The Practice of Behavioral Strategy 9781681231587, 9781681231594, 9781681231600

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The Practice of Behavioral Strategy

A volume in Research in Behavioral Strategy T. K. Das, Series Editor

RESEARCH IN BEHAVIORAL STRATEGY T. K. Das, Series Editor Published Behavioral Strategy: Emerging Perspectives Edited by T. K. Das The Practice of Behavioral Strategy Edited by T. K. Das In Development Decision Making in Behavioral Strategy Edited by T. K. Das

The Practice of Behavioral Strategy

edited by

T. K. Das City University of New York

INFORMATION AGE PUBLISHING, INC. Charlotte, NC • www.infoagepub.com

Library of Congress Cataloging-in-Publication Data   A CIP record for this book is available from the Library of Congress   http://www.loc.gov ISBN: 978-1-68123-158-7 (Paperback) 978-1-68123-159-4 (Hardcover) 978-1-68123-160-0 (ebook)

Copyright © 2015 Information Age Publishing Inc. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, microfilming, recording or otherwise, without written permission from the publisher. Printed in the United States of America

CONTENTS About the Book Series.......................................................................... vii 1 Analysis and Improvement of M&A Decision Making Processes in the High-Tech Sector: A Behavioral Strategy Perspective.............. 1 Saleema Kauser, Alexander W. Gordon, K. Nadia Papamichail, and Charitha C. Reddy 2 Behavioral Governance: The Role of Scenario Thinking in Dealing With Strategic Uncertainty.................................................... 41 Theo J. B. M. Postma and Robert P. Bood 3 A Practice-Based View of Business Modeling: Cognition and Knowledge in Action............................................................................ 77 Arash Najmaei, Jo Rhodes, and Peter Lok 4 Incumbent Behavior and Competitive Strategy Paradigm Shift.... 105 Tomomi Hamada and Tsutomu Kobashi 5 Strategizing in Project-Based Organizations: The Role of Internal and External Relationships............................................ 127 Lena E. Bygballe and Anna R. S. Swärd 6 Selecting a Certification Body in the Fair Trade Market: The Importance of Strategic Capabilities and Cooperative Behavior.............................................................................................. 145 Mantiaba Coulibaly and Fabien Blanchot 7 Exploration at the Creation Stage and Exploitation at the Distribution Stage: Creation and Diffusion of Innovative Products in the U.S. Movie Industry................................................. 169 Ayako Kawasaki and Motonari Yamada

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8 Behavioral Strategy and Resource-Based Theory: An Application and Implications...................................................... 193 Mona Rashidirad, Ebrahim Soltani, and Hamid Salimian 9 The Effect of Corporate Governance and Corporate Culture on Strategy Execution and Performance: Evidence From the Indonesian General Insurance Industry.......................................... 213 Budi W. Soetjipto and Herris B. Simandjuntak About the Contributors...................................................................... 233 Index................................................................................................... 241

ABOUT THE BOOK SERIES Behavioral strategy continues to attract increasing research interest within the broader field of strategic management. Research in behavioral strategy has clear scope for development in tandem with such traditional streams of strategy research that involve economics, markets, resources, and technology. The key roles of psychology, organizational behavior, and behavioral decision making in the theory and practice of strategy have yet to be comprehensively grasped. Given that strategic thinking and strategic decision making are importantly concerned with human cognition, human decisions, and human behavior, it makes eminent sense to bring some balance in the strategy field by complementing the extant emphasis on the “objective’ economics-based view with substantive attention to the “subjective” individual-oriented perspective. This calls for more focused inquiries into the role and nature of the individual strategy actors, and their cognitions and behaviors, in the strategy research enterprise. For the purposes of this book series, behavioral strategy would be broadly construed as covering all aspects of the role of the strategy maker in the entire strategy field. The scholarship relating to behavioral strategy is widely believed to be dispersed in diverse literatures. These existing contributions that relate to behavioral strategy within the overall field of strategy has been known and perhaps valued by most scholars all along, but were not adequately appreciated or brought together as a coherent subfield or as a distinct perspective of strategy. This book series on Research in Behavioral Strategy will cover the essential progress made thus far in this admittedly fragmented literature and elaborate upon fruitful streams of scholarship. More importantly, the book series will focus on providing a robust and comprehensive forum for

The Practice of Behavioral Strategy, pages vii–viii Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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the growing scholarship in behavioral strategy. In particular, the volumes in the series will cover new views of interdisciplinary theoretical frameworks and models (dealing with all behavioral aspects), significant practical problems of strategy formulation, implementation, and evaluation, and emerging areas of inquiry. The series will also include comprehensive empirical studies of selected segments of business, economic, industrial, government, and nonprofit activities with potential for wider application of behavioral strategy. Through the ongoing release of focused topical titles, this book series will seek to disseminate theoretical insights and practical management information that will enable interested professionals to gain a rigorous and comprehensive understanding of the subject of behavioral strategy. —T. K. Das City University of New York Series Editor Research in Behavioral Strategy

CHAPTER 1

ANALYSIS AND IMPROVEMENT OF M&A DECISION MAKING PROCESSES IN THE HIGH-TECH SECTOR A Behavioral Strategy Perspective Saleema Kauser Alexander W. Gordon K. Nadia Papamichail Charitha C. Reddy

ABSTRACT Decisions relating to Mergers & Acquisitions (M&As) are amongst the most important strategic decisions that a firm has to make, yet more often than not these decisions are highly flawed and can lead to large strategic failures. Despite the fact that there have been a number of psychological studies on M&As, there has been a significant lack of direct application of the field of behavioral strategy to M&As, in particular in our understanding of the decision The Practice of Behavioral Strategy, pages 1–39 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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2    S. KAUSER et al. making process. This, in combination with the abovementioned high M&A failure rate, the importance of effective strategic decision making, and a call for further development and application of behavioral strategy, constitutes a “research gap.” Building on traditional strategic management research and in line with the increased calls for the further development and application of behavioral strategy to the decision making process, this chapter aims to identify and customize a framework to analyze the applicability of behavioral strategy to high-tech M&As in order to help understand decision making failings.

INTRODUCTION Traditional management disciplines are based on the idea that strategic decision-makers are rational and that both individual and firm-level strategic decisions are already optimal, dismissing the possibility for improvement (Bromiley, 2005; Das, 1986; Das & Teng, 1999; Hodgkinson & Healey, 2011). However, behavioral economics and psychology have shown that in the real world our cognitive biases prevent us from making rational decisions (Ariely, 2009), and argue that “most human choice is not made deliberately and consciously by weighing up and evaluating all the possible variables and permutations” (Gordon, 2011, p. 173). Simon (1947), explained that while man intends to be rational, he is constrained by his cognitive limitations. Decision makers make suboptimal decisions due to inherent biases in the human brain (Gordon, 2011, p. 173). Powell, Lovallo and Fox (2011) posit that decision makers are humans with poor self-control and faulty cognition, which influence the decision making process. This demonstrates the social element by highlighting the effect of human limitations on organizational decision making as a whole and suggests that it is also important to consider the psychological factors such as cognitive biases, which can underpin the quality of the decision making process. Mergers and acquisitions (M&As) are growing at a rapid pace, and studies have shown that the decision making process can have a great impact on their performance (Bogan & Just, 2009). The purpose of this research is to understand how such cognitive biases might influence the decision making process of M&As. Over the last few decades, M&As have proliferated and enabled firms to cope with the increasing aspects of globalization and technological developments. They allow organizations to grow as well as increase their resource-competency base so that they can compete successfully in the global marketplace (Sudarsanam, 2003). However, the decision making process within M&As can be highly complex, and poor decisions have been shown to have a significant impact on the company’s profits, productivity, reputation, customer reputation, customer loyalty, stability, and viability (French, Maule, & Papamichail, 2009). Evidence suggests that only a small fraction of M&A deals will actually create long-term value for

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shareholders of the acquiring firms. Bekier, Bogardus, and Oldham (2001) stated that more than one third of M&As either fail or provide little payoff. They argue that the majority of M&As end up in failure because the cognitive biases on the part of senior managers have resulted in erroneous decisions. They talk about how an overload of information can lead to complexity in decision making because of a framing bias. The report argues that the biasness cause us to accept what we believe to be true. This means that we subconsciously ignore or reject anything that threatens what we think and so when we have to deal with new facts, we use our worldview to interpret information and data that supports this view. This is further intensified by the overconfidence bias of the managers’ experience, who then believe that they have the expertise and knowledge to make decisions. We can understand then why erroneous decisions are made. With such a substantial amount of failures, it is therefore important to analyze the M&A decision making process in order to understand the value creation logic (Haspeslagh & Jemison, 1991; Jemison & Sitkin, 1986; Sudarsanam, 2010). Blenko, Mankins, and Rogers (2010, p. 57) state, “A company’s value is no more (and no less) than the sum of the decisions it makes and executes.” They find a significantly positive correlation between decision effectiveness and financial results. Furthermore, Keeney (2004) and Papamichail and Rajaram (2007) emphasize the importance of a high-quality decision process in order for high decision effectiveness. McKinsey Quarterly surveyed 2,207 executives, and 60% thought that bad strategic decisions were as frequent as good strategic decisions (Lovallo & Sibony, 2010). According to a survey conducted by the Economic Intelligent Unit (EIU) (2007), 78% of the respondents consider that senior management decisions at their organizations are incorrect at least some of the time. Understanding and recognizing the cognitive biases may help to limit the negative impacts of the errors or bad strategic decisions (Dai, Tang, & Demeuse, 2011). Moreover, studies also show that there is a close link between the organization’s performance and decisions. A study by Bain & Company (Blenko et al., 2010) of executives from 760 companies reported that over 95% of the time financial and performance outcomes were related to effective decision making. In line with this, many scholars are promoting the increased application of the emerging field of behavioral strategy in order to improve strategic decision making (Bruner, 2005; Kahneman & Klein, 2009; Lovallo & Sibony, 2010; Powell et al., 2011; Thaler & Sunstein, 2008). All argue for the design of applicable and structured behavioral decision support practices to improve suboptimal executive decision making. Powell et al., (2011), also state that this could help to improve the “psychological architecture of the firm.” Furthermore, Hodgkinson and Healey (2011) underline the need for integration of research on metacognition and emotion management

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to behavioral strategy research. They argue this because such processes ultimately determine how reflective processes, such as the counteraction of psychological biases, function. Moreover, there is a limited insight on the decision making process within M&As including a lack of understanding on cognitive biases which underpin the decision making process. The aim of this chapter is to help identify, adapt, and apply a behavioral strategy framework to M&As within the high-tech sector. We identify and customize a framework to analyze the applicability of behavioral strategy to high-tech M&As to help understand their decision making failings. The assumption that examining the psychological behavior of the M&A decision making process can help us to understand how people’s emotional and cognitive biases influence decision making and how these can then impact on the outcome of the M&A. BACKGROUND There is vast research on decision making in organizations (Simon, 1947, 1960, 1987). However, we know little about the decision making process from the emotional and cognitive perspective in mergers and acquisitions. Hence, the following section will explain why considering cognitive biases and their influence in decision making is important, as well as demonstrate the importance of the further development and increased application of behavioral strategy approach. Finally, by using the behavioral strategy approach, we identify a framework that is subsequently used to analyze decision making within M&As with an attempt to understand their failings. Factors Influencing Decision Making The introduction of the term decision making in business has changed the way managers/executives make important decisions within the organization and has led to subsequent research in strategic decision making. Many researchers have focused on the factors that affect decision making (Campbell, Whithead, & Finkelstein, 2009) and have shown that important decisions made by intellectual, intelligent, and responsible people with the best piece of data and objectives may become flawed due to cognitive biases. Simon (1947) introduced a phenomenon called bounded rationality, which indicates that decisions cannot be made in a rational manner because of human cognitive limitations and organizational complexity (Campitelli & Gobet, 2010; French et al., 2009; McKinnon, 2003). Simon (1947) argues that man is rational and constrained by his cognitive limitations. Decision makers do not make optimal decisions based on a set of

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well-specified alternatives but instead search for alternatives using limited sets of performance criteria, and make a decision once a satisfactory alternative is found (Bazerman, 1994; Campetelli & Gobet, 2010; French et al., 2009). This demonstrates the social element by highlighting the effect of human limitations on organizational decision making as a whole. Hammond, Keeney, and Raiffa (1998) contend that the faults in decision making lie in the mind of the decision maker rather than in the decision making process. They identified certain hidden psychological traps, including the framing trap, estimation and forecasting trap within decision making, which may influence the choice of the decision maker. However, awareness of the biases in isolation or combination is the best way to overcome these psychological traps. This indicates the importance of considering cognitive biases as a significant factor which can distort the reasoning and choice of strategic decisions. Kahneman, Lovallo, and Sibony (2011) demonstrated how cognitive biases, for instance confirmation bias (i.e., ignoring evidence that contradicts their predefined notions), and anchoring bias (i.e., outweighing a particular piece of information during the decision making), among others, can influence decisions made. These biases will be discussed later in this section. The quality of business decisions can be affected and jeopardized by these dangerous biases. Furthermore, few studies have been conducted on ways to overcome these biases. Campbell et al. (2009) provide insights about safeguarding against biases by identifying red flags (useful when detected before making a decision) and suggested ways to minimize the effects by reviewing the recommendation by a third party, evaluating the proposal and self-questioning the options before making any important decisions. Awareness of the biases and reducing them appropriately would make a difference in the quality of the business decisions. Research also indicates that executives/leaders make decisions in an unconscious process called emotional tagging and pattern recognition (Campbell et al., 2009). These processes generally make fast and effective decisions, but they could be misled by sentimental attachments, self-interest, or distorted memories. Using systematic approaches, companies can avoid many faulty decisions that are caused by the way the brain functions. Heuristics, biases, and risk effects in both individual and intragroup decision making play a vital role in decision making and refers to the use of simple and efficient rules for judgements under uncertainty (French et al., 2009; Payne, Bettman, & Johnson, 1993). There are three kinds of heuristics: (a) representativeness, which is a shortcut that occurs when an individual overrelies on simple, intuitive information to judge the probability of an event under certainty; (b) availability occurs when people judge the probability of an event by the ease with which similar examples can be recalled or imagined; and finally, (c) adjustment from an anchor occurs when humans overrely on the first piece of information available (the anchor)

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during the decision making process. (French et al., 2009; Tversky & Kahneman, 1974). From a theoretical point of view, this suggest that individuals tend to behave in a manner inconsistent with the expected utility theory when faced with risk. For instance, individuals may be intuitively risk-averse when choosing between probabilistic alternatives if the decision outcomes are known (Kahneman & Tversky, 1979). In other words, they are more likely to select the outcome with better gains than losses and behave inconsistently when the same outcomes are presented in a different manner. This inconsistency attests to the fact that biases can subconsciously affect those in positions where high-risk decisions are made on a constant basis, such as senior executives executing strategy. Thus, the effect of heuristics can evoke emotions, which may influence judgements in a positive or negative manner (French et al., 2009) and lead to predictable and systematic errors. We have highlighted briefly how psychological factors such as cognitive biases can influence the quality of a decision made. The next section will briefly explain the idea behind behavioral strategy such that our cognitive biases are an important factor in making effective decisions. The Development of a Behavioral Strategy Approach to Decision Making Behavioral strategy deals with both social and cognitive psychology, which can be applied to strategic management practices and theories (Powell et al., 2011). The theory proposes a new beginning for behavioral strategy for three reasons: (a) strategic management has not kept pace with the behavioral activities in finance and economics, (b) a lack of psychology in strategic management theory, (c) and because of advancements in merging strategy with psychology (Powell et al., 2011). Firms are composed of a group of asymmetrically knowledgeable players who interpret the external world subjectively and that subjective learning process and knowledge need to be coordinated for successful strategy formulation. The notion that firms’ heterogeneity stems from economics does not align with emotion, human, cognition, learning, and social interactions (Powell et al., 2011). These approaches fail to mention the process of coordination and interaction of knowledge within the firm and the market (Yu, 2003). Bromiley (2005) argues that the perspectives following this approach have severe limitations and assume that strategic decision makers are rational, and that both individual and firm level strategic decisions are already optimal, thus dismissing the possibility for improvement. Bromiley further posits that a behavioral approach would provide a better solid foundation whereby cognitive and behavioral processes underpin capabilities to promote the firm’s learning and performance (Hodgkinson &

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Healey, 2011). Moreover, the strategic management field has been increasingly influenced by sociological approaches that deal with human interaction, bounded rationality, and other factors influencing strategic decision making (Huy, 2012; Ricciardi & Simon, 2000; Schwenk, 1995). Powell et al. (2011) have shown that the thoughts, feelings, and social relation of executives or general managers can influence the activities or the performance of an organziation. Simon (1978) further posits that people are rational, with cognitive limitations. His model of bounded rationality demonstrates that individuals do not make optimal decisions based on a set of well-specified alternatives. Simon (1978) stated, We must give an account not only of substantive rationality—the extent to which appropriate course of action are chosen—but also procedural rationality—the effectiveness, in light of human cognitive powers and limitations, of the procedures used to choose actions. As economics moves out toward situations of increasing cognitive complexity, it becomes increasingly concerned with the ability of actors to cope with the complexity, and hence with the procedural aspects of rationality. (p. 9)

Behavioral strategy is built on the past research in cognition, organizational behavior, behavioral decision theory, and strategy (Powell et al., 2011). Research of this concept has developed substantially over the last two decades (Hodgkinson & Healey, 2011). Powell et al (2011) cite that there are three schools of behavioral strategy: Pluralist, Reductionist, and Contextualist (see Figure 1.1). Reductionism

Shared problems Multiple methods Shared community

Pluralism

Contextualism

Figure 1.1  An integrative view of behavioral strategy (Powell et al., 2011, p. 1380).

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A summary of the key points concerning each school is illustrated in Table 1.1. The three schools of behavioral strategy function relatively independently and have clearly been developed and reinforced by a significant volume of literature since the middle of the last century. However, Powell et al. (2011) argue that the current status of behavioral strategy is narrowly fragmented and unfocused. They argue that if strategy theory were strongly grounded in psychology, then the experience of large corporate failures such as HP/Compaq and AOL/Time Warner, which constituted part of the “macro-culture of poor executive judgment,” would help improve a firm’s future performance. Other researchers have also called for the integration of behavioral strategy with strategy-management theory and practice (Gavetti, Leventhal, & Ocasio, 2007; Hodgkinson & Healey, 20011; Nag, Hambrick, & Chen, 2007). Hence, they proposed a unified conceptual model of the three schools of thought to address the challenges of behavioral strategy (see Figure 1.1). The reductionist paradigm focuses on psychological characteristics of economic decision making; the pluralist paradigm TABLE 1.1  A Summary of the Main Differences Between the Three Schools of Behavioral Strategy Pluralist Core processes of interest

• Politics • Intergroup bargaining • Conflict resolution • Problem solving Key psychological • Social cognition concepts • Social identity theory • Reference groups Assumptions • They consist of about firms small groups of individuals with conflicting preferences and objectives • Conflict resolution and bargaining are undertaken to solve strategic problems Contributions • Behavioral theory to strategy of the firm • Group identification

Source: Adapted from Powell et al., 2011.

Reductionist

Contextualist

• Individual and • Sense making intergroup decision • Managerial making perceptions and actions • Prospect theory • Heuristics and biases • Bounded rationality • Decisions made by top-level executives • Decisions are subject to biases

• Cognitive schema • Meaning • Language

• Biases in strategic decisions

• Cognitive schema • Sense making • Managerial perception • Enactment rationale

• They are socially constructed • Actions are emergent • Actions are externally influenced

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concentrates on complex judgments in organizations from the psychological perspective, and the contextualist deals with mental frames and topmanagement perception. Behavioral strategy should attempt a better disciplinary unity, and three ways to build this unified discipline are problem integration, methodology integration, and community integration (Powel et al, 2011). Hodgkinson and Healey (2011) however argue that these prescriptions are one-dimensional and focus only on thoughts not feelings. Given that people are “manifestly driven by emotion” (Hodgkinson & Healey, 2011, p. 1512), the authors state that such behaviorally based dynamic capabilities should take account of emotional processes which can both assist and inhibit deliberate reasoning. Kahneman and Klein (2009) underline that these emotional reflexive processes must be trained, harnessed, and understood if they are to be useful for creating an “intuitive expertise.” A number of researchers (Campbell et al., 2009; Lovallo & Sibony, 2010) argue that firms can improve their strategic decisions if they are able to identify known biases that affect their strategic decision making and create structured ways of counteracting them. Lovallo and Sibony (2010) suggest two things to consider when attempting to de-bias decisions: choosing what information to present, and choosing how to present it. Powell et al. (2011, p. 1379) call this a “choice architecture” and underline its importance at the firm level, given that “judgmental errors stem from a combination of cognitive errors and the context of choice.” Kahneman et al. (2011) present a decision-quality control checklist that describes a number of biases that may be encountered when making decisions. We utilize this checklist as part of our analysis in explaining the decision making failings of M&As. This checklist includes what Powell et al. (2011) refer to as the “combination of architecture and decision analysis” and therefore constitutes an embodiment of the structured decision support practices discussed above in the literature. Behavioral Strategy and Mergers & Acquisitions Corporate strategic decision making is the most important yet the most complex and unstructured type of decision making in an organization (French et al., 2009). Within this domain, M&As are amongst the largest and most significant decisions that a firm ever has to make (Bruner, 2005; Schweizer, 2005; Sudarsanam, 2003). As discussed above, the traditional approach to strategic management assumes rationality, efficiency, and equilibrium within markets. Furthermore, the traditional objective of strategy has been to understand the best way for a firm to achieve superior economic performance and increase shareholder value (Barney, 2002). Therefore, traditional approaches to research on M&As have also followed an “economic approach.”

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Mergers and acquisitions have many interconnected motives. Given that the traditional rationale for M&A activity is that firms seek to improve the financial performance of the firm (King, Colvin, & Hegarty, 2003; Sudarsanam, 2010), these motives involve the objective of either reducing costs or increasing revenue and profit, directly or indirectly. Strategic, economic, and market motives are seen to be value increasing, whereas personal motives are not (Bradley, Desai, & Kim, 1988; Hopkins, 1999). Personal motives include those such as hubris and empire building, which are highly linked to behavioral strategy and so will be explained below. Strategic, economic, and market motives are traditionally highly interdependent (Nguyen, Yung, & Sun, 2012). These value-increasing motives involve intentions for synergy creation. Efficiencies are gained through elimination of duplicated functions or activities (economies of scale), with further value created by the distribution of both new and existing products through both new and existing channels (economies of scope) (Cullinan, Le Roux, & Weddigen, 2004). Value-increasing motives also include tax advantages, increased market power, entry to a new market, or the acquisition of complimentary products (Bogan & Just, 2009; Graebner, 2004; Larsson & Finkelstein, 1999). Further value-increasing motives include the acquisition of R&D through patents, knowledge held by scientists, or laboratories, which is especially the case in the high-technology industry (Desyllas & Hughes, 2009; Graebner, 2004; Ranft & Lord, 2000). Haspeslagh and Jemison (1991) explain that the conventional view of the M&A process is based on the strategic, economic, and financial evaluation of the target firm by the acquiring firm. This “rationalist” view assumes that the process is defined by a rationalistic quantification of the costs and benefits of the merger or acquisition, focusing on value creation. There is also the view that there is no disagreement between any of the decision makers, and thus the process is sequential and smoothly executed by “an undivided, homogenous decision unit” (Sudarsanam, 2003, p. 309). Given the aforementioned traditional M&A objective of achieving increased economic performance, measures of M&A performance are also predominantly financial, with a focus on objective measures such as stockmarket-based measures and accounting returns (Papadakis & Thanos, 2010), regarded to be somewhat one-dimensional (Lubatkin & Shrieves, 1986) and purely retrospective in nature (Chenhall & Langfield-Smith, 2007). Furthermore, stock market measures only show the market’s expectations of future profitability, rather than profitability itself (Montgomery & Wilson, 1986). These approaches are in line with the rationalist view of the M&A process and assume that the merger decision is rational when in fact it is extremely complex (Bogan & Just, 2009). Thus, mergers and acquisitions involve myriad complex decisions, including strategic, logic, organizational behavior, and finance dimensions (Straub, Borzillo, & Probst, 2012) and

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thus are highly exposed to social and cognitive psychological problems (Calandro, 2008; Duhaime & Schwenk, 1985; Ullrich & Van Dick, 2007). A DECISION MAKING FRAMEWORK Our proposed framework will be used to analyze the presence of both emotional and cognitive barriers in general (see Table 1.2). Given the importance of the emotional processes in decision making, we have drawn on TABLE 1.2  Integrative Framework of Psychological Barriers Barriers

Definitions

Emotional Barriers Environment of An organizational culture that discourages sharing of emotions Emotional Closedness Affect Heuristic

When decisions are strongly influenced by emotions

Identity-Based Emotional Barriers

Employees’ emotional attachments to elements of the business, which can influence the outcome of a decision if neglected

Poor Emotional Commitment

Lack of emotional commitment toward a decision

Cognitive Barriers Self-Interested Biases

Decisions motivated by self-interest

Groupthink

When a consensus overcomes conflict in group decisions due to a preference for harmony

Saliency Bias

Justification for a decision with inadequate analogies to similar past successes

Confirmation Bias

Only searching for information that supports one’s view/decision

Availability Bias

Only using information available and overlooking missing information

Anchoring Bias

When numbers relevant to a decision are developed by adjusting from another

Halo Effect

When one’s judgement of the level of success/failure of a product/ firm is influenced by one’s overall impression of it/them

Sunk-Cost Fallacy

Evaluating a decision with reference to historically unrecoverable costs

Endowment Effect

Paying more to retain something currently owned than to acquire something owned by someone else

Overconfidence, Optimistic Biases

Overconfidence or overoptimism in a decision

Planning Fallacy

Underestimating how long something will take to complete

Competitor Neglect

Failing to consider how competitors will react to a decision

Disaster Neglect

Failing to consider the possibility of a disastrous outcome of a decision

Loss Aversion

Excessive conservatism when making a decision

Source: Adapted from Kahneman et al., 2011.

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research which emphasizes that both individual and collective emotional capabilities should be built into organizational routines (Hodgkinson & Healey, 2011; Huy, 2012). Three emotional issues are utilized to analyze the presence or lack of emotional management of both the individual and collective: emotional closedness refers to an emotionally-open organisational culture encouraging employees to express their emotions and identify with each other, and can help avoid insurmountable disagreements (Hodgkinson & Healey, 2011; Huy, 2012); identity-based emotional barriers are elements of the business with which employees identify strongly (Lovallo & Sibony, 2010), and poor emotional commitment refers to a lack of emotional commitment on the part of employees and can hinder the efficiency and effectiveness of the strategic decision making process, or even block it altogether. It is important to manage these, as employees might become resistant to change if they feel that such emotional attachments are being neglected (Hodgkinson & Healey, 2011). The second part of the framework utilizes the “decision-quality control checklist” proposed by Kahneman et al. (2011) to analyze the decision making failings of M&As. Below is an explanation of all the cognitive biases in the decision-quality control checklist (see Table 1.2) which are usually faced by the executives in organizations. Given that heuristics is an emotional barrier, it has been included in the Emotional Barriers section. Interest Biases develop due to the presence of conflicting incentives, inappropriate emotional attachments, and misaligned perceptions of corporate goals. Individual rationality and self-deception are the most common problems. Heuristics refers to the tendency of the decision maker to evaluate something they like by minimizing the costs and risks, and exaggerating the benefits, and the opposite when they evaluate something they dislike. Groupthink refers to the tendency of the decision makers to minimize conflict by agreeing to a decision because it appears to be gathering sufficient support. Groupthink usually occurs when there is diversity of backgrounds and different perspectives within a team. In complex decision making, an absence of dissent in a team could cause a problem. To overcome this bias, the senior executive should create an environment where practical disagreements are a productive part of the decision making process rather than a sign of conflict between the individuals. Saliency Bias concerns a decision maker’s memorable event, and their judgements are strongly based on this event. The main danger of this bias is that the analogy may not be relevant to the current situation. Usually senior executives are exposed to saliency bias, where their experience will rely on certain analogies, which may be misleading (Lovallo & Sibony, 2010). This can be overcome by using various alternatives and a broader range of comparison (Kahneman et al., 2011). Confirmation Bias is the tendency of the decision maker to ignore the evidence that would disprove their predefined hypothesis. This

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usually involves underweighting the evidence that is against a preferred idea and overweighting the evidence that is consistent with a particular belief (Lovallo & Sibony, 2010). This can be overcome by assessing various alternatives, by listing the pros and cons, and looking for evidence that would disprove the predefined notion. Availability Bias occurs when the decision maker tends to overlook what is missing; this is because our intuitive mind constructs a rational narrative based on the evidence. This can be overcome by preparing a checklist, which specifies the information that is relevant to a certain kind of decision. Anchoring Bias refers to the decision makers’ make judgments based on an initial value, which can lead to inadequate adjustments of subsequent estimates (Lovallo & Sibony, 2010). Halo Effect is the tendency of decision makers to make certain inferences based on a general impression. SunkCost Fallacy is when a decision maker considers the historical costs which are not recoverable to make future decisions. Overconfidence, overoptimistic Bias: overconfidence refers to the tendency of the decision makers to overestimate their abilities to make appropriate decisions that will affect the outcomes (Lovallo & Sibony, 2010). Overoptimistic refers to the tendency where they overestimate the likelihood of the possible outcome. Competitor Neglect is a bias where the decisions are taken without factoring in competitors (Lovallo & Sibony, 2010). Disaster Neglect is when, in decision making, many companies can propose a range of scenarios, at least a best and a worst case. Loss Aversion is the tendency of the decision maker to feel losses more severely than gains for the same amount (Lovallo & Sibony, 2010). This checklist is in line with previous work (Keeney, 2004; Papamichail & Rajaram, 2007), which emphasizes quality in the decision making process. The checklist is aimed at “adding a systematic review of the . . . process” to the review of the content involved in a decision. It tells the executive what questions to ask, and its aim is to “unearth . . . the cognitive biases of the teams making recommendations [to the executives]” (Kahneman et al., 2011, p. 60). Powell et al. (2011) state that an improvement of choice architecture and the de-biasing of the decision processes of the firm as a whole would perhaps “yield better executive judgments” (p. 1378). RESEARCH APPROACH The high-tech industry is highly integrated (Rheaume & Bhabra, 2008), with rapid technological advances resulting in turbulent changes (Marks & Mirvis, 2001; Miller, 2001), and is hypercompetitive (O’Reilly & Pfeffer, 2000). In 1998, high-tech acquisitions in the United States alone totaled 5,000, worth more than $500 billion (Chaudhuri & Tabrizi, 1999). Mergers and acquisitions have been hugely popular in the high-tech sector, allowing companies

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to obtain competencies, create opportunities, share resources, as well as staying ahead of competition in fast changing markets (Chaudhuri & Tabrizi, 1999; Graebner, Eisenhardt, & Roundy, 2010; Marks & Mervis, 2001; Santos & Eisenhardt, 2009). Furthermore, the high-tech sector lends itself extremely well to the study of M&A decision making because the failure rate within this sector has been reported as high as 90% (Graebner et al., 2010). The high failure rate may be attributed to the complexity of the decision making in high-tech M&As. Often the technological capabilities of hightech firms are highly interconnected with the knowledge and capabilities of the employees who created them (Chaudhuri & Tabrizi, 1999; Desyllas & Hughes, 2009). This means that the recognition of the importance of people during high-tech M&A due diligence is imperative, as otherwise the acquired technologies may fail to create value (Benou & Madura, 2005). This makes the cultural fit of the companies involved in the M&A even more important (Chadhuri & Tabrizi, 1999). Furthermore, Frick and Torres (2002) emphasize the necessity for the decision making process of such deals to be fast, otherwise the probability of deal completion is low. This adds to the complexity, as the effectiveness of such large strategic decisions is often contingent on the meticulous checking of large amounts of information. Therefore, this study has chosen high-tech M&As because not only are the motives extensive, but the high level of volatility, level of complexity of decision making, and high failure rate will provide a real insight into why high-tech M&As fail to create value. The core of our investigation includes two diverse case studies of M&A performance within the high-tech sector. First, the AOL/Time Warner (AOLTW) merger case was chosen because it embodies the extreme negative performance end of the spectrum of high-tech M&As. This $350 billion merger, formed in 2001, was intended to be a “visionary” merger that would redefine the media and communications industries (Arango, 2010; Bruner, 2005) by forming the “world’s first fully-integrated, Internet-powered media and communications company” (AOL, 2001, p. 1). However, by 2002, the merger had lost $99 billion in value and subsequently demerged in 2009 (Hu, 2003a, 2003b). In contrast, Cisco Systems was selected as the second case, as it exemplifies the extreme positive performance end of the spectrum. Cisco Systems are renowned for their highly successful acquisition strategies (Chatman, O’Reilly, & Chang, 2005; Mayer & Kenney, 2004). Goldblatt (1999) reported that “No company typifies . . . M&A better than Cisco Systems” and highlights the 162% stock price rise in 1998 as a notable example of their outstanding strategy. The diversity of the M&A performance of these two firms offers the potential for significant inferences to be drawn with regard the application of behavioral strategy. Data for the case analysis was collected using secondary sources. The main sources constituted academic case studies, journal articles, official

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M&A documentation from the Securities and Exchange Commission, company annual reports, financial accounts, and credible news websites. ANALYSIS OF STRATEGIC DECSION MAKING IN THE AOL/TIME WARNER CASE Background The AOL and Time Warner merger announced on January 10, 2000, came together to become the world’s first Internet-powered media and communications company. The merger was valued at $183 billion and became the fourth largest company in the United States. Both companies were significant players in their industries: AOL supplied 40% of online Internet services in the United States, while Time Warner provided to over 18% of U.S. media and cable households (Rubinfeld & Singer, 2001). The merger was considered to be a revenue-enhancing synergy, helping AOL with its broadband strategy and Time Warner to be able to benefit from AOL Internet resources and expertise. Moreover, the merger was to link AOL’s broad customer relationships and Time Warner’s content and service distribution together. Subsequently, the merger achieved an average revenue growth of over $33 billion, but in terms of net profits, the merger was not creating value for its shareholders (Hu, 2003a). Moreover, synergies between the two companies were not being realized, and the two companies could no longer agree on anything (Arango, 2010). The following section will attempt to analyze the emotional and cognitive biases in the decision making process of this merger. Presence of Emotional Barriers Emotional closedness was evident in both AOL and Time Warner prior to the merger, which impacted on the merger outcome. In the case of Time Warner, its conglomerate structure and decentralized approach to management meant that divisions lacked coordination (Bruner, 2005). This became evident in the postmerger when frustrations amongst divisional heads caused a cultural clash with AOL employees, who were perceived as being arrogant (Picard, 2004). The AOL top-down and aggressive management style (Klein, 2003), resulted in an organizational culture, where employees repressed individual emotions and were bound to executive decisions (Radhika, 2003a; Ray, 2012). This lack of emotional openness led to severe postmerger problems where employees became so oppressed that they dissented by campaigning to remove the AOL chairman (Bruner, 2005).

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The affect heuristic was highly present in the AOL/Time Warner merger. Following the merger discussions in September 1999 (Bruner, 2005), it took only 3 months for the merger deal to be constructed. The speed at which this merger deal took place helps demonstrate the presence of the affect heuristic. Steve Case was highly focused on planning for the future of the online world (Radhika, 2003a) and relentlessly followed a strategy of “aggressive growth,” helping the company to increase its stock price by 10 times by the year 2000 (Bruner, 2005). The hugely inflated stock price of AOL and the devalued price of Time Warner provided an opportunity for Case to follow his aggressive strategy of growth (Bodie, 2006). By leveraging AOL’s large stock price to gain 55% of the new company (Adams, 2002; Klein, 2003), the merger fueled his obsession of building and transforming the future of technology, entertainment, and media industries (AOL, 2000; Thompson, 2003). This is clearly clarified by Case in the in the AOL 2000 Annual Report: “In the future, we believe that the interactive medium will continue to blur the old boundaries between [these] industries . . . Our new company will have the ability to lead in this world” (AOL, 2000). Furthermore, the Wall Street Journal reported, “[Case] never . . . let up on his endless . . . references to ‘convergence’ and ‘interactive’ and all sorts of other computing hoo-ha, and linking it with the future of all mass media” (Swisher, 2003, p. 3). Therefore, it is clear that the merger appealed to two of Case’s main focuses: increasing AOL stock price, and leading the future of the global online technology business. Given this appeal, the rationale for the merger was catalyzed by an emotional drive to fulfill these goals. It can be said that this emotional drive not only overpowered the ability to avoid the biases that will be explained later, but it negatively influenced the effectiveness of the due diligence process. This led to cultural problems within the merged company as well as a failure to realize the promised synergies; two key reasons in the failure of the merger (Bruner, 2005; Klein, 2003; Swisher, 2003). The resistance shown by Time Warner divisional heads in 1998 represents identity-based emotional barriers. However, the fact that the resistance was ignored had large effects on the merger. This can be evidenced through the postmerger problems, such as the rebellion of Time Warner employees against AOL’s email system (Picard, 2004) and the disputes amongst executives about the new managerial structure (Weber, 2003). This caused many top executives to leave the company (Radhika, 2003b). Poor emotional commitment was present on the part the AOL during the merger decision making process. Although it was Steve Case who proposed the merger to Jerry Levin (Bruner, 2005), evidence suggests that he showed poor emotional commitment toward the integration of the two companies. Case constantly referred to the huge incentives for the deal and focused on the revenue and synergistic opportunities, such as cross-promotion of

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content; cross-platform marketing, and cost savings through the digitalization of Time Warner content (Bruner, 2005). His lack of emotional commitment can also be seen through the fact that he sold the majority of his shares in AOL in January 2000, just before the AOL share price crashed (Swisher, 2003). Case also failed to commit to the integration and personnel development of the management structures of the two companies during decision making. To speed up the processing of the deal by the Federal Trade Commission (FTC), Case relinquished exclusive control of the Time Warner broadband assets to competitors (Kwoka & White, 2004), given that the exclusivity of the cable assets was one of the main drivers he had emphasized in the public merger (Bruner, 2005; Swisher, 2003). The differences between his public and private behavior regarding the deal thus demonstrate Case’s poor emotional commitment toward the merger. Presence of Cognitive Barriers Kahneman et al. (2011) define self-interested biases to be those that include outcomes that will help the individual or group to gain more than usual “empire-building.” Empire-building outcomes include personal financial motives or increased power, reputation or career options. In this case, empire-building motives were present from both sides. Time Warner wanted to be at the forefront of the technology industry (Thompson, 2003). Levin understood that the Internet would be a transformational medium: “Levin got caught up in his self-image as a leading thinker about transformative technology” (Bruner, 2005, p. 278). The media reported that Levin’s career aspiration had been to be “captain of the biggest ship” (Ahrens & Henry, 2002). Evidence of empire-building motives were also present within AOL. Steve Case’s mantra was to “get big, fast” (Bruner, 2005, p. 269). The focus on stock prices began to take over the way that the company behaved, and AOL began to acquire growth by buying companies, culminating in the Time Warner merger. Case’s goal was to become one of the biggest and most powerful media and communications companies in the world (Swisher, 2003). Evidently, Case and a number of AOL employees with personal financial motives for the merger held stock options that they believed would grow hugely with the increased market value of the merged company (Bruner, 2005; Radika, 2003a). Both companies had personal financial and empire-building motives, and the lasting effects of these self-interested biases during the decision process are clear, given what transpired in the postmerger. One could argue that the decision to unite these two very different companies was erroneous, given that it was termed the “worst deal in history” (Swisher, 2003, p. 9), with an annual loss of $99 billion in 2002 (Hu, 2003a; Klein, 2003).

