Lessons XV XVI: Towards a New Strategy of the
Firm: How to Create a Culture for Success.
Achieving Unique Corporate Capabilities As a
Condition for Being a Leader in the Market (I)
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The Dynamics of Firm’s Boundaries and Organizational
Strategic Process
 Unique Organizational Capabilities
 The Boundaries of the Firm
 Bounded Rationality
 Knowledge-based Theory of the Firm
 Dynamic Transaction Costs
 Options-based Theory of the Firm
The Dynamics of Firm’s Boundaries and Organizational
Strategic Process
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Any firm’s boundaries are dynamic due to the following potential
factors:
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Changing market demand’s conditions;
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Changing configuration of competition within the market;
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Changing internal organizational configuration.
Organizations adjust their boundaries in order to:
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React to both external and internal environments. External
environment is the business environment surrounding the
organization as business entity. Internal environment is the
organization and dynamic of business entity.
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Leverage the use of core competences in order to achieve
competitive advantage in the market.
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Decision-makers in organizations take corrective actions in order
to adjust firm’s internal capabilities to external influencing factors.
The strategic processes are long-term actions taken to adjust
firm’s outcomes and goals to external business environment. A
change in legal environment might induce business failures.
– For example, changing environmental protection laws might bring in a
significant increase of associated costs. Many organizations from
economies located in Central and Eastern Europe are facing high costs due
to environmental regulations imposed by EU legal frameworks.
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Therefore,
decision-makers in organizations should take
preempting decisions based on agreed strategic processes. Any
strategic process is a set of continuous and changing planning and
actions implemented in order to preempt potential risk factor
coming from internal, i.e. organizational and external business
environments.
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The organizational strategic processes should be regarded as
ways of minimizing potential transaction costs induced by market
transactions. There is little evidence that firms can eliminate
transaction costs at all. There are always market factors inducing
transaction costs. The reason is that the market is a collection of
separate entities with independent decision mechanisms. Any
organization has its own decision process. Firm’s stakeholders
might have interests in more than one organization but there is
no evidence that one stakeholder can have the power to control
all of the entities (i.e. organizations) in the market.
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The firm cannot get rid of the transaction cost. Nevertheless, organizations
can minimize it. The extent to which any firm can get maximum benefits
from minimizing the potential transaction costs depends on the way how
different actors (e.g. decision-makers, employees, etc.) have the ability to
leverage present and potential organizational capabilities and resources
in order to achieve competitive advantages in the market. Long-term
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planning and being successful in managing changes within strategic processes
are prerequisites in the process of achieving competitive advantages by any
organization.
Organizations choose either to buy products and services from “market firms”
or produce them internally. Firms make alliances, joint ventures with other
firms or expand their businesses through franchising. “Make-or-buy”
decisions, alliances, joint ventures and franchising are all different types of
“strategic moves”. The extent to which a firm choose to either make or buy a
product or services, enter into alliances or joint ventures, expand their
operations through franchising depends on its capability of foreseeing the
potential associated costs.
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A multinational firm might be advantaged in terms of costs
incurred when entering an alliance or joint venture with a local
firm. Choosing to enter into alliance or joint ventures with a local
or regional player might be less expensive in terms of capital
costs.
– For example, SABMiller[i] would consider outsourcing some of its costs
through joint ventures with local partners in different markets. Therefore,
SABMiller would, finally, use potential local partner’s resources and
capabilities in order to leverage its own capabilities and resources. A joint
venture’s advantage is joining partners’ capabilities and resources. Both
profits and associated risks are shared.
[i] SABMiller is one of the world’s largest brewers with a brewing presence in over
40 countries across four continents.
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The theory of the firm is concerned with explaining the
economic organization, i.e. how organizations shape their
boundaries in a business environment where transaction costs
influence the decision-making processes. There is a continuous
reconfiguration process of firm’s boundaries, as stakeholders want
to maximize their potential benefits. Thus, stakeholders having
various interests in different organizations influence the decisionmaking processes in order to maximize their own benefits and
minimize potential costs. The firm’s boundaries are changeable as
the decision-making processes within different organizations are
dynamic due to various influencing power of different
stakeholders.
