Strategic Frameworks

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Many of the strategic HRM frameworks have evolved from traditional and contemporary concepts within the field. In the resource-based view (RBV), ideas based on the seminal work of Edith Penrose view the organization in terms of its productive resources. In particular, the core message behind RBV suggests that an organization’s sustained competitive advantage comes from the ability to acquire and manage resources. This model can be used to explain why organizations within the same industry can experience vastly different levels of performance.

The concept of competitive advantage was originally set forth in the work of Michael Porter more than a quarter of a century ago. He argued that an organization’s competitive advantage was created by the value the organization could create for customers. Porter points out that this value was achieved by outperforming competitors in distinctive ways, utilizing what he termed the “Five Forces.” Porter also suggested there were generic strategies in the areas of focus, quality, and cost leadership, which also could be used to gain a competitive advantage.

For this Discussion, consider how these different frameworks influence strategic HRM policies and practices, which provide the organization with an opportunity to increase organizational performance and achieve a competitive advantage. In addition, reflect on how HR professionals utilize these frameworks as a way to increase their value as a strategic partner.

Write a cohesive and scholarly response based on your readings and research this week that addresses the following:

  • How does using a framework such as resource-based view (RBV) or Porter’s Five Forces enable an organization to achieve a competitive advantage, by implementing strategic HRM practices throughout the organization?
  • Argue which framework you think is most important for HR professionals to employ: RBV, Porter’s Five Forces, or another strategic HRM framework of your choice based on your research this week.
  • Then respond to someone that advocated for a different framework than you, adding value to the discussion by exploring the value of each.

Must use APA format and have at least 3 references. Also must have an introduction and a conclusion.

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article title On the Path towards a Competence-based Theory of the Firm Jörg Freiling, Martin Gersch and Christian Goeke Abstract Jörg Freiling University of Bremen, Germany Martin Gersch Freie Universität Berlin, Germany Christian Goeke Freie Universität Berlin, Germany Exploiting the potential and tackling the problems of resource-based and competencebased research, this paper develops a proposal for a competence-based theory of the firm (CbTF). The CbTF is based on the fundamentals of market process theory and is independent of existing approaches to explaining the nature of the firm. The paper addresses the basics of the theory in terms of the philosophy of science by referring to the Lakatos model and the position of CbTF in organization theory. The fundamental question of the nature of the firm is approached by the notion of an organizational ‘ambiente’ and by using findings of entrepreneurship research. Keywords: theory of the firm, philosophy of science, market process theory, competence-based view, organizational ‘ambiente’ Introduction Is the resource-based view useful? The response from academics is ambiguous. Some researchers argue that the objections made are so basic that the resourcebased view should be discarded (e.g. Priem and Butler 2001). Others (e.g. Barney 2001) still promote the utility of this view by pointing out some of its strengths and comparable weaknesses of other ‘established’ theories. The debate continues with many open questions, e.g.: 1 Is the resource-based view fatally flawed? 2 Does the resource-based view provide a theoretical framework or at least pave the way to such? Organization Studies 29(08&09): 1143–1164 ISSN 0170–8406 Copyright © 2008 SAGE Publications (Los Angeles, London, New Delhi and Singapore) www.egosnet.org/os 3 What are the minimum requirements for establishing a framework in resource-based research that realizes an enduring approach for management and organization theory? This paper argues that, despite some promising progress, the serious problems of the resource-based view can only be resolved through a solid grounding in the philosophy of science. Many of the justified objections call for an approach that re-engages with the fundamentals of scientific thinking. The purpose of this paper is to locate a reconfigured version in the landscape of organization theory DOI: 10.1177/0170840608094774 1144 Organization Studies 29(08&09) in order to identify (in)commensurable approaches and to avoid problematic eclectic work. Having positioned its approach, this paper intends to analyse one of the most basic questions of business research in circumstances of incomplete information, uncertainty and dynamism in markets: to explain the very nature of the firm — in a particular manner that sets it apart from other theories in use. The paper is organized as follows: firstly, state of the art, resource-based research is analysed in order to illustrate the most fundamental criticisms. These represent the core of any further consideration and the basis of a re-conceptualization introduced in the second step. Accordingly, a suggestion for a so-called ‘competence-based theory of the firm’ (CbTF) is introduced, stressing the role of entrepreneurship, dynamic capabilities and competences. The discussion within the scope of the philosophy of science takes the different existing concepts into account and is finally guided by the methodology of Lakatos (1970), pointing out elements of the ‘hard core’ as basic assumptions of the theory. The derivation of a consistent terminology, based on the phenomena to be explained and what is considered to account for them (‘explanandum’ and ‘explanans’, referring to Hempel and Oppenheim 1948), is subject to subsequent considerations. These prepare the ground for an outline of the basic causal structures of a refined resource-based theory. In order to understand the fundamental position of this approach, the location of CbTF in management and organization theory is the subject of the third step. It transpires that CbTF belongs to the approaches of evolutionary economics that are positioned far from the traditional mainstream of economic theories, namely the functionalist paradigm according to Burrell and Morgan (1979). In particular, the CbTF appears as a part of market process theory with an interesting aspect: market process theory, as developed by Mises (1949), Hayek (1978) and Kirzner (1973), addresses the market level and does not represent a management theory. Accordingly, researchers still lament a ‘missing chapter’ in market process theory, namely a chapter that would fill the ‘concreteness gap’ concerning intra-organizational processes (Boettke 1994; Loasby 2002). The other way round, embedding CbTF in market process theory facilitates further progress towards a ‘new IO approach’: by combining considerations on the micro level (firm) and the macro level (market/industry), the opportunity arises to address the dynamics of competition from a particular, co-evolutionary point of view. In this sense, this paper makes a contribution to the metamorphosis debate triggered by Penrose (1995) and Pitelis (2002). Finally, the paper attempts to explain the very nature of the firm by extending some of the contributions of, for example, Conner (1991), Foss (1993), Madhok (1996) and Hodgson (1998). Historical Background and State of the Art in Resource-based Theory Resource-based and competence-based thinking can be traced back to the early steps of economic theory. Adam Smith (1776/1904) pointed out the opportunities of division of labour and coordination. Promising further steps were made Freiling et al.: Towards a Competence-based Theory of the Firm 1145 by Charles Babbage (1832/1963) and Friedrich List (1841). They stressed asymmetrically distributed skills and capabilities among individuals more than had Smith, pointing to the necessity of resolving the coordination problem of the division of labour. In particular, List (1841) formulated the ‘law of the confederation of productive forces’ by referring to the fact that productivity not only depends on the division of labour but also on linking the different activities. This unification of the productive forces, carefully monitored by the entrepreneur, is in List’s view the only way fully to exploit the opportunities offered by the division of labour, while simultaneously opening a road to the competence discussion of the 1950s (e.g. Penrose 1959), and the 1990s (e.g. Prahalad and Hamel 1990; Teece et al. 1997), and most recent discussions on entrepreneurial issues of the theory of the firm (e.g. Langlois 2007). Notably, these streams in classical theory indicate that, in the beginning, entrepreneurship and entrepreneurial functions on the one hand and initial capability-based considerations on the other were part of the same nucleus. Incidentally, this same link can be identified in the work of Edith T. Penrose (1959: 77). There has been much progress in resource and competence research in the meantime and capability-based approaches continue to inform strategic management theory (e.g. Helfat et al. 2007). Why is this? The competence perspective acknowledges the importance of time and historicity in economic decision making by referring to organizational paths. It explains why every organizational entity is equipped with specific resources and an identity, and sheds interesting light on internal factors such as tacit knowledge, social complexity, organizational routines and competences (Dierickx and Cool 1989). There remain, however, some fundamental problems of resource-based and competence-based research that obstruct the path of an affirmed theoretical approach: • The ‘house’ of resource-based approaches in strategic management theory is neither a homogeneous nor a coherent one (Knudsen 1996; Acedo et al. 2007). Within the scope of a resource-based view we can identify: a resource-based theory (e.g. Barney 1991), a resource-advantage theory — rooted in no less than 11(!) research traditions of a different kind (Hunt 2000) — and a resource-endowment view (Mahoney 1995). A competencebased view consists of at least the core competence debate (Prahalad and Hamel 1990), the dynamic capabilities approach (Teece et al. 1997) and competence-based strategic management (Sanchez et al. 1996) — not to mention the huge number of knowledge-based approaches. Knudsen (1996: 13) points out: ‘it is probably not reasonable at this point to describe the competence perspective as a coherent research programme, or paradigm, characterized by a common hard core and positive heuristic’. The lack of coherence is accompanied by considerable problems: – There is still no declarative statement on basic assumptions in use (Knudsen 1996). The terminology is confusing in many respects. Most important is the fact that terminological considerations are not aligned with the underlying ‘explanandum’ and ‘explanans’ of competencebased research. Moreover, there is still confusion about the object of explanation. 