the framework via in-depth interviews was carried out. What follows is divided into five sections. As a point of departure, the first of these draws on existing literature to highlight the way in which the HRM role of FTMs, particularly in manufacturing organisations, has been changing, and within this the elements depicting the four factors influencing their performance are taken into account. Following this, the next two sections briefly presents the study’s research methodology and provides background information on the case study setting. Finally, the analysis and findings from the study are reported and the implications of them are discussed in a concluding section, and suggestions for further research are made. The changing role of FTMs From a historical perspective, the role of FTMs can be seen to have gone through a number of periods of transition. In this section the change cycle, which shows that the FTM’s role consists of four main periods of change, that is, the manager-in-charge (MiC), manager-in-the-middle (MiM), manager-on-the-margin (MoM), and manager-in-charge-plus (MiCP), is discussed. More importantly, within these periods of transition, the four key factors acting to influence the FTM’s HRM performance are highlighted. MiC The role of FTMs during the nineteenth century effectively took the form of self-employed, or internally employed, sub-contractors (Dickson, 1975; Dawson, 1991; Wren, 1979). FTMs employed their own staff and were therefore effectively responsible for all the major aspects of labour management, such as the recruitment and selection, wages, and undertaking disciplinary action to deal with what they deemed as poor performance (Child and Partridge, 1975 cited in Esland et al., 1981; Thurley and

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Hamblin, 1963; Thurley and Wirdenius, 1973). As the factory system developed, in order to secure greater control, owners increasingly opted, to bring this labour management function “in-house”, through both the direct employment of FTMs and the people they managed. During this period of transition, FTMs continued to possess considerable power over those they managed and hence retained elements of their previous sub-contracting role (Thurley and Hamblin, 1963; George, 1972; Melling, 1980). Additionally, their findings suggest that, FTMs often displayed unfair behaviours towards their staff, such as hiring and firing them as they pleased. They were perceived as people with power or rather able to elicit control over those they recruited. In addition, they were not formally trained for any of these HRM activities; it can be assumed however that they may have acquired the necessary competencies through informal learning, or intuition, may have guided them in taking action. Finally, these studies highlighted that there was no formal strategy to guide the way they were recruited, although, it seems clear that organisations that recruited FTMs, as well as FTMs themselves were clear that their main responsibility was to control their staff. That is, they were recruited as a means of exercising greater control over the workforce. Owen’s (1994), in his work, has provided useful debates about how FTMs were recruited, and performed their “people management” role during the Industrial Revolution era. Owen’s empirical studies looked at managers in the UK steel industry. His work was concerned with the sociological aspects of the FTMs’ early background and career. Particularly, his findings revealed that recruitment was geared towards favouring e´litist groups, for example, those with middle class backgrounds with a broad education, whilst denying access to those less favourably advantaged, of management potential. Other authors writing of this period present a different story. That is, salaried FTMs of this era were usually illiterate workers promoted from the ranks because they evidenced a greater degree of technical skills or had the ability to keep their staff disciplined (George, 1972). Whereas, studies carried out by the Ministry Committee of Training of Supervisors (in 1954), drew attention to the need for the formal training of these FTMs. George (1972) also pointed out that FTMs of this era were untrained in the intricacies of management, and were left to their own devices – to develop their own leadership styles, and learned very little from others. MiM and MoM The increasing influence of “scientific management”, related managerial prescriptions, and the associated development of specialist management functions, such as personnel management, served to increasingly circumscribe the role of FTMs and diminish not only their managerial responsibilities, but also their decision-making authority (Thurley and Wirdenius, 1973; Child and Partridge, 1982). Subsequently, these moves towards weakening their role were compounded in the 1960s and 1970s by the growing power of trade unions and, in particular, workplace union organisations, with this growth having three somewhat distinctive effects in this regard. These being, first, attempts by shop stewards to by-pass FTMs and deal directly with more senior managers, second, a propensity on the part of such managers to also deal with stewards and thereby undermine the authority of FTMs and, third, changes in pay relativities which operated to the disadvantage of FTMs and, indeed, prompted an expansion of unionism among them as their status (Boyd and Scalon, 1965; Thurley,

1972; Thurley and Wirdenius, 1973; IDS, 1987) and relative pay position deteriorated (Goodman, 1977). Against this backcloth depicting a lack of support towards FTM in carrying out their “people management role”, commentators drew attention to the ambiguous and diminished position that FTMs occupied in organisational management structures and the way in which this had affected their self-identity within them (Bowey, 1973; Lowe, 1995). In fact, for some they had become “lost managers” (Child and Partridge, 1982). MiCP The decline of trade union power from the beginning of the 1980s and the parallel growth in product market competition acted, in conjunction with the emergence of new managerial philosophies and increased interest in Japanese production techniques (Lowe, 1995), to encourage many employers to try to introduce more decentralised, cost-effective, focussed, and flexible management structures. In many cases, a central part of this process of reform was the re-configuration of the FTMs role in a way that sought to re-emphasise its managerial component (Cunningham and Hyman, 1999). At the same time, this encouraged them to move to a more facilitative and empowering type of leadership – strategic management type of role (Ghobadian et al., 1998). This role encompassed greater responsibility for human resource issues, such as training and development, staff recruitment, discipline and absence management, and crucially, managing their teams’ performance (IDS, 1991, 1990; CBI, 1992; Millward, 2000; Kraut et al., 2005). Overall, the changes were made in the expectation that they would serve to engender improved workforce performance – ensuring quality products to meet customer demands. In the event, however, the existing evidence suggests that they have met with very mixed success, both within and across organisations (WRU, 1982; White, 1983; NEDC, 1991). In turn, this evidence has prompted a good deal of debate as to the reasons for this (Lowe, 1992; Bevan and Hayday, 1994; IDS, 1990; Storey, 1992; CBI, 1992; Crail, 2004; Myland, 1996; Gwent TEC, 1999/2000; Roffey Park, 1998, 1999; Karami et al., 2004; Armstrong, 2001; Edgar and Geare, 2005). Within these debates, and the research findings that have informed it, the four broad sets of factors (the perceptions and attitudes of primary stakeholders (including FTMs) of the role; the degree to which their new role is adequately defined and clearly communicated; the extent to which they receive appropriate training and the overall development opportunities made available; and how far broader organisational systems and structures serve to facilitate or hinder role/performance) have been identified as exerting an important influence over the way in which FTMs respond to, and cope with, their new re-configured HRM roles (also see Figure 1). Regarding perception/attitudes, Armstrong (2001) wrote: Behaviour will be influenced by the perception of individuals about the situation they are in. That is, their ability to sense things correctly or incorrectly.

Therefore, if behaviour is to be modified, a fundamental change in perception is necessary (Rose, 1987). The way in which people perceive and make judgements about people at work can be explained via attribution theory, which is concerned with the assignment of causes to events. An attribution is made, for instance, when the primary stakeholders of the FTM’s role (such as senior managers or frontline staff) perceive and describe FTMs as being inadequate for the HRM role because they are not HRM

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experts or because they are perceived and described as lacking the required authority to undertake certain tasks such as authorising training and handling grievance or discipline. Attitude on the other hand has been broadly defined as a settled way of thinking or feeling, and can be influenced by the work environment, such as organisational culture (norms and values). For example, where some FTMs in the manufacturing/engineering industry lack commitment to their HRM role because they believe that the function of managing people is a personnel/HRM specialist function which ought to be left to personnel/HRM professionals, like that of engineering, which requires technical competencies as opposed to “people management competencies, should be left to engineers”. Other work environment influences are stakeholders, and policies concerned with pay, recognition. As for the role of FTMs, Woodall and Winstanley (1998), posit that the concept “role” is open to double meaning and can be challenged on many fronts. “Role” can be defined as: [. . .] a part played by a person in a particular social setting and is influenced by his or her expectation of what is appropriate; a usual or customary function (Collins English Dictionary, 1999).

More specifically: Roles are a set of expected behaviour patterns attributed to someone occupying a given position in a social unit such as an organisation (Maund, 2001).

From his large number of case studies, Hale (1986) emphasised the need to understand what is known about what managers do. He adopted an a posteriori philosophy and looked at what managers actually did. He emphasised the need to base this on a wider context of managerial behaviour. That is, behaviour based on “managerial tasks”, “managerial responsibilities” and the “managerial function”. In doing so, Hale found some commonalties between the managerial roles. His findings identified five primary managerial indicators, which can also be used to evaluate the role of FTMs. These are: (1) the substantive elements of managerial work (what managers do)[2]; (2) the distribution of managers’ time between work elements (how managers work); (3) interactions (with whom managers work); (4) informal elements of managerial work (what else managers do); and (5) Themes which pervade managerial work (what qualities managerial work has). A major survey conducted by the IRS (2000) also identified the following as key HRM tasks of FTMs, therefore, further supporting Hales’ five primary managerial indicators. The key tasks identified are monitoring/controlling absence, handling discipline, managing the health and safety aspect of their staff, team development, providing the necessary induction training of their staff, planning/allocation of work, recruitment, training their staff, appraising their staff, handling grievance, and briefing their team. Huczynski and Buchanan (1991), state that “role” can be defined as: [. . .] the pattern of behaviour expected by others from a person occupying a certain position in an organisational hierarchy.

