Diversification, industry dynamism, and economic performance the impact of dynamic related diversification on the multi busine

Due to its strategic importance, the debate on corporate diversification has gained prominence within academic research and in boardroom discussions alike.2 The era of modern diversified

and Economic Performance

Dynamic-related Diversifi cation

on the Multi-business Firm

Erlangen, Germany

Dissertation Universität Erlangen-Nürnberg, 2013

ISBN 978-3-658-02676-9 ISBN 978-3-658-02677-6 (eBook) DOI 10.1007/978-3-658-02677-6

Th e Deutsche Nationalbibliothek lists this publication in the Deutsche Nationalbibliografi e; detailed bibliographic data are available in the Internet at http://dnb.d-nb.de

Library of Congress Control Number: 2013942503

Springer Gabler

© Springer Fachmedien Wiesbaden 2014

Th is work is subject to copyright All rights are reserved by the Publisher, whether the whole

or part of the material is concerned, specifi cally the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfi lms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, compu-ter soft ware, or by similar or dissimilar methodology now known or hereaft er developed Exempted from this legal reservation are brief excerpts in connection with reviews or schol-arly analysis or material supplied specifi cally for the purpose of being entered and executed

on a computer system, for exclusive use by the purchaser of the work Duplication of this lication or parts thereof is permitted only under the provisions of the Copyright Law of the Publisher’s location, in its current version, and permission for use must always be obtained from Springer Permissions for use may be obtained through RightsLink at the Copyright Clearance Center Violations are liable to prosecution under the respective Copyright Law

pub-Th e use of general descriptive names, registered names, trademarks, service marks, etc in this publication does not imply, even in the absence of a specifi c statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use While the advice and information in this book are believed to be true and accurate at the date

of publication, neither the authors nor the editors nor the publisher can accept any legal sponsibility for any errors or omissions that may be made Th e publisher makes no warranty, express or implied, with respect to the material contained herein

re-Printed on acid-free paper

Springer Gabler is a brand of Springer DE

Springer DE is part of Springer Science+Business Media

www.springer-gabler.de

For Lena

in the widely-held belief that related diversification can improve firm performance, empirical results are mixed This is partly due to the limitation that most prior research narrowly focuses

on explaining the diversification-performance linkage through the traditional lens of synergies based on product/market-relatedness; alternative perspectives that could provide a more comprehensive understanding tend to be sidelined

In his doctoral thesis Matthias Knecht examines today’s turbulent economic environments and identifies industry dynamism as a major factor influencing the multi-business firm Based

on the resource-based school of thought and the dynamic capabilities view Knecht systematically analyzes the impact of dynamic environments on the organization and explains

in detail how combining businesses from similarly dynamic industries can result in superior economic performance Through his work on corporate diversification and dynamic environments he is able to integrate for the first time these two highly relevant streams of the strategic management literature

The first empirical part of this work develops a comprehensive, theoretically-grounded methodology to measure industry dynamism along multiple dimensions Using a global dataset of unprecedented breadth and depth, Knecht is able to comprehensively measure and interpret the dynamism of a wide range of industries The second empirical part of the project develops two unique methods to quantify dynamic-relatedness in order to address the effect of dynamic-related diversification on performance Based on his innovative conceptual work Knecht is able to provide empirical proof that dynamic-relatedness contributes significantly to firm performance

This dissertation is a cornerstone in advancing our knowledge about successful corporate diversification It makes important contributions to theory development by opening up a new perspective on relatedness and should be seen as a highly valuable contribution to ongoing research in the field of corporate diversification

Professor Dr Harald Hungenberg

The writing of this dissertation has been one of the most significant academic challenges I have ever had to face It is the product of a journey that demanded sacrifice, discipline, and compromise, yet it has also been one of the most rewarding experiences of my life Though this dissertation is an individual work, it never would have been possible without the support, guidance, and inspiration of so many people around me It is to them that I owe my deepest gratitude

I owe special thanks to Professor Harald Hungenberg who took on the role of doctoral advisor with passion and dedication despite his many other academic and professional commitments His deep knowledge in the field of strategic management is a constant source of inspiration, and his openness creates an inclusive work environment that has been a great pleasure to be part of I am also highly indebted to Professor Kathryn R Harrigan for her generous invitation

to continue my research at Columbia Business School in New York It was a exceptional privilege to benefit from her extensive experience and from her insightful challenges to my ideas I will always cherish the openness and academic caliber of the vibrant community at Columbia University, which supported and substantially improved the quality of my dissertation I moreover owe sincere gratitude to my supervisor Dr Martin Weiss for his invaluable input and strong commitment to my research He coached me from the start and provided suggestions that were instrumental to overcoming the challenges I encountered during the process Furthermore, it gives me great pleasure to acknowledge the support of my friend and fellow doctoral candidate Frank Freund I will never forget the countless nights we spent problem solving on flip charts or the hours on the phone bouncing ideas and challenging findings I am truly indebted and thankful to Frank on the professional level as a sparring partner and on the personal level as a motivator, supporter, and friend during the ups and downs of the dissertation I could not have wished for a better companion on this journey

I am also very grateful to my employer McKinsey & Company for the opportunity to pursue this research and for their material support of my dissertation Furthermore, I would like to express my deepest gratitude to the Foundation of German Business (Stiftung der Deutschen Wirtschaft, SDW) for awarding me a PhD scholarship and for granting financial support during my time at Columbia Business School

X

Finally, I would like to thank my parents and my brother for their unconditional support and

encouragement throughout the dissertation Moreover, I will be forever indebted to my wife

Lena for her constant support and encouragement throughout this academic endeavor I thank

her for unyielding devotion and love, selfless patience, and the freedom she gave me that

allowed me to focus None of this would have been possible without the love and patience of