1146 Organization Studies 29(08&09) – Closely connected with the explanandum debate and this kind of reasoning, the tautology critique (e.g. Priem and Butler 2001) is still justified and represents a key challenge for further research. • Different research traditions frequently find themselves combined with competence research. Many of them are simply incommensurable and end up in problematic kinds of eclecticism from the viewpoint of the philosophy of science, while others are at best misleading. For example: is the often practised extension of transaction cost economics (TCE) with time-oriented aspects (e.g. Langlois 1992, 2006) or the combination with competence theory really useful if we consider that TCE belongs to the neoclassical research tradition and is equilibrium-oriented, whereas competence research claims to be a market process approach belonging to evolutionary theory? Referring to a debate on another level: is there any virtue in making use of biological analogies when analysing organizational issues? It was Penrose who had triggered this discussion more than 50 years before, when she remarked: ‘(E)ven as a metaphor it [biological evolution] is badly chosen … (I)n seeking fundamental explanations of economic and social phenomena in human affairs the economist … would be well advised to attack his problems directly and in their own terms rather than indirectly by imposing sweeping biological models upon them’ (1952: 819). In confronting these fundamental problems, the question of how to proceed arises. Regarding the numerous deficiencies of transaction cost theory, Sydow (1992) in a similar situation outlined four alternatives: (1) fast forgetting, (2) improving, (3) combining or (4) re-conceptualizing. Rejecting alternative (1) in face of the considerable explanatory power of resource-based research, alternatives (2) and (3) do not come into play, because minor improvements are unable to overcome the deficiencies mentioned and combination is not a primary route, as many fruitless trials have already shown (Schneider 1997). Re-conceptualization thus remains, and is the subject of our next section. Competence-based Theory of the Firm: First Steps in Responding to Recent Problems It is clear that competence research lacks foundation in the philosophy of science (Foss 2005). In particular, there is no solution to the problem of eclecticism. Feyerabend (1975) raises a plausible claim for theoretical pluralism. As long as pluralism is not understood the ‘anarchic’ way introduced by Feyerabend, this goes along with appropriate criteria to connect insights from different theories. Unfortunately, these criteria do not yet exist. In order to respond to this problem, to avoid a too long discussion on meta aspects of the philosophy of science and to establish a reliable grounding, a framework is useful in order to derive the research basics systematically. Lakatos (1970) developed such a framework of conceptualizing the ‘hard core’ of a scientific programme. Lakatos (1970: 132–138) argues that every theory can be described by a hard core consisting of incontestable basic assumptions. These hard-core assumptions are accompanied by a number of further assumptions and auxiliary hypotheses that should serve Freiling et al.: Towards a Competence-based Theory of the Firm 1147 as a ‘protective belt’ against falsification. This protective belt is subject to adjustments and replacements helping to defend the hard core (as far as possible) and to reveal new facts, and is accompanied by positive and negative heuristics. To define such basic cornerstones of a theory, it is argued, is vital for giving order to the chaos of observable phenomena and thereby facilitating the generation of new insights (Smith, according to Loasby 1999: 8). In order to conceptualize CbTF’s hard-core elements, as claimed for example by Foss (2005), it is necessary to summarize the fundamental modus of competencebased thinking. Based on prior research contributions, which can be regarded as frame-forming and generally accepted among competence researchers, the following aspects are to be considered: • The whole research stream is an economic one. • Economic agents are equipped with scarce and in many cases not perfectly mobile factors (Barney 1991). • They make decisions under circumstances of incomplete, asymmetrically dispersed information. • They reflect, learn and exercise by each decision. The results are idiosyncratic capabilities and ‘entrepreneurial theories’ (Harper 1995) in every point in time. • Former decisions are often dependent from later decisions. Accordingly, not only history matters (Dosi 1982) but also individual and organizational paths evolve. • The factors that are available to firms are not totally homogeneous (Barney 1991). By means of bundling and specification processes they become heterogeneous so that every firm can be regarded as a unique bundle of factors (Penrose 1959), in particular of resources and competences. • Although the firm as an entity is embedded in a constraining business environment, there is still leeway for entrepreneurial action and for shaping outer conditions according to firm-specific goals. The opportunities to shape depend on the organizational development, the commitments made and the resources and competences available. The challenge now is to transform these cornerstones into a hard core in the sense of Lakatos (1970). This requires the formulation of basic assumptions derived from the above-mentioned considerations and their integration into a cohesive whole (a ‘hard core’). The commonalities of market process theory and competence-based research are an anchor point for the derivation of the assumptions. Such an explicit hard core is no end in itself — it is rather considered very useful for aligning relevant research in a theoretically robust way. Due to reasons mentioned below, we suggest calling the research programme on this common ground ‘Competence-based theory of the firm’. The CbTF offers the opportunity to build a consistent theoretical framework backed by the philosophy of science. Designed as an evolutionary approach of the economic kind, the elements of the hard core (HCE) are arranged according to the fundamental work of Backhouse (1998) as follows: 1148 Organization Studies 29(08&09) Figure 1 Knowledge and Radical Uncertainty (based on Rese 2000: 70) Knowledge relevant for the market 1 ... that a player already has. 2 ... of which the player knows but does not long for. 3 ... of which the player does not know. 4 ... that does not exist yet. Competence-based Theory of the Firm: Experience and alertness determine a player’s cognition of what knowledge exists. The knowledge attained by a player at a certain point of time: knowledge on knowledge. Radical ignorance The player does not have all relevant knowledge. New knowledge is created constantly. HCE 1: Subjectivism. This construct, well known from the market process theory of the New Austrian Economics (Mises 1949), points to the fact that economic agents differ in what they know, what they want, what they do and what they are equipped with (e.g. skills). Individuals make decisions from their own points of view and their respective interpretations. In this sense, every individual is equipped with specific knowledge, motivation, expectations and abilities. These endowment items are subject to changes over time (learning, training, etc.) with the result that new asymmetries evolve. Subjectivism plays a crucial role in explaining the idiosyncratic nature of the firm, in accord with resourcebased and competence-based thinking. HCE 2: Radical uncertainty. HCE 1 implies the incompleteness of information and knowledge in the actions and decisions of individuals. HCE 2 goes further (Shackle 1972): ‘The history-to-come which will flow from men’s decisions is nonexistent until those decisions themselves are made. What does not yet exist cannot now be known’ (Shackle 1972: 3). CbTF presumes radical uncertainty, just like the market process theories, as demonstrated in Figure 1. HCE 3: Methodological individualism. Decisions are made by individuals. Also in harmony with market process theory, methodological individualism means that all decisions in organizations can be traced back to single individuals and their contributions to aggregated phenomena (e.g. organizational learning, culture — cf. Spender 2006). In literature, there is no uniform concept of methodological individualism. Kincaid (2004) coined the term ‘varieties of individualism’ and identified five modes. In particular, ‘explanatory individualism’ asserts that social phenomena can be fully explained in individualistic terms. In order to address organizational phenomena at best without giving up the individualistic viewpoint, we refer to the moderate methodological individualism according to Foss (2005). This implies that ‘at least metaphorically … institutions exert influence on individual behaviour … in the sense that ‘they’ structure incentives and therefore impact behaviour’ (Foss 2005: 10). Similarly, organizational competences can be explained by analysing intra- (Teece 2007) and inter-personal behaviour. This understanding is chosen due to the economic character of CbTF. In case of sociological considerations, concepts such as methodological interactionism (Nooteboom 2006) are able to highlight the relationships among agents. Freiling et al.: Towards a Competence-based Theory of the Firm 1149 HCE 4: ‘Homo agens’. In face of the HCEs mentioned, the traditional ‘homo oeconomicus’ model of economic theory does not fit. Mises (1949) modelled human action by referring to the ‘acting man’ (‘homo agens’) as a proactive player, permanently looking for new opportunities to improve his situation (Lachmann 1986). Combinations of objectives, means and alternatives are given but are subject to entrepreneurial action and modifications in order to bring things to a favourable outcome. In particular, two basic features are required in order to model the ‘homo agens’: alertness, being relevant only in settings of radical uncertainty, and economizing, which implies making (limited) rational choices within the scope of the surroundings mentioned. The notion of the ‘homo agens’ seems to fit perfectly with resource-based and competence-based thinking. HCE 5: Moderate voluntarism. Closely connected with the ‘homo agens’ and in combination with radical uncertainty, moderate voluntarism implies that the agents’ moves might have some impact on their relevant environment in such a way that favourable conditions can be shaped in a desirable manner through proactive, creative management (Prahalad and Hamel 1990; Teece 2007). Nevertheless, the power of an agent is restricted, bringing the embeddedness argument into play: the given legal system, market standards and power constellations in competition indicate that, even for alert entrepreneurs, not everything is possible. HCE 6: Time matters. Time plays a prominent role in competence research in general and in CbTF in particular due to historicity and the non-consummatory run of events (i.e. no definable outcomes of actions). Historicity implies possible irreversibilities in decision making which cause lock-ins as well as lock-outs and affect the path-oriented organizational development (Dosi 1982). Path relatedness has an ambiguous impact. On the one hand, it confines the development options of individuals and organizations. Not every action in the future is possible, as past decisions and developments might still influence what is conceivable for the future and what is not: events are intertemporally connected. On the other, path effects enable agents and organizations to trigger accumulation processes, for example those regarding resource and competence building. In this context Dierickx and Cool (1989) coined the term ‘asset mass efficiencies’. Moreover, events are not only inter-temporally connected but also to a certain degree self-energizing (Arthur 2000). Actions are not only surrounded by other actions (which form a sequence together with the initial action: Rizzo 1994) but also go along with time lags as regards their effects. This thinking is deeply embedded in competence research, as revealed in the discussion on isolating mechanisms or flexibility and inertia (Rumelt 1984). The run of events and final result are open (Arthur 2000: 112). The irreversibility argument applies. These six elements of the hard core make up the foundation of CbTF. Comparing the different HCEs to corresponding work under the umbrella of market process theories, in particular the New Austrian Economics (Vaughn 1994), one can say that CbTF is compatible in terms of basic assumptions with these research programmes. Even Hunt (2000) affirms a strong backing of resource-based theory in Austrian Economics. 