Theorizing the Future of Strategy…

Theorizing the Future of Strategy:

Questions for Shaping Strategy Research in the Knowledge Economy

N. Venkatraman

David J. McGrath Jr. Professor of Management

Boston University

School of Management

595 Commonwealth Avenue

Boston MA 02155

Ph: 617 353 7117

E-mail:

Mohan Subramaniam

Assistant Professor of Management

Boston College

Operations and Strategic Management Department

The Wallace E. Carroll School of Management

354 D, Fulton Hall

140 Commonwealth Avenue

Chestnut Hill, MA 02467-3808

Phone: 617 552 0435

Email:

Forthcoming in

The Handbook of Strategy and Management

Sage Publications, U.K.

INTRODUCTION

Much is being said today about how our economy is being transformed into a knowledge-based economy. There is a growing belief that intangible knowledge-based assets are replacing tangible physical assets as the primary impetus behind competitive advantage. Performance differentials seem to be explained more by intellectual, rather than physical resources. Scholars and practitioners alike now appear to think that the traditional rules of competition may be increasingly losing relevance in this new economy, and there is a pressing need for organizations to find and embrace “new” rules to survive and prosper.

What are these “new” rules? How do they challengeour traditional ideas of strategy that we hold dear in our research and teaching? Do they change our traditional wisdom about strategy? What directions should future research in strategy take? In this chapter, we provide a framework to discuss these issues. We believe that strategy as a field of inquiry is at crossroads today as it was in the late 1970s at the time of the Pittsburgh conference that led to Schendel and Hofer (1979). We need to look at the key issues facing corporations today and develop a proactive approach so that the theory of strategy continues to guide and shape leading-edge practice.

We present our ideas in this chapter in two sections. In the first section, we discuss how our current understanding of strategy has evolved over time. We capture this evolution in our thinking about strategy over three eras: first, wherein strategy was viewed as a portfolio of businesses, second, as a portfolio of capabilities, and third, as it is now surfacing in the current knowledge based economy, as a portfolio of relationships. Each of these eras represents how organizations have rallied around a particular concept of strategy with an associated set of norms for creating competitive advantage. Also, underlying each of these norms are distinct paradigms: economies of scale for the first era, economies of scope for the second era, and finally, economies of expertise for the third and current era (see Figure 1).

In discussing the evolution of strategy over these eras, we synthesize and put forward our cumulative state of the art understanding of strategy. We emphasize cumulative, as we believe that the emerging new concepts are not replacements, but supplements of old concepts. Economies of scale and scope, for example, are undoubtedly necessary for companies to compete even in the new knowledge-based economy. The difference however is in their significance. From being key drivers of distinctive competitive advantage in earlier eras, scale and scope have now become parity factors. That is, whilethe benefits of scale and scope are necessary for companies to continue competing, they are no longer sufficient to create distinctive advantage. New concepts, such as the economies of expertise that we are proposing in this chapter, are emerging as providers of vital supplements to the benefits of scale and scope, for companies to break parity and surge ahead of their rivals.

In presenting this cumulative understanding of strategy we also set the stage to question the validity of the emerging concepts in light of what we observe to be the needs and characteristics of the knowledge-based economy. And, in doing so, we attempt to forge new directions for future research on strategy. We proceed to do so in the second section by raising four questions that represent the key conundrums and challenges for theorizing the future of strategy in the knowledge economy. Our discussion around each of these questions provides avenues for future studies to unravel, further develop and validate the “new” rules to effectively compete in the knowledge economy.

SECTION ONE: EVOLUTION IN OUR CONCEPTUALIZATION OF STRATEGY

Figure 1 represents our view of how the concept of strategy has evolved over the years in terms of three eras. These are stylized so that we are able to highlight the key themes and perspectives on theorizing about strategy. They are also meant to provide a foundation for us to develop a set of questionsthat epitomize our new challenges.

Figure 1: The evolution of strategy from a theorizing perspective
Era 1
/ Era 2 / Era 3
Description / Portfolio of businesses / Portfolio of capabilities / Portfolio of relationships
Key drivers of competitive advantage / Economies of scale / Economies of scale and scope / Economies of scale, scope and expertise
Key resources / Physical assets / Organizing skills for managing relatedness across businesses / Position in the network of expertise
Unit of analysis / Business unit / Corporation / Network of internal and external relationships
Key concept / Leverage industry imperfections / Leverage intangible resources / Leverage intellectual capital
Key questions / What products?
What markets? / What capabilities? / What streams of expertise?
Dominant view / Positioning / Inimitability of processes and routines / Network centrality

Era 1: Strategy as a Portfolio of Businesses (circa 1970s).