my family

Dr Matthias Knecht

XI

F OREWORD VII

A CKNOWLEDGMENTS IX

C ONTENTS XI

L IST OF F IGURES XVII

L IST OF T ABLES XIX

L IST OF A BBREVIATIONS XXI

1 I NTRODUCTION 1

1.1 Problem Definition 1

1.2 Research Gap and Motivation 3

1.2.1 Diversification, Relatedness, and Performance 3

1.2.2 The Dynamism of Industries 5

1.3 Research Question 6

1.3.1 Industry Dynamism 7

1.3.2 Corporate Diversification 8

1.3.3 Method of Reasoning 10

1.4 Dissertation Outline 11

2 T HEORETICAL B ACKGROUND 14

2.1 Guiding Theories in Strategic Management 14

2.1.1 Market-based View 15

2.1.2 Resource-based View 19

2.1.3 Dynamic Capabilities View 24

2.2 Terminology 28

2.2.1 Resources 29

2.2.2 Capabilities and Competencies 30

2.2.3 Dynamic Capabilities 32

2.2.4 Rents 35

2.3 The Environment of the Firm 37

2.3.1 Definition of the Macro Environment 38

XII

2.3.3.1 Munificence 41

2.3.3.2 Complexity 42

2.3.3.3 Dynamism 44

3 C ORPORATE D IVERSIFICATION 47

3.1 Corporate Diversification: An Introduction 47

3.1.1 Definition of Diversification 47

3.1.1.1 Related and Unrelated Diversification 49

3.1.1.2 Horizontal, vertical, and conglomerate diversification 50

3.1.1.3 Domestic and international diversification 51

3.1.2 A Process Perspective on Diversification 52

3.1.3 A Status Perspective on Diversification 53

3.1.4 Perspective on Corporate Diversification in this Research 54

3.2 Motives for Diversification 55

3.2.1 Synergies 56

3.2.2 Agency Theory 59

3.2.3 Market Power 60

3.2.4 Risk Reduction 62

3.2.5 Transaction Costs 64

3.3 Limits and Costs of Diversification 66

3.3.1 Implementation Costs 66

3.3.2 Complexity and Coordination Costs 67

3.3.3 Limited Cognitive Capacity 68

3.4 Diversification and Economic Performance 70

3.4.1 Substitutability vs Complementarity 71

3.4.2 Relatedness and the Realization of Synergies 73

3.4.3 Operational Relatedness 74

3.4.4 Strategic Relatedness 75

3.4.5 Relatedness as a Multidimensional Construct 77

3.5 The Diversification-Performance Puzzle 78

3.5.1 State of Research on the Diversification-Performance Linkage 78

3.5.2 Methodological Considerations 85

3.6 Interim Conclusion 88

4 I NDUSTRY D YNAMISM 90

4.1 Industry Dynamism: An Introduction 90

4.1.1 The Concept of Dynamism 90

4.1.2 Understanding Dynamism: A Growing Confusion 92

XIII

4.1.3 Academic Contributions on Dynamism 93

4.2 Definition of Dynamism in the Context of this Research 99

4.2.1 Dynamism as a Multidimensional Construct 99

4.2.2 The Three Dimensions of Dynamism 100

4.2.2.1 Frequency 102

4.2.2.2 Intensity 103

4.2.2.3 Uncertainty 105

4.3 Impact of Dynamism on the Multi-business Firm 108

4.3.1 Dynamic Capabilities 110

4.3.1.1 Capabilities in Dynamic and Undynamic Environments 110

4.3.1.2 Performance Effect of Dynamic Capabilities 111

4.3.1.3 Synergies Through the Transfer of Dynamic Capabilities 113

4.3.2 Dominant Logic 115

4.3.2.1 Concept of the Dominant Logic 116

4.3.2.2 Impact of Dynamism on the Dominant Logic 117

4.3.2.3 Managerial Synergies through Dynamic-relatedness 118

4.3.3 Synthesis: Dynamism as a New Dimension of Strategic Relatedness 119

4.4 Hypotheses and Research Model 121

4.4.1 Standards for Hypothesis Development 121

4.4.2 Performance Effect of Dynamic-related Diversification 122

4.4.3 Performance Effect of Relatedness on the Dimensions of Dynamism 123

4.4.4 Effect of Product/Market-based Relatedness 125

4.4.5 Overview Research Model 127

5 E MPIRICAL A NALYSIS I: I NDUSTRY D YNAMISM 129

5.1 Measurement of Industry Dynamism 129

5.1.1 Literature Review on the Measurement of Dynamism 130

5.1.1.1 Methodology 130

5.1.1.2 Results 135

5.1.2 Development of Measures for the Dimensions of Dynamism 137

5.1.2.1 Requirements for the Measurement Approach 137

5.1.2.2 Measuring Frequency 140

5.1.2.3 Measuring Intensity 144

5.1.2.4 Measuring Uncertainty 149

5.1.3 Interim Conclusion 154

5.2 Methodological Considerations 155

5.2.1 Dataset 155

5.2.2 Measurement Specification 159

5.2.3 Combining the Dimensions of Dynamism 161

5.3 Empirical Analysis and Discussion of Results 166

5.3.1 Descriptive Results 166

XIV

5.3.4 Regional Differences in Dynamism: A Geographical Analysis 180

5.3.5 Dynamism Clusters and Relatedness: Similarities Across Industries 183

5.3.6 Limitations 185

5.3.7 Interim Conclusion 186

6 E MPIRICAL A NALYSIS II: D YNAMIC - RELATED D IVERSIFICATION 188

6.1 Measurement of Dynamic-relatedness 188

6.1.1 Approaches to the Measurement of Diversification and Relatedness 189

6.1.1.1 Continuous Measures 190

6.1.1.2 Categorical Measures 198

6.1.1.3 Alternative Measures 205

6.1.2 Development of the Dynamic-relatedness Measures 209

6.1.2.1 Distance-based Measure 210

6.1.2.2 Cluster-based Measure 215

6.2 Research Model 218

6.2.1 Research Design and Process 218

6.2.2 Operationalization of Variables 220

6.2.2.1 Independent Variables 220

6.2.2.2 Dependent Variables 222

6.2.2.3 Control Variables 225

6.2.2.4 Moderator Variables 230

6.2.3 Dataset and Sample Selection 231

6.3 Empirical Analysis 235

6.3.1 Descriptive Analysis 235

6.3.1.1 Methodological Remarks 235

6.3.1.2 Results of the Descriptive Analysis 236

6.3.2 Panel Analysis 241

6.3.2.1 Estimator Selection and Model Definition 243

6.3.2.2 Performance Effect of Dynamic-related Diversification 250

6.3.2.3 Performance Effect of Relatedness on the Dimensions of Dynamism 255

6.3.2.4 Moderating Effect of Product/Market-based Relatedness 260

6.3.2.5 Robustness of Results 264

6.3.2.6 Summary of Results 267

6.3.3 Interpretation of Results 268

6.3.3.1 Dynamic-relatedness and Performance 269

6.3.3.2 Relatedness on the Dimensions of Dynamism and Performance 273

6.3.3.3 Moderating Effects 275

XV

7 C ONCLUSION AND O UTLOOK 277

7.1 Conclusion 277

7.1.1 The Dynamism of Industries 277

7.1.2 Corporate Diversification and Dynamic-relatedness 278

7.2 Implications for Academics and Practitioners 280

7.2.1 Implications for Academic Research 280

7.2.2 Implications for Corporate Management 282

7.3 Limitations 283

7.4 Outlook and Agenda for Future Research 284

A PPENDIX 287

B IBLIOGRAPHY 305

XVII

Figure 1: Dissertation Outline 13

Figure 2: Structure-Conduct-Performance Paradigm 16

Figure 3: Resource-Conduct-Performance Paradigm 20

Figure 4: Macro Environment and Task Environment 40

Figure 5: The Dimensions of the Environment 44

Figure 6: Ansoff Matrix 49

Figure 7: Types of Diversification Strategies 52

Figure 8: Information Asymmetry and the Principal-Agent Relationship 60

Figure 9: Risk Reduction Through Portfolio Diversification 63

Figure 10: Themes and Linkages of Diversification Research Based on Ramanujam and Varadarajan (1989) 80

Figure 11: Relationship Between Diversification and Performance Based on Palich, Cardinal, and Miller (2000) 83

Figure 12: Industry Clockspeed in Selected Industries 98

Figure 13: The Three Dimensions of Dynamism 101

Figure 14: Frequency Dimension of Dynamism 103

Figure 15: Intensity Dimension of Dynamism 105

Figure 16: Uncertainty Dimension of Dynamism 107

Figure 17: Continuum of Frequency, Intensity, and Uncertainty 113

Figure 18: Standards for Hypothesis Development 122

Figure 19: Overview of Research Hypotheses 127

Figure 20: Research Model Overview 128

Figure 21: Literature Review Process 133

Figure 22: Academic Journals and Number of Contributions in the Final Literature List 135

Figure 23: Final List of Contributions Over Time 136

Figure 24: Reliability and Validity 138

Figure 25: Measurement of Frequency via Slope Reversals 143

Figure 26: Measurement of Intensity with the Adjusted Coefficient of Variation of First Differences 148

Figure 27: Calculation of Prediction Errors for the Measurement of Uncertainty 154

Figure 28: Overview of the Measurement of the Dimensions of Dynamism 155

XVIII

Figure 29: Quarterly Revenue Records by Industry Classification 158

Figure 30: Overview of the Global Industry Classification Standard (GICS) 160

Figure 31: Aggregation of Individual Measures to the Dynamism Value 162

Figure 32: Dynamism Ranking of Industries 170

Figure 33: Changes in Dynamism (2003–2010) 174

Figure 34: Changes in the Dimensions of Dynamism (2003–2010) 175

Figure 35: Changes in Dynamism Ranking 2003–2010, Top Five Industries 176

Figure 36: Changes in Dynamism Ranking 2003–2010, Bottom Five Industries 177

Figure 37: Changes in Dynamism in the U.S (2003–2010) 181

Figure 38: Changes in Dynamism in Europe (2003–2010) 182

Figure 39: Comparison of Relative Changes in Dynamism between the U.S and Europe 182

Figure 40: Dynamism Cluster 183

Figure 41: Industry Cluster Based on the Three Dimensions of Dynamism 184

Figure 42: Rumelt’s (1974) Categorization of Diversification Strategies 200

Figure 43: Rumelt’s (1974) Categorization of Diversification Strategies in Terms of the Specialization Ratio and the Related Ratio 201

Figure 44: Classification of Diversification Strategies Based on Varadarajan and

Ramanujam (1987) 202

Figure 45: Overview of Continuous, Categorical, and Alternative Measures of

Relatedness 208

Figure 46: Distance-based Measurement of Dynamic-relatedness 214

Figure 47: Overview of the Distance-based and Cluster-based Measures for

Dynamic-relatedness 217

Figure 48: Hypothesis-driven Research Process 219

Figure 49: Regional Representation in the Final Dataset 233

Figure 50: Geographic Overview of Companies in the Dataset 234

Figure 51: Distribution of Sample Firms’ ROS and ROA 237

Figure 52: Distribution and Growth of Sample Firms’ Total Assets 238

Figure 53: Average Asset Intensity and R&D Intensity by Industry 239

Figure 54: Assessment of the Robustness of Results 266

Figure 55: Overview of Research Hypotheses and Results 268

XIX

Table 1: Definitions of Dynamic Capabilities 34

Table 2: Overview of Meta-analytic Studies on the Diversification-Performance Linkage 86

