Economies of scope through multi-unit skill systems:
the organisation of large design firms
Marcela Miozzo
ManchesterBusinessSchool
University of Manchester
Booth Street West
Manchester M15 6PB
Tel: 0161 306 3423
Fax: 0161 275 7143
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Mark Lehrer
SawyerBusinessSchool
SuffolkUniversity
8 Ashburton Place
Boston, MA02108-2770
Tel: (617) 573 8338
Email:
Robert DeFillippi
SawyerBusinessSchool
SuffolkUniversity
8 Ashburton Place
Boston, MA02108-2770
Tel: (617) 573 8243
Email:
Damian Grimshaw
ManchesterBusinessSchool
University of Manchester
Booth Street West
Manchester M15 6PB
Tel: 0161 306 3457
Email:
Andrea Ordanini
Management Department
Bocconi University
Via Rontgen, 1
20136 Milano
Tel. : (39) 0258363623
Email:
Paper prepared for British Journal of Management,
submitted December 2009, revised February 2009
Economies of scope through multi-unit skill systems:
the organisation of large design firms
Abstract
From a study of three large design firms in Italy, the UK and the US, this paper derives a distinct model of how large knowledge-intensive business service (KIBS) firms organise to manage growth and realise economies in ways that differ from the organisational techniques that are familiar from scale-and-scope studies of large manufacturing enterprises (Chandler, 1962, 1977). Case studies were compiled from interviews conducted at the three firms. Large design firms were selected as a contrasting context to Chandlerian manufacturing firms. Design firms were expected to differ from manufacturing firms in terms of strategy, organisation and the overall possibilities of achieving economies of scale and scope. Our results show that competitive advantage of these large KIBS design firms derives from a particular multi-unit skill system that enables these firms to exploit economies of scope. There are four distinctive organisational features of such KIBS firms. First,multiplebusiness units within the firm play a dual role. These are able both to engage in inter-unit coordination and resource-sharing and to attract business independently, often with heterogeneous business models among units. Second, these firms develop formal organisational routines for involving multiple business units in client projects, thus facilitating the migration of clients’ business from one unit to another. Third, there is an important role for cross-unit strategic ‘insight’ agents. Fourth, these firms expand through the founding of specialised, even idiosyncratic new business units (often with the important role of mastering new technological skills).
Keywords
firm organisation, knowledge-intensive business services, scale economies, scope economies, service industries
1. Introduction
Although we know a great deal about the organisation and management of large manufacturing firms, we know comparatively little about the applicability of such patterns to large service firms. There has been limited research, for example, on whether service firms are organised in the same way as manufacturing companies to realise economies of scale and scope or if organisational patterns in service firms are fundamentally different. Little research to date has examined organisational structure as a way to generate and exploit new forms of knowledge in service firms (Anand et al., 2007). This paper contributes to filling this gap by focusing specifically on a type of service companies representative of knowledge-intensive business service firms (KIBS) and in which economies of scale and scope would seem, a priori, the most difficult to realise: the case of large design firms in which the final service is largely customised for each specific customer and project.
The business histories by Chandler (1977; 1990) showed how, thanks to new communication and transportation technologies in the mid-nineteenth century, new forms of business organisation emerged to exploit economies of scale and scope. Chandler initiated a tradition of scholarly work on organisation, strategy and business capabilities. This tradition identified now-familiar principles of production and organisational techniques to manage scale and scope, especially mass production and the adoption of multiple divisions to reduce complexity and promote more entrepreneurial freedom (Chandler, 1962), as well as vertical integration in order to reduce hold-up by suppliers and other uncertainties in the production process (Williamson, 1975). Techniques such as these remain common among large and powerful manufacturing firms. While some service segments have much in common with manufacturing industries, others, such as the sector of design firms, are quite different.
At the same time, however, our research has focused on larger design services companies that are implicitly or explicitly organised in specific ways to realise economies of scale and scope. The paper begins with the hypothesis that these larger design firms operate as flexible firms – on the one hand, responding to demands by customers for specific service offerings, and, on the other hand, depending on somewhat standardised products and formalised processes to deliver them. We explore this hypothesis by examining the way in which a selected group of large design firms organise to manage growth and realise economies.
Like Chandler, we have examined scale and scope from an organisational perspective rather than from an economic, production-function viewpoint. The central research questions guiding the present study are: 1) How do large knowledge-intensive business service firms manage growth and organise to capture economies of scale and scope? 2) What sources of competitive advantage do such firms attempt to exploit to enable economies of scale and scope beyond (or instead of) the rather abstract declining marginal costs of neo-classical economic theory?
The study reveals that large knowledge-intensive business services (KIBS) firms cultivate particular organisational patterns to exploit economies of scope. The three large design KIBS firms investigated in this study all feature multiple business units, which engage in fairly extensive inter-unit coordination and resource sharing to obtain economies of scope, with coordinated migration of customers’ business from one unit to another, and continuous change involving the founding of specialised new units.
