Towards a Competence Theory of the Firm

Nicolai J. Foss, Christian Knudsen, Nicolai J. Foss, Christian Knudsen

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781317798767
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

This book explores a new theory of the firm produced through an exchange between management theory and economics. In the process economics is seen to provide a foundational element for strategy research whilst developing a more realistic theory of the firm with a greater emphasis on its internal features. The success of competence theories of the firm also reflects their ability to explain significant trends in the business world, notably the declining importance of conglomerates and critical features in the success of Asian and Japanese business.

1

Introduction

The emerging competence perspective

Nicolai J. Foss

The Emergence of a New Perspective in Strategy Research

This book contributes to the competence perspective on firms and firm strategies that has been emerging within the strategic management field over the last decade. Arguably, the competence perspective is – in its various guises – the dominant perspective on firm strategy today. Thus, strategic management scholars are very much agreed on ascribing primary importance to the resource and competence side of firms when accounting for the sources of long-lived competitive advantage, which is perhaps the central theme of strategic management research. This dominance can also be found in the thinking of managers and strategists; for example, the necessity of a ‘return to the core business’ is now almost universally emphasized by practitioners.

In this version, the competence perspective may perhaps be seen as a rediscovery of the proposition advanced by Adam Smith more than two hundred years ago, that specialization yields productivity advantages. But whereas Smith can be read as emphasizing specialization in terms of products, the modern competence perspective rather emphasizes specialization in terms of competence.

By ‘competence’, we understand a typically idiosyncratic knowledge capital that allows its holder to perform activities – in particular, to solve problems – in certain ways, and typically do this more efficiently than others. Because of its skill-like character, competence has a large tacit component, and is asymmetrically distributed. It may reside in individuals, but is in the context of the theory of the firm and strategic management perhaps best seen as a property of organizations rather than of individuals (it is therefore hard to imitate and transfer). At least, that is how the concept is used in this book.

By ‘a competence perspective on firms and firm strategies’, then, is meant, first, a consistent conceptualization of firms in terms of competence: firms are seen essentially as repositories of competence. And, second, it is firms’ ability to accumulate, protect and eventually to deploy competences to product markets that is seen as determinative of their long-run competitive advantages. Moreover, firms’ competence endowments co-determine their boundaries, notably their degree of diversification.

This view of the firm is not only to be found within the strategic management field; it is also emerging within economics, particularly in the evolutionary theory of the firm, as propounded by Richard Nelson and Sidney Winter in their 1982 book, An Evolutionary Theory of Economic Change. Here, too, firms are seen as essentially heterogeneous entities, characterized by their unique and path-dependent knowledge-bases (rather than simply by scale).

The same year, 1982, that saw the publication of Nelson and Winter’s book also witnessed the publication of a seminal article by Stephen Lippman and Richard Rumelt, ‘Uncertain Instability: An Analysis of Interfirm Differences in Efficiency under Competition. They demonstrated that, if one assumed that firms had difficulties imitating the firm-specific sources of superior performance, an equilibrium with firm of diverging efficiencies could be sustained. This opened the door for a rigorous economic approach to the analysis of firm strategies as a matter of the accumulation and protection of resources that yield Ricardian rents because of their superior inherent efficiencies.

Two years later, Birger Wernerfelt, building on Edith Penrose’s The Theory of the Growth of the Firm (1959) and on Lippman and Rumelt’s article, published his ‘A Resource-based View of the Firm’, probably the most influential academic article on firm resources. Since then, the more academic and largely US-based part of the competence perspective has normally been referred to as ‘the resource-based view’. Important contributors to this strand within the competence perspective include, in addition to Wernerfelt and Rumelt, Jay Barney, Cynthia Montgomery, Ingemar Dierickx and Karel Cool.

Closely related to the resource-based view, but with a somewhat more practical orientation, is a string of contributions beginning with C. K. Prahalad and Gary Hamel’s enormously successful 1990 article in the Harvard Business Review, ‘The Core Competence of the Corporation’. Work that is closely related to the resource-based or core competence work is ‘the capabilities approach’ (Langlois 1992), ‘the competence perspective’ (Foss 1993), and ‘the dynamic capabilities approach’ (Teece, Pisano and Shuen 1990). Recent European-based work on ‘competence-based competition’ (Hamel and Heene 1994) also falls within this group.¹

In this book, we use the term ‘the competence-based perspective’ or, even simpler, ‘the competence perspective’ as the common denominator for these different, though closely related, influences. This is because all the above theories are agreed on ascribing primary strategic importance to those firm-specific assets that are knowledge-related and intangible, often tacit, hard to trade and shared among the agents of the firm. The assets that conform to these characteristics are what we understand as ‘competences’.

Although it may seem so, the interest in conceptualizing the firm in terms of its competences is no new phenomenon per se. As Christian Knudsen argues in chapter 2 and Brian Loasby in chapter 3, it is in a sense a renewed interest, since a knowledge-based conceptualization of the firm was present in the important British economist, Alfred Marshall’s (1925) work, and blossomed in the classic work of Edith Penrose (1959) on The Theory of the Growth of the Firm. Penrose’s work in particular has provided much inspiration for resource-based scholars (Wernerfelt 1984), and also for evolutionary theorists such as Richard Nelson and Sidney Winter (1982). In fact, it may with much justice be said that what Ronald Coase is to the contractual approach, Penrose is to the competence perspective.

However, in spite of its many precursors, the competence perspective did not really blossom until the end of the 1980s. Since that time, however, it has virtually dominated strategy content research; the percentage of articles written from a competence perspective in such journals as Strategic Management Journal, Journal of Management, and also more popular journals such as California Management Review or Harvard Business Review, is now quite high. Even the weekly, The Economist, well known for its harsh comments on management thinking, now routinely employ concepts such as ‘core competences’ in its business section. Given this quite widespread acceptance, why did it take so long before the competence perspective became influential?