We begin with the first era wherein the concept of strategy could be described as a portfolio of businesses (Aaker and Day, 1986; Harrigan, 1981; Hofer and Schendel, 1978; Woo and Cooper, 1981). Note the focus on “business”, as this was the domain in which strategy was largely conceptualized. Even for multi-business corporations, the strategic thinking was at the level of each of its individual businesses. Competitive strategy was at the business unit level (Galbraith and Schendel, 1983; Govindarajan, 1989; Huff, 1982; Karnani, 1982; Porter, 1980) and industrial organization economics played a significant role in shaping our thinking about strategy and competitive advantage (see Bain, 1956; Mason, 1939; Porter, 1981, for a historical perspective). Business performance was explained by factors of industry structure and the conduct of firms within the industry (Scherer and Ross, 1990, Gale, 1972).Corporate performance was believed to be an aggregate of performances across the individual business (Kurt and Montgomerry, 1981; Rumelt, 1974). This era can be classified through the lens of strategy as a portfolio of businesses.

In this view, early thoughts of competitive business strategy largely revolved around gaining advantage through economies of scale. Concepts of learning and experience curves (e.g., Hall and Howell, 1985; Henderson, 1979; Lieberman, 1987) dominated strategic thinking, as firms fought to dominate businesses through gaining market share (Buzzell, Gale and Sultan, 1975). And this experience curve logic bridged the link between an individual business unit and the corporation as a portfolio of businesses through the generation and utilization of cash as a key strategic resource. Balancing the generation and use of cash led to constructs like the BCG portfolio matrix and its variants. The BCG matrix highlighted the need for every business in a company’s portfolio to focus on relative market share in high growth industries—businesses that did not achieve dominance were expected to be divested. Academic research echoed these views with several studies based on the PIMS database reinforcing the strategic significance of markets share (e.g., Buzzell and Wiersema, 1981; Ramanujam and Venkatraman, 1984; Wensley, 1982).

Porter’s (1980) influential work further refined and legitimized this thinking by anchoring it within the concepts of industrial organization economics (Caves, 1980). Industry boundaries defined businesses for the purpose of strategic analysis. And, industries were evaluated based on their attractiveness -- a function of the imperfections in their structural characteristics (e.g. degree of concentration, barriers to entry/exit, rivalry). From a strategist’s perspective perfect markets were unattractive, as these markets did not provide above normal profits, or rents. Imperfect markets in contrast were the strategist’s ideal, as these markets enabled firms to earn monopoly rents. The concept of strategy thus evolved into finding ways by which firms could leverage imperfections in industry structures, so as to gain monopoly power. Exploiting learning curves and striving for market share represented some of the means by which firms could create imperfections in the structure of the industry and leverage monopoly power (Amit, 1986).

Companies competed with physical assets as their key resources, because they were primary means to create imperfections within the industry. For example, investments in physical assets and associated fixed costs raised barriers to entry, and investments in physical capacities were means to signal the potential for protracted price wars and hence deterred rivalry (Dixit, 1980; Salop, 1979; Wernerfelt and Karnani, 1987). Moreover by increasing the intensity of physical assets firms could further take advantage of their economies of scale. The specific means by which a firm leveraged market imperfections were captured in its positioning. A strong position implied that the firm was leveraging market imperfections very well; a weak position in contrast implied that the firm was not leveraging market imperfections very well. Business units were found to cluster around specific positions in an industry to form strategic groups (Cool and Dierickx, 1993; Hatten and Hatten, 1987; McGee and Thomas, 1986) – and these positions determined their competitiveness (Caves and Ghemawat, 1992; Porter, 1980). Positioning thus became the dominant view of strategy.

Although IO economics largely influenced this view, research in organization theory provided complementary ideas in the form of analyzing environmental characteristics and matching organizations structures with these characteristics. For example, environmental certainty (Thompson, 1967; Lawrence and Lorsch, 1967), or environmental munificence (Pfeffer and Salancik, 1978) were concepts similar to that of industry attractiveness as proposed by industrial organization economics. Our objective in this chapter is not to be exhaustive, but to develop the logic behind a dominant view of strategy that could be characterized by a portfolio of businesses. A list of representative studies of this era is presented in appendix 1 for reference.

Era 2: Strategy as a Portfolio of Capabilities (circa mid 1980s)

While industrial organization theory gave the field of strategy much-needed conceptual rigor, two shortcomings of theorizing strategy from this perspective soon became apparent. First, was the absence of a persuasive logic for managing multiple businesses. Viewing strategy for a multi-business corporation as a mere aggregation of strategies in individual businesses was clearly not adequate. Rumelt’s (1974) ambitious attempt to develop a scheme to understand the different logics of diversification was an important contribution that pioneered a different line of inquiry. Research in the area of corporate diversification provided compelling evidence that unrelated diversification – or managing unrelated businesses – was rarely successful (e.g. Bettis, 1981; Montgomerry, 1979; Palepu, 1985; Varadarajan and Ramanumam, 1987). These findings highlighted the fact that even if a firm crafted out strong positions in multiple businesses, it need not be successful at the aggregate level (Rumelt, 1982). Clearly, some synergies across businesses had to be leveraged for effectively managing a multi-business corporation (Prahalad and Bettis, 1986). The concept of strategy based on “positioning” did not adequately address cross-business synergies, and hence the value-added of a corporation.