Table 3: Overview of Selected Academic Contributions on Dynamism 95

Table 4: Definition of Frequency, Intensity, and Uncertainty 108

Table 5: Distribution and Correlation of the Dynamism Variable (DYN) over time 167

Table 6: Correlation of Dynamism, Frequency, Intensity, Uncertainty 169

Table 7: Migration Matrix of Absolute Dynamism Values over Time, Selected Industries 179 Table 8: Operationalization of the Independent Variables 222

Table 9: Operationalization of the Dependent Variables 224

Table 10: Operationalization of the Control Variables 229

Table 11: Operationalization of the Moderator Variables 231

Table 12: Central Tendency, Dispersion, and Correlation of Variables 242

Table 13: Performance Effect of Dynamic-related Diversification 249

Table 14: Test of the Model Assumptions 252

Table 15: Performance Effect of Relatedness on the Dimensions of Dynamism 257

Table 16: Moderating Effect of Product/Market-based Relatedness 262

XXI

BSD Broad spectrum diversity

Capex Capital expenditures

CAPM Capital asset pricing model

CEO Chief executive officer

CV Coefficient of variation

DC Dynamic capabilities

DCV Dynamic capabilities view

EBIT Earnings before interest and

taxes

EBITDA Earnings before interest,

taxes, depreciation, and

appreciation

FE Fixed effects

ff Following pages

GDP Gross domestic product

GICS Global Industry

RE Random effects ROA Return on assets ROS Return on sales

RR Related ratio SBU Strategic business unit SCP Structure-Conduct-Performance SEE Standard error of estimate SIC Standard Industrial

Classification

SR Specialization ratio TCE Transaction cost economics

VR Vertical ratio VRIN Value, rarity, inimitability, non-

substitutability VRIO Value, rarity, inimitability,

organization YoY Year-over-year

1 I NTRODUCTION

1.1 Problem Definition

Determining a firm’s scope and the businesses to include in its corporate portfolio is one of the most important decisions for top management and lies at the core of corporate strategy.1 In particular, the decision to diversify governs the breadth and scope of the firm, the markets it serves, and the customers it can reach Due to its strategic importance, the debate on corporate diversification has gained prominence within academic research and in boardroom discussions alike.2

The era of modern diversified multi-business firms can be broadly characterized as a period of increasing diversification and subsequent refocusing.3 Triggered by a strict antitrust policy in the United States and fueled by the growth of business school-trained executive talent, the rise

of diversified conglomerates began in the 1960s with numerous acquisitions undertaken by large American corporations.4 While the firms grew in size and global reach, new portfolio management techniques provided the necessary tools to manage these increasingly complex organizations.5 Although these organizations were admired at first for their supposedly superior management methods and advanced organizational design, performance problems caused share prices to decline significantly during the 1970s.6 Investors learned an important lesson: as the benefits of corporate diversification rose, so did its costs Admiration of the sophistication and power of conglomerates gave way to skepticism about their performance.7The conglomerates of that time where accused of a variety of problems, among them excessive organizational complexity, agency problems, overspending on corporate headquarters, and cross-subsidizing value-destroying investments.8 As a result the broadly diversified company became an attractive takeover target for financial investors who were interested in breaking up the company and selling its parts at a premium The wave of corporate takeovers reached its peak in 1989 with the spectacular buyout of RJR Nabisco by the private equity firm Kohlberg Kravis Roberts (KKR) for the stunning sum of USD 25 billion.9 The leveraged buyout mania of the 1980s threatened the power and autonomy of corporate top management and led to a rethinking of the strategies appropriate for diversified companies.10 This era of pervasive buy-outs prompted a shift towards refocusing and divesting unrelated and non-performing businesses in order to free up resources and focus on

1 See Grant (2005), pp 444ff.; Zhou (2011), p 625

2 See Bowen and Wiersema (2005), p 1153

3 See Markides (1992), p 398; Palich, Cardinal, and Miller (2000), p 158

4 See Ravenscraft and Scherer (1987), pp 20ff

5 See Hall (1978), pp 18ff.; Haspeslagh (1982), pp 60ff

6 See Goold and Luchs (1993), p 10

7 See Goold and Luchs (1993), p 8

8 See Adner and Zemsky (2006), p 2; Hitt et al (2006), p 848; Markides (1992), p 400; Zhou (2011), p 624

9 See Jensen (1989), p 69

10 See Goold and Luchs (1993), p 13

M Knecht, Diversification, Industry Dynamism, and Economic Performance,

DOI 10.1007/978-3-658-02677-6_1, © Springer Fachmedien Wiesbaden 2014

2 1.1 Problem Definition

the firm’s core competencies.11 The long standing motto “big is beautiful” lost its appeal In

their popular book In Search of Excellence Peters and Waterman (1982) sum up the going

wisdom of the 1980s by observing that widely diversified firms are less successful than their focused peers “Stick to the knitting” and a return to specialization were the newly accepted principles within many diversified U.S corporations.12 This strategy was largely successful; Markides (1995), for instance, has provided ex-post empirical evidence that the refocusing activities of the overly diversified firms of the 1980s resulted in performance improvements.13This push towards specialization has ebbed over the years Three decades after the shift towards corporate refocusing, diversified multi-business firms still dominate the list of the world’s largest corporations.14 With conglomerate firms responsible for more than 50% of total production in the U.S.,15 they represent an integral part of today’s economy Well-known western behemoths like General Electric, Siemens, Tyco, and Cisco span the world with innumerable business units serving distant markets and diverse customer needs In Asia, specifically in Korea, the powerful global, multi-business firm has a long tradition.16 The so-called Chaebols – mostly family-controlled, diversified conglomerates – are an engine of innovation and growth with Samsung, Hyundai, and LG being among the most prominent examples.17 An in-depth understanding of this dominant organizational form therefore has great practical relevance

Yet despite the importance of the diversified corporation as an organizational form, academic findings are far from clear-cut Diversification seems profitable for some firms but lethal for others As such, researchers still disagree and empirical findings are ambiguous with regards

to one of the most pressing questions in strategic management research:18 what makes a diversification strategy successful? This central question is at the heart of the research presented in “Diversification, Industry Dynamism, and Economic Performance.” Whereas traditional conceptualizations of the factors that determine diversification success have led to equivocal results, I introduce a new perspective on corporate diversification that extends the discussion and demonstrates substantial explanatory power in accounting for the performance effects of corporate diversification

11 For a definition and discussion of core competencies see section 2.2.2

12 See Lewis (1990), pp 43ff.; Lichtenberg (1990), p 16; Williams, Paez, and Sanders (1988), pp 403–406

13 See Markides (1995), pp 101ff

14 See Fortune (2012)

15 See Marinelli (2011), p 1

16 See Jwa (2003), pp 26–27

17 See Haggard, Lim, and Kim (2003), pp 41, 131

18 See Bausch and Pils (2009), p 158; Ramanujam and Varadarajan (1989), p 523

1.2 Research Gap and Motivation

Empirical evidence on the performance effects of corporate diversification presents a somewhat confusing picture Datta, Rajagopalan, and Rasheed (1991) summarize the contradictory results in their meta-analysis and note that despite years of research, “very little can be said with certainty on the diversification-performance relationship.”19 Markides and Williamson (1994) identify as the major reason for the conflicting empirical findings the fact that prior empirical research neglected important factors that determine diversification success.20 In this study I follow the call of Markides and Williamson (1994) and others to supplement the factors traditionally thought to determine diversification success with the identification of additional drivers of successful corporate diversification In this research I identify the dynamism of industries as a principal force in the firm’s environment and a major factor influencing diversification success Through the analysis of industry dynamism and its effect on the diversification-performance relationship, this study integrates for the first time two central but as yet unconnected streams in the strategic management literature and opens

up a new and promising perspective on corporate diversification I briefly review the two central constructs of this dissertation – corporate diversification and industry dynamism – in the following and demonstrate the connection between the dynamism of industries and the performance of a corporate diversification strategy