1150 Organization Studies 29(08&09) Based on this hard core, the question about CbTF’s epistemological aim (the explanandum) arises, which goes along with further terminological considerations. It is argued that, without aligning the terminology with the epistemological intention, no adequate response to the tautology objection (Priem and Butler 2001) can be found and no consistency in reasoning is possible. One issue that competence research and CbTF have in common is that differences among firms are not primarily explained by factors belonging to market structure and business environment but by the availability and usage of resources and competences. The predominant epistemological aim of resource and competence research is to explain inter-firm performance differences by attributing them to the availability and usage of competences and resources (Barney 1991). Such a procedure is not unproblematic for at least two reasons: (1) it focuses on the performance that was actually realized in markets and thus suggests that only successful players have competences; (2) it makes use of an ex-post view because, due to uncertainty (HCE 2), ex ante no one can know which player will be more successful than the other. The aspects point to the roots of the tautology debate (Priem and Butler 2001). In face of these arguments, this paper proposes a modified explanandum. What can a modified explanandum look like if the HCEs and the tautology critique are to be considered? It is argued that addressing ‘striving for competitiveness’ rather than ‘observable competitive advantages’ as the object of explanation is useful in order to proceed. In particular, in the area of the theory of the firm the most fundamental aspect is the existence of institutions. Competitiveness as a construct is therefore conceptualized as the firm’s ability to remain in markets under conditions of — or at least almost — free competition. More precisely, according to Schneider (1998: 68), the firm’s competitiveness as a non-failure in the market process consists of two components: (a) the ability to prove itself in market processes with parties from the market’s counter-side (vertical component); and (b) the ability to withstand the menacing forces of rivals or third-parties in the business environment (horizontal and lateral component). Thus, a longing for competitiveness is merely the way to ensure today’s and tomorrow’s subsistence. Striving to avoid tautological reasoning and primarily intending to explain why firms exist, CbTF’s epistemological aim is therefore the explanation of current and future firm competitiveness in markets due to inhomogeneous availability of competences and resources. The reason for choosing this explanandum is twofold: (1) According to HCE 2, when longing for competitiveness, players act under radical uncertainty. Thus they cannot know in advance whether they will achieve competitive advantage based on their resources and competences. (2) Referring to HCE 6, time matters. Each player will paint his/her own specific, more or less visionary picture of later market requirements. In this context he/she will set up a value-added system, backed up by heterogeneous potentials (resources and competences) and guided by the available entrepreneurial forces (HCE 4, homo agens), in order to provide a competitive input to the market which is — hopefully, but not necessarily — the root of competitive advantage (‘striving for competitiveness’). This argument can even be strengthened with regard to the parallels between CbTF and the Austrian business cycle and capital theory Freiling et al.: Towards a Competence-based Theory of the Firm 1151 (Foss and Ishikawa 2007). Constraining forces will work, based on historicity (HCE 6) and embeddedness (HCE 5). This process is ongoing and pathdependent — as long as a firm remains competitive. The shift from ‘competitive advantage’ to ‘striving for competitiveness’ has considerable impact on the definition of the main terms in competence research. Firstly, as long as resources (and competences) explain the roots of competitiveness and the uncertain development of competitive advantages, it is not sufficient to understand them as ‘anything which could be thought of as a strength or a weakness of a given firm’ (Wernerfelt 1984: 172). Resources and competences are an outcome of the firm’s combination and refinement processes, enabling it to be better prepared for proving itself in market processes with customers/suppliers and withstanding the pressure of competitors. As Penrose (1959: 75–76) stated: ‘The fact that most resources can provide a variety of different services is of great importance for the productive opportunity of a firm. It is the heterogeneity, and not the homogeneity, of the productive services available or potentially available from its resources that gives each firm its unique character.’ Accordingly, the following differentiation is required and in accord with the HCE debate and the epistemological aims of CbTF: Assets are homogeneous external or internal factors that can usually be procured in markets, serving as input for value-added/upgrading processes. Resources can be understood as those assets that have undergone a firm-specific upgrading process. Therefore they should (in face of HCE 2, without any certainty) contribute to the actual and future competitiveness of a firm and thus account for the firm’s heterogeneity. Competences mean a repeatable, non-random ability to render competitive output. This ability is based on knowledge, channelled by rules and patterns. The more competences that are applied, the less room there is for windfall profits. Competences direct goal-oriented processes for surfacing future performance potential while offering concrete input to the market. The role of the above-mentioned terms is depicted in Figure 2. In particular, it is not necessarily the case that the activation of competences guarantees success in the market process. The better the whole value-added system is synchronized with actual and potential market requirements based on visionary shaping of the external conditions, however, the more promising the presumptions are. The outcome is that CbTF delivers a platform to overcome the tautology critique. In particular, the argument can be made without referring to the rent discussion anchored in equilibrium-based thinking (Foss 2002: 152). To go one step further, the dynamic character of CbTF will be delineated. All the assets, resources and competences representing the firm’s potential are variable. The left-hand side of Figure 3 shows that the potential (readiness for action) at one point in time is the basis for a specific action. This action, which is also based on intention and expectation, can also yield new insights, for example via customer feedback in the market process. In this way, the potential at the next point in time will be modified so that the readiness for action later on will change: time matters (HCE 6). The right-hand side of Figure 3 1152 Organization Studies 29(08&09) Figure 2 CbTF's Chain of Reasoning ‘Meta competences’ Shaping of market input processes Shaping of readiness for action Market processes Visionary shaping Transaction?! Offering of products/services Processes (Market input) competences Resources (Asset upgrading) competences Assets Market feedback Upgradability Upgrading Ability of activation Activation Offer to market highlights the accumulation processes over time. By taking a number of actions into account, the helix structure indicates shifts in the firm’s readiness for action. Due to similar action of rivals and uncertainty (HCE 3), it is not possible to state whether or how far these processes will contribute to a higher level of competitiveness. On the other hand, an invalidation of such processes is possible, for example if competitors are able to trigger innovative processes with creative–destructive impact (Schumpeter 1934). It is apparent that the focused theoretical programme of CbTF offers a starting point for addressing the nature of the firm. Before analysing this topic, a debate on the positioning of CbTF in organization theory will help in locating the paradigm that embraces CbTF. Locating CbTF in Management and Organization Theory Primarily in the 1970s and 1980s, many proposals were made in order to structure the considerable heterogeneity of organization theory (e.g. Burrell and Morgan 1979; Astley and Van de Ven 1983). Such taxonomies are useful for identifying streams of organization research that fit into one — existing or evolving — paradigm (Kuhn 1962) and make use of similar and compatible assumptions, research principles, laws and scientific methods (Chalmers 1999). More important, regarding problematic kinds of eclecticism, is the identification of the ‘boundaries’ of a paradigm or a research programme. Bearing in mind the cornerstones of CbTF based on the HCEs, the taxonomy developed by Burrell and Morgan (1979) appears to be useful in understanding CbTF’s fundamental position and the all-encompassing paradigm. Figure 4 demonstrates that Burrell and Morgan (1979: 1) deal with the basic ontological dimension, whether the reality under investigation is external or internal to the Freiling et al.: Towards a Competence-based Theory of the Firm Figure 3 Action and Readiness for Action (Ortmann 2008) 1153 R5 R4 A4 Readiness for action X1 in t1 Action (application and creation of new readiness) R3 Readiness for action X2 in t2 R2 A3 A2 A1 R1 individual — a question directly mirrored in the HCEs mentioned above. Fundamentally, the subjectivist approach to social science is to be separated from the objectivist approach. As to the ontological question, subjectivism is expressed by a position of nominalism, and objectivism by realism. According to HCE 1, CbTF follows nominalism and assumes that reality is not a given, but a product of the mind. Furthermore, the assumption concerning human nature reflects CbTF’s roots in subjectivism: HCE 5 points to moderate voluntarism, which implies that human action is to a large extent not a strict consequence of environmental conditions, as suggested for example by traditional IO. The position is not an extreme one, however, the agent’s free will being restricted by embeddedness. Subjectivism reveals interesting methodological consequences: the subjective position tends towards ideographic methodology, favouring qualitative analysis governed by the subject matter under investigation (Burrell and Morgan 1979: 2–7). As they argue: ‘The ideographic approach to social science is based on the view that one can only understand the social world by obtaining first-hand knowledge of the subject under investigation. It thus places considerable stress upon getting close to one’s subject and exploring its detailed background and life … The ideographic method stresses the importance of letting one’s subject unfold its nature and characteristics during the process of investigation.’ (Burrell and Morgan 1979: 6) The second dimension in use addresses the ‘order versus conflict’ debate, triggered in particular by Dahrendorf (1959). Whereas the sociology of order touches upon the explanation of structures, the sociology of conflict addresses change and its implications. CbTF takes an intermediate position. Change happens, due to the entrepreneurial action (HCE 4: homo agens) of individuals — either individually or together with others acting in organizations — according 1154 Organization Studies 29(08&09) Figure 4 Paradigms for the Analysis of Social Theory (Burrell/Morgan 1979: 22) the sociology of radical change ‘radical humanist’ ‘radical structuralist’ subjective objective ‘interpretive’ ‘functionalist’ the sociology of regulation to HCE 3 (individualism). Change is possible, however, though at the same time restricted by prior decision making and the embeddedness of the firm in the environment. Due to the historicity argument (HCE 6) and the relevance of organizational inertia in social and economic life, scepticism towards radical change is part of CbTF thinking. To summarize, in terms of the Burrell and Morgan taxonomy, CbTF belongs to the interpretive paradigm — but without radical positioning. Thus CbTF is located near to the border with the radical humanist paradigm. The diversity of approaches belonging to the interpretive cluster (e.g. Weick 1995; Choo 1998) reminds us to be wary of the mutual exchange of constructs and findings: although similar in nature, the assumptions are not necessarily the same. Moreover, CbTF does not follow thinking in terms of radical subjectivism — as HCE 5 (moderate voluntarism) suggests. These considerations indicate that central debates in organization theory do not end up as ‘either/or’ categorizations (implicitly suggested by the given taxonomy) but rather as ‘as well as’ considerations, such as pointed out by Astley and Van de Ven (1983). Nevertheless, in order to understand the idiosyncracies of a theoretical perspective with its commonalities and differences when compared to other research streams, the taxonomy of Burrell and Morgan is useful: in a nutshell, many of the organization theories in use belong to the functionalist paradigm, including IO, new institutional economics and neoclassical theory. Regarding the fundamental viewpoint, the assumptions and methodology of those theories are so different from theories belonging to the interpretive cluster that incommensurability is inevitable. This is one basic outcome of this section: in terms of the philosophy of science it does not make sense to combine theories of the functionalist (e.g. TCE) and the interpretive paradigm (e.g. CbTF; but not RBV in general, cf. Foss 2002, who bemoans the heterogeneity problem of the RBV) due to incompatibility. This holds true regardless of the fact that important constructs (e.g. specificity) can be evolutionarily re-conceptualized in CbTF. Moreover, it leads to an educated guess that the explanations of the nature of the firm will differ from, for example, transaction cost theory if CbTF thinking is Freiling et al.: Towards a Competence-based Theory of the Firm 1155 applied. An explanation that goes beyond opportunism is possible. This string of thoughts directly links with resource and competence research (e.g. Conner 1991; Foss 1993; Madhok 1996). Another outcome is that commensurable theories can be identified. The CbTF, as a theory belonging to the tradition of evolutionary economics, is deeply rooted in market process theory. Hunt (2000) and Foss and Ishikawa (2007) come to similar conclusions. Incidentally, in this regard this paper lies very close to the work of Penrose (1959), whose entrepreneurial and discovery process-based touch was stressed by Foss (2002). When one considers basic assumptions, the way of reasoning and the methodology in use, the compatibility becomes apparent. Market process theory, in particular that formulated by the New Austrian Economics (Mises 1949; Kirzner 1973; Hayek 1978), deals with trial and error processes resting upon entrepreneurship, knowledge and skills (such as alertness) as the cutting edge in competition. The same applies to CbTF, whereupon CbTF goes one step further and addresses the aligned interplay of skills by the competence construct. Following the evolutionary logic, market process theory explains how new ideas/actions and innovative impulses evolve (variation), to what extent they succeed or fail in competition (selection) and whether they become part of future market processes (retention). Although market process theory has proven indispensable in understanding markets and industries, it still faces the abovementioned problem of a ‘missing chapter’, namely, that the explanation of value-added processes in the firm in connection with individual (and organizational) action is insufficient (Boettke 1994; Loasby 2002). CbTF, however, is in a position to finally bridge this gap, for at least two reasons. Firstly, CbTF is compatible with market process theory, as outlined above. One can regard CbTF not only as belonging in the same paradigm as market process theory, but as an integral part of market process theory. Secondly, CbTF offers a variety of causal structures which are part of the explanans. These causal structures open the road to understanding the very nature of the firm — a question of such a fundamental nature that the corresponding findings can simultaneously be used in order to explain effects in competition. Stepping Ahead: The Competence-based Nature of the Firm Why do firms exist? What are firms made up of? These questions represent the start of a theory of the firm and are the subject of the considerations of this section. Follow-up questions would relate to the firm’s development over time, its possible downfall, its boundaries, and internal organization (Foss 1993; Langlois and Robertson 1995). In order to address the issue of the nature and essence of the firm, apart from established theories such as the transaction cost approach (Williamson 1985), the work of Penrose once more comes into play: ‘A firm is more than an administrative unit; it is also a collection of productive resources the disposal of which between different uses and over time is determined by administrative decision’ (Penrose 1959: 25). In order to understand the firm, she points out: ‘The essential 1156 Organization Studies 29(08&09) difference between economic activity inside the firm and … in the “market” is that the former is carried on within an administrative organization, while the latter is not’ (1959: 15). The following considerations shed additional light on the internal conditions of firms, helping to explain why firms as institutions are indispensable modes of economic coordination facing alternative governance designs. Transaction cost theorists argue that, in the case of specific environmental conditions, firms are required in order to overcome the transaction-related problems connected with opportunistic behaviour and information impactedness. The explanation rests to a great extent upon the negative consequences of uncertainty. CbTF gives rise to additional arguments. In reference once again to the classical pedigree of competence research, the argument of List (1841) is invoked. Clearly, the opportunities provided through division of labour are not independent of the underlying institutional design. Admittedly, division of labour works in markets as wells as in firms and cooperatives but not in the same way. List (1841) and his ‘law of the confederation of productive forces’ shows a promising modus by referring to the necessity of orchestrating the processes of divided work — thoughts that recur in Penrose (1959). This leads to the question of what really differs if we compare markets and firms à la Penrose. The answer is close to her proposal of the ‘area of (administrative) coordination’ (Penrose1959: 20): the firm offers a specific ‘ambiente’. This ambience, representing a fertile background for firm-specific coordination, resource and competence usage as well as development, is required in order to unveil the productive forces of the firm and to contribute to competitiveness as conceptualized above. Moreover, and with regard to the entrepreneurial touch of CbTF, it helps to generate new productive forces. Why does this take place differently in firms than in markets or loosely coupled systems of cooperation? The answer can be given by referring to the causal structures of CbTF, borrowed from resource-based research and, if possible, adapted to CbTF. What does prior research suggest in this context? Based on a system of different assumptions, Kogut and Zander (1992) refer to so-called ‘higher order organizing principles’ of the firm, which is a first indication that coordination in firms differs from that in other institutions. These higher-order organizing principles rest upon procedures by which social relations among employees are recreated and coordinated. With the help of these principles, knowledge can be used in a structured way to facilitate value-added activities and to enable voluntary action. Similarly rooted, Hodgson (1998: 189) makes an interesting suggestion by pointing out the firm’s capacity to protect and develop competences in the organization. Although we need arguments as to how this might occur, a fertile background triggering these development processes seems to make a difference between the firm and alternative modes of governance. Hodgson recognizes a capacity of the firm as an institution to mould and integrate the individual perceptions, preferences, abilities and actions of its personnel. Foss (1996: 18) states that firms exist due to a more efficient coordination of learning activities compared to other institutions. This is worth taking up, by tackling the question of what is different in the case of organizing learning within firms compared to within other institutions. Helfat and Peteraf (2003) Freiling et al.: Towards a Competence-based Theory of the Firm 1157 conclude that, under the cover of causally ambiguous relations among individuals in organizations, joint interpretations emerge that lead to collective minds. Finally, the point of Penrose (1959) is taken into consideration: firms offer outstanding opportunities for production thanks to the system of productive resources that constitutes the firm. In this context, Ravix (2002: 167) concludes that production requires a certain environment, which is a given in the case of firms as institutions. Accordingly, we should pay attention to the way in which this combination of productive assets, resources and competences is formed. All these findings are useful for a preliminary understanding of the specific ‘ambiente’ of a firm and its raison d’être. In