ASQ Research Discussion - Volume 1, Number 8
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Volume 1, Number 8, December 14, 1995
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In this issue:
- Moderator's comments and home page announcement
- Request for research concerning manager's intuition (R. Kent Pollard: rkpo@stud.uni-sb.de)
- Further discussion of what determines whether the likelihood that businesses will fail decreases or increases with age when size is controlled: Implications for diffusion of organizational capabilities within an industry (Will Mitchell: wmitchel@umich.edu)
1. Moderators comments and home page announcement
- a. Lag: We apologize for the lag between the last posting and this. A combination of new systems, overload, illness, and other factors held us up, but we are back on track.
- b. Archive: We are pleased to announce the creation of the ASQ conference and research homepage. We have archived past discussions and other good stuff at the web address listed at the beginning of this posting. The page also has connections to the ASQ Administrative Homepage. We used the Windows version of Netscape to create the home page. Please let us know if you have problems getting to the material.
2. Request for research concerning manager's intuition (R. Kent Pollard: rkpo@stud.uni-sb.de)
Who is doing or has recently done empirical research in manager's intuition in (or opposed to) planning (most likely/often "strategic planning")?
As close as I'm coming is:
- a) Pearce/Freeman/Robinson, "The Tenuous Link Between Formal Strategic Planning and Financial Performance" in: Academy of Management Review 12-4 (1987), 658-675, (which covers the planning side but only up to the early 1980's) , and
- b) Sinha, Deepak K., "The Contribution of Formal Planning to Decisions" in: Strategic Management Journal 11 (1990), 479-492.
3. Further discussion of what determines whether the likelihood that businesses will fail decreases or increases with age when size is controlled: Implications for diffusion of organizational capabilities within an industry (Will Mitchell: wmitchel@umich.edu)
I have been thinking about the question that I raised earlier, about the different results that some studies show for the relationship between business age and dissolution when business size is controlled. Some studies find that the risk of shutting down increases with age when size is controlled, while others find that the risk of dissolution remains stable or declines with age. One set of explanations for the different results relates to differences in the industries or times of the studies. Another set of explanations relates to whether size and age measure the same concepts in the different studies. My sense is that the differences can help us work towards understanding a deeper issue, concerning the destruction and diffusion of organizational capabilities within an industry. The following comment sketches some ideas concerning this issue.
The central idea here is that many valuable business capabilities are embedded in organizational routines. By routines, I mean patterns of activity unique to the particular organizations in which they are found. By embedded in organizational routines, I mean that the capabilities depend on multiple interactions actions among several people and therefore constitute a nondecomposable whole. Capabilities that are embedded in organizational routines are usually destroyed when a business shuts down because groups of people disband. In contrast, the capabilities may continue to exist when a new owner buys a business, if groups of people remain with the business under the new ownership. The organizational nature of the capabilities creates incentives for new owners to buy businesses in several circumstances. First, new owners sometimes purchase unsuccessful businesses in order to acquire their valuable capabilities. Second, new owners sometimes purchase successful businesses in order to transfer valuable capabilities from the target to the acquiring firm. Third, new owners sometimes purchase successful businesses that have reached the limits of their current capabilities in order to transfer resources from the acquiring firm to the target.
The first circumstance has implications for differences in the age-dissolution results when size is controlled. Take as a starting point the assumption that small size is often a sign of commercial weakness for old businesses, where size is relative to other businesses in an industry. Small young businesses, by contrast, may simply be strong businesses that are preparing for growth. Conceptually, therefore, size is a measure of commercial success, while age is a measure of how likely a business will enjoy subsequent growth. As a result, we would expect a high exit rate from an industry among old small businesses, if we believe that many old small businesses are unsuccessful businesses. The issue arises, though, as to what form the exit will take.
Consider the case where business dissolution is the only possible form of exit. In such cases, we would expect an increasing relationship between business age and business dissolution in studies that control for business size. That is, the older a small business, the less likely that it will enjoy subsequent growth and the more likely that it will shut down owing to commercial failure.