1.2.1 Diversification, Relatedness, and Performance

Starting with the work of Chandler (1962), the association between diversification and performance has been a central topic of strategic management research.21 As Chatterjee and Wernerfelt (1991) and others have argued, the link between diversification and performance is probably the most researched topic in the field of strategic management and an area of great importance.22 The hypotheses as to why diversification should improve economic performance range from economies of scale and scope23 to increased debt capacity,24 anti-competitive behavior through market power,25 and risk reduction.26 The most frequently claimed reason centers on the realization of synergies between the business units in a

19 See Datta, Rajagopalan, and Rasheed (1991), p 545

20 See Markides and Williamson (1994), p 149

21 See Bowen and Wiersema (2005), p 1153

22 See Szeless, Wiersema, and Müller-Stewens (2003), p 146; Wiersema and Bowen (2011), p 152; Wulf (2007), p 26

23 See Teece (1980), pp 224–226; Scherer (1980), pp 90ff

24 See Lewellen (1971), pp 522–524

25 See Edwards (1955), p 331; Markham (1974), pp 31–32; Shepherd (1970), p 3; Seth (1990), p 101 However, empirical evidence has been brought forward disputing the market power argument; see Caves (1981), pp 289ff.; Montgomery (1985), pp 789ff

26 See Lubatkin and Chatterjee (1994), p 109; for a review see Hoskisson and Hitt (1990), pp 476–477

4 1.2 Research Gap and Motivation

corporate portfolio.27 Since relatedness28 between the business units is a prerequisite to reap the benefits of synergies, numerous studies have been dedicated to uncovering the impact of related diversification on the performance of the multi-business firm.29

Despite intense research efforts and tremendous progress over the last decades, widespread dissent persists regarding how relatedness contributes to performance,30 and the linkage between diversification and firm performance remains blurry.31 This may be due, on the one hand, to methodological problems related to the two systems most widely used to measure relatedness The continuous measurement approach based on the Standard Industrial Classification (SIC) system32 suffers from poor content validity,33 while the influential categorical measurement scheme developed by Rumelt (1974) scores low on reliability.34 On the other hand and apart from methodological considerations, Markides and Williamson (1994) point out that researchers have not been able to grasp the full picture of relatedness due

to the negligence of important strategic factors

Only recently have researchers begun to broaden their toolboxes beyond the traditional measures and analyze alternative dimensions of relatedness.35 Importantly, these alternative measures of relatedness capture aspects to which traditional measures are blind While traditional measures often measure relatedness on the operational level, alternative measures concentrate on the strategic dimension of relatedness Because these alternative measures provide unique insights and produce promising results, more of these measures are needed to help us understand the underlying relationship between diversification and performance.36 In this research I argue that the dynamism of industries affects an organization on all levels and has been neglected as a factor of relatedness I briefly introduce the concept of dynamism in the following and discuss its influence on the diversification-performance relationship

27 See Amit and Livnat (1988b), p 100; Jovanovic (1993), pp 197–198; Szeless, Müller-Stewens, and Wiersema (2002), p 150

28 See Tanriverdi and Venkatraman (2005) for a list of possible types of relatedness

29 For a review see Datta, Rajagopalan, and Rasheed (1991), Palich, Cardinal, and Miller (2000), Ramanujam and Varadarajan (1989), Bausch and Pils (2009)

30 See Bausch and Pils (2009), p 158; Ramanujam and Varadarajan (1989), pp 523ff

34 See Ganz (1991), p.108; Pitts and Hopkins (1982), pp 623ff.; Sambharya (2000), pp 163ff

35 For instance, Farjoun (1994) analyzed relatedness based on the expertise and skills of employees in an industry; Robins and Wiersema (1995) studied technology flows among industries as an indirect indicator of potential strategic relationships between businesses; whereas Tanriverdi and Venkatraman (2005) used survey data to quantify relatedness in terms of a firm’s strategic knowledge resources See Farjoun (1994), pp 185ff.; Robins and Wiersema (1995), pp 282ff.; Tanriverdi and Venkatraman (2005), pp 100–115

36 See Markides and Williamson (1994), pp 149–150

1.2.2 The Dynamism of Industries

Since the early work of Emery and Trist (1965) on the evolution of environments towards an increasingly turbulent state, scholars have argued for accelerating dynamism in the firm’s environment However, research in the area did not increase until the 1980s when Dess and Beard (1984) introduced their influential methodology to quantify dynamism along other dimensions of the environment,37 and Bourgeois and Eisenhardt (1988) introduced the term

“high-velocity environment” to describe highly unstable and turbulent competitive settings.38This surge of academic interest39 in dynamic environments was spurred by the advent of new technologies during the 1980s and 1990s (e.g., the microcomputer and the internet) and the subsequent rise of new industries Research in this area argues that competitive environments

in many industries have become increasingly turbulent and unpredictable,40 while periods of competitive advantage have shortened.41 Thomas (1996) even found evidence for a general hypercompetitive shift in the United States towards an increasingly turbulent environment that has the ability to transform whole industries and render established capabilities and organizational structures obsolete.42

In search of means to deal with an increasingly dynamic environment, researchers began to develop strategies to maneuver its challenges.43 The capability to adapt to rapid changes and the organizational flexibility to exploit unprecedented opportunities now seems paramount for organizational survival and success.44 Recommendations range from building a more flexible organizational structure45 to cultivating the necessary dynamic capabilities;46 focusing on a set

of a few simple rules instead of a large body of regulations;47 and managing successive temporary competitive advantages instead of sustainable long-term advantages.48

Despite its position at the forefront of many research agendas, the concept of industry dynamism suffers from growing confusion It lacks not only a universal definition but also a common, pragmatic understanding Overlapping and even conflicting definitions have created

37 See section 2.3 for a definition of the organizational environment and the three dimensions identified by Dess and Beard (1984): munificence, complexity, and dynamism

38 See Bourgeois and Eisenhardt (1988), p 816, Dess and Beard (1984), pp 55–57

39 See, among others, the work of Castrogiovanni (1991); D’Aveni (1994); Davis, Eisenhardt, and Bingham

(2009); Eisenhardt, Furr, and Bingham (2010); Hannan and Freeman (1977); and McCarthy et al (2010)

40 See Bogner and Barr (2000), p 212

41 See D’Aveni, Dagnino, and Smith (2010), p 1373; Fine (1996), p 147; Lee et al (2010), p 1433;

Pacheco-de-Almeida (2010), p 1499

42 See Thomas (1996), p 221

43 See Eisenhardt and Sull (2001), pp 111–112

44 See Anand and Ward (2004), p 369; Zollo and Winter (2002), p 340

45 See Davis, Eisenhardt, and Bingham (2009), pp 437ff

46 See Eisenhardt and Martin (2000), p 1105; Teece and Pisano (1994); p 553; Zahra, Sapienza, and Davidsson (2006), p 922

47 See Eisenhardt and Sull (2001), pp 111–112

48 D’Aveni, Dagnino, and Smith (2010), p 1373; Fine (1996), p 147; Lee et al (2010), p 1433;

Pacheco-de-Almeida (2010), p 1499

a common understanding and application of the concept of dynamism

Moreover, this study goes beyond the holistic interpretation and operationalization of industry dynamism and investigates the influence of dynamism on the diversified firm As discussed in greater detail in section 4.3, dynamism greatly affects important strategic attributes of the corporation While highly dynamic environments require a flexible organizational structure, adaptive resource allocation mechanisms, and quick decision making processes, stable industries call for more stringent organizational structures and strong routines that foster efficiency.50 In between these extremes of highly dynamic and undynamic industries exist a myriad of forms of dynamism, all of which force a company to adapt and develop specific capabilities Dynamism therefore influences a company at all levels of the organization: the way it is managed, the capabilities needed to stay competitive, and the organizational structure required to adapt to its environment.51

Given the high levels of dynamism in certain industries and the stable conditions in others, the multi-business firm faces a unique challenge due to its simultaneous exposure to different dynamic environments In this study I argue that the potential for superior performance is greatest if the diversified firm positions its businesses in industries with similar dynamism, a

strategy that I call dynamic-related diversification Dynamic-relatedness can unlock a number

of synergistic benefits that are discussed in detail in section 4.3 Thus, I introduce dynamism

as a new dimension of relatedness and in the empirical part of this study assess the effect of dynamic-relatedness on performance

1.3 Research Question

Based on the problem definition and research motivation discussed above, the key objectives

of this dissertation are twofold: (1) to provide a holistic definition and measurement of

industry dynamism and (2) to investigate the influence of industry dynamism on the performance of the diversified firm

49 A detailed analysis of the dimensions of dynamism is undertaken in section 4.2.2

50 See Davis, Eisenhardt, and Bingham (2009), pp 437–438

51 See Ambrosini and Bowman (2009) pp 35–36; Garg, Walters, and Priem (2003), pp 272ff

1.3.1 Industry Dynamism

Industry dynamism is the central construct of this dissertation Since both a convincing definition and a holistic measurement methodology are absent from the literature, the concept

of dynamism has to be well defined and operationalized in all of its dimensions before it can

be applied in empirical research The following three research questions consequently target the first set of objectives of this dissertation and focus on clearly defining the concept of dynamism, developing a quantitative measurement methodology, and applying that methodology to a large-scale sample of data

1 Definition of industry dynamism: How can industry dynamism be defined, based on

prior academic contributions? What dimensions constitute the overarching construct of industry dynamism?