contrast to TCE, these considerations not only focus on coordination/transaction but also production/transformation. CbTF tries to integrate the two economic challenges into a cohesive whole by acknowledging the aspect of time and evolution. Understanding the fertile background offered by firms as institutions requires going some way further. It is argued that the answer can be given by referring once again to the division and unification of labour and the role of entrepreneurship (List (1841; Penrose 1959). In face of the moderate voluntarism of CbTF (HCE 5) and the homo agens notion (HCE 4), entrepreneurial motives are important in order to address the very nature of CbTF more comprehensively. Taking the subjectivism argument (HCE 1) seriously, entrepreneurs are equipped with different entrepreneurial spirits, minds and skills. Some of them might be powerful people, others less so. Nevertheless, two points are important when conditions of radical uncertainty (HCE 2) and historicity and nonergodicity (HCE 6) apply. Firstly, the power of every entrepreneur is restricted due to embeddedness. To unveil power, as in the case of ‘creative destruction’ (Schumpeter 1934), a ‘division of entrepreneurial labour’ is as necessary as a ‘unification of the entrepreneurial forces’. However, the problem of limited power of individuals is not internalized in Schumpeter’s world of pure voluntarism and power exerted by elitist entrepreneurs. Therefore, our proposal refers to List (1841) as well as Penrose (1959) where interpersonal alignments between people play a decisive role. Responding to Witt’s (1999) interesting question of whether entrepreneurs need firms, the CbTF position is an unambiguous one: entrepreneurs very often need firms because they believe in a world of radical uncertainty (HCE 2), to attain their goals sooner, better or more comprehensively with the help of the institution and the specific mode of coordination accompanying it. They expect to pool influential forces to shape outer conditions and to be better prepared regarding upcoming challenges in future markets. Such a way of thinking is far from TCE and similar theories. Secondly, it is questionable whether entrepreneurship is restricted to one person or those few in the roles of owners or senior management. To unveil the creative potential of a firm requires triggering entrepreneurial thinking and action in every part of the firm. Accordingly, CbTF’s understanding of the firm takes into account what Mises (1940: 246) noted when he touched on the entrepreneurship issue in the context of methodological individualism (HCE 3): as long as the term 1158 Organization Studies 29(08&09) ‘entrepreneur’ is discussed in economic studies, the reference is not to a single person but rather to a function to be performed by people. The viewpoint of Mises (1940) is useful in many ways: leaders with formal authority have to align their entrepreneurial activities, which presupposes the existence of structures. The same applies with regard to the notion that everyone within a firm has at least some discretion to perform entrepreneurial functions, as mentioned earlier. Among these, structures, routines and competences play a prominent role. Separated from other constructs, however, they are not sufficient to enable understanding of what constitutes the ambience of the firm. We will address this idea later when considering the isolating mechanisms of the RBV. To continue the entrepreneurship debate within the scope of CbTF, the question arises as to how entrepreneurship is relevant in explaining the existence and nature of the firm. Sanchez and Heene (1996) develop the framework of the firm as an open system (see Figure 5). This view, also reinterpretable in terms of methodological individualism, points to the importance of governing system elements. The strategic logic comprises rationales employed and entrepreneurs’ minds (Sanchez et al. 1996: 10). The strategic logic of a single person is often restricted by past events and experiences. The firm as a stable institution ties entrepreneurial forces together and helps to overcome individual mental barriers. Identifying business opportunities and developing ideas about how to generate completely new opportunities is therefore a matter of entrepreneurial division and unification of labour. Paths can be created or opened up by pooling ideas and other kinds of assets within the scope of the firm. Taking a look inside the firm in order to understand the ambience more comprehensively, Figure 5 demonstrates the importance of a well-structured value-added net, consisting of a multitude of different assets and governed by management processes that find themselves in recursive relationship to the strategic logic. This structure is subject to permanent adaptations triggered internally or externally, for example by absorbing firm-addressable assets, by learning in the market process with respective feedback loops, or by a consultant’s advice. That asset mass efficiencies of firms differ from similar effects of other institutions (Dierickx and Cool 1989) can well be explained by these internal and market processes. In order to understand why the firm might offer a fertile ambience, more isolating mechanisms (Rumelt 1984) come into play. Regarding the isolating mechanisms, the roles of interconnectedness of assets as well as social complexity become apparent. Firms offer an environment where a multitude of relations among people and links among assets and resources evolve. Notably, the same holds true for other institutions. There are considerable differences, however, as to the quantity and quality of these couplings. In respect of the term ‘complexity’, a usual conceptualization encompasses the multitude of elements, including the quantity, density, and variety of relations between them. Transferring this conceptualization to our context, the complexity of asset networks within firms differs significantly from that within markets. Colleagues find themselves in regular and intense personal interaction. Day by day, employees become better used to available systems and technologies (HCE 6: time matters). Awareness of the opportunities of the firm as an institution grows over time so that 1159 Freiling et al.: Towards a Competence-based Theory of the Firm Figure 5 The Firm as an Open System (Sanchez and Heene 1996: 41) Environment: Scanning, benchmarking, consultants, new managers... Boundaries of the firm as open system Strategic Logic: operating rationale for goal attainment Management Processes: process for coordinating deployments of assets and capabilities Data Intangible Assets: e.g. knowledge, reputation, relationships ... Data Tangible Assets: physical assets, e.g. machines, buildings Data Operations: production, marketing, distribution Firm addressable resources: available external resources Fading transparency and increasing oranizational inertia Decisions, procedures Product Offerings Product Markets Competition Information by the market the notion of asset mass efficiencies applies due to synergies — in just the way that market process theory suggests (Hayek 1978). By scrutinizing the asset (re-)configuration activities in this tightly coupled context, it emerges that, due to the stability and the long-term horizon of firms, certain action-oriented structures evolve that are considered as routines in evolutionary theories (Pentland and Rueter 1994). Those action sequences, containing mental blueprints of how to proceed and deeply embedded in people’s minds, are channelled by the organizational goals as well as the explicit and implicit rules that are the result of interaction processes among individuals (HCE 3). Such a background, preparing the employees for specific action in contextual value-added activities, is significantly different from the more or less anonymous ‘arm’s-length’ context of markets. These couplings can well explain the immobility of certain resources — which might be associated with inflexibility. How far these specification processes are useful in order to increase the firm’s competitiveness remains open in a world of radical uncertainty (HCE 1). Nevertheless, the firm is prepared regarding certain situations that might arise, in a different way to those of other institutions. Whereas rules and routines add some flesh to the bones of the ‘ambiente’ notion, the role of tacit knowledge is also important. Beside the fact that tacit knowledge fuels routines to a great extent, implicit knowledge represents a core challenge of coordination. Whereas tacit knowledge is almost permanently in use by its bearer, the outcome of a group of people depends on the extent to which tacit knowledge is transferred among individuals and skilfully put to use by the team. In the context of institutions, the question arises why a single person should transfer tacit knowledge to others — considering that the transfer is costly, indeterminate and time-consuming. In markets, this kind of transfer will 1160 Organization Studies 29(08&09) not take place, due to a lack of incentive structures. In firms, however, the situation is quite different (Freiling 2004): transfer is not only possible due to permanent ‘training on the job’ by the potential recipients, but is positively aimed for, due to mutual understanding and the belief that it will ‘pay off’ in terms of successful outcomes for the firm, which depend on skilful workers and their efficient interaction. All the isolating mechanisms mentioned above explain a coordination difference of firms vis-à-vis other institutions. Isolating mechanisms can work in different ways: they can contribute to developing the ambience of the firm as well as protecting the causally ambiguous asset network in face of appropriation strategies by rivals Finally, the pressing question arises again as to what differentiates the ambience of firms from those of alternative institutions. Do the mechanisms mentioned work only in firms or also in other institutions? The response is twofold: it seems likely that similar forces might appear in other institutional contexts. Particularly from a non-evolutionary point of view, there is no real difference. When an evolutionary perspective is applied, however, the situation changes. Time matters, in many ways, and causes accumulation effects that are institution-specific. The enduring character of the firm creates favourable conditions in order to develop coordination modes that differ from other institutions in terms of quality. This seems to be a core argument and indicates that not only was there something like a paradigm shift (Kuhn 1962) from IO to RBV in strategic management, but that we are over halfway towards another paradigm shift, from non-evolutionary, functionalist theories to evolutionary theories, with market process theory as one prominent representative. Outlook The approach chosen in this paper is different from prior attempts. Many scholars have favoured the connection of new institutional economics with the resource-based and competence-based perspective (e.g. Conner 1991; Langlois and Robertson 1995; Hodgson 1998). In the case of making adaptations among different research streams and testing commensurability, this procedure is possible from the perspective of the philosophy of science. The proposal of this paper, contributing to the metamorphosis of the theory of the firm, is to focus the enormous scope of resource and competence research and to investigate the opportunities for explanation on this platform rooted in market process theory. The approach we have proposed indicates the need to take some steps back in order to move forward. With regard to the fundamental problems of resource and competence research, however, it seems to be worth a try to confront the opportunities presented in order to address these issues. Moreover, this research approach appears to be able to close a long-lasting gap in market process theory on the one hand, while benefiting from the advantages of market process theory on the other. In this respect, embedding entrepreneurial thinking deeper in competence research is one opportunity that presents itself, tying together the work of classical theorists, that of Penrose and Freiling et al.: Towards a Competence-based Theory of the Firm 1161 more recent strands of management theory, in order to combine entrepreneurship theory and strategic management. Another opportunity presented by this theory is that it leads to an understanding of the interplay between the ontological levels of the firm and industry/the market. Note References We gratefully acknowledge the support of Christos Pitelis and helpful comments by three anonymous reviewers. Acedo, F. J., C. Barroso, and J. L. Galan 2007 ‘The resource-based theory: Dissemination and main trends’. 