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Kahneman et al. (2011) state that in many corporations, boards can make ineffective decisions because decision makers believe that there is sufficient support for the decision. In relation to this case study, the possibility of groupthink was inferred in the case of both boards’ decision to merge. This was deduced from the language within the S-4 form—a form filed with the Securities and Exchange Commission (SEC)—in which both boards unanimously approved the merger (SEC, 2000). Despite this, the AOL board members stated, The . . . board did not assign particular weight or rank to the factors it considered in approving the merger . . . individual members of the America Online board may have given different weight to various ones. The America Online board considered . . . factors as a whole, and overall considered them to be favorable to and to support its determination. (SEC, 2000, p. 34)

The Time Warner board also followed the same approach. That both boards only considered the details of the weights or ranking of factors on a group level during its decision making procedures implies that the decision process was superficial. Such a process means executives can “hide behind a group decision” and can lead to “group momentum,” otherwise defined as groupthink (Fanto, 2001). Thus, the effects of groupthink are clearly evident in the postmerger failure to realize synergies, as well as the disputes between the executives regarding management style and structures (Bruner, 2005). Kahneman et al. (2011) explain saliency bias as the inference that reference to past successes by decision makers justifies the current course of action. However, in the case of the AOL/Time Warner merger, such references can perhaps provide the basis for false inferences. The AOL board displayed examples of saliency bias in the S-4 form. For instance, “The [AOL] board . . . took note of the fact that the merger is with a long-time business partner . . . with a proven history of successful collaboration . . . between the two companies” (SEC, 2000, p. 33). Here they reference the success of the past partnership between the companies, ignoring the extensive differences between collaborating with a company and merging with them. Time Warner also demonstrated saliency bias through their justification for the lack of a collar in the S-4 form. (A collar is a contractual precondition that the terms of the deal will be renegotiated if the share price of one or both of the companies trades outside an indicated range before the merger). They explain that “while the absence of [a collar] exposes Time Warner stockholders to some market risk, the risk is mitigated by the fact that holders of Time Warner’s . . . stock will participate in any appreciation in the value of America Online’s . . . stock” (SEC, 2000, p. 37). Here it can be deduced that the Time Warner board inferred that the fact that AOL’s stock price had grown at a compounded annual rate of 285% since 1992

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(Bruner, 2005, p.  269) meant that it would continue to grow. Therefore, they justified their risk of not having a collar because they would profit from the increased growth in AOL’s stock price. Both companies showed evidence of saliency bias during their decision making process. AOL’s confidence that previous successful collaborations would also denote a successful merger meant that perhaps the due diligence was not as extensive as it should have been. Time Warner’s decision not to include a collar meant that when the AOL stock price crashed, they experienced a large market loss, as will be explained under “disaster neglect.” Confirmation bias can disrupt a decision makers’ view of the world, as well as how they behave, which may have huge effects in large corporations (Cohan, 2007). During the merger decision making process, Time Warner displayed this bias to a high level. Cohan (2007) reports that Levin deliberately ignored the advice of his fellow board members who opposed the deal and failed to objectively seek out the risks involved, and allocated 3 days of due diligence to the decision making process. Levin further failed to inform all his executives about the deal until hours before the announcement to avoid further negation. This culminated in ineffective due diligence and lack of awareness of the potential risks involved, both of which would have potentially made it clearer that the choice of partner and the terms of the deal required rethinking. Availability bias can cause a decision maker to take no notice of the fact that information is missing when the available evidence creates a coherent narrative (Kahneman et al., 2011). With reference to megamergers, Fanto (2001) has noted that availability bias is a commonly occurring fact on boards where executives become overly fixated with issues extant in their consciousness. During 1998, Jerry Levin had tried to digitalize Time Warner, but faced much opposition from within the company (Bruner, 2005). Toward the end of the 1990s, he had also become aware of the convergence of technology, media, and telecoms and the need for a “transformational acquisition” (Bower, 2001; Bruner, 2005). This may have caused Levin to have a myopic focus on enabling the survival of Time Warner in the new digital age. For instance, in the S-4 form, it is noted that “The Time Warner board considered management’s view that AOL Time Warner’s . . . capabilities will provide it with a greater capacity to capitalize on . . . convergence of media, entertainment and communications than Time Warner (or America Online) alone” (SEC, 2000, p. 35). This suggests that the board’s view that the advantages of the merger were partly centered on the issue of responding to the industry convergence. With regard to M&A decision making, anchoring usually denotes that the financial evaluation of each company and the deal structure is done by referencing comparable firms and M&A transactions (Fanto, 2001). Fanto (2001) affirms that the presence of the anchoring heuristic in the AOL/

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Time Warner merger decision making was “strong.” During the M&A decision making process, firms usually rely on investment banks to provide the financial evaluation of each firm and the deal structure to be fair. The AOL/Time Warner S-4 form stated that “[the banks] compared the financial performance of America Online and Time Warner and the prices and trading activity of . . . common stock with those of other comparable publicly traded companies . . . [and] . . . reviewed the financial terms . . . of precedent transactions that [were] deemed relevant” (SEC, 2000, p. 48). This shows that other comparable firms and transactions were used as anchors in the financial evaluation of both firms and of the deal structure. The effects of the anchoring heuristic however are unclear, as Fanto argues that this is common in the financial evaluation of M&As. In this case, the terms of the evaluation of the firms and deal structure turned out to affect Time Warner negatively. According to Bruner (2005), the deal represented over $100 billion in goodwill, as 55% ownership of the new company acquired by AOL was largely based on their intangible assets. It was also reported that by January 2002, the value of these assets had dropped between $40 and $60 billion (Barker, 2002). The halo effect is especially evident in the Time Warner side of the merger. If we consider the events leading up to the merger, during the 1990s, Time Warner’s performance was poor. Despite this, Levin alluded to the fact that the stock price did not reflect the true worth of the company and alleged that a move into the Internet space required a merger (Bruner, 2005). By October 1999, AOL’s market capitalization had reached an all-time high of $231 billion (Bruner, 2005) and became the biggest name in the Internet space (BBC, 2000). The presence of the halo effect can be deduced from the fact that AOL carried a lot weight in the negotiations of the merger, largely because of their well-documented successes in the digital world. Despite the fact that Time Warner had revenues of $26.2 billion and AOL’s stood at $3.8 billion (First Union, 2000), Levin gave up 55% ownership of the new company to AOL (Adams, 2002). The halo effect can also be inferred from the fact that the only option for Levin was to merge with AOL or build Internet capabilities internally (Lohr & Holson, 2000). Hammond et al. (1998), explain the sunk-cost fallacy to be making decisions in order to justify flawed decisions from the past. From the available information, this was only present from the Time Warner side of the deal. During the merger decision making process, Time Warner executives brought to light not only that there would be significant cultural differences with the AOL managers, but also that AOL was being investigated for inappropriate bookings for $190 million in revenues (Cohan, 2007). It has been suggested that he made a decision not to act on this information in order to justify his decision to undertake the merger with AOL (Bruner, 2005). In addition, walking away from the deal would have cost $3.5 billion.

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The effects of not acting on this information on the outcome for Time Warner are exemplified through the fact that the merger overall was deemed to be a huge failure, and Levin resigned as CEO in December 2002 (Klein, 2003; Picard, 2004; Swisher, 2003). There was a high level of overconfidence from both sides in this merger. This overconfidence in turn caused overoptimism and a planning fallacy. There was also a level of competitor neglect during the premerger decision making process. Fanto (2001) states that overoptimism is often a key explanation for value-destroying mergers. Firstly, overconfidence is evident in the fact that Time Warner employees described Steve Case as “arrogant” and that “Levin’s ego” was seen as the ‘crux of the issue’” (Bruner, 2005, p. 278). Furthermore, in the S-4 form (SEC, 2000, pp. 34–35), both companies state that the merged company “will create a preeminent global company that, for the first time, will fully integrate traditional and new media and communications businesses and technologies.” It is interesting for such a high level of confidence to exist in a merger of this size given the figures that show how often mergers fail to create value and given that both companies were so large and so different in their structures and culture (Bruner, 2005; Hiltzik & Silverstein, 2000; Morgensen, 2000). Yet it was this overconfidence that stimulated a large amount of overoptimism and planning fallacy. For instance, in the S-4 form, both companies highlight that within the first year alone they would be able to create synergies in excess of $1 billion (SEC, 2000, p. 33). In addition, Case renounced sole control over Time Warner’s broadband cable assets to competitors (Bruner, 2005; Radhika, 2003a). In doing so, he underestimated the power of competitors to switch from narrowband to broadband more quickly and successfully than AOL/Time Warner. This level of neglect is highlighted by Swisher (2003, p. 207): “Cable was the driver of everything. Without it, the merger made a lot less sense.” The effects of these biases on the merger were wide-ranging. The optimistic target of $1 billion of synergies was not reached (Applegate, Miller, & Rei, 2002; Bruner, 2005), and AOL/Time Warner’s earnings targets were also missed. For example, its reported third quarter revenues of $9.3 billion were far below expectations (Radhika, 2003b). Finally, the effects of the inability to utilize their broadband assets led to the loss of 10 million subscribers by 2003 (Bruner, 2005). Disaster neglect was present in both AOL and Time Warner. As noted earlier, AOL recognized the imminent end to the Internet bubble and was using Time Warner for “capital preservation” (Swisher, 2003, p. 105). By merging with Time Warner, Case managed to avoid poor returns for the AOL shareholders (Schleifer & Vishny, 2003). Ang and Cheng (2006) underline that AOL’s strategy succeeded, as its stock was worth twice what it would have been without the merger. They also state that Time Warner’s stock was worth less than half what it would have been without the merger.

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Thus, Steve Case did well by the AOL shareholders, and it was Time Warner who neglected the potential for disaster. Evidence of disaster neglect can also be seen during the financial negotiations leading up to the merger. Jerry Levin made the decision with the Time Warner board to accept the proposition of merging without a “collar” (which will be explained) in the all-stock, fixed-share exchange deal (Applegate et al., 2002; Bruner, 2005; Swisher, 2003). This type of deal meant that the value of the stock of each of the firms on a specific day would be registered, and the overall price of the stock on that day would be fixed and used to buy shares in the new company (Rappaport & Sirower, 1999). Given that there were widespread doubts as to the fundamental worth of AOL’s stock (Swisher, 2003), Jerry Levin neglected the possibility of disaster by agreeing not to include a collar. As already noted, Time Warner’s revenue was five times that of AOL (Bruner, 2005), and so by giving AOL 55% ownership of the new company in exchange for their overvalued shares, Levin was opening up Time Warner to a potential disaster if the price was to crash. Thus, the negotiated balance of ownership of the combined entity was not founded on proven performance but on indefinite growth prospects in synergies and intangible assets such as subscribers (Bruner, 2005). A quotation from Swisher (2003, p. 2) sums up how the deal was received amongst critics: “A company without assets was buying a company without a clue.” Overall, disaster neglect was present from Time Warner’s side in the decision not to include a collar in the all-stock, fixed-share deal. The effects of this on Time Warner were clear in that they suffered a large portion of the loss of the value of AOL shares during the Internet crash. In fact, between the announcement and the consummation of the deal, it is reported that the overall value decreased by $200 billion (Bruner, 2005). Lovallo and Sibony (2010) and Fanto (2001) underline the similarities between loss aversion and the “status quo bias.” Moreover, Fanto (2001) purports that risk-averse feelings caused by loss aversion can lead to decision making looking to maintain the status quo—or become subject to the “status quo bias.” He adds that both biases are common in megamerger decision making due to the contentious nature and levels of uncertainty involved. Due to evidence of the status quo bias, it can be inferred that loss aversion was present during the decision making process leading up to the merger of AOL and Time Warner. Both companies had to manage the way that uncertainty and potential risks were presented. According to Fanto (2001), the merger was presented as a “merger of equals,” which “by definition, maintains the status quo” (p. 31). Fanto purports that this maintenance of the status quo is also evident in the fact that they emphasized the continuation of the board members. It is clear that to a small extent, loss aversion can be witnessed in the presence of the status quo bias. However, there were adverse effects of these biases on the outcome of the merger. Bruner (2005, p. 278), cites Gordon

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Crawford: “There was a lot of unhappiness caused by the management structure in this deal . . . People at Time Warner did not like Steve; they thought he was arrogant, incompetent and insensitive.” ANALYSIS OF STRATEGIC DECSION MAKING: THE CISCO SYSTEMS CASE Background Cisco is a world leader in the design, manufacture, and sales of networking equipment. It operates in over 65 countries with a staff of approximately 60,000 employees and annual revenue of $11.5 billion. Cisco’s business environment is primarily in the areas of technological developments, evolving standards, changes in customer requirements, and new production introductions (Goldblatt, 1999). The company has been involved in a number of acquisitions since the 1990s and is well known for its aggressive strategic buyouts. Over this period, Cisco has acquired more than 100 companies (Chatman et al., 2005). Cisco’s focus has been on smaller companies and acquired companies and is known for using a clear strategy in its selection of companies to ensure synergy creation through the acquisition of technologies. Moreover, Mayer and Kenney (2004) state that Cisco’s acquisition strategy was better than any other high-technology firm in history, with many successes and far fewer failures. Goldblatt (1999) supports this statement, saying that “No company typifies . . . M&A better than Cisco Systems” and highlights the 162% stock price rise in 1998 as a notable example of their outstanding strategy. Mayer and Kenney, go on to underline that the prolonged success of increasing market growth and employee retention is particularly impressive, given that all of the acquisitions were in the high-tech industry. The particularly impressive element of Cisco Systems’ case is their prolonged success, especially during the period between 1993 and 2001. During this time, they also became the most valuable company in the world, with a market valuation of $555 billion (Wong, 2000). Given this, the following section provides an analysis of the decision making process within the merger and associating them with a suitable emotional and cognitive bias. Presence of Emotional Barriers Cisco System’s successful acquisition strategies during 1993–2001 can be attributed to the level of emotional openness within the organizational culture. Cisco’s organizational culture is well known for its openness (O’Reilly,

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1998). Chatman et al. (2005, p. 145) note that “open communication” is one of Cisco’s main cultural principles, and all employees are encouraged to participate in the firm’s strategy. John Chambers (CEO of Cisco) was quoted as saying “Sure email would be more efficient . . . But I want to hear the emotion, I want to hear the frustration, I want to hear that person’s level of comfort with the strategy we’re employing” (O’Reilly & Pfeffer, 2000, p. 47). This illustrates his willingness to listen to his employees and allow them to express their emotions openly. Emotional openness can also be shown in that Chambers held a monthly meeting for all employees’ birthdays (O’Reilly & Pfeffer, 2000), during which he was available to deal with employee queries. This environment of emotional openness may have positively affected the company’s acquisition strategies. For instance, in the early stages of due diligence, Cisco always met with employees of the target firm to discuss the terms of the deal. Chambers stated, “We’ve learnt that to make it [the acquisition] successful, you have to tell employees up front what you are going to do, because trust is everything in this business. You have got to tell them early so that you don’t betray their trust later” (Rifkin, 1997). Finally, Cisco frequently organized a postmerger “buddy system,” which gave employees from both sides personalized attention in an attempt to create an environment which allowed the expression of emotions. Cisco’s acquisition strategy can also be seen to be successful because they had systematized the process to such an extent that any exposure to the affect heuristic was minimized to the greatest extent possible. The decentralized nature of Cisco’s management structure empowered managers within both specific business units and business development groups to make decisions regarding acquisitions (Prasanth & Gupta, 2004). This process actively minimizes the possibility of the affect heuristic. In the case of a business unit, identifying the need for an acquisition follows approval among the managers within that unit. A “sponsor” would then bring this to the attention of the board, who would then decide whether or not to continue through the next stages of due diligence and integration (Mayer & Kenney, 2004; Prasanth & Gupta, 2004). Similarly, within the business development groups, which consisted of technology specialists and employees from different business units (Mayer & Kenney, 2004), Cisco’s systematized process allowed these units to work with senior board executives in making a final decision concerning acquisitions (Prasanth & Gupta, 2004). The fact that there were several stages in this identification process meant that any potential emotional component to the recommendation had been diluted by the time it reached board level. The affect heuristic was therefore minimized by Cisco through a systematized acquisition-identification process, where final approval rested with the board, which objectively checked for biases. The effects on the acquisition process were positive because the empowerment of employees to make decisions allowed for a “high surface area” strategy (Mayer & Kenney, 2004).

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As part of their systematized acquisition process, Cisco also demonstrated a high level of awareness of the potential for identity-based emotional barriers. It is argued that a key reason for their successful acquisition strategy was their ability to remove these barriers from the process. One of Cisco’s key measures of a successful acquisition strategy was employee retention (Mayer & Kenney, 2004). Chambers emphasized the role of people in an acquisition in a quote: “Most people forget that in a high-tech acquisition, you really are acquiring only people. That’s why so many of them fail” (Tempest, 1998, p. 4). This emphasis on the importance of people is clear in Cisco’s strategy (O’Reilly, 1998). Sarah Wellman, senior vice president of business units, explained, “Cisco will never engage in a ‘hostile’ takeover . . . the entire acquisition process must be characterized by honesty and trust . . . all people must be fully informed throughout the acquisition . . . to avoid negative surprises and maximize retention” (O’Reilly & Pfeffer, 2000, p. 43). This shows that Cisco aims to avoid problems related to identitybased emotions barriers in acquisitions by engaging in constant communication with the target firms during the due diligence process. Furthermore, Cisco always attempted to ensure that employees of the target firm kept their jobs and positions, which further reduces identity-based emotional barriers, as well as increasing the likelihood of acquisition success (Bunnel, 2000). A further example of Cisco’s success in overcoming identity-based emotional barriers is the fact that over 70% of the senior managers of the acquired companies were still with Cisco in 1997 (O’Reilly, 1998). Between 1993 and 2001, Cisco fostered emotional commitment toward their acquisition strategies in several ways. By engendering a commitment to employees, Cisco had positive effects on the outcome of each of it acquisition strategies. Cisco created a dialogue to realize internal emotional commitment toward its acquisition strategies and provide a clear strategic direction to make it clear to employees what they were trying to achieve. They also established a clear set of strategic guidelines that would help them to become the best in each market segment acquired (O’Reilly & Pfeffer, 2000). This built-in emotional commitment provided employees with a sense of ownership over the company’s strategic direction. Furthermore, employees received stock options (O’Reilly & Pfeffer, 2000), which was another incentive for their level of emotional commitment toward acquisitions. Employees believed that the acquisition would be positive for the company and would therefore help their stock options grow in value (Rifkin, 1997). Presence of Cognitive Barriers Cisco was successful in avoiding self-interested biases during their acquisition processes in several ways. First, as a personality, John Chambers was

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described as being modest, with little “CEO-style bravado” (O’Reilly & Pfeffer, 2000, p. 46), and was lauded for his “visionary strategy” (Chatman et al., 2005, p. 139) and his ability to drive an entrepreneurial culture (O’Reilly & Pfeffer, 2000). Thus, references to “vision” and “entrepreneurial culture” portray that the agile growth driven by Chambers was grounded in the aim of achieving the company’s aforementioned goals for the future. This collaborative culture helped Cisco avoid self-interested biases in the way that the acquisition process was systematized. As noted above, the identification of potential acquisition targets often took place within a single business unit or the business development group, but the final decision lay with three senior board executives to safeguard against any bias (Prasanth & Gupta, 2004). Cisco’s centric vision of acquisitions is summed up by Michael Volpi, Chief Strategy Officer (at the time), who stated, “We don’t do [acquisitions] because we can swing a good deal—they are strategic. We do them to grow [Cisco] in the right direction” (Mayer & Kenney, 2004, p. 312). Groupthink was also avoided by Cisco during their acquisition processes. During the acquisition process, Cisco typically involved leaders of each of the different business units in the negotiations stage (O’Reilly & Pfeffer, 2000). Cisco recognized the importance of the buy-in from each of the business units while also acknowledging the importance of diversity during the decision making process (Yemen, Chaterjee, & Bourgeois, 2003). The due diligence process is often described as the “war room” (O’Reilly, 1998, p. 6), in which a variety of opinions mix in the process, which, in conjunction with an emotionally open environment, would encourage contradictory opinions. The very fact that it was called the “war room” demonstrates their commitment to encouraging differing perspectives. Furthermore, Cisco’s systematized acquisition process made it necessary for each candidate to be approved at each stage of the process by different people (O’Reilly & Pfeffer, 2000). This emphasizes the importance placed on avoiding groupthink through involving a diversity of people, with different opinions, at different stages of the due diligence process. Cisco avoided saliency bias through their rigorous selection procedure. Stage one of Cisco’s acquisition processes involved the identification of the target company (Mayer & Kenney, 2004). After agreeing that the identification of the target company was right, a collaborative process that involved a “sponsor” (as explained earlier), including the BDG and BU’s, to draw up a list of criteria and potential target companies. This rigorous selection process was an integral part of the acquisition process. John Chambers quotes, “I think the most important decision in your acquisition is your selection process. If you select right, with the criteria we set, your probabilities of success are extremely high . . . We spend a lot of time on the upfront” (Rifkin, 1997). Cisco followed five principles to achieve acquisition success: having a shared vision, a short-term win-win for the acquired company, a long-term

Analysis and Improvement of M&A Decision Making Processes    27

win-win for both parties, right chemistry or cultural compatibility, and a reasonable geographic proximity (O’Reilly & Pfeffer, 2000). Cisco also went to significant lengths to ensure that their acquisition proposals were not subject to confirmation bias. Cisco made sure that the proposal was carefully scrutinized and that a list of several target companies was drawn up (Mayer & Kenney, 2004). Once a potential target was chosen, it was relentlessly screened against their five principles (as noted above). This element of screening shows that Cisco avoided confirmation bias by comparing potential candidates against the required criteria rather than only seeking information that supported their proposal. Overall, it can be said that Cisco made significant efforts to reduce the potential for subjectivity to confirmation bias during their acquisition process. Many industry analysts claim that two of Cisco’s key success factors were the depth of their preacquisition analysis and emphasis on the cultural fit (Chatman et al., 2005). The ability of Cisco to avoid being subject to the availability bias can also be seen to be a key success factor of their acquisition strategies. During the premerger process, there is evidence of Cisco attempts to gather as much information as possible about the deal in order to make the right decision. Cisco utilized a “planning matrix” tool to help them analyze markets and identify opportunities when making decisions about acquisitions (O’Reilly & Pfeffer, 2000). This helped them avoid the availability bias, because they were aware of the critical information that they needed prior to due diligence. An example of the success of this extensive due diligence is that in one acquisition, Cisco found $60 million in uncovered liabilities—more than the value of the company itself. For Cisco, this meant that the deal was closed quickly due to the honest communication and mutual exchange of critical information during the due diligence process (O’Reilly, 1998). This often allowed Cisco to achieve their aim of taking the acquired company’s product to market under the Cisco name within 3–6 months—a very important factor in the high-tech industry, where product life cycles are usually between 6 and 18 months (O’Reilly & Pfeffer, 2000). Given Cisco’s focus on their acquisition strategy of minimizing the time to market, the acquisition price sometimes became a lower priority. Thus, presence of an anchoring bias in Cisco’s financial negotiations as part of their acquisition strategy is clear. Chambers is quoted as saying, “We pay between $500,000 and $2 million per person in an acquisition, which is a lot” (Rifkin, 1997). It appears that Cisco had a predetermined amount that anchored how much they paid per employee for a target company. The fact that they were aware of this anchor makes it clear that Cisco did not prioritize financial motives for mergers. Mike Volpi (Vice President of Business Development at the time) stated, “We have the [acquisition] process down. We have a generic process. Sometimes in all this speed we end up paying too much. But the acquisitions are not financial—we don’t do them

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because we can swing a good deal—they are strategic” (O’Reilly & Pfeffer, 2000, p. 46). In line with their focus on time-to-market, this implies that any potential anchoring bias or avoidance of overpayment would seen as a lower priority for Cisco if they saw a strategic advantage in targeting an acquisition. The effects of their focus on strategic over financial motives for acquisitions meant that overpayments were sometimes made, but they were usually able to get the acquired product to market within 3–6 months (O’Reilly & Pfeffer, 2000). Cisco managed to avoid being subject to the halo effect by recognizing the dependencies involved in acquiring high-tech companies. Chambers quotes, “At what we pay [for mainly small acquisitions] . . . we are not acquiring current market share. We are acquiring futures” (Tempest, 1998, p. 5). In other words, Cisco recognized that in order to successfully acquire a new technological resource, they had to take into account that the continuation of the quality of the resource was dependent on the retention of the employees who created it. Therefore, acquisitions were based on the expected future growth of the product or company and not a “current” large market share. Furthermore, during due diligence, Cisco emphasized a thorough evaluation of the target’s management, technology, financing, and talent in order to help make a decision, which further constitutes an avoidance of the halo effect. Although this meant that the due diligence process took a little to complete, it often meant that the integration process could take place very quickly (O’Reilly & Pfeffer, 2000). Cisco is shown to avoid both the sunk-cost fallacy and the endowment effect during its acquisition. Cisco learned that in order to maintain its success, it was important to be able to disregard past expenditures and make decisions based on their potential to benefit the company in the future. In some cases, Cisco has had the opportunity to acquire a company that fitted culturally, with a good product, for an extremely good price, but because Cisco was aware that once the product went to market the services of acquired employees would no longer be required, the acquisition was decided against (O’Reilly & Pfeffer, 2000). Chambers is also quoted as saying that this ability was very much part of their overall strategy: “We’ve killed nearly as many acquisitions as we’ve made . . . even when they were very tempting . . . You can get caught up in winning the acquisition and lose sight of what will make it successful. That’s why we take such a disciplined approach” (Rifkin, 1997). Cisco was also able to overcome the endowment effect through this disciplined process. For example, in 1995, Cisco had a technology that was extremely promising for the future of the industry. They recognized that their customers wanted more instant solutions, and a decision was made to acquire a company for $120 million that would answer the customers’ calls rather than wait for their promising technology to come into fruition (O’Reilly, 1998). In this case, Cisco could have invested

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more money in their own technology in order to retain its expected value for customers, but they decided to acquire a company with a less-advanced technology that would satisfy their customers more. There is also evidence of Cisco avoiding planning fallacy, overconfidence and overoptimism, and competitor neglect. Cisco incorporated many lessons from their experiences in their acquisition strategies (Yemen et al., 2003). In terms of overcoming planning fallacy, Cisco learned that through experience, integration could take place within desired time frame of 100 days if the integration process clearly outlined the objectives in the premerger stage (Garbuio, Lovallo, & Horn, 2012). By building on this experience and learning from their mistakes, they were able to create an aggressive integration process plan for each acquisition (Rifkin, 1997). Given the short product life cycles in this industry, moving quickly was essential for success in the marketplace. Charles Giancarlo (Vice President of Business Development) stated, “Early if not elegant . . . If you are a year late, that market might not exist anymore. We’d rather learn from our mistakes . . . If we are not making mistakes, we aren’t moving fast enough.” (Rifkin, 1997). Here, “early if not elegant” is explaining the time taken to take new products to market, emphasizing the relative importance of time-to-market over smoothness of the process. Cisco’s planned short time scale to complete acquisitions and take products to market was not underestimated, as it was based on experience which they used to overcome planning fallacy. Cisco also used their experience to overcome overoptimism and overconfidence. They used their experience from information on failed M&As and on this basis built appropriate strategic guidelines, which directed their decision to pursue or not pursue an acquisition (O’Reilly & Pfeffer, 2000). Their use of experience to overcome overconfidence is further demonstrated in their reaction to the difficult integration of StrataCom. John Morgridge (Chairman at the time) stated, “We gained insight on the unique challenges of doing a big deal versus a small one. We felt pretty good with the small deals. Whenever you feel like that, you better watch out” (Bunnell, 2000, p. 83). They learned a great deal from doing what was their biggest ever acquisition, valued at $5 billion (Mayer & Kenney, 2004). Cisco’s avoidance of competitor neglect can also be said to have been down to experience. Chambers stated that he learned at IBM that to stay ahead in the high-tech industry one needed to keep up with the latest trends and competition in the industry (Schlender, 1997). He stated, “I have a list of . . . little companies that I’m tracking very closely; guys who start from a fresh sheet of paper have an enormous advantage technologically . . . They keep us on our toes” (Killick & Rawoot, 2001, p. 28). The ability to overcome such strong biases was one of the main reasons for Cisco’s capability in acquiring 41 companies during 1999 and 2000 (Byrne & Elgin, 2002).

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The avoidance of disaster neglect was a key part of Cisco’s acquisition success. Evidence of this can be seen in several examples, all of which were built on experience. Firstly, Cisco’s acquisition strategy was one that was very much built on the awareness of what could go wrong. This was particularly true during the period when Chambers was CEO. Chambers understood that Cisco would need to be built on change in order to succeed in the hypercompetitive high-tech industry. Chambers understood the potential pitfalls in Cisco’s acquisition strategy and therefore wanted to be able to avoid them by making Cisco a dynamic corporation. In doing so, Chambers believed that they needed to undertake smaller acquisitions. He did not believe that a “merger of equals” would be a good idea, as he recognized that this would cause the company to lose growth (O’Reilly & Pfeffer, 2000). It would further catalyze competitor reactions that may destabilize the industry. He stated, “Our more typical acquisitions will continue to be smaller engineering acquisitions. We will continue to go after private companies. You can acquire 81of them much quicker with far fewer legal nightmares. There is also a lot less risk in those deals” (Rifkin, 1997). It was even reported that Cisco had acquisition rules to acquire only companies with no more than 75 employees, 75% of whom were engineers (Eisenhardt & Sull, 2001). Furthermore, Cisco was highly aware of the potential for disasters and therefore was always planning against them by diligently appraising the proposal before passing it. This meant that rather than doing one megamerger and facing potential disaster, Cisco was able to acquire and integrate an average of one company a month between 1993 and 2001 (Mayer & Kenney, 2004). Cisco also claimed that they had an 80% success rate during this time (Byrne & Elgin, 2002), far above the average success rate of M&As of below 50% (O’Reilly, 1998). Cisco also used their experience to avoid loss aversion as part of their overall acquisition strategy. Cisco understood that aggressive strategic agility was an essential capability if Cisco was to keep up with the increasingly fast rate of change in the high-tech industry and grow. Chambers stated, “You always want to balance . . . paranoia with the confidence and ability to move forward” (O’Reilly, 1998, p. 3). Cisco used its experience of missed growth opportunities in order to tailor its strategies so as not to be risk averse. Chambers stated, “We began looking at every quarter and adjusting our plan up or down . . . we made the conscious decision . . . that we were going to shape the future of our entire industry” (Rifkin, 1997). This new perspective, driven by the need to avoid loss aversion and seize opportunities, also permeated to individual acquisitions. For example, a key factor that Cisco took into account when assessing a potential target was the mistakes that the target company had made in the past (Yemen et al., 2003). Thus, avoidance of loss aversion had infiltrated the criteria for new targets.

Analysis and Improvement of M&A Decision Making Processes    31

CONCLUDING REMARKS We have shown how both emotional and cognitive biases during the M&A decision making process can jeopardize the quality of the decisions made and negatively impact the merger/acquisition outcome. The decision makers possess biases and flaws in the way they think and feel, which can distort the process of decision making. From the analysis of the two case studies above, it is clear that both emotional and cognitive biases can influence decision making and affect the quality of the decisions and their outcomes. Our analysis supports the view that emotional and cognitive biases are prominent in top-level management (Kahneman et al., 2011; Paluch, 2011). This is clearly evident in the case of AOLTW, where the frequency of inadequate outcomes was unavoidable due to emotional and cognitive biases. Table 1.3, provides a comparison between the two cases as an attempt to highlight the differences between the two cases in terms of their TABLE 1.3  Comparison of AOL/Time Warner and Cisco Systems (Psychological Barriers) AOL/Time Warner Occurrence Presence of Emotional Barriers Emotional Closedness High Affect Heuristic High Identity-Based Emotional Medium Barriers High Poor Emotional Commitment Presence of Cognitive Barriers Self-Interested Bias High Groupthink Medium Saliency Bias Medium Confirmation Bias Medium Availability Bias Medium Anchoring Bias High Halo Effect High Sunk-Cost Fallacy High Endowment Effect Overconfidence High Planning Fallacy Overoptimism Competitor Neglect Disaster Neglect High Loss Aversion High

Cisco Systems

Effect

Avoidance

Effect

Very Negative Very Negative Very Negative

High High High

Very Positive Positive Very Positive

Very Negative

High

Very Positive

Very Negative Negative Negative Negative Negative Very Negative Negative Very Negative

Medium High High High High Low High High

Positive Positive Positive Very Positive Very Positive Average Positive Very Positive

Very Negative

High

Very Positive

Very Negative Very Negative

High High

Very Positive Very Positive

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behavior toward both the emotional and cognitive barriers with a view to understanding why high-tech M&A failures occur. This may be used as a set of guidelines tailored toward improving M&A decision making by managing emotional and cognitive barriers. In Table 1.3, the differences between AOLTW and Cisco systems are that the “Occurrence” column refers to the passive act of failing to overcome the barriers and the “Effect” column refers to the presence they had on the merger. Regarding Cisco Systems, given that it was the “successful” case study, the “Avoidance” column refers to the active efforts made to overcome the barriers, and the “Our” analysis indicates that AOLTW merger decision making shows that a high occurrence of emotional barriers meant that employees were unable to express their true opinions about the merger. The emotional drive of senior personnel, together with a lack of or emotional commitment on part of employees involved in the decision making process, led to improper due diligence and postmerger cultural problems. Cisco Systems encouraged emotional openness and commitment by empowering employees to make decisions both internally and with target companies. Cisco recognized the importance of people as part of their strategy and overcame these barriers through their in-depth due diligence and open communication. Research suggests that an awareness of such barriers can improve the decision making process (Kahneman et al., 2011). Thus, a better understanding of people’s emotional behavior might help improve excessive risk taking and large corporate failures (Powell et al., 2011).  The M&A decision making process can ensure that decision makers have maintained a neutral perspective at each stage by recognizing the importance of people during the entire process. Building a culture of emotional openness within the company and ensuring open communication of emotions within and between the target company can have positive affects on individual actions and the outcome of the decision process (Elfenbein, 2007). Moreover, a clear direction of goals communicated to employees through incentivizing employees to commit to the strategic direction can encourage open communication in the strategic direction. Our findings have also highlighted that cognitive biases can lead to suboptimal decisions. The behavioral characteristics of the AOLTW merger resulting from the decisions made, influenced by cognitive biases, are observed to have negative implications for the merger outcome (see Table 1.3). From the above analysis, we see that AOLTW had high occurrences across cognitive barriers, which had negative effects on the outcome of the merger. By comparison, it appears that Cisco understood these components in people’s behavior and was thus better able to make effective decisions concerning its acquisitions. In the case of AOLTW, the overconfidence of senior executives resulted in poor judgments regarding the target company, ignoring negative factors that would impact the merger, as well

Analysis and Improvement of M&A Decision Making Processes    33

as disregarding the opinions of their employees. This led to behavioral uncertainty and also poor performance on both sides of the merger. Unlike Cisco, AOLTW failed to involve their employees in the decision making process. Moreover, Cisco followed a rigorous and disciplined selection and due diligence process by involving a diversity of people and took account of a diversity of opinions at different stages when making decisions. Evidence clearly supports the view that conflicting interests between parties can disturb the stability of a merger (Weber & Schweiger, 1992). Cognitive biases are present in people and in teams involved in making choices and decisions, and our findings suggest that it is important for large corporations to recognize and overcome these barriers for efficient decisions to be made. It is important that corporations are first of all aware that such biases exist within the firm. Only then can employees review the exposure to these biases when making decisions. Good and bad decisions are part of any merger and acquisition package. Our analysis of Cisco demonstrates that timely and well-considered alternatives might lead to more efficient decisions and lead to positive merger and acquisition outcomes. The CEO of Cisco made an appropriate strategy of integrating the corporate cultures of its acquisitions by overcoming many of the cognitive biases. Culture has been shown to determine the behavior of employees in partnerships (Das & Kumar, 2010) and can influence the decision making process (Lisø, 2011). Cisco is well known for its cultural integrity in its acquisitions, and hence the majority of its decisions is realized for the common interest and benefits both parties. Cisco’s decision making process in its acquisitions appears to be highly focused on achieving its objectives through considering all alternatives. The outcomes of these decisions resulted in due diligence. According to Thaler and Sunstein (2008), decision makers are normal human beings with flawed cognitive abilities and poor self-control. Rather than try to fix the rooted error of human cognition, firms need to concentrate on various ways to counteract the biases by improving the psychological architecture of the environment (Powell et al., 2011). Increasing awareness of biases among decision makers would help in overcoming these predispositions while making important decisions. To overcome any bias and increase the quality of decisions, the main aspects to concentrate on are the identification of the required information, evidence, and to consider all probable alternatives. Each party should evaluate information independently and conduct shared decision making by debating the pros and cons of the decision in due diligence. REFERENCES Adams, M. (2002). Making a merger work. HR Magazine, 47(3), 52–57.

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Analysis and Improvement of M&A Decision Making Processes    35 Byrne, J. A., & Elgin, B. (2002, January 20). Cisco shopped till it nearly dropped. Bloomberg. Retrieved August 6, 2013, from http://www.bloomberg.com/bw/ stories/2002-01-20/cisco-shopped-till-it-nearly-dropped Calandro, J. (2008). Assessing the risk of M&A: Bruner’s disaster framework applied to Berkshire Hathaway’s genre acquisition. Strategy & Leadership, 36(6), 20–27. Campbell, A., Whithead, J., & Finkelstein, S. (2009). Why good leaders make bad decisions and how to stop it from happening to you. Harvard Business Review, 87(2), 60–66. Campitelli, G., & Gobet, F. (2010). Herbert Simon’s decision making approach: Investigation of cognitive processes in experts. Review of General Psychology, 14, 454–464. Chatman, J., O’Reilly, C., & Chang, V. (2005). Cisco Systems: Developing a human capital strategy. California Management Review, 47(2), 137–167. Chaudhuri, S., & Tabrizi, B. (1999). Capturing the real value in high-tech acquisitions. Harvard Business Review, 77(5), 123–130. Chenhall, R. H., & Langfield-Smith, K. (2007). Multiple perspectives of performance measures. European Management Journal, 25, 266–282. Cohan, P. S. (2007). When the blind lead. Business Strategy Review, 8(3), 65–70. Cullinan, G., Le Roux, J.-M., & Weddigen, R. M. (2004). When to walk away from a deal. Harvard Business Review, 82(4), 96–104. Dai, G., Tang, K. Y., & Demeuse, K. P. (2011). Leadership competencies across organizational levels: A test of a pipeline model. Journal of Management Development, 30(4), 366–380. Das, T. K. (1986). The subjective side of strategy making: Future orientations and perceptions of executives. New York, NY: Praeger. Das, T. K., & Kumar, R. (2010). Interpartner sensemaking in strategic alliances: Managing cultural differences and internal tensions. Management Decision, 48, 17–36. Das, T. K., & Teng, B. (1999). Cognitive biases and strategic decision processes: An integrative perspective. Journal of Management Studies, 36, 757–778. Desyllas, P., & Hughes, A. (2009). The revealed preferences of high technology acquirers: An analysis of the innovation characteristics of their targets. Cambridge Journal of Economics, 33, 1089–1111. Duhaime, I. R., & Schwenk, C. R. (1985). Conjectures on cognitive simplification in acquisition and divestment decision making. Academy of Management Review, 10(2), 287–295. Economist Intelligence Unit. (2007). In search of clarity—Unravelling the complexities of executive decision-making. [online] Retrieved from http://graphics.eiu.com/ upload/EIU_In_search_of_clarity.pdf. Eisenhardt, K. M., & Sull, D. N. (2001). Strategy as simple rules. Harvard Business Review, 79(1), 106–116. Elfenbein, H. A. (2007). Emotion in organizations: A review and theoretical integration. Academy of Management Annals, 1, 315–386. Fanto, J. A. (2001). Quasi-rationality in action: A study of psychological factors in merger decision making. Ohio State Law Journal, 62(4), 1333–1408. First Union Equity Research. (2000). AOL-Time Warner financial. First Union. French, S., Maule, J., & Papamichail, N. (2009). Decision behavior, analysis and support. Cambridge, UK: Cambridge University Press.

36    S. KAUSER et al. Frick, K. A., & Torres, A. (2002). Learning from hi-tech deals. McKinsey Quarterly, 1, 113–123. Garbuio, M., Lovallo, D., & Horn, J. (2012). Overcoming biases in M&A: A process perspective. In S. Finkelstein & C. Cooper (Eds.), Advances in mergers & acquisitions (Vol. 9, pp. 83–104). Bingley, UK: Emerald. Gavetti, G., Levinthal, D., & Ocasio, W. (2007). Neo-Carnegie: The Carnegie school’s past, present and reconstructing for the future. Organization Science, 18, 523–536. Goldblatt, H. (1999). Cisco’s secrets. Fortune, 140(9), 177–182. Gordon, W. (2011). Behavioral economics and qualitative research—A marriage made in heaven. International Journal of Market Research, 53(2), 171–185. Graebner, M. E. (2004). Momentum and serendipity: How acquired leaders create value in the integration of technology firms. Strategic Management Journal, 25(8/9), 751–777. Graebner, M. E., Eisenhardt, K. M., & Roundy, P. T. (2010). Success and failure in technology acquisitions: Lessons for buyers and sellers. Academy of Management Perspectives, 24(3), 73–92. Hammond, S. J., Keeney, R. L., & Raiffa, H. (1998). The hidden traps in decision making. Harvard Business Review, 76(5), 47–58. Haspeslagh, P. C., & Jemison, D. B. (1991). Managing acquisitions: Creating value through corporate renewal. New York, NY: Free Press. Hiltzik, M., & Silverstein, S. (2000, Janauary 12). AOL, Time Warner face many merger obstacles. Los Angeles Times. Retrieved August 1, 2013, from http:// articles.latimes.com/2000/jan/12/news/mn-53270 Hodgkinson, G. P., & Healey, M. P. (2011). Psychological foundations of dynamic capabilities: Reflexion and reflection in strategic management. Strategic Management Journal, 32(13), 1500–1516. Hopkins, H. D. (1999). Cross-border mergers and acquisitions: Global and regional perspectives. Journal of International Management, 5, 207–239. Hu, J. (2003a, January 30). AOL loses Ted Turner and $99 billion. CNET News. Retrieved July 1, 2013, ftrom http://news.cnet.com/2100-1023-982648.html Hu, J. (2003b, September 18). AOL Time Warner drops AOL from name. CNET News. Retrieved July 26, 2013, from http://news.cnet.com/AOL-Time-Warner-drops-AOL-from- name/2100-1025_3-5078688.html Huy, Q. N. (2012). Emotions in strategic organization: Opportunities for impactful research. Strategic Organization. 10, 240–247. Jemison, D. B., & Sitkin, S. B. (1986). Acquisitions: The process can be a problem. Harvard Business Review, 64 (2), 107–116. Kahneman, D., & Klein, G. (2009). Conditions for intuitive expertise: A failure to disagree. American Psychologist, 64(6), 515–526. Kahneman, D., Lovallo, D. P., & Sibony, O. (2011). Before you make that big decision. Harvard Business Review, 89(6), 50–60. Kahneman, D., & Tversky, A. (1979). Prospect theory: An analysis of decisions under risk. Econometrica, 47, 313–327. Keeney, R. L. (2004). Making better decision makers. Decision Analysis, 1(4), 193–204.