– Give some examples of influencing powers induced by different
stakeholders.
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Therefore, decision processes influenced by various stakeholders
having interests in different organizations generate transaction
costs. The market is a collection of transactions and their
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associated costs shaped by a multitude of stakeholders’ groups.
The transaction costs are not only those costs associated with
market factors. There are, also, some other influencing factors
coming from different stakeholders that may shape transaction
costs.
– Give some example of transaction costs induced by different stakeholders
having different “stakes” in an organization.
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The firm exists because the economic organization provides the
conditions for lowering these costs. Economic organizations are based
on the ability to negotiate long-term contracts with some of its stakeholders.
Employers negotiate long-term employment contracts in order to “direct the
work of the employee whereas such a power did not exist in a principal-agent
agreement.”[i] The firm’s owners have the ability (…) to (re)direct the work of
their employees”[ii] based on long-term employment contracts. It is a way of
diminishing the associated transaction cost by spreading it over a long-term
contract carried out within the firm. Every contract made either internally or in
the market generates associated transaction costs. The ability of firm’s owners
to minimize these costs is what, actually, brings in distinct characteristic of the
economic organization.
[i] Phelan, Stevan E.; Lewen, Peter. “Arriving at a Strategic Theory of the Firm”. School of
Management, University of Texas at Dallas, 1999, Available from:
www.utdallas.edu/~plewin/phelan.PDF
[ii] Ibid., p. 11
Unique Organizational Capabilities
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Firms develop a set of resources used for adding value within the
business.
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Resources are inputs into the firm’s complex system. Added value is
the output. Technical equipments, patents, human resources are
example of resources. The business success depends, finally, on
firm’s abilities to leverage those unique capabilities, i.e. “the ability
to perform a task or activity that involves complex patterns of
coordination and cooperation between people and other
resources”[i]. Examples of unique capabilities are high quality and
excellent customer services.
[i] Phelan, Stevan E., op. cit., p. 17
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Strategic management might be regarded as changing organizational processes
based on a set of complex and unique organizational capabilities, including
managerial ones, for generating sustainable competitive advantages.
Strategists are concerned with those capabilities and resources that generate
rents, i.e. surplus of revenue over cost. “Strategists seek to create, and protect,
rents in order to enhance the value of their firm.”[i] Competitive markets induce
rents due to “luck or differences in expectations concerning the value of a
resource”[ii] The strategic value of organizational resources “depends on the way
a firm combines, coordinates, and deploys that resource with other firm-specific
and firm-addressable resources”[iii]. The unique organizational capabilities are
difficult to imitate by the competition “because of time compression
diseconomies, asset mass efficiencies, interconnectedness of asset stocks, asset
erosion, and causal ambiguity”[iv].
[i] Ibid., p. 17
[ii] Barney cited by Phelan, Stevan E., op. cit., p. 18
[iii] Sanchez & Heene, 1997 cited by Phelan, Stevan E., op. cit., p. 18
[iv] Dierickx & Cool, 1989 cited by Phelan, Stevan E., op. cit., p. 18
The Boundaries of the Firm
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The boundaries of the firm are changeable as both the internal and
the external environments are dynamic. The organizational settings
are, also, changeable, as some of those unique organizational
resources might be reallocated in order to get maximum benefits.
The managerial ability or inability to reallocate organizational
resources and capabilities within the organizational settings or in the
business environment influence the boundaries of the firm.
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Companies can achieve competitive advantages by expanding into
similar activities. “Complementary activities lie in the same value chain
but require dissimilar capabilities.”[i] Some firms have chosen to
expand along the vertical chain by developing their own capabilities
and capital at early steps within the vertical chain.
[i] Phelan, Stevan E., op. cit., p. 19
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For example, some retailers developed their own distribution
facilities positioned upstream in vertical chain. Distribution and
retailing activities might be complementarily regarded as
operations performed within inter-linked stages along the vertical
chain. Implementing replenishment systems along vertical chains
in retail industry created the premise for developing
complementary activities. It is a way of vertical integration along
the vertical chains in retail industry where retailers control both
distribution and retailing activities.