2. Conceptual background
2. 1. Firm organisation and competitive advantage
The pioneering research of Chandler (1977; 1990) argued that patterns of firm organisation and governance conditioned firms’ ability to manage growth and obtain competitive advantages. In the mid-nineteenth century, a number of US firms seized on opportunities opened up by the availability of large-scale transportation and communication infrastructure (railroad, postal services and telegraph), ultimately developing novel practices and forms of organisation. These included investment in large scale manufacturing facilities; in national and international marketing and distribution networks; and in new management systems (especially the multidivisional firm) to administer, monitor and allocate resources for future production and distribution.
A small number of manufacturing firms pioneered the coordination of mass production and distribution, diffusing the twin principles of interchangeability of parts and flow of production on the shop floor (with plant layout designed to maximise throughput efficiency). Systematic research and development organised in the in-house corporate R&D laboratory provided a new source of technological innovation, beginning in the electrical and chemical industries (Hounshell, 1984; Best, 1990). The firms able to master these new techniques gained powerful competitive advantage, became oligopolies, and dominated their industries for decades thereafter, competing strategically by improving products and processes and expanding into new markets. These firms obtained economies of scale (when increasing the input factors of production increases output more than proportionally) and economies of scope (which arise when it is less costly to combine two or more product lines in a firm than to produce them separately, especially by relying on shared inputs).
Further contributions building and expanding on these insights pointed to the role of skill formation in the organisation of firms and their ability to reap economies of scale and scope. Studies of the Japanese (lean) industrial firms stressed the importance of relational contracting with shop-floor workers and incentive schemes (rank hierarchy, long-term employment and seniority promotion, role of personnel departments and unions) in explaining the rise of these firms from the 1950s to 1980s (Aoki, 1990; Womack et al., 1991). Cooperation and relational contracting between employers and shop-floor workers permitted employers to use new technologies to their maximum potential, and new production concepts, such as just-in-time and collaborative relations with suppliers, became new sources of competitive advantage.
Less attention, in contrast, has been paid to the organisation of service firms and to the economies that they can exploit for competitive advantage, especially knowledge-intensive service firms that by nature have to provide highly customised services.
2.2 Management and organisation of service firms and industries
For the purpose of this paper, we focus on service industries as defined by the standard statistical frameworks (e.g. European NACE or North American NAICS).[1]Firms in service industries display somewhat distinctive features compared to manufacturing firms and industries. Five features of service firms in particular suggest ways in which large service firms may be organised and governed differently from large manufacturing firms. This may lead to differences in the ability to exploit economies from manufacturing firms.
First, service firms are characterised by the intangibility of their products. In principle, this makes it difficult for them to pursue differentiation (Enderwick, 1992). Differentiation of service provision is generally achieved by the creation of tangible attributes though marketing. Examples include the standardisation of the interior (such as the case of American Express) or the exterior (such as Pizza Hut) of buildings. Therefore, it is argued that scale economies in service firms are less important than in manufacturing firms and occur mainly in marketing (branding or investment in corporate image), concerning more the provider rather than the service supplied (Campbell and Verbeke, 1994). The emphasis on branding is said to reinforce specialisation by the provider in a narrow set of services (to maintain a clear corporate image for customers) and limit diversification into new products or sectors (Enderwick, 1992).
Second, service firms rarely have R&D departments (with important exceptions such as large telecommunications and IT service firms). More generally, service firms tend to be poorly integrated into national or regional systems of innovation, making little use of R&D facilities offered by institutions such as universities, research institutes, and government laboratories (Miles, 2008). In general, service firms set up product or project development teams on an ad hoc basis (Sundbo, 1998). Many innovations are developed in the course of specific projects for clients, and are therefore not always easy to distinguish from the customisation of the usual service. Some authors refer to the notion of “co-production” of knowledge with clients to denote the way that routine work for specific clients is intertwined with learning and innovation (Bettencourt et al., 2002). Such co-production with clients can be advantageous for the commercialisation of innovations that are nearly market-ready, but this mode of innovation is argued to entail limited coordination of learning experiences within the firm, so it is a challenge to reproduce innovation once developed in subsequent projects (Brady and Davies, 2004). Owing to efforts of innovation scholars to understand innovation in service firms, there has been a shift in the literature to understand one of the main forms of innovation in services – that is, organisational innovation (den Hertog, 2000). However, organisational innovations are difficult to measure and classify; the main indicator used to measure firm-level innovation in innovation studies, patents, is biased against service firms: although patent data provide the longest running historical record of technological activity, they fail to cover most aspects of the evolution of new services. Overall, these complexities in the innovation patterns of service firms suggest we need new models to understand how service firms are organised to exploit innovation and obtain economies.
Third, service firms are characterised by the inseparability of production and consumption, which creates a need for quality assurance, since customers find it difficult to separate the quality of the service from that of the service provider. This means that many service firms seek competitive advantage through investment in skill formation such as employee training (Schemenner, 1986; Enderwick, 1992). As shown for the Japanese manufacturing firms, skill formation may play a role in differentiation. Another implication is that service firms may pursue strategies of customisation and market segmentation favouring the provision of services on a small scale and local basis, to suit local market preferences.