Although the academic debate lacks a common understanding of industry dynamism, isolated concepts and partial definitions are plenty.52 To provide a complete overview of the relevant academic work, this dissertation conducts an in-depth literature review based on guidelines proposed by David and Han (2004), Pilbeam, Alvarez, and Wilson (2012), and Tranfield, Denyer, and Smart (2003) that serves as the starting point for developing a new definition and measurement methodology for dynamism.53 The diversity of dynamism components discussed in the literature points to the fact that dynamism is a multidimensional construct.54Thus, special attention is paid to uncovering the distinct dimensions and defining dynamism accordingly

2 Development of a measurement methodology for industry dynamism

(operationalization): How can the different dimensions of dynamism be measured and

integrated into a holistic construct? Can objectivity and comparability of results be ensured?

In building the mechanics of the measurement construct, this research draws on existing theory whenever possible and strives to make use of tried and proven methods published in leading academic journals The methodology defined herein measures each dimension of dynamism separately and subsequently aggregates these dimensions to derive conclusions

52 See, among others, the work of Ashill and Jobber (2010), p 1281; Bergh and Lawless (1998), p 89; Bogner and Barr (2000), p 217; Cannella, Park, and Lee (2008), p 772; Davis, Eisenhardt, and Bingham (2009), pp 415–420; Downey, Hellriegel, and Slocum (1975), p 628; Eisenhardt, Furr, and Bingham (2010); Fine (1996),

p 1; Miller and Friesen (1983), p 222; Nadkarni and Narayanan (2007a), p 245; Sharfman and Dean (1991),

8 1.3 Research Question

about the dynamism of industries Since objectivity and reliability are important requirements

to generalize empirical findings, this research concentrates on objective, quantitative methods based on secondary data.55

3 Measurement and interpretation of dynamism for a range of industries: How dynamic

are individual industries? Are similarities apparent among industries in terms of dynamism? Has dynamism changed over the years and does it vary across countries and regions?

The development of the measurement methodology provides the tools to determine the dynamism of a wide range of industries For this purpose, a comprehensive dataset has been built comprising more than 1,330 individual firms from across the globe Industries are ranked

by their dynamism scores, and similarities between industries are determined by employing cluster analytic techniques The analysis of changes in industry dynamism over time and across regions reveals insights that might be counterintuitive to some commonly held perceptions The results generated during this stage are a prerequisite for the following empirical investigation of dynamic-relatedness and can be readily employed in the subsequent analyses

1.3.2 Corporate Diversification

The second key objective of this study aims at shedding light on the causal relationship that is

at the center of this dissertation: the influence of industry dynamism on the performance of the diversified firm According to theory, relatedness among the business units of a diversified firm is supposed to translate into superior performance when compared to unrelated diversification.56 This study offers a new perspective on corporate diversification by introducing dynamism as an important yet neglected dimension of relatedness To uncover the

effects of a dynamic-related diversification strategy57 on performance, three research questions are developed They concentrate on the development of measurement tools for dynamic-relatedness, the application of the measures to a broad range of sample firms, and the investigation of interaction effects with other dimensions of relatedness

4 Development of a measurement methodology for dynamic-relatedness

(operationalization): What are the key requirements for a measure of

55 The approach for the measurement of industry dynamism developed in this study has been presented at the 31 st

annual Strategic Management Society Conference in Miami in 2011 See Freund and Knecht (2011), pp 1ff

56 See Markides and Williamson (1994), p 151; Wulf (2007), pp 37ff

57 When following a dynamic-related diversification strategy, a multi-business firm diversifies into businesses

that operate in industries with similar dynamic characteristics See section 4.3.3 for a more detailed

description of dynamic-relatedness

relatedness? Can traditional approaches to determine relatedness be applied to measure dynamic-relatedness?

The wealth of studies on related diversification in the strategic management literature provides a rich pool of approaches to measure relatedness and serves as a starting point for the development of the dynamic-relatedness measure A detailed discussion of the traditional approaches uncovers their specific strengths and weaknesses as well as their applicability to industry dynamism Since the construct of dynamism differs from other variables used in previous studies, I have made adjustments to traditional approaches and employed measures specifically designed for this research

5 Dynamic-related diversification and firm performance: Does a dynamic-related

diversification strategy affect corporate performance? And if so, which dimension of dynamism has the most significant influence?

The second empirical part of the dissertation aims to provide answers regarding the effect of dynamic-related diversification on firm performance I use advanced statistical methods on the large-scale, global dataset that supports this research and employ various controls and moderators to rule out unintended effects As dynamism is a multidimensional construct, the performance effects of relatedness on each single dimension of dynamism can vary Therefore, in addition to analyzing the overarching construct of dynamism, each dimension has to be investigated separately to single out its effect on performance

6 Interdependency between dynamic-relatedness and other measures of relatedness: Do

other dimensions of relatedness influence the link between dynamic-relatedness and firm performance? If so, does this interaction effect reinforce or weaken the primary relationship?

Unlike dynamic-relatedness, a number of other dimensions of relatedness have been extensively covered in the literature.58 I argue that the effects of similarity between a firm’s businesses are amplified if relatedness extends beyond the dimension of dynamism to other dimensions of relatedness To account for this effect an additional measure of relatedness that

is widely used in the strategic management literature – the so called product/market-based relatedness – is computed and applied to the model The simultaneous analysis of both forms

of relatedness (dynamic-relatedness and product/market-based relatedness) can reveal important insights into the interdependencies of the different dimensions of relatedness

58 See Bettis (1981), pp 380ff.; Jacquemin and Berry (1979), pp 359–362; Palepu (1985), pp 243–245

10 1.3 Research Question

1.3.3 Method of Reasoning

A brief excursus on my method of reasoning should further clarify the research approach and the resulting structure of this dissertation As Bryman and Bell (2007) discuss at length in their book on business research methods, researchers generally subscribe to an epistemological and ontological orientation.59 Depending on their orientation, researchers can

apply deductive or inductive reasoning to arrive at a conclusion Deductive reasoning is

typically associated with a positivist position and is most commonly employed in quantitative research, where the researcher deduces hypotheses based on existing knowledge of a particular domain.60 This approach is sometimes informally referred to as a “top-down” approach since it starts with the general theory and works towards specific hypotheses and their subsequent testing.61 Inductive reasoning is predominantly emphasized in qualitative

research with an interpretivist position.62 This “bottom-up” approach63 generally works upwards, starting from the specific observation to finally arrive at the general theory It involves the identification of patterns in empirical data, which lead to the broader generalizations of conclusions and theory.64

Since the research questions in the six areas outlined above build on existing theories, formulate hypotheses, and test relationships on empirical data, they implicitly outline a deductive research approach.65 This method – sometimes called the “hypothetico-deductive” method66 – generally entails a series of steps.67 First, certain phenomena are observed and existing theory is studied The researcher’s resulting ideas and assumptions are translated into academically sound hypotheses, which the researcher subsequently tests on empirical data or

in a laboratory setting Due to the logical impossibility of verifying a general statement, a hypothesis can never be proven right Hence the researcher’s aim is the falsification of the hypothesis.68 If the evidence supports the hypothesis and falsification fails, a new theory is supported or an existing theory is confirmed, and a generalization of the conclusion is possible after repeated studies show support of the hypothesis According to the process of deductive reasoning, the first step in this dissertation is the in-depth study of the concept of industry dynamism and its influence on corporate diversification General observations are made regarding the simultaneous exposure of diversified firms to a range of industries with varying levels of dynamism Questions arise about the appropriate strategy for addressing these varying levels of dynamism from a corporate perspective, which leads to the