There are several causal factors behind the emergence of the competence perspective, some of which are external and some of which are internal to the strategy field. They include:

• The death of the conglomerate: the need for a return to core business becomes conventional wisdom.
• The empirical importance of internal factors for understanding competitive advantage, exemplified by the superior efficiencies ascribed to Japanese production methods.
• Advances in economic theory, particularly with respect to the treatment of contracts, incentives, information and strategic interdependence.
• An increasing interest in firm heterogeneity within economics.
• A related and also increasing interest in emphasizing the knowledge dimensions of the firm within economics and strategic management.

The first two reasons on this list are clearly external, empirically based reasons. They both refer to the changes in organizational forms and in dimensions of competition that have accompanied the increasing internationalization and the more fervent technological change that have characterized many industries.

Let us consider the case of ITT (The Economist 1995). On 13 June 1995 Rand Araskog, president of the American conglomerate, ITT, announced that ITT was soon to be broken up into three free-standing firms, concentrating on insurance, hotels and manufacturing, respectively. The news made ITT rise on the New York Stock Exchange. In fact, stocks had been rising for some time in the expectation that ITT’s divestment plans were soon to be announced. This suggests that investors are no longer particularly fond of conglomerate organization.

Perhaps more than any other firm, ITT was instrumental in defining the conglomerate as a viable organizational form in the 1960s. Under the remarkable Harold Geneen, ITT expanded strongly, primarily by merging with other firms, and consisted by 1970 of more than 400 businesses, operating in more than 70 countries all over the world. Under Rand Araskog, ITT has divested itself of more than 200 businesses, but still covers areas ranging from casinos to phone directories. In fact, Araskog has had difficulties determining precisely where ITT’s core business lies.

Dozens of similar stories can be found. They all serve to illustrate the increasing emphasis in managerial practice on concentrating on core strengths. These are seen as the more permanent features of the firm, while products and strategic business units are seen as much more transitory. This is a view of the corporation that harmonizes with an increasingly internationalized world with shortening product life-cycles. In such a world, competitive success cannot rest on anything as fleeting as products or strategic business units; rather, it must be founded on something deeper – namely the knowledge capital in the form of competences that allow a firm to spawn new unanticipated products. The cultivation and management of synergistic learning processes in the firm therefore become key in this process. Strategy is about stretching knowledge assets and applying these to new areas.

According to some writers, notably Prahalad and Hamel, the above competence view on the corporation and on strategy has been near-standard fare in Japanese and other East Asian management practice for years and to a large extent accounts for the competitive successes of Asian firms in many industries. However, it has only recently been reflected in strategic thinking, and it has yet to make a substantial impact on Western management and strategy practice.

In addition to these external, more empirical reasons for the recent change in strategy thinking, there are some more internal developments. These may be summarized as having to do with a more intimate liaison between economics and strategy, a liaison that has become stimulated by a more realistic treatment of the firm within economics.

Economics and Management Studies

It has gradually become an increasingly prevalent recognition that economic theory may be important to management studies, and perhaps particularly to the strategy discipline.² This has not always been so. Consider the verdict issued by the prominent British economist, Arthur Pigou:

it is not the business of economists to teach woollen manufacturers to make and sell wool, or brewers how to make and sell beer, or any other business men how to do their job. If that was what we were out for, we should, I imagine, immediately quit our desks and get somebody – doubtless at a heavy premium, for we should be thoroughly inefficient – to take us into his woollen mill or his brewery.

(Pigou 1922: 463)

Now, business firms still employ relatively few microeconomists, and the influence of economics on management may arguably primarily manifest itself through the curricula of business schools. Through this route, however, economics is bound to have an influence on the practical execution of firms’ strategies. As some prominent proponents of the economic turn in strategy thinking have recently emphasized, this is not the same as saying, in an ‘imperialist’ manner, that strategy thinking should be only applied to microeconomics (Rumelt, Schendel and Teece 1994: 547–9). Instead, economics is thought of as being able to further ‘conversation’ within the strategy discipline and management studies in general, rather than to block it.

This is because economics provides a relatively clear and unambiguous ‘language’ in which many – if not all – strategy issues may be precisely represented. Furthermore, many would agree that the basic insights of economics³ have a high degree of validity – which means that economics may supply a body of well-corroborated knowledge that may serve as a foundational element for strategy research. For example, economics helps better understanding and answering questions such as the following. What are the sources of competitive advantage? How can competitive advantage be sustained? How sensitive is competitive advantage to environmental changes?

Such questions are quite simply hard to understand and answer without understanding the nature of basic competitive forces. Sociology and psychology do not tell us much directly about what is perhaps the key question of strategy research: which factors may make a competitive advantage sustainable? In order to pose and answer this question meaningfully, knowledge of the mechanisms that may off-set the equalization of returns over firms is necessary. For example, economics may supply the answer that a competitive advantage can be made sustainable to the extent that the relevant rent-yielding competences can be made costly to imitate.

What makes it more plausible that economic modes of thought may help us address and understand such questions is also the fact that economics has become, in many ways, much more ‘realistic’. There is now a much more sophisticated treatment of information, incentives, coordination and strategic interaction than was the case, say, two decades ago. It is not that all of these developments are equally obviously helpful; but some of them clearly are helpful. This is perhaps particularly obvious in the domain of the theory of the firm.

Early importers of economics to the strategy discipline were for a long time inspired by a kind of economics that did not leave much room for resources and competences, and, in effect, had little to say about the firm. To strategy scholars such as Richard Caves and Michael Porter, economics meant the Bain-Mason structuralist approach in industrial organization (IO) economics. To them, basic IO concepts such as entry barriers and collusion behind s...