Fourth, because of the importance of labour inputs into many services, there is the risk of too much variety in service quality. Attempts have been made to ensure uniform quality, especially through automation and industrialisation. Indeed, in some services sectors, firms have developed strategies and organisational techniques for large-scale operations, with considerable division of labour, simplification of tasks, and substitution of machines for labour such as in transport, communication, and broadcasting services (Miozzo and Grimshaw, 2006). Fast food chains (e.g. McDonald’s) likewise illustrate the potential in some service sectors for large-scale enterprise applying many of the standardisation and vertical integration techniques familiar from manufacturing companies. Some researchers speak of a trend towards the “industrialisation of services” (Levitt, 1976), with service firms emulating many industrial practices (mass production of standardised products, higher division of labour, increasing technological intensity, etc.). Similarly, other service segments exploit network coverage (especially through ICTs), as witnessed in retail banking. However, these techniques seem to be at odds with the exploitation of proprietary innovations and customisation required in many other segments of the service sector.
Fifth, extraordinary heterogeneity among service firms and industries makes generalisation difficult; no historian has been able to paint a coherent broad-brush characterisation of firm growth in the service sector such as Chandler provided for large manufacturing companies. As indicated, an umbrella concept like “scale and scope” applies less uniformly across service firms than across manufacturing companies (even taking into account the above noted differences among manufacturing firms, e.g. the large US multidivisional firm vs. the Japanese firm). Inter-sectoral heterogeneity necessitates recourse to typologies for service firms. Typologies of innovation patterns in service firms are of some use in describing how different service firms are organised for competitive advantage. Miozzo and Soete (2001) developed a taxonomy of innovating service firms, building on Pavitt’s (1984) sectoral taxonomy of innovation. They argue that there are three broad types: production-intensive network service firms; supplier-dominated firms; and science-based and specialised supplier firms (Miozzo and Soete, 2001).
This last category, science-based and specialised supplier firms, includes the particular segment of the services sector studied in this research: knowledge-intensive business services (KIBS). KIBS are concerned with providing knowledge-intensive inputs to business processes of organisations. This category covers business services founded upon technical knowledge and/or professional knowledge (Miles, 2008). This captures those business services based on social and institutional knowledge involved in many traditional professional services (such as management consultancy and legal services) as well as emerging technical knowledge that is vital in high-tech services (such as IT and R&D services). In professional KIBS, such as accountancy, legal services, and advertising, innovation is on-the-job. Some innovations are mediated by professional networks, with professional (and regional) associations diffusing information about best practice and new services while providing training and quality assurance (Miles, 2008). Other KIBS firms, however, depend on interactive patterns of innovation, being closely involved with their clients in the co-production of innovation (Bettencourt et al., 2002), combining such flows of information with more generic knowledge to generate novel perspectives. For these KIBS sectors, the challenge is to reproduce innovations developed on a one-off basis.
Given this heterogeneity among service firms, different types of service firms will have varying organisational forms and realise varying types of economies. A point of departure for classifying variations in service firm organisation is the framework of Gadrey (1996) and Gallouj (2002), who rework the typology of Salais and Storper (1992). They suggest that different “worlds of service production” can be defined by two axes: standardised vs. customised service products on the one hand and demand-driven vs. supply-driven mode of production on the other. This yields four basic quadrants of service firms and organisations: creative, professional and personalised, Fordist and flexible (Table 1).
Creative services organisations and firms (quadrant 1) depend less on the requirements of specific customers and more on the ability of the service provider to sense what kinds of innovative service offerings will likely find a market. Here, the service relationship is weaker and the autonomy of the producer higher. Technological intensity can be low (e.g. human and social research science in university think tanks) or high (e.g. natural science laboratories). In contrast, professional and personalised services organisations and firms (quadrant 2) are characterised by weakly standardised service characteristics and a strong service relationship, implying mobilisation of the customer’s competences together with those of the service provider’s (high level of co-production). Technological intensity can be low (as in small consultancies or specialised personal services such as for the elderly, for example) or high (as in large international audit and consultancy agencies, for example). In Fordist firms (quadrant 3), the service relation is relatively weak while technological and capital intensity is high. Service products are highly standardised and firm processes are highly formalised (e.g. fast food restaurants, mass insurance, mass tourism and automated banking).
Flexible firms (quadrant 4) – the quadrant of primary interest in this research – requires firms to square the circle. On the one hand, firms have to respond to demands by customers for specific service offerings; on the other hand, these same firms depend on somewhat standardised products and formalised processes to deliver them. According to Gadrey (1996) and Gallouj (2002), service firms manage this tension by producing service offerings made up of varying combinations of highly formalised modules of characteristics. Customisation requires active participation of the client in determining the right combination of modules to obtain a satisfactory solution. Similarly, Hargadon (2003) underlines the importance of combinatorial innovations, including the identification of new uses for old ideas. Technological and capital intensity in the world of flexible service production can be very high (as in certain areas of insurance supply, hotel trade or transport).