Introduction
Strategy, from an enterprise point of view, is concerned with answering two central questions:
- What business should we be in?
- How should we compete?
To an external observer, strategy is associated with two questions:
- How do firms behave?
- Why are firms different?
This derives from the fact that two firms within the same industry often competed in very different ways. Fundamentally, this heterogenity is a product of the firms' strategy, though management practice, structure and culture do play a part in creating and sustaining these differences.
How did strategy originate as a field of study and practice?
Mainstream economic theory - the price theory - has traditionally ignored the role of managers and left little scope for strategic choice in economic affairs. From Adam Smith down to the present day, economists have sought to show that a completely decentralized economic system, coordinated only through market prices could be efficient and little attention was given to why private firms might make use of managerial hierarchies to plan and coordinate their activities. The "firm" of economic theory observes market prices and then makes an efficient choice of output quantities, the assumption being that all firms are essentially alike, having the same access to information and technology, and the decisions they make are essentially rational and predictable, compelled only by cost and demand.
Seminal work by Banard [1938] stressed the difference between managerial work directed at making the organization
efficient, and work that made the organization
effective, a distinction critical to the concept of strategy. Simon [1947] extended Banard's ideas in his attempt to build a framework for analyzing a business and Selznick [1957] introduced the idea of a firm's "
distinctive competence." Shumpeter [1934] provided an alternative to the static concept of competitive efficiency favoured by most economists, and Knight's [1965] work on the risk-bearing function of entrepreneurs laid an early foundation for much of today's organizational economics.
It was Chandler [1962] who showed how executives at some large American companies discovered and developed roles for themselves in making
long-term decisions about the
direction of the company and then made investments and modified organizational
structure to make those strategies work. In formulating a thesis to summarize his findings, Chandler found it convenient to define two terms -
strategy and
structure.
The thesis that different organization forms result from different types of growth can be stated more precisely if the planning and carrying out of such growth is considered a strategy, and the organization devised to administer these enlarged activities and resources, a structure.
He defined
strategy as
"the determination of the basic long-term goals and objectives of an enterprise, the adoption of a course of action and the allocation of resources necessary for carrying out these goals."
To Banard's concept of strategy, Kenneth Andrews [1965] added Selznick's "distinctive competence" and a notion of an uncertain environment, to which management and the firm had to adapt. In Andrew's views, the environment, through constant change, gave rise to opportunities and threats, and the organization's strengths and weaknesses were adapted to avoid the threats and take advantages of the opportunities. An internal appraisal of strengths and weaknesses led to identification of distinctive competencies; and external appraisal of environmental threats and opportunities led to identification of potential succcess factors. These twin appraisals were the foundation for strategy formulation, a process analytically distinct from strategy implementation.
Andrews conceived
strategy as akin to identity, defining it as "
the pattern of objectives, purposes, or goals and major policies and plans for acheiving these goals, stated in such a way as to define what business the company is in or is to be in and the kind of company it is or is to be."
Igor Ansoff of Lockheed Electronics was more explicit in stating that strategy provided a "
common thread" of
five component choices (1)
product-market scope, (2)
growth vector (or direction in which scope was changing, e.g., the emphasis on old versus new products or markets), (3)
competitive advantage (unique opportunities in terms of product or market attributes), (4)
synergy internally generated by a combination of capabilities or competencies, and (5) the
make or buy decision.
In retrospect, it seems that Ansoff was attempting to define what we would today call
corporate strategy, while Andrews was more focused on
business strategy.
In the same period, the Boston Consulting Group (BCG) became best know for its two related conceptual inventions: the experience curve and the growth-share matrix.
In brief,
experience curve theory maintained that whoever
captured market share early, whoever gained the most experience in production would end up with the
lowest cost and whoever had the lowest cost would have the
highest margin. With the highest margin came
cash flows and an ability to withstand
competition and whatever actions it required.
Within a few years, such reasoning led to the
growth-share matrix, whose terminology of
cash cows,
dogs,
stars and
question marks became famous and widely adapted.