Analysis and Improvement of M&A Decision Making Processes    37 Killick, M., & Rawoot, I. (2001). Cisco Systems Inc—Growth through acquisitions. Graduate School of Management, University of Western Australia, Perth. Case Number 301-018-1. King, D. R., Colvin, J. G., & Hegarty, W. H. (2003). Complementary resources and the exploitation of technological innovations. Journal of Management, 29, 589–606. Klein, A. (2003). Stealing time: Steve Case, Jerry Levin, and the collapse of AOL Time Warner. New York, NY: Simon & Schuster. Kwoka, J. E., & White, L. R. (2004). The antitrust revolution: Economics, competition and policy (4th ed.). New York, NY: Oxford University Press. Larsson, R., & Finkelstein, S. (1999). Integrating strategic, organizational and human resource perspectives on mergers and acquisitions: A case survey of synergy realization. Organization Science, 10, 1–26. Lisø, S. O. (2011). The influence of culture on decision making in a strategic alliance. Unpublished master’s dissertation. University of Agder, Norway. Lohr, S., & Holson, L. M. (2000, January 16). Price of joining old and new was core issue in AOL deal. New York Times. Retrieved August 1, 2013, from http:// www.nytimes.com/library/financial/011600aol-time.html Lovallo, D. P., & Sibony, O. (2010). The case for behavioral strategy. McKinsey Quarterly, 2, 30–43. Lubatkin, M., & Shrieves, R. E. (1986). Towards reconciliation of market performance measures to strategic management research. Academy of Management Review, 11, 497–512. Marks, M. L., & Mirvis, P. H. (2001). Making mergers & acquisitions work: Strategic and psychological preparation. Academy of Management Executive, 15(2), 80–92. Mayer, D., & Kenney, M. (2004). Economic action does not take place in a vacuum: Understanding Cisco’s acquisition and development strategy. Industry and Innovation, 11, 299–325. McKinnon, A. (2003). Decision making in organizations. Retrieved August 1, 2013, from http://homepages.inspire.net.nz/~jamckinnon/business/Decision-Making %20in%20Organisations.pdf Miller, E. S. (2001). The impact of technological change on market power and market failure in Telecommunications. Journal of Economic Issues, 35, 385–393. Montgomery, C. A., & Wilson, V. A. (1986). Mergers that last: A predictable pattern? Strategic Management Journal, 7, 91–96. Morgensen, G. (2000, January 11). Merger poses some tough questions for shareholders. New York Times. Retrieved August 1, 2013, from http://partners.nytimes.com/library/financial/011100time-marketplace.html Nag, R., Hambrick, D. C., & Chen, M. J. (2007). What is strategic management, really? Inductive derivation of a consensus definition of the field. Strategic Management Journal, 28, 935–955. Nguyen, H. T., Yung, K., & Sun, Q. (2012). Motives for mergers and acquisitions: Ex-post market evidence from the US. Journal of Business Finance & Accounting, 39, 1357–1375. O’Reilly, C. (1998). Cisco Systems: The acquisition of technology is the acquisition of people. Stanford Graduate School of Business, Stanford, CA. Case Number: HR-10.

38    S. KAUSER et al. O’Reilly, C. A., & Pfeffer, J. (2000). Cisco Systems: Acquiring and retaining talent in hypercompetitive markets. Human Resource Planning, 23(3), 38–52. Paluch, D. (2011). Overconfidence bias in decision making at different levels of management. MBA. Gordon Institute of Business Science, University of Pretoria, South Africa. Papadakis, V. M., & Thanos, I. C. (2010). Measuring the performance of acquisitions: An empirical investigation using multiple criteria. British Journal of Management. 21, 859–873. Papamichail, K. N., & Rajaram, V. (2007). A framework for assessing best practice in decision making. Paper presented at the 29th International DSI Conference, Bangkok, Thailand. Payne, J. W., Bettman, J. R., & Johnson, E. J. (1993). The adaptive decision-maker. Cambridge, UK: Cambridge University Press. Picard, R. G. (2004). Strategic responses to media market changes. Jönköping International Business School Ltd. JIBS Research Report Series No. 2. Powell, T. C., Lovallo, D., & Fox, C. R. (2011). Behavioral strategy. Strategic Management Journal, 32, 1369–1386. Prasanth, K., & Gupta, V. (2004). Cisco’s acquisition strategy. ICMR Center for Management Research Case Reference Number 304-049-1. Radhika, N. (2003a). Steve Case: The story of AOL’s architect. ICMR Center for Management Research Case Reference Number 803-034-1. Radhika, N. (2003b). AOL Time Warner: A merger gone wrong? ICMR Center for Management Research Case Reference Number 303-059-1. Ranft, A. L., & Lord, M. D. (2000). Acquiring new knowledge: The role of retaining human capital in acquisitions of high-tech firms. Journal of High Technology Management Research, 11, 295–319. Rappaport, A., & Sirower, M. (1999). Stock or cash? The tradeoffs for buyers and sellers in mergers & acquisitions. Harvard Business Review, 77(6), 147–158. Ray, S. (2012). Cultural dimension analysis of AOL-Time Warner merger. Journal of Applied Library and Innovation Science, 1(2), 39–41. Rheaume, L., & Bhabra, H. (2008). Value creation in information-based industries through convergence: A study of U.S. mergers and acquisitions between 1993 and 2005. Information and Management, 45(5), 304–311. Ricciardi, V., & Simon, H. K. (2000). What is behavioral finance ? Business, Education and Technology Journal, 2(2), 1–9. Rifkin, G. (1997, April 1). Growth by acquisition: The case of Cisco Systems. Strategy+Business. Retrieved August 4, 2013, from http://www.strategybusiness.com/article/15617?gko=3ec0c&tid=2778 Rubinfeld, D. L., & Singer, H. (2001). Open access to broadband access: A case study of the AOL/Time Warner merger. Berkeley Technology Law Journal, 16(2), 631–675. Santos, F., & Eisenhardt, K. M. (2009). Constructing markets and shaping boundaries: Entrepreneurial power in nascent fields. Academy of Management Journal, 52(4), 643–671. Schlender, B. (1997). Computing’s next superpower: Cisco Systems. Fortune, 135(9), 64–70.

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CHAPTER 2

BEHAVIORAL GOVERNANCE The Role of Scenario Thinking in Dealing With Strategic Uncertainty Theo J. B. M. Postma Robert P. Bood

ABSTRACT Strategic uncertainty is associated with unpredictability of decision outcomes related to strategic problems that emerge from the external environment. This suggests two major kinds of uncertainty: environmental and strategic uncertainty. Environmental uncertainty follows from events and changes in the external environment that may impact the strategic management of the organization and hence may increase the unpredictability of strategic decision outcomes. Strategic uncertainty relates to decision outcomes as such, which is both in practice and in the literature also referred to as “strategic risk.” Over the past decades, the evolving literature on “behavioral governance” has identified and discussed a range of group interaction and team process factors that shape and influence corporate governance. We discuss how 74 listed companies at the Amsterdam Stock Exchange cope with strategic risk and strategic risk management, as revealed in their annual reports, to exemplify the relevance and meaning of behavioral governance. Based on our review

The Practice of Behavioral Strategy, pages 41–75 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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42    T. J. B. M. POSTMA and R. P. BOOD of the literature on scenario thinking and analysis, we argue that it may offer a preeminent approach to influence, challenge and support the way boards function and take decisions in this context. Scenario thinking supports the identification of environmental uncertainties and their consequences.

INTRODUCTION Andrews (1981, p. 174) wrote that “central decisions that will determine the company’s nature and performance 10 and 20 years into the future, are laden with risk, uncertainty, and contention.” In recent years, substantial governance problems of firms and financial institutions have triggered an increasing interest in so-called risk management. Identifying, monitoring, and mitigating risks are nowadays considered key determinants of firm performance and value (Slywotzky & Drzik, 2005). Frigo and Anderson (2011, p. 22) define strategic risk management as a process for identifying, assessing and managing risks and uncertainties affected by internal and external events or scenarios, that could inhibit an organization’s ability to achieve its strategy and strategic objectives with the ultimate goal of creating and protecting shareholder and stakeholder value.

They also indicate that the current role of risk management in dealing with external risks and uncertainties is limited and seemingly immature. We follow the theoretical distinction made between risk and uncertainty (Knight, 1921; March & Simon, 1958). Whereas for risk decision makers the probability distribution of possible outcomes of alternative courses of action is known, they lack that insight for uncertainty. In addition, we distinguish between environmental and strategic uncertainty. Environmental uncertainty springs from events and changes in the external environment that may impact the strategy and performance of the firm and hence increases the unpredictability of strategic decision outcomes. Strategic uncertainty refers to the situation in which any insight into the probabilities of possible outcomes of strategic options is missing. From our tentative exploration of the way Dutch stock-listed firms report on strategic risks and our review of the literature, we conclude that companies tend to equate and mix up strategic risks with environmental uncertainty. We hold that a company’s exposure to strategic risk and uncertainty is a critical issue for strategic management and will remain so. In recent years, failures of corporate governance, in particular those that ended in bankruptcy of financial institutions, have led to new and stringent corporate code and law provisions to improve corporate risk control and management. As such, risk management has increasingly become a central part of corporate governance. Dominated by agency theory, research on corporate

Behavioral Governance    43

boards has generally related structural board characteristics such as size and composition directly to corporate performance and by and large ignored behavioral aspects of their functioning and decision making. The limitations of this black-box approach to understand corporate performance and failure have been well illustrated and discussed (e.g., see Finkelstein & Hambrick, 1996; Huse, 2009; Wan & Ong, 2005; Zahra & Pearce, 1989). In 1992, Pettigrew (1992) already commented on board research inspired by agency theory that “great inferential leaps are made from input variables such as board composition to output variables such as board performance with no direct evidence on the processes and mechanisms which presumably link the inputs to the outputs” (p. 171). Forbes and Milliken (1999) build on these insights and suggest focusing on studying board behavior processes and group dynamics as strategy emerges from the behavior of key decision makers. Over the past decades, the evolving literature on “behavioral governance” has identified and discussed a range of group interaction and team process factors that shape and influence corporate governance. We regard connecting the emerging fields of behavioral strategy and governance as a fruitful route to study how boards deal with the topics of strategic risk and uncertainty. Risk management provides a range of instruments to support and underpin the quantification of consequences of strategic decisions and options. As such, it can adequately deal with strategic risks but has severe limitations when it comes to situations of uncertainty that can, by definition, not be quantified. We distill from the extant literature on scenario thinking and analysis that it may offer a preeminent approach to influence, challenge, and support the way boards function and take decisions in this context. Scenario thinking supports the identification of environmental uncertainties and their consequences (Wack, 1985a, 1985b). By offering alternative, complementary views on the future, scenario thinking challenges current perspectives and increases awareness of potential decision biases. Since the early 1960s, both academics and practitioners have promoted scenario thinking and analysis as a means to deal effectively with the host of uncertainties that surround the future context of business organizations (Van der Heijden, 1996; Van der Heijden, Bradfield, Burt, Cairns, & Wright, 2002). The aim of this chapter is to show how scenario thinking may support boards in dealing with environmental uncertainty, strategic risk, and strategic uncertainty. In order to do so, we first discuss how 74 listed companies at the Amsterdam Stock Exchange cope with strategic risk and strategic risk management, as revealed in their annual reports, to exemplify the relevance and meaning of behavioral governance. Subsequently, we discuss the role of the board and its contribution to strategy and the distinction between environmental uncertainty versus strategic risk and strategic uncertainty. We then turn to theory on corporate governance, discuss how

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agency theory explains the functioning of boards and indicate whether and to what extent theory of behavioral governance may provide additional insights with respect to strategic risk and strategic uncertainty. Finally, we explore the possible role and contribution of scenario thinking in dealing with environmental uncertainty and strategic uncertainty and risk. EMPIRICAL RESEARCH IN THE DUTCH CONTEXT To get a tentative idea of the strategic risk behavior in practice, we studied how boards of Dutch firms deal with strategic risks in practice since they have a legal obligation to report on their firm’s compliance with the Dutch Corporate Governance Code. Our empirical research builds on the premise that firms, as they state in their annual report, voluntarily comply with the Dutch Corporate Governance Code and in doing so disclose their strategic risk behavior in their annual reports (Akkermans, et al., 2009; Postma, Van Ees, & Hermes, 2011). Corporate governance systems vary around the world (Shleifer & Vishny, 1997). The Dutch context offers an interesting setting, as the ruling corporate governance system uniquely combines the characteristics of both the market-based Anglo-Saxon system (with legal protection of investors) and the bank-based continental-European regime (with substantial antitakeover defenses and concentrated ownership) (De Jong, Kabir, Marra, & Roëll, 2002; Van Ees & Postma, 2004). In The Netherlands, the Dutch Corporate Governance Code (hereafter, the Code) is the main instrument to influence and direct the governance behavior of companies and their boards. The first Code was introduced in 1997 by the Peters Committee, followed by an updated version, known as the “Tabaksblat Code,” in 2003 and further revised in 2008 to cover several shortcomings and increase compliance (Akkermans et al., 2009). Central in the first Code onwards is the self-enforcement by companies to voluntarily implement its recommendations—“the strength of the Code is proportionate to the extent to which the company’s stakeholders endorse it and try to comply with it” (Corporate Governance Code Monitoring Committee [CGCMC], 2008, p. 6). Similar to other national corporate governance codes, the Dutch code applies the “comply or explain” principle—companies either comply with the rules and best practices set out in the Code or explain why they do not choose to do so (Hooghiemstra & Van Ees, 2011). Larger firms are more often inclined to comply as they are more closely scrutinized by media and investors because of their size and public interest (Akkermans et al., 2007). Symbolic compliance and management of meaning may explain the compliance behavior of companies (Westphal & Zajac, 1998, 2013). Management of meaning refers to symbolic actions of the board or its chair to favorably affect main stakeholders.

Behavioral Governance    45

Unsatisfied with the ostensive symbolic character of compliance by listed firms and reinforced by the financial crisis in 2008, the then-active corporate governance code monitoring committee (Committee Frijns) in particular elaborated best practices on (strategic) risk management. The explanation of the Code states that “rather than providing an exhaustive list of all possible risks, the company should identify the main risks it faces, i.e., strategic and operational risks, financial risks, legal and regulatory risks and financial reporting risks” (CGCMC, 2008, p. 39). In addition, a firm’s sensitivity to external factors and variables should be described. The joint management and supervisory boards (executives and nonexecutives, notably including the audit committee) are responsible for reporting on strategic risk and strategic risk management. Empirical Research: Design, Results, and Discussion Design In total, we analyzed the reports of 74 companies listed at the Amsterdam Stock Exchange equally spread by Euronext Amsterdam across three different categories: 25 large companies listed in the AEX-index, 24 midcap firms in the AMX-index, and 25 smaller firms in the AScX-index. We selected the fiscal year 2012, as it was the most recent year for which all annual reports were available at the start of the study. We consider the way listed companies report about strategic risks and their strategic risk management as a main indicator for their behavior on this subject. Our research in particular focused on (a) whether companies applied the Dutch governance code or another code, (b) if they reported separately on (strategic) risk in the context of corporate governance, (c) what (kind of) strategic risks they listed, and (d) if and how they actively managed these risks. We identified main characteristics of the risk management system employed, including the governance code and risk systems and frameworks. We regard the presence of an explicit “in-control statement,” together with the presence of an audit committee, as evidence that the board of a company is indeed in control, which is in about 75% of the firms researched indeed the case. In addition, we checked whether and how both the management and supervisory boards reported on risk and if a specific risk management system was mentioned. Finally, given the focus of our research, we checked if companies explicitly reported on the use of scenario thinking or a comparable approach to explore environmental uncertainty and strategic risks. To develop an initial diagnostic framework to map the risks reported by companies, the two authors of this chapter first performed an exploratory pilot study on the annual reports of 5 companies; the 10 companies selected represented a cross section of the 74 companies. Findings were

46    T. J. B. M. POSTMA and R. P. BOOD

compared and extensively discussed which, in combination with a recent, less extensive study by Deloitte (2013) on strategic risk reporting during the same year, resulted in a comprehensive checklist. After validation based on the 10 companies, a research assistant then used the checklist on the remaining companies. The full checklist of supposedly strategic risks that we derived from the 10 annual reports during the pilot study consisted of 11 main categories and 48 subcategories that are usually reported as risk categories by a company (e.g., see Slywotzky & Drzik, 2005). Five categories cover the broader contextual environment (macro-economy, politics, regulation, demographics, and cybercrime), five categories look for risks in the business environment (technology, raw materials, personnel, markets, and customers), and one category covers shocks and surprises that may suddenly hit a company (so-called wild cards). As discussed in the foregoing, our research indicates that most of the “risks” reported rather qualify as broader environmental uncertainties. Results Table 2.1 gives an overview of the general characteristics of how companies organize their risk management function. As is clear, the vast majority of the firms indicate compliance with the Code, while a few of the larger multinationals (such as Shell, Unilever, and Philips) also comply with SOX TABLE 2.1  General Characteristics of Risk Management Reporting Characteristic

AEX AMX AScX (N = 25) (N = 24) (N = 25)

Application of Dutch Corporate Governance Code Another governance code (incl. SOX and governance code from the UK, France, or Luxembourg) Risk section present in chapter on corporate governance compliance Explicit in-control statement present Audit Committee (AC) present In-control statement plus AC Audit Committee responsible for risk reporting Use of risk management system COSO Self-developed risk management framework Alternative system reported Indication of scenario thinking used No indication of risk management function

22 9

24 2

24 0

24

24

25

20 25 20 22 19 10 2 0 3

23 23 21 20 9 4 3 1 12

23 23 15 14 8 2 4 2 12

Mean number of reported main categories (maximum is 11) Mean number of reported subcategories (maximum is 48)

6.4 10.9

5.5 8.3

4.8 7.2

Behavioral Governance    47

or the UK governance code because of cross-listing of shares. The same holds for the formal requirements that the Dutch and other codes prescribe, which includes the presence of a risk management section in the chapter on corporate governance compliance, an explicit in-control statement, and the presence of an audit committee that is, although less so in the smaller listed firms, ultimately responsible for (reporting on) the company’s risk management function. Whereas most of the larger firms indicate what risk management framework they use, nearly half of the medium-sized and smaller firms listed in the AMX and AScX indexes give no indication at all that they use a framework. Among the companies that do, the framework developed by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) dominates. This framework, developed by five main accounting associations and institutes in the United States and first published in 1992, describes the main components of an effective internal control system (COSO, 2004). Note that 40% of the firms listed in the main AEX index have developed their own risk framework, most often based on the COSO model. Examples include Heineken Risk Management and Control System, Philips Business Control Framework, and Shell Control Framework. A small minority of firms, additionally or alternatively, reports on the use of other frameworks in risk management, including SWOT-analysis, Enterprise Risk Management, or ISO31000. Only three companies mention that they use scenario thinking in this context. Table 2.1 indicates that companies on average report one or more risks in 5.6 of the main categories and in 8.8 subcategories. Table 2.2 shows the highest scores across all firms on the main and subcategories of strategic risks. Still in the midst of the aftermath of the economic crisis of 2008, it comes as no surprise that macro-economic changes are at the top of the list—all firms except one report that they face substantial risks in this category, mostly related to the economic crisis and recession. One out of four companies considered the break-up of the Eurozone in one way or the other as a possible outcome of the Eurocrisis. Moreover, judging from the scores, companies were also concerned about changing legislation and regulation, in particular, tightening financial supervision in response to the crisis. The second-most reported category of risks relates to structural market changes companies face or foresee in the coming years. They include a wide variety of possibilities, notably including the entrance of new competitors that introduce radically new business models against which it is difficult to compete carrying old legacies and logics (Christensen, 1997). Rapid technological change and digitalization of industries is a key driver behind this. Many firms fear to be left behind in mature and saturated markets and

48    T. J. B. M. POSTMA and R. P. BOOD TABLE 2.2  Highest Scores on Risk Subcategories and Main Risk Mitigation Tactics Main risk category

%

Risk subcategory

Macro-economic changes

99

Economic recession/crisis 80 Business or geographic diversification

Structural market changes

74

Structural detrimental exchange rate changes

68 Hedging or interest-rate swaps

Insufficient human capital

65

Availability of qualified staff

61 Contracting to increase labor flexibility

Wild cards

64

Not responding to trends

43 Cost reduction

Technological changes

61

Long-lasting detrimental interest rates

36 Selling of risky assets

Availability of commodities 54

Price changes

31

Changing law and regulations

54

New entrants

30

Changing consumer preferences and demands

27

Dependence on suppliers

30

Cyber crime

23

Pressure on prices and margins

27

Political risks and unpredictability

31

Eurozone breakup

26

Demographic changes

7 Business disruption

%

Risk mitigation tactic

24

segments in which commoditization pushes down prices and margins to an absolute minimum. Finally, note the high score of wild cards (64%) and the relatively low score of cyber crime (23%). The low score of demographic changes may be explained by its predictability. The mitigation tactics to deal with disproportionate effects of risks that are mentioned most often are related to the risks that by far get the most attention—macro-economic changes and volatility. Risk mitigation tactics reported range from escaping the recession by exchanging stagnating areas for high-growth geographies and industries to traditional financial instruments like hedging and swapping to deal with adverse or volatile exchange and interest rates. In general, companies seem to be reluctant in reporting both the possible implications and the specific risk mitigation tactics they have put into place. Reporting of the sensitivity of results to the detrimental effects of specific risks is by and large lacking (Deloitte, 2013). Moreover, while mitigation tactics for the risks mentioned are largely missing, the tactics reported are most often phrased in very generic terms. Either companies have not prepared any mitigation tactics or do not want to, partially or fully, disclose their strategic intentions and options considered to their competitors.

Behavioral Governance    49

Discussion Our research into the reporting of risks by 74 Dutch listed companies suggests that the problems experienced in practice of the COSO framework may have a different reason than immaturity of implementation. Given their generic nature and phrasing, for by far the majority of risks companies reported in their annual report in our sample, we conclude that it is impossible to assess impact and likelihood. The knowledge required to estimate the extent of influence of an event on the realization of a goal (impact) and the chance of prevalence of an event (likelihood) is insufficient. As we elaborated above, this is inherent to strategic uncertainty that springs from environmental uncertainty. For this reason, we argue that the COSO framework is incomplete and needs to be complemented with approaches to effectively deal with strategic and environmental uncertainty. In line with the COSO framework, the explanation of the Dutch Corporate Governance Code states that the management board should describe a company’s risk profile, that is, its risk appetite and risk sensitivity. Similar to Deloitte (2013), we noticed that firms were scant in reporting on this. Risk appetite refers to a company’s or key decision makers’ risk propensity. Prospect theory predicts that decision makers frame expected outcomes relative to an initial reference point (Kahneman & Tversky, 1979). Experiments showed that people weigh expected losses more heavily than gains, a phenomenon that is known as “loss aversion.” In doing so, they tend to accept risks when it comes to losses while being inclined to be risk averse when it concerns possible gains. However, because of an instant endowment effect (Kahneman, Knetch, & Thaler, 1990), people quickly reframe their position to new reference points. They accommodate more rapidly to gains, which generates risk-seeking behavior, than to losses, which stimulates risk aversion (Abelson & Levi, 1985). Moreover, people tend to undervalue moderate and high probabilities and overrate small probabilities even if these are highly unlikely (Tversky & Kahneman, 1992; see also the high scores of wild cards in Table 2.2). The preceding indicates that, as Das and Teng (2001) argue, risk propensity and risk behavior are directly related. Unpredictability of events, as is the case in situations of environmental uncertainty in particular, can easily distort the estimation of probabilities and hence influence strategic decision making and strategic risk taking. This reconfirms the need for approaches that support and bolster strategic risk behavior and decision making. STRATEGIC RISK AND UNCERTAINTY As indicated in the introduction, we distinguish two kinds of uncertainty: strategic and environmental uncertainty. We will explain and discuss this distinction in the following in the context of strategic thinking and decision

50    T. J. B. M. POSTMA and R. P. BOOD

making at the board and top-management levels of a company. Before doing so, we will first discuss the role of the board and its relation to management. The Board’s Strategy Role The literature on the board’s contribution to strategy suggests that boards go beyond rubber-stamping strategic initiatives put forward by management (Westphal & Frederickson, 2001). We infer from this that the board’s involvement in strategy is substantive (Finkelstein & Hambrick, 1996; Hambrick & Mason, 1984). Fama and Jensen (1983, p. 2) observe that the contract structures in organizations that separate “ownership” and “control” also “separate the ratification and monitoring of decisions from the initiation and implementation of the decisions,” that is, decision control and decision management, respectively. Whereas decision control is the main task of nonexecutive, external directors, the organization’s board and management are primarily responsible for decision management. The latter initiate and implement strategy, the former authorize, monitor, and evaluate the execution. Hence, the board of directors, and more in particular the executive directors, supervise the management of the corporation while the nonexecutive board members in turn supervise the executive directors on behalf of the principles, that is, the shareholders. Note that the chairman may be considered a linking pin between the board and management, and in particular connect with the CEO; in cases that these positions of chair and CEO are combined, there is CEO-duality. The chair also plays a key role as the public voice of the board and as a link with external stakeholders (Bezemer, 2014). Zahra (1990) discusses five reasons why directors should contribute to strategy: boards can play a main role as “boundary spanners” to increase environmental awareness and sensitivity, their expertise and experience in other companies make them a valuable resource in the strategy process, rising shareholder activism may induce them to participate more actively, and while internal complexity may stimulate directors familiar with the company to participate, external complexity may necessitate nonexecutive board members to support the CEO and top management. Together these factors reinforce the call for an active, continuous, and institutionalized strategy role of boards. Dominant CEOs, weak boards, and incompetence to deal with complexity may nevertheless hinder this role. To realize a board’s full potential, Zahra therefore stresses the importance of an integrative perspective that takes board composition, internal process and the mix of skills represented by directors into account. The board’s detachment from operations helps to contribute fresh objectivity and breadth of experience free of management myopia. . . . The central function of a working board is to review the management’s for-

Behavioral Governance    51 mulation and implementation of strategy and to exercise final authority in ratifying with good reason management’s adherence to established objectives and policy. (Andrews, 1980, pp. 170–172)

In order to do so, Andrews stresses that boards should be diversely composed, structure themselves to make their monitoring function practicable, and install audit, remuneration, and nomination committees. The flow of information to these committees needs to economize on time and inform about the quality of the management and information systems. In this way, and by becoming gradually acquainted with the firm over time, external board members can be helpful in shaping the corporation’s strategy. All in all, we question whether the strategy role of the board in practice is as coherent, dynamic, and interactive as conceived and assumed by agency theory and normative strategic management models (such as, e.g., Ansoff, 1965; see also Jacobs, 2010; Mintzberg, 1994). Boards may lack diversity in composition, contributing to the selective perception of the internal and external environment (Hambrick & Mason, 1984); interaction between boards and management may be hindered by inadequate communication and information processes and structures and hence information asymmetry; or board members may have a different risk appetite and risk sensitivity. In order to clarify the distinction and relation between strategic risk and uncertainty, we first discuss the role of the board in dealing with strategic problems. Dealing With Strategic Problems Surrounded by Strategic Risk and Uncertainty A main task of top management is to identify, structure, and adequately deal with the most important challenges threatening the organization’s ability to survive and adapt in the future (Lyles & Thomas, 1988). Such “strategic problems” are not ordinary, everyday routine problems for which most often a range of proven methods and solutions is already available. They are often referred to as “plastic” and “wicked” (Camillus, 2008; Ramaprasad & Mitroff, 1984). Amongst other characteristics, wicked problems do not have a universal formulation, every problem is in essence unique and so are its solutions (Rittel & Webber, 1973). As Flood and Jackson (1991, p. xi) put it, We are faced with “messes,” sets of interacting problems, which range from the technical and the organizational to the social and political, and embrace concerns about the environment, the framework of society, the role of corporations and the motivation of individuals . . . the search for some super method that can address all these problems is mistaken and must quickly lead to disenchantment.

52    T. J. B. M. POSTMA and R. P. BOOD

Strategic problems are complex, hard to define, unique, and surrounded by causal ambiguity (Jacobs, 2010; Ramaprasad & Mitroff, 1984). As causes are numerous and intricate, and possible consequences are only partially known, Checkland and Poulter (2006) refer to them as “problematical situations,” for which there is no single solution to solve them. Conceiving and formulating strategic problems is critical, as it shapes solutions, may solve another problem, or even compound a problem. Ready-made solutions are not available, while finding solutions is a never-ending process of trial and error as they, by definition, cannot be “solved.” The process of conceiving, structuring, and deciding on strategic problems can be considered as an individual, group, or organizational process or a combination of these. The problem context involves multiple objectives and stakeholders that have different attitudes toward risk. A host of sources of environmental uncertainty may affect the realization and predictability of impact and outcomes over time. As a result, the outcomes of strategic problems may range from smaller or larger gains to losses that may substantially harm the functioning and viability of the firm. Goodwin and Wright (1991) argue that judgment of such problems and the organizational and environmental context in which they play by decision makers is critical. Following Knight (1921) and March and Simon (1958), we distinguish between risk and uncertainty. Whereas for risk the probability distribution of possible outcomes of alternative courses of action is known to decision makers, that insight is lacking for uncertainty. Decision makers may have knowledge about the alternatives, but they cannot always quantify the outcomes. In the case of certainty, decision makers have complete and accurate knowledge about alternatives and their possible outcomes. Strategic uncertainty points to the inability to quantify the outcomes of strategic decision alternatives. In part, strategic uncertainty springs from environmental uncertainty, which reflects the unpredictability and sheer randomness of external events and trend breaks that may impact the outcome of strategic decisions and the performance of the firm. Strategic risk then reflects the situation in which it is possible to quantify the occurrence of outcomes in an inherently uncertain world and by doing so results in calculable loss or gain. Risk management supports the identification and quantification of risk using a distinct set of methods and tools (e.g., see Hopkin, 2012). According to Hopkins and Nightingale (2006), two dimensions are crucial: knowledge about the presence and adequacy of outcomes of alternatives and knowledge about the likelihood or probability they will indeed occur. As Table 2.3 shows, either one of these may be problematic to a company or not. Combining the two dimensions and variations results in four distinct kinds of risk and uncertainty. Hopkins and Nightingale suggest that probabilistic risk can be addressed with a range of statistical methods available. Examples include Bayesian or frequentist probabilistic methods, tools

Behavioral Governance    53 TABLE 2.3  Classification of Risk and Uncertainty Knowledge about outcomes (weight, meaning)

Knowledge about likelihoods (probability)

Not problematic Problematic

Not problematic

Problematic

Probabilistic risk

Ambiguity

Uncertainty

Ignorance

Source: Hopkins & Nightingale (2006).

from utility theory, as well as decision and cost/benefit analysis (Welsch & Cyert, 1970). Situations of ambiguity and uncertainty may be addressed with methods like (depending on available knowledge) sensitivity analysis, analogies, judgmental bootstrapping, extrapolation of time series, and scenario thinking (Armstrong, 2001). Complex situations dominated by high degrees of ignorance, which come close to what Perrott (2007) refers to as a knowledge deficiency called “what we don’t know we don’t know,” may be addressed by precaution-based management approaches (Klinke & Renn, 2002) or only through agility and antifragility (Taleb, 2012). In addition to constant factors that are assumed not to change (like the rise of the sun every morning), the scenario literature slices environmental uncertainty into two categories (Van der Heijden, 1996; Wack, 1985a): predetermined elements and critical uncertainties. Wack (1985a, p. 77) defines predetermined elements as “those events that have already occurred (or that almost certainly will occur) but whose consequences have not yet unfolded.” He refers to it as the proverbial rabbit that is already in the hat of the magician (Wack, 1985b). Demographic developments are prototypical examples—based on current data like fertility and mortality rates, it is possible to calculate population size in the medium term. If companies carefully scan and analyze their environment, many seemingly uncertain factors and developments turn out to be predetermined; only when and to what extent consequences will manifest them may be uncertain. Hence, we conclude that part of strategic uncertainty can turn into strategic risks or even into certainties by observing and analyzing the outside world much more systematically and carefully. As we will explain later on, scenario thinking supports the identification of predetermined elements. If everything was certain or predetermined, traditional planning tools would largely suffice. Part of the future that is, however, highly uncertain and crucial for the performance of a company at the same time is called “critically uncertain”—it is to a more or lesser extent unknown if and how they manifest themselves or how responses to them will be. As Rumsfeld (2002) pointed out in the context of the Iraq War, next to “known knowns” and “known unknowns,” there are also “unknown unknowns”—“the ones

54    T. J. B. M. POSTMA and R. P. BOOD

we don’t know, we don’t know.” As Wack (1985b) asserts, both the breaking of trends as the implications and the responses to them can be critically uncertain, also when important disruptions are predetermined. By way of illustration, it is predetermined that new energy sources will to a large extent replace fossil fuels, yet we do not know how fast this transition will go or what, for example, geopolitical changes it will induce. The manifestation of structural change as well as critical uncertainty about how the company’s environment may develop create strategic problems that ask for adequate responses to withstand or, if possible, benefit from it. Decision makers will, explicitly or implicitly, generate and consider alternative strategic options to do so (note that in the extreme case, they are ignorant of critical change and uncertainty and hence implicitly choose pursuing the status quo or “muddle through”). Strategic uncertainty with respect to the outcomes of any strategic alternative that decision makers consider varies with the extent of environmental uncertainty. Even when the range of possible outcomes is known, insight into the probability distribution of outcomes may be lacking or even missing, creating a situation of ignorance. By combining the distinction made by Hopkins and Nightingale (2006) between knowledge about outcome and likelihood, as introduced above, with the kinds of environmental uncertainty that may be present, we distinguish six different strategic situations decision makers may face. The most straightforward situation of full certainty occurs when environmental uncertainty is lacking and knowledge about the outcomes of options is present. Lack of such knowledge creates a gambling situation, which actors sometimes purposefully search for. To the extent that knowledge about predetermined elements and the possible outcome of alternative courses of action is available, a situation of strategic risks arises in which traditional risk management would be effective. However, the more such knowledge is missing, the more ambiguous the situation will turn out to be. Finally, environmental uncertainty creates strategic uncertainty or, when knowledge about the outcomes of alternatives is missing, ignorance. Note that the situations in Table 2.4 are positioned on two continua and may overlap. TABLE 2.4  Strategic Situations of Certainty, Risk, and Uncertainty Environmental uncertainty

Knowledge about Present the outcomes of options Missing

Certain likelihood irrelevant

Predetermined likelihood largely known

Uncertain likelihood fully unknown

Certain

Strategic risk

Strategic uncertainty

Gambling

Ambiguity

Ignorance

Behavioral Governance    55

Strategic decision making becomes more difficult the more complex, dynamic, and uncertain the environment is. Traditional planning and risk management will suffice when decision makers can safely assume that the world around them is either certain or the probability distribution of the occurrence of events and change is known. However, the more knowledge about possible environmental change and the outcomes of strategic options is lacking and cannot be gained, the more formal forecasting methods, planning, and risk approaches will fail. As indicated above, the reason for this lies in the role of judgment that is required to deal with situations of ambiguity, strategic uncertainty, and ignorance and, at the same time, influence and restrict appreciation of the situation. In order to deal with such situations, people tend to apply heuristics or cognitive simplification rules of thumbs (Bradfield, 2004). While this may be effective in many cases, it can easily lead to gross misjudgments and strategic failure. Table 2.5 lists key heuristics that individuals and groups apply in such situations (Mintzberg, Ahlstrand, & Lampel, 1998). In collaborative settings, resembling strategic decision making in boards, group-based biases like groupthink may be present. Groupthink refers to the situation in which judgment, input, and creativity of individuals are compromised by social conformity to group norms (Janis, 1972). This can be a consequence of group cohesiveness, insulation, high stress, and strong directive leadership (Russo & Schoemaker, 1989). Groupthink impairs the quality and effectiveness of group decision making. Problem-solving methodologies based on various forms of systems thinking (Flood & Jackson, 1991) and process-based approaches like scenario thinking (Van der TABLE 2.5  Decision Heuristics and Cognitive Biases Heuristic

Description

Availability

Reliance upon specific events easily recalled from memory to the exclusion of other pertinent information Inconsistency Inability to apply the same decision criteria in similar situations Recency The most recent events dominate those in the less recent past, which are downgraded or ignored Anchoring Predictions are unduly influenced by initial information, which is given more weight in the forecasting process Underestimating certainty Excessive optimism, illusory correlation, and the need to reduce anxiety result in underestimating future uncertainty Optimism, wishful thinking People’s preferences for future outcomes affect their forecasts of those outcomes Selective perception People tend to see problems in terms of their own background and experience Source: Mintzberg et al. (1998).

56    T. J. B. M. POSTMA and R. P. BOOD

Heijden, 1996) that mobilize the diversity and creativity of all stakeholders may be supportive in these cases. They may also raise awareness with respect to still unknown factors and change about which the group is to a more or lesser degree ignorant when knowledge cannot be gained in any way, alternatives like precautionary contingency planning and rapid response may only remain (e.g., see Klinke & Renn, 2002; Taleb, 2012). With Das and Teng (2001), we argue that risk propensity and risk behavior are directly related. Especially in situations of high environmental uncertainty, the use of heuristics can easily lead to substantial cognitive distortions and hence influence strategic risk behavior and decision making. Risk propensity, which can be expressed as an attitude toward a situation and hence differ between agents with divergent capabilities, is subject to individual judgment and social conformity (Hopkins & Nightingale, 2006). Therefore, risk propensity and behavioral aspects, like framing of problems and their problematical situations, are central in studying risk. The risk literature makes a distinction between operational and strategic risks. Given their nature, operational risks are more often associated with probabilistic risk, as they in general refer to phenomena that are frequently observed and well characterized (Hopkins & Nightingale, 2006). Strategic risk, which we focus on in this chapter, tends to be more unique in nature and surrounded by more environmental uncertainty. Strategic risk is explicitly recognized in the financial sector. For instance, the Basel accords, which concern internationally accepted banking supervision standards aimed to prevent the collapse of banks and banking conglomerates, identify strategic risks as a separate risk category next to, for example, pension risks, liquidity risks, or reputational risks. They refer to strategic risks as arising from the external environment and adverse decisions and indicate that these risks need to be mitigated by a structured risk management system. Based on their review of the literature on strategic risk, Cooper and Faseruk (2011) conclude that as this stream of literature is fragmented and limited—there is no clear agreement on the definition of strategic risk. In addition, they point to the dominance of financial risk, which is a separate risk category in between operational and strategic risks. Cooper and Faseruk (p. 20) warn that “organizations that focus too much attention on financial risks and insufficient on strategic risks may well jeopardize the viability of their enterprises and their business.” BEHAVIORAL CORPORATE GOVERNANCE THEORY Based in both economics and law, agency theory conceptualizes an organization as a nexus of explicit and implicit contracts (cf. Eisenhardt, 1989; Jensen & Meckling, 1976). An agency relationship exists between the

Behavioral Governance    57

“principals,” being the shareholders or key stakeholders, and the “agents” or executives and top managers, who manage the company and take decisions on behalf of the principals. According to agency theory, agents are rational, utility-maximizing and self-interested actors. Agency theory assumes that they take decisions for the firm as a whole and hence individual decisions and judgments made by agents at the microlevel aggregate to the macrolevel of the firm. The separation of ownership and control can result in agency problems when agents and principals have opposing interests or conflicting risk attitudes. It may arise from information asymmetry when agents do not share information with principals and instead start to behave opportunistically. So-called agency costs arise when executives deviate from established goals or negatively affect the value of a firm through adverse decisions and actions. The range of governance structures and bonding activities that principals install in order to monitor and control the behavior of agents aim to diminish net agency costs. Regulating the principal-agent relationship can be done directly and indirectly (e.g., see Berglöf & Pajuste, 2005; Denis & McConnell, 2005; Rediker & Seth, 2010). Direct regulation can be done by a firm internally through nonexecutive directors or a separate supervisory board that monitors and rewards executives, while indirect regulation is arranged externally via the managerial labor market, product markets, and the market for corporate control, codes, law, and regulation or through external monitoring institutions. In practice, a bundle of governance mechanisms can be employed that jointly act to control the consequences of managerial discretion (Rediker & Seth, 2010). Opening Up the Black Box of Board Behavior Actual board behavior may not always be in line with what agency theorists consider to be “good” corporate governance structure. Most importantly, while much emphasis in corporate governance research is on formal structures, the processes through which boards perform their roles—such as monitoring, providing services through contributing strategic advice and knowledge resources, and providing legitimacy and boundary spanning— are not considered in detail (Huse, 2009; Zahra & Pearce, 1989). Board structure may however indirectly condition or shape board behavior (Finkelstein & Hambrick, 1996; Zahra & Pearce, 1989). Research on corporate governance that studies actual board processes and behavior aims to open up the black box that hides the ambiguous relationship between structural attributes of boards and board performance (e.g., see Forbes & Milliken, 1999; Hillman & Dalziel, 2003; Huse, 2009; Pettigrew, 1992). This stream of research is reinforced by disappointing

58    T. J. B. M. POSTMA and R. P. BOOD

outcomes of conventional research on board effectiveness. Meta-analyses of studies that directly relate structural attributes of boards, such as board size, composition, and demography, to corporate performance produce inconsistent and ambiguous results (Adams, Hermalin, & Weisbach, 2010; Bhagat & Black, 2002; Daily, Dalton, & Canella, 2003; Dalton, Daily, Ellstrand, & Johnson, 1998; Dalton, Daily, Johnson, & Ellstrand, 1999; Hermalin & Weisbach, 2001). Note that this matches the signals that emanate from corporate scandals—time and time again installed governance structures fail to prevent fraud and bankruptcy. The literature on the role and functioning of boards indicates a growing dissatisfaction with the “black box research” of corporate boards driven by agency theory. Drawing from the literature on cognitive and group psychology, Forbes and Milliken (1999) were among the first to link the effectiveness of boards to the interactions between its members. In order for boards to perform their control and service tasks effectively, board members need to act as a decision making group and cooperate to exchange information, evaluate the merits of competing alternatives, and reach well-reasoned decisions (Forbes & Milliken, 1999, p. 490). In addition, they point to the role of process factors as board effort norms, cognitive conflicts, the use of knowledge and skills, and board cohesiveness in influencing board effectiveness. McNulty and Pettigrew’s (1999) landmark empirical study focuses on the contribution of part-time board members, like the chairman and nonexecutives, to strategy development. They interviewed well over 100 board members to discover what directors actually do and how they contribute to strategy. The study reveals a range of behavioral dynamics with respect to strategy, including “taking and shaping strategy” and “shaping the content, context and conduct of strategy.” Rindova (1999) develops a cognitive perspective on the participation of directors in strategy making by depicting them as experts who contribute their expertise and experience. When engaging in the board and its various subcommittees as part of the group that is responsible for strategic decision making, directors inevitably bring in specific strategic skills, like scanning, interpretation, and choice of alternatives, contingent on the requirements of the decision making task, context, and corresponding challenges. Moreover, she argues that, from a cognitive perspective, a director’s involvement will increase when uncertainty and complexity of decisions increase. In line with the notion of required variety and diversity of boards, Judge and Zeithaml (1992) indicated that the involvement of directors in strategy making increases as a result of growing external pressure like legal liabilities and complexity of the business environment. Pugliese et al. (2009) performed an extensive meta-analysis of 150 publications on the contribution of board of directors to strategy. In line with the foregoing, they noticed that research evolved from normative and

Behavioral Governance    59

structural approaches toward behavioral and cognitive ones. On this basis, they concluded that “best governance practices and the emphasis on board independence and control may hinder the board’s contribution to the strategic decision making” (p. 292). Behavioral Corporate Governance Behavioral aspects of agency theory are limited to the motivation of managers to act in the interests of their principals, in part through nonexecutive supervision and specific reward structures. Behavioral approaches of economics and corporate governance usually focus on the decision making activities of firms and managers. Rooted in publications by the Carnegie school (Cyert & March, 1963), this stream of research, amongst other things, contends that complex decisions, such as strategic ones, result from the complex interaction between a range of behavioral factors. Factors like bounded rationality of decision makers, multiple and conflicting goals, and varying aspiration levels work together to restrict the extent to which complex decisions can be optimized. Most importantly, the more decisions and circumstances become complex, the more behavioral factors become salient. We therefore argue that insights from behavioral governance should be taken into consideration when studying strategic problems and decision making in the board context within the context of an uncertain environment. The field of behavioral governance is relevant, as it questions the core behavioral assumptions made by agency theory, like depicting decision makers as being rational and selfish optimizers. In order to discuss two main approaches of behavioral governance (Van Ees, Gabrielsson, & Huse, 2009; Westphal & Zajac, 2013), we shortly introduce the notion of behavioral strategy as it is relevant for the board’s strategy role. Lovallo and Sibony (2010) argue that improving the strategic decision making process requires a thorough understanding of the biases that may affect its effectiveness. Moreover, they conclude that process factors are more important in explaining variance in decision outcomes than the quantity and quality of analyses preceding strategic decisions. This corresponds with Mintzberg et al. (1998), who pointed, in the context of the cognitive school of strategy, at the central role of decision heuristics and biases in decision making (see Table 2.5). The editors of the 2011 special issue of the Strategic Management Journal about behavioral strategy define this emerging field broadly as follows: Behavioral strategy merges cognitive and social psychology with strategic management theory and practice. Behavioral strategy aims to bring realistic assumptions about human cognition, emotions, and social behavior to

60    T. J. B. M. POSTMA and R. P. BOOD the strategic management of organizations and, thereby, to enrich strategy theory, empirical research, and real world practice. (Powell, Lovallo, & Fox, 2011, p. 1371)

Building on decades of practice-oriented experimental research in the field of social and cognitive psychology, Van Ees et al. (2009) sketch the outlines of a behavioral theory of decision making within boards. They start from the premise, as introduced by Simon (1960) and Cyert and March (1963), that decision makers are not rational and selfish optimizers per se, but rational satisfiers who rely on routines and heuristics in decision making to cope with the uncertainty and complexity they face. As a result, they are bound to make errors both at the individual and group level. In addition, Van Ees et al. (2009) argue that as firms have multiple coalitions of stakeholders with possibly opposing interests, corporate decision making inevitably is a highly politicized process with ongoing conflict resolution and negotiation between coalitions. They call for venturesome and eclectic research to empirically investigate these issues and further clarify the relationship between board functioning and firm performance. Focusing on social structural governance relationships, Westphal and Zajac (2013) introduce a different point of view. They argue that the behavior of decision makers is embedded in socially constructed relationships in the context of which actors engage in activities like management of meaning, flattery, and ingratiation, and search for confirmation. In line with this, Westphal and Fredrickson (2001, p. 1115) indicate that corporate strategies also lead to the development of beliefs and ideologies at the group and organizational levels of analysis that justify or validate the strategy and facilitate implementation. . . . as a result of these socialization and commitment processes, evaluations of strategy by outside directors may be strongly influenced by the corporate strategy of their home firm.