59 See Bryman and Bell (2007), pp 16ff

60 See Bryman and Bell (2007), p 21

66 See Sekaran and Bougie (2010), p 88

67 See McNeill and Chapman (2005), p 70

68 See Jacobs (1998), p 44

dissertation’s central hypotheses about the effects of dynamic-related diversification on firm performance This inherently deductive process is structured in seven chapters that are outlined in the next section

1.4 Dissertation Outline

Chapter 2 provides the theoretical background of this study; it discusses the guiding theories

in strategic management in order to build a foundation and point of reference for this research Accounts of the market-based and resource-based views of the firm are detailed, followed by

an introduction to the dynamic capabilities view Thereafter the important terminology used throughout this research is defined, in particular, the key terms resource, capability, competency, dynamic capability, and rent The chapter closes with a discussion of the environment of the firm, to which the following chapters refer extensively The macro and task environments of the firm are defined, and the three dimensions of the environment are discussed in detail

Chapter 3 lays the groundwork for a comprehensive understanding of one of the core topics

of this dissertation: corporate diversification Followed by a thorough definition of corporate diversification from a process and status perspective, the motives of diversification are discussed with special attention to the synergy motive After outlining the limits of corporate diversification, the chapter shifts focus to the lively debate on how corporate diversification impacts firm performance and then gives an overview of conflicting academic studies on the topic

Chapter 4 introduces industry dynamism as the most important dimension of the firm’s task

environment An in-depth literature review of previous academic work at the beginning of the chapter provides the basis for a new holistic definition of industry dynamism Subsequently, the impact of industry dynamism on the firm’s dominant logic and the transferability of its (dynamic) capabilities is discussed The chapter concludes by translating its key findings into

a set of hypotheses that are empirically tested in chapter 6

Chapter 5 is the first of two empirical chapters and focuses on the analysis of industry

dynamism First, the measurement of industry dynamism is developed based on the definition developed in chapter 4 Each dimension of dynamism is measured separately and is subsequently integrated into an overarching construct The measurement is based on a comprehensive literature review and incorporates established concepts whenever possible The dynamism for a broad range of industries is determined based on the large-scale, global dataset underpinning this research Industries are subsequently ranked and clustered regarding

12 1.4 Dissertation Outline

their dynamism profiles The changes in industry dynamism over time are discussed and differences between countries and regions are analyzed

Chapter 6, the second empirical chapter, builds on the empirical findings of chapter 5 and

tests the core hypotheses of this research regarding the impact of dynamic-related diversification on firm performance The chapter proceeds in three stages First, historical approaches to measure relatedness are evaluated and their applicability for the research question is discussed Based on these findings, two distinct measures for dynamic-relatedness are developed: a distance-based and a cluster-based measure Because both measures have specific strengths, the empirical analysis will use both in order to achieve highly robust results Second, the research model is presented, including all variables (dependent, independent, control, and moderator variables) necessary for the empirical analysis Third, the hypotheses developed in chapter 4 are tested using multiple linear panel regressions The impact of each dimension of dynamism on corporate performance is thereby evaluated Lastly, the moderating effect of product/market-based relatedness on the linkage between dynamic-relatedness and firm performance is investigated

Chapter 7 concludes the dissertation by summarizing its main contributions and suggesting

directions for future research Ideas to further develop and apply the methods and constructs proposed in this study are outlined Furthermore, the implications of the results for academics and practitioners are discussed, and its limitations are outlined

Figure 1: Dissertation Outline

Introduction and Background

Chapter 1 – Introduction

Chapter 2 – Theoretical Background

Conclusion and Outlook

Chapter 7 – Conclusion and Outlook

Key Phenomena

Chapter 3 – Corporate Diversification

Chapter 4 – Industry Dynamism

Introduction and Background

Chapter 1 – Introduction

Chapter 2 – Theoretical Background

Introduction and Background

Chapter 1 – Introduction

Chapter 2 – Theoretical Background

Conclusion and Outlook

Chapter 7 – Conclusion and Outlook

Chapter 6 Empirical Analysis IIDynamic-related Diversification

Key Phenomena

Chapter 3 – Corporate Diversification

Chapter 4 – Industry Dynamism

Key Phenomena

Chapter 3 – Corporate Diversification

Chapter 4 – Industry Dynamism

14 2.1 Guiding Theories in Strategic Management

This chapter provides the dissertation’s theoretical background and gives an overview of important theories in the field of strategic management, namely, the market-based view (MBV), the resource-based view (RBV), and the dynamic capabilities view (DCV) Since a researcher’s point of view is bound to influence the subject of interest and the interpretation of empirical findings, this chapter contrasts these different perspectives and makes explicit the view I have espoused in this project I subsequently define the terminology used in the course

of this dissertation and give an overview of the environment of the firm This chapter thereby serves as a general framework for the discussions and analyses to follow

2.1 Guiding Theories in Strategic Management

A glance at the many textbooks, papers, and articles on strategic management reveals a broad range of competing approaches and views.69 Directly or indirectly, these views are concerned with the question of why certain firms are more successful than others, which ultimately leads

to the fundamental question of how a firm can improve its performance and achieve a sustainable competitive advantage over its competitors.70 Hoskisson et al (1999) compare the

evolution of the theory of strategic management to a swinging pendulum; its emphasis oscillates between a firm’s external opportunities and threats and its internal, firm-specific strengths and weaknesses.71 Two prominent views of the firm represent these two opposed conceptions: the market-based view and the resource-based view

The market-based view (MBV) explains a firm’s performance through the external industry

structure and the strategic conduct of competitors within the industry.72 According to this

“outside-in” perspective,73 the performance of a firm and its competitive advantage can be largely attributed to the structure of its industry, for instance, to entry barriers that keep additional competitors at bay and protect profit margins.74

In contrast, the resource-based view (RBV) focuses on internal, firm-specific resources and

capabilities to explain performance.75 This “inside-out” perspective76 explains a firm’s

69 See Bea and Göbel (2006), pp 40ff for a review; see also Knyphausen-Aufsess (1995)

70 See Bamberger and Wrona (1996), p 130; Bea and Haas (2005), p 26

71 See Hoskisson et al (1999), pp 418ff

72 See Bea and Haas (2005), p 26; McGahan and Porter (1997), p 15; Hungenberg (2011), pp 61–62; Wolf (2005), p 415

73 See Bea and Haas (2005), p 26

74 See Makhija (2003), p 432

75 See Freiling (2001), p 7; Grant (2005), pp 132ff.; Harrison and St John (1994), p 16

76 See Henry (2008), p 126

M Knecht, Diversification, Industry Dynamism, and Economic Performance,

DOI 10.1007/978-3-658-02677-6_2, © Springer Fachmedien Wiesbaden 2014

competitive advantage through its distinctive combination of rare resources, which are inimitable to competitors and valuable for the specific purpose of the firm.77

The MBV and RBV explain firm performance from very different perspectives, and they emphasize different sources of competitive advantage.78 However, despite their opposing positions, scholars have argued that the MBV and RBV are not as contrary as they seem In his groundbreaking paper “A Resource-based View of the Firm”, often cited as defining modern thinking on the RBV, Wernerfelt (1984) notes that the two perspectives are just “two sides of the same coin” and not mutually exclusive.79 In their explanation of competitive advantage, Bamberger and Wrona (1996) likewise note that the two views complement each other.80

Because both views of the firm are important for understanding corporate diversification and both have ramifications for the management of multi-business firms, they are discussed in greater detail in the following Furthermore, this chapter discusses a recent advancement of

the RBV, the dynamic capabilities view (DCV) Despite legitimate argument that the DCV

cannot yet claim to be a comprehensive theory on par with the established RBV and MBV, it nonetheless addresses major shortcomings of the traditional views, and its arguments are of high relevance for this research

2.1.1 Market-based View

The MBV of the firm has its roots in the field of industrial organization (IO) economics.81Greatly influenced by the early work of Harvard economist Mason (1939) and his doctoral student Bain (1956), IO economics analyzes the structure of industries, the effects of concentration on competition, and the boundaries between firms and markets, among other factors.82 In order to mimic real-world situations, IO economics addresses the shortcomings of standard textbook models of perfect competition through the introduction of frictions, such as entry barriers, transaction costs, and information asymmetry.83