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The firm should adjust their own boundaries by expanding into
areas where they have competitive advantages. “Growth will
thus be constrained by the fungibility and transferability of the
firm’s most valuable resources (which are by definition rare and
difficult-to-imitate).”[i] Some firms could not have the resources
and capabilities for integrating vertically along the vertical chain.
Some others may consider inefficient and/or expensive to
transfer some of their most valuable resources by expanding
vertically or entering into other forms of joint planning between
firms.
The reasoning behind reconfiguring firm’s boundaries is that
companies should adjust their activities by taking only those
actions that will generate competitive advantages.
[i] Ibid., p. 19
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The extent to which some firms choose to enter or not into
different forms of joint planning and/or asset ownership depends
on the potential abilities or inabilities to perform better in terms of
profitability.
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Some firms may not succeed in the reallocation process of assets
and capabilities. The reason is that these firms cannot realize
“gains (through economics of scale, scope and experience) by
expanding into similar activities”[i], either horizontally or vertically
(through vertical integration).
[i] Ibid., p. 19
Bounded Rationality
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Managers cannot anticipate all the factors influencing
organization’s activity. Factors like information asymmetry induce
imperfect knowledge of the factors influencing the future state of
the business. “Managers do not have perfect knowledge of future
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states of the world, of alternative actions that may be taken
should such states arise, nor of the payoffs from adopting various
alternatives”[i].
Manager’s past experience, beliefs, skills and values influence the
resource allocation decisions. There is no single way in using
some organizational resources by two managers even if there are
identical bundles of resources.[ii] “Managers in competing firms
do not face the same set of choices. Rather, they have different
menus with different choices”[iii].
[i] Newell & Simon, 1972, cited by Phelan, Stevan E., op. cit., p. 20
[ii] According to Phelan, Stevan E., op. cit.
[iii] Teece, Pisano, & Shuen, 1997 cited by Phelan, Stevan E., op. cit., p. 20
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The owners and/or managers of the firms cannot take full
advantage from using the information available in the market as
“the future is, to a greater or lesser degree, uncertain and
unknowable”[i], according to Austrian and evolutionary theory.
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Firms rather adapt than optimize the use of their own resources
in a competitive business environment with imperfect information.
The firms never know if they reached an optimum position as the
information is imperfect or the decision makers cannot have access
to all of the information required for reaching an optimum
position.
[i] Hayek, 1945; Nelson & Winter, 1982 cited by Phelan, Stevan E., op. cit., p. 21
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Nevertheless, some firms can be efficient and others inefficient in
terms of resources and rents’ reallocation between various entities
in the competitive environments.
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Efficient companies manage to reallocate resources and rents for
their own benefits. Inefficient firms fail to reallocate their own
resources and capabilities by not generating “rents” from entering
into competition in the business environment.
In the neoclassical approach, inefficient firms fail to compete and
leave only efficient companies.[i]
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[i] According to Phelan, Stevan E., op. cit.
There is, also, an evolutionary approach that offers new insights into
the nature of efficient firms. A company may under-perform on
the short run but a new strategic change process would payoff
over an extended period of time.[i]
[i] Ibid.
Knowledge-Based Theory of the Firm
This theory is based on the following assumptions:
 Knowledge is used in generating products and services
Knowledge is a strategic resource
 Knowledge is created and held by individuals, not firms
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Firms exist because the market cannot coordinate the knowledge of
individual specialists.[i]
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Grant argues that coordination of specialized knowledge is difficult even if there
is a cooperation between different organizational members. “Rules and
directives”[ii], “sequencing”[iii], “routines”[iv], “group problem solving and
decision-making[v]” are mechanisms used for coordinating specialized knowledge.
The firm generates competitive advantage based on its “ability to integrate
knowledge held by individuals within the organization”[vi].
[i] According to Grant, R.M. (1999) “Toward a Knowledge Based Theory of
Firm”, Institute of Industrial Relations, University of California, Berkeley.