Such expectations may arise from both formally specified duties and responsibilities, and/or from individual experiences. For example, members of a particular organisation may expect a FTM to behave in a particular way based on what they have typically understood and witnessed FTMs doing in the past. Child and Partridge (1982) have noted that FTMs and their staff may well disagree as to the authority FTMs themselves possess. Therefore, it is necessary to recognise that a role, which is particularly perceived as managerial to certain members of the organisation, may be understood differently amongst other members of the same or different organisation (Gill and Johnson, 1997), when not clearly communicated. It is clear from the literature on devolution to the line that the FTM’s role tends to be imbued with ambiguity often influencing expected results – their performance of their HRM role. According to Armstrong (2001), individuals tend to become insecure or lose confidence in themselves when they are unclear about what their role is and indeed, what is expected of them. Therefore, it seems logical to suggest that defining the FTM’s role should be part of the strategy to enhance performance. Laitainen (2002, cited in O’Regan et al., 2005) defined performance as the ability of an object to produce results in a dimension determined a priori, in relation to a target. Poor performance has been known to be caused by roles having incompatible elements, for example, as identified in the literature, where there is a clash between what senior managers, HRM personnel, and the FTMs’ own staff expect of them, and what FTMs themselves believe is expected of them (Armstrong, 2001). This can be deemed as an indication that the role had not been clearly established and communicated in the first place, which then makes it almost impossible to consider and put an appropriate training and development strategy in place. Where training and development is concerned, several issues are highlighted for consideration. According to Wilson (1994), “managers are required to manage, and to manage effectively they have to be in control.” Putting forward a case for holistic management systems (HMS), Wilson posited, that in order to build on their strength of managing, they need to be trained in learning to succeed, particularly if they are required to integrate their business and behavioural skills and to develop the perspective required for managing complex and changing organisations. FTMs play a crucial role in the learning and development of their staff, however, they are unlikely to be successful without the organisation’s substantial investment in management development as well (Gibb, 2003). Keep (cited in Santos and Stewart, 2003) maintains that training investment symbolises that employers value employees, which in turn enhances employee motivation and commitment to the organisation. This proposition also gained support from the Employment in Britain Survey, which drew from a dataset of 3,855 employed individuals. The results revealed that 94 per cent of the respondents felt that the training received had been beneficial (financial/non-financial), for example, in terms of increased earnings, gaining job satisfaction or being promoted, achieving qualifications, and being committed to their job, (Gallie and White, 1993 cited in Santos and Stewart, 2003). Organisational commitment is defined as: [. . .] the employee’s feelings of obligation to stay with the organisation: feelings resulting from the internalisation of normative pressures exerted on an individual prior to entry or following entry (Allen and Meyer, 1990).

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Allen and Meyer, however, distinguish between three types of commitment: (1) Affective commitment: an employee identifies with, is involved in, and has emotional attachment to the organisation. (2) Normative commitment, which is based on a sense of obligation – an employee feels that they ought to stay, as things may change, for example. (3) Continuous commitment: an employee recognises the cost associated with leaving the organisation, and therefore, they feel that they have no choice but to stay. This may explain why some FTMs do not leave their organisation where they have not been offered training/development opportunities and as a result are not motivated to perform their HRM role to a high standard. From the discourse so far, there are clear indications that suggest that the provision of a clear definition of the role, and the way in which the FTMs HRM role is perceived/attitudes elicited in this regard, as well as training and development are linked to the issue of broader organisational support. In the general body of HRM literature, there is increasing evidence, which supports the link between strategic integration and performance[3], (Boselie and Paauwe, 2005; Wright et al., 2005; O’Regan and Ghobadian, 2002). However, drawing from the literature on the devolution of HRM to line managers, a broader or integrated approach towards the strategic HRM of FTMs is rarely discussed and practised. For example, signs of this are highlighted in Lowe (1992, 1995). Particularly, in his thesis on supervisors in the automobile industry, Lowe (1995) posited that authors have tended to treat the subject of FTMs in a “peripheral and cursory way”. Whittaker and Marchington (2003) reporting on the devolution of HRM to line managers, focus on two major concerns, which also implicitly draw attention to the need for broader organisational support for FTMs, or otherwise, their strategic management. First, they posited that FTMs tend to have “many other pressing priorities than managing and developing the people working for them”, and are therefore likely to take HRM issues less seriously than production or service goals. Evidence of this is found in Gratton et al.’s (1999) studies, carried out on pioneering organisations. The results of their research showed that there were no specific key HRM performance indicators or any other HRM performance criteria (formal or informal) vis-a`-vis the role of FTMs. According to Cunningham and Hyman (1999), FTMs tended to find their HRM role frustrating where they were unable to devote sufficient time to their HRM duties. Second, FTMs, whilst having these HRM responsibilities devolved to them, were found to lack sufficient skills and competencies to carry out the HRM role successfully without the necessary support from HRM practitioners. This notion is supported by a vast amount of research for example, IRS (2000), Gennard and Kelly (1997), and McGovern et al. (1997). Furthermore, as highlighted by several authors, for example, (Cooper, 2001) and Lowe (1995), often enough senior managers and HRM managers have been accused of not providing enough support towards FTMs in the undertaking their HRM role. One of the main reasons given for this is the fear of having their own HRM role disbanded if FTMs accept the responsibilities that are associated with HRM tasks devolved to them. In Whittaker and Marchington’s (2003) study, they have revealed the importance of the primary stakeholders of the HRM role working in partnership with FTMs rather than against them, if decision making regarding HRM issues are going to be fast and

effective (Renwick, 2003). The mere fact that such unnecessary tensions exist between FTMs, senior line managers and HRM specialist, as well as the fact that the HRM function continues to appear to be vulnerable to further contractions (Cunningham and Hyman (1999) suggest that a much broader approach to managing FTMs is required if devolution is going to be successful. Furthermore, the fact that studies such as Whittaker and Marchington (2003, cited in Hutchinson and Purcell, 2003) “have shown that the devolution of HRM responsibilities to the line has left many FTMs under-prepared, under-supported, and under-trained” is a clear indication that a holistic strategic approach to managing FTMs is required. Particularly, an approach which takes the key factors influencing the performance of their HRM role into consideration when determining the strategic process. Overall, the literature, which comprises a large number of studies reasonably connected to this work, suggests that the four groups of factors (mentioned above), combine to either support or undermine the FTM’s effective HRM performance. The literature further suggests that, the FTM’s performance in this regard, is in large part, shaped by the degree to which they are designed, introduced, and operationalised – the strategic process (O’Regan and Ghobadian, 2002). The fact, nevertheless, remains that few studies have sought to explore these suggestions in a systematic and holistic manner. In effect, therefore, the small, but in-depth, study reported here represents an attempt to address this weakness in the existing literature. Methodology This research paper seeks to address the issue of the key factors influencing the HRM performance of FTMs, drawing on detailed case study findings obtained from a company involved in the aerospace and automotive industries. The company had recently sought to increase the HRM responsibilities of its FTMs, however, without a more holistic strategy; they have experienced some problems with the FTMs’ performance in this regard. Case setting The company concerned, referred to as AeroCo, forms part of a large British multinational, and employs approximately 300 people. AeroCo commenced as a technical engineering development unit within its parent company – a global engineering company focused on the automotive and aerospace industries and active in more than 30 countries in Europe, the Americas and Asia Pacific. At the end of the 1990s, however, it was launched as a stand-alone business offering integrated engineering solutions to clients in these industries. Subsequently, it also expanded into working with clients in the rail industry and into offering recruitment services – supplying sub-contract resources to customers. Up until towards the end of the twentieth century, the business environment for AeroCo was relatively benign, with growth rates of 30-40 per cent a year occurring from 1997 until the end of the millennium. By 2000, however, the business climate had become less benign. Notwithstanding, the potential existed for large-scale growth, particularly in overseas markets such as the USA where a $10 billion aerospace design market exists. This change in the business environment, linked to the setting of demanding growth targets by its parent company, prompted recognition on the part of