Now add business divestiture as a form of exit. That is, allow new owners to buy existing businesses and then either attempt to operate them either on a standalone basis or restructure them within other businesses. The unsuccessful business may attract the new owners if they want to obtain organizationally embedded capabilities from the acquired business or if the new owners believe that they can provide capabilities to the target that will turn around unsuccessful business. Divestiture has different organizational implications for the focal business when compared to dissolution. Dissolved businesses lose their organizational integrity. By contrast, divested businesses usually retain part of their original organizational structure within the new ownership, at least initially. Thus, divestiture provides a means of retaining valuable capabilities within an economic sector, even though the business fails.
This discussion suggests the following proposition.
Proposition 1: The greater the frequency of business divestiture in an industry, the less likely that old small businesses will shut down.
A second stage to the question then arises: what gives rise to greater or lesser frequency of business divestiture frequency in an industry? Legal conditions are one obvious factor. If the law does not allow divestiture of particular types of business, whether owing to antitrust concerns or to restrictions on ownership of particular types of businesses, then few businesses will be divested. Thus,
Proposition 2: The greater the legal impediments to business divestiture in an industry, the more likely that old small businesses will shut down.
A second factor that will affect the frequency of business divestiture is the degree to which business capabilities (a) are organizationally embedded and (b) can be transferred between target and acquiring firms. First, if few capabilities are organizationally embedded, then there will be little need to acquire a business in order to obtain its capabilities or transfer capabilities to it. Instead, the capabilities can be exchanged individually, without taking on the added expense and difficulty of merger and acquisition. Second, if capabilities are so strong embedded in a particular organizational context that they cannot be transferred between acquiring and target businesses, there will be no value in acquiring the unsuccessful business. The two points suggest a nonmonotonic relationship between organizational embeddeness and the frequency of business divestiture. This in turn, suggests a similar relationship for dissolution of old small businesses.
Proposition 3a: The likelihood of business divestiture will have a nonmonotonic relationship with the degree to which valuable capabilities are embedded in the organizations of the focal business or potential acquirers, first rising and then falling.
Proposition 3b: The likelihood that old small businesses will shut down will have a nonmonotonic relationship with the degree to which valuable capabilities are embedded in the organizations of the focal business or potential acquirers, first falling and then rising.
These predictions and rationales are incomplete. I think, though, that they hint at intriguing ideas about the nature of business capabilities and the diffusion of capabilities through an organizational environment.
Put at a very general level, there are implications here for evolutionary theory of strategy. Following Richard Nelson and Giovanni Dosi, one can view an evolutionary theory in the social domain as containing three elements: (1) random elements that generate variation in business strategy over time, (2) imperfect processes by which variations diffuse through an industry, and (3) selection mechanisms that winnow businesses from the industry on the basis of differential success of the variations. Start by assuming that differences in the firm-specific capabilities held by competitors cause some of the variations in business strategies within an industry. Business divestiture is then relevant for both the diffusion process and the imperfections of the process. Transfer of capabilities following acquisitions plays a key role in the diffusion of valuable business resources through an industry. A successful business can expand the use of strong firm-specific capabilities that underlie its success by acquiring a competitor and then transferring resources to the target. Transferring capabilities from targets to acquirers also provides a means by which capabilities of unsuccessful businesses or businesses that have reached the limits of their success can survive within an industry. Thus, the transfer process both helps successful businesses expand and preserves valuable portions of unsuccessful businesses.
The incentives for business acquisition also cause imperfections in the processes by which transfer of capabilities helps variations diffuse through an industry. Imperfections in the transfer of organizationally complex capabilities often cause suboptimal deployment between acquiring and target firms. Moreover, the fact that almost all acquisitions involve only two businesses means that diffusion of capabilities usually is limited to only part of an industry at one time.