This was the first time that a clear line of distinction had been made between the two levels -
operational decision making and
corporate strategy - though a dichotomy developed in those seeking to understand how strategies were formed and implemented (
process) and those seeking to understand the relationship between strategic choice and performance (
content).
Evolution of the Concept
Late in the 60's and early in the 70's, concepts of strategic and long-term planning played important roles in the field. This movement owed much to the diffusion of war-based planning experience in the corporate field, though much of this was descriptive in nature rather than analytical or empirical.
The prominence of long-range planning and then strategic planning, failed to survive the economic turmoil that began with the oil embargo of 1973. Planning processes too easily degenerated into goal-setting exercises, failing to embody any real understanding of competitive advantage. Moreover, when more sophisticated planning process designs were advaned, problems of execution or implementation increased.
Careful observation of actual organizational decision making gave rise to more subtle conceptions of process, in which strategies were arrived at indirectly and, to some degree, unintentionally. Uncertainty led to tentativeness, search and serial trial, and some learning - a chaotic process - which , with a certain amount of luck, might accumulate to a strategy, which could then be named and descried as coherent only ex post. Treatise such as "
muddling through", "
logical incrementalism" and "
emergent strategy" all attempted to gain insight into organizational process which produced strategy as a somewhat intended outcome.
Strategy and Performance
Attempts to understand and test the
connection between strategy and performance also began in the 70's. Here,
three strands of work need to be highlighted (1) centered at Harvard and following on Chandler, generated and tested propositions about
corporate growth and diversification strategies, (2) focusing on
business strategies, began with the brewing studies (study of the brewing industry) at Purdue, and (3) also at Harvard, used an industrial organizational perpective to study business strategy, and culminated in Michael Porter's work on analysing
competitive strategy and competitive advantage.
The goal of the
brewing studies was to explore the proposition that
performance was a function of strategy and environment.
Chandler's pioneering work had also inspired further interest in empirically demonstrating a relationship between
growth strategy,
organizational form and the
expected performance of the enterprise. This led to an understanding of the forms of diversification that improved performance and those that did not.
Porter's Five Forces Framework
Porter imported into the strategy field, concepts developed over the years in
industrial organization (IO) economics, using these to build a general, cross-sectional
framework for explaining individual firm performance. The "
Five Forces" framework substituted a structured, competitive economic environment, in which the ability to bargain effectively in the face of an "
extended rivalry" of competing firms, customers and suppliers determined profit performance. Porter used this framework to define and explain the
strategies available to firms in their quest for
survival and profit.
This bridge to
industrial organization economics brought over a number of concepts from that field to research on strategy and performance.
Game theory modeling in industrial organization found applications in strategic management. The
event-study method of
financial economics were used to investigate
strategic and organizational change as well as the
strategic fit of acquisitions. New security-market performance measures were applied to old questions of
diversification and
performance,
market share and
performance among others.
Transaction cost viewpoints on
scope and
integration were adopted and new theories of the
efficiency of social bonding were advanced.
Studies on innovation began to use the language and logic of
economic rents and
appropriability, and research in venture capital responded to the
agency and
adverse selection problems characteristic of that activity.
Agency theory perspectives have been used in the study of
firm size,
diversification, top
management compensation and
growth.
Research on strategy process continued apace. The most vital new ideas were generated by a study of global firms. In the 80's, increasing globalization of the worlds economy led to a careful study of how large multi-national corporations directed and coordinated their myriad resources and activities. The emerging framework represents management as needing to maintain "
differentiation" in some activities to acheive gains from
specialization, and
tight integration in orther areas to acheive
economies of scale and
focus. In addition, management is seen as actively managing a complex
system of linkages among activities, which enables
critical coordination and facilitates
organizational learning.
The purpose of the description above has follow the advent of research into strategy and performance, which had been to understand real-world phenomena and establish a base for making useful prescriptions. What began in the 60's as a simple concepts of strategy intended to give insight into the phenomena described in cases evolved into a serious search for intellectual foundations.