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AeroCo that it had to reform its “way of doing business” in order to improve its market competitiveness. To this end, it embarked on a major change process. As part of this change process, AeroCo sought to identify how it could improve the role currently played by engineering team leaders (ETLs)[4] otherwise referred to as FTMs in this study. For example, between 2002 and 2003 the Company created a team, comprising five FTMS, two trade union representatives and two internal project sponsors (including the operations director), to carry out a benchmarking exercise to examine how the role played by the company’s FTMs compared with those which existed in a number (four) of comparable organisations. Based on this exercise, the company concluded that action was needed to improve a number of aspects of their role. In particular, it decided that it should henceforth embody a greater degree of responsibility for human resource issues, including: . matching team skills with the market environment; . development of team members; . project management, including the planning and allocation of work; . internal communications; and . performance monitoring and control. Prior to the interviews for this study, FTMs were already involved in the undertaking of these HRM duties. In fact, as reported by some FTMs, although, tasks such as monitoring and controlling team performance was not part of their formal job description, they had carried out such tasks in the past but on an ad hoc basis. Research methods The CSPs were asked to comment on factors acting to enhance or hinder the FTMs performance, and actions, which they felt could be taken to support FTMs in the undertaking of this role, in order to operationalise the four factor framework (see Figure 1). Additionally, the CSPs were asked to indicate the extent to which they understood the four-factor framework vis-a`-vis the HRM performance of FTMs, therefore, testing the validity and usefulness of the framework via in-depth interviews. Data for this study were obtained via two main data collection methods: in-depth semi-structured interviews and company documentation. FTMs and those who were involved in their management were interviewed. In all, four of the former were interviewed (including one shop steward) and these supplemented by further interviews with a human resource manager and six senior managers. These managerial personnel were selected because of their varied and/or expert knowledge and experience of the people management role and performance of FTMs. Thus, purposive sampling strategy was adopted, which also enabled the adoption a snowball effect, making it possible to gain access from one critical case study participant to another. Having access to a variety of critical case study participants was instrumental for generating and including the opinions of the primary stakeholders of the FTM’s people management role, otherwise enabling a heterogeneous effect. The seeking of in-depth views as to the relevance of the framework outlined above, vis-a`-vis the understanding of the people management role and the factors influencing the HRM performance of FTMs constituted a central component of these interviews. This sampling strategy compares favourably with studies conducted by Bryman and Bell

(2003), Saka (2003), Willemyns et al. (2003), and Boyd et al. (1993), particularly, vis-a`-vis studying management behaviour and decision-making. Simultaneously, company documentation was surveyed in order to triangulate, and thus substantiate the interview data. On completion of the fieldwork, all interview data (tape recorded) were transcribed word by word, and later content and context analysed (and pattern-matched) manually and electronically using a computer-aided qualitative data analysis system (CAQDAS)[5] (Kelle, 1995; Maclaran and Catterall, 2002) to enable both quantitative and qualitative in-depth processing of the data, as well as cross-referencing with company documentation. Company documents also provided a general background, and these included benchmark exercise carried out, FTM role and attitude survey, and two confidential change management reports. While both qualitative and quantitative analyses were carried out, it is the qualitative component of this analysis, however, which is drawn on in this paper. The use of CAQDAS enabled the data to be explored both quantitatively and qualitatively through a combination of content analysis, context analysis, and pattern matching. This was done in order to identify the indicators of the themes (otherwise, framework components), and furthermore, to decipher the interrelationships between the themes. Thus, the indicators were categorised under the theme domain in which they emerged. The analysis involved the performance of several coding level tasks, and generating coding reports in order to scrutinise the data and decipher the relevant attributes of the themes. That is, to demonstrate for example, how the existence, otherwise, non-existence of appropriate HRM policies, practices and procedures are contributing to the performance of FTMs, thus organisational and business performance. Purcell et al. (2003) referred to this type of scrutiny as dealing with the “black box” problem. Case study analysis and findings In general, the findings obtained from the case study interviews revealed that whilst some FTMs were carrying out their human resource responsibilities effectively, this was far from universally the case. They further indicated that this variable performance reflected a number of influences, which acted to facilitate or hinder the way in which they carried out their people management responsibilities. More specifically, those interviewed highlighted the way in which the people management performance of FTMs was critically influenced by all of the central elements of the conceptual framework that had developed based on the earlier literature. That is, the definition of their people management role; the training and development opportunities that had/had not been available to support it; the personal attitudes and perceptions of FTMs and other primary stakeholders; and the broader organisational arrangements which were in place or not in place, to support their effective management of people – and more generally, lent weight to its validity as a whole. The perceptions and attitudes of primary stakeholders (including FTMs) of the role The influence of the personal perceptions and attitudes of FTMs emerged strongly from the interviews. For example, describing the unreceptive, and in contrast, the practical, hands-on attitude of some FTMs towards their HRM role, a senior manager commented:

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[. . .] You’ll find that, it’s the “proactiveness” of people that makes them stand out as real people’s people and outstanding developers. Some people will just come up to you and say, “I need some extra people, or I’ve got a problem, what are you going to do about it.” And other people will come along with a solution. Umm, you know they’ve already done the thinking and the groundwork for what needs to be done. So I think you just find that it comes from the ETLs themselves [. . .]

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Furthermore, the findings revealed that there were signs showing that some cultures embedded within Aero are expressed in the way FTMs behave towards their devolved people management responsibilities. That is, where FTMs elicited that their proactive or in contrast passive behaviours towards their HRM role could be ascribed to their settled way of thinking or feeling. For example, some FTMs at AeroCo held certain values such as “people should do the jobs that they are employed to do”. Evidently, this belief was associated with a corresponding behaviour towards the role, as revealed by several comments made by senior managers. Particularly, revealing this type of FTM ethos, one manager stated: [. . .] Now, some, as a result of the their beliefs to do with the role are proactive, whereas those that are not it’s down to their belief that it’s not their responsibility to do it. It’s the ones who are proactive that make sure that they get the support that they need, and they do get it somehow, and this make you realise that it is possible to manage their role in such a way that it compliments the businesses objectives.

In a similar vein, another commented that: How you perceive things will determine the way you behave, you know, your attitude towards the job. For example, the way the ETL perceives his or her role would determine how seriously he or she undertakes the tasks.

More specifically, in the context of an operational environment whose organisational culture had in the past, placed considerable emphasis on supervisory personnel possessing high levels of technical engineering competence as constituting the key qualifying attribute for the role, FTMs did not conceive their role in a broader and less technically orientated way. The following quote clearly illustrates this point: If you asked them, they’d rather continue, as they were, they’d say no to getting more involved. People are used to, or comfortable with what they know. The moment you start putting the pressures on them to change and to go in a different direction, some people handle it but they’ll say, “Well if you want me to do that, I can’t do that, you’ll have to get someone else in to do that.” You’ll actually end up moving people from the roles that they are good at a lot of the time; umm, some people take to this and say, “Yes, I’ve got more power, more responsibility, I own this, I can report it”.

Above all, the quote suggests that some senior managers attributed the FTM’s behaviour to their resentment towards change, particularly where FTMs felt that they lacked competencies, and that the time and weight of the change was burdensome. Resistance to change usually occurred because of the way in which individual FTMs perceived a situation, even though their awareness of the situation may have been false or at least misguided. For example, regarding the way some FTMs have perceived the devolution situation and the corresponding behaviour elicited, one senior manager commented:

Other people are saying, “. . . you’re stopping me doing what I enjoy doing and what I’m paid to do, therefore I don’t want to do it. All this needs to be considered if we are going to develop a highly skilled workforce”.

The extent to which FTMs receive appropriate training and the overall development opportunities made available The actions that had, or had not been taken, by AeroCo to create training and development opportunities for FTMS in relation to their people management responsibilities were similarly highlighted by the CSPs as another key influential factor, as the quotes below demonstrated. Whilst it is clear that there was some form of training for FTMs, this was not specifically for HRM matters. Additionally, the actual training was not necessarily formalised or focussed and this demonstrated that policies were in this regard either fragmented or simply did not exist. As clearly stated by another manager: We’ve been having talks about developing our ETLs, and we need to if business needs are going to be met. But the policies are not altogether there yet. If you’re looking at policies for training ETLs, there aren’t any specific policies governing our training methods, or recruiting FTMs. We tend to use workshop methods for training, that’s the only one I’ve seen which has been used, but it’s not regular and it’s certainly not enough. Oh! And typically, we do on-the-job training . . . yes, we have on the job training. And we have internal trainers but mainly for the technical side of things. We also have a mentoring scheme, though it’s not directly aimed at the ETLs, but graduates . . . So senior engineers and at times ETLs would be asked to mentor graduates.” Generally they [ETLs] need more. Some have a lot of experience already, but they need to keep up with things. So all of them need this people management training of some sort, we can’t rely on yesterday’s. So policies in this respect would be helpful.