Second, industrial organization theory was largely about industry structure. As a result, theorizing strategy from this viewpoint lead to a highly “industry focused” view of strategy. The emphasis on market imperfections made strategic analysis focus more on what objectives to achieve, as opposed to how to achieve those objectives. There was thus a pressing need for a framework that enabled a systematic analysis of internal workings of a company (to answer the “how to” question), and more importantly, for a theory to explain how organizations could effectively compete both within and across industries.

A stream of research described as the resource-based theory of the firm evolved to address these shortcomings. As opposed to focusing on market imperfections through product-market positions, this research stream focused on how organizations conducted its activities – or, on an organization’s processes and routines. The logic being that if organizational processes and routines were valuable and difficult for rivals to imitate, firms could create and sustain competitive advantage (Barney, 1991; Conner, 1991; Petaraf, 1993). Note that this framework does not limit its frame of reference to any particular industry, but does consider competitors in its analytical lens by underscoring the inimitability of processes and routines as a necessary condition for competitive advantage.

The significance of this framework was that it allowed a strategist to systematically analyze and understand the internal processes and routines bywhich an organization competed in the market place (Collis, 1994; Robins and Wiersema, 1995). For, embedded within these processes and routines were an organization’s distinctive capabilities that determined how effectively they could compete either within or across businesses and industries (Hitt and Ireland, 1985; Nelson, 1991). The theory of strategy thus evolved from a portfolio of businesses to a portfolio of capabilities.

Prahalad and Hamel’s (1990) influential work on core competencies underscored the key differences between these two perspectives of strategy (portfolio of businesses and portfolio of capabilities). They argued that firms that restricted their strategic analysis to single industries and limited their attention to how they were positioned in their focal industry alone, often failed to anticipate the potential for new competitors to transform the structure of their industry and to seriously undermine prevailing product-market positions. They made their case through examples of several such new competitors (e.g. Honda, Canon, Sharp and so on), who were different from conventional competitors in several ways.

One, they came in with strengths absorbed from different industries. For example, Canon entered the photocopier business to challenge Xerox by leveraging their strengths in optics and imaging garnered from their camera business. Two, prevailing product-market positions in the focal industry did not pose significant barriers to them as they could leverage their strengths gained from other industries to create new (and more effective) product-market positions. Again, Canon bypassed the entry barriers Xerox had erected for its large copiers sold to big corporations by choosing to compete with small copiers for copy-service franchisers (such as Copy Cop). Three, they could generate a stream of products that were difficult to foresee and plan counter-attacks for, as they were not necessarily based upon the conventional wisdom accumulated in the focal industry. Xerox for example could not anticipate Canon’s entry into their industry with small copiers, and for years could not retaliate with equivalent products because their business model was designed only to reinforce their existing product-market position (Henderson and Clark, 1990).

The core logic that competitors such as Canon competed with was rooted in developing a portfolio of capabilities. These capabilities were embedded in their internal processes and routines that cut across severalorganizational functions and levels. These processes and routines constituted activities that systematically absorbed learning from different businesses, shared and integrated this learning across the organization, and then leveraged this shared learning through a stream of new products (Galunic and Rodan, 1998; Teece and Pisano, 1997). For example, Honda’s focus was not so much in its product-market positioning in any single industry but on reinforcing its capabilities in “power-trains” and leveraging them to generate a stream of new products cutting across different businesses such as lawn-movers, motor-cycles, out-board boats and automobiles (Prahalad and Hamel, 1990). The competitive advantage for this company did not stem from any specific product-market position in any single industry, but from they way it organized its activities – or its processes and routines -- that enabled it toexecute cross-functional learning across multiple businesses and effectively harness it in its new products.

This new lens modified the focus of competitive strategy from that of creating industry imperfections through product-market positioning to understanding how to develop and leverage organizational capabilities. Consequently, the key drivers of competitive advantage shifted from economies of scale to economies of scope. Economies of scope were about leveraging organizational relatedness (Grant, 1988, Farjoun, 1998). That is, competitive advantage was no longer merely a function of how well an organization could leverage imperfections in any one specific industry, but a consequence of how learning across industries could be transferred, shared and effectively deployed in any of several businesses (Markides, 1994). Over and above physical assets in any one business, the organizing skills that enabled companies to achieve the transfer and deployment of learning across industries through their processes and routinesbecame vital for competitive advantage. In addition to creating impregnable product-market positions in any specific industry for deterring rivalry, the inimitability ofprocesses and routines – that enabled organizations to leverage learning across industries in ways their rivals could not – became critical to create and sustain competitive advantage (Galunic and Rodan, 1998). These processes and routines and related organizing skills constituted the intangible assets of organizations that critically supplemented the benefits of physical assets for competitive advantage (Hall, 1992; Itami, 1987).

Even though this line of thinking was conceptually elegant and supported by anecdotes and case studies, empirical tests of key propositions are limited. Some of the key problems include the measurement of processes and routines that typically span across different organizational levels, and the development of valid metrics for the causal ambiguity or inimitability of these routines. Some critics have also called this view tautological, because of arguments such as: a resource has to be valuable for competitive advantage. We however believe that this perspective is equally valid today and is attractive for researchers to develop further points of view and hypotheses that are tested with data from companies. Again we present a representative, but not exhaustive list of studies that represent this view in Appendix 2.