Development and Trends in Allied Disciplines
The evolution on the thinking of
strategic management increasingly relied on the theories and methods of
economics and
organizational sociology, as well as on
political science and
psychology. As a consequence, the
boundaries that mark the strategy field have been blurred.
Given these trends, it is important to understand the fundamental questions being asked in allied disciplines and to be aware of the changes sweeping these fields.
Let us take a look at some of these, specifically:
- Economics
- Organizational Sociology
- Political Science
Economics
Of late, at least five concepts have disrupted traditional microeconomics and the neoclassical "theory of the firm" that is taught in b-schools the world over, namely: (1)
uncertainty, (2) information assymetry, (3) bounded rationality, (4) opportunism and (5) asset specificity. In various combinations, they are the essential ingredients of new subfields within economics.
For example:
- Transaction cost economics rests primarily on the conjunction of bounded rationality, asset specificity and opportunism. The fundamental assertion in transaction cost economics is that transactions should take place in the regime which best economizes on the costs imposed by bounded rationality and opportunism. Within strategic management, transaction cost economics is the ground where economic thinking, straetgy and organizational theory meet. Transactio cost economics begins ith the assertion that one cannot write enforceable contracts that cover all contingencies.
- Agency theory rests on the combination of opportunism and information assymetry. Agency theory concerns the design of incentive arrangements and the allocation of decision rights among individuals with conflicting preferences or interests. Agency theory makes no presumptions as transaction cost economics, and instead seeks the optimal form of such a contract. Agency theory has two branches:
- Principle-agent is chiefly concerned with the design of optimal incentive contracts between principals and their employees or agents.
- Corporate control is concerned with the design of the financial claims and overall governance structure of the firm and as such is most significant to strategic management. The hypothesis most familiar to strategic management is Jensen's [1986] "free cash flow" theory of leverage and takeovers. According to a BCG diagnosis, most firms mismanaged their portfolios, misusing funds generated by mature cash-rich businesses ("cows"), usually by continuing to reinvest long after growth opportunities had evaporated.
- Game theory derives much of its punch from assymetries in information and/or in the timing of irreversible expenditures (asset specificity). Modern Game Theory raises deep questions about the nature of rational behaviour. The idea that a rational individual is one who maximizes utility in the face of available information is simpy not sufficient to generate "sensible" equilibria in many noncooperative games with asymmetric information. To obtain "sensible" equlibria, actors must be assigned beliefs about what others' beliefs will be in teh event of irrational acts. Game Theory as applied to an industrial organization has two basic themes of particular interest: committment strategies and reputations.
- Committment is central to strategy and among the committment games that have been analyzed are those involving investment in specific assets and excess capacity, research and development with and without spillovers, horizontal mergers and financial structure.
- Reputations arise in game where firms or actors may belong to various "types" and others must form beliefs about which type is the true one. For example, a customer's belief (probability) that a seller is of the "honest" type constitutes the seller's reputation, and that reputation can be lost if the seller behaves in a way that changes th customer's beliefs. Reputation can also describe relationships within the firm, and the collection of employee beliefs and reputations can be collectively called its "culture".
- The evolutionary theory of the firm and of technological change rests chiefly on uncertainty and bounded rationality. Firms compete primarily through a struggle to improve and innovate. In this struggle, firms grope towards better methods with only a partial understanding of the causal structure of their own capabilities and of the technological opportunity set. Key to their view is the idea that organizational capacities are based on routines which are not explicitly comprehended, but which are developed and bettered with repetition and practice. This micro-link to learning-by-doing means that the current capability of the firm is a function of history, and implies that it is impossible to simple copy best practice even when it is observed. And because evolutionary economics posits a firm that cannot change its strategy or structure easily or quickly, the field has a very close affinity to population ecology views in organizational theory. Both challenge the naive view that firms can change strategies easily, or that changes will even matter when attempted and made.
Each of these five subfields have generated insights and themes important to strategic management.