As highlighted in the literature review section, a core element of management as a function, is control. In order for managers to manage successfully they have to learn to be in control; and this learning comes from the learning opportunities provided, which in turn is derived from the training and development opportunities made available. However, training and development obstacles can exist because of an unwillingness to make any substantial investment in training, which in itself can be a consequence of disruptive organisational cultures. As vehemently stated by one of the FTMs: I definitely think training and development is something we can do with; it’s actually one of my objectives for the year, but I think the company’s focus is on the technical and not on people management, and that’s a barrier. What I think, we’ve got to become better at that, but historically we stem from being a technical company; we’ve looked at project management/people management as a separate function and not an extension of a technical role. Normally you’d have your team leaders but certainly the assistant chief designer would be doing all the project roles, but then you lose any focus on that technical side.

One CSP, aware of the training methods, “good” training strategy and policies in place, and the presence of a separate training department at his former place of work, believed that larger companies tended to show more concern regarding the training and development of their FTMs. He remarked: On-the-job training tends to be the most common, but I’d say training’s been inadequate, The reason I’m a bit iffy there is that, in my previous company, which is British Aerospace, I was

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there for 13 years, and being a very big company they had a training department separate from the HR department, and they had training on all aspects from technical to management to people management, this was reflective of the training policies on people management which were clear and realistic. So that is where I’d done some of my previous training. I must say, they had a good training strategy in place. But I’ve not had any here is, it might be my fault . . ., maybe it’s just gone past me, perhaps they’re not interested in it . . . I don’t know.

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This lack of attention to training and development existed, in turn, according to other CSPs, against the backcloth of a lack of clear criteria as to the competencies that FTMs needed to perform their role efficiently and effectively. For example, regarding the training and development of FTMs in the area of HRM, one CSP summed up the need for specific HRM criteria when she said: There aren’t any criteria for assessing people management skills and this isn’t helpful, we know it and are working on it by developing better systems and procedures that help to put the role in a better frame, one that would make it clearer. At the moment, the criteria used in selecting them would be based on availability. Well, it would be technical skills, availability and the ability to run a team. Um, sometimes that ability is not proven by his people potential or ability. There is informal coaching, but I don’t think there is formal people management training. I don’t know, it could be a big seminar or something (laugh) that we do that has worked in the past, but that is not good though. . . something is being done about it, and that’s why you are here.

Without any specific criteria for assessing people management skills, to some FTMs, it could seem as though AeroCo did not value them. In turn, this could materialise into a lack of motivation and commitment on the part of FTMs that feel this way, to undertake their devolved HRM role. Another senior manager (former FTM) who drew attention to pertinent training and development issues shared a similar view: [. . .] ETLs are typically recruited in-house. It’s non-objective. We tend to look at what is needed up the line. There’s no formal selection criteria, and there is no recruitment process at the moment. We need to place more emphasis on the psychological contract, and we tend to introduce personality and psychometric tests without a clear focus on what these are meant to achieve. ETLs need people management training, we need to develop competency frameworks to match their training, and this needs to be linked to recruitment and pay. We could invest more time and money in up-skilling and development, but we need to consider the speed of application of skills and knowledge; they need to be applied immediately. They definitely need to be able to identify what would make them do their job better, and when we have done this, to make sure that we set clear objectives and we do everything possible to make sure we achieve them.

The degree to which the FTM’s new role is adequately defined and clearly communicated The issue of training and development was further linked, by CSPs, to a lack of clarity regarding the HRM role of FTMs. That is, clearly defining the role in terms of tasks, authority, status, as well as the competencies required to perform the tasks effectively and efficiently. For instance, some FTMs who did not have the required competencies treated their HRM role as if it was an “easy job” or at least, their attitude demonstrated that they might have felt that it was. One FTM stated: I’ll be the first to admit that the proper project people, i.e. people with a project background like myself and people in that role with an engineering background, neither of us necessarily have the correct skill sets to handle the team leadership motivation or that kind of stuff. And

this is a major failure. I mean I could run a project, I mean if you gave me a project and a big stick and a good engineering guy who knows what he’s got to do to produce the deliverable, I could get the project out of the door to the time and cost of the programme. But I’d probably upset a whole lot of people in the process [laugh].

This explained why some FTMs would not seek the necessary training or be proactive in seeking out development opportunities in order to perform the role successfully. Similarly, if those responsible for recruiting and managing FTMs perceived the HRM role as an “anyone can do it” type of job, then they are not likely to give much thought to defining the role in such a way that the training needs would be apparent and therefore clearly identified. As one of the managers interviewed put it: [. . .] but if the training is going to be provided, now you see, this depends on how the role and the tasks they have to perform are perceived by those responsible for defining it. If it is vague, then that’s no good. Because if people don’t see it as difficult without training, then that’s their attitude, isn’t it? The problem we have here, is not everyone agrees with the role, so you get some supporting the role and others not. So first, I think we need to help the guys by making this clear to everyone, and that includes ETLs.

It is worth noting that in a rapid and continuous changing environment, pressures due to time limitations and organisational culture may act as barriers to training and development. Therefore, such barriers could make it difficult to follow formalised training procedures such as systematic training, which involves carrying out a training needs analysis (TNA) that would be based on a pre-planning (for example, clearly defining the role in terms of tasks, authority, status and competencies), actual planning, designing, implementation and evaluation of the training. However, at AeroCo, the problems that existed with regard to training and development stretched beyond following formalised training procedures. There were mixed views about whether formalised or focussed policies and procedures existed for FTMs or not. In addition to this, and perhaps more importantly, there was no consistency as to whether the FTMs HRM role was not clear or not, that is whilst some of the managers interviewed felt that the role was clear, a majority felt that this was not the case. As part of AeroCo’s move towards developing an appropriate strategy, they embarked upon a major change initiative involving the devolvement of greater HRM responsibilities to FTMs, and then later a benchmarking exercise with five other leading UK multinationals, which resulted in the role becoming clearer than in the past. In the words of one FTM: The roles are much more clearly defined now. Again, over the last few years the human resources department particularly has established a number of processes and formalised the processes so that now it is much clearer. Just for example, the personal development plan process it is now formulated, embedded within the procedure and it has to be adhered to; whereas in the past it was always ad hoc, so in the last couple of years it’s all been more structured.

It was apparent however, as at the time of the fieldwork investigation for this study, there were no formal job descriptions or personnel specifications for FTMs, which reflected their HRM responsibilities, and an appropriate internal job analysis had not been undertaken. This is an indication that the role still lacked the level of recognition that it deserved. Prior to the benchmark exercise the role tended to lack any formal structure, and was viewed as a temporary role which had a propensity to rotate than

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have any typical standard, and a majority of FTMs tended to adopt a hands-off approach where personnel issues were concerned. After the benchmark exercise, some structure had been put in place but the FTM’s HRM role was still not made fully explicit. The extent to which the role lacked a clear definition was expressed by several CSPs. Indeed, the lack of clarity was identified as having, more generally, an adverse affect on those selected to fulfil the FTM role. One manager in his description of the situation remarked: I don’t think we’ve done that properly, things are not properly matched, for example, matching the right people with the right jobs – and I’m talking about ETLs that aren’t good at the job and those that are but, you know. I mean, there was a hole, I think we recognised it and we’ve put something in that just to plug the gap, but we haven’t done it the right way, but we’ve put something there. Are we really utilising these people who are frontline left-tenants properly in terms of the business need, the HR need. Are we clear about whom they are – the motivators and leaders of men? Of course we ain’t! You can put them in but they ain’t going to win us the battle. I mean, we’ve talked about roles and responsibilities and the recognition, the soft issues of man management skills within the team and I don’t think we’ve done that.

Another CSP highlighted that some FTMs had not been able to set themselves apart from their former passive HRM role and embrace the their “newly devolved HRM responsibilities”. To some extent, their inability to adapt to their new was attributed to the insecurity they felt or the loss of confidence associated with roles that are not properly defined. This tended to lead to uncertainties about what was expected of them – the psychological contract. It is therefore clear that if the FTM’s HRM performance is going to be enhanced, then a training strategy, which encompasses a well defined, but somewhat, flexible HRM role description, leading to the identification of appropriate training and development needs must be developed first. How far broader organisational supports (strategic HRM) serve to facilitate or hinder the FTM’s role/performance The influences wielded by the factors identified above clearly lend weight to the suggestion that if FTMs are to carry out their people management responsibilities effectively attention needs to be paid by employers to a number of, inevitably inter-related, factors. That is, the perceptions and attitudes of primary stakeholders (including FTMs), the development of clear role expectations and related selection criteria, and the putting in place of training and development activities that are closely linked to these expectations and that are likely to engender attitudes and behaviours supportive of them. The interview findings, however, further revealed that the occurrence of such attitudes and behaviours are facilitated or hindered by the degree to which the broader organisational environment is supportive of them. Alternatively, to put it another way, the extent to which the organisational and managerial cultures, structures and systems within which they work serve to reinforce their importance and desirability. A number of features of these systems were identified as being of importance. These, notably, included effective: . internal channels of communicating what FTMs are expected to do; . the standards of performance they are expected to achieve and the opportunities available for skills development;

. . .

the establishment of clear and appropriate levels of authority and status; the existence of effective performance management frameworks; and in the context of a project-based operational environment and a matrix-based management structure, adequate mechanisms for collaboration between FTMs and those in the wider organisation in possession of resources critical to the performance of them and their teams.

