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Why Firms Win, by Phin Upham

September 20, 2011 Business, Corporate, Phin Upham, Technology No Comments

Why do some firms, like IBM or GE succeed while others fail?  In this essay Phin Upham explores some of the seminal points of view in the field of organizational theory.

There are many views in organizational theory which can explain why some firms are better at doing certain things than others, why some firms have a sustainable “competitive advantage.”  One source of advantage for firms can be argued to be a form of the dynamic capabilities view.  The so-called capabilities view, alone, is a very powerful group of ideas.  It explains, I think, much of the successes, failures, and sources of struggle that the business world travails.  The dynamic capabilities view adds some complexity – and it is especially valuable in times of uncertainly to change.  But its added value is, I believe, sometimes overstated by the authors of essays on the topic.  While it is important, a firm that has good capabilities and a fairly rational structure captures much of the competitive advantage that is relevant.  Dynamic capabilities, which adds on the “learning to learn” piece of the puzzle, as far as it goes beyond normal firm learning (it would be unfair to say that every firm, even a normally well functioning one, has a dynamic capability to learn from itself – this would debase the term into a truism.  So I limit it to well above average or explicit sorts of abilities to “learn to learn”), is a marginal improvement.

The capabilities point of view for organizations is underpinned by the work of Nelson and Winter (1982) “Organizational Capabilities and Behavior.”  This view begins with the level of the individual – suggesting that in individuals, skilled behavior is a product of routine, tacit knowledge and a product of past behavior/learning.  This essay relaxes some of the assumptions of classical micro-economics including inputs are homogenous, entrepreneurs are identical, firms optimize, etc..  In fact, Nelson and Winter argue, decisions in organizations may not be optimal, they may just be the descriptions that either personal experience or organizational memory imply.  Organizational memory, accessed and contributed to by individuals, exists in individuals personal and organizational experience, external memory (such as files), and the physical state of the plant itself.  Nelson and Winter generalize from this individual perspective (influenced by the work of Simon on organization and Kohneman and Tversky on heuristics) to apply this view of “evolutionary economics” to an organizational level.  So, the theory is build up from the micro to the macro level in such a way as there is both a conceptual parallel between the micro and the macro, and that there is also a causal link between the behavior of individuals in a firm and the nature and behavior of the capabilities of that firm.

Nelson and Winter go on to construct a picture of organizational routines that are in effect truces between organizational and individual motivations.  Organizational routines, which are build up as a confluence of both the individual skills and the organizational physical memory and physical equipment configuration, allow for organizational capabilities.  This view provides the foundation of the capabilities view and also generates some interesting consequences.  The first is that organizational routines (and thus organizational capabilities) resist changes, even ones that are for the better.  Secondly, this implies that the organizational capabilities are very hard to imitate by outside firms that attempt to copy a given ability.  In fact, even replication inside the firm can be difficult since as Dosi, Giovanni, Nelson and Winter – editors (2000) argue, not only are the attributes necessary to accomplish a skill unknown but the successful execution of the skill requires a complex interconnection of these attributes. This resistence to change is a soure of the the ability for capabilities to be seen as a competitive advantage as well.  It a fimr could simply modify itself to be like another fimr – routines and all – then it would not be a very log lasting advantage for theother firm.  But the path dependency and lack of simplicity of capabilities lends them much of the r power as sources of durable competitive advantage.

Capabilities, though, cannot be of the common garden variety if they are to be valuable.  Jay Barney (1991) argues that if capabilities are to confer strategic advantage, they must be of a special type.  They must do more than be useful, they ust confer a sustained competitive advantage.  This implies that other firms are unable to duplicate (at least in the medium term) the advantages that the capabilities confer.  In order for a resource (or capability, which can be seen as a sort of resource) to act as a source of competitive advantage, it must be valuable, rare, imperfectly imitable, and without common, imitable, or strategically equivalent substitutes.  Dericks and Cool (1989) elaborate further on how these firm level capabilities might work.  They describe how strategic asset stocks can be seen as flowing over time – either rising or falling.  Thus, many capabilities grow over time, they cannot be acquired immediately.  This is due to time compression diseconomies, asset mass efficiency, causal ambiguity, and a number of other factors elaborated on.  Lastly, Jan Rivkin (2001) describes how capabilities must not be too complex or they will be un-imitable within the company (the company cannot take full advantage of them) nor to simple, or every other competitor will copy them (a la White Castle in Winter and Szulanski (2000)).  So capabilities must be of a certain sort to be durable competitive advantages – hard to imitate, rare, non-substitutable, but able to be replicated (in fact, a non-replicable capability might even be a better source of competitive advantage then a replicable one – since it will likely be  more sustained, but it is also less valuable since it is less leveragable.).