Available from: http://ist-socrates.berkeley.edu/~iir/cohre/grant.html
[ii] Ibid.; [iii] Ibid.; [iv] Ibid.; [v] Ibid.; [vi] Ibid.
the
Dynamic Transaction Costs
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Dynamic transaction costs are defined as:
“…the costs of persuading, negotiating, coordinating and teaching outside
suppliers…[about your capabilities and strategic architecture]…it is the cost of
not having the capabilities you need when you need them.”[i]
Paul Jaminet argued that, “dynamic transaction costs are transaction costs which
are of only transient importance.”[ii] Dynamic transaction costs are generated
“during the period of entrepreneurship when the value network is created, not
during the operating period when relationships are stable.”[iii] It is the case of
vertically integrated organizations during earlier periods of organizational
development. The dynamic transaction costs are rather regarded as transition
costs incurred in earlier stages of organizational development.
[i] Langlois & Robertson, 1995, cited by Phelan, Stevan E., op. cit., p. 25
[ii] Jaminet, Paul (2005), Relationship Economics, Available from:
http://www.relationshipeconomics.com/shorter_pieces/subway_v_starbucks.htm
[iii] Ibid.
The costs associated with the transition from one organizational
structure to another are related with the optimal organizational
structure:
“If the advantages of the optimal structure are great enough to
justify the transaction costs involved in switching structures, then
the value network will change structures early in the operating
period; if not, it may retain a less-than-optimal structure.”[i]
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[i] Ibid.
Options-Based Theory of the Firm
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The decision making process in organizations is about choosing one or more
options regarding the business activity. The decision process impacts the
resource allocation in organizations. The extent to which some organizational
resources can be reallocated within the firm or in the market depends on a
multitude of constraining factors as follows:
 Firms’ owners and/or managers decide to reallocate resources based on the
least cost way of producing a given output;
 Some firms’ resources “cannot - or can only with difficulty – be sold or used
for another purpose”[i]
 Uncertainty : Firms’ owners and/or managers cannot – or can only with
difficulty – control all the factors influencing the decision making processes.
[i] Burger-Helmchen, Thierry. “How do real options come into existence? A step toward an
option-based theory of the firm”, Bureau d’Economie Théorique et Appliquée, University
Louis Pasteur, Available from:
http://econwpa.wustl.edu/eprints/fin/papers/0409/0409054.abs
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Thus, the decision making process is about choosing the least-cost decision
option that would induce irreversibility in the reallocation of organizational
resources. Strategic decisions should induce irreversibility in the reallocation of
resources. “The irreversibility condition is also an entry barrier to potential
imitators. The sustainability of the profits flowing from a core competence or
an option depends on the difficulty to imitate them.”[i]
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Firms’ owners and/or managers cannot – or can only with difficulty –
choose the least-cost and most efficient decisions due to uncertainty
induced by endogenous (e.g. technological uncertainty) and exogenous (e.g.
market uncertainty) risk factors. “In fact the firm is not willing to undertake
any action because the very nature of the option is made to catch the value
included in that uncertainty in an asymmetric way.”
[i] Ibid., p. 7
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Some firms manage to reduce those risk factors induced by uncertainty by
developing a set of unique capabilities required for securing organization’s
positioning in terms of competitive advantages.
– For example, the organizational leadership can be a unique capability as long as the
firm successfully managed to become a leader in the market.
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Organizational resources are transformed through various distribution and
production processes. Some resources are acquired (e.g. stocks), others are
transformed in the production process and, finally, sold as final products,
generating added value for the firm. “The decision to acquire a resource must
ultimately depend on:
– a) its premium (or acquisition price),
– b) its current value to the firm, and
– c) its ability to be recombined with other resources to create value – the expected value
of future gains represents the resource’s option value.”[i]
[i] Phelan, Stevan E., op. cit., p. 26
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Therefore, some inputs should be outsourced and others should
be internalized. Some firms might find too expensive to acquire
and transform internally (i.e. within firm’s operational activities)
certain resources as their acquisition prices and/or firm’s ability to
recombine them with other resources exceeds the cost associated
with having the same resources acquired and transformed by
entering into contractual agreements with so-called “market
firms”).
“Firms should internalize only a few inputs that:
– 1) are exceptionally difficult to obtain through markets and
– 2) are capable of generating superior options values for the firm.”[i]
[i] Foss, 1998 cited by Phelan, Stevan E., op. cit., p. 26