77 See Barney (1986), pp 1232ff.; Peteraf (1993), pp 179ff

78 See Roquebert, Phillips, and Westfall (1996), p 655

79 See Wernerfelt (1984), p 171

80 See Bamberger and Wrona (1996), p 147

81 The terms “industrial economics” and “industrial organization economics” are inconsistently used in the literature This dissertation follows the arguments of Schmalensee (1988) and Stigler (1968) in that the questions and topics addressed by this field of research are inherently the content of economic theory Thus,

the term “industrial organization economics” is appropriate as used by Hoskisson et al (1999) See

Schmalensee (1988), p 643; Hoskisson et al (1999), pp 418ff

82 See Bain (1956); Hoskisson et al (1999), p 419; Mason (1939); Stigler (1968), p 1

83 See Barney and Clark (2007), p 77

16 2.1 Guiding Theories in Strategic Management

According to IO economics and the Harvard school of thought, the Structure–Conduct–Performance (SCP) paradigm became popular from the 1940s to the 1960s as a way to analyze the relation between the structure of an industry, the industry conduct, and the resulting industry performance.84 The SCP paradigm was originally employed by the U.S government to support the design of antitrust policy,85 and it quickly became a standard tool for the analysis of industries The paradigm relates performance to industry structure using a

two-step approach According to the SCP paradigm, the industry structure (e.g., the number

of buyers and sellers in the industry, entry/exit barriers, and competitor’s cost structures) determines the behavior and strategies of competing firms in that industry This industry

conduct (e.g., pricing and product strategies, investments in research and advertising, and

distribution strategies) in turn affects the performance of firms in the industry.86 Following this reasoning, the SCP paradigm explains performance differences between firms largely through the structure of their industries, a factor external to the firm itself It thereby emphasizes variations in industries’ profitability and can assist in estimating the performance level that can be reasonably expected from a company within a certain industry.87 However, the behavior of an individual firm and its specific assets and resources remain largely neglected.88

Figure 2: Structure-Conduct-Performance Paradigm89

84 See Barney and Clark (2007), pp 13–14; Sawyer (1991), p 110

85 See McKinsey & Company (2008), p 1

Probably the most influential contribution for the strategic management discipline based on

IO economics was made by Harvard Professor Michael Porter during the early 1980s In his

hallmark paper “How Competitive Forces Shape Strategy” and his books Competitive

Strategy and Competitive Advantage, Porter addressed an important shortcoming of the SCP

paradigm.90 Due to the SCP paradigm’s focus on the industry as a whole, firm-specific strategies and recommendations are difficult to derive from the framework.91 Based on the

concepts of IO economics, Porter developed the market-based view (MBV) One of the key

propositions of Porter’s work is that a firm’s performance depends on the attractiveness of its industry and the firm’s relative positioning against competitors.92

Against the Harvard Business School’s tradition of using the case study method to describe business world phenomena, and against traditional economists’ habit of employing statistical modeling, Porter opted to use intuitive frameworks to capture his ideas As Henry (2008) describes, frameworks are able to readily capture the complexity of real-world problems while simultaneously reducing the dimensionality of the problem Unlike the implications of most case studies, those derived from frameworks can be generalized across a broad range of industries, without the caveat of oversimplifying reality as most econometric models do.93

Michael Porter’s 5 Forces framework is arguably one of the most pervasive frameworks that

has been taught in business school to date and that is currently used by management scholars The framework offers a systematic approach to assess competition within an industry and can

be used by companies to choose attractive industries to enter.94 According to Porter, an industry’s attractiveness is determined by five competitive forces that shape the opportunity for superior performance in an industry These forces are:

(1) Threat of entry by potential competitors

(2) Threat of substitute products

(3) Bargaining power of suppliers

(4) Bargaining power of buyers

(5) Intensity of rivalry among established firms95

The stronger these forces are collectively, the more intense the competition and the lower the attractiveness of the industry.96 As advocates of the MBV argue, competitive advantage arises

as a result of superior positioning against other players in an industry By differentiating their

90 See Porter (1979), Porter (1980), Porter (1985)

91 See Mintzberg (1990), p 125

92 See Bea and Haas (2005), p 27; Porter (1980)

93 See Henry (2008), pp 68–69

94 See Henry (2008), p 69; Weigl (2008), p 90

95 See Hill and Jones (2010), p 43; Porter (1979), p 6

96 See Bea and Haas (2005), p 27

18 2.1 Guiding Theories in Strategic Management

products and services from the ones of competing firms, companies attain a privileged product market position and inhibit the market’s inherent tendency to move toward perfect competition.97 Through the achievement of superior positioning, a firm can command monopoly rents by intentionally limiting production below competitive levels.98 Instead of being a price taker in a perfectly competitive arena, superior positioning allows the firm to retain some control over price99 and increase profits by curbing competition.100 The resulting above-normal future returns are supposed to result in higher current firm value.101

end-Porter proposed three generic strategies a firm can pursue to achieve a superior position in an

industry, namely: (i) cost leadership, i.e., producing at a lower cost than competing firms; (ii) differentiation, i.e., differentiating products through attributes that appeal to customers, like higher product quality, branding, and innovative product features; (iii) focus, i.e., concentrating on a narrowly defined segment of the market.102 According to Porter, a common strategic flaw is management’s unwillingness to choose between these generic strategies An attempt to achieve competitive advantage through the simultaneous pursuit of different strategies usually leads to inconsistent and sometimes conflicting actions, leaving the firm

“stuck in the middle” with lower than average profits.103

In contrast to traditional IO economics, Porter’s pioneering work emphasizes managers’ individual decision making in choosing attractive industries and strategically positioning their firms within the industry.104 Yet, despite the popularity of the MBV and its prominence as one

of the guiding theories in strategic management, it has its critics The following summarizes some of the most important criticisms of the MBV

First, Porter calls to work towards imperfect market conditions through differentiation and the erection of entry barriers Establishing such protective barriers, however, may benefit competitors already active in the market The costs incurred in the erection of entry barriers might furthermore outweigh the incremental benefit gained by resulting monopoly rents.105Second, against Porter’s advice to choose any one of the generic strategies, not all strategic options are fully available to each firm Small firms, for example, likely need to pursue a focus strategy to be able to compete with their larger, more scale-efficient competitors.106

97 See Schwenker and Spremann (2009), p 43

Third, one of the most important and widely cited criticisms of the MBV is its assumption of resource homogeneity and the mobility of resources within an industry Despite early management scholars’ insight that competing firms within an industry are by no means all the same,107 the MBV considers firms to be homogeneous entities.108 If temporary heterogeneity

in resource allocation occurs between firms, the MBV assumes it will be instantly corrected through market mechanisms and the unlimited mobility of resources.109 This assumption stands in stark contrast to reality Through its focus on the structure of an industry as a

condition external to the firm, the MBV thereby neglects a firm’s internal characteristics,

structures, and resources.110

These criticisms are supported by empirical studies While evidence exists that industry structure influences performance, Rumelt (1991), Schmalensee (1985), Roquebert, Phillips, and Westfall (1996), McGahan and Porter (1997), and others find that when it comes to explaining performance differences between firms, industry effects play only a minor role compared to firm-specific effects.111 The industry structure’s lack of explanatory power suggests that the externally oriented MBV is not capable of fully explaining the performance differentials between firms These limitations led to the development of an alternative view with a stronger focus on internal, firm-specific aspects: the resource-based view.112

107 See for example the work of Barnard (1938) and Chandler (1962)

108 This holds for all strategically important characteristics except for scale, thus, focusing on the industry instead

of the individual firm as the level of analysis is justified See Roquebert, Phillips, and Westfall (1996), p 654; Rumelt (1991), p 66

109 See Barney (1991), p 100; Zahn, Foschiani, and Tilebein (2000), p 49

110 See Wolf (2005), pp 415ff

111 See Hawawini, Subramanian, and Verdin (2003), pp 1ff.; Mauri and Michaels (1998), pp 211ff.; McGahan and Porter (1997), pp 15ff.; Roquebert, Phillips, and Westfall (1996), p 659; Rumelt (1991), p 179; Schmalensee (1985), pp 341ff