We summarize the previous discussion of behavioral approaches of corporate governance in Table 2.6 and compare them with the classical agency theory on a number of relevant aspects. In order to prevent the suggestion of false antitheses, we propose to eclectically combine elements of the three theories on corporate governance. For this reason, we included the core concepts and explanandum of each theory to indicate both their explanatory and instrumental use (Donaldson & Preston, 1995). Agency theory explains board existence and the range of board structures. As agents may behave opportunistically and have considerable leeway to judge and decide on strategic problems, nonexecutives have the power to curb their opportunism. The behavioral theory of boards explains that board’s decision making is influenced by processes of strategizing and mutual interaction. It therefore concentrates on board

Behavioral Governance    61 TABLE 2.6  Comparison of Theories of Corporate Governance Behavioral aspects of corporate governance theories

Behavioral theory of boards (Van Ees et al., 2009)

Behavioral theory of socially situated actors (Westphal & Zajac, 2013)

Agency theory

Behavioral assumptions about strategic decision makers

bounded rational rational, selfish satisfiers, subject to optimizers, may cognitive biases trigger goal conflict and risk aversion

Unit of analysis

relationship agent/ executive versus principal/ nonexecutive

board decision making

Firm conception

nexus of contracts

nexus of coalitions of nexus of social stakeholders relationships between groups of actors

Core concepts of strategic behavior

judgment needed by agents; curbing opportunism

agents subject to biases; measuring actual board performance

symbolic compliance; social conformity

Approach toward strategy

the process shapes goal incongruence strategic decision and information making asymmetry requires monitoring and control

strategy is a social construct and result of interaction process; use of models

Explanandum

board’s existence and structure

board dynamics

codes and use of best practices and models; symbolic management

Main board role

monitoring

service

legitimacy and boundary spanning

decision making shaped by social construction and pressure to conform relationships between stakeholders

dynamics while assuming that directors are not rational decision makers and are instead subject to cognitive biases. Discussion One of the main challenges in our research was to capture actual board behavior while we could not actually observe it. As a proxy, we therefore took reporting on strategic risks by companies as a main indicator of a board’s strategic behavior. As the main goals of the Dutch Corporate Governance Code are increasing transparency and accountability in order to positively

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affect management behavior (Akkermans et al., 2007), we find it justified to interpret the risk section of the corporate governance chapter in the annual report. This is also supported by Van der Laan, Van den Berg, Kaufmann, and Van Ees (2013), who show a high compliance of Dutch listed firms in 2012 to the best practices on risks as mentioned in the Code. The social theory of corporate governance explains why firms comply with codes and characterizes their actions (such as reporting on certain risk models) as a way to signal conformity and transparency to the main stakeholders. Note that this opens the door of symbolic compliance to the Code. Moreover, the responses of firms to standards of good governance, both compliance and noncompliance, creates uniformity (Hooghiemstra & Van Ees, 2011). SCENARIO THINKING For half a century, practitioners and academics alike have promoted the use of scenario thinking to explore environmental uncertainty. We discuss the main arguments for this and explore how scenario thinking may play a central role in behavioral governance. First, we discuss the three main schools that have emerged in scenario thinking over the years and conclude that, although not without limitations, the so-called intuitive logics school is most suitable for this role. We then explore its potential role and contribution within the context of the behavioral theories of governance as introduced above. Scenario Schools Instead of offering a single view on the future like classical forecasting does, scenario thinking offers a set of alternative perspectives on how the future may emerge and evolve (Chermack & Lynham, 2002; Porter, 1985; Schwartz, 1991; Van der Heijden, 1996). Scenario thinking has a longer history in practice than in research. The origins of the use of scenarios in long-term business planning go back to Herman Kahn’s work at the RAND Corporation for the U.S. Air Force in the 1950s (Bradfield, Wright, Burt, Cairns, & Van der Heijden, 2005). Kahn developed scenarios of a “nuclear war by miscalculation” to demonstrate that military planning was dominated by wishful thinking and ignored possible future developments. It led to an American school of scenario thinking that assumes sufficient information about the environment can be collected to create accurate scenarios (Wilkinson & Eidinow, 2008). Bradfield et al. (2005, p. 801) call it the “probabilistic modified trends school” as it “evaluates changes in the

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probability of the occurrence of events . . . to generate a range of alternative futures rather than a single point naïve extrapolation of historical data.” Around the same time, a distinct scenario approach emerged in France called La Prospective in response to the limitations of classical forecasting to deal with trend breaks and disruptions. La Prospective had its roots in developing normative scenarios to support policymaking, initially for government but later on also for companies and institutions (Bradfield et al., 2005). Godet (2001) extended the methodology with a probabilistic approach and combined a mixture of quantitative and analytical tools and methods. It fits in with the importance attached to procedural rationality and aimed at making scenarios less the art it is, according to propagators of the intuitive logics school (Godet, 2000b; e.g., see Schwartz, 1991; Wack, 1985a). Using a combination of software and experts, La Prospective attempts to reveal subjective biases and identify the most probably scenarios. The approach attracted much less attention in both literature and practice and is still mainly used in France, according to Godet (2000a, p. 9) “given the Anglo-American domination in any area related to strategy.” At the end of the 1960s, Shell picked up the notion of alternative future scenarios from Kahn’s initial ideas. However, instead of assigning probabilities to various outcomes, Shell stressed the plausibility of scenarios and the role of narratives (Wilkinson & Kupers, 2013). From the start, subjectivity and intuition instead of models and calculations played a central role. Shell’s approach became known as the “intuitive logics school” and still dominates scenario practices around the world (Bradfield et al., 2005; Wilkinson & Eidinow, 2008). Taking a social-constructivist perspective, this school emphasizes the importance of social processes in which exploration of the future takes place. It explains the subtitle of Van der Heijden’s (1996) seminal work (“Scenarios”) on the background and methodology of scenario thinking—“the art of strategic conversation.” The gradual understanding of a problematical situations grows in the interplay of analyzing the predictable and the ongoing conversation within organizations in exploring unknown territory: The scenario approach creates a strategic conversation, allowing for and reflecting different perceptions of the situation, but in such a way as to create room for people to hear the arguments of others and engage in a meaningful comparison of different viewpoints. (Van der Heijden, 2000, p. 36)

In our view, given the distinction made in the foregoing between strategic risk and uncertainty, by trying to quantify probabilities, both the probabilistic modified trends school and La Prospective seem to focus on strategic risk instead of uncertainty. Recall that strategic uncertainty refers to situations in which options and the range of possible outcomes are known, while essential

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knowledge is lacking to assign probabilities. Both approaches depend on historical data analysis or expert views, or a combination of both, to assign probabilities. Any extrapolation, by definition, misses random events and variability that have not manifested themselves before (Wack, 1985b), while experts turn out not to be very good in making predictions (Tetlock, 2005). We contend that the intuitive logics school is best positioned to explore environmental and strategic uncertainty and their implications. Instead of “merely quantifying alternative outcomes of obvious uncertainties” (Wack, 1985a, p. 74), scenarios explore and expand predetermined elements within the context of major uncertainties in order to get a better feel for the key forces that shape the external context (Wack, 1985b). The intuitive logics school is however also not without limitations. Scenario studies working within the premises of the intuitive logics school do not have a particularly strong track record in dealing with major developments and in particular discontinuities that have not been thought of before (Van Notten, Sleegers, & Van Asselt, 2005). Reasons for this lie in the supposed requirements of internal consistency of scenarios and the emphasis on causal logics (Postma & Liebl, 2005). The Role and Contribution of Scenario Thinking According to Van Asselt (2000), uncertainty originates either in variability or a lack of knowledge. Variability contributes to a lack of knowledge and is in part unattainable due to its random, unpredictable nature. She argues that lack of knowledge moves along a continuum that ranges from inexactness to irreducible ignorance. Whereas to the one end, knowledge is unreliable and springs from limited knowledge and viewpoints, toward the other end it results from inherent, structural uncertainty. Predetermined elements are part of the former, as only the consequences have not yet fully manifested themselves (Wack, 1985a; Van der Heijden, 1996). Critical uncertainties are positioned toward the other side of the continuum and cannot, to a more or lesser degree, be known in advance. Part of these are the “unknown unknowns.” As Van der Heijden (2000, p. 32) argues, when we enter a new problematical situation, much of what we perceive as uncertain “will be due more to our lack of data and understanding than to fundamental indeterminacy in the system.” Learning about the situation reveals a host of predetermined elements and adds to the predictability of the situation. For Wack (1985b, p. 132), “the exploration and expansion of the predetermined elements” is the basis of scenario thinking. Hence, part of environmental uncertainty is mere perception and can be reduced through careful analysis of causal relations and interaction. As Wack (p. 150) argues, scenarios can play a central role here by introducing a variety of perspectives:

Behavioral Governance    65 By presenting other ways of seeing the world, decision scenarios allow managers to break out of a one-eye view. Scenarios give managers something very precious—the ability to reperceive reality. In a turbulent business environment, there is more to see than managers normally perceive. Highly relevant information goes unnoticed because, being locked into one way of looking, managers fail to see its significance.

When knowledge about predetermined elements grows, part of environmental uncertainty can be translated into strategic risk and hence strategic uncertainty reduces. However, as Van Asselt (2000) noted, part of environmental and strategy uncertainty is inherently unknown and will remain so until events and developments manifest themselves. As stressed by theories of behavioral governance, in complex situations dominated by strategic ambiguity, uncertainty, and ignorance, decision makers tend to apply heuristics to simplify the situations they face, resulting in all kinds of cognitive biases. It leads to distortions in the appreciation of strategic situations, decision making, and option generation. Roubelat (2006) asserts that as scenarios help organizations to look wider, they can challenge current strategic paradigms or, as Van der Heijden (2000, p. 33) refers to it, “one’s own mental model of the future.” Raising new research questions time and time again to gain understanding of the environment is a key part of the scenario process. One of the key challenges in collective decision making in boards is balancing the dilemma between groupthink and fragmentation (Van der Heijden, 2000). Consensus is required to take effective joint action, and a stronger consensus will in general result in more powerful joint action (Westphal & Fredrickson, 2001). Too much consensus at an early stage can however also have adverse effects and hinder learning (Bood & Postma, 1997). Early closure feeds a one-eye view of the world and reaffirms current mental models and strategic paradigms. How we see the world shapes what we think and know about the world and directs how we act in the world and vice versa (Chermack, 2003). Examples of gross misjudgments and strategic failure by major corporations are plentiful and, amongst many others, include Polaroid and Kodak, which underestimated the rapid rise of the digital camera (even though Kodak invented it). By taking a wider view and raising new questions in an iterative process to further explore the environment and gain new insights, scenario thinking aims to challenge and stretch a board and organization’s assumptions and perceptions. Whereas groupthink distorts strategic decision making, so does too much differentiation, for instance, along so-called fault lines (such as gender, country of origin, age group) and the more so in highly politicized corporate contexts and cultures with a variety of opposing coalitions (Van Ees et al., 2009). As Van der Heijden (2000, p. 35) states, “Differentiation is necessary, but fragmentation is dangerous.” It can lead to a vicious circle

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in which views and mental models increasingly diverge, driving boards and organizations apart and leading to incoherent and ineffective strategies and operations. Based on two in-depth case studies, Cairns, Wright, Van der Heijden, Bradfield, and Burt (2006) argue that scenario thinking can help to overcome fragmentation by facilitating a strategic conversation in which tacit knowledge of individuals is converted into explicit group knowledge. Crafting and thinking through alternative views on the future, that is, the scenarios, helps to make sense of “seemingly conflicting and contradictory ideas without exclusion” in a collective process (Cairns et al., 2006, p. 1022). Moreover, Van der Heijden et al. (2002, p. 5) argue, What is valuable here is the ability to accept diversity of opinion and belief, and to understand how these different views might affect the organization’s future. By challenging their own perspectives on the way the world is, organizations and their boards can understand and develop an ongoing awareness of the ambiguous, dynamic and complex nature of the world, leading to greater structural insights into the nature of possible futures and their implications.

However, Cairns et al. (2006) also note that it is not a guarantee for success and pluralism aimed for not definitely sustainable. The preperceptions and preconceptions of powerful individuals of the problematical situation at hand may hinder or even oppose the incorporation of a wider agenda, as may the dominance of dealing with daily hassle. All participants and coalitions involved need to acknowledge the importance of embracing conflict, valuing difference, and wanting to see through the eyes of others. In addition to identifying and increasing awareness of the role of cognitive biases, governance needs to explicitly address the set of social relationships, networks, and institutions in the context of which boards act and take decisions as well as the sociocognitive orientation as shaped by former socialization and previous experiences that enables and constrains them. Roubelat’s (2000) argument that scenario thinking should help both expand existing networks and create new ones, across organizational boundaries, is relevant in this context. The strategic conversation is a socially constructed reality within the situated context of social interaction, in particular within, in this case, the board and organization and the broader market and macroenvironment in general (Chermack & Van der Merwe, 2003; Van der Heijden, 2000). Over time, shared mental models emerge within the firm that include a range of implicit and explicit assumptions about the future business environment. Part of this common knowledge may be transmitted by generations of board members and institutionalized into complex social structures and intricate constructs of meaning that are taken for granted (Berger & Luckmann, 1966). In an ongoing dialectic process of communicative

Behavioral Governance    67

interaction, individuals internalize and reaffirm this objective reality into their own subjective reality as “common sense.” Without critical questioning, the constructed reality may only be challenged when it does no longer hold up. Polaroid’s CEO Gary DiCamillo’s statement that “it’s amazing, but kids today don’t want hard copy anymore . . . This was the major mistake we all made . . . That was a major hypothesis, that I believed in my marrow, that was wrong” is a particularly dramatic example of this (Nagy Smith, 2009). Scenarios offer ways to learn together by simulating and “rehearsing the future” and gain experience within the context of different possible future settings, that is, the scenarios (Bood & Postma, 1997; Schwartz, 1991). During the conversation that takes place while identifying and discussing intended and unintended consequences of strategies, investments, and plans, existing mental models and assumptions about the future can be questioned, challenged, and modified. This learning perspective differentiates scenario thinking from the regular toolbox of risk management. As Vince and Gabriel (2011) indicate, learning is not merely a rational, cognitive process but can at times be laden with emotions and feelings tied up with organizational power and politics. They plead for creating a secure environment through an ethic of care to neutralize a culture of cynicism and fear of criticism and failure, and enable to unsettle established practices. Stepping beyond the present and exploring the long-term future in the context of relevant and challenging scenarios, past and current conflicts and interests, contributes to creating such a secure environment. It opens up excellent possibilities to involve outside, nonexecutive board members in an open conversation and mobilize their strategic skills, expertise, and experience, gained and developed in other companies and sectors, to challenge established thinking within the firm. This notably includes identifying and elaborating strategic options that have not been considered before, which is especially important with increasing strategic complexity and uncertainty. CONCLUSION The recent rise of corporate governance problems of firms and financial institutions in the past decades has considerably raised the interest in strategic risk management. Companies especially seem to have difficulty adequately coping with situations of high environmental ambiguity and uncertainty, the more so if ignorance comes into play. Such situations can unexpectedly introduce structural change and disruption and present “wicked” strategic problems for which effective strategic options are lacking and need to be developed step by step over time. Inappropriate and untimely strategic responses can result in substantial gain or loss and potentially affect the longterm sustainability of the firm.

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Judgment plays a critical role in dealing with strategic problems and appreciating the context in which these evolve. However, in particular, in complex situations with significant ambiguity and uncertainty, the use of simplifying heuristics and established mental models as well as the role of risk propensity and group interaction can result in major cognitive and process biases. These in turn can distort interpretation and perception and hence negatively influence strategic decision making and strategic risk taking, the more so in times of rapid, structural change. Chances of getting caught by surprise are potentially largest when boards are fully ignorant and critical environmental events and developments are not within their sight. Our study among strategic risk management practices suggests that boards may also mix up strategic risks with environmental uncertainty and, implicitly or explicitly, make wrong, risk-based assumptions about what is inherently unpredictable. In order to assess how Dutch companies organize their risk management, we studied how 74 companies listed at the Amsterdam Stock Exchange reported on strategic risk in their annual reports as prescribed by the Dutch Corporate Governance Code. Because this Code is the main instrument to positively influence and direct governance behavior, we regard the reporting of strategic risks and mitigation strategies as a main indicator for board behavior on this subject. The results of our inquiry reveal that the majority of what the companies report as “strategic risks” in essence resembles more of what we define as “environmental uncertainties”—possible events and developments that have, to a greater or lesser degree, an unpredictable impact on relevant strategic options and hence contribute to strategic uncertainty. We consider the finding that mitigation tactics for the “risks” reported are largely missing or are mostly expressed in generic terms in part as a confirmation of this nature. The still-dominant stream of corporate governance theories based in economics and law, like agency theory, relates structural board characteristics to corporate performance and by and large ignores behavioral aspects of board functioning and decision making. Although acknowledging that structural board characteristics play a role in conditioning and shaping board behavior, previous research on actual board processes and behavior has questioned their importance. Also, the host of corporate scandals indicates that recommendations made by main governance theories have failed to prevent fraud and bankruptcy. For one thing, research indicates that the board’s role, in particular of nonexecutive members, in strategy development is limited. As a result, the distinction between management decision and management control is imperfect and the board’s strategy role in practice not as coherent and supportive as conceived and assumed by, for example, agency theory. Boards can play a vital role in shaping corporate strategy (Andrews, 1980, 1981; McNulty & Pettigrew, 1999; Zahra,

Behavioral Governance    69

1990). Outside, nonexecutive members can increase environmental awareness, bring in “fresh objectivity” and complementary expertise and experience. All of these prove especially valuable during times of high external complexity to compensate for cognitive and process biases that work within the firm’s management and question their risk propensity. Scenario thinking and analysis offers a valuable approach in situations of high environmental ambiguity and uncertainty to influence, challenge, and support the way boards function and take decisions when traditional risk management methods and tools fail. Crafting and thinking through alternative scenarios of the future within the realm of the ”intuitive logics school” makes it possible to exchange a variety of ideas in an open strategic conversation between executive and nonexecutive members of the board (Van der Heijden, 2000). The secure strategic space this creates allows for external board members to challenge established strategic paradigms, question current mental models, point to prevailing cognitive and group biases, and stretch perceptions. At the same time, boards gradually create a shared understanding of environmental uncertainties and strategic problems the firm faces and identify and evaluate strategic options to benefit from attractive opportunities while addressing strategic risks and uncertainties. The balance between differentiation and integration that arises prevents both excessive fragmentation and groupthink. While opening up new perspectives on the future, scenarios also offer “alternative interpretations of the present” (Ogilvy, 2002, p. 128) and in doing so help to broaden outside views and identify weak signals of structural change and discontinuities. It is this collective learning process about environmental uncertainty that distinguishes scenario planning from regular risk management tools. As knowledge and understanding of a problematical situation grows, the perceived environmental uncertainty declines as part of it translates into predetermined elements, and perceived strategic uncertainties may transform into strategic risks over the course of a scenario exercise. Exploring and expanding what turns out to be less uncertain is at the core of scenario thinking when dealing with strategic uncertainty (Wack, 1985b). Because scenario thinking is however also not without limitations when unprecedented events and discontinuities unexpectedly arise, boards can never take anything for granted when it concerns the long-term viability of the firm. ACKNOWLEDGEMENTS We thank our research assistant Lukasz Matwij for his assistance in collecting the empirical data about strategic risks at Dutch companies. His sup-

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CHAPTER 3

A PRACTICE-BASED VIEW OF BUSINESS MODELING Cognition and Knowledge in Action Arash Najmaei Jo Rhodes Peter Lok

ABSTRACT In this chapter, we situate the strategic management of business models within the strategy-as-practice view to create a more nuanced view of how managers manage business models. We introduce the notion of business modeling as the practice of managing business models and posit that managers are actively involved in actions guided by their cognition and knowledge structures that shape their practice of business modeling. More specifically, this chapter builds on practice theory, activity theory, and sociocognitive view and develops an argument for why the practice of business modeling is essential to understand how business models work. This practice involves various actions that span organizational boundaries and cut across levels of analysis. Our view is premised on the assumption that the practice of business modeling represents a form of dyadic reciprocal causation in which a business model of the firm guides managerial actions, which in turn leads to adjustments in

The Practice of Behavioral Strategy, pages 77–104 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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78    A. NAJMAEI, J. RHODES, and P. LOK the business model through learning practices. The theoretical and practical implications of this view will be discussed and several directions for research will be presented.

INTRODUCTION Strategy is supposed to lead the firm to a sustainable success (Carter, Clegg, & Kornberger, 2008). The success of any business however lies in its business model. Any firm has implicitly or explicitly a business model which delineates how it does its business (Teece, 2010). The business model is a set of assumptions about the business and the corresponding set of activities that define how a firm creates value for its customers and captures this value by transforming it into profit and wealth (Zott & Amit, 2010). More specifically, business models help managers enact opportunities by structuring resources into multilevel activities, spanning boundaries of the firm (George & Bock, 2011). Business models lack agency. That is, they are not self-propelling entities, are not available in the strategic factor markets, and thus cannot be traded and are not protected by property rights. Enterprising individuals or teams with entrepreneurial capacity and strategic mindsets develop and manage business models for specific commercial purposes (Amit & Zott, 2001, 2012; Chesbrough & Rosenbloom, 2002). This is the managerial agency that makes a business mode a business model. That is why similar firms serving similar markets have business models that enable them to produce differential value offerings. That said, a business model—as a mental model representing the business of the firm in the mind of executives or a full-scale model of realized organizational activities that shows how a firm does its business—needs to be developed and constantly adjusted or remodeled. We call this process business modeling and consider it a strategic phenomenon initiated at the managerial level that directly influences a firm and its path to success. The emerging perspective of behavioral strategy is a suitable theoretical lens through which to examine this phenomenon. Behavioral strategy concerns the psychological and cognitive contexts through which strategic phenomena are crafted and executed by strategists (Gavetti, Greve, Levinthal, & Ocasio, 2012). The practice turn (Golsorkhi, Rouleau, Seidl, & Vaara, 2010; Johnson, Langley, Melin, & Whittington, 2007; Vaara & Whittington, 2012) within this domain pays closer attention to the actual actions undertaken during these phenomena. According to this view, strategy is something people do (Jarzabkowski & Spee, 2009). Therefore, the practice turn concerns the way psychological and cognitive factors are enacted or translated into strategic actions (Orlikowski, 2000). Being about the action, the practice of

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behavioral strategy is informed by at least three closely related theoretical frameworks: the practice theory (PT), the activity-system view or interchangeably the activity theory (AT), and the sociocognitive theory (SCT). The practice theory builds on three core themes (Whittington, 2006). These three are (a) the social context, in which practice (i.e., doing or something) takes place; (b) the actual act of doing something (i.e., how the practice is performed or how the activities are conducted); and finally, (c) the actor who performs the practice (the human side of practice or the human action and the knowledge, skills, and other factors that form the foundation of one’s actions). The activity theory (Jarzabkowski, 2005), on the other hand, suggests that any activity is to fulfill a specific goal and involves human action. It further argues that all actions that contribute to the fulfillment of the goal are part of the activity. Thus, activities differ in terms of their constituent actions. Finally, the sociocognitive theory (Bandura, 1989, 2001) argues that human action is based on human agency. Further, human agency is regulated by cognitive capabilities that are developed partly through the personal experience and partly through the observation and environmental factors. Research on the practice of strategic behaviors has received considerable attention (Jarzabkowski & Spee, 2009) and has begun to go beyond strategy and permeate other branches of management such as information systems (Whittington, 2014). However, very little, if any, attention has been paid to the practice of developing and adjusting the business model (BM) of the firm as a fundamental strategic undertaking of the firm (Eckhardt, 2013). Business models are living entities that co-evolve with markets to enable organizational adaptation (Najmaei, 2013). Managing this co-evolution is a strategic undertaking involving actions that influence value creation and value capturing activities of the firm. Drawing on the practice view, business modeling encompasses managerial actions that shape the actual act of managing the business model of the firm in evolving markets. This perspective situates the strategic management of business models within the practice view and offers new insights into a more practical view of business models. We argue that not only is such a view lacking but also it strongly resonates with the theory and practice of behavioral strategy and particularly its practice view. In particular, not only does this view extend the boundaries of strategy-as-practice into the realm of business model literature but also it directly addresses the call for a deeper understanding of the microfoundation of business models (Demil, Lecocq, Ricart, & Zott, 2013). We believe our view advances scholars’ understanding of some new avenues though which strategic management theories can interact with and inform the business model literature to enhance cumulative progress in this field of inquiry. Toward this end, the remainder of this chapter is organized as follows: The next section reviews the theoretical evolution of the practice view in

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the behavioral strategy. The second section extends the view of the behavioral strategy and its practice to the business model literature by illuminating how business models differ from strategies and how business modeling is a complex adaptive strategic phenomenon represented by a set of strategic activities practiced by managers. Drawing upon the first two sections, the third section outlines a practice-based view of business modeling and illustrates its potential dimensions and aspects. In particular, it delineates boundaries of this view relative to the cognitive and organizational view of business models and shows how this view adds original value to the current body of knowledge on the practice of strategies. Finally, the fourth section sheds light on various implications of this view for theory, practice, and management education and proposes a set of research directions for inspiring further research in this field. ACTIONS, ACTIVITY SYSTEMS, AND PRACTICE OF STRATEGY An Overview of Strategy as Practice The traditional conception of firms or business organizations in economics and management has been based on the neoclassical economics that follow assumptions of full rationality (Augier, 2004). This view offers incomplete and misleading accounts for behaviors of business enterprises in the changing and industrialized world, for a number of reasons (Kaplan, 2011). It assumes that (a) a firm enjoys perfect information and certainty about environmental outcomes, (b) it suffers no control or adaptability problems and hence can maximize profit, and (c) its strategies and performance are predictable. Hence, this view fails to provide a clear abstraction and explanation for firms’ heterogeneities in a real business environment in which risk and uncertainty are undeniable (Knight, 1921, 1965). In this view, “there is no room for strategy of any kind on the part of decision makers” (Cyert & Williams 1993, p. 5), and literature fails to provide explanations for firm behaviors from the perspective of internal mechanisms such as attributes of executives and their actions (Hambrick, 2007; Hambrick & Mason, 1984). The stream of strategic leadership relaxes these assumptions by focusing on “the people who have overall responsibility for an organization—the characteristics of those people, what they do, and how they do it” (Hambrick, 1989, p. 6). This view builds on the behavioral theory of the firm (Cyert & March, 1963) and suggests that personality, cognition, and behaviors of executives shape the foundation of strategies and their distal, organizational, and proximal performance consequences (Gavetti et al., 2012;

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Powell, Lovallo, & Fox, 2011). As this branch has started to mature and accumulate a body of coherent knowledge, scholars have shaped a subspecialization known as the strategy as practice (hereafter SAP). SAP provides a more-specific view of activities and actions undertaken during the formulation and execution of strategies (Chia, 2004; Jarzabkowski, 2003, 2004). SAP shifts the attention from strategy as a property of an organization (i.e.,  something that an organization has) to strategy as a practice (i.e.,  something that people do) (Whittington, 2006). Hence, it attends to a more microlevel view by specifying detailed day-to-day processes and practices, also known as microstrategies, that constitute organizational strategies and their consequences (Johnson, Melin, & Whittington, 2003). In SAP, strategies are viewed as situated, socially accomplished activities (Jarzabkowski & Spee, 2009). This perspective not only enables SAP to offer insightful accounts for both theorists and practitioners that are closer to the reality of the business (i.e., business in action) but also helps scholars better understand microlevel phenomena that link resources and institutional logics to macrolevel strategies and firm-level outcomes (Johnson et al., 2003). The notion of practice in SAP germinates from the bridge between individualism and societism in the social theory. The former overemphasizes the role of individual human actions while the latter overemphasizes the significance of social forces in shaping the dynamics of social systems (Whittington, 2006). Three pillars of this view are social systems, individuality, and actors who perform the practice (Whittington, 2006). Social systems refers to shared understandings, meanings, cultural rules, procedures, and norms that guide and enable human action. Individuality concerns “how” actions are actually carried out by capturing their practical sense in the context and “actors” refer to those whose skills and initiative activities shape the practice (Carter et al., 2008; Jarzabkowski & Spee, 2009; Whittington, 2006). By focusing on actual actions in their social contexts, SAP becomes distinct from other microlevel frameworks of behavioral strategy such as strategic cognition (Narayanan, Zane, & Kemmerer, 2011) and a microfoundation view (Felin, Foss, Heimeriks, & Madsen, 2012). To understand this distinction better, we distinguish among practice, actions, and activities. From the Practice View to Activities and Actions In the language of SAP, practice in the singular form is conceptually different from practices in the plural form. A practice is the actual activity, while practices are norms, rules, traditions, and procedures are any form of social, symbolic materials by which a practice is constructed (Jarzabkowski, 2004; Jarzabkowski & Spee, 2009). More specifically, a practice is composed of activities. It resembles recurrent activities, while practices resemble formal

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procedures or structures of activities (Carter et al., 2008). Therefore, a practice is akin to a self-reinforcing recurrent learning activity (Carter et al., 2008). An activity itself involves several actions which are done synchronously or asynchronously to achieve certain objectives. Following this logic, a practice becomes vaguely synonymous with routines and rules (Carter et al., 2008) and in its plural form becomes responsible for reinforcing stability and efficiency or an agent for adaptation and changes, depending on its objective. Having said that, it is useful to know that practices are in fact, “what is inside processes” (Johnson et al., 2003, p. 11) and collectively form organizational processes. The flow of activity through which the strategic goal of the practice is accomplished becomes the praxis, defined as “as a stream of activity that interconnects the micro actions of individuals and groups with the wider institutions in which those actions are located and to which they contribute” (Jarzabkowski & Spee, 2009, p. 73). The conceptual distinction between practice (praxis) and practices in SAP is consistent with the practice theory in sociology. Reckwitz (2002) defines them aptly as follows: “Practice” (Praxis) in the singular represents merely an emphatic term to describe the whole of human action. “Practices” in the sense of the theory of social practices, however, is something else. A “practice” (Praktik) is a routinized type of behavior which consists of several elements, interconnected to one other: forms of bodily activities, forms of mental activities, “things” and their use, a background knowledge in the form of understanding, knowhow, states of emotion and motivational knowledge . . . A Practice—a way of cooking, working, etc. . . . Likewise, a practice represents a pattern which can be filled out by a multitude of single and often unique actions reproducing the practice (a certain way of consuming goods can be filled out by plenty of actual acts of consumption). The single individual—as a bodily and mental agent—then acts as the “carrier” (Träger) of a practice—and, in fact, of many different practices which need not be coordinated with one another. (pp. 249–250)

An actor or practitioner performs practices in a manner that forms an identifiable process. A practitioner can be an individual actor such as a CEO or an aggregate actor such as the top management team (TMT) of a firm (Jarzabkowski & Spee, 2009). Therefore, when studying strategies as practice, it is important to attend to the actual doing of a practice, the activities that constitute it, and specify whether they have been undertaken by an individual or an aggregate actor (Vaara & Whittington, 2012). The activity theory in sociology (Vygotsky, 1978) helps clarify this issue. According to Vygotsky (1978), an activity involves human action and interaction. All actions and interactions that contribute toward the fulfillment of a specified goal are part of an activity (Zott & Amit, 2010, p. 225). To

A Practice-Based View of Business Modeling    83 Strategies and strategic processes Practices

Activities

Actions

Figure 3.1  From actions to practice.

conclude, one could conclude that actions of actors form activities and a stream of activities shape practice of doing strategies. Figure 3.1 offers a schematic representation of this argument. It is important to discriminate between two views of activity systems in SAP. As we will show in the next section, this distinction is central to a practice-based view of business modeling. In general, activities when coordinated form activity systems. In strategy, there are at least two activity-system perspectives. The economic-oriented activity system view emphasizes productive activities of the firm as a unit of production (Stigler, 1951). In this view, a firm engages in a series of distinct operations: purchasing and storing materials; transforming materials into semifinished products and semifinished products into finished products; storing and selling the output; extending credit to buyers; etc. . . . therefore it is partitioned among the functions or processes which constitute the scope of its activity. (Stigler, 1951, p. 157)

The second view takes a strategic flavor and emphasizes activities that shape strategic behavior of the firm. This view builds on the Porter’s “value chain” view (Porter, 1985) which he later called “the activity-based view” (Porter, 1998). Porter defines an activity as a discrete economic process within the firm (Porter, 1985) and argues that the essence of strategy is differentiation and all differences among firms derive from activities they perform. Therefore, “differentiation arises from both the choice of activities and how they are performed” (Porter, 1996, p. 62). Accordingly, competitive advantage is created when firms do different activities or do similar activities differently (Porter, 1996). This argument puts activity systems at the center of strategy analysis. Further, the way individual activities are performed is instrumental

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in the strategic performance of the firm because the value of individual activities depends on the configuration of other activity choices of a firm and fit among all activities it performs (Porter & Siggelkow, 2008). Activities at the firm level differ from activities at the individuals’ level in the sociological view of activity systems described before. Our contention is that, even though a firm-level activity-system view is a useful framework for strategy analysis, it loses its utility and collapses when applied at the individuals’ level. Building on the activity theory (Vygotsky, 1978), firm-level activities can be seen as goal oriented, collective actions carried out by individuals through a social process that both shapes the context and is shaped by the context of the activity (Zott & Amit, 2010). Therefore, since, individuals perform firm-level activities, the activity system discussed here should be viewed as an individual-level activity system composed of human actions that collectively construct the firm-level activity systems (Figure 3.2). Building on this argument, human action is the cornerstone of the activity-system view and is the pivotal unit of analysis in the practice of strategy. Perhaps the Austrian economist Von Mises (1949) has offered the most famous account for the human action. He describes action as purposeful behavior, real things not planned but unrealized acts. Further, he eloquently argues that, human-action theory concerns real actions not psychological events that result in actions. In this view, Action is will put into operation and transformed into an agency, is aiming at ends and goals, is the ego’s meaningful response to stimuli and to the conditions of its environment, is a person’s conscious adjustment to the state of the universe that determines his life. (p. 11)

The notion of consciousness implies that human actions are those actions that individuals choose to perform for a reason (Greve, 2001). As put by Von Mises (1949, p. 14), the main reason for the acting man is “to substitute a more satisfactory state of affairs for a less satisfactory.” Therefore, Activity 1

Firm level

Individual level

Individual level

Activity 2

Action 1

Action 2

Activity 2

Action 3

Figure 3.2  A schematic view of actions and activities at individual and firm level.

A Practice-Based View of Business Modeling    85

the actor knows why she/he has done this particular action not something else and has a certain level of control over the sequence of movements that constitute the action (Greve, 2001). We do not intend to engage in an in-depth analysis of the psychology of action. However, it should suffice to say that the SAP view concerns the actions of strategic elites, executives, or top managers whose behaviors are driven by strategic goals and define how strategic courses of action are formulated and executed to achieve those goals (Carter et al., 2008; Johnson et al., 2007; Suddaby, Seidl, & Le, 2013). The essence of SAP is to explain factors and mechanisms that enhance or hinder executives from acting strategically. In this view, executives’ actions are publicly observable movements in contrast to their mental representations (Rouse, 2006), which implies the primacy of individual choice and factors that are instrumental in executives’ choice making. In the next section, we will further elaborate this argument by synthesizing insights from a knowledge-based view, strategic cognition, and particularly the theory of social cognition. Knowledge, Cognition, and a Social Cognitive View of Strategic Actions Acting means using agency intentionally to make things happen (Bandura, 2001). Therefore, action is based on the capacity to exercise control over thoughts and motivation (Bandura, 1989; Von Mises, 1949). Individuals through their actions change themselves and their situations (Bandura, 1989). Before we delve further into the mechanism of action, it seems reasonable to discriminate action from behavior. Behavior refers to “doing of any sort,” however action is “behavior imbued with meaning” (Cook & Brown, 1999) or as we see, actions are meaningful behaviors. Individuals use symbolic structures of knowledge to interpret the surrounding world and ascribe meaning to their behavior (Reckwitz, 2002). These representational structures in the mind are cognitive entities used in computational algorithms for interpretation of the world (Gavetti & Rivkin, 2007). Knowledge structures are developed through learning along life trajectories (Nooteboom, 2009), and their existence implies both the possession of knowledge and engaging in the act of knowing (i.e., acquiring knowledge). Therefore, different individuals have different cognitive structures to the extent that their learning along their life trajectories differs (Nooteboom, 2009). The social cognitive theory (Bandura, 1989) explains these differences via an emergent interactive perspective according to which actions are taken through reciprocal interactions among cognitive and environmental

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events (Bandura, 1989). More specifically, actions involve knowledge and cognitive mechanisms of knowing in the form of reasoning and information processing (Bandura, 2001; Reckwitz, 2002). Knowledge structures contain general and specific information about an action that are mobilized through the process of “knowing” how to guide and inform actions. This phenomenon involves “knowing what” and “knowing how,” which are linked to each other within an action (Reckwitz, 2002). Thus, the capacity to act improves as knowledge structures and cognitive capabilities driving the capacity of knowing advance. In other words, the interactions between cognition and knowledge represent inward mechanisms that help individuals cope with this uncertainty and generate conditions for outward human action (Reckwitz, 2002). This line of thinking is consistent with the view of Cook and Brown (1999), in which existing knowledge possessed by individuals represents something they use in their actions, whereas their act of “knowing” represents a cognitive process that is done as a part of an action. Since actions occur over time and the future is unknown, actions are inherently associated with uncertainty (Mcmullen & Shepherd, 2006). Social cognitive theory suggests that people judge the correctness of their actions in the face of uncertainty using predictive and operative thinking drawing on the state of knowledge that is constantly evolving through these interactions (Bandura, 1989). Because of the uncertain nature of actions, people evaluate their actions through constant learning about (a) the outcomes of their actions in terms of their contribution to the purpose of the action, (b) the effects that other people’s actions produce, and (c) deductions from established knowledge structures and what necessarily results from them (Bandura, 2001). Effective actions are then used in the formulation of predictive rules for future actions (Bandura, 1989). These interactions underpin various evaluative mechanisms such as “observational learning, inferences from exploratory experiences, information conveyed by verbal instruction, and innovative cognitive syntheses of preexisting knowledge” (Bandura, 1989, p. 1181), which collectively guide the production of appropriate behavior and provide the internal standards for corrective adjustments to future actions (Bandura, 1989). Consequently, in acting as agents, people draw on their existing knowledge and cognitive skills to produce desired actions and assess outcome of their actions (Bandura, 2001; Cook & Brown, 1999; Gavetti & Rivkin, 2007). Therefore, we posit that the actor and his actions are held together and linked to cognitive processes that constantly relate knowledge structures to the act of knowing. Building on this view, in the next section we propose an actioncentered view of how executives manage their business models through a set of actions collectively known as the practice of business modeling.