In combination, the following quotes serve to demonstrate the relevance of these factors: Firstly, I think ETLs need to know that they are being thoroughly supported right throughout the organisation, and we can certainly show this through our organisation structure, which is complicated for starters, it doesn’t quite allow the cooperation that is needed. We need commitment at all levels, and what would also help this is by providing the necessary information they need about the business itself, what they have at their disposal to meet their objectives and ultimately business objectives etc. . . ., they need to know exactly what training is available and that this is a learning organisation, not just by word but by the way provision is made. . . So, our communication could improve on that score. They need to know that they have full cooperation and are able to collaborate throughout the organisation, it’s about role acceptance, – not everybody knows what people management tasks they have authority to undertake, yet much is expected, and that’s not good for their performance if we are going to enhance their performance. Well, obviously if you want them to get more involved managing the business, then you need to be clear that that’s what you want them to do; likewise with their people management role if you want them more involved in this then how you make this clear is important. I did say this before; we have done this to some degree on some of the other programmes actually. When they come and do these nine to eight plans with this business development strategy to sort of improve our position with the customer, by inviting the team leader into those sorts of activities gives them a greater sense of understanding and the direction of the business a bit more. We know it is his responsibility to manage his team to achieve that goal, but we should be supporting anything that would enable him or her to do that – training if it’s training, HR advice if it’s advice they need. Again, we have this problem with this high-level team leader that doesn’t necessarily feel involved with the decisions that are made. It’s not necessarily making decisions cause they’re made at the business level, but at least having a say at some of the meetings that are involved around them, there’s visibility and he knows what’s going on.

Applicability of the conceptual framework Taken together, the findings obtained from the interviews, then, added weight to the conceptual explanatory framework that had been developed from the earlier literature review and the related view that the performance of FTMs is a product of the degree of strategic fit, both vertical and horizontal, that exists between their role and wider business strategies, structures, and systems on the one hand, and human resource policies, activities and resources, on the other. In fact, these conclusions received reinforcement from the responses that CSPs gave when explicitly asked, towards the end of interviews, for their views on this framework. Thus, as the following quotes show, they invariably made comments that supported its relevance to an understanding of how FTMs performed in relation to their people management role:

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Well, first and foremost, the role needs to be made clear and we’ve done that to some extent. But that depends on how that role is perceived by those responsible for defining it in the first place. In fact, then we can look at the broader organisational support along with training and development, which feed into performances. Because from this we can see, those behaviours and the things we do that are not supporting the role and performance in a positive way. It’s like a cycle with one thing feeding into the other and that being done constantly – positive attitudes can be continuous and so can negative ones: with this, this can help you monitor what you see. Well that’s how I see it anyway, and that’s how I’m interpreting the diagram you’ve got there. It’s a good one actually. Especially, the perception and attitudes are going to be linked to the business support that you’ve got, which also links to performance management because that feeds back into the perception. Yes, I think they’re all very strongly linked really. And training and development, I mean again that’s linked to performance assessment; but I mean the training and development is driven by the business needs probably more than anything else actually. As I said before, the strategic need, it’s driven by the project need at the moment. Training and development is probably less of a driver, I mean the role is driven by the business requirement and you may have training to supplement that role. Umm, we rarely look at a strategic map and say, although we are starting to, say we need to focus into position; that’s what we’re starting to do now, and training up team leaders in technical skills, and we need to this with their people management as well. So this if you like, is like a strategic map, and you could call this a strategic map. So if you are going to do these things you can’t disassociate any of them. Ultimately, for me, what I’m out to get is performance, and you get a sense of this during appraisals, and quality of output - that’s what we’re after, so really these are in-put if you like. All of these have to be modified by the individuals because we’re a complex organization as we all are. Whilst there is commonality in the ETL role, there is 20% difference because of the nature of each project or each team or whatever. Looking at your diagram . . ., I see a good starting point would be to understand the perceptions and attitudes below and above, as well as ETLs of this people management role. Trying to get these to merge is a tough challenge, but we must aim to get them to be the same to make the role work, and of course, the role must be made clear. Then training and development, which part of it is mentoring (see left side of structure); broader organisational support, and then their performance must be monitored and managed successfully. It is important to understand that each one feeds into the other, and to get some perspectives on how. We are not doing this at the moment; we need to get better at communication. If you remember, I said that we could do with investing more time and money in up-skilling and development and to do this the role must be clear. So that’s the role that needs to be clearly outlined, and the wider organisational support or broader support you have here; and then yes, the training and development would come into it, but then again that depends on the one hand, the perception of – whose perception are we talking about? Cause, whether training is offered, depends on the way those in charge of training perceive it – if it is a necessity or not; but if you are talking about team leaders receiving training or asking for training then of course, this depends on whether they perceive it as a necessity or not. If they hate the role, or have been forced to take on the role, their attitude will show this when they are offered training or after training . . . it will be; you know “well I didn’t ask for it did I. If they are keen, then they would take the initiative for their personal development, and some do already.

More specifically, as the above quotes suggest, the variable way in which, FTMs had carried out their new people management responsibilities, was seen as being explicable in terms of the company’s inadequate strategic approach towards their definition and

operationalisation, with the result that the full intended benefits of the changes made were substandard. The following, and final two quotes, serve to make this point more explicitly: If I can just go back to your previous question then I’ll link it with the framework you have here. We are working on pulling everything together – “the fit”. This is evident with the evolution of PDPs[6] and the grading system, trying to bring this in line with the business needs. The achievement of the fit is not HR driven at the moment and it should be, it should be a HRM driven initiative, and flexible. We need to establish where the weaknesses are and what the development needs are, where they lie, and the best ways of implementation. We need a better understanding of the evolution process in order to understand the role more. We need to improve communication, for example, when the pay system changed this was not communicated properly and there are implications for this I’ve talked about this already. And therefore we’ve created a role within the organisation because we believe that there is a need for that role. But we haven’t equipped the occupants of that role sufficiently to get the benefits that we would be getting if that role was being implemented and applied fully . . . It’s about enabling and empowering. I can’t understand for the life of me, I mean, and it is a classic set of leadership rules, how do we on the one hand orchestrate a massive leadership undertaking like the Gulf war and yet we can’t motivate four of five engineer designers . . . Where are the lessons learnt? So is the fit right? No it isn’t.

Conclusion The past decade has seen employers seeking to establish more devolved management structures that place more emphasis on local level managerial decision-making. An important component of this shift in many organisations has been the re-configuration of the role of FTMs to encompass a wider range of people management responsibilities. Recent evidence pointing to the crucial influence FTMs can exert over worker perceptions, attitudes and motivation has lent some weight to the wisdom of this change (Purcell et al., 2003). At the same time, the available evidence also indicates that, in practice, it has often proved to be problematic. Against this background, the present paper has used detailed case study evidence to explore how far the success or otherwise of such a process of change is explicable in terms of the role played by four, inevitably to some extent inter-related, sets of factors: (1) The perceptions and attitudes of FTMs and other primary stakeholders of the role. (2) The clarity with which their new role is defined; the degree to which its introduction is linked to. (3) The provision of appropriate training and development activities. (4) The extent to which all this is integrated into the broader way in which the organisation is structured and operates. The findings obtained served to highlight the relevance of all of these factors and, in doing so, pointed to the fact that to be successful attempts to reform the role of FTMs, organisations need to take due cognisance of all of them. In short, the study’s findings highlight the fact that those organisations that wish to enhance the people management role of FTMs need to adopt a holistic strategic approach towards achieving this objective. This is because, organisations which use a