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Shuen 1997 ‘Dynamic capabilities and strategic management’. Strategic Management Journal 18/7: 509–533. Vaughn, K. I. 1994 Austrian economics in America. Cambridge: Cambridge University Press. Weick, K. F. 1995 Sensemaking in organizations. Thousand Oaks, CA: Sage. Wernerfelt, B. 1984 ‘A resource based view of the firm’. Strategic Management Journal 5/2: 171–180. Williamson, O. E. 1985 The economic institutions of capitalism. New York: Free Press. Witt, U. 1999 ‘Do entrepreneurs need firms?’ Review of Austrian Economics 11: 99–110. Jörg Freiling Jörg Freiling has a PhD in Business Administration and is a Full Professor at the University of Bremen. He is Director of the SCOUT Institute for Competence-based Strategic Management and holds the LEMEX Chair for Small Business and Entrepreneurship. His research interests include the theory of the firm, the management of organizational competences, the impact of entrepreneurship on organizational performance, change management and SME management in international business. Address: LEMEX Chair for Small Business and Entrepreneurship, Faculty of Business Studies & Economics, University of Bremen, Wilhelm-Herbst-Strasse 5, D-28359 Bremen, Germany. Email: freiling@uni-bremen.de Martin Gersch Martin Gersch has a PhD in Business Administration and Business Informatics. He is a Full Professor at the Freie Universität Berlin (Germany) and head of the Competence Centre E-Commerce. His research interests include evolutionary theories, resource and competence research, strategic and information management, industry transformation, change processes, e-business, innovative business models, e-learning, and competitive (dis)advantages and traps. Address: Freie Universität Berlin, School of Business & Economics, Garystrasse 21, 14195 Berlin, Germany. Email: martin.gersch@fu-berlin.de Christian Goeke Christian Goeke is a Research Associate at the School of Business and Economics at the Freie Universität Berlin (Germany). He received his PhD in economics and business administration from the Ruhr-University Bochum (Germany). His current research focuses on strategic challenges of industry transformation, with a special focus on the coevolution of objects on different levels of analysis, alliance strategies, and competencebased strategic management. Address: Freie Universität Berlin, School of Business & Economics, Garystrasse 21, 14195 Berlin, Germany. Email: christian.goeke@fu-berlin.de www.hbrreprints.org Awareness of the five forces can help a company understand the structure of its industry and stake out a position that is more profitable and less vulnerable to attack. The Five Competitive Forces That Shape Strategy by Michael E. Porter Included with this full-text Harvard Business Review article: 1 Article Summary The Idea in Brief—the core idea The Idea in Practice—putting the idea to work 2 The Five Competitive Forces That Shape Strategy 18 Further Reading A list of related materials, with annotations to guide further exploration of the article’s ideas and applications Reprint R0801E This document is authorized for use only in Laureate Education, Inc. 's MHRM 6605 Strategic Human Resource Management at Laureate Education - Baltimore from Feb 2018 to Apr 2019. The Five Competitive Forces That Shape Strategy The Idea in Brief The Idea in Practice You know that to sustain long-term profitability you must respond strategically to competition. And you naturally keep tabs on your established rivals. But as you scan the competitive arena, are you also looking beyond your direct competitors? As Porter explains in this update of his revolutionary 1979 HBR article, four additional competitive forces can hurt your prospective profits: By understanding how the five competitive forces influence profitability in your industry, you can develop a strategy for enhancing your company’s long-term profits. Porter suggests the following: • Savvy customers can force down prices by playing you and your rivals against one another. • Powerful suppliers may constrain your profits if they charge higher prices. • Aspiring entrants, armed with new capacity and hungry for market share, can ratchet up the investment required for you to stay in the game. COPYRIGHT © 2008 HARVARD BUSINESS SCHOOL PUBLISHING CORPORATION. ALL RIGHTS RESERVED. • Substitute offerings can lure customers away. Consider commercial aviation: It’s one of the least profitable industries because all five forces are strong. Established rivals compete intensely on price. Customers are fickle, searching for the best deal regardless of carrier. Suppliers—plane and engine manufacturers, along with unionized labor forces—bargain away the lion’s share of airlines’ profits. New players enter the industry in a constant stream. And substitutes are readily available—such as train or car travel. By analyzing all five competitive forces, you gain a complete picture of what’s influencing profitability in your industry. You identify game-changing trends early, so you can swiftly exploit them. And you spot ways to work around constraints on profitability— or even reshape the forces in your favor. POSITION YOUR COMPANY W HERE THE FORCES ARE WEAKEST Example: In the heavy-truck industry, many buyers operate large fleets and are highly motivated to drive down truck prices. Trucks are built to regulated standards and offer similar features, so price competition is stiff; unions exercise considerable supplier power; and buyers can use substitutes such as cargo delivery by rail. To create and sustain long-term profitability within this industry, heavy-truck maker Paccar chose to focus on one customer group where competitive forces are weakest: individual drivers who own their trucks and contract directly with suppliers. These operators have limited clout as buyers and are less price sensitive because of their emotional ties to and economic dependence on their own trucks. For these customers, Paccar has developed such features as luxurious sleeper cabins, plush leather seats, and sleek exterior styling. Buyers can select from thousands of options to put their personal signature on these built-to-order trucks. Customers pay Paccar a 10% premium, and the company has been profitable for 68 straight years and earned a long-run return on equity above 20%. EXPLOIT CHANGES IN THE FORCES Example: With the advent of the Internet and digital distribution of music, unauthorized downloading created an illegal but potent substitute for record companies’ services. The record companies tried to develop technical platforms for digital distribution themselves, but major labels didn’t want to sell their music through a platform owned by a rival. Into this vacuum stepped Apple, with its iTunes music store supporting its iPod music player. The birth of this powerful new gatekeeper has whittled down the number of major labels from six in 1997 to four today. RESHAPE THE FORCES IN YOUR FAVOR Use tactics designed specifically to reduce the share of profits leaking to other players. For example: • To neutralize supplier power, standardize specifications for parts so your company can switch more easily among vendors. • To counter customer power, expand your services so it’s harder for customers to leave you for a rival. • To temper price wars initiated by established rivals, invest more heavily in products that differ significantly from competitors’ offerings. • To scare off new entrants, elevate the fixed costs of competing; for instance, by escalating your R&D expenditures. • To limit the threat of substitutes, offer better value through wider product accessibility. Soft-drink producers did this by introducing vending machines and convenience store channels, which dramatically improved the availability of soft drinks relative to other beverages. page 1 This document is authorized for use only in Laureate Education, Inc. 's MHRM 6605 Strategic Human Resource Management at Laureate Education - Baltimore from Feb 2018 to Apr 2019. Awareness of the five forces can help a company understand the structure of its industry and stake out a position that is more profitable and less vulnerable to attack. The Five Competitive Forces That Shape Strategy by Michael E. Porter COPYRIGHT © 2007 HARVARD BUSINESS SCHOOL PUBLISHING CORPORATION. ALL RIGHTS RESERVED. Editor’s Note: In 1979, Harvard Business Review published “How Competitive Forces Shape Strategy” by a young economist and associate professor, Michael E. Porter. It was his first HBR article, and it started a revolution in the strategy field. In subsequent decades, Porter has brought his signature economic rigor to the study of competitive strategy for corporations, regions, nations, and, more recently, health care and philanthropy. “Porter’s five forces” have shaped a generation of academic research and business practice. With prodding and assistance from Harvard Business School Professor Jan Rivkin and longtime colleague Joan Magretta, Porter here reaffirms, updates, and extends the classic work. He also addresses common misunderstandings, provides practical guidance for users of the framework, and offers a deeper view of its implications for strategy today. In essence, the job of the strategist is to understand and cope with competition. Often, however, managers define competition too narrowly, as if it occurred only among today’s harvard business review • january 2008 direct competitors. Yet competition for profits goes beyond established industry rivals to include four other competitive forces as well: customers, suppliers, potential entrants, and substitute products. The extended rivalry that results from all five forces defines an industry’s structure and shapes the nature of competitive interaction within an industry. As different from one another as industries might appear on the surface, the underlying drivers of profitability are the same. The global auto industry, for instance, appears to have nothing in common with the worldwide market for art masterpieces or the heavily regulated health-care delivery industry in Europe. But to understand industry competition and profitability in each of those three cases, one must analyze the industry’s underlying structure in terms of the five forces. (See the exhibit “The Five Forces That Shape Industry Competition.”) If the forces are intense, as they are in such industries as airlines, textiles, and hotels, almost no company earns attractive returns on page 2 This document is authorized for use only in Laureate Education, Inc. 