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STRATEGIZING BUSINESS MODEL CHANGE: THE PRACTICE OF BUSINESS MODELING Whenever a firm is established it adopts a business model (Teece, 2010). There appears to be two schools of thought in the adoption of business models. The cognitive school sees business models as cognitive representations of the business in the mind of managers. According to this view, a business model makes implicit assumptions about customers, competitors, revenue and cost structures, and the nature of changes in the market in the mind of managers (Teece, 2010). These assumptions are then reflected in managers’ hypotheses about how to make and deliver market offerings and convert revenue into profit (Teece, 2010). The business model becomes a part of firm’s dominant logic (Obloj, Obloj, & Pratt, 2010) and represents managers’ mental models or mindsets about markets (Tollin, 2008). The cognitive school can be best summarized as a perspective in which business models are conceptualized as mental models about the business or simplified representations of the reality of business; alternatively, knowledge structures about dimensions of the business, and markets in the mind of managers that help them to ascribe meaning to their business and its position in the marketplace. As previously noted, knowledge structures inform and guide actions. Therefore, business models serve as filters that help managers sift through information, ascribe meaning to them, picture their business, and make choices with regard to customers, value offerings, cost and profit formulas, competitors, and the behavior of their business in the business ecosystem (Teece, 2010). For instance, a business model enables managers to describe their business, tell stories about it, and attract customers and investors (Magretta, 2002). On the other hand, the organizational school conceptualizes business models as structures of resources for exploiting opportunities (George & Bock, 2011), a reflection of the firm’s realized strategies (Casadesus-Masanell & Ricart, 2010), or a carefully designed set of interrelated activities involving human, technological, and capital resources for creating value (Zott & Amit, 2010). Alternatively, business model has also been viewed as “a complex set of interdependent routines that is discovered, adjusted, and fine-tuned by doing” (Winter & Szulanski, 2001, p. 731). According to this organizational view, a business model entails boundary-spanning structures that convert resources into value-creating and capturing activities (Zott, Amit, & Massa, 2011). Drawing on this view, Casadesus-Masanell and Ricart (2010), posit that strategy is the choice of business model and all other organizational choices are to implement, refine, and adjust the business model of the firm. In this view, business models are built on industry value chains and represent various constellations of activities that define competitive spots in an industry (Magretta, 2002).

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Both views converge on the fact that business models are dynamic entities; they need to adjust to market changes and successful managers, and by implication, firms continuously adjust their business models (Aspara, Lamberg, Laukia, & Tikkanen, 2011, 2013; Katkalo, Pitelis, & Teece, 2010; Teece, 2007). Despite this notion, the existing business model literature is surprisingly silent about how these cognitive and organizational views relate to each other. The main contention of this chapter, as noted earlier, is that a practice-based view would link these two schools by offering a theoretical conversation that connects managers’ actions and practices with the firm’s activity systems to create a better picture of how business models are developed and adjusted to co-evolve with markets. Drawing on this premise, we define business models as “knowledge structures held by managers about their business that are transformed into multilevel and boundary-spanning organizational activities for creating and capturing value.” We suspect that the emphasis on only cognitive or organizational activity views rather than synthesizing them would add to the complexity surrounding the concept of business models. Accordingly, by defining business modeling as the process of adopting, implementing, and adjusting business models, we imply that business models are dynamic living entities that are managed through activities of managers. Subsequently, we posit that business modeling involves managerial actions, activities, and practices, building on changes in their mental models and converted into changes in the organizational models of activities. The practice of business modeling is a strategic practice. Such practices are defined as an identifiable context-specific process commonly performed by managers from a variety of firms (Bromiley & Rau, in press). Some examples are the practice of business model reinvention or business model transformation performed by executives of firms such as Apple, Nokia, HP, and such, or the practice of business model replication in which a business model is replicated in new geographical locations (Winter & Szulanski, 2001). This practice is frequently performed by retailers, banks, and the like. Table 3.1 illustrates a summary of key terms and their definitions used in this line of thinking. As we will outline in the remaining part of this section, managers vary in their capacity to perform actions, coordinate them in activities, and lead organizations toward business model changes. Following the definition of business modeling, we distinguish between actions involved in the adoption of a business model and those involved in the process of changing/adjusting a business model. Strategizing Actions and Genesis of Business Models A business model is developed to exploit an opportunity. An opportunity here refers to an “economic circumstance where if the correct good or service were to be properly organized and offered for sale that the result would

A Practice-Based View of Business Modeling    89 TABLE 3.1  Key Terms and Their Definitions in the Practice-Based View of Business Modeling Key term

Definition

Business model

Knowledge structures held by managers about their business that are transformed into multilevel and boundary-spanning organizational activities for creating and capturing value.

Business modeling

The process of adopting, implementing, and adjusting business models.

Business modeling actions

Managerial actions that underpin their business modeling process.

Business modeling activities

Coordinated business modeling actions aimed for achieving specific goals.

Business modeling practices Repeated routinized patterns of business modeling activities. The practice of business modeling

Identifiable context-specific business modeling process commonly performed by managers of different firms such as the practice of business model reinvention, the practice of business model replication, etc.

Cognition

The process of developing and adjusting knowledge structures though cognitive actions such as learning (knowing).

Knowledge

Knowledge structures used to ascribe meaning to the world.

be profitable” (Eckhardt & Shane, 2010, p. 48). Existence of an opportunity implies that a market has not reached its full potential and thus there is room for action to take it closer to its potential (Dimov, 2011). Opportunities are recognized based on perceptions of market relationships and simply reflect ideas about what can be done given the existing knowledge and resources (Dimov, 2011). These ideas can emerge through searches based on prior experience or knowledge (Shane, 2000) or by serendipitous discovery and fortuitous circumstances (Vaghely & Julien, 2010). To enact an opportunity, the individual needs to form a mental picture of the business and then develop some structures to increase the viability of the opportunity and reduce its uncertainty as well as its sensitivity to the environment (Dimov, 2011). This mental picture and corresponding structures form the origin of the business model of the firm. Structures within the business model may include different components of a business such as financial and nonfinancial resources, employees, and necessary relationships with customers, suppliers, regulatory bodies, and other institutions (Teece, 2010) within the social context, such as markets and industries in which the business is situated (Dimov, 2011). Individuals may employ a variety of techniques to develop these structures and acquire necessary resources for their business model to enact opportunities. For instance, some may use symbolic actions to acquire necessary resources (Zott & Huy, 2007), whereas others may rely on bricolage to gain necessary resources (Baker & Nelson,

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2005). Some also acquire resources by developing ties (formal and informal relationships) with different resource holders (Zhang, Soh, & Wong, 2010, 2011). These structures enable the founder to carve out a space in the market and secure and sustain this space to run the business (Dimov, 2011). Through its business model, the venture gains legitimacy (Lounsbury & Glynn, 2001) and becomes a new part of the market (Dimov, 2011). Therefore, adoption and development of a business model is a praxis, an unfolding phenomenon composed of strategic activities embedded in the marketplace. It is composed of numerous actions of an enterprising individual—an actor—a practitioner who recognizes opportunity, assesses its feasibility and desirability, acquires necessary resources, and structures them in some productive ways to take advantage of the opportunity. These microstrategies or strategizing actions precede development of a business model. A practice-based view of the genesis of a business model involves actions germinating from the interactions between existing knowledge about the business and ongoing knowledge acquired though learning about the business and its dynamics as they unfolds in the market to carve the position of the firm. These socially constructed and embedded actions explain (1) how enterprising individuals actually recognize and evaluate opportunities that can be exploited by a new business model, (2) obtain and use various tools or means to develop this cognitive capacity and (3) tools, and means they use to acquire and allocate resources to exploit the recognized opportunity. The practice of developing a business model is based on the capacity to develop and adjust knowledge structures or mental models about the market. Hence, it involves two sets of actions: the “business model ideation” that encompasses cognitive processes of sensing and evaluating conditions in the market using existing knowledge and experience. This could be a single venturing idea or a series of modified ideas (Dimov, 2011) and “business model structuring,” which includes knowing and learning to know how to acquire and allocate resources to turn the idea into tangible outcomes and engaging in actual acquisition and structuring of resources. It is important to discriminate between business model “ideation” and “structuring.” This classification is at the heart of our argument because it enables scholars to better understand specific actions, activities, and practices involved in the formation of business models across serial (those who establish multiple ventures in sequence), portfolio (those who establish multiple ventures in parallel), and nascent (those who have established only one venture so far) entrepreneurs (Parker, in press). Strategizing Postdevelopment Business Model Changes As noted earlier, when a business model is developed, it becomes a part of the market. Thus, business models are to co-evolve with markets if

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businesses based on them are to survive. This co-evolution is carried out when managers adjust their knowledge structures about the position of their firms in the markets and change their resource structures accordingly. Failure to do so will result in the loss of the capacity to compete and adapt. Business model changes take various forms depending on the nature of changes in the marketplace. In rapidly changing markets, managers need to constantly emphasize radical changes and develop new business models, whereas in less dynamic markets, business models are more likely to go through episodes of incremental changes. In either scenario, managers’ ability to initiate and manage necessary business model changes is instrumental in the continued success of the firm. Prior research suggests that managers tend to develop enduring beliefs about the correctness of their business model and protect it, especially when it has been successful for a period of time (Hambrick, Geletkanycz, & Fredrickson, 1993). Therefore, to become able to adjust their business models, managers need to overcome cognitive barriers and become free of nostalgia, denial, and arrogance (Hamel & Välikangas, 2003). Actions that managers undertake to achieve this goal are a central part of their business modeling. For instance, an executive could be committed to the current business model without emphasizing business model changes, perhaps because “it is all he or she knows, unaware of other options” (Hambrick et al., 1993, p. 404). Another explanation could be that executives may know the value of a specific change in the business model, but they tend to reject or discount it because they don’t have enough market and technological knowledge to assess the uncertainty involved in pursuing it (Mosakowski, 2002). Several activities could help managers tackle these obstacles. For example, metacognitive training has been argued to help managers recognize the value of cognitive resiliency (Haynie, Shepherd, & Patzelt, 2012). In addition, constant involvement in various knowledge-acquiring activities such as experimentation, vicarious learning, grafting, and scanning have been proven effective for enabling managers change their knowledge structures (Chandler & Lyon, 2009). Therefore, a practice-based view of this phenomenon suggests that there is a plethora of possible actions and activities undertaken by managers to reduce cognitive inertia that is associated with their resistance to initiating business modeling activities. Managers can use various tools, techniques, and polices, ranging from cognitive training to advice-seeking practices, in order to initiate and manage incremental and radical changes to their business model. Structural barriers stemming from complex configurations of resources represent another side of business modeling. In some cases, managers are cognizant of the value and urgency of business model changes; they have also obtained necessary knowledge to implement required changes. However, the existing business model of the firm is associated with complex

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configurations of resources, capabilities, and bundles of interdependent activities that, with any change, would lead to unmanageable internal complexity. Under these circumstances, business modeling involves actions and activities that reduce internal complexity, simplify resource structures, and reconfigure complex activities. The practice of business modeling becomes about the ability to divert resources from the existing structures to new ones in a less complicated fashion. This diversion involves reconfiguring, rebounding, and rearranging resources across boundary-spanning activities that may need to be strategized and executed separately, concurrently, or sequentially over an extended period of time (Achtenhagen, Melin, & Naldi, 2013; Aspara et al., 2011, 2013). Prior research on dynamic capabilities (Eisenhardt & Martin, 2000; Teece, Pisano, & Shuen, 1997) suggests that reconfiguring resource structures is based partly on knowing resources and their versatility, and partly on managerial creativity and imagination in using resources differently in different conditions. Managers develop dynamic managerial capabilities using their cognitive and social capabilities (Adner & Helfat, 2003) to examine benefits and opportunity costs associated with changes in the activity system of the firm. Then they decide which activities should be maintained, modified, or discarded. These undertakings can take various forms, such as developing new product lines, changing delivery systems, discontinuing a service, and such, and indicate numerous business modeling possibilities. Through these business modeling practices, managers enable the firm to adjust its business model in order to achieve an evolutionary fit (Helfat et al., 2007). Therefore, managers’ actions to restructure resources and reconfigure activities lie at the heart of the practice-based view of business modeling. This view opens up numerous research avenues to explore and examine tools, techniques, and policies that managers employ to perform these activities. These may include different types and numbers of analogies (Lovallo, Clarke, & Camerer, 2012), or a business model canvas (Osterwalder & Pigneur, 2009) that maps out different scopes of a firm’s activity system. Because managers vary in their ability to overcome cognitive inertia and reconfigure their resource structures, firms vary in their business modeling; some adjust their business models timely by reconfiguring their activity systems, while others fall behind and lose their competitive spot in the marketplace. Therefore, a practice-based view of business modeling supersedes both the cognitive view and organizational view of business modeling (see Table 3.2) by creating a more realistic and practical view of various business modeling actions that take place in the context of the firm and its business landscape.

A Practice-Based View of Business Modeling    93 TABLE 3.2  Theoretical Positioning of a Practice-Based View of Business Modeling Practice-based view of business modeling

Cognitive view of business modeling

Organizational view of business modeling

Conceptualization Evolution of a business Evolution of a business Evolution of a business of business model from the model from the permodel from the modeling perspective of actions spective of cognitive perspective of and practices of structures of managorganization wide managers who have ers who have the activities involving the responsibility for responsibility for the resources, and the business model business model of capabilities of the firm the firm Unit of analysis

Managerial practices Changes or rigidity and actions involved in managers’ in the management Mindset, logic, of business models. cognitive structures, hypothesis, assumptions that enhance or constrain business model adjustments

Organizational strategies, activities and initiatives involving various human, technological and financial resources that transform, reinforce or create business models

Level of analysis

Both Micro and Macro Micro

Macro

Key assumption

Managerial actions are Understanding building blocks of managerial how business models cognition is the key are adopted and to understand how change. business models are adopted change.

Firm-level activities, routines, and capabilities form building blocks of business model evolution.

Theoretical roots

Action Theory, Strategic Cognition, Practice Theory, Behavioral View SAP, Socio-Cognitive Theory

Dynamic Capabilities, Organizational Activity-System View, Resource-Based Theories

DISCUSSION The view developed in this chapter indicates that a practice-based view of business modeling has both theoretical and practical appeal. Not only would it provide a set of theoretically grounded insights into the behavioral foundation of the management of business models as a key strategic action, but it would also facilitate the understanding of how executives actually engage in the practice of business modeling. It offers a sound theoretical ground for delving into

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real actions involved in developing and adjusting business models. It is also scalable, meaning that it can be applied in small as well as large firms. In the following subsections, we outline some of the implications of this view. Theoretical Implications The practice-based view of business modeling outlined here sheds new light and further extends current research on the management of business models in several ways. First, it adds to the activity-based view of business models (Achtenhagen et al., 2013; Zott & Amit, 2010) by outlining a behavioral foundation for executives’ actions that inform and configure firmlevel activity systems. Particularly, the departure point of this chapter from the recent works of Zott and Amit (2010) and Achtenhagen et al. (2013) is its focus on the individual-level actions that shape both organizational-level activity systems (Zott & Amit, 2010) and strategizing activities (e.g., quality and cost-structure policies, product line and customer segment expansions) (Achtenhagen et al., 2013). It suggests that managers’ intentional actions embedded in the social practice of managing their business could account for mechanisms that enable or constrain business model changes. More specifically, our behavioral accounts offer a theoretical foundation for actions and activities that construct the organizational-level activity-based view of business models. This departure may seem at first a subtle point, however, we believe, at least for two reasons, it is a substantial one. First, the activity-system view sees the business model as a system of interrelated organizational activities. This neglects the role of business models as cognitive structures that influence managerial actions. As a result, our practice-based view offers a complementary view, offering a more complete understanding of what business models are, how they function, and how they are managed though the actions of managers. Second, we outlined business modeling as a socially constructed process involving a dyadic reciprocal causation in which the business model of the firm as a mental model guides managerial actions. Learning and evolution of these actions would, in turn, lead to adjustments in the business model of their firms. This reciprocity is an important mechanism through which strategic practices are institutionalized. It hence offers novel insights into the microfoundations of business model institutionalization and helps scholars gain a deeper understanding of how the strategic practices of managers and the business model of the firm interact in forming multilevel boundary-spanning intuitional activities (Zott et al., 2011). In addition, the practice-based view of business modeling has potential to advance the current body of knowledge on the neoinstitutional dimension of strategy-as-practice (Suddaby et al., 2013). As noted, business models represent cognitive structures encompassing assumptions about customers,

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markets, and broader business ecosystem. The neoinstitutional view pays specific attention to institutional logics or beliefs about external worlds that shape institutional practices of managers (Friedland & Alford, 1991). Practices of business modeling builds on these structures. It, hence, suggests that business models change through interactions between actors’ (i.e., managers) cognition and knowledge of the external intuitional setting of the business; that is, cause-and-effect relationships in markets and industries where the business is situated. Studying these practices using our framework offers new insights into how business models serve as intuitional logics in guiding strategic actions of managers and how managers’ actions in return can lead to adjustments in intuitional logics shared by members of an organization. Further, since business models become part of markets, business model changes can lead to macroinstitutional changes. These changes have been evidenced by the evolution off social networking business model from Yahoo360 to Facebook or the evolution of airline industry. Therefore, a practice-based view of business modeling as outlined here can offer a more nuanced understanding of some mechanisms through which conversations between SAP and neointuitionalism theory yield theoretical and practical insights into the nature of managerial work and its implications at both micro and macro levels. Managerial Implications Since every business has a business model that influences and is influenced by the actions of its managers, our view can yield very important and timely implications for managers of all businesses regardless of their size, form, and scope of operation. First, effective business modeling has become a priority for managers in order to reinforce business adaptability, survival, and growth. Studying managerial actions at the core of business models may help them to better recognize their own ability to engage in distinct but related activities that shape value creating and capturing the capacities of their business. Our study suggests that this ability stems from learning and cognitive flexibility. The capacity to learn trends and patterns in the marketplace and technological landscape of the business can be expanded through consultations and external advice-seeking actions that in return lead to an improved cognitive capacity for business modeling. Secondly, understanding actions and practices in context offers important insights for training of effective managers capable of initiating and leading strategic changes such as redirecting and reinventing business models. This is a key premise of SAP view (Vaara & Whittington, 2012; Wright, Paroutis, & Blettner, 2013). Accordingly, managers should be aware of this and try to instill such training in their personal development agenda.

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Implications for Management Education Managing business models has become an important topic for MBAs. Hence, we believe our study also has implications for management education. Our study posits that business models go beyond simple conceptual models, schematic activity systems, and organizational structures; they are instead multilevel complex systems of managerial cognition and action transformed into organizational activities. This conception has wider implications for management education in our business schools. It is clear that if this is the case, management educators need to spend more time cultivating this view in business schools’ learning environment and deliver this view effectively to the students of organizational change, entrepreneurship, and strategic management. Teaching this view would make study of business models and business modeling of exemplar executives such as Steve Jobs more practical and relevant to a broader audience. Therefore, “if one of the key goals of business schools is to better qualify our students for the real world” (Wright et al., 2013, p. 119), then by using the model proposed in this chapter, we can equip the next generation of management students with the needed knowledge required for the effective management of business models in the competitive realities of today’s business world. Directions for Future Research As a research area, a practice-based view of business modeling is a fertile ground for future study. We are convinced that future work might benefit from conversations between business models and SAP literature as two growing domains of inquiry. These links help to build a stronger theoretical and empirical foundation for the study of managerial actions and practices with regard to business models, how they come into existence, and why they change. Insofar as research directions in managerial practice of business modeling is concerned, we believe that clustering these actions in two categories of business model development and postdevelopment changes highlight compelling avenues for future research. This approach is consistent with our model and maintains a conceptualization of business models (Zott et al., 2011) and current research trends in this field (Demil et al., 2013). Capturing actions and practices in context requires context-specific qualitative approaches. Therefore, we build on existing reviews of research on SAP (Suddaby et al., 2013; Vaara & Whittington, 2012; Wright et al., 2013) and particularly qualitative research methods to offer a series of directions, specific areas within these directions, key possible research questions, and useful research methods. Table 3.3 offers a summary of these directions.

Actions undertaken to detect opportunities Actions undertaken to assess its feasibility Actions undertaken to acquire resources to exploit it Tools and techniques used toward achievement of these goals

Initial business modeling opportunityrecognition activities. Initial resource structuring (acquiring and allocating necessary resources to exploit the opportunity) activities.

Tackling the cognitive Actions undertaken to change What actions do managers really inertia and turning and adjust assumptions about perform to adjust their cognitive it into a cognitive the current and new business structures? resiliency for initiating models What strategic tools, methods and and managing business Actions undertaken to choose policies do help managers to model changes activities and configuration of change their assumptions about

Development of new business models

Postdevelopment business model changes

How do actual managers recognize opportunities for new business models? What strategic tools, techniques do they use? What actions do managers take to acquire necessary resources to enact business model opportunities? Are there any common practices among managers of firms in an industry with regard to these actions? What contextual factors constrain or enhance these actions?

Corresponding research areas Some research questions

Research direction Key dimensions

Ethnographic observation In-depth interviews Document analysis such as minutes of meetings and managers’ diaries Shadowing (continued)

Ethnographic observation In-depth Interviews Document analysis such as minutes of meetings and managers’ diaries Shadowing Analysis of video and audio recordings

Some research methods

TABLE 3.3  A Summary of Research Directions for a Practice-Based View of Business Modeling

A Practice-Based View of Business Modeling    97

Corresponding research areas Some research questions

Some research methods

Reconfiguring resources that are needed to the correctness of their business Analysis of video and audio organizational change, be maintained, or models? recordings activities, changing discarded What conditions are more/less conexisting resource Actions undertaken during ducive to these cognitive changes? structures, developing, strategic activities of changing Are there common areas of practice and managing new old and creating new among managers of similar firms structures structures. in terms of involvement in these Heterogeneous and cognitive activities? homogenous actions across What actions do managers really radical or incremental perform to adjust their resource restructuration of resources structures? What strategic tools, methods, and policies help managers change their existing resource structures? What sort of actions are performed concurrently or sequentially during restructuring of resources? What conditions are more/less conducive to these resource-based changes? Are there common areas of practice among managers of similar firms in terms of involvement in these resource-management activities?

Research direction Key dimensions

TABLE 3.3  A Summary of Research Directions for a Practice-Based View of Business Modeling (continued)

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Addressing the above research questions helps scholars gain an expanded understanding of why and how executives engage in the practice of managing their business models and what they usually do to develop and change their business models. It is also important to mention that, given the centrality of business models in organizing resources and initiating and commercializing innovations, such attempts would give life and power to more robust, fine-grained research on the role of managerial actions and practices in dynamic capabilities, initiating and responding to disruptive business model innovations and corporate venturing among others. CONCLUSION Organizational scholars have argued that strategic management of business models is key to success of the firm. This chapter has helped to develop a behavioral account for some of the specific mechanisms through which executives manage their business models. In this chapter, we drew on the theory of practice and its branch in the strategic management, the strategyas-practice (SAP) view to develop a dynamic behavioral view of business models, labeled as “a practice-based view of business modeling.” It suggested that successful executives constantly adjust their business models through the practice of business modeling. This practice involves strategic actions that are informed and guided through the interaction between executives’ cognition—act of knowing—and knowledge structures. Both knowledge as a cognitive resource and knowing as a process of learning are particularly important, because they represent complementary structures that jointly build the capacity to manage business models. This chapter is perhaps the first step toward a practice-oriented, action-focused understanding of business models. Given the paucity of empirical work on this field, we believe there is a growing need for empirical research that focuses on specific business modeling actions situated in the practices of the ordinary daily work of executives. This is a productive inquiry essential to ongoing research on the behavioral and microfoundation of strategy and strategic work. It is our hope that this chapter inspires further research to connect notions from behavioral theories with more fine-grained and specific perspectives of business models to shed new light on how the business literature captures the essence of differences and similarities among managers’ actions in adopting and adjusting business models.

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102    A. NAJMAEI, J. RHODES, and P. LOK Helfat, C. E., Finkelstein, S., Mitchell, W., Peteraf, M. A., Singh, H., Teece, D. J., & Winter, S. G. (2007). Dynamic capabilities: Understanding strategic change in organizations. Malden, MA: Blackwell. Jarzabkowski, P. (2003). Strategic practices: An activity theory perspective on continuity and change. Journal of Management Studies, 40, 23–55. Jarzabkowski, P. (2004). Strategy as practice: Recursiveness, adaptation, and practices-in-use. Organization Studies, 25, 529–560. Jarzabkowski, P. (2005). Strategy as practice: An activity based approach. London, UK: Sage. Jarzabkowski, P., & Spee, A. P. (2009). Strategy-as-practice: A review and future directions for the field. International Journal of Management Reviews, 11, 69–95. Johnson, G., Langley, A., Melin, L., & Whittington, R. (2007). Strategy as practice: Research directions and resources. Cambridge, UK: Cambridge University Press. Johnson, G., Melin, L., & Whittington, R. (2003). Guest editors’ introduction: Micro strategy and strategizing: Towards an activity-based view. Journal of Management Studies, 40, 3–22. Kaplan, S. (2011). Research in cognition and strategy: Reflections on two decades of progress and a look to the future. Journal of Management Studies, 48, 665–695. Katkalo, V. S., Pitelis, C. N., & Teece, D. J. (2010). On the nature and scope of dynamic capabilities. Industrial and Corporate Change, 19, 1175–1186. Knight, F. H. (1921). Risk, uncertainty and profit. New York, NY: Harper & Row. Knight, F. H. (1965). Risk, uncertainty and profit (Reprint and Extension). New York, NY: Harper & Row. Lounsbury, M., & Glynn, M. A. (2001). Cultural entrepreneurship: Stories, legitimacy, and the acquisition of resources. Strategic Management Journal, 22, 545–564. Lovallo, D., Clarke, C., & Camerer, C. (2012). Robust analogizing and the outside view: Two empirical tests of case-based decision making. Strategic Management Journal, 33, 496–512. Magretta, J. (2002). Why business models matter. Harvard Business Review, 80(5), 86–92. Mcmullen, J. S., & Shepherd, D. A. (2006). Entrepreneurial action and the role of uncertainty in the theory of the entrepreneur. Academy of Management Review, 31, 132–152. Mosakowski, E. (2002). Overcoming resource disadvantages in entrepreneurial firms: When less is more. In M. A. Hitt, R. D. Ireland, S. M. Camp, & D. L. Sexton (Eds.), Strategic entrepreneurship: Creating a new mindset (pp. 107–130). New York, NY: Wiley-Blackwell. Najmaei, A. (2013). Leading growth: CEO’s cognition, knowledge acquisition and business model innovation in face of dynamism—A mixed-methods study of Australian SMEs. Unpublishd doctoral thesis, Macquarie University, Sydney, Australia. Narayanan, V. K., Zane, L. J., & Kemmerer, B. (2011). The cognitive perspective in strategy: An integrative review. Journal of Management, 37, 305–351. Nooteboom, B. (2009). A cognitive theory of the firm: Learning, governance and dynamic capabilities. Cheltenham, UK: Elgar. Obloj, T., Obloj, K., & Pratt, M. G. (2010). Dominant logic and entrepreneurial firms’ performance in a transition economy. Entrepreneurship: Theory & Practice,34, 151–170.

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CHAPTER 4

INCUMBENT BEHAVIOR AND COMPETITIVE STRATEGY PARADIGM SHIFT Tomomi Hamada Tsutomu Kobashi

ABSTRACT Theories that explain “incumbent failure” in competitive environments have attracted significant academic and practical attention. This chapter reviews previous literature investigating the determinants of established firms’ strategic choice behaviors, such as their positioning view, resource-based view, path-dependency, core rigidities, and organizational inertia. Moreover, it proposes a conceptual framework to comprehensively interpret the nonoptimal decision making or behavior of incumbents, combined with behavioral strategy. Using the automobile industry as a case study, we test this framework by observing possible successes and failures of new entrants and incumbents to explain intermittent strategic paradigm shifts. Specifically, this study conceptually and systematically describes the following behaviors: (a) firms choose to behave rationally in an industry when they are new entrants, however, a shifting strategic paradigm in the industry renders them unable to do so; (b) firms’ behavioral choices considerably rely on their past decision making behaviors; and (c) firms’ strengths can turn into weaknesses when confronted

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106    T. HAMADA and T. KOBASHI by new entrants with new strategic paradigms. Despite such incumbent inertia, it is observed that some established firms adapt to the next generation by shifting their strategy, while others create a new strategic paradigm in an industry. Finally, this study seeks to identify the conceptual patterns of incumbent firms that successfully adapt to changes in the competitive environment.

INTRODUCTION The variable nature of the competitive environment makes it difficult for established firms to immediately adapt to competitive environmental changes on every occasion. Instead, many established firms are either delayed in their responses to environmental changes or neglect to adapt altogether, forcing them to ultimately withdraw from the industry. A number of researchers have explored the tendency of firms to fail to adapt to environmental changes, a phenomenon often referred to as “organizational inertia” or “incumbent inflexibility” (e.g., Gilbert, 2005; Hannan & Freeman, 1984; Hill & Rothaermel, 2003; Tushman & Romanelli, 1985; Zajac & Bazerman, 1991). An issue that has received significant attention from academics and business practitioners concerned with organizational inertia is technological innovation, also understood as product and process innovation. New products arising from radical technological change often replace incumbent products or services and act as competence-destroying innovations, thus inciting drastic changes in a given industry’s environment (Anderson & Tushman, 1990). As such, established firms whose successes have been contingent on an existing product or service may fail to adapt to the changed environment and lose support from its corresponding market (e.g., Christensen, 1997; Christensen & Bower, 1996; Henderson & Clark, 1990; Tripsas & Gavetti, 2000). There is an abundance of empirical research demonstrating that despite significant R&D capabilities, assets, and knowledge, leading firms can sometimes fail in this regard (e.g., Christensen, 1997). In that case, what factors restrict the strategic behavior of established firms? The perspective of behavioral strategy gives us part of the answer to this question. Based on this perspective, it can be said that the social cognition and emotions of top or middle managers who make decisions about resource allocations in the firm significantly influence the entire firm’s strategic behavior. Drawing on various perspectives, a large body of academic literature analyzes the decisive factors behind the firms and decision makers’ behavior. By linking these perspectives and incorporating a behavioral strategy perspective, this chapter will suggest a theoretical framework to explain the factors restricting the behaviors of firms across a sequence from a firm’s entry into the market to its adaptive responses in the product environment.

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The next section outlines a conceptual framework explaining incumbent inflexibility by integrating various theoretical perspectives and behavioral strategy: a positioning view, a resource-based view, a path-dependency approach that considers strategy choice, and a perspective focusing on core rigidities. On the basis of this framework, it can be said that firms can make rational decisions in the market-entry stage when choices are restricted. And it has extended the framework suggested in the second section from a onetime explanation to time-series explanation, revealing a more historical strategy paradigm shift for an entire industry. In this extended framework, firms in an industry are divided into various “strategic groups,” and the firms in the group that entered the market early often remain more psychologically constrained in the decision makers’ strategic decisions in terms of resource allocation compared with their followers. This theoretical framework is developed in the following section by using the automobile industry as a case study. Then it moves beyond the constraints highlighted by the framework and offers practical recommendations for how established firms can address organizational inflexibility. The last section concludes the chapter by synthesizing the theoretical and practical implications of this study. MECHANISMS OF INCUMBENT NONOPTIMAL DECISION MAKING Literature Review This section reviews notable literature regarding the positioning view, the resource-based view, the path-dependency view, and the core-rigidity view to examine a firm’s market entry, its growth in the industry, and its tendency to display inertia. By integrating these perspectives, it is possible to conclude that the decision maker in an organization can make a rational positioning decision, in light of the industrial market structure, at the first stage of that process; however, as the firms accumulate specific resources, they gradually become restricted by the psychological factors affecting their resource-allocation decisions, finding themselves habituated to a particular strategy and technology. In this chapter, strategic decision or “strategy” points to a firm’s business-level decision making in terms of its operations, product designs, organizational structures, business partners, pricing policies, product specifications, and other considerations. Positioning Views Firms enter a market with a particular purpose. Most decisions regarding the market involve positioning and developing competitive structures. Porter (1980, 1985) has suggested that many factors should be considered in

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achieving a sustainable competitive advantage, based on an SCP paradigm that includes market structure and firm performance. Firms develop their business strategy by evaluating the threat of new entrants and substitute products, the bargaining power of customers and suppliers, and the competitive rivalry in the market. On the other hand, it is also widely noted that firms’ decision making is often represented by one of three generic strategies: cost leadership, differentiated, or focused. Before acting, firms choose the technologies, product designs, brand image, product quality, function, and specification, while also evaluating marketing strategies and customer demographics. According to this approach, such strategic positioning determines the behavior of firms; subsequently, firms normally maintain these behaviors, with minor adjustments of their position. In this positioning view, when firms enter markets unencumbered by others with interests in the same market (e.g., investors, affiliates, and suppliers), they can make rational decisions and determine that “we can earn a profit in this position, but not in that position.” At this point, managers who make decisions regarding resource allocation do not have a commitment to or overconfidence about a firm’s possessed resource and past successes. Therefore, they have a comparatively low possibility of possessing decision bias (Amit & Schoemaker, 1993) and blind spots (Zajac & Bazerman, 1991) in strategic decision making. Resource-Based Views Once firms position themselves in a market structure with a particular strategy, they can recognize the lack of required resources such as technologies and employees for conducting that strategy and its resulting operations. The firms then attempt to acquire and accumulate the necessary resources. Scholars of strategic management have long adopted a resourcebased view to explain firm-specific differences in performance, profitability, and competitive advantage within specific industries (e.g., Amit & Schoemaker, 1993; Barney, 1986, 1991; Barney & Clark, 2007; Dierickx & Cool, 1989; Peteraf, 1993; Wernerfelt, 1984, 1995). In a resource-based view, the firm is treated as the framework for managing activities among individuals and groups; the firm also represents the framework for evaluating productive resources and their capabilities (Amit & Schoemaker, 1993; Barney & Clark, 2007). Because firms are heterogeneous in terms of their respective resources and capabilities, they differ with regard to the efficiency of their respective productive factors (Amit & Schoemaker, 1993; Barney, 1991). Those resources that promote (or constrain) a firm’s performance can assume a variety of forms, visible or tacit, and these resources can include technology, knowledge, production, operations, corporate culture, and business philosophy (Barney, 1986). The resources in question can also include human resources (Wright, Dunford, & Snell, 2001); information systems (Wade

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& Hulland, 2004); supply chains (Ketchen & Hult, 2007); or organizational routines (Grant, 1991). In turn, these resources may play various organizational roles impacting a firm’s competence (Prahalad & Hamel, 1990), its capabilities (Sirmon, Hitt, & Ireland, 2006; Snow & Hrebiniak, 1980; Stalk, Evans, & Shulman, 1992), or its complementary assets (Teece, 1986). The resource-based perspective stipulates that performance differs among firms as a result of the heterogeneity and immobility of the firms’ respective resources (Barney & Clark, 2007; Barney & Hoskisson, 1990). In other words, the selection criterion of resources to acquire and accumulate depends on the success or failure of the business, consequently, firms accumulate heterogeneous resources. Finally, resources provide firms with sustainable competitive advantages when those resources are heterogeneous and immobile. Path-Dependency Once a business model begins to succeed, firms try to accumulate more resources to maintain their competitive advantage. Here, the purpose of resource accumulation may change from acquiring new technologies to finding new ways to exploit existing resources. The phenomenon of a firm’s strategy and technology, when limited to a fixed direction, is often interpreted as “path-dependency” and can represent a model for increasing profits. Arthur (1994) noted that firms’ selection of technology at the first stage of market entry is random, but that their selection of technology after market entry is path-dependent. Because the experience and knowledge accumulated in the past do not diminish, firms can continue to benefit by drawing upon such resources. On the other hand, in such a situation, decision makers are psychologically incentivized to acquire and accumulate resources to complement or supplement existing accumulated resources. This acquisition can also focus on complementary assets and the modification of existing products and processes (Teece, 1986). The acquisition of complementary resources to exploit existing experience and knowledge appears to manifest in a cyclical pattern and is related to firms’ changes in their competitive advantage. This cycle enhances firms’ path-dependency of resource accumulation, improving the efficiency of resources in the existing business and increasing the scale of economy. Naturally, this is interpreted as a positive feedback of resource accumulation. Thus, firms’ technology and strategy selection criteria remain on a path to exploit existing resources and to succeed in the existing business. This type of resource selection decision is not made at the market-entry stage, which is characterized by rational positioning strategies.

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Core Rigidities If the competitive environment never changes, successful firms can profit from positive feedback from path-dependent resource accumulation. Unfortunately, however, no industry is immune to change. Competition from rivalries increases as the market potential grows. Research and development is an ongoing process as the speed of technological development accelerates every year. The newly launched products emerging from this flux can be “competence destroying” for established firms. Consequently, when facing competitive environmental change, established firms often cannot adapt because their accumulated resources, which they understandably hesitate to abandon, are not successfully exploited in the new environment. The term “competence-destroying” was coined in an area of study related to technological innovation. When technological discontinuities (Anderson & Tushman, 1990; Dosi, 1982; Tushman & Anderson, 1986) occur during transitions from old to new technologies, established firms must adapt to new technological knowledge bases and price-performance paths, abandoning their previous practices. Scholars have claimed that discontinuous innovation occurs when the existing competencies (e.g., technological skill, knowledge, distribution networks, and production systems) of established firms are destroyed. These scholars have referred to this type of innovation as “competencedestroying innovation” (Abernathy & Clark, 1985; Anderson & Tushman, 1990). As competence-destroying innovation evolves within an industry, established firms require new resources. These new resources are often inconsistent with the incumbent competencies of these firms. When this occurs, established resources become obsolete and are either combined with new resources (Teece, Pisano, & Shuen, 1997) or completely substituted (Anderson & Tushman, 1990). If established firms are unable to adapt to new innovations in either of these ways, they risk losing a significant portion of their market share and may ultimately be forced to withdraw from an industry (Anderson & Tushman, 1990; Christensen, 1997). Why do some established firms hesitate to adapt to competence-destroying change? With a focus on a firm’s core capabilities, Leonard-Barton (1992) developed the concept of “core rigidities” as an explanation for incumbent inertia. She defined core capabilities as those elements of a knowledge set that are deeply embedded in an organization’s value system. She further noted that, as a result of the difficulty associated with changing them, core capabilities can impede a firm from engaging in new activities, such as research and development. As a result, incumbent firms experience some difficulty implementing radical new activities. In other words, decision makers find it difficult to change their manner of resource allocation due to their hesitation to abandon the possible use of established knowledge and resources.