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multifaceted framework such as that presented here, to assist with the close coordination of business and HRM activities, more specifically HRM devolution and the strategic management of FTMs are likely to perform better. Furthermore, the study’s findings indicate that such an approach needs to encompass both “vertical” and “horizontal” dimensions, which the framework suggests. Thus, regarding the former, the strategic approach has to extend to ensuring that the new role not only “fits” with operational business needs, but also wider management decision-making structures. Meanwhile, in relation to the latter, the holistic strategic approach needs to encompass a close integration between all aspects of relevant human resource activities. Speaking in more general terms, these include for example: . Developing and establishing appropriate, explicit but flexible role/job descriptions, which assist with ensuring that role vacancies are appropriately filled and the psychological contract is considered. . Developing and establishing appropriate and explicit units of performance criteria and developing high-performance systems, which is essential if adaptable training programmes are going to be developed and established, and other development opportunities are going to be created. . Developing and establishing flexible reward incentives, developing information communication technologies, and developing and establishing appropriate and flexible HRM policies and procedures in order to contribute towards building a supportive environment in which FTMs genuinely feel motivated and committed to their HRM role, and the organisation as a whole. Consequently, the findings point to the fact that human resource functions wishing to devolve aspects of their activities to FTMs need to think through carefully how this can be done in a way, which is compatible with the wider corporate, business, cultural, structural and operational features of the organisational environment. In other words to ensure that any such change is pursued in an integrated rather than “isolated”, narrowly functional-based, manner. That is, from a perspective which encompasses corporate, business and functional strategies. Limitations and areas for further research Overall, the FTM four-factor interrelationship framework provides a checklist for organisations eager to manage FTMs in a strategic way, so that FTMs can take on and cope with their devolved HRM responsibilities or otherwise feel genuinely committed and motivated in this regard. However, it must be stated that whilst the literature survey was not entirely industry specific, the sample was restricted to one sector, and one case study organisation. Therefore, the analysis applies to the aerospace manufacturing/engineering sector. In addition, while the study presents the views of primary stakeholders of the FTM’s role (and indirectly the views of the FTM’s staff), the views of FTMs staff are not directly represented as the study did not attempt to interview them in order to examine the differences of views at a more sub-organisational level. Although the main strengths of the adopted methodology are placed in the data analysis, which is extensive and in-depth, it would have been beneficial to augment the in-depth semi-structured interviews with quantitative statistical data. Therefore, future research should consider an approach, which can be more generalised to a wider external environment. A framework relative to a broader

range of sectors would be of immense value to managers involved in HRM strategy and decision making at the FTM’s level. Notes 1. Strategic HRM has been conceptualised in number of similar ways, for example strategic fit or integration (Morris and Pennington, 1998; Wood, 1999; Sheehan, 2003; Karami et al., 2004). Child (2005) describes “integration as a condition in which there is adequate coordination between the different, but complementary, activities that collectively create value.” According to Brewster and Larsen (1992) Strategic integration is defined as the degree to which HRM issues are considered as part of the formulation of the business strategy. Similarly, Armstrong (2001) states, “Strategic HRM is concerned with the relationship between HRM and strategic management of the firm. It refers to the overall direction the organisation wishes to pursue in achieving its objectives through people. . .Strategic HRM addresses broad organisational issues relating to changes in structure and culture, organisational effectiveness and performance, matching resources to future requirements, the development of distinctive capabilities, knowledge management and the management of change.” 2. The items enclosed within the brackets are added to Hale’s (1986) original text as an attempt to merge Buchanan and Huczynski’s (2004) theory with Hale’s theory. 3. Strategic HRM and performance, or strategic planning and performance. 4. ETLs is the title used for FTMs at AeroCo. 5. QSR NVivo 2.0. 6. Performance development plans. References Allen, N.J. and Meyer, J.P. (1990), “The measurement and antecedents of affective, continuance and normative commitment to the organisation”, Journal of Occupational Psychology, Vol. 63 No. 1, pp. 1-18. Armstrong, M. (2001), A Handbook of Human Resource Management, 8th ed., Kogan Page, London. Bevan, S. and Hayday, S. (1994), Helping Managers to Manage People, Institute of Manpower Studies, BEBC, London. Boselie, P. and Paauwe, J. (2005), “Human resource function competencies in European companies”, Personnel Review, Vol. 35 No. 5, pp. 550-6. Bowey, A.M. (1973), “The changing status of supervisors”, British Journal of Industrial Managers, Vol. XI No. 3, pp. 393-414. Boyd, K.B. and Scalon, B. (1965), “Developing tomorrow’s foremen”, Training Directors Journal, Vol. 1. Boyd, K.B., Dess, G.G. and Rasheed, A.M.A. (1993), “Divergence between perceptual and archival measures of the environment: causes and consequences”, Academy of Management Review, Vol. 18, pp. 204-26. Brewster, C. and Larsen, H.H. (1992), “Human resource management in Europe: evidence from ten countries”, Journal of International Management, Vol. 3 No. 3, pp. 409-33. Brewster, C. and Larsen, H.H. (2000), “Responsibility in human resource management”, in Brewster, C. and Larsen, H.H. (Eds), Human Resources Management in Northern Europe: Trends, Dilemmas, and Strategy, Blackwell, Oxford. Bryman, A. and Bell, E. (2003), Business Research Methods, Oxford University Press, Oxford.

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Ward Wright, M., Baker, A. and Staff of Mountbatten (2005), “The effects of appreciative inquiry interviews on staff in the UK National Health Service”, International Journal of Health Care, Vol. 18 No. 1, pp. 41-61. White, C.G. (1983), “Redesign of work organization – its impact on supervisors”, occasional paper, WRU, London. Whittaker, S. and Marchington, M. (2003), “Devolving HR responsibility to the line, threat, opportunity or partnership?”, Employee Relations, Vol. 25 No. 3, pp. 245-61. Willemyns, M., Gallois, C. and Callan, V. (2003), “Trust me, i’m your boss: trust power in supervisor-supervisee communication”, The International Journal of Human Resource Management, Vol. 14 1, February, pp. 117-27. Wilson, J.G. (1994), “Holistic management systems”, Management Services, Vol. 28 Nos 1/2, pp. 12-14. Wood, S. (1979), “Human resource management and performance”, International Journal of Management Reviews, Vol. 1 No. 2, December. Woodall, J. and Winstanley, D. (1998), Management Development: Strategy and Practice, Blackwell Publishers, Oxford. Work Research Unit (WRU) (1982), Meeting the Challenge of Change – Guidelines and Case Studies, Department of Employment, London. Wren, D. (1979), The Evolution of Management Thought, Wiley, New York, NY. Further reading Edwards, R. (1979), Contested Terrain: Transformation of Work in the 20th Century, Heinemann, London. Guest, D.E. (1987), “Human resource management and industrial relations”, Journal of Management Studies, Vol. 24 No. 5, pp. 503-21. Millward, N., Stevens, M., Smart, D. and Hawes, W. (1992a), The Workplace Industrial Relations Survey, The ED/ESRC/PSI/ACAS Surveys, Aldershot, Dartmouth. Millward, N., Stevens, M., Smart, D. and Hawes, W.R. (1992b), Workplace Industrial Relations in Transition: The ED/ESRC/PSI/ACAS Surveys, Dartmouth, Aldershot. Purcell, J. (2004), “Older and wiser? Reflections on the search for the HRM holy grail”, keynote address at the 3rd Dutch HRM Network Conference, University of Twente, Enschede. Roffey Park (2002), Management Agenda, Roffey Park Institute, Horsham. Senge, P.M. (1992), The Fifth Discipline: The Art and Practice of the Learning Organisation, Century Business, London. Terry, M. (1986), “How do we know if shop stewards are getting weaker?”, British Journal of Industrial Relations, Vol. 24 No. 2, pp. 169-80. Corresponding author Lola Peach Martins can be contacted at: [email protected]

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From a hierarchy to a heterarchy of strategies: adapting to a changing context Bala Chakravarthy and James Henderson IMD – International Institute for Management Development, Lausanne, Switzerland Abstract Purpose – The purpose of this paper is to question the continued usefulness of the hierarchy of strategies framework and to propose a new approach. Design/methodology/approach – The study reviews extant literature and theorizes a new approach. Findings – The paper finds that the hierarchy of strategies was a useful framework when it was first proposed, but since then a changed business context has made this framework obsolete. What is needed instead is a framework around a heterarchy of strategies. The locus of decision making is no longer hierarchical and corporate, business and functional strategies are far more interdependent and interlinked than they have been in the past. Research limitations/implications – Research on a hierarchy of strategies has run its course. Future empirical and theoretical work should focus on a heterarchy of strategies. Practical implications – The paper provides a framework for managers whether from corporate, business divisions or functions to help with the continuous renewal of their firm. Originality/value – Prior empirical and theoretical strategy research has taken the hierarchy of strategy framework for granted. The original contribution of this paper is to propose an alternative framework around a heterarchy of strategies. Keywords Corporate strategy, Change management, Continuing development Paper type Conceptual paper

