Economic Foundations of Strategy Chapter 5: Dynamic Resource Based Theory: Capabilities

1. Economic Foundations of StrategyChapter 5:Dynamic Resource Based Theory:Capabilities Joe Mahoney University of Illinois at Urbana-Champaign

2. Resource-Based Theory, Dynamic Capabilities and Real Options • Itami and Roehl (1987):Mobilizing Invisible Assets • Nelson and Winter (1982): An Evolutionary Theory of Economic Change

3. Itami and Roehl (1987):Mobilizing Invisible Assets • Itami and Roehl (1987) emphasize the vital role of accumulated experience and information to a corporation’s strategic resources. • The invisible assets of the firm are based on information. • Invisible assets are often a firm’s only real source of sustainable competitive advantage.

4. Itami and Roehl (1987):Mobilizing Invisible Assets • Invisible Assets: • Trade Secrets • Data Bases • Information • Personal and organizational networks • Know-how • Brand name • Reputation • Corporate Culture

5. Itami and Roehl (1987):Mobilizing Invisible Assets • Many invisible assets are quite fixed (at least in the short run). There is no easy way to obtain a well known brand name or advanced technological production skills in the market. Nor can money buy an instantaneous change in corporate culture or employee morale.

6. Itami and Roehl (1987):Mobilizing Invisible Assets • Accumulation of these resources requires on-going, conscious, and time-consuming efforts; you cannot just go out and buy them off the shelf. For this reason a firm can differentiate itself from its competitors through its invisible assets.

7. Itami and Roehl (1987):Mobilizing Invisible Assets • The important feature of invisible assets are: • Unattainable with money alone; • Time-consuming to develop; • Capable of multiple simultaneous uses; and • Able to yield multiple, simultaneous benefits.

8. Itami and Roehl (1987):Mobilizing Invisible Assets The information that you learn on your current project can become the basis for your next project and the potential for such spillover effects should be taken into account.

9. Itami and Roehl (1987):Mobilizing Invisible Assets • Information flow is at the heart of invisible assets. • Information can be classified as: • Environmental • Corporate • Internal

10. Itami and Roehl (1987):Mobilizing Invisible Assets • Environmental Information • Environmental information flows from the environment to the firm, creating invisible assets related to the environment. This type of information flow includes production capabilities, customer information, and channels for bringing in information.

11. Itami and Roehl (1987):Mobilizing Invisible Assets • Corporate Information • Corporate information flows from the firm to the environment, creating invisible assets stored in the environment. This category includes such invisible assets as corporate reputation, brand image, corporate image, and influence over the distribution channel and its parts suppliers, as well as marketing know-how.

12. Itami and Roehl (1987):Mobilizing Invisible Assets • Internal Information • Internal information originates and terminates within the firm, again affecting the invisible asset stock. This category includes corporate culture, morale of workers, and management capability, as well as the firm’s ability to manage information, the employees’ ability to transmit and use the information in decision making, and the employees habits and norms of effort expended.

13. Itami and Roehl (1987):Mobilizing Invisible Assets • Information has three characteristics that make synergy possible: • Information can be used simultaneously for multiple purposes; • Information does not wear out from overuse; • Bits of information can be combined to yield even more information.

14. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • Nelson and Winter (1982) develop an evolutionary theory of the capabilities and behavior of business firms. • The firms in their evolutionary theory will be treated as motivated by profit and engaged in search for ways to improve their profits, but their actions will not be assumed to be profit maximizing over well defined alternatives.

15. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • The theory emphasizes the tendency of more profitable firms to drive the less profitable firms out of business.

16. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • Maintain that much of firm behavior can be more readily understood as a reflection of general routines and strategic orientations coming from the firm’s past than as a result of a detailed survey of the remote twigs of a decision tree extending into the future. • Firms are modeled as having, at any given time, certain organizational capabilities and decision rules. Over time these organizational capabilities and rules are modified as a result of both deliberate problem-solving efforts and random events. • Translates into a description of a Markov process.

17. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • They describe their theory as unabashedly Lamarckian in emphasizing adaptation: the evolutionary economic theory of the firm contemplates both the “inheritance” of acquired characteristics and the timely appearance of variations under the stimulus of adversity. • Individual Skills • Organizational Capabilities and Routines

18. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • Routines • Well specified technical routines for producing things; • Procedures for hiring and firing, ordering new inventory, or stepping up production in items in high demand; • Policies regarding investment, research and development (R&D), or advertising; and • Business strategies about product diversification and overseas investment.

19. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • In their evolutionary theory, these routines play the role that genes play in biological evolutionary theory. • Most of what is regular and predictable about business behavior is plausibly subsumed under the heading of “routine.” • In evolutionary theory, decision rules are treated as simply reflecting at any moment in time the historically given routines governing the actions of the business firm.

20. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • In their evolutionary theory, routine-guided, routine-changing processes are modeled as “searches.” • The concept of search is the counterpart of that of mutation in biological evolutionary theory. • Through the joint action of search and selection, the firms evolve over time, with the condition of the industry in each period bearing the seeds of its condition in the following period.

21. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • Search for entrepreneurial (Schumpeterian) economic rents: • New products and new markets • New technologies and methods of transportation • New sources of supplies • New types of organizational arrangements

22. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • Search for entrepreneurial (Schumpeterian) economic rents: • Ideas that strike not at the margins of the profits and outputs of the existing firms but at their foundations and their very lives. The fundamental impulse that keeps the capitalist engine in motion is: The process of creative destruction.

23. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • Several Functions of Routines: • Routine as Organizational Memory • Routine as Intra-organizational Truce • Routine as Target: Control and Replication • Routines and Skills: Parallels

24. Nelson and Winter (1982): An Evolutionary Theory of Economic Change • Nelson and Winter (1982) conclude that the attempt to optimize and accordingly to control technological advance will, according to evolutionary theory, lead not to efficiency but inefficiency. • They emphasize the importance of experimentation in complex systems.