's MHRM 6605 Strategic Human Resource Management at Laureate Education - Baltimore from Feb 2018 to Apr 2019. The Five Competitive Forces That Shape Strategy investment. If the forces are benign, as they are in industries such as software, soft drinks, and toiletries, many companies are profitable. Industry structure drives competition and profitability, not whether an industry produces a product or service, is emerging or mature, high tech or low tech, regulated or unregulated. While a myriad of factors can affect industry profitability in the short run—including the weather and the business cycle—industry structure, manifested in the competitive forces, sets industry profitability in the medium and long run. (See the exhibit “Differences in Industry Profitability.”) Understanding the competitive forces, and their underlying causes, reveals the roots of an industry’s current profitability while providing a framework for anticipating and influencing competition (and profitability) over time. A healthy industry structure should be as much a competitive concern to strategists as their company’s own position. Understanding industry structure is also essential to effective strategic positioning. As we will see, defending against the competitive forces and shaping them in a company’s favor are crucial to strategy. Forces That Shape Competition Michael E. Porter is the Bishop William Lawrence University Professor at Harvard University, based at Harvard Business School in Boston. He is a sixtime McKinsey Award winner, including for his most recent HBR article, “Strategy and Society,” coauthored with Mark R. Kramer (December 2006). harvard business review • january 2008 The configuration of the five forces differs by industry. In the market for commercial aircraft, fierce rivalry between dominant producers Airbus and Boeing and the bargaining power of the airlines that place huge orders for aircraft are strong, while the threat of entry, the threat of substitutes, and the power of suppliers are more benign. In the movie theater industry, the proliferation of substitute forms of entertainment and the power of the movie producers and distributors who supply movies, the critical input, are important. The strongest competitive force or forces determine the profitability of an industry and become the most important to strategy formulation. The most salient force, however, is not always obvious. For example, even though rivalry is often fierce in commodity industries, it may not be the factor limiting profitability. Low returns in the photographic film industry, for instance, are the result of a superior substitute product—as Kodak and Fuji, the world’s leading producers of photographic film, learned with the advent of digital photography. In such a situation, coping with the substitute product be- comes the number one strategic priority. Industry structure grows out of a set of economic and technical characteristics that determine the strength of each competitive force. We will examine these drivers in the pages that follow, taking the perspective of an incumbent, or a company already present in the industry. The analysis can be readily extended to understand the challenges facing a potential entrant. Threat of entry. New entrants to an industry bring new capacity and a desire to gain market share that puts pressure on prices, costs, and the rate of investment necessary to compete. Particularly when new entrants are diversifying from other markets, they can leverage existing capabilities and cash flows to shake up competition, as Pepsi did when it entered the bottled water industry, Microsoft did when it began to offer internet browsers, and Apple did when it entered the music distribution business. The threat of entry, therefore, puts a cap on the profit potential of an industry. When the threat is high, incumbents must hold down their prices or boost investment to deter new competitors. In specialty coffee retailing, for example, relatively low entry barriers mean that Starbucks must invest aggressively in modernizing stores and menus. The threat of entry in an industry depends on the height of entry barriers that are present and on the reaction entrants can expect from incumbents. If entry barriers are low and newcomers expect little retaliation from the entrenched competitors, the threat of entry is high and industry profitability is moderated. It is the threat of entry, not whether entry actually occurs, that holds down profitability. Barriers to entry. Entry barriers are advantages that incumbents have relative to new entrants. There are seven major sources: 1. Supply-side economies of scale. These economies arise when firms that produce at larger volumes enjoy lower costs per unit because they can spread fixed costs over more units, employ more efficient technology, or command better terms from suppliers. Supplyside scale economies deter entry by forcing the aspiring entrant either to come into the industry on a large scale, which requires dislodging entrenched competitors, or to accept a cost disadvantage. Scale economies can be found in virtually every activity in the value chain; which ones page 3 This document is authorized for use only in Laureate Education, Inc. 's MHRM 6605 Strategic Human Resource Management at Laureate Education - Baltimore from Feb 2018 to Apr 2019. The Five Competitive Forces That Shape Strategy are most important varies by industry.1 In microprocessors, incumbents such as Intel are protected by scale economies in research, chip fabrication, and consumer marketing. For lawn care companies like Scotts Miracle-Gro, the most important scale economies are found in the supply chain and media advertising. In small-package delivery, economies of scale arise in national logistical systems and information technology. 2. Demand-side benefits of scale. These benefits, also known as network effects, arise in industries where a buyer’s willingness to pay for a company’s product increases with the number of other buyers who also patronize the company. Buyers may trust larger companies more for a crucial product: Recall the old adage that no one ever got fired for buying from IBM (when it was the dominant computer maker). Buyers may also value being in a “network” with a larger number of fellow customers. For instance, online auction participants are attracted to eBay because it offers the most potential trading partners. Demandside benefits of scale discourage entry by limiting the willingness of customers to buy from a newcomer and by reducing the price the newcomer can command until it builds up a large base of customers. 3. Customer switching costs. Switching costs are fixed costs that buyers face when they The Five Forces That Shape Industry Competition Threat of New Entrants Bargaining Power of Suppliers Rivalry Among Existing Competitors Threat of Substitute Products or Services harvard business review • january 2008 Bargaining Power of Buyers change suppliers. Such costs may arise because a buyer who switches vendors must, for example, alter product specifications, retrain employees to use a new product, or modify processes or information systems. The larger the switching costs, the harder it will be for an entrant to gain customers. Enterprise resource planning (ERP) software is an example of a product with very high switching costs. Once a company has installed SAP’s ERP system, for example, the costs of moving to a new vendor are astronomical because of embedded data, the fact that internal processes have been adapted to SAP, major retraining needs, and the mission-critical nature of the applications. 4. Capital requirements. The need to invest large financial resources in order to compete can deter new entrants. Capital may be necessary not only for fixed facilities but also to extend customer credit, build inventories, and fund start-up losses. The barrier is particularly great if the capital is required for unrecoverable and therefore harder-to-finance expenditures, such as up-front advertising or research and development. While major corporations have the financial resources to invade almost any industry, the huge capital requirements in certain fields limit the pool of likely entrants. Conversely, in such fields as tax preparation services or short-haul trucking, capital requirements are minimal and potential entrants plentiful. It is important not to overstate the degree to which capital requirements alone deter entry. If industry returns are attractive and are expected to remain so, and if capital markets are efficient, investors will provide entrants with the funds they need. For aspiring air carriers, for instance, financing is available to purchase expensive aircraft because of their high resale value, one reason why there have been numerous new airlines in almost every region. 5. Incumbency advantages independent of size. No matter what their size, incumbents may have cost or quality advantages not available to potential rivals. These advantages can stem from such sources as proprietary technology, preferential access to the best raw material sources, preemption of the most favorable geographic locations, established brand identities, or cumulative experience that has allowed incumbents to learn how to produce more efficiently. Entrants try to bypass such advantages. Upstart discounters such as Target and Wal- page 4 This document is authorized for use only in Laureate Education, Inc. 's MHRM 6605 Strategic Human Resource Management at Laureate Education - Baltimore from Feb 2018 to Apr 2019. The Five Competitive Forces That Shape Strategy Mart, for example, have located stores in freestanding sites rather than regional shopping centers where established department stores were well entrenched. 6. Unequal access to distribution channels. The new entrant must, of course, secure distribution of its product or service. A new food item, for example, must displace others from the supermarket shelf via price breaks, promotions, intense selling efforts, or some other means. The more limited the wholesale or retail channels are and the more that existing competitors have tied them up, the tougher entry into an industry will be. Sometimes access to distribution is so high a barrier that new entrants must bypass distribution channels altogether or create their own. Thus, upstart low-cost airlines have avoided distribution through travel agents (who tend to favor estab- lished higher-fare carriers) and have encouraged passengers to book their own flights on the internet. 