Capabilities are made up of a web of interconnecting routines, skills, bases of knowledge, firm-specific assets, and physical setups.  They are based around tasks not products (Wernerfelt 1984) and reside at the firm level.  Strategy at the capability level involves extracting rents from rare firm-specific resources.  Competitive advantage in this view lies upstream from products in idiosyncratic and difficult to imitate resources.  Thus, a firm in this view must be aware not only of its situation but also of its intra-firm advantages (strengths) and disadvantages (weaknesses) and attempt to take advantage of these factors and gain a durable source of competitive advantage.

This foundation of capabilities is can be built upon and made more rich by the idea of dynamic capabilities which focuses on, according to Teece, Pisano and Shuen (1997), the firm’s ability to achieve success by being responsive to change, build organizational mechanisms to encourage rapid and flexible product innovation, as well as management’s ability to “effectively coordinate and redeploy internal and external competencies.”  This approach focuses on how organizations renew their competencies, about the management and reconfiguration of competencies to achieve new and innovative forms of competitive advantage as it is about exploiting existing competencies.  Competitive advantage, thus, lies not only in the specific assets embedded in the form but also in the managerial and organizational processes which manage these resources, by the path dependencies and market positions taken by the firms

Henderson and Cockburn (1994) attempt to tease apart some aspects of dynamic capabilities.  They differentiate between component competence, or the competence embedded in local areas of the firm and architectural competence which they see as the competence that allows for the integration and flexible use of component competencies.  Pisano’s (2000) detailed study of how organizations manage their learned knowledge is a good example of the complex but vital thrust of dynamic capabilities.  Pisano argues that organizations received two benefits from doing an action – that of the product or result of the action, and also the knowledge that this production generated. If an organization only focuses on exploiting its resources, this second sort of knowledge is not fully utilized.  Thus, Pisano argues for the strategic use of action such that it will allow one to build knowledge bases and generate more capabilities that did not originally exist.

The idea that dynamic capabilities brings into the strategic framework – that both capabilities and the generation of new capabilities as well as the flexible combination of capabilities in response to changes in the market are vital – is extended by Collis (1994) who points out explicitly that since dynamic capabilities or “learning to learn” are, in some senses, the 2nd order of normal capabilities, why could we not take a 3rd and 4th order capabilities in order to gain competitive advantage.  He concludes that there will never be a final, ultimate source of competitive advantage since one cannot avoid infinite regression in capabilities.  Dynamic capabilities build on the resource based view and extend the literature into the sort of evolutionary and complex world that Nelson and Winter envision for strategy.  They lend an important component to the dynamic capabilities view – one which emphasizes how a firm renews and maintains capabilities – advantages – over time and through change.  We can see this idea of dynamic capabilities, with the idea of capabilities within this lending a large part of its power, being a powerful candidate for sustained competitive advantage.

Jay Barney’s to essays in this classes readings make a powerful argument about sustained competitive advantage.  The first, 1986, argues that any capability that is valuable must be acquired and thus it will, barring superior insight or luck, be as expensive as it is valuable.  So if a firm can gain competitive advantage from dynamic capabilities to, say, encourage information flow between R&D and manufacturing, and this advantage was well known, then all firms would acquire this ability up to the point where the cost of this ability was equal to its advantage.  Then this would not be a source of competitive advantage.  This argument is somewhat less powerful than it appears when applied to dynamic capability/capability mix since 1) firms are heterogeneous in their paths and abilities so a strategy pursued in one firm might not be possible or successful in another, so a valuable competitive advantage in one attribute might not be quickly devalued as others try to imitate of they cannot imitate (Diericx and Cool would agree in their 1989 piece).  Barney attributes the ability of a firm to gain competitive advantage through competency in this article to uncertainty while I attribute it more to heterogeneity of firms.  Barney moves closer to this view in his second article in 1991.  He argues that a resource must be valuable, rare, imperfectly imitable, and without common or imitable strategically equivalent substitutes.  He also claims that sustained competitive advantage is one which cannot be copied by others even over time.

Phin Upham has a PhD in Applied Economics from the Wharton School (University of Pennsylvania).  Phin is a Term Member of the Council on Foreign Relations.  He can be reached at phin@phinupham.com.

Read more by Phin on The Academic Ledger

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