112 See Wolf (2005), p 416

113 See Hoskisson et al (1999), p 418

114 See, among others, Barney (1991), Conner (1991), and Wernerfelt (1984)

115 See, among others, Kogut and Zander (1992) and Spender and Grant (1996)

116 See, among others, Cannella and Hambrick (1993), Finkelstein and Hambrick (1996), and Kesner and Sebora (1994)

117 See Henry (2008), p 126; Sehgal (2011), p 43

20 2.1 Guiding Theories in Strategic Management

culture, no two companies are alike.118 The optimal combination of these resources and their efficient allocation towards specific problems and opportunities sets a firm apart from the competition.119 The goal of a resource-based approach is therefore to implement a strategy that is based on the firm’s heterogeneous resources and that is not being implemented by competitors This strategy would provide a sustained advantage due to its inimitability.120 In contrast to the SCP paradigm of IO economics, the RBV employs the Resource–Conduct–Performance (RCP) paradigm to explain performance as shown in Figure 3

Figure 3: Resource-Conduct-Performance Paradigm121

This focus on a company’s internal resources can be traced back to the early classics like

Barnard’s (1938) work, The Functions of the Executive, and Selznick’s (1957) development

of the sociological leadership model in his work on Leadership in Administration.122 Selznick was one of the few scholars of his time to emphasize firm-specific resources and capabilities

as central to the development of what he called “distinctive competencies.”123 However, the original conceptualization of the firm as a bundle of resources is expressed in Penrose’s

(1959) groundbreaking work, The Theory of the Growth of the Firm Penrose’s idea that a

firm’s unique character stems from its heterogeneous resources124 forms the basis of the RBV and has been applied and modified by numerous authors thereafter.125 Two of its underlying

118 See Collis and Montgomery (1995), p 119

119 See Stalk, Evans, and Shulman (1992), pp 62ff

120 See Barney (1991), pp 99ff

121 Based on Bea and Haas (2005), p 28; Corsten (1998), p 17; Rasche (1994), p 4

122 See Barnard (1938), Selznick (1957) Elements of resource-based theory can also be found in the work of Coase (1937); Stigler (1961); Chandler (1962); and Williamson (1975)

123 See Selznick (1957), pp 139ff

124 See Penrose (1959), p 24

125 For a review of the historical development of strategic management theory, including but not limited to the

resource-based view, refer to, among others, Hoskisson et al (1999), pp 419ff.; Pettigrew, Thomas, and

assumptions in particular distinguish the RBV from the MBV: (i) the resource endowments of firms are considered heterogeneous, and (ii) not all resources are perfectly transferrable, thus, heterogeneity of resource allocations between firms can persist.126 The RBV thereby implies the existence of imperfect factor markets.127 Despite its common unifying idea, the RBV is not a single cohesive theory but, as Collis and Montgomery (1995) put it, an “umbrella term” used to point to different approaches within the field of resource-oriented theory.128

Despite the fact that signs of the RBV can be found in early management literature, the RBV did not receive much attention before the work of Wernerfelt and Rumelt became available in

1984 In his seminal paper “A Resource-based View of the Firm”, Wernerfelt gave the RBV its name and set the ground for the current understanding of resource-oriented theory.129 He analyzes firms based on their resource profiles and broadly defines resources as “those (tangible and intangible) assets which are tied semi-permanently to the firm.”130 In an analogy

to the creation of entry barriers in the MBV, Wernerfelt postulates the erection of “resource position barriers” through the acquisition and defense of valuable resources in order to generate high returns.131

Building on the work of Wernerfelt, scholars began to examine more closely how variations

in firms’ resource endowments lead to differences in performance Rumelt (1984) links the sustainability of a competitive advantage to so-called “isolating mechanisms,” which serve as barriers to imitation These barriers work in favor of the firm in possession of a valuable resource and explain why competitors are often unable to copy a firm’s strategic asset and wipe out its competitive advantage.132 The barriers to imitation are often based on causal ambiguity: the fact that the source of a firm’s competitive advantage is hidden from outside observers.133 Especially knowledge-based and socially complex resources are protected by causal ambiguity.134

As Barney (1991) points out, not all resources have the potential to establish a unique, profitable resource position for the firm In his widely cited VRIO framework, Barney (1991,

22 2.1 Guiding Theories in Strategic Management

1995, 1997) identifies four resource characteristics necessary for a resource to be a potential source of sustainable competitive advantage: value, rarity, inimitability, and organization.135

™ Value The resource must be valuable in such a way that it enables the firm to exploit

opportunities and/or neutralize threats.136 Thereby the costs involved in obtaining or creating the resource must not exceed the discounted future rents that are expected to be generated through its use.137

™ Rarity To be a source of competitive advantage, the resource may not be controlled by

numerous firms.138 Rarity precludes a large number of competitors using the same valuable resource, which thereby prevents strategic parity In particular, firm-specific, internally developed resources that cannot be bought on factor markets fulfill the criterion

of rarity.139

™ Inimitability A valuable and rare resource may provide the firm with a temporary

competitive advantage To remain a long-term and sustainable advantage, however, the resource must resist imitation by duplication or substitution of a similar resource.140Inimitability of a resource depends on multiple factors, including historical context, the learning process by which the resource was created, the social complexity of the resource, and its causal ambiguity.141

™ Organization A valuable, rare, and inimitable resource has great potential to generate

sustainable competitive advantage The realization of this inherent potential depends upon the firm’s ability to fully leverage the resource.142 Only if the organization adequately supports the exploitation of the resource through its reporting structures, management control systems, and compensation policies will the firm enjoy sustainable competitive advantage.143

Building on the work of Barney (1991) and other authors, Peteraf (1993) developed a model linking resources and firm performance in her work on “The Cornerstones of Competitive Advantage.”144 She identifies four conditions underlying sustained competitive advantage:

135 Barney introduced the VRIN framework in 1991 and later changed it to VRIO to reflect the need for an organization to be capable of exploring and capitalizing on a firm’s resources See Barney (1991), pp 99–

120, Barney (1995), pp 50–57, Barney (1997), pp 162ff

136 See Barney (1995), p 50

137 See Mahoney and Pandian (1992), p 370

138 See Barney (1995), p 52 The importance of rarity does not imply that common but valuable resources are unimportant In fact, such resources may be essential for the survival of the firm

139 See Barney (1991), p 107

140 See Barney (1995), p 53

141 See Barney (1999), pp 141–143, Dierickx and Cool (1989), pp 1507ff The argument of inimitability is closely related to Rumelt’s thoughts on “isolating mechanisms” and refers to similar causes that prevent imitation See Rumelt (1984), p 141

142 See Barney (1995), p 56

143 See Barney and Hesterly (2010), pp 68ff

144 See Peteraf (1993), pp 179ff

heterogeneity (firms possess resources with different levels of efficiency), ex post limits to competition (imperfect imitability and substitutability of resources), ex ante limits to competition (a favorable resource position is attained before competition started), and imperfect resource mobility (resources are non-tradable or less valuable to other users).145Especially her thoughts on the mobility of resources underline the importance of transferability and the need to take a resource’s relative value to a specific firm into account

Resources are perfectly immobile if they cannot be traded or are idiosyncratic and have no

value outside the firm due to their specificity.146 Imperfectly mobile resources are tradable

between firms; however, they will be most valuable within the firm in possession of the resource This may be due to the resources’ specification to firm-specific needs or to exceedingly high transaction costs related to transferring the resource.147 This applies also to co-specialized assets, which have to be used in combination with other assets to fulfill their economic purpose.148 Due to the decreased value of immobile (or imperfectly mobile) resources to firms other than the firm in possession, the rents generated by these resources are supposed to be higher than their opportunity costs.149 These resources are generally bound to the firm and can be a source of sustained competitive advantage.150 With her arguments on the mobility of resources, Peteraf clearly underlines the two core assumptions of heterogeneity and imperfect transferability of resources that are central to the RBV

Outside of the academic debate, Prahalad and Hamel (1990) popularized the RBV through their influential article “The Core Competence of the Corporation”.151 Building on resource-

based theory, the authors developed the concept of core competencies, and they argue that

firms should concentrate on a limited set of distinctive competencies.152 Without anticipating section 2.2.2, it should be noted here that core competencies are unique bundles of skills and technologies and have to fulfill certain requirements to be considered “core.”153 By translating the academic concept of valuable resource bundles into more actionable directives Prahalad and Hamel (1990) made the RBV relevant to corporate executives and attracted a large following.154

As is often the case with competing views like the MBV and the RBV, their differences can

be overstated Many scholars argue that their supposedly opposed positions complement each

151 See Prahalad and Hamel (1990)

152 See Prahalad and Hamel (1990), pp 79ff

153 See Prahalad and Hamel (1990), p 83; Thiele (1997), p 73

154 See Kotler, Berger, and Bickhoff (2010), p 52