7. Restrictive government policy. Government policy can hinder or aid new entry directly, as well as amplify (or nullify) the other entry barriers. Government directly limits or even forecloses entry into industries through, for instance, licensing requirements and restrictions on foreign investment. Regulated industries like liquor retailing, taxi services, and airlines are visible examples. Government policy can heighten other entry barriers through such means as expansive patenting rules that protect proprietary technology from imitation or environmental or safety regulations that raise scale economies facing newcomers. Of course, government policies may also make entry easier—directly through subsidies, for instance, or Differences in Industry Profitability The average return on invested capital varies markedly from industry to industry. Between 1992 and 2006, for example, average return on invested capital in U.S. industries ranged as low as zero or even negative to more than 50%. At the high end are industries like soft drinks and prepackaged software, which have been almost six times more profitable than the airline industry over the period. Profitability of Selected U.S. Industries Average Return on Invested Capital in U.S. Industries, 1992–2006 50 10th percentile 7.0% 25th percentile 10.9% Median: 14.3% 75th percentile 18.6% Average ROIC, 1992–2006 90th percentile 25.3% Number of Industries 40 30 20 10 0 0% or lower 5% 10% 15% 20% 25% 30% ROIC 35% or higher Return on invested capital (ROIC) is the appropriate measure of profitability for strategy formulation, not to mention for equity investors. Return on sales or the growth rate of profits fail to account for the capital required to compete in the industry. Here, we utilize earnings before interest and taxes divided by average invested capital less excess cash as the measure of ROIC. This measure controls for idiosyncratic differences in capital structure and tax rates across companies and industries. Source: Standard & Poor’s, Compustat, and author’s calculations harvard business review • january 2008 Security Brokers and Dealers Soft Drinks Prepackaged Software Pharmaceuticals Perfume, Cosmetics, Toiletries Advertising Agencies Distilled Spirits Semiconductors Medical Instruments Men’s and Boys’ Clothing Tires Household Appliances Malt Beverages Child Day Care Services Household Furniture Drug Stores Grocery Stores Iron and Steel Foundries Cookies and Crackers Mobile Homes Wine and Brandy Bakery Products Engines and Turbines Book Publishing Laboratory Equipment Oil and Gas Machinery Soft Drink Bottling Knitting Mills Hotels Catalog, Mail-Order Houses Airlines 40.9% 37.6% 37.6% 31.7% 28.6% 27.3% 26.4% 21.3% 21.0% 19.5% 19.5% 19.2% 19.0% 17.6% 17.0% 16.5% 16.0% 15.6% 15.4% Average industry 15.0% ROIC in the U.S. 13.9% 14.9% 13.8% 13.7% 13.4% 13.4% 12.6% 11.7% 10.5% 10.4% 5.9% 5.9% page 5 This document is authorized for use only in Laureate Education, Inc. 's MHRM 6605 Strategic Human Resource Management at Laureate Education - Baltimore from Feb 2018 to Apr 2019. The Five Competitive Forces That Shape Strategy indirectly by funding basic research and making it available to all firms, new and old, reducing scale economies. Entry barriers should be assessed relative to the capabilities of potential entrants, which may be start-ups, foreign firms, or companies in related industries. And, as some of our examples illustrate, the strategist must be mindful of the creative ways newcomers might find to circumvent apparent barriers. Expected retaliation. How potential entrants believe incumbents may react will also influence their decision to enter or stay out of an Industry Analysis in Practice Good industry analysis looks rigorously at the structural underpinnings of profitability. A first step is to understand the appropriate time horizon. One of the essential tasks in industry analysis is to distinguish temporary or cyclical changes from structural changes. A good guideline for the appropriate time horizon is the full business cycle for the particular industry. For most industries, a three-to-five-year horizon is appropriate, although in some industries with long lead times, such as mining, the appropriate horizon might be a decade or more. It is average profitability over this period, not profitability in any particular year, that should be the focus of analysis. The point of industry analysis is not to declare the industry attractive or unattractive but to understand the underpinnings of competition and the root causes of profitability. As much as possible, analysts should look at industry structure quantitatively, rather than be satisfied with lists of qualitative factors. Many elements of the five forces can be quantified: the percentage of the buyer’s total cost accounted for by the industry’s product (to understand buyer price sensitivity); the percentage of industry sales required to fill a plant or operate a logistical network of efficient scale (to help assess barriers to entry); the buyer’s switching cost (determining the inducement an entrant or rival must offer customers). harvard business review • january 2008 The strength of the competitive forces affects prices, costs, and the investment required to compete; thus the forces are directly tied to the income statements and balance sheets of industry participants. Industry structure defines the gap between revenues and costs. For example, intense rivalry drives down prices or elevates the costs of marketing, R&D, or customer service, reducing margins. How much? Strong suppliers drive up input costs. How much? Buyer power lowers prices or elevates the costs of meeting buyers’ demands, such as the requirement to hold more inventory or provide financing. How much? Low barriers to entry or close substitutes limit the level of sustainable prices. How much? It is these economic relationships that sharpen the strategist’s understanding of industry competition. Finally, good industry analysis does not just list pluses and minuses but sees an industry in overall, systemic terms. Which forces are underpinning (or constraining) today’s profitability? How might shifts in one competitive force trigger reactions in others? Answering such questions is often the source of true strategic insights. industry. If reaction is vigorous and protracted enough, the profit potential of participating in the industry can fall below the cost of capital. Incumbents often use public statements and responses to one entrant to send a message to other prospective entrants about their commitment to defending market share. Newcomers are likely to fear expected retaliation if: • Incumbents have previously responded vigorously to new entrants. • Incumbents possess substantial resources to fight back, including excess cash and unused borrowing power, available productive capacity, or clout with distribution channels and customers. • Incumbents seem likely to cut prices because they are committed to retaining market share at all costs or because the industry has high fixed costs, which create a strong motivation to drop prices to fill excess capacity. • Industry growth is slow so newcomers can gain volume only by taking it from incumbents. An analysis of barriers to entry and expected retaliation is obviously crucial for any company contemplating entry into a new industry. The challenge is to find ways to surmount the entry barriers without nullifying, through heavy investment, the profitability of participating in the industry. The power of suppliers. Powerful suppliers capture more of the value for themselves by charging higher prices, limiting quality or services, or shifting costs to industry participants. Powerful suppliers, including suppliers of labor, can squeeze profitability out of an industry that is unable to pass on cost increases in its own prices. Microsoft, for instance, has contributed to the erosion of profitability among personal computer makers by raising prices on operating systems. PC makers, competing fiercely for customers who can easily switch among them, have limited freedom to raise their prices accordingly. Companies depend on a wide range of different supplier groups for inputs. A supplier group is powerful if: • It is more concentrated than the industry it sells to. Microsoft’s near monopoly in operating systems, coupled with the fragmentation of PC assemblers, exemplifies this situation. • The supplier group does not depend heavily on the industry for its revenues. Suppliers serving many industries will not hesitate to page 6 This document is authorized for use only in Laureate Education, Inc. 's MHRM 6605 Strategic Human Resource Management at Laureate Education - Baltimore from Feb 2018 to Apr 2019. The Five Competitive Forces That Shape Strategy Industry structure drives competition and profitability, not whether an industry is emerging or mature, high tech or low tech, regulated or unregulated. harvard business review • january 2008 extract maximum profits from each one. If a particular industry accounts for a large portion of a supplier group’s volume or profit, however, suppliers will want to protect the industry through reasonable pricing and assist in activities such as R&D and lobbying. • Industry participants face switching costs in changing suppliers. For example, shifting suppliers is difficult if companies have invested heavily in specialized ancillary equipment or in learning how to operate a supplier’s equipment (as with Bloomberg terminals used by financial professionals). Or firms may have located their production lines adjacent to a supplier’s manufacturing facilities (as in the case of some beverage companies and container manufacturers). When switching costs are high, industry participants find it hard to play suppliers off against one another. (Note that suppliers may have switching costs as well. This limits their power.) • Suppliers offer products that are differentiated. Pharmaceutical companies that offer patented drugs with distinctive medical benefits have more power over hospitals, health maintenance organizations, and other drug buyers, for example, than drug companies offering me-too or generic products. • There is no substitute for what the supplier group provides. Pilots’ unions, for example, exercise considerable supplier power over airlines partly because there is no good alternative to a well-trained pilot in the cockpit. • The supplier group can credibly threaten to integrate forward into the industry. In that case, if industry participants make too much money relative to suppliers, they will induce suppliers to enter the market. The power of buyers. Powerful customers— the flip side of powerful suppliers—can capture more value by forcing down prices, demanding better quality or more service (thereby driving up costs), and generally playing industry participants off against one another, all at the expense of industry profitability. Buyers are powerful if they have negotiating leverage relative to industry participants, especially if they are price sensitive, using their clout primarily to pressure price reductions. As with suppliers, there may be distinct groups of customers who differ in bargaining power. A customer group has negotiating leverage if: • There are few buyers, or each one purchases in volumes that are large relative to the size of a single vendor. Large-volume buyers are particularly powerful in industries with high fixed costs, such as telecommunications equipment, offshore drilling, and bulk chemicals. High fixed costs and low marginal costs amplify the pressure on rivals to keep capacity filled through discounting. • The industry’s products are standardized or undifferentiated. If buyers believe they can always find an equivalent product, they tend to play one vendor against another. • Buyers face few switching costs in changing vendors. • Buyers can credibly threaten to integrate backward and produce the industry’s product themselves if vendors are too profitable. Producers of soft drinks and beer have long controlled the pow...
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