Organizational Sociology
The fundamental issue addressed by sociology is the
structure and
subjective meaning of
social interaction. The centre of the puzzle was and continues to be the
stability of social strucutres and the amazingly strong controlling
forces they exert on their members actions. Two concerns distinguish the sociologists approach: an interest in
authority and a real concern with the subjective experience of
social interaction. Traditionally,
organizational sociology has been concerned with the processes whereby
authority is legitimized (accepted), with the general problem of
social structure in society, and with the limits and dysfunctions of
bureaucracy.
From the mid-60's through the 70's,
contingency theory synthesis emerged and was widely disseminated.
Contingency theory is built on a variety of earlier insights, like for example, that high performing organizations did not have the same
structure, but
matched structure to the technological demands of production.
Contingency theory hypothesised that organizations which contain sub-systems "
matched" to their environment perform better that those with a less perfect fit. Under competition, this implies that
structure follows environment and must be able to cope with
uncertainty, the most important variable in the environment. If strategy is taken to include choice of environment, this becomes consistent with the dictum that structure follows strategy.
Sub-fields of organizational sociology that are relevant to strategic management include:
- Resource Dependence: Who or what determines what organzations do? The resource dependence model argues tthat much of what organizations do is determined by outsiders - by those parties who control the flow of critical resources upon which the organization depends. The strategic activities of management, according to this perspective, are those of accomodating or finding ways to insulate the organization from the demands of those who control critical resources. Resource dependence theory also speaks of the distribution of power within organizations, specially those who can influence external parties or the flow of discretionary resources.
- Organizational Ecology: Economics, and to a large extent, strategic management, view the firm as actively adapting to changed conditions.Organization ecology makes the opporite presumption - that firms do not adapt. Instead of the adaptive firm, organization ecology sees a population of firms that change in composition over time as some flourish, others perish, and new organizations are born. It sees the strategy of a firm as fixed at its inception and as unchanging over time, quite at odds with the literature on strategic change. However, strategic change may well be the exception rather than the rule, and strategic inertia appears more realistic than the economist's assumption of rapid, rational response to change. The study of organizational culture is another developing stream of thought that intersects organizational sociology in many areas. Culture is sometimes seen as an impediment to change and at other times as the source of unusual excellence. In either case, the technology of changing, protecting or creating culture is at a very primitive state of development.
Political Science
The systematic investigation of political structures and processes has a tradition extending back to the Greek philosophers. And like strategic management, political science lacks a central, generally accepted paradigm, and its many streams are not tied together in any coherent way. However two dramatic shifts in paradigm have occurred in the last 50 years. The first was the "behavioural revolution" that commenced in the 1950s as contrasted against the classical "rational" models. researchers began to look at what political actors actually did rather than at descriptions of rules and structure or at a framer's expectations.
The second paradigm shift was political science's own "new institutionalism". Among its antecedents were the many empiracal studies of voting - effects of blocs, splinter groups, rules and so forth, on voting behaviour and outcomes. New institutionalism in political science also included abstract and rigorous analysis of how individual preferences combine through voting to produce political outcomes.
Bottomline
Each of the allied disciplines speaks to a unique metaphor. Economics is concerned with public welfare and wealth distribution in society. Sociology is concerned with groups of individuals and their activities as groups. Political science is concerned with choices made by groups where the objective function is diffuse and specified by the group itself. Psychology is concerned with individuals, the mind, and individual behaviour. That all of these have something to do with individuals in combination with group choices and welfare is evident. But what of strategic management?
Strategic management has to do with groups, their birth and their continuing success. It does not assume that the groups purpose is beneficial, but simply that the group forms and tries to exist because it has purpose. Moreover, groups exist within a context, and the context governs conditions of success. It is the managements responsibility to see that the gorup adapts to its context, and survival in the end is an objective definition of success. So the perspective is that of the management team assigned the responsibility of ensuring success, with success defined as either the entrepreneurial act of starting an organization, or those acts that condition survival.
The fundamental issues addressed by strategic managemetn then are different from those addressed by the allied disciplines themselves. Related they are to be sure, but different perspectives seperate their domains of enquiry, and one must expect different fundamental questions to be addressed by each discipline.
Bibliography
- Fundamental Issues in Strategy: A Research Agenda by Rumelt, Teece and Schendel [HBS Press; 1994]