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Additionally, established routines and capabilities can force organizations to maintain their respective status quos and restrict the acquisition and/or development of new resources necessary for environmental adaptation (Gilbert, 2005; Henderson & Clark, 1990; Leonard-Barton, 1992). The winner’s curse of decision makers (Ball, Bazerman, & Carroll, 1991) causes them to stick to established routines in operations and corporate capabilities and limit their strategic choices in resource allocation. Under strong organizational pressure to maintain the status quo, it is difficult for incumbent firms to acquire the required new resources in the next strategic phase in an industry because decision makers possess cognitive bias against environmental change. In other words, the reason that established firm possess incumbent inertia and cannot adapt to competitive environmental change is their possessed resources and the psychological limitations of decision makers who overestimate the usability of these resources, restricting their behavior to select new strategies and technologies in the resource allocation decision making process. When there is a trade-off between existing and desired resources, abandoning the existing path of resource accumulation is difficult; therefore, established firms normally hesitate to change related strategies. Irrational Behavior of Established Firms Firms can exhibit irrational behavior during market entry and business growth. Here, one factor behind irrationality is the initiator, or leader, of destabilizing change in the market’s environment, which can often be competence-destroying for established firms. Much of the previous literature on the topic has identified firms new to the market as leaders of this change. It is frequently observed that when new firms enter a market armed with new strategies, technologies, and products, and when these new firms gain customer acceptance, then established firms cannot easily shift their strategy to adapt to the new reality. According to the above conceptual framework, new-entry firms have few restrictions compared with established firms during the positioning stage. Because, as noted above, managers have a higher possibility of expressing cognitive bias in decision making as a result of established business success and acquisition as well as accumulation of resources and knowledge, this implies that they are therefore more likely to exercise nonrational decision making when facing competence-destroying environmental change. New-entry firms observe market structures and make rational decisions of differentiation from established firms, considering the established firms’ strengths and weaknesses. The next section reviews the literature related to first-movers and followers, addressing their respective advantages and

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disadvantages. This entails adapting the conceptual framework described above to allow for a consideration of a time-series strategic paradigm shift across an entire industry. MECHANISMS OF STRATEGIC PARADAIGM SHIFT IN INDUSTRY This section extends the scope of the conceptual framework described above to include a more dynamic interpretation. As is commonly understood, the dominant strategy in an industry shifts over the years from established to new entrants. An early-mover group has comparatively more restrictions when choosing strategy and technology compared with the follower group, so followers can make more rational decisions at market entry. In observing a longer time span of an industry’s history, established firms’ inflexibility can be effectively understood within the framework of the resource accumulation cycle. The beginning of this section reviewed previous literature on first-mover advantages and disadvantages. Then the section adapted a resource-accumulation framework to understanding the differentiation of strategic behavior between early-movers (or first-movers) and followers during paradigm shifts linking with a behavioral strategy perspective, and concluding that the early movers suffered from disadvantages during times of transition. Dynamics of First-Mover (Dis)Advantages Early entry into a market creates certain advantages and disadvantages for firms. Lieberman & Montgomery (1988, 1998) identified technological leadership, the preemption of assets, and buyer switching costs as three primary sources of first-mover advantages. First-movers can follow the learning curve quickly and gain comparative advantage in the competition to lower costs. They can also engage in early research and development to advance new technologies, accumulating important skills and knowledge. Moreover, first-movers can preemptively exploit valuable and/or scarce resources such as input factors, store or factory locations, and customers’ cognitive positions. Finally, buyer switching costs often prevent buyers from selecting transaction partners besides first-movers. First-movers also suffer from the following disadvantages. First, first-movers frequently have their innovations imitated at a lower cost, with followers benefitting from the free-rider effect. Second, first-movers unintentionally reduce technological and market uncertainty for later-movers, who then benefit from overall stability. Third, changes in technology or customer

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demand, led by other innovators, can cause the efforts of a first-mover in a corresponding market to result in failure. Fourth, incumbent inertia due to a decision maker’s psychological hesitation to adapt to a changing environment can diminish the first-mover’s advantage. This discussion on first-mover (dis)advantages evaluates the relationship between entry timing in industry and firm performance. The grouping of firms based on entry timing and similar strategies is also relevant for comparing the new entry group and the established firms group. It is also useful to understand the influence of cycles of paradigm shifts, initiated by new entrants with technological change, and the resulting inflexibility of established firms. Strategic Paradigm Shift Observing the history of an industry, a dominant strategic group (composed of established firms) is normally substituted by the next generation of strategic group (Christensen, 1996; Henderson & Clark, 1990). The firms that enter the market in the same period observe the same market developments in an industry, and they also consider how they can gain competitive advantage and differentiate themselves from established firms. As noted above, new entrants do not possess vast resources and technological knowledge in the corresponding market. Therefore, they can make rational decisions in choosing strategy and technology, differentiating themselves from established firms in terms of product and process technologies. Consequently, the firms that enter a developed market as contemporaries are likely to pursue comparatively homogeneous strategies than those of established firms. In this chapter, the firms that enter a market at approximately the same time pursue similar positioning strategies. They also acquire and accumulate comparatively similar resources and make similarly rational decisions, thus belonging to the same strategic group. Scholars have observed that followers in an industry adopt strategies different from those of earlier firms regarding new product concepts, product designs, organization structures, and technologies, consequently outperforming established firms. With the passage of time in an industry, firms in the same strategic group acquire and accumulate comparatively similar resources to succeed. In that case, each of the firms in the same group faces the same competitive environment and confronts it with similar solutions. Of course, competition prevails, and the firms within each group can be differentiated in terms of their relative success. However, the degree of strategic differentiation within the same group remains slight in comparison with firms of different strategic groups that entered the market at a different time.

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Finally, the firms that stay abreast of market trends accumulate similar resources, depending of course on their being subject to similar cycles of resource accumulation. Similarly, the earlier strategic group faces the challenges of a new strategic paradigm shift, making it difficult to adapt because of managers’ psychological limitations when allocating resources. Behavior of Follower Firms Followers normally adopt a strategy differentiated from those of establish firms. Therefore, sometimes this strategy results in competence-destroying technologies for established firms; in such cases, an established firm’s capabilities and resources can become obsolete. Followers’ behavior is not restricted because decision makers in follower firms do not have psychological limitations in resource allocation. Therefore, they can make rational decisions regarding market entry and positioning. When established firms have successfully dominated the market and earned a good reputation, new entrants are discouraged from entry. Therefore, by observing established firms’ strategic characteristics, new entrants adapt a differentiation strategy in terms of their technologies and operations. Consequently, followers evaluate the resources required for differentiation strategies, and they tend to follow the resource accumulation path of established firms. Behavior of Incumbent Firms The firms in a new strategic group often introduce to an industry new differentiated strategies along with new products or processes. These novelties are sometimes competence-destroying for established firms. Accordingly, there are two patterns of established firms’ behavior. One is that the firms change or abandon their own accumulated resources and capabilities, which represent a trade-off with competence-destroying technologies, and then they change their strategies. Another pattern is that the firms ignore the effects of new entrants and adhere to the status quo, maintaining their strategies and resources. In other words, the former status is that managers’ psychological factors heavily affect resource allocation decisions, and the latter status is that managers try to eliminate, as much as possible, the psychological factors that may cause nonrational decisions. According to the above conceptual framework, firms conduct a strategy under a given competitive advantage and acquire and accumulate the required resources and capabilities. Further, the firms repeat their resource accumulation cycles and become path-dependent in terms of choosing technologies and resources. The more the firms can retain their competitive advantages, the more they accumulate resources and capabilities specific to their success. Such resources and capabilities are difficult to change or abandon; they become rigid because they include tacit and ambiguous

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factors such as routine, corporate culture, and philosophy. When a new strategic generation enters a market with new products or technologies, such firms face the challenge of changing their strategies, resources, and capabilities; in the end, these firms are deprived of their customers by the new entrants. In such a manner, a change in the balance of power between established firms and new entrants leads to an industry’s strategic paradigm shift. It is shown that the cognitive and social psychology of the managers responsible for deciding resource allocation are critical factors in a firm’s survival and are also important in understanding industrial competition among incumbent and new-entrant firms. CASE STUDY To confirm the conceptual framework constructed in theoretic reviews, this section explains the strategic paradigm shift and its mechanism according to the history of the automobile industry. In the automobile industry, the firms in an earlier-entry group cannot adapt immediately to a strategic paradigm shift led by the next generation, namely, later-entry groups with new strategies, products, or operations. In addition, this paradigm shift repeats itself in an industry. Automobile Strategic Paradigm Shift For about 20 years from 1908, Henry Ford focused on the development of the automobile, mass manufacturing, and a istribution network for dealing with huge tapped potential demand. With the aim of reaching out to the general public, the Model T was developed, which was finally accepted by about 50% of the market until 1920. At this stage of development, the automobile that was brought to the market at the earliest time and at the cheapest price was accepted by the mass market. Therefore, the firms that could efficiently manufacture automobiles on such terms stood to earn huge profits. To gain economies of scale, the Ford Motor Company was exclusively involved in production efficiency, establishing long manufacturing conveyor belts, large investments in factories and facilities, eliminating worker’s personal skill and responsibility in manufacturing, and cutting production cost and product price. It accelerated the manufacturing and distribution of automobiles by huge manufacturing factories and distribution channels. Public demand for automobiles reached its peak around the middle of 1920, and the American automobile industry entered a new phase from growth to competition. Next, the challenge shifted from efficient

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manufacturing of the automobile to marketing for matching various customer demands and product launches. The General Motors (GM) Company understood this new aspect of the industry and provided automobiles rich in design, surface, and price at a reasonable cost. GM also reconstructed its organizational structure to decentralization for effective adjustment and evaluation of the performance and planning of each product function. Thus, firms had to focus not only on expanding manufacturing efficiently, but also on unit-cost reduction, procurement, inventory control, and adjusting the size of labor force, and manufacturing, depending on the prediction of demand trends as well as the business strategy plan. Around 1924, the demand for the Model T decreased; by the end of 1920, Ford incurred huge losses due to the failure to adapt to such dominant strategic paradigm shifts led by GM. However, Ford hesitated to accept the drastic changes in the market structure, led by GM’s new differentiation strategy, accompanied with varied automobile designs and efficient organizational structure, and continued the mass production of Model T for a long time. While, at that time, industrial technologies of Japanese firms were potentially immature. In 1937, there was a spin-off of the Toyota Automobile Company from the Toyota Industries Corporation. Toyota researched the Ford and Chevrolet models that were becoming popular in Japan, and they developed automobiles with similar materials and parts as well as manufacturing technologies. However, Toyota faced the challenge to launch high quality and functional products at similar costs with Western firms. The Koromo factory, built in 1937, was designed based on Toyota’s manufacturing philosophy of “Just-in-Time,” emphasizing consecutive and synchronized manufacturing lines, the demand-pull distributing inventory “Kanban” system, the standardization of production, the cross-line training of workers, and flexible adjustment of workforces and facilities. Moreover, Toyota also adapted its Toyota Production System to suppliers and realized its Just-inTime in the supply network. On the other hand, Toyota researched and developed operation management technologies and methods, especially focusing on quality management. The Total Quality Control (TQC) system was introduced to factories in 1961, which is typified by the machine and line automated stopping device “Andon,” statistical process controls, and quality control methods and “Kaizen.” TQC methods and philosophies were shared not only among departments of Toyota but also interfirm with suppliers. By doing so, Toyota achieved high quality products in the manufacturing line by developing ingenious management techniques. In 2008, Toyota earned the first position in worldwide sales, and in 2013, Toyota was the first automobile manufacturer that achieved an annual amount that exceeded $10 million. At this time, the new focus of competition was how to deal with the expansion of developing countries’ market.

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Because the majority of automobile markets shift from developed countries to developing countries, characterized by economic and population growth, launching low cost automobile models has become a priority among established automobile firms. As their economic situation is improving, emerging markets in developing countries show their potential for further expansion in the future. The automobile markets in developing countries have also been rapidly expanding. According to the FOURIN World Automobile Statistical Yearbook (2010), the ratio of sales in emerging markets to developed countries is increasing annually and exceeded 50% in 2010. Those in the middle income bracket in emerging markets will require an automobile priced appropriately for their income levels. To deal with such a situation, established automobile companies launched low-cost automobiles for developing countries by reconfiguring suppliers’ networks, product designs, parts and materials for procurement, and low price and quality setting. On the other hand, Toyota has been unable to price its automobile models low enough relative to rivals, so its share of emerging markets remains modest. In contrast, firms that are ranked lower in the world market are expanding their shares in emerging markets by implementing low-cost strategies. FOURIN reported that Toyota’s low-cost automobile market share in the Brazil, Russia, India, China, South Africa (BRIC) bloc is 2% in Brazil (9th place), 5% in Russia (5th), 1% in India (not reaching 10th), and 6% in China (6th). These numbers are low compared to other established rivals like the Hyundai Motor Company, Volkswagen, Nissan, and Renault. Even local firms have performed better than Toyota’s low-cost automobile in some emerging markets. The history of the automobile industry shows that new entrants observe market structures and analyze the behavior of established firms and then make a decision regarding market positioning strategy. GM focused on product variation and organizational structure, and Toyota focused on production systems and quality-control methods. These cases also suggest that the competitive environmental changes initiated by followers are sometimes competence-destroying for established firms. Strategic Groups and Their Conditions in Each Era The aforementioned Ford, GM, and Toyota take differentiated strategies from early movers. As a result, GM outperformed Ford, and then Toyota outperformed GM. Today, Toyota is suffering from the strategies of the next generation of firms that are actively launching low-cost automobiles in developing countries. In this chapter, the second and third sections further analyze this phenomenon of a dominant strategy shift, as observed in the automobile industry, and it explores related practical considerations.

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In the era that Ford launched the Model T, it made huge investments in designing and establishing production lines and facilities embedded in factories specific to efficient mass manufacturing. One example of Ford’s investment is the Ford River Rouge Complex, which assembles automobiles and manufactures parts and some materials required in automobiles. The profits from selling the Model T were reinvested in development for achieving greater efficiency in the manufacture of even more Model Ts. In this way, Ford acquired and accumulated specific resources to enhance and complement its own core capabilities, mass production system of the Model T. On the other hand, Ford’s resource-accumulation cycle became narrow and path-dependent, and exhibited an increasing amount of organizational inertia at the same time. The Rouge factory is regarded as one of the rigid resources, because a mere change in the design of the Model T and its production line was impossible without enormous expenses. The huge investments in fixed facilities led to huge fixed costs and Ford’s organizational inflexibility in adapting to a new generation of strategies. Meantime, while observing Ford’s success and market satiation, GM positioned itself in a market as the firm launched a wider variety of automobile designs and meeting varied demands of customers and a new organizational structure, different from the Model T. Decentralized organizational structure was functioning effectively at that time in managing diverse operations and meeting market demand . However, the Japanese firms that followed, including Toyota and Nissan, entered into the market with high quality and functional automobiles, mostly in the same price range. Japanese firms began to erode the world market share of GM and other Western firms. With regard to quality, in meeting parts procurement, decision making at the preparatory stage of the foundation of a joint venture between GM and Toyota—the New United Motor Manufacturing, Inc. (NUMMI)—the balance of quality and cost for most of GM’s automobile parts was deemed to be inferior to Toyota. GM still retained its decentralized organizational structure, while Toyota exhibited a more centralized organization. GM was plagued by organizational inefficiencies, such as 20 procurement functions included in all of its parts, automobile, and truck departments, and many development systems for each of automobile models. GM’s decentralized organizational structure, which was a former advantage, became dysfunctional and resilient to reform because managers who decide resource allocation tend to stick to such advantages. Consequently, GM displayed a degree of rigidity in competing with Japanese firms. In the postwar era, Japanese firms were committed to catching up with and overcoming Western firms, and they adopted a lean production system as they differentiated themselves from established Western firms. Japanese firms focused on achieving high quality with lower costs in operation and production by eliminating wasteful manufacturing processes. These Japanese

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firms did not compete with Western firms in terms of automobile design. Gradually, Japanese automobile manufacturers earned a high reputation worldwide. Toyota and other Japanese firms were known for their strict assessment of product quality, and its standards, productivity of factories, and cost-cutting plans not only for their own manufacturing lines but also for their suppliers. Today, however, a market that does not insist on quality first is emerging in developing countries. Indeed, Toyota’s “quality first” policy and culture to give high reputation to automobile quality from the world are functioning as rigid resources. Therefore, Toyota is hesitating to introduce lower quality and functional automobiles into emerging markets. In the above cases of GM and Toyota, the firms made rational decisions by observing the strategies of established firms and then developing appropriate strategies of differentiation. Eventually, GM and Toyota managed to outperform established firms. On the other hand, established firms could not adapt immediately to such strategies of the new generation because of rigid resources and organizational inertia caused by the decision makers’ psychological hesitation to abandon established knowledge and resources. Figure 4.1 shows that strategic paradigm shifts occurred in the automobile industry. Representative firms and the car models of each strategic group are categorized based on the chronological information of automobile manufacturing technologies and markets as exhibited in the Toyota Automobile Museum. This material shows Japanese and foreign firms’ strategies and car models in each era together with major events in Japan and from around the world. The Toyota Automobile Museum is owned by Toyota and exhibits 140 car models that impacted the global or Japanese automobile market and industry. This chronological material is mainly written in Japanese. The historical progress of automobile-related technologies among world automobile manufacturers is grouped into three sections: “The Era of Pioneers,” “From Realization of Mass-Manufacturing and Communalization to Motorization Progress,” and “From Fashioned Cars to Completion of Automobile Manufacturing Technologies.” The progress of automobile-related technologies is given in Japanese and is divided into the following sections: “The Beginning of Japanese Automobiles,” “First Japanese Style of Automobile Manufacturing,” “Technological Development for Mass Manufacturing,” and “Dealing With the Market’s Need for Diversification.” In each section, representative automobiles and their manufacturers are shown, for a total of 62 car models from Japanese firms and 59 car models from foreign firms. Global progress in automobile technologies are shown starting from Leonardo da Vinci’s self-propelled cart, Cugnot’s steam carriage, Benz’s Patent Motorwagen, and Benz’s Velo, while Japanese progress is shown from Hakuyo-sha Automo-go, Toyota’s AA, Nissan’s Datsun 16 sedan, up to

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Figure 4.1  Competitive strategy paradigm shift in the automobile industry. Source: Toyota Automobile Museum exhibition on “A Progress of World and Japanese Automobile.”

current models. We revised the category names using categorized information as given in order to match this chapter’s assertion. In Figure 4.1, the first strategic group, including Ford, only focused on maximizing production efficiency to sell cheap and standardized automobiles to the public. The second strategic group, including GM, prioritized meeting a more varied range of customer demands by distinguishing themselves in the design, specification, quality, and price of automobile lines. The next strategic group was led by Toyota, with its lean production system focusing on increasing quality and specification level comparing with established Western firms in the same price range. It is impossible to predict the future situation of the automobile industry. However, Toyota is certainly facing a daunting challenge, which is to meet the demand in emerging markets with automobiles that are to be sold at ultralow prices (and hence at lower quality), but that are still functional.

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DISCUSSION New-entrants groups observe the successful strategies and behaviors of established firms and analyze which strategies and technologies are most appropriate for differentiation with established firms in a rational manner. New entrants gradually do not possess the rigid resources such as they hesitate to change or abandon, so they can challenge established firms. In this case, the possibility that decision makers’ psychological factors inhibit rational decisions in resource allocations is comparatively low. On the other hand, established firms’ competitive advantage, namely, firm’s specific resources accumulated through success in existing business, possibly becomes their weakness and a source of irrational decision making. Also, established firms require much time to switch to the new strategies displayed by the industry’s new entrants from which they have gained competitive advantage. Given this observation, how should established firms overcome core rigidities to address market conditions changes? Dynamic capability and an ambidextrous organization may provide some response to this question. Dynamic capability refers to a specific type of organizational capacity that integrates, constructs, and reconfigures an organization’s internal and external resources and capabilities. Some of these resources and capabilities include skills, functional abilities, business management methods, current institutions, and learning routines and patterns (Lavie, 2006; Teece et al., 1997). However, as noted above, changing or reconstructing existing rigid resources is often difficult for established firms, and consequently firms require much time for changing organization and strategy. In addition to providing insight into how dynamic capabilities assist incumbent organizations in a general sense, the concept of an “ambidextrous” organization’s capacity is vital to explaining firms’ survival under changing market conditions (O’Reilly & Tushman 2008). An ambidextrous organization (Tushman & O’Reilly, 1996) is one that explores and exploits multiple business-related activities simultaneously. Exploration refers to an organization’s search for variety and flexibility through experimentation and corresponding risk. Exploitation relates to incremental learning processes that promote improvement, readjustment, standardization, or cost reduction (March, 1991). Ambidextrous organizations are largely capable of adapting to changes in the competitive environment. In the automobile industry, a case is found where a firm adopts a new strategy while still maintaining a high performance in its existing business. For example, Toyota succeeded in developing its market for hybrid automobiles. Toyota Motor Corporation launched the gasoline-electric hybrid vehicle Prius in 1997 and became the first company to achieve mass manufacturing of an HV product. Currently, Toyota is attempting to increase the prevalence of HVs by applying a series/parallel hybrid driving system

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developed for the Prius and other vehicle models. This hybrid driving system frequently changes the combination of patterns for the gasoline- and electric-powered engines to improve fuel efficiency, depending on the travel speed and situation. To realize this system, Toyota developed new components, such as a nickel-metal hybrid (Ni-MH) battery, a power control unit, a power generator, a motive dividing device, an electric motor, and a regeneration brake. Toyota also developed additional components and interfaces required to facilitate interaction between new and established components such as a thermal energy recovery system to incorporate into gasoline engine modules. Moreover, a hybrid automobile stands as a viable alternative to normal the gasoline engine automobile, so hybrid automobiles can also be considered a “disruptive innovation” with potential for replacing the existing automobile business in the future. The reason why Toyota can manage its ambidextrous organization is that Toyota does not have trade-off between exploiting its accumulated resources and launching the hybrid automobile (Hamada, 2014). In reality, Toyota’s prior resources do not present an obstacle to launching the hybrid automobile. For example, regarding Toyota’s production system, although the modular parts supplied to Toyota for its HV line are different than those supplied for their existing product lines, Toyota’s assembly process remains unchanged. As such, the production system can also remain unchanged, although the overall architecture changes somewhat. To illustrate, in its Tsutsumi factory in Toyoda city, Toyota manufactures their new Prius line concordantly with their traditional models, the Camry and Premio. In the same manner, Toyota’s specific routines, culture, and philosophy, which prioritizes quality and safety, do not trade off with launching the hybrid automobile. On the other hand, meeting the needs of emerging markets requires significant cost cutting in manufacturing, with some sacrifice in terms of product quality. Some firms achieve price reduction with minor changes in product design and architecture or in the manufacturing process without sacrificing the safety and utility of their automobiles. This can be accomplished by increasing the rate of modularized parts from suppliers, communizing similarly shaped parts, omitting partially high-cost material, and lowering uncritical specifications. However, because cutting quality is against Toyota’s “quality first” policy and existing quality criteria, then Toyota cannot cut its automobile cost and quality drastically. Accordingly, the achievement of ambidextrous organization is conditionally possible. When maintaining firms’ accumulated resources are traded off with exploring new strategies and technologies, firms should abandon their own rigid resources. Resource-allocation managers tend to try to maintain knowledge and resources required for maintaining an established business’s success. Additionally, in many cases, managers who make decisions having big impacts on firm strategies are persons who have

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contributed to the established business and therefore serve in an important position. To put it another way, to avoid incumbent inertia and resource rigidities, established firms can take product or process innovations in the areas that are not traded off with their accumulated resources. In those cases, firms often have an advantage compared to new entrants because they possess accumulated knowledge and experiences, and they can realize innovation depending on the existing business path. CONCLUSION The conceptual framework suggested in this chapter evaluates the difficulty of switching established firms’ strategies to adapt to a new generation of strategies. This framework also highlights the mechanisms of a strategic paradigm shift in an industry. Decision makers’ cognitive and social psychological factors underlie these frameworks. New entrants can observe and analyze the existing market structures of an industry, make strategic decisions regarding market positioning, and adopt the appropriate technologies required for product differentiation from established firms. However, once these firms experience success and accumulate the resources and capabilities specific to those corresponding strategies, then these resources become rigid and impede adaptation to a newer generation of strategies, simply because these resources are difficult to change or abandon. Therefore, established firms cannot easily switch their strategies promptly to a new strategy. In other words, based on the behavioral strategy, the following can be said: When firms enter a new market, the possibility that decision makers’ psychological factors inhibit their rational decisions is lower. Meanwhile, however, as the firm acquires and accumulates corresponding knowledge and resources contributing to business success, the possibility of such an inhibition exerting itself is stronger. Additionally, firms that enter a market in the same period compete with each other in terms of the same business field and strategy, therefore, they hesitate to adapt to a new strategic paradigm in the same manner of expressing inertia when facing an environmental change. As one of the methods to overcome a firm’s organizational inertia, it is suggested that established firms enjoy an advantage in exploring new technologies and markets in areas that are not traded off with their own accumulated resources. This means that firms should consider new businesses or products in a corresponding field that will help to avoid psychological resistance by decision makers toward abandoning established knowledge and resources. As with Toyota, established firms have an advantage over the new entrants in combining new and established knowledge and resources to lead new technological innovation.

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CHAPTER 5

STRATEGIZING IN PROJECTBASED ORGANIZATIONS The Role of Internal and External Relationships Lena E. Bygballe Anna R. S. Swärd

ABSTRACT This chapter explores how strategizing is performed in project-based organizations (PBO). The findings show how strategizing happens through the interplay between strategic efforts on the company level and experiences made on the project level. Strategizing in project-based organizations is found to be an emergent process that is closely intertwined with project practice where external actors have great influence. The findings also show how the temporary nature of project-based organizations changes into more tight and permanent intra- and interorganizational relations and the opportunities and potential challenges such changes incur.

The Practice of Behavioral Strategy, pages 127–143 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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INTRODUCTION The project-based organization (PBO) is common in many types of industries, ranging from traditional industries such as construction to newly emerging industries such as information and communication technologies (Hobday, 2000). The PBO differs from the traditional notions of the firm with divisions and central leadership and where the firm is seen as a collection of resources within clear boundaries (e.g., Davies & Brady, 2000; Gann & Salter, 2000; Hobday, 2000). The PBO organizes its main business functions in projects, and the PBO’s collection of resources is built up through the execution of projects (Lindkvist, 2004), which often take place at the boundaries of the firm (Gann & Salter, 2000). Structures, strategies, and capabilities are organized around the needs of the projects (Hobday, 2000). As such, the PBO also differs from project-oriented firms (Arvidsson, 2009), which typically use projects for specific purposes such as effectuating change or strategic interventions. While the role of projects in implementing strategy has been subject to considerable research efforts (Morris & Jamieson, 2004), the intersection between corporate strategy and ongoing project practice in PBOs has received less attention. The aim of this chapter is to explore how strategizing takes place in the PBO. It is argued that the way strategies are developed, implemented, and shaped in PBOs, that is, strategizing, can be understood as a dynamic process of mutual influence between corporate strategic efforts and projectbased practices. The chapter is thus part of a stream of research dealing with the interplay between projects and organizational processes (e.g., Brady & Davies, 2004; Davies & Brady, 2000; Gann & Salter, 2000; Grabher, 2002; Hobday; 2000). While the traditional project literature often treats projects as isolated entities, this stream of research argues that projects are not “islands” (Engwall, 2003; Grabher, 2002) but instead interwoven with an organizational and social context feeding the project with key resources of expertise, regulation, and legitimization (Grabher, 2004). The PBO is characterized by weak couplings between the project level and the central level (Dubois & Gadde, 2002a), which means that strategic interventions and central management control are likely to be challenging (Gann & Salter, 2000). The autonomous nature of projects and their importance in terms of turnover and core competence suggest that what happens in these projects is just as likely to affect corporate strategy as vice versa. This chapter builds on the above notions of the interplay between project and companywide processes to explore strategizing in PBOs. It extends this research, however, by applying insight from research that sees strategy as emergent processes going on at several levels in the organization (Mintzberg & McHugh, 1985) and recent contributions within the strategy-aspractice domain, which sees the strategizing process as tightly interwoven

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with practice (e.g., Jarzabkowski & Spee, 2009; Whittington, Molloy, Mayer, & Smith, 2006). These contributions argue that strategy is not something an organization has, but something practitioners do. To understand how strategies are formed means to understand the microprocesses (lower-level actions and activities) of how individual- and group-level processes affect the strategic firm level and vice versa (Devinney, 2013). This means that we seek to ground the research of strategizing in realistic assumptions about human cognition, emotion, and social interaction (Powell, Lovallo, & Fox, 2011) because we believe that strategic decisions seldom are purely rational but could rather be seen as a process where behavioral mechanism are important because one at the outset will be unable to foresee alternative actions but rather that these are discovered over time (Levinthal, 2011). Thus, we see strategy as an emergent process focusing on the microprocesses and practices. The empirical basis of the chapter is a longitudinal field study of a strategizing process in a construction firm in which a new project-improvement strategy emerged. Construction firms are often decentralized organizations, where a high degree of discretion is granted to the projects (Gann & Salter, 2000). Furthermore, these projects involve close interaction with clients and subcontractors. Similar to the challenges of aligning project and companywide processes, there is a potential challenge here of aligning the project relations to the more permanent nature of these relations. Studying a construction firm allows us to examine strategizing in this setting, what managers and other practitioners do as part of the strategizing process, and how this process is affected by internal and external actors and relations. The contribution of the chapter is threefold. Firstly, it adds knowledge about strategizing in the PBO as interplay between the central level and the project level, and the role of external actors and relations in the process. This contribution adds not only to the PBO literature, but also to the strategizing literature, where the influence of the external environment on strategizing processes is gaining increasing attention (e.g., Whittington et al., 2006). Secondly, it brings insight into the processes in which the temporary nature of PBOs changes into more tight and permanent intra- and interorganizational couplings and the opportunities and potential challenges such changes incur. Furthermore, this chapter contributes to the behavioral strategy stream that has called for research that can bring strategy theory closer to empirical facts and that we should seek to integrate strategy research with strategy practice (Powell et al., 2011). The chapter is organized as follows: In the next section, the theoretical basis is outlined; presenting literature concerned with the nature of PBOs and the challenges in these organizations in terms of the relationship between headquarters and the project organization, the relationship between the organization and external partners, and the role of practices in the emergence of strategy, drawing on the strategy-as-practice and strategy

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process perspectives. The methods section presents the case study research design, methodological considerations, and data collection before presenting the results from the case study. Finally, we discuss the findings in relation to the theory and suggest some key managerial implications and avenues for future research. THEORETICAL FRAMEWORK Strategizing in Project-Based Organizations Research has found that strategic planning is difficult in the PBO (Betts & Ofori, 1992), as there often is a misalignment of corporate and project strategies (Milosevic & Srivannaboon, 2006). The PBO derives most of its income from activities over which central-level management exercises little control (Gann & Salter, 2000). Even if projects and the overall organization can be seen as loosely coupled in some sense, they are nevertheless dependent on each other. Projects are not isolated entities, but rather tightly interwoven with an organizational and social context, feeding the project with key resources of expertise, regulation, and legitimization (Grabher, 2004). Projects can be more or less dominated by their parent organization, ranging from pure temporary organizational forms to more stationary organizational forms (Modig, 2007). Furthermore, the ability to integrate the experiences of projects into the continuous business processes is of severe importance in order to ensure the coherence of the PBO (Gann & Salter, 2000). As Hobday (2000, p. 875) argued, “The structures and business processes of PBOs are likely to be shaped by the changing profile of the projects, especially their size, complexity, and duration.” Changes in strategic direction depend on a series of feedback loops between top-down strategic interventions and project-based learning processes and concurrent changes on different levels of the organization (Davies & Brady, 2000). Therefore, the ability to integrate project experiences into the overall organizational business processes is severely important to ensure the PBO’s coherence and competitiveness. However, little is yet known about how firms build links among project-level operations, portfolios of projects, and central activities (Gann & Salter, 2000). The literature on change in PBOs has long acknowledged the tension between project and companywide processes (e.g., Bresnen, Goussevskaia, & Swan, 2005; Hobday, 2000). The PBO allows for creating and re-creating new organizational structures around the needs for each product and each major customer. Integration across projects and management control can be constrained however because of the tendency of project isolation and the project managers’ high degree of autonomy and right to decide which tools to apply and how to apply them (Hobday, 2000). As Gann and Salter

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(2000) noticed, project teams have often limited contact with senior management, are based off-site, and work in teams with many other firms. Each project is a temporary organization, with its unique purpose and constellation of participants, who, when the project is finished, are assigned to a different project with another team and a new deadline. In the general strategy literature, it has long been recognized that strategies are formed both in the upper echelons of an organization and in the periphery, where middle managers play an important role in the strategizing process (Balogun, Huff, & Johnson, 2003; Floyd & Wooldridge, 2000; Jarzabkowski, Balogun, & Seidl, 2007; Mintzberg, 1979; Regnér, 2003). Strategies may very well develop based on insights gained through performing the primary activities within firms, meaning that the activities carried out in the projects will be especially important in the PBO. Based on a study of a PBO, Mintzberg and McHugh (1985), proposed a “grassroots” model of strategy formation in which strategies emerge out of precedents set by individuals and streams of activities that eventually pervade the organization as behaviors of several actors converge. In recent studies of strategy formation, a renewed interest has occurred in the processes and detailed practices that constitute day-to-day activities of organizational life and that relate to strategic outcome (Johnson, Melin, & Whittington, 2003). The strategyas-practice perspective delves into the sociological aspects of strategizing activities and what managers actually do (Whittington, 2007). Within this perspective, strategy is defined as “a situated, socially accomplished activity, while strategizing comprises those actions, interactions, and negotiations of multiple actors and the situated practices that they draw upon in accomplishing that activity” (Jarzabkowski et al., 2007, pp. 7–8). Combining the insights from the PBO literature with the strategizing literature means that to understand strategizing in PBOs, we need to look at the interplay between the project and the corporate level of the PBO over time, and the day-to-day practices that constitute this interplay. However, it is not sufficient to look at such intraorganizational processes. The performance of many PBOs, such as construction companies that we study here, depends not only on the single firm, but on the efficient functioning of an interorganizational network (Gann & Salter, 2000). The Relationship Between the Organization and External Partners for Strategizing Many PBOs need to create complex interfaces with customers and suppliers in order to deliver their projects. In construction, there are both a temporary project network and a more permanent network of actors (Dubois & Gadde, 2000). Adaptations in permanent relationships provide efficiency

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in day-to-day operations as well as possibilities for development. However, despite the fact that adaptations in relationships may lead to beneficial productivity and innovation effects, there is an obvious problem in construction; adaptations and more permanent relationships require substantial investments and create the kind of interdependencies that construction companies often try to avoid (Dubois & Gadde, 2000). Thus, even if there are repeated transactions in construction, construction companies behave as if they do not expect to benefit from these investments in later projects (Holmen, Pedersen, & Torvatn, 2005). The prevailing pattern of couplings among construction parties, including lack of coordination and communication between construction participants in the permanent network, adversarial contractual relationships, lack of customer-supplier focus, price-based selection, and ineffective use of technology, have been suggested as the “root causes” of the observed performance problems in construction (Cox & Ireland, 2002). The temporary aspect of relationships limits time to develop trust, restricts social exchange (Bignoux, 2006), and opens up for opportunistic behavior (Das & Teng, 2000). With no guarantee or expectations of the future, each actor will be suspicious of the other partners’ intentions and consequently claim as much value as possible from the relationship from the beginning (Ness & Haugland, 2005). The immediate gains from behaving opportunistically may be tempting compared to the more uncertain gains that may come from behaving cooperatively (Das, 2006). In interorganizational project relations, the partners are prone to having both common and private goals. It is in the partners’ best interest to cooperate, but at the same time they are competing (Lui & Ngo, 2005). This leads to uncertainty and risk that need to be controlled, which often is done through detailed contracts. In the construction industry, there seems to be expectations of partners being opportunistic, and the industry is arguably carrying a burden of low expectations (Arino, de la Torre, & Smith Ring, 2001). External actors are likely to play an important role in the strategizing processes in construction firms, not only as sources of new ideas but also as taking part in effectuating changes in project processes and products. In summary, we find that strategizing in the PBO is likely to grow out from both deliberate and emergent decisions, action, and interactions (Mintzberg & McHugh, 1985) on the project and corporate levels, influenced by internal as well as external relations. Evolving project practices are important for enabling the development and refinement of important core project capabilities (Floyd & Wooldridge, 2000) that contribute to competitive advantage and therefore eventually can turn into an organizational strategy (Mintzberg & McHugh, 1985). Thus, we find that interplay between strategy and project practice as well as internal and external relations is crucial for the understanding of strategizing in the PBO.

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METHODOLOGY AND DATA COLLECTION The PBO represents a complex and decentralized organizational form, which is likely to offer interesting insight into strategizing and the role of internal and external relations. The chapter presents an embedded case study of a construction company. The case illustrates how strategizing is an interplay between the Head Office’s strategic efforts and project-based practices, affecting and affected by both internal and external relations. Some of the events occurred prior to the enquiry, allowing for retrospective reflections, while much of the development processes were possible to trace in real time. The study was therefore process-oriented, that is, real-time, theory-led and contextual (Pettigrew, 1997). A qualitative case study design was chosen because it allows for in-depth investigations and rich descriptions of relational phenomena and their dynamics and complexity (Dubois & Araujo, 2006). Data collection took place between January 2010 and April 2014. The case is based on both archival data (company websites, business publications, minutes from meetings, company reports, evaluation reports, etc.) and interviews with managers at the company’s head office, managers in different regions and districts, as well as project managers and other project participants. Different data-collection methods were used to achieve triangulation, ensuring the quality of the study (Yin, 1994). A semistructured interview guide was used where the focus was on the development of the new companywide improvement process, the relationship between the firm level and the project level in this process, the role of external partners in the process, and how the strategic direction of the firm was affected. A total of 18 interviews have been conducted, each lasting between 60 and 120 minutes. All of the interviews have been transcribed verbatim and sent back to the respondents for verification and clarification. The analysis has relied on an abductive research logic, which means that theoretical and empirical insights were intertwined and informed each other (Dubois & Gadde, 2002b). Data collection is about observations and verification, which means that one observes, asks questions, and studies documents relevant for the topic of interest. In the interviews, we probed themes that seemed to be important for our research interest and looked for them in subsequent interviews and documents. Memos were created that systematically ordered field notes parallel with data collection. The initial report became a narrative of the dominant themes expressed by the participants in the study and this, in combination with archival material, was used to determine chronological event histories in time-ordered case matrices (Miles & Huberman, 1994) that formed the basis for the withincase analyses. The next step in the analysis consisted of qualitative and inductive coding of the data to identify concepts and categories that could

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describe and explain how the new practice developed and affected strategy (Bryman & Bell, 2007). The software Nvivo was used to code and analyze the interview material. FINDINGS—STRATEGIZING IN THE PBO In the beginning of the 21st century, the case company was experiencing a loss in profits, and customers were not as loyal as earlier. Previously, the company had relied on repeat business with several larger customers, but increasingly price had become a more important selection criterion for the customers. Internally, one experienced also that there were high absence rates among the workers. As a result, the corporate strategy team headed by a new managing director initiated a new companywide improvement process in 2003, with the aim of building a common “we culture.” The initiative included more involvement and empowerment of the single craftsman in decisions and planning of the projects and the creation of a shared culture. The basic assumption was that involvement would lead to better satisfaction and commitment among the workers, which in turn would increase productivity and quality of the projects. This was seen as an important means to reach the firm’s overall goals of increasing profits and customer satisfaction. The improvement process was framed as a staircase, starting in the internal organization and then advancing to external actors. As one of the corporate managers noticed, “We realized that before we could involve other actors, we had to start with ourselves.” The initial focus was on involving the company’s own workers to a greater extent and more systematically than earlier in the projects’ decision processes, through engaging them in a joint start-up meeting. However, the idea about involvement and the “we culture” was adopted by the company’s units to varying degrees. Project managers had always had great autonomy in how to carry out their projects and some of them were reluctant to involve the workers in the planning process. Simultaneously, a new project practice based on lean principles was starting to be used by one of the company’s district offices. The manager of this office, together with some project managers, had visited a construction project in Denmark that was using lean construction (Ballard & Howell, 2003). Furthermore, the office was approached by a master’s student from the university nearby who had visited the United States, where he had learned about lean construction. He now wanted to present these ideas. Finally, the office had for some years been working together with a professor from the same university who was an expert on work-life conditions and empowerment of workers. Together, these sources inspired the office to develop a new way of doing projects. At the central level of the company, one soon became aware that the concept of the “we culture” had not been as successful as one

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had hoped for and that the lean project practice could represent a more systematic approach to achieve involvement and the needed improvement. Pilot projects were initiated across several of the district offices based on the experiences from the initiating office. The new practice was called Collaborative Planning, where the key element was to involve each single worker in planning their own work. The basic assumption underpinning it was that the worker actually performing the task needs to be involved and understand how his/her way of performing a task will influence others. On the central level, the new practice appeared compatible with the “we culture” initiative, and the practice was recognized as an important business opportunity. From the central-level point of view, the pilot projects had an aim of further gaining experiences that could be used to refine the practice, and also one hoped that the pilot projects would serve as success stories that would encourage project managers to involve the craftsmen to a greater degree. Experiences in the use of the practice were diffused across the projects through a written guide developed at the central level and through designated facilitators that were appointed with the role of supporting the projects and encouraging the use of the practice. At the local level, success (and failure) stories would be exchanged informally during visits, workshops, and input from those who had used the practice. Some of these meetings were initiated by central management level while others were unplanned and informal. Having a strong tradition for giving autonomy to the local offices and each project, this reflected the way the new project practice was implemented. There was acceptance for variance in degree of adoption, even though there was disagreement among managers on the central level as to how mandatory the practice should be. At the project level, it was acknowledged that top management wanted involvement on all projects, but there was also an understanding that there would be no enforcement as project managers still had a special status and autonomy. It soon became apparent that creating an involvement culture in the projects would be hard to achieve without including external actors. Subcontractors often perform more than 50% of the work on a construction site, and the case company is no exception. The evaluations from the pilot projects concluded that involvement of subcontractors was necessary but had not been done to a satisfactory extent. While the corporate managers had seen the involvement of subcontractors as a matter of course, the projects had not. The projects where subcontractors had been involved experienced differences. Some subcontractors were open to the new work practice while others were more sceptical about the extended time used for planning and also had doubts in terms of who should bear the costs and who would gain. Some of the projects had also experienced that subcontractors came to the meetings expecting to be informed but with no intention to actively participate. Those subcontractors with positive experience

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of the new work method however found that they could save time and money as the work processes were running more smoothly. Some subcontractors even offered to lower their bids for the next project given that the new way of working would be used. Similar to many construction companies, the case company has traditionally used price as a main selection criteria when choosing subcontractors. Even if repeated business is common, there are no explicit strategies toward long-term relationships with subcontractors. However, as one of the managers explained, “Long-term relationships with subcontractors and suppliers are important if we want to succeed; we cannot just use them and throw them away afterwards. It requires a dialogue also between projects.” Several of the interviewees expected that the subcontractors, which were experienced in and willing to comply with the new way of working, were likely to be prioritized. Nevertheless, the company was still cautious of the potential risks associated with getting too close with the subcontractors in terms of their not staying competitive on price. Based on the experiences and the evaluations of the pilot project, there was a clear understanding that involvement would be hard to achieve without also including the client. Involvement and increased cooperation during project execution presupposes that the client is able to provide sufficient documentation and can make decisions in a timely manner; otherwise planning is difficult. Based on these experiences, the central level refined the specification of project practice and included the client in the plan hierarchy with structural meetings in order to ensure that the drawings were completed and distributed on time. Similar to the situation with subcontractors, for some of the projects, this worked very well, with good results, while in other projects it failed. The ability to engage the client was nevertheless seen as a key success factor, and the interviewees called for more attention being paid to informing existing and potential clients about the new method and to use the successful projects to sell the concept. Even if many clients are public actors, and long-term relationships are prevented, it is recognized that both public and private clients are increasingly aware of using other selection criteria than price. Some private clients that have been involved successfully are indeed repeating the business with the company. As one of the corporate managers noticed, “I think we’ve got something now that is so good that it will increase our competitiveness; clients and subcontractors will see that to work with us is more profitable than working with someone else.” Thus, the new project practice is also seen as a means to reawaken a more companywide customer strategy, which was put on ice some years ago. The new way of working in the company based on involvement has also come to influence the way that formal corporate strategies are developed in the firm. These formal strategies have traditionally been done by top

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management. In 2011, however, managers at the different local offices were involved in outlining their own objectives, strategies, and action plans for the new period between 2012 and 2015. Corporate-level management would outline some key areas and overall objectives of the firm at-large. For instance, each region was asked to make a plan for how they would involve the craftsmen. To further increase the speed of involvement, an initiative was launched by the headquarters that made involvement a central part of the HES reporting system. The reason for this was that the corporate management level believed that HES was a well-functioning system that was well respected. This was an area where the corporate level had the ability to require that the projects used uniform systems and processes, based on external regulations, and making involvement part of HES would arguably reinforce the implementation of both practices. DISCUSSION AND IMPLICATIONS The case study findings show that strategizing in the PBO happens through the interplay between strategic efforts on the company level and initiatives and experiences made on the project level, which are further fed back to the organization. This finding is in line with previous PBO literature that shows how change in the strategic direction and the building of new core capabilities happen through the interplay between top-down strategic interventions and project-based learning processes (Davies & Brady, 2000). A key management task in this respect is the integration of experiences from projects into the continuous business processes (Gann & Salter, 2000). The company in our case seeks such integration through facilitating exchange of experiences at the project level feeding these experiences back to the central level. This is seen as a necessary way of implementing change, because it means that the projects sustain some of their autonomy while the organization as a whole is improving. For instance, the new companywide project work practice aided the creation of a common platform in the company and enabled exchange and use of experiences across the company. Simultaneously, it allowed for local adjustments and flexibility, which implies that new knowledge can be created. This balance between stability and variety is important for developing sustainable capabilities (Brady & Davies, 2004). The case shows the importance of external actors in changing project work practices in multi-actor environments, such as construction. It is highly acknowledged among the company’s managers that the change depends on clients and subcontractors for being successful, but that this in turn requires another way of working with these actors than the traditional arm’s-length relationships, which is evident in construction (Dubois & Gadde, 2000). Implementing changes in construction project work practice in general

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requires an involvement of subcontractors since they perform much of the work. The findings show that the spread of the new practice was influenced and constrained by external actors as, for instance, when subcontractors were reluctant to spend extra time on planning. However, over time, some of the subcontractors experienced that involvement was also in their best interest as they would more easily be able to plan ahead. Consequently, the external actors influenced strategizing in the case firm. For instance, the subcontractors’ initial reluctance to spend increased time on planning resulted in a top-down initiative where involvement became part of the HES reporting system, which also affects the work of the subcontractors. The new project practice also relied on closer interaction with the client. In a setting where the development of trust has poor conditions and shortterm gains are pursued (Bignoux, 2006), it is difficult to implement a new work practice that initially requires more time and money being spent. As Ness and Haugland (2005) remark, in situations with no guarantee or expectations of the future, each actor in a relationship will be suspicious of the other partners’ intentions. The company in our case relied on the power of good examples and real experiences. Some of the subcontractors that experienced the benefits from the new work practice lowered their bids, and the contractor was more aware of the benefits of choosing subcontractors that had complied successfully with the new way of working. The same was true for clients, where the company would seek to repeat business with those clients who had been involved in successful applications of the project practice. The findings suggest that the change in project work practices over time is likely to change the internal and external relations of the company, both on the project level and the organization level. Figure 5.1 conceptualizes this idea. If we first look at the internal relations, we find that the couplings between the permanent organization and the project level become tighter than before, even if the autonomy of the projects is intact. These tighter couplings enable productivity in terms of enabling return on previous learning investments, as the experiences can be transferred across the organization. Furthermore, the new practice involves tighter couplings between Internal relationships

External relationships

Organizational level

Tighter couplings between organization and projects

Tighter couplings with external actors across projects

Project level

Tighter couplings between internal members of the organization in projects

Tighter couplings with external actors in projects

Figure 5.1  Change in internal and external relationships.

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the internal project participants. This also facilitates productivity and innovation, since the combination of more knowledge is enabled. Looking at the external relationships, we find a similar tendency toward tighter couplings. On the organizational level, fewer subcontractors will be in the preferred pool, and it is reasonable to expect that some of these relationships will develop into more long-term relationships. Even if there are some companywide frame agreements with subcontractors, the projects primarily choose these themselves. There are however some informal agreements at the district level where some subcontractors are preferred over others. As the local units increasingly start to nurture relationships with a fewer number of subcontractors, these couplings will become tighter between projects. The choice is based on previous experience in addition to the price offered. However, some of the districts that use the new project practice have somewhat changed their way of choosing subcontractors based on an assessment of how willing these subcontractors are to participate in the extended planning and meeting sequence stemming from the new practice. This also means that positive or negative previous experiences with the subcontractor will affect the assessment. When it comes to clients, there is little systematic contact between the projects. An exception is one of the districts where the project managers are urged to communicate with clients on a more permanent basis. Some clients are starting to use other criteria than price in their bidding documents, and this means the new work practice will give benefits when it comes to winning bids for projects that emphasize and evaluate how the contractor plans to carry out the project. Based on these findings, we argue that the internal as well as external relations to the organization and the projects are likely to become more tightly connected, moving the organization toward a more stationary form (Modig, 2007) where it is easier to accomplish organizational learning and economies of scale. The organization as such is changing and becoming more stable and similar, and securing the same quality from project to project will be easier. However, there is also a risk in that the projects may lose their autonomy, as this has been seen as one of the main benefits of the PBO because it has allowed for local adaptation and creativity. The organizational strategy thus seems to be changing, albeit unintentionally, due to the increased focus on involvement and the external actors’ influence in the process. There are however benefits of extending external relationships from being temporary and short term in nature to becoming more permanent and stable, both in terms of productivity and innovation (Dubois & Gadde, 2002a). A long-term orientation encourages trust development and reduces opportunistic behavior. Additionally, when partners have a common understanding and are used to working together in the same manner over time, the start-up of a project will be faster and easier as they already know each

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other and what is expected from each partner (Das & Teng, 2000). When external relations become more tightly connected on the project level as well as on the organizational level, it is likely to contribute to the emergence of latent relationships where relationships are ongoing and continuous but dormant between projects. Previous research suggests that the latent organization allows for ongoing relationships, reducing the costs and uncertainties of relationship coupling and decoupling (Starkey, Barnatt, & Tempest, 2000), offering several of the benefits of permanent structures. The temporary organization allows for flexibility and creativity, whereas a more permanent organization has benefits of learning, economies of scale, and innovation, meaning that flexibility and creativity may have to be traded for learning and structure. Based on our findings, we suggest that the latent relationships stemming from the tighter couplings potentially can lead to increased learning, more effective processes, and trusting relationships without the organization becoming static. CONCLUSIONS, LIMITATIONS, AND FURTHER RESEARCH In this chapter, we have focused on strategizing in PBOs. We have showed that strategies emerge across levels and boundaries, and that this process facilitates and necessitates closer interaction both in the internal organization and the external project organization, and consequently changes relationship strategies. In line with the behavioral strategy stream of research (e.g., Powell et al., 2011) and the strategy-as-practice perspective (e.g., Jarzabkowski et al., 2007), we have shown that the emergence of strategy can be understood by focusing on microprocesses and what actors actually do. We argue that the PBO represents an extreme organizational form where these processes become especially salient because the primary value-creation activities take place at the local level. The understanding of strategizing, how strategies emerge, and the consequences to internal and external relations is important also from a managerial point of view. The study indicates that managers at the central level need to be aware of new initiatives rising from the local level as these may become important for the competitive advantage of the firm. Managers at the local level must be aware that they are not only responsible for implementing strategies but it is also likely that their actions may have implications for the future of the organization. When relations internal as well as external to the organization and the projects are becoming more tightly connected, the organization as such is changing and becoming more stable and similar, and securing the same quality from project to project. However, there is a risk of the projects losing their autonomy, which managers stress is one of the main benefits of the organization.

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The study has some limitations, and the most obvious one concerns the design with only one case study in the construction industry. The question is whether these findings may be applicable also in other contexts and for a larger sample. However, we do not claim generalization. The findings reported in this chapter open up a number of avenues for future research. Firstly, it would be relevant to study whether practices can emerge to become strategies in similar settings or industries where autonomy is granted to lower levels. Also, finer-grained understanding of this process might be gained from studying actions and interactions of managers and the tools they use in their day to day interactions. Furthermore, we propose in this study that there is a movement toward tighter couplings in the industry and that this affects how one carries out the strategy process within the firm; but also that this has implications for the strategies one has toward subcontractors and clients. It would be interesting to study whether this is a pattern that continues over time and what the implications are in the long run— whether tighter coupling really becomes a strategic advantage. REFERENCES Arino, A., de la Torre, J., & Smith Ring, P. (2001). Relational quality: Managing trust in corporate alliances. California Management Review, 44(1), 109–131. Arvidsson, N. (2009). Exploring tensions in projectified matrix organisations. Scandinavian Journal of Management, 25, 97–107. Ballard, G., & Howell G. A. (2003). Lean project management. Building Research & Information, 31(2), 119–133. Balogun, J., Huff, A., & Johnson, P. (2003). Three responses to the methodological challenges of studying strategizing. Journal of Management Studies, 40(1), 197–224. Betts. M., & Ofori, G. (1992). Strategic planning for competitive advantage in construction. Construction Management and Economics, 10, 511–532. Bignoux, S. (2006). Short term strategic alliances: A social exchange perspective. Management Decision, 44(5), 615–27. Brady, T. & Davies, A. (2004). Building project capabilities: From exploratory to exploitative learning. Organization Studies, 25(9), 1601–1620. Bresnen, M., Goussevskaia., A. & Swan, J. (2005). Organizational routines, situated learning and processes of change in project-based organizations. Project Management Journal, 36(3), 27–41. Bryman, A., & Bell, E. (2007). Business research methods (2nd ed.). Oxford, UK: Oxford University Press. Cox, A., & Ireland, P. (2002). Managing construction supply chains: The common sense approach. Engineering, Construction and Architectural Management, 9(5/6), 409–418. Das, T. K. (2006). Strategic alliance temporalities and partner opportunism. British Journal of Management, 17(1), 1–21.

142    L. E. BYGBALLE and A. R. S. SWÄRD Das, T. K., & Teng, B. (2000). Instabilities of strategic alliances: An internal tensions perspective. Organization Science, 11(1), 77–101. Davies, A., & Brady, T. (2000). Organisational capabilities and learning in complex product systems: Towards repeatable solutions. Research Policy, 29, 931–953. Devinney, T. M. (2013). Is microfoundational thinking critical to management thought and practice? Academy of Management Perspectives, 27(2), 81–84. Dubois, A., & Araujo, L. (2006). Research methods in industrial marketing studies. In H. Håkansson, D. Harrison, & A. Waluszewski (Eds.), Rethinking marketing: Developing a new understanding of markets (pp. 207–227). West Sussex, UK: Wiley. Dubois, A., & Gadde, L.-E. (2000). Supply strategy and network effects—Purchasing behavior in the construction industry. European Journal of Purchasing & Supply Chain Management, 6, 207–215. Dubois, A., & Gadde, L.-E. (2002a). The construction industry as a loosely coupled system: Implications for productivity and innovation. Construction Management and Economics, 20(7), 621–631. Dubois, A., & Gadde, L.-E. (2002b). Systematic combining: An abductive approach to case research. Journal of Business Research, 55, 553–560. Engwall, M. (2003). No project is an island: Linking projects to history and context. Research Policy, 32(5), 789. Floyd, S. W., & Wooldridge, B. (2000). Building strategy from the middle. Reconceptualizing strategy process. Thousand Oaks, CA: Sage. Gann, D. M., & Salter, A. J. (2000). Innovation in project-based, service-enhanced firms: The construction of complex products and systems. Research Policy, 29, 955–972. Grabher, G. (2002). Temporary architectures of learning: Knowledge governance in project ecologies. Organization Studies, 25, 1491–1514. Grabher, G. (2004). Cool projects, boring institutions: Temporary collaboration in social context. Regional Studies, 36(3), 205–214. Hobday, M. (2000). The project-based organization: An ideal form for managing complex products and systems? Research Policy, 29, 871–893. Holmen, E., Pedersen, A.-C. & Torvatn, T. (2005). Building relationships for technological innovation. Journal of Business Research, 58, 1240–1250. Jarzabkowski, P., Balogun, J., & Seidl, D. (2007). Strategizing: The challenges of a practice perspective. Human Relations, 60(1), 5–27. Jarzabkowski, P., & Spee, A. P. (2009). Strategy as practice: A review and future directions for the field. International Journal of Management Review, 11(1), 69–95. Johnson, G., Melin, L., & Whittington, R. (2003). Micro-strategy and strategizing: Toward an activity-based view. Journal of Management Studies, 40(1), 3–22. Levinthal, D. A. (2011). A behavioral approach to strategy: What’s the alternative? Strategic Management Journal, 32, 1517–1523. Lindkvist, L. (2004). Governing project-based firms: Promoting market like processes within hierarchies. Journal of Management Governance, 8, 3–25. Lui, S. S., & Ngo, H.-Y. (2005). An action pattern model of inter-firm cooperation. Journal of Management Studies, 42(6), 1123–1153. Miles, M. B., & Huberman, A. M. (1994). Qualitative data analysis. Thousand Oaks, CA: Sage.

Strategizing in Project-Based Organizations    143 Milosevic, D. Z., & Srivannaboon, S. (2006). A theoretical framework for aligning project management with business strategy. Project Management Journal, 37(3), 98–110. Mintzberg, H. (1979). The structuring of organizations. Englewood Cliffs, NJ: Prentice-Hall. Mintzberg, H., & McHugh, A. (1985). Strategy formation in an adhocracy. Administrative Science Quarterly, 30, 160–197. Modig, N. (2007). A continuum of organizations formed to carry out projects: Temporary and stationary forms. International Journal of Project Management, 25, 807–814. Morris, P., & Jamieson, A. (2004). Translating corporate strategy into project strategy: Realizing corporate strategy through project management. Newton Square, PA: Project Management Institute. Ness, H., & Haugland, S. (2005). The evolution of governance mechanisms and negotiation strategies in fixed duration interfirm relationships. Journal of Business Research, 58(9), 1226–1239. Pettigrew, A. M. (1997). What is a processual analysis? Scandinavian Journal of Management, 3(4), 337–348. Powell, T. C., Lovallo, D., & Fox, C. R. (2011). Behavioral strategy. Strategic Management Journal, 32, 1369–1386. Regnèr, P. (2003). Strategy creation in the periphery: Inductive versus deductive strategy making. Journal of Management Studies, 40(1), 57–82. Starkey, K., Barnatt, C., & Tempest, S. (2000). Beyond networks and hierarchies: Latent organizations in the U.K. television industry. Organization Science, 11(3), 299–305. Whittington, R. (2007). Strategy practice and strategy process: Family differences and the sociological eye. Organization Studies, 25(10), 1575–1586. Whittington, R., Molloy, E., Mayer, M., & Smith, A. (2006). Practices of strategizing/organizing: Broadening strategy work and skills. Long Range Planning, 39, 615–629. Yin, R. K. (1994). Case study research: Design and methods. Thousand Oaks, CA: Sage.

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CHAPTER 6

SELECTING A CERTIFICATION BODY IN THE FAIR TRADE MARKET The Importance of Strategic Capabilities and Cooperative Behavior Mantiaba Coulibaly Fabien Blanchot

ABSTRACT The literature on fair trade provides important insights into the functioning of a specific market, the profile of its actors, and its certification process. However, it does not address how industry players (producers, distributors, importers, associations holding a fair trade label) choose their certification body. Yet this is an important topic. Indeed, fair trade is presented as a multistakeholder partnership, and alliance literature suggests the importance of the process of selecting partners in successful partnerships. In this chapter, we propose a typology of the selection criteria that actors in fair trade may use, building on the literature on alliances. These selection criteria refer to the strategic capacities of the potential partner and its propensity to adopt a

The Practice of Behavioral Strategy, pages 145–168 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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146    M. COULIBALY and F. BLANCHOT cooperative behavior. Our framework partially meets objectives and methods of behavioral strategy. We also present the fair trade system and the results of our exploratory study to better understand the real behavior of actors in selecting a certification body in the fair trade market. We find that producers play a secondary role in the selection of the certification body, unlike importers, distributors, and associations holding a fair trade label. We also find that these last actors base their choice on three of the four categories of selection criteria identified in the literature on alliances (capability, compatibility, commitment, and reliability of potential partners).

INTRODUCTION The fair trade movement has been growing in recent years, though it still only represents a small part of international trade (Ozcaglar-Toulouse, 2005). Generally, fair trade literature discusses the major principles of this trade and the processes of production and marketing of fair trade products (Hamzaoui-Essoussi & Linton, 2010; Hertel, Aarts, & Zeelenberg, 2002; Olivier & Swan, 1989). In particular, scholars present the main actors (stakeholders) of fair trade, and the manner in which certification of economic actors is led, in order to guarantee fair trade labeled products. Certification is presented as a voluntary evaluation of economic actors (producers, distributors, importers) by a certification body, followed by regular inspections. To the extent that fair trade is seen as a multifirm partnership, an important question is how stakeholders in the fair trade are selected. Indeed, as suggested in literature on strategic alliances, the partner profile appears to be one of the main key success factors of partnerships, as well as the initial characteristics of the agreement and the way of managing the relationship (Arrègle, Dacin, Hitt, & Borza, 2003; Blanchot, 2006; Chen, Chen, & Wei, 2009; Das & Teng, 2003; Lin, Peng, Yang, & Sun, 2009; Luo, 1997; Sarkar, Echambadi, & Harisson, 2001; Saxton, 1997). Surprisingly, this issue is not addressed in the fair trade literature, at least when one takes an interest in how the certification body, the cornerstone of the system, is selected by other actors of fair trade. Consequently, the main objective of this research is to understand how actors choose to put themselves in the fair trade market and particularly how the certified choose their certifier. To this end, we will rely on two research fields: fair trade literature, in order to understand the fair trade systems, its actors, and its processes; and alliance literature, in order to suggest a typology of the selection criteria that actors in fair trade may use. We will also rely on an exploratory study to assess this typology in the particular context of fair trade and to better understand the real behavior of actors in selecting a certification body.

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Our contribution is closely connected to behavioral strategy as a field of research. According to Powell, Lovallo, and Fox (2011), Behavioral strategy merges cognitive and social psychology with strategic management theory and practice. Behavioral strategy aims to bring realistic assumptions about human cognition, emotions, and social behavior to the strategic management of organizations and, thereby, to enrich strategy theory, empirical research, and real-world practice (p. 1371). . . . in behavioral strategy, the whole question is how particular forms of behavior arise in and among organizations. If we do not show the mechanism, we do not explain the phenomenon. (pp. 1374–1375)

Indeed, in accordance with this field of research, we focus on how actors behave in selecting their partners, and we include in our framework, even if not exclusively, some social and psychological considerations (trust, reputation, feeling of justice, etc.). This chapter consists of three mains parts. In the first section, we discuss the criteria categories generally used by firms to select their partners, based on literature relating to alliances. In the second section, we present the fair trade system, including actors and processes. We begin by discussing the fair trade concept and the principles behind certification (the process used by certifiers to accredit the certified). We then examine the profile of two significant certification bodies (FLO and Ecocert). In the third section, we investigate, in an exploratory manner, the actual behavior of main actors of the fair trade (producers, distributors, importers and owners of a fair trade label) in choosing a certifier (certification body). Results presented are based on the testimony analysis of nine professionals. SELECTION CRITERIA OF PARTNERS: STRATEGIC CAPACITIES AND COOPERATIVE BEHAVIOR The partner profile appears to be one of the main key success factors for alliances and interfirm cooperation as well as contextual elements, the initial characteristics of the agreement, and the way of managing the relationship (Arrègle et al., 2003; Blanchot, 2006; Chen et al., 2009; Das, 2005, 2006; Das & Teng, 2003; Lin et al., 2009; Luo, 1997; Sarkar et al., 2001; Saxton, 1997). The criteria favored by companies when selecting partners are diverse and they vary according to the context (Dacin, Hitt, & Levitas, 1997; Geringer, 1991; Glaister & Buckley, 1997; Nielsen, 2003). Nevertheless, scholars observed two constants. Firstly, firms give priority to partners who can contribute to control the key success factors that they do not feel themselves capable of controlling. To this end, they use criteria related to the strategic capacities of the potential partner. Secondly, they favor partners that are

148    M. COULIBALY and F. BLANCHOT Partner capability

Partner compatibility Types of selection criteria

Partner commitment

Partner reliability

Contingency factors: alliance type; firms’ profile; alliance governance structure; institutional context of partners and alliance

Figure 6.1  Selection criteria and contingency factors.

most susceptible to adopting cooperative behavior. To do this, they appeal to criteria regarding the relationship capacities of the potential partner, which can be grouped into three categories: partner compatibility, partner commitment, and partner reliability. Figure 6.1 summarizes the main selection criteria that firms take more or less into account when selecting a partner and the contingency factors that may affect the criteria privileged. We discuss these elements below. Partner Capability Partner capability refers to the capacity of each partner to provide the other with the contributions it needs to accomplish its goals (financial payoffs, image enhancement, learning, skills transfer, market access, etc.). The contributions provided may be various and they may be similar for each partner (e.g., to obtain economies of scale) or different. For instance, according to Brouthers, Brouthers, and Wilkinson (1995, pp. 19–23), firms seek complementary skills offered by partners to obtain a competitive advantage, which leads them to analyze the skills and technologies owned by potential partners in the market. The evaluation of complementary skills considers the experience of potential partners, their capabilities, and their potential for making a real contribution. The contributions sought may include financial assets, physical assets (equipment), or intangible assets (e.g., knowledge). Corroborating the importance of a firm’s capability, Ahuja (2000) shows that the attractiveness of a potential partner is a function of its accumulated technical and commercial capital. The social capital of partners is also important (Ahuja, 2000; Shi, Sun, Pinkham, & Peng, 2014). In fact, the capabilities sought by partners vary according to their context. For instance, Hitt, Dacin, Levitas, Edhec, and Borza (2000) showed that

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the managers of companies in developed countries emphasize the unique skills and local market knowledge of their potential partners, while firms from emerging countries appear more sensitive to the financial resources, technical capacities, and intangible assets of their potential partners. Similarly, Arrègle et al. (2003) showed that the skills and idiosyncratic resources sought after (alliance as a means to reach the resources or the skills of the partner or to internalize them by learning) vary according to the institutional context of the firms (cultural, economic, and political system). Partner Compatibility Partner capability is not enough to ensure the success of a cooperation. In alliances, the strategic goals of partners must either converge or be mostly compatible if they are different (Doz & Hamel, 1998; Luo, 2002; Parkhe, 1991). If this is not the case, partners will have difficulty agreeing on the management of their alliance. Compatibility also refers to three other fields: culture, risk, and the existing network. Partners must consider their respective cultures when evaluating their ability to cooperate without too much difficulty (Parkhe, 1991; Pothukuchi, Damanpour, Choi, Chen, & Park, 2002), even though national, organizational, or professional cultural differences might not necessarily impede successful cooperation (Blanchot, 2008, 2013; Blanchot & Guillouzo, 2011). Similarly, empirical research carried out by Angué and Mayrhofer (2010) suggests that administrative, geographical, and economic distances between firms’ contexts reduce the probability of cooperation. Partners must also take in account their respective risk in the alliance. According to Brouthers et al. (1995), a commensurate level of risk taken by the partners is an incentive to hold them together, and this balance would be especially problematic when a well-established or larger company approaches a smaller firm. Partners must finally take into account the respective portfolios of alliances (Heimeriks, Duysters, & Vanhaverbeke, 2007; Heimeriks, Klijn, & Reuer, 2009). The challenge here is to avoid conflicts between different alliances and between the partners of different alliances: the risk that one projects damages another, that there are negative interdependencies (especially between the alliances concluded with the same partner), the risk that alliances partially or totally recover (redundancy), the risk that partners belong to rival networks or that are in situations of strong rivalry (they may consequently refuse to communicate sensitive information, share customers, or be afraid of theirs being shared with other partners), the promotion of rival technology, or the risk that a partner requires exclusivity in some domains, which prevents working effectively with other partners.

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Partner Commitment A potential partner can have the capacity to make contributions that the others need and may be “compatible,” but not have the willingness to significantly commit to. A commitment is an inclination for cooperation and a willingness to make efforts to achieve certain goals (Cherni & Fréchet, 2006), a willingness to make short-term sacrifices to accomplish longer-term benefits, a tangible contribution made by partners to an alliance project, or an affirmative action taken by one party that creates a self-interested stake in the relationship and that demonstrates something more than a mere promise (Shah, Goldstein, Unger, & Henry, 2008). Partner commitment can notably be estimated during the agreement negotiation period from the contributions that the potential partner is ready to make. A commitment is credible if it becomes detrimental when the alliance fails, due to its sacrificial and/or irreversible nature (Gulati, Khanna, & Nohria, 1994). It can take the form of a long-term contract with a third party (which makes sense only within the framework of the cooperation), of a communication which emphasizes the importance of the alliance and commits the firm’s reputation to its success, of the dissolution of a division which previously realized the tasks confided to the partner, of a specific investment to the relation, and so on. The fact that each partner brings to the other one contributions he needs increases the probability of alliance success for two reasons (Blanchot, 2006). First, it favors the achievement of the targeted objectives and it increases the recognition of the usefulness (or value-creation potential) of the alliance. As such, it also reduces the risk of dissolution (Arino & de la Torre, 1998; Doz, 1996). Second, it creates a situation of interdependence. The level of this interdependence depends the degree to which each partner needs the other to reach its goals. The more there is interdependence, the more the partners are interested in pursuing the alliance (Puthod, 1996; Xia, 2011) and in getting involved in the relationship. Furthermore, the more the partners are mutually dependent, the more they dread dissolution, and consequently the more conflicts are well managed (Cherni & Fréchet, 2006; Das & Teng, 2003, p. 293). Finally, the importance of the commitments may facilitate mutual adjustments, because it increases the stakes in the alliance (Reuer, Zollo, & Singh, 2002). Partner Reliability According to Nielsen’s (2003) research, trust between top management teams is the most important partner-related selection criterion in strategic alliances. In fact, trust is closely linked to partner reliability. This link appears clearly in some definitions of trust. For instance, Shah and

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Swaminathan (2008) and Chua (2012) operationally define trust through two dimensions: benevolence and competence. Benevolence-based trust focuses on the motives and intentions of the alliance partners. It exists to the extent that partners in an alliance will act in a manner that shows their reliance on the partner’s goodwill and avoidance of opportunism. . . . Competence-based trust exists to the extent that partners consistently exhibit traits such as credibility and expertise. As such, competence-based trust reflects the degree to which partners are willing to rely on each other’s expertise, capabilities, and judgments. (Shah & Swaminathan, 2008, p. 474)

This definition suggests that the reliability of a partner depends on its future behavior and on the quality of its assets and skills, including organizational and financial aspects required to be able to bring its contributions correctly (Luo, 1997). To judge the reliability of a potential partner and create the trust required, a firm can draw on its own experience (firsthand knowledge) or on the reputation of the potential partner (secondhand knowledge). These two criteria are effectively taken into account by firms (Nielsen, 2003). To reduce the uncertainty associated with the selection of a partner (uncertainty about the quality of the resources or the skills brought by the partner and its ex post behavior), firms also tend to embed their economic relationships (alliances) in preexisting social relationships and through networks of personal relations (Meuleman, Lockett, & Manigart, 2010; Mitsuhashi, 2002) because social networks create pressure. Contingency Factors Aside from the fact that they make possible the elaboration of a typology of the criteria used by firms to select their partners, research results on alliances suggest that privileged selection criteria depend on four contextual elements: (a) alliance type (Li & Ferreira, 2008; Nielsen, 2003; Shah & Swaminathan, 2008)—outcome interpretability (degree of ease or difficulty associated with assessing or interpreting the outcomes of a particular alliance project), process manageability (degree of ease or difficulty associated with managing the implementation process of a particular alliance project), motives for alliance formation, scope of the alliance, and so on; (b) profile of the firms (Glaister & Bucley, 1997; Nielsen, 2003; Shi et al., 2014)—prior alliance experience, foreign firms’ experience in a local market, perceived capabilities; (c) alliance governance structure (Li & Ferreira, 2008; Nielsen, 2003), allocation of responsibilities and authority, legal form of the alliance (e.g., equity based); and (d) institutional context of partners

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and alliance (Angué & Mayrhofer, 2010; Arrègle et al., 2003; Glaister & Bucley, 1997; Hitt et al., 2000; Li & Ferreira, 2008)—cultural, political, and economic context. In short, building on existing research, we identified four key partner selection criteria (capability, compatibility, commitment, and reliability) and four factors affecting the use of these criteria by firms when they select a partner for an alliance (alliance type, firms’ profile; alliance governance structure; institutional context of alliance and partners). This grid is the one we used to study the selection process of a certification body by certified organizations in the fair trade market. Before presenting the methodology and results of this study, we present the fair trade system. FAIR TRADE: THE PROCESS AND CERTIFICATION SYSTEM In this section, we will focus on the main principles of the certification process (standards and conditions to select actors) and the main certified actors considered in the selection process (producers and distributors). This enables the understanding of how a certification body selects certified actors. We will begin by presenting the fair trade concept, the main actors implied in the fair trade market, and the certification process. We will then present the two main certifiers in the fair trade market and their actions in the certification process. Fair Trade: Principles and Actors Fair trade can be defined as “a trading partnership, based on dialogue, transparency and respect, that seeks greater equity in trade. It contributes to sustainable development by offering better trading conditions to, and securing the rights of, marginalized producers and workers, especially in the South.” This widely accepted definition was proposed in 2001 by FINE, an association of four main fair trade networks (Poret, 2007, p. 61): FLO (Fairtrade Labeling Organization, an association of producer networks, national labeling initiatives, and marketing organizations that promote and market the fair trade certification mark in their countries), IFAT (International Federation for Alternative Trade, an international network of fair trade organizations, including producer cooperatives and associations, export marketing companies, importers, retailers, national and regional fair trade networks and financial institutions, and fair trade support organizations), NEWS (Network of European World Shops, a network of national associations representing several thousand shops), and EFTA (European Fair Trade Association, a network of 11 powers of importation).

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Fair trade helps producers, importers, and retailers to accomplish the global objective indicated in the FINE definition: resolve the problems linked to the inequitable trade between the North and the South (Hira & Ferrie, 2006, p. 114). It is based on a “network of cooperatives (or of small producers) of the South which supplies its products to an importer of the North. These products are resold, after transformation, either through a network of supermarkets, or through a network of specialized shops” (Charlier et al., 2006, p. 10). Fair trade promotes “principles of equity in the exchanges and claims the creation of new links between the consumers and the producers, in particular between the consumers in the North and the producers disadvantaged in the South” (Ballet & Carimentrand, 2006, p. 62). In other words, it promotes partnership relationships rather than traditional market relations. Different actors exchange and cooperate in the fair trade. The main actors of the conventional sector of fair trade are shown in Figure 6.2: fair trade associations, certifiers or certification bodies, and producers or groupings of small producers like cooperatives, distributors (specialized stores, supermarkets), importers, transformers/manufacturers, and consumers (Charlier et al., 2006; Coulibaly, 2009). Fair trade associations (such as Max Havelaar) ensure that fair trade rules are respected. They accompany and assist the producers and distribution networks that have products on the market. They also guide transformers and consumers in their choices. They entrust the control of importer

Cooperatives or group of small producers

Producers

Fair trade association

Shops, wholesalers specialized in the fair trade, etc.

Importers

Supermarkets

Certifiers

Transformers

Consumers

Figure 6.2  Description of the conventional sector of fair trade (adapted from Charlier et al. (2006, p. 10).

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activities to a certification body (such as FLO-Cert). The fair trade associations therefore subcontract certification to certifiers. This allows them to guarantee the process that tracks products on the fair trade market. Thus, the role of the fair trade associations in the certification process is limited to checking the audit (verifying that everything is in order), (Coulibaly, 2009; Coulibaly & Sauvée, 2010). Certifiers or certification bodies have to prove their capacity to carry out inspections according rules established in ISO 65/EN 45011 (which defines the general conditions of evaluation and accreditation carried out by the certification body). Some certification systems include a control function in the process by involving private institutions and public authorities (Jahn, Schramm, & Spiller, 2005, pp. 57–58). Producers are organizations of small producers or members of cooperatives. They are generally located in southern hemisphere countries, especially in South America, in Southeast Asia, and southern and western Africa (Coulibaly, 2009). The small producers organizations have to respect specific principles: the use of their own properties and means of production; the use of family labor; the equal sharing of profits with distributors; the participation of all of their members in the decision making process (Brinckmann & Hughes, 2010, p. 48). Distributors are the retail chains of fair trade products located in the northern hemisphere. Products stemming from fair trade are distributed via several distribution networks: (a) commercial or associative shops specializing in fair trade; (b) mail-order selling; (c) retail chains, which sell products integrating fair trade ingredients (Body Shop and Occitane); and (d) hypermarkets and supermarkets that sell fair trade products (Poret, 2007, p. 61). Importers buy products from producers or cooperatives and sell them directly to the consumers via retail chains (or their own network). Importers and/or distributors are required to respect four principles: (a) paying producers a price which covers the costs of sustainable production (fair trade minimum price); (b) paying producers an additional amount, which allows them to invest in development (fair trade premium); (c) paying advances to producers if necessary; and (d) signing contracts which allow for long-term sustainable production. Consumers are generally urban buyers who have a higher income and are aware of sustainable development. There are of course also low-income earners who are interested in fair products (Coulibaly, 2009). The Certification Process An approved and independent certification body controls the respect of specifications defined by a fair trade label. Examples of fair trade labels are

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“Fairtrade” (the Max Havelaar association fair trade label), Ecocert Equitable, Fair for Life, Fairwild, Forest Garden Products, Naturland Fair, BioÉquitable, Main dans la Main, and Nespresso AAA. These fair trade labels are related to foodstuffs such as coffee, cocoa, tea, sugar, rice, and fruit. They are associated with different fair trade approaches that correspond to various specifications. To be certified by an independent certification body, producers, importers, manufacturers, and retailers must respect the following (Balineau & Dufeu, 2010, p. 332; Charlier et al., 2006, p. 60): (a) the rights of the workers (with a democratic structure, a fair wage and health and regulations in the workplace); (b) the process of sustainable development (no use of chemical products); (c) the autonomy of the producers—payment of a fair price in a regional or local context, help with the financing of the production, and more generally, improvement of producer conditions; (d) faith, transparency, and dialogue; (e) the different principles from northern and southern organizations with reference to the spirit of solidarity. Several certification bodies exist on the fair trade market. The majority of the certification market is controlled by FLO International (Brinckmann & Hughes, 2010, p. 50). To avoid confusion between the bodies that set the specifications and those who certify their application, FLO separated its fair trade labeling from Max Havelaar (owner of the fair trade label). Max Havelaar therefore changed its status from an NGO (nongovernmental organization) to a private business seeking customers (Charlier et al., 2006). A second major certification body in the fair trade market is Ecocert. We present these certification bodies below. The Main Certification Bodies FLO (Fair Trade Labeling Organization) includes several bodies: FLO, FLO-Cert, and also national initiatives. FLO defines the standards and the specifications for each product, and it helps producers to develop their activities. FLO-Cert ensures respect for the fair trade standards by producers, importers, and industrialists, and approves these economic actors. With regard to producers, FLO-Cert controls the working conditions, organization, production techniques, and quantities sold. Concerning importers, FLOCert controls the respect of price agreements, the terms of the contract, the financing and payment, and the equality between quantity delivered and quantity imported. When producers and importers fulfill expectations, FLO issues them fair trade licenses for the use of a fair trade label, such as the label “Fairtrade” (Poret, 2007, pp. 61–68). The cost of certification for an economic actor (e.g., a producer or an importer) varies according to whether it is the company’s first certification

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or a renewal. For certification renewals, FLO-Cert asks for an annual fee, calculated according to the volume of product sold under the fair trade label. FLO-Cert also demands a minimum payment of €500, even if no products are being marketed. The cost of initial certification varies according to the organization’s workforce (permanent employees and seasonal workers) (Charlier et al., 2006, pp. 99–100). The FLO certification system has some limitations that may lead actors (producers, distributors, or importers) to prefer another certifier (e.g., Ecocert) or combine the FLO certification with another certification. These limitations are first related to two conditions imposed by FLO: contractual relations all along the chain, from producers to distributors, have to be formalized, and there must be compliance with the specifications defined by FLO and an annual audit is to be carried (Ballet & Carimentrand, 2006, p. 67). Furthermore, FLO does not define specific standards for each industry or fair trade product (e.g., no specific standards for fair trade cotton), and standards adopted do not always take account of the regulations specific to each country producing fair trade products (Charlier et al., 2006, p. 30). A last limitation of the FLO certification system is related to the high cost of certification for producers and importers (Poret, 2007, p. 61). Ecocert is a control and certification body. It is an independent company with its own international network. In France, the Ecocert network is subdivided into four entities: Ecocert SA (Limited Company), Ecocert France SAS (French Simplified Corporation), Ecocert Greenlife SAS, and Ecocert Environnement SAS. Ecocert SA is the parent company. Ecocert France SAS handles control and certification activities for organic farming. Ecocert Greenlife SAS is their subsidiary, which manages the control and certification of eco products (cosmetics, textiles, cleaning products, etc.). Ecocert Environnement SAS controls and certifies environmental management systems, carbon-neutral projects, environmental aspects, tertiary ecological management organizations, and sustainable development. Ecocert is also present in Europe (Germany, Spain, Portugal, Romania, Serbia, and Turkey), in Africa (South Africa, Burkina Faso, Madagascar, Morocco, and Tunisia), in Asia (China, South Korea, India, and Japan), and in the Americas (Brazil, Canada, Colombia, Equator, and the United States). Ecocert provides control and certification services in several business sectors: organic farming, organic cosmetics and treatments, organic textiles, environmentally friendly products, and fair trade products, as well as quality and safety control. Ecocert provides faster certification (compared to FLO). Different Ecocert entities handle the certification: auditors, actors in charge of certification, and a certification supervisory committee. These entities operate over the span of one year. The auditors conduct inspections on a given site by taking into account criteria established in their specification guidelines. Their mission consists of drafting the audit reports and transferring

Selecting a Certification Body in the Fair Trade Market     157

them to the Ecocert office. These audits are linked to the entire production chain (production, manufacturing, packaging, labeling, storage, distribution, import). Auditors are entitled to carry out unexpected inspections. Concerning the actors in charge of certification, they study the audit reports and estimate their compliance with technical specifications (when compliant, certification is granted; and in the case of noncompliance, corrections or penalties are issued). The supervisory certification committee is an independent technical body, which includes operators in the sector, consumers, experts, and administrative representatives. This committee ensures the respect of the certification processes, provides opinions, and examines appeals and complaints. Ecocert has created several system of reference in association with representatives from various stakeholders (professional, consumers, and users). These system of reference include environmental and social criteria. The main system of references are ESR (Equitables, Solidaires, Responsables, meaning fair, sense of solidarity, responsible) for organic and fair trade products; environmentally friendly cleaners; Eve (Ecologiques Verts Espaces, meaning environmentally friendly green spaces); environmentally friendly and organic spaces for well-being; environmentally friendly production of water plants and their transformation, and so on. Furthermore, to complete the control process, Ecocert issues certificates of compliance to its repositories. To value their initiative, Ecocert awards signs of recognition with distinctions, which are available to these organizations (e.g., “Ecocert Certified” or “Approved by Ecocert,” or the logo “controlled by Ecocert”) (see www.ecocert.com). Certification at the Heart of Fair Trade Market Partnerships In the fair trade market, relations between southern producers and northern distributors (or importers) can be described as partnerships or cooperative relationships, because of two of their characteristics: they are interfirm relations, each actor being and remaining legally independent, and they don’t take the form of discrete contracts (classical contracts, discrete market transactions), but rather the form of recurrent and relational contracts (Ring & Van de Ven, 1992). They are (designed to be) long-term relations with repeated transactions between the same actors; they include reciprocal commitments and a motivation of equitable outcomes and not only efficiency considerations; they may involve long-term investments, and disputes may be resolved through internal mechanisms designed to preserve the relationship and ensure that both the efficiency and equity outcomes sought in the long-term relationship are realized.

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But these partnerships have an additional characteristic: as suggested in the precedent section, certification bodies largely mediate them, in that certifiers play a central role in the creation and governance of partnerships. Therefore, we can say that certification bodies are at the heart of the partnerships in the fair trade market. Indeed, as noticed earlier, the certification body makes requests for the fair trade contract, which influence the balance of the relationship (e.g., equity norm), its importance (e.g., the quantity of products sold), and its duration (durability of the license, at least). Moreover, the certification body constitutes in itself a governance device which promotes governance mechanisms, including control, contracts, and incentives. Given the key role of the certifier, the question arises of how economic actors (producers, importers, distributors) select the certifier. Surprisingly, the literature on fair trade does not address this issue of partner selection (the choice of certifier by certified). In the next section, we empirically explore this issue by drawing on both the literature on fair trade and the literature on the criteria for selecting partners in alliances. SELECTION OF THE CERTIFICATION BODY IN THE FAIR TRADE MARKET We focus on how some key economic actors (producers, importers, distributors, and the owner of the fair trade label) choose a certifier on the fair trade market. The question is also to verify the latitude of each actor; we suppose that producers have weak latitude in comparison to importers, distributors, and fair trade organizations (fair trade label owners). Even more, we conjecture that producers are selected rather than that they select, given their small size, their localization in the South, and their distance from the consumer market. Our research is exploratory. We successively present the methodology and the main results of this empirical study. Methodology We used qualitative methods. We carried out semidirective interviews (Romelaer, 2005; Yin, 2003) with some key actors on the fair trade market. The employees interviewed had different responsibilities within their organizations: president, head of communication, head of department, and so on. Eight interviews were usable within the framework of our study (see Table 6.1).

Selecting a Certification Body in the Fair Trade Market     159 TABLE 6.1  Profiles of the Interviewees (Type of Organization and Function) Type of organization (main activity)

Functions of the interviewed

Distributor (fair trade shop) Distributor (fair trade shop) Distributor Distributor Distributor and importer Association (owner of a fair trade label)

Head of communication Head of division Head of communication President Director of division Head of agricultural production, impact, and standards Association (owner of a fair trade label) Head of division Association (acting as a consultant) Manager Association (center for students promoting North–South President solidarity and sustainability development)

We used an interview guide (see Table 6.2) to focus the interview on the main objective of the research: isolating the selection criteria of the certifier by certified (and by other actors). We conducted face-to-face interviews (30 minutes each on average). Following the transcription of the interviews, we conducted a content analysis in order to identify how actors select their certification body; specifically, we sought to determine whether the selection criteria identified in the literature on alliances are those used by the actors of the fair trade market. We also sought to identify whether other selection criteria such as those identified in the literature were used.

TABLE 6.2  Interview Guide Profile of the interviewee and characteristics of its organization 1. Function of the interviewee 2. Activity of its organization 3. Size of its organization (in particular, number of stores if it’s a distributor) Actors of the partnership 1. Who are the main actors in the fair trade market? 2. Who are your partners in the fair trade market? Process of selection 1. Do you think that some actors have participated and some actors have not participated in the process of selection (of the certification body)? 2. What is the role of the producer in the selection of the certification body? (Does the producer select the certification body)? 3. How do you select your partners in the fair trade market? 4. What are the main criteria that you consider to select the certification body?

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Results The interviews corroborate the hypothesis that producers play a secondary role in the selection of certification bodies and that it is mainly distributors and associations holding a fair trade label that select the certification body. Specifically, producers are usually approached by a distributor (or association holding a fair trade label), and then they simply accept or refuse to enter the certification process offered to them, according to the characteristics (e.g., duration) and cost of the certification process, which may vary significantly: The cost of the certification and the duration of the audit depend on various sectors: the number of members in the organization, the number of products that the organization has certified, and then there are also questions of accessibility. For example, we have organizations in the system that are rather small [35 members, organizations on a primary level], you are maybe going to spend two days of auditing to verify all the points. On the other hand, we have production organizations in Ghana and Kenya, or others where there are more than 80,000 members. In that case, producers with more than 80,000 members are grouped into organizations. These are often rustic organizations, which then group together into regional organizations to have a national structure. So the certifier must control each level and address all questions of transparency and democracy. They can spend many days or sometimes even weeks conducting the audit. All of these processes depend on the reality of the producers. (Head of division, Association-owner of a fair trade label, March 2013)

Of course, producers can get in touch directly with a certification body, but this does not seem to be a common approach. However, it is up to producers to make a request for certification: For the certification, it is a spontaneous request from them [the producers]. Sometimes they are accompanied by their economic partner. Then, when they are certified, they go into a cycle where we make audits every year to verify the respect of standards. When they want to enter the market, they are put in touch with FLO-Cert [follow the main stages, audits]. (Head of division, Association-owner of a fair trade label, March 2013) The small producers make a request and there is an inspection [as is done for organic certification]. There are established criteria. There is a quality control inspection; there’s a progressive logic. They can also ask to work with a certifier; it is their choice. (Head of communication, Distributor, March 2014)

In addition, the relationship between the producer and the certification body is contractual and takes the form of a partnership with mutual commitments:

Selecting a Certification Body in the Fair Trade Market     161 Producers have a certification contract with the certification body. The independent certification body verifies that producers are in keeping with all the criteria, including production criteria, environmental problems with the soil, with water, with biodiversity, etc. The producers have a contract every year with FLO-Cert. We are currently in an initiative of progress. (Head of agricultural production, impact, and standards, Association-owner of a fair trade label, June 2013) It is FLO-Cert who ensures the daily control of production organizations and with the actors in the North. Therefore, when brands are implicated in the manufacturing process, they are required to have the FLO-Cert certificate. (President, Distributor, May 2013)

With regard to the relationship between the certification body and distributors and associations (which hold a fair trade label), two different situations appear. Just like for producers, the relationship between the certification body and the fair trade association is based on contracts: We work with FLO-Cert on the basis of contracts. For coffee, we have a contract with FLO-Cert to verify the requirement criteria, governance, and the organization of the producers [producers are audited regularly] . . . We maintain the certification contract for annual controls and standards. For example, the production standards for coffee which were revised in 2011–2012. (Head of agricultural production, impact, and standards, Association-owner of a fair trade label, June 2013)

Differently, the relationship between the distributor and the certification body is not always direct. A fair trade organization (owner of a fair trade label) such as Max Havelaar may play the role of intermediary. Nevertheless, distributors may select the certification body of the producers with which they work and can themselves be certified, notably when they are importers: Producers make a commitment to live better, to make good products [natural or organic]. The fair trade is not only about a fair price, it is also about environmental aspects; not putting chemicals in organic products. We control all of these aspects. Our role is to improve the producer’s lives, to live decently, to find dignity. We respect people and nature. All of these concepts are not respected today by international politics; there’s no environmental protection. (Head of division, Distributor-A fair trade shop, March 2014) We are certified by FLO; all our coffees are certified by FLO, and we have no other certifiers for the coffee. (Director of division, Distributor and importer, 2013)

Distributors and associations (holders of a fair trade label) appear to use three of the four categories of criteria (identified in the literature on

162    M. COULIBALY and F. BLANCHOT Partner capability: Partner compatibility:

ability of the certification body to enforce fair trade standards, to create a sense of procedural justice and to assist economics actors

objectives, standards, and focus area of the certification body

Types of selection criteria

Partner commitment: not a criterion?

Partner reliability: quality of the process used by the certification body to accredit producers

Figure 6.3  Selection criteria of the certification body in the fair-trade market.

alliances) to select a certification body: capability, compatibility, and reliability. Moreover, the real criteria (which fall into the categories of criteria of our typology) are specific to the environment of fair trade (role of context as a contingency factor) (see Figure 6.3). Regarding compatibility, particular attention is paid to the choices made by the certification body in terms of objectives, standards, and focus areas (targeted products and producers). For distributors, the certification body has to certify the products they need, has to be able to collaborate with various types of producers (large and small), and to take into account not only economic dimensions but also social dimensions in its certification process (not basing the relationship solely on the price of the product). If no certification body meets all these criteria, distributors (or associations holding a fair trade label) may decide to work with more than one certification body. We work with three certifications bodies. The choice is made according to the specifications. We have no standards that belong to a public system [neither France nor the European Union]. We work with the Max Havelear label— certified fair trade Max Havelaar by an independent body, namely, FLO-Cert. Our second partner is a certification body, Fundeppo. The third is Ecocert. At the beginning, certification was done by FLO, but now we work with very small producers, so we also work with Ecocert and Fundeppo. FLO-Cert works with Max Havelaar when production is large-scale— coffee, tea, cocoa, bananas. According to the price, this certification is less good but currently better

Selecting a Certification Body in the Fair Trade Market     163 connected to the world system. We defined the prices with producers. With Ecocert, there are no standards for coffee or the cocoa; it is more the economic actor that carries the project. People recognize us more for our role as an actor and project leader. For the Producteurs Paysans label, it is specifically important to offer certification with organized grower- and agriculturefocused fair trade; a type of producer which is defined after the certification process has started. (Head of communication, Distributor, March 2014) For sugar, our project is certified according to the Max Havelaar FLO standard and Ecocert for coffee. All of the actors in our chain are certified by Ecocert according to their guidelines and specifications for our coffee production project, including production, transformation, and roasting. They are the ones who control certify us and we post our Bio fair label. (Manager, An association acting as a consultant, 2013)

Regarding reliability, particular attention is paid to the quality of the process used by the certification body to accredit (select) producers. This is an ingredient of the trust in the certification body and of the commitment of the distributor: The selection is made around an agreement and trust. An agreement is given to the cooperatives of the South by Solidaire Monde or Artisans du Monde. Three years are required before the agreement is issued because we must establish a relationship of trust, and respect the work rules of the global organization [no child labor]. Artisans du Monde also requires commitment to and trust about the agreement after the negotiation process is finished. We work with [approximately] 164 producers. It is for the more small producers. (Head of communication, Distributor-A fair trade shop, March 2014)

Regarding capability, it appears that what is important is the ability of the certification body to enforce fair trade standards, to create a sense of procedural justice, and to assist economic actors to achieve their market objectives: The certifier must be capable of converting criteria [fair trade standards] for point control. The point control guidelines used by auditors allow for equality between the different partners. There is no place for subjectivity. To work with the certifier, we must deal with everybody in the same manner. (Head of division, Association-owner of a fair trade label, March, 2013)

It doesn’t seem that credible commitments from the certification body are a selection criteria by economic actors. One possible explanation is that there is no risk of lack of commitment by the certifier. Indeed, the cost of replacing a certifier may be low, so that the pressure on the certification body to respect its commitments may be high.

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CONCLUSION Certifications bodies (e.g., FLO-Cert and Ecocert) play an essential role in the fair trade market. They verify that producers, importers, and distributors respect the general principles of fair trade. They notably control the production process (quantity, quality, sustainability of the product, respect for the environment), the payment of a minimum price, and respect for human rights (salaries, improvement of living conditions) before providing certification and, then, regularly. They also encourage collaboration and negotiation among producers. In brief, certification bodies are key agents to ensure the reliability of fair trade and to govern partnerships in this particular market. Therefore, they deserve to be selected with care by those who depend on them, namely, producers, importers, distributors, and associations holding a fair trade label. Research on alliances suggests that there are four broad categories of criteria for selecting a potential partner: strategic capability, compatibility, commitment, and reliability. Our exploratory study of the actual behavior of producers, distributors, importers, and associations holding a fair trade label attests to the (exclusive) use of these categories of criteria, with the exception of the commitment criteria. It also suggests the limited role of the producers in the selection of a certification organization. The results contribute to a better understanding of the behavior of actors in the fair trade market. They may be useful for guiding the actions of certification bodies so they are successful in the fair trade market. Moreover, these results suggest the reliability of the typology used to study how fair trade actors select a certification body. However, the exploratory nature of the study gives to our results more the character of proposals that strong conclusions. Further research on a larger scale is needed to confirm the identified behaviors. REFERENCES Ahuja, G. (2000). The duality of collaboration: Inducements and opportunities in the formation of inter-firm linkages. Strategic Management Journal, 21, 317–329. Angué, K., & Mayrhofer, U. (2010). Coopérations internationales en R&D: Les effets de la distance sur le choix du pays des partenaires [International R&D cooperation: The effects of distance on the choice of the country of partners]. M@n@gement, 13(1), 1–37. Arino, A., & de la Torre, J. (1998). Learning from failure: Toward an evolutionary model of collaborative ventures. Organization Science, 9, 306–325. Arrègle, J. L., Dacin, M. T., Hitt, M. A., & Borza, A. (2003). Les modèles de sélection des partenaires dans le cadre d’une alliance internationale: Perspectives de France et d’Europe centrale [Partners selection models in an international

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168    M. COULIBALY and F. BLANCHOT Shi, W. S., Sun, S. L., Pinkham, B. C., & Peng, M. W. (2014). Domestic alliance network to attract foreign partners: Evidence from international joint ventures in China. Journal of International Business Studies, 45, 338–362. Xia, J. (2011). Mutual dependence, partner substitutability, and repeated partnership: The survival of cross-border alliances. Strategic Management Journal, 32, 229–263. Yin, R. K. (2003). Case study research: Design and methods. Thousand Oaks, CA: Sage.

CHAPTER 7

EXPLORATION AT THE CREATION STAGE AND EXPLOITATION AT THE DISTRIBUTION STAGE Creation and Diffusion of Innovative Products in the U.S. Movie Industry Ayako Kawasaki Motonari Yamada

ABSTRACT Organizational ambidexterity, which includes both exploration and exploitation, has been a central issue in the innovation literature. Organizations pursue exploration through the creation of innovative products to adapt to tomorrow’s needs, while they also need to exploit their established resources to efficiently manufacture and diffuse their innovations. Existing literature, however, tends to focus on the manufacturing industry. Organizational ambidexterity in content industries has received relatively little attention. The content industry, however, is typical of the industry associated with ambidex-

The Practice of Behavioral Strategy, pages 169–191 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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170    A. KAWASAKI and M. YAMADA terity. The industry involves two opposite requirements: creating innovatively new products and acquiring revenues by diffusing them to consumers. These two aspects correspond to the creation associated with exploration and the diffusion associated with exploitation. Pursuing the two processes within one organization is likely to fail, since the diffusion stage involves large organizations, whereas the creation stage in the content industry requires a few core individuals, or a network of small firms combined to produce one innovative product outside the control of large companies. We therefore examine the dual structure of ambidexterity, in which one part consists of firms focusing on exploration, and the other part includes companies focusing on exploitation. By focusing on the movie industry, we investigate differences and common features between the content and manufacturing industries in terms of the focal stage in the value system. The effectiveness of this dual system is shown through case studies of the U.S. movie industry, where organizational ambidexterity is observed. A few individuals create the core of a work, and combine small firms to complete the work, and Hollywood distributors exploit their resources to diffuse products.

INTRODUCTION The British Council (2014) has defined the creative industries as “those industries that are based on individual creativity.” The creative industries consist of 13 sectors, such as art, film, music, publishing, and television and radio (British Council, 2014). The market size of the performers and creative artists industry in the United States is $27 billion (IBISWorld, 2013). Despite this large market, the creative industries have received relatively little attention in the innovations and organizations literature on organizational ambidexterity. Although there is a huge accumulation of research on the creative industries, the products perceived as innovatively new by consumers have seldom been viewed as innovation. There is some research that addresses Impressionism in the visual arts industry as an innovation (Priem, 2007; Wijnberg & Gemser, 2000). Beyond this work, however, little research has viewed innovative products in the content industry such as music, movies, or publishing as innovations. The content industry is a part of the creative industries (British Council, 2014). In this chapter “innovative” products mean products which are innovative in terms of content, rather than the technology such as recording media used to deliver that content. Research Question The source of innovativeness that corresponds to creativity in the content industry resides in a few individuals rather than in a large organization

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(Alvarez & Svejenova, 2005; Yamashita & Yamada, 2010). Thus, it is worth considering whether a large organization needs to include individuals in the organization in order to control them, or whether to let individuals have authority (autonomy) and be outside an organization. Existing literature on innovations and organizations however tends to focus on the manufacturing industry, where quite large organizations, rather than individuals, play a more critical role at the manufacturing stage. Therefore, innovation literature which highlights the manufacturing industry tends to focus on larger organizations rather than individuals or the relationships between individuals and an organization (organizational structure). There is little literature that addresses all of these three perspectives: an individual perspective, organizational perspective, and interactive process perspective. Much of the literature presents either individualist perspectives or organizational perspectives. One of the reasons why research from an interactive process perspective is seldom carried out is that existing literature has focused on the manufacturing industry that involves large organizations at the focal stage, and the individuals who are forced to sink their individuality into the large organizations. In the context of the manufacturing industry, it is not likely that conflict between an individual and an organization often happens. That is, relatively little interaction between an individual and an organization can happen. Thus, the interactive process perspective is seldom needed. The content industry, however, involves two opposite aspects that can generate conflicts and interaction: individuals who want to autonomously and freely create innovative works regardless of expense or uncertainty that the works might not sell and the large organizations which attempt to acquire revenues by efficiently diffusing these works to consumers. These two aspects correspond to the creation associated with exploration and the diffusion associated with exploitation. Pursuing the two processes within one organization is likely to fail, since the diffusion stage involves large organizations, whereas the creation stage in the content industry requires a core of a few individuals or a network of small firms organized by the core individuals to produce one innovative product outside the control of large companies. Research Purpose We therefore consider the dual structure of ambidexterity, in which one part consists of core individuals and small firms focusing on exploration, and the other part includes companies focusing on exploitation in distribution (diffusion) in the context of the content industry. We examine the effectiveness of this dual system in the content industry through case studies

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of the U.S. movie industry, where organizational ambidexterity is observed. A few individuals create the core of a work and combine with specialized small firms to complete the work, associated with exploration. Then large Hollywood distributors not engaged in the creation exploit their vast resources to diffuse the products, associated with exploitation. LITERATURE REVIEW ON INNOVATIONS AND ORGANIZATIONAL AMBIDEXTERITY The Innovation Process The innovation process includes not only the discovery of new ideas and the creation of innovative products, but also the diffusion by which these products are adopted by many groups in a social system (Rogers, 1962; Tidd, Bessant, & Keith, 2005; Utterback, 1971; Yamada, 2010). According to Zaltman, Duncan, and Holbek (1973), the innovation process is composed of two stages: initiation and implementation of innovations. The implementation stage consists of two substages: manufacturing and diffusion of innovative products. First, the initiation stage associated with exploration corresponds to R&D activities in the manufacturing industry. And the manufacturing stage where products are made in large quantities is associated with exploitation. The diffusion stage is also captured by the term of exploitation. The diffusion stage corresponds to the distribution stage in the manufacturing industry. We follow Rogers (1962) in defining diffusion of innovations as the process by which an innovation (an innovative product) is communicated from its source of creation to its ultimate users—consumers. Diffusion is defined as selling innovative products to consumers, which means that diffusion is the commercialization of innovations, corresponding to exploitation (Owan, 2006). We focus on the initiation and diffusion stage, since the manufacturing stage is not worth consideration in the context of the content industry. The creation stage of completing a work in the content industry can be viewed as the initiation stage, since the creation stage is associated with exploration characterized by terms such as risk taking, experimentation, play, flexibility, and variation. Individual Creators and Organizational Diffusion Let the innovation process mentioned above be applied to the content industry. We consider the creation stage to involve creative individuals such as composers to create the core of a work. The creation stage also involves

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supporters such as music producers who arrange or complete the work by organizing the specialized firms needed. Copying the completed work to diffuse it to consumers in the form of a CD is consistent with the manufacturing stage. This manufacturing however is not worth considering, since in the content industry the stage requires no specialized skill. We therefore disregard the manufacturing process in the content industry. This chapter views the distribution stage in the content industry as the diffusion stage. Distributors distribute tangible copies of original works such as CDs or films to retailers, or sell distribution rights such as the right to show film works in a theater to retailers at the distribution stage. This stage involves larger organizations which have accumulated resources, such as distribution channels or access to retailers, rather than smaller firms or individuals. Individuals and Organizations in the Innovation Literature and Studies in Creativity Individual, Organization, and Interactive Process Perspectives There is little literature that addresses all of these three perspectives: an individual perspective, organization perspective, and interactive process perspective. Slappendel (1996) considers the three perspectives, as noted by Kautz (2004) and Kautz and Nielsen (2004). Other frameworks present only individualist perspectives (e.g., Elliot, 1996; Fink 1998; Iacovou, Benbasat & Dexter, 1995; Thong 1999; Thong & Yap, 1996; Utomo & Dodgson 2001) or structuralist perspectives (e.g., Bagchi, Hart, & Peterson, 2004; Gefen, Rose, Warkentin, & Pavlou, 2005; Premkumar & Ramamurthy, 1995; Thong & Yap, 1995; Yao, Xu, Liu, & Lu, 2002). Slappendel (1996), however, has provided an interactive process model (Kautz & Nielsen, 2004). This model views an innovation as a dynamic phenomenon. Slappendel (1996) carried out a comprehensive literature review on innovations in organizations and showed a framework to classify the existing literature into three categories based on innovation causality: the individualist, the structuralist, and the interactive process perspectives. The individualist perspective views individuals as the main source of change and innovation. On the other hand, the structuralist perspective assumes that the characteristics of an organization to which individuals belong enable innovation. The interactive process perspective assumes that an innovation is produced by the interaction of structural influences and the action of individuals. However, Slappendel’s framework can be viewed as the only one that sufficiently considers the interactive process perspective between the individuals and organizations (organizational structure).

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One of the reasons why research from the interactive process perspective is seldom carried out is that existing literature has highlighted the manufacturing industry, which involves large organizations at the focal stage and the individuals who are forced to sink their individuality into the large organizations. The Need to Separate Individuals at the Creation Stage from a Large Organization Yamashita and Yamada (2010) suggest that the creative individuals of talent are buried in an organization, if the organization forces the unified ways of the organization on them. There is also some literature which insists that individuals at the creation stage need to keep some distance from others and play a core role (Cattani & Ferriani, 2005; Cross & Parker, 2004). Other research which analyzed the network of creators of TV programs demonstrated that the TV programs created by a project team of creators that is solely isolated from others tend to be more individual and original, and then acquire more viewers than the TV program created by larger groups of people (Soda, Usai, & Zaheer, 2004). These studies suggest that the creation stage in creative industries involves a few core individuals, and they should not have connection with too many people, which can correspond to a large organization. Organizational Ambidexterity: Exploration and Exploitation As mentioned above, the content industry involves individuals who can create more original and innovative works if they are separated from an (large) organization. The reason why the individuals in the content industry need to be isolated from many other individuals or a large organization is that the individuals tend not to be good at establishing connection with others, especially people or organizations which pursue things such as efficiency or control associated with exploitation, because of the intense individuality in the individuals associated with exploration for innovation. On the other hand, the distribution stage in the content industry requires large organizations which acquire revenues by efficiently diffusing these works to consumers by controlling many distribution channels, which is associated with exploitation. The content industry therefore has two totally opposite aspects that can generate conflicts and interaction: individuals associated with exploration who want to autonomously and freely create innovative works regardless of expense or uncertainty that the works might not sell; and the large organizations associated with exploitation which attempt to acquire revenues by efficiently diffusing these works to consumers. Some literature on innovation insists that there is great difference between the organizations facilitating exploration and the organizations

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enabling exploitation (Roberts, 2004). A dual structure of ambidexterity, in which one part consists of individuals and firms focusing on exploration, and the other part includes companies focusing on exploitation, is needed here, especially in the content industry, which has a big gap between exploration and exploitation. Organizational ambidexterity, which includes both exploration of new possibilities and exploitation of old certainties, has long been a central issue in the field of innovation literature (Holland, 1975; Kuran, 1988; Schumpeter, 1934). According to March (1991), exploration consists of things such as search, variation, risk taking, experimentation, play, flexibility, discovery, and innovation. Exploitation, on the other hand, includes things such as refinement, choice, efficiency, selection, implementation, execution, and so on. Exploitation is necessary to compete in mature technologies and markets where control and traditional, proven methods of business, are prized; while exploration is needed to compete in new technologies and markets where flexibility, risk taking, autonomy, and experimentation are needed (O’Reilly & Tushman, 2013). Ambidexterity in an organization is defined as achieving both exploration and exploitation in the organization. That is, the organization attempts to be creative and adaptable, while continuing to benefit from more traditional, established ways of business (March, 1991). Innovative Creation in the Content Industry as an Innovation Individual creativity, which the content industry is based on, is the source of the act or process of making something that is new or that did not exist before. Creation in the content industry therefore can be viewed as an innovation. An innovation is understood as an idea, practice, or object that is perceived as new by an individual or other unit of adoption (Rogers, 1962). In this chapter, innovations correspond to innovative products created based on novel ideas of creative individuals in the content industry. Another issue is that the criteria for assessing innovativeness of works in the content industry are not sufficiently delineated in the extant literature. Therefore, we refer to Wijnberg and Gemser (2000), who consider the visual arts industry, one of the creative industries, in assessing innovativeness in the content industry. Wijnberg and Gemser state that the rise of a group of painters known as the Impressionists, who were innovators, was facilitated by the selection system dominated by experts such as critics in the visual arts industry. This suggests that it is an expert experienced in the field who can appreciate the degree of innovativeness in a work. According to Wijnberg and Gemser, innovativeness is the most highly prized product characteristic in the selection system of experts such as critics or judges for an award in the field.

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This chapter therefore views the products in the content industry which are highly valued by experts as innovation. More specifically, the movies that won the most film prizes among all the top 30 films of yearly box office revenues are viewed as innovations. For example, the Academy Awards members are the most gifted and skilled artists or craftsmen in the motion picture world. And the Academy Awards are given for outstanding and extraordinary distinction in lifetime achievement, or for exceptional contributions to the state of motion picture arts and sciences (AMPAS, 2007) rather than sequels to a film that has been accepted by many consumers. Specific Phenomena Distinguishing the Creative Industry From the Manufacturing Industry Common Features of the Manufacturing Industry and the Content Industry Some of the creative industries, such as painting, where artists sell the only one original work to a buyer, cannot have a mass market distribution process. Since the content industry, which includes publishing, music, and movies, involves a distribution process by which the content of work is diffused in the form of tangible manufactured goods, such as CDs, however, the content and manufacturing industries have something in common. It is therefore apt to apply the existing perspectives on innovations and organizations literature already proved in the manufacturing industry to the content industry. Innovation of Exploration and Exploitation in the Content Industry As mentioned above, March (1991) views production as exploitation, which is supposed to be a process with relatively low uncertainty. In the manufacturing industry, this means making products in large quantity. This chapter however views the production companies in the content industry as the actors doing exploration. They do not tend to be engaged in the manufacturing process, which means the manufacturing of media like CDs, but in more creative processes associated with exploration with high uncertainty. In the content industry, the manufacturing of media is carried out by distributors. Content industries are composed of three processes: the creation, manufacturing, and distribution of innovative works. The creation stage, shown in Figure 7.1 with a black arrow, involves three actors: creative individuals, supporters of the individuals, and production companies. One work is completed by these three actors at the creation stage, associated with exploration. Creative individuals include writers, composers, or directors who create the core of works. Supporters include editors or producers who support

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Figure 7.1  The value system in the content industry.

the creative individuals in order to complete a work. Production companies carry out general work on production. For example, production companies in the movie industry subcontract their services and equipment to independent producers who organize a film project. Independent producers collect and coordinate small firms that are specialized in various areas of production, such as lighting, editing, or actors’ agents, in order to carry out a project. The production companies, which are often small, are engaged in general works, frequently established to generate just one project and then dissolved (Storper & Christpherson, 1987). As mentioned above, the core creation stage is based on a few individuals. Therefore the creation stage is characterized by “Individual Activities” as shown in Figure 7.1. On the other hand, the distribution stage with exploitation shown in Figure 7.1 is characterized by “Organizational Activities.” Distributors of content need to distribute the content in large quantity since the price of one piece of content, such as a CD, is fixed and not differentiated according to the quality of the content. Differences Between the Manufacturing Industry and the Content Industry As stated above, the main actors at the creation stage in the content industry are creative individuals and independent producers. The creation stage with exploration (Figure 7.1) is therefore characterized by individual activities rather than organizational activities. Creative individuals can create innovative works, insisting on prioritizing the so-called artistic integrity of their works if they are positioned at the top of a hierarchy. Baker and Faulkner (1991) and Yamashita and Yamada (2010) suggest that creative individuals can take the high hand with major distributors by personally assuming multiple roles in production. We therefore assume that creative individuals can hold positions at the top of a hierarchy by personally assuming multiple roles in their production (creation). However, the manufacturing

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industry tends to involve relatively larger organizations, such as R&D institutions or manufacturers even in creating just one product (a prototype). And the manufacturing stage in the manufacturing industry, where the original product is produced in large quantities, requires much more specialized skills to manufacture compared with producing just one product or prototype. There is a great difference between creating one product and manufacturing it in the manufacturing industry. The manufacturing stage is therefore considered as the focal stage of the manufacturing industry, as shown in the “The Focal Stage of an Innovation” line in Table 7.1. The manufacturing stage corresponds to exploitation in the innovation literature. Although the distribution stage in the manufacturing industry is also important, the success in manufacturing a product with complementary assets (Teece, 1986) that satisfies users’ needs nearly corresponds to the success of diffusion. That is, the skills specific to distribution are seldom required. According to Ogawa (1996) and Yamada (2010), the technologies in the manufacturing industry can be classified into two categories: engineering and skills. Since mechanization has developed well, employees who do not possess skills based on secret tips or intuition of individual experts can nonetheless manufacture products of high quality. This means that skills in using machinery are required today more than intrinsic skills of individual experts (Yamada, 2010). For this reason, the manufacturing industry involves larger organizations that have enormous facilities rather than either TABLE 7.1  Differences Between the Manufacturing and Content Industries The Manufacturing Industry

The Content Industry

The Focal Stage of an Innovation

Manufacturing with Exploitation

Creation with Exploration

What the Focal Stage Involves

Economies of Scale Achieved by Efficient Mass Production

Innovativeness and Creativity in an Individual

The Main Actors of the Focal Stage

Large Organization

Individuals (Creative Individuals and Supporters)

The Importance of Individuality of Individuals

Relatively Low

High

Characteristics of the Individuals in the Industries

Individuals Forced to Sink their Individuality and Not to Have Conflicts with an Organization

The Content Industry is Represented by these Words: Intense Individuality and Conflicts with a (Large) Commercial Organization.

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small companies without machinery or individuals with intrinsic skills. The manufacturing stage is associated with accumulated resources such as machinery or efficiency. The manufacturing process in content industries refers to copying the original as media, such as CDs or films. The manufacturing process in content industries requires no special skills. The manufacturing process therefore is not addressed in this chapter. In the manufacturing industry, (large) “organizations” rather than “individuals” carry out both the initiation stage (e.g., R&D and the implementation stage—manufacturing and diffusion). Individuals in the manufacturing industry tend to be forced to sink their individuality and not to have conflicts with an organization. The content industry, in contrast, involves the individuality of specific persons. In the content industry, the core of a work is created by individuals. Some work such as music can be completed by only one or a few individuals, such as composers in the music industry. Another difference between the content industry and the manufacturing industry is the degree of integration between the production and distribution processes. For example, Hollywood distributors are not engaged in the actual creation of works. They exploit their resources to diffuse works that they do not produce. In the manufacturing industry, however, the production and distribution processes tend to be carried out by the same actor such as an assembly maker to attain efficiency. Characteristics Specific to the Content Industry: The Important Role of Individuals Composers in the music industry, which is one of the creative industries, are creative individuals, and producers are supporters, as mentioned above. In the movie industry, directors or scriptwriters can be viewed as creative individuals and producers correspond to the supporters. Creative individuals and supporters are much more important than distributors in the content industry, since distributors cannot do anything without the work created from scratch by creative individuals and then completed by supporters. Creation of an innovation—exploration—is therefore more critical than distribution of an innovation, which corresponds to exploitation. Content industries comprise two factors: creative freedom for innovativeness and business pressures to generate products according to commercially proven models. In the first phase, creative individuals attempt to produce innovative products, which are novel and artistic works. In the second phase, the work needs to be diffused by (large) organizations commercializing it. These two processes above can be rephrased as the creation stage and the diffusion stage of innovations. The distribution stage as diffusion involves established large companies, since companies need to exploit vast

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resources, such as capabilities to carry out advertisement, various distribution channels, or access to nationwide retailers, in order to efficiently distribute products to consumers. DEFINING THE DUAL INDUSTRIAL SYSTEM FOR STRUCTURAL AMBIDEXTERITY IN THE CONTENT INDUSTRY Considering the discussion above, we can suggest that the individuals in the content industry who create innovative works are positioned at the top of a hierarchy, establishing relationships with a few individuals and small firms with the same orientation to creation. Creative individuals are placed at the top of the hierarchy (Figure 7.2), since the focal stage of the content industry is the creation stage, which is supported by individual creativity. The individuals also need to be separated from large organizations of commercialism pursuing exploitation. We present a dual system for structural ambidexterity in the content industry in Figure 7.2. This dual system at the creation stage, labeled as “Exploration for Innovative Creation” (Figure 7.2), consists of creative individuals, supporters of creative individuals, production companies, and small subcontracting firms. Although production companies are “organizations,” they are not given a strong presence in the dual system since the production companies subcontract their services and equipment to supporters who organize a project by collecting and coordinating small subcontracting firms that are specialized in various areas of creation. Production companies, which are small, are only engaged in general works related to production. Production

Figure 7.2  The industrial dual system for structural ambidexterity in the content industry.

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companies in the dual system are established to produce just one work, and then dissolved. This dual system at the distribution stage, labeled as “Exploitation of rich resources” in Figure 7.2, involves a major organization as a distributor, which has various distribution channels such as cable television used for advertising or distributing works. The bottom line is that there is disintegration between exploration at the creation stage and exploitation at the distribution stage. This disintegration enables individuals to freely create innovative products, while major organizations as distributors efficiently diffuse works to consumers. CASE STUDY OF STRUCTURAL AMBIDEXTERITY IN THE U.S. MOVIE INDUSTRY Structure of the U.S. Movie Industry: The Creation and Distribution of a Film Work The movie industry consists of four main actors: creative individuals, producers who act as supporters of creative individuals, distributors, and exhibitors (cinema owners). Creative individuals such as scriptwriters, directors, or composers, generate the core of a film work. Producers support these creative individuals by organizing a film project (Storper & Christpherson, 1987). Creative individuals and producers reside at the creation stage in the industry. Major distributors, called Hollywood companies, often bear a prominent presence in the movie industry. There are six major distribution companies: Warner Bros., Universal, Sony (Columbia), Paramount Pictures, Buena Vista (Disney), and 20th Century Fox. The other distributors in the U.S. movie industry are called independent distributors, who are small and medium-sized enterprises. Exhibitors (cinema owners) also play a critical role in the diffusion of film products, however, it is a distributor who decides the scope of the movie’s release, such as wide release, platform release, or limited release to theaters. Hollywood major distributors are not engaged in the creation of works. They exploit their resources to diffuse the works to consumers by advertising on TV or wholesaling film products to theaters or to cable TV outlets that the major distributors control. Selecting Innovative Products in the Movie Industry As stated above, an innovation process includes not only the creation of new technology or products, but also the diffusion process by which these

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technologies or products are adopted by many groups in a social system (Rogers, 1962; Tidd et al., 2005; Utterback, 1971; Yamada, 2010). We have collected data on the top 30 movie titles in the yearly box office (revenues that cinemas attained) ranking from 2010 to 2014 (Box Office Mojo, 2014). We sort the data in descending order of box office revenues per theater in order to consider whether each title is actually diffused to consumers. The ranking based on box office gross does not always provide us with proof of diffusion, since major distributors can bring great pressure to bear on numerous theaters to show their movies. In that case, box office per theater can be relatively low. We therefore use the data in descending order of box office revenues per theater. We view the movies that won the most film prizes among all the top 30 films of yearly box office revenues as innovations. The film Gravity, shown in Table 7.2, attained the most film prizes among all the top 30 films of yearly box office in 2013. Thus, we consider it one of the innovative films (innovations). We collected the four most innovative films each year from 2010 to 2013 (Table 7.3). We considered the four innovative films in these three aspects: the disintegration between the creation and distribution stages, the position of creative individuals in the hierarchy of the industry, and the manner of creation. The Disintegration Between the Creation and Distribution Stages We have examined the company credits of the four innovative films by referring to the Internet Movie Database (IMDb), a website presented by Amazon.com. We focused on production company credits to see whether major distributors are engaged in the creation (production) stage. The three films shown in shaded cells in Table 7.3 were distributed by major distributors, as indicated in the “Distributor” row. This suggests that the diffusion stage in the content industry involves large distributors in order for innovative films to be commercially successful by exploiting distributors’ resources, such as advertising budget and access to numerous theaters in or outside the United States. This can result in broad diffusion of innovative films (innovations) to consumers. The three major distributors who distributed the three innovative films shown in the “Distributor” row in the shaded cells in Table 7.3, however, were not engaged in the actual creation process, as shown in the “Major Distributors as Production Companies (Credits)” row in Table 7.3. A cross mark in the row in Table 7.2 and Table 7.3 indicates that the films did not involve major distributors in the production company credits. This means that the major distributors were not engaged in the actual creation process. The films which include major distributors as production companies in the production company credits are marked with a circle or triangle in the same row in Table 7.2 and Table 7.3. This means that the major distributors

3

1

2

4

6

1

2

3

4

5

Universal (Major)

Warner Bros. (Major)

Despicable Me 2

Gravity 3,820

4,003

4,253

Buena Vista (Major)

Iron Man 3

3,742 4,163

Buena Vista (Major)

Frozen

Theaters

The Hunger Games: Lionsgate Catching Fire

Distributor

Title

Source: AMPAS (2007), IMDb (2014), Box Office Mojo (2014)

Total Gross

Total Gross per theater

Rank

71,752

91,946

96,171

102,010

107,034

9 0 0 0 32

◯ ◯ ◯ △ △

Major Total Distributors Gross per as Production Theater Companies Awards ($) (Credits) Received

TABLE 7.2  Yearly Box Office 2013 per Theater in the United States

4(DPSE)

0

2

2

2

◯

◯

◯

◯

◯

Integration Flexibleof Roles Specialization at the at the Creation Creation Stage Stage

Exploration at the Creation Stage and Exploitation at the Distribution Stage    183

8

13

5

2011

2012

2013

6

18

13

18

Total Gross Distributor Weinstein Buena Vista (Major) Universal (Major) Warner Bros. (Major)

Title

The King’s Speech

The Help

Les Misérables (2012)

Gravity

Source: AMPAS (2007), IMDb (2014), Box Office Mojo (2014)

11

2010

Total Gross per Theater

Rank

TABLE 7.3  Yearly Innovative Films (2010–2013)

71,752

50,840

56,307

52,420

27 8 19 32

× △ △

Awards Received

×

Major Total Distributors Gross per as Production Theater Companies ($) (Credits)

4

8

2

0

Integration of Roles at the Creation Stage

◯

◯

◯

◯

FlexibleSpecialization at the Creation Stage

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were engaged in deciding the contents of works, as shown in the same row in Table 7.2. If the production company credits include the description “present” in parentheses after the names of major distributors, however, those films are marked with a triangle. Although the films marked with a triangle include major distributors as production companies, the credits include the description “present” put in parentheses, which means that the major distributors were not engaged in the actual creation process but played a role as just a financer (Table 7.2 and Table 7.3). Therefore, there is disintegration between the creation and distribution stages of four innovative films in the movie industry. The Position of Creative Individuals in the Hierarchy of the Industry We also examined whether creative individuals assume plural roles at the creation stage in order to examine where creative individuals are positioned in the hierarchy of the industry. If creative individuals play plural roles, such as directors who are also scriptwriters and producers, the creative individuals are considered to be high in the hierarchy. Integrating roles can increase individuals’ control in relation to the rational economic actors that are major distributors. This enables the individuals to insist on prioritizing the so-called artistic integrity of their works, and prevents major distributors from interfering in the creation. It means that the creative individuals in the movie industry can freely carry out exploration at the creation stage, such as experimentation, risk taking, or play, without intervention of the large Hollywood distributors, since the individuals can have more power relative to the major distributors by assuming multiple roles at the creation stage. Integrating roles at the creation stage is observed in the data of the three innovative films in shaded cells, as shown in the “Integration of Roles at the Creation Stage” row in Table 7.3. The number 0 in the “Awards Received” row in Table 7.2 indicates that the films did not win any honorable film prizes. The values in the “Integration of Roles at the Creation Stage” row in Table 7.2 tend to be low, between 0 and 2, in the data of these films with no film prizes. The film Gravity, shown in Table 7.2, on the other hand, includes the high value of four in the “Integration of Roles at the Creation Stage” row in Table 7.2. This means that Alfonso Cuarón, who is the director of the film, also plays other roles, such as scriptwriting, editing, and producing (IMDb, 2014). The film Gravity won the most film prizes among all the top 30 films of yearly box office revenues in 2013, as shown in the “Awards Received” row in Table 7.2. This is because personally assuming several roles in the creation of the film enabled the creative individual to be positioned at the top of the hierarchy and allowed him to insist on prioritizing the artistic integrity of his works, preventing major distributors from interfering in the creation.

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Manner of Creation All of the four most innovative films were created by small specialized firms in each area of creation such as lighting, editing, or actors’ agency, associated with flexible specialization. The four most innovative films are marked with circles in the “Flexible Specialization at the Creation Stage” row in Table 7.3. The firms in the “Small Specialized Firms (Specialize in Actual Production)” category in Table 7.4 were engaged in the actual creation of the work Les Misérables. Their scale of output is limited and the scope of their activities tends to be narrow since the firms are relatively small. These firms were organized by a core of a few individuals, a couple of independent producers to create just one innovative film product. This means that the creation stage in the U.S. movie industry is characterized by individual activities since the creation stage is based on a few individuals. The creation stage in the content industry can be represented by terms such as risk taking, experimentation, play, flexibility, innovation, and variation. This corresponds to exploration, as noted by March (1991). If large organizations were engaged in the creation in the content industry as a large and organizational process, they would seldom take high risks, pursuing efficiency with their rigid organizational structures. This leads to lack of flexibility, variation, and innovation. TABLE 7.4  Company Credits for Les Misérables Production Companies (Specialize in General Works) Universal Pictures (Presents) Relativity Media (in Association with) Working Title Films Cameron Mackintosh Ltd. (as Cameron Mackintosh) Distributors Universal Pictures (2012) (UK) (Theatrical) Small Specialized Firms (Specialize in Actual Production) Double Negative (Visual Effects) The Mill (Visual Effects) Utopia (Visual Effects) Snow Business International (Snow Effects) (Uncredited) Vox Barbarae (Dialect Coaching) Feet ‘n Frames (Foley) Royal Shakespeare Company (Original London Production) Dakota Music Services (Music Preparation) Firstep Productions (Production Services: France) ACS France (Aerial Equipment Provided by) ARRI Lighting Rental (Lighting Equipment) Source: IMDb (2012)

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Although production companies are shown in Table 7.4, they specialized in generic tasks, subcontracting their services and equipment to an independent producer who organized the film project. The company credit of “Universal Pictures (Presents)” shown in the “Production Companies (Specialize in General Works)” category in Table 7.4 indicates that Universal Pictures was not engaged in the actual creation process but played a role as just a presenter engaged in financing and distribution. Table 7.4 therefore suggests the disintegration between the creation and distribution stages of innovative products in the movie industry. We can therefore apply the dual industrial system for structural ambidexterity shown in Figure 7.2 to the U.S. movie industry. The industry consists of two parts: one part consisting of creative individuals and SMEs focusing on exploration, and the other part including large companies focusing on exploitation. The square “Exploration for innovative creation” in Figure 7.3 indicates that