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Introduction Strategic management has the ambition to be the field that informs the decisions and actions of general managers. In pursuit of this high goal the field has from time to time worshipped at various theoretical altars, both in economics and sociology. For example, it has looked to industrial-organization and transaction-cost economics, agency, network, contingency and, more recently, resource-based (or its cousin the dynamic-capabilities-based) theories of the firm, for inspiration. While some of these theories have helped guide general management decisions and actions, many have been hard to operationalize. The field still lacks an actionable theory. While theoretical anchors are seen as giving the field academic respectability, strategic management has helped practitioners more by its frameworks and typologies. The traditional hierarchical view of strategies: corporate, business unit and functional, must be viewed in this light. While the hierarchical view of strategies

has never had the pretensions of being a theory, it did capture the essence of what was seen as best practice in the 1960s and 1970s. It was a useful framework. While the hierarchy of strategy is still often taught in business schools today, its theoretical relevance and empirical support have been severely questioned. It does not mirror the actual locus of decision making or the causality of strategy making in a global firm today. In a transnational firm, the corporate office continues to drive corporate strategy for optimal portfolio balance. But this portfolio is defined not just along business lines but also along geography and resource dimensions, traditional prerogatives for business units and functions Business units and functions are run globally and heads of these business units and functions are also corporate officers. Strategic initiatives at a business or functional level may indeed drive the development of corporate strategy, which, in the hierarchy of strategy, is viewed from the top down Corporate, business and functional strategies are not hierarchical anymore; they are contemporaneous and interactive. Instead of a hierarchy of strategies, we should think more in terms of a heterarchy of strategies (Hedlund, 1986). In a hierarchy every strategic decision-making node is connected to at most one parent node. In a heterarchy, however, a node can be connected to any of its surrounding nodes without needing to go through or get permission from some other node. We will review in this short article both the antecedents of the hierarchical view and why it was seen to be useful followed by its limitations and growing irrelevance to the strategic management challenges of today. We conclude the paper with a brief description of what corporate, business and functional strategies look like in a heterarchical world. Hierarchy of strategies: a framework for its time Two of the classics in the field of strategic management, the first by Ansoff (1965) and the other by Andrews (1971), both had corporate strategy in their titles. Strategy making, at the time, was considered the sole preserve of the firm’s corporate officers; hence the term corporate strategy. Only with the eventual democratization of strategy making did a hierarchy of strategies begin to emerge. The origin of the hierarchical view of strategies dates back to the 1920s when some of the largest US firms started pursuing a strategy of diversification. At that time, these firms were typically organized functionally. But diversified growth using these organization structures soon led to severe coordination and resource allocation problems. Top management, in firms such as Dupont and General Motors, responded to this problem with the creation of the multidivisional organization structure, or the M-form (Chandler, 1962). Following Chandler’s (1962) pioneering work showing how a strategy of diversification led to the use of a multidivisional structure, other researchers sought theoretical reasons for the emergence and adoption of the M-form organization structure. Using transaction cost economics reasoning, Williamson (1975) argued that the M-form was adopted because it did a better job than capital markets in allocating scarce capital between competing investment proposals. He suggested that both the monitoring and policing costs were also lower in the multidivisional structure when compared to capital markets. However, the multidivisional structure was itself becoming unwieldy. Leading firms like General Electric (GE) invited McKinsey & Company, one of the founders of the now

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flourishing management consulting industry, to examine its corporate structure. GE had at that time nearly 200 profit centers and 145 departments. The McKinsey consultants advised GE’s top management to organize their firm’s businesses along strategic lines, influenced more by external industry conditions than internal organizational considerations (Ghemawat, 1997). GE’s profit centers and departments were consolidated into a smaller number of strategic business units (SBUs). Each SBU became a standalone entity deserving of its own strategy and dedicated functional support. While corporate strategy was concerned with domain selection (the portfolio of businesses that the firm should have in order to deliver value to its shareholders); business unit strategy was concerned with domain navigation (competitive positioning of each of the firm’s business within its industry environment). Finally, functional strategies specified the contributions that were expected from each function and their relative salience to the success of the firm’s business strategy. Corporations also turned to consultants for answers regarding resource allocation. Starting with BCG’s growth share matrix, numerous other consulting firms introduced portfolio planning matrix as an answer to the resource allocation problem. The two axes of the matrix were typically the industry’s attractiveness and the company’s position within the industry. Each of the corporation’s SBUs could be mapped onto this matrix. SBUs with strong market positions in growing industries, the “star” businesses, were lavished with additional resources; even as SBUs with weak positions in stagnating or declining industries, the so-called “dog “ businesses, were slated for divestment. By the mid-1970s, portfolio planning became very popular. Indeed, by the early 1980s over half of the Fortune 500 had introduced portfolio planning techniques (Haspeslagh, 1982). Further, in order to bridge the multiple levels of decision making within the firm top management needed a process. Formal planning and control systems began filling this void. A study by Stanford Research Institute showed that a majority of US companies used formal planning systems by 1963. Vancil and Lorange (1977) and Lorange (1980) describe three distinct phases in a typical strategic planning process: agenda setting, strategic programming and budgeting. Aspirations of top management when cycled through these three phases and three layers of management (corporate, divisional and functional) resulted in concrete budgets for business units and functions within the firm. When the three phases were followed in a rigid sequential fashion, the intent was frozen when strategic programs began to be developed. In turn, the programs were non-negotiable once budgets were decided. By the early 1980s, with the diffusion of M-form structure, the creation of SBUs, the adoption of formal planning systems and portfolio planning techniques, the separation of business unit and corporate strategies was complete in the USA and Europe. Functional strategies had to be subservient to the business strategies that they supported, and business strategies in turn had to be aligned with the firm’s corporate strategy. Furthermore, this hierarchical view of strategy was also mapped on to levels of management within the firm. The locus of decision making for each strategy was thus clearly specified. The corporate office was the primary architect of strategy. Divisional managers helped in a more restricted fashion by detailing their business strategy within strict corporate guidelines. Functional managers supported their divisional heads with well-aligned functional strategies.

It was assumed then that this unidirectional causality and hierarchically determined locus of decision making was the sine qua non for superior firm performance. No theoretical basis was provided for this assertion. Nor were there systematic empirical studies conducted to verify this claim. The assumption was that since the framework emerged from the practices of high performing companies like General Motors, Dupont, ITT and GE, it had to have universal appeal. It appeared to be a useful framework in practice and that seemed to have sufficed. However, the hierarchical view of strategies has since unraveled because of both empirical and theoretical developments on corporate, business and functional strategies. It has also lost its relevance today mostly because strategic management has changed dramatically due to an increasingly turbulent business context (Chakravarthy, 1997). Strategy making in a transnational corporation cannot afford to be hierarchical. It has to be more inclusive and heterarchical. We will examine next these challenges to the hierarchical view of strategies. The empirical challenge The portfolio planning models used in diversified firms were severely criticized on several grounds. First, industry growth as a proxy of industry attractiveness or relative market share as a proxy for company position, were seen as too simplistic. Second, these matrices were also open to multiple interpretations leading to the same business being variously described as a dog, cash cow or even star (Wind et al., 1983). Third, portfolio planning tools stated nothing about the potential synergies that obtained across the firm’s business units. Finally, they provided the corporation’s business units meaningless directives (such as “grow,” “harvest,” or “divest”) for dealing with their competitive realities (Gluck and Kauffman, 1979). Academic researchers also began focusing on the links between diversification strategy and firm performance (see Ramanujam and Varadarajan, 1989 for a review.) The research tended to show that corporations with a portfolio of unrelated businesses (e.g. conglomerates) or set of vertically integrated businesses performed far worse than corporations with a portfolio of related businesses (Rumelt, 1982). Unless the firm’s corporate strategy explicitly worked for synergies across the firm’s businesses, its shareholders gained very little by trusting the firm’s top management to allocate resources on their behalf. The linear and top-down view of strategy making was also challenged, notably by the work done by strategy process scholars. One of the pioneering studies on strategy process showed that strategy making was not top down as suggested by the hierarchical view of strategies but was essentially bottom up (Bower, 1970). In a detailed field study, Bower found that strategy originated from the “discrepancies” (something needed to change) experienced by functional managers, then given impetus by business divisional managers and finally approved by top management. Another influential researcher, Mintzberg (1994), had similarly argued against the over reliance on planned strategies and the linear top down conceptualization of strategy making. He provided numerous empirical examples of strategies that had “emerged” with apparently little planning. Additional studies in strategy process kept chipping way at the hierarchical view of strategies (Chakravarthy and White, 2001). Following Simon (1945), Bower (1970) suggested that the role of top management was not so much to make strategic decisions, but rather to set the premises for these

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decisions by shaping the strategic and organizational context of the firm. More recent research on strategic planning and control systems (Chakravarthy and Lorange, 1991; Lorange, 1980; Simons, 1994) has sought to describe how strategic planning systems can themselves set such a context. These newer studies suggest that the degree of interactions and iterations in a firm’s planning system have an important role in determining whether the strategies its managers pursue will explore new strategy frontiers and seek new competencies or exploit existing markets and competencies (March, 1991). The theoretical challenge The changing definition of corporate strategy Agency theory began questioning the wisdom of trusting corporate managers to make the right resource allocation decisions on behalf of the firm’s shareholders. In the mid-1980s, shareholder activism and leveraged buyouts opened up a market for corporate control (see Jensen, 1989 for a review). Questions were raised as to who was the right corporate parent for the businesses in a firm’s portfolio. At the same time, the development of the resource-based view of the firm showed that synergy benefits did not come from the relatedness across product markets but from the underlying competencies across businesses. Indeed, Montgomery and Wernerfelt (1988) found that a corporation was constrained in terms of its diversification distance not because of product-market relatedness but because of the specificity of the underlying resources and their transferability into different businesses. Corporations with more general resources seemed to diversify across a wider variety of industries. Thus, the definition of corporate strategy expanded to not only include which businesses to be in but also how to manage those businesses: through coordination, control and organization such that the total value of the corporation was greater than the sum of each business unit value as a standalone entity (see Collis and Montgomery (1995) or Goold and Campbell (1987) for a review). The ascendance of business strategy By the early 1980s, heightened competition especially from Germany and Japan, shifted top management attention to competition, competitive strategy, and competitive advantage. Corporations, such as GE, became less fixated on synergy and more interested in making each of their businesses no. 1 or no. 2 in market position vis-a`-vis their global competitors. Academic research picked up on these concerns rather quickly. Building on industrial organization research, Porter’s (1980) work on industry analysis and competitive strategy came as a big relief. Business strategy was elevated to the same if not greater level of importance than corporate strategy. Growing importance of functional strategies Competitive advantage, according to Porter (1985) stemmed from the “fit” of the discrete activities that a firm performed in designing, producing, marketing, delivering with its business unit strategy. The disaggregation of businesses into their component activities in Porter’s value chain heightened the importance of functions to competitive success. This led to the emergence of specialized functional consulting firms in marketing strategy, supply chain strategy, manufacturing strategy, and the like.

Research on “functional strategies” started to appear in the academic literature (see for example: Wheelwright (1984) and Swamidass and Newell (1987) for manufacturing strategy; Varadarajan and Jayachandran (1999) and Dickson and Ginter (1987) for marketing strategy; Dyer (1984) and Lengnick-Hall and Lengnick-Hall (1988) for human resource strategy; and Johnson (1984) and Miller (1995) for R&D strategy). Functional strategies were not merely subservient to business and corporate strategies but in their own right were important to the competitive success of the firm. Indeed functions were the homes of many of the firm’s distinctive competencies.

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Towards a heterarchy The hierarchy of strategy has become irrelevant. Empirical studies have shown that the traditional role of corporate strategy – portfolio planning – does not lead to higher performance and the causality of strategy formulation is not always top down. Furthermore, advances in agency, industrial organization, resource based theories (including others) have shaped our thinking on what the new roles, causality and locus of decision making in corporate, business unit and functional strategies could be. Faced with the turbulent environment that confronts a typical firm today, we should thus view corporate, business and functional strategies not as a top-down hierarchy with very separate roles and responsibilities but as an interdependent network or heterarchy with the fundamental challenge, for all levels of strategy, being continuous renewal (Chakravarthy, 1996). Continuous renewal The continuous renewal challenge can be best understood through a simple framework (see Figure 1) (Chakravarthy and Lorange, 2007). The matrix is defined by the two

Figure 1. A framework for continuous renewal

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traditional dimensions of markets that a firm currently participates in or wishes to; and the distinctive competencies that it has or seeks to access in order to defend its presence in these chosen markets. These correspond to the traditional product-market axis and the more recent resource and capabilities axis. Markets refer to the customer sectors and geographies that a firm participates in. Each market has a defined set of customers and competitors. Firms also operate globally and can define their markets by the countries in which they operate. Whichever markets the firm competes in there are always new markets that are open to it. Some of these may have to be discovered de novo by the firm (Hamel and Prahalad, 1994), but others may already exist and are merely new to the firm. Distinctive competencies are the second dimension. These may be in the form of firm’s tangible assets like raw material reserves, financial resources, plant, equipment, distribution channels, logistical assets, patents, etc. as well as in its intangible assets like brand name and customer relations. They could also be in the firm’s know-how and skills, which are embedded in its people and processes. Any element of the firm’s value chain is a potential source of distinction; whether it is procurement, R&D, operations, logistics, selling or even support-activities like information technology. Since competencies eventually lose their distinction, new distinctive competencies are needed both to protect the core business of the firm and to provide a platform to enter new markets. Renewal is not only a matter of positioning the firm in a more attractive opportunity space, but is equally about accumulating new distinctive competencies that will allow a defense of these new found positions. In fact there is a growing body (Barney, 1986; Barney, 1991, Collis and Montgomery, 1995; Peteraf, 1993; Prahalad and Hamel, 1990; Teece et al., 1997) of research in strategic management that extols the virtues of the competence dimension (sometimes to the exclusion of the equally important product-market dimension). We believe that market positioning and distinctive competencies are complementary dimensions in defining a renewal initiative. Continuous renewal must involve market positioning and distinctive competencies simultaneously. It is about exploiting existing market positions and distinctive competencies, as well as exploring new markets and competencies – not one or the other but one and the other. The lower left-hand cell in Figure 1 describes the present core of the firm, the markets that it participates in and the distinctive competencies that it currently has. Protecting and extending the core is the obvious first renewal initiative. The other initiative is competing for the future by proactively migrating to new markets and acquiring new competencies (migrating to the upper right-hand cell in Figure 1). This migration is transforming the core. Chakravarthy and Lorange (2007) propose two other renewal initiatives that link these two: leverage and build. The upper left hand cell in Figure 1 describes new markets that the firm can enter by leveraging the existing competencies that it already has. But this is just the initial step. Complementary new competencies will have to be added in order for the firm to compete successfully in these new markets. Similarly, the lower right hand cell describes the new distinctive competencies that the firm must build in order to protect its existing market franchise. But this too cannot be a dead end initiative. The new competencies that are built must allow for future leverage into new markets. Both leverage and build should logically lead to the other (hence the bent arrows for leverage and build in Figure 1). If the two are linked systematically, it can help the firm migrate to new markets and new competence platforms progressively over time.

A new blend of strategies Strategy is about commitments (Ghemawat, 1991) and yet it is also about learning. The resources on which a firm commits to a strategy may not be as distinctive as first assumed, or it may lead to newer opportunities that are far more attractive. Commitments have to be flexible as well. This may sound like an oxymoron, but this is precisely what the challenge is in continuous renewal. The portfolio choice here is not just in terms of the market dimension but also the competence dimension. Actively monitoring the protect and extend, build, leverage and transform initiatives in the firm’s portfolio is a key element of corporate strategy in a transnational firm. Instead of managing a portfolio of businesses or resources, the new corporate role is to manage a portfolio of renewal initiatives. Top management also has to focus on deliberate and controlled experiments. It has to be the prime mover in Transform initiatives, either setting these up as corporate ventures or by creating the right platform through targeted acquisitions. It may also prompt build and leverage initiatives but should generally rely on the business and functional divisions to propose these. Build and leverage are initiatives that call for a partnership between top management and business/functional heads. The business division head in a transnational company is the corporate officer responsible for its major markets. This manager is typically the prime mover for the protect and extend initiative. In contrast with the role assigned to this manager under the hierarchical view of strategies, the business divisional head is also expected to explore for new markets and competencies and not just be responsible for strategy execution. In this capacity this manager does shape corporate strategy. The functional manager in a transnational company is the corporate officer responsible for its competencies. Maintaining functional excellence, promoting its sharing and leveraging it across the entire firm are also some of the key responsibilities of this manager. His role is vital to the build and leverage initiatives of the firm. He must also partner with the business division head on protect and extend initiatives. As Bartlett and Ghoshal (1989) so eloquently described, transnational strategy is in part global efficiency and learning, but in part also about local responsiveness. The strategy process has to be highly interactive and iterative. It is essentially heterarchical in nature. Build, leverage and transform initiatives require a bottom up adaptive planning process, and in contrast a protect and extend initiative requires a top down integrative planning process. While the two systems can co-exist within a firm, they have to be administered differently by the corporate officers. Interactions in planning refer to the levels of managers who are involved in developing the firm’s strategic plan. The greater this interaction, the richer are the strategic alternatives which are considered. High interaction is crucial for exploration (Chakravarthy and Lorange, 1991). Another consideration is the degree of iteration in the planning process. When each phase of planning (agenda setting, strategic programming and budgeting) is seen more as a guide to the next without rigidly constraining it, the planning process is more iterative. For exploration, the planning process must encourage the continuous questioning of the relevance of approved strategic programs and the appropriateness of accepted goals. Figure 2 provides a contrast between what we propose here and the traditional hierarchical view of strategies.

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Figure 2. From hierarchy to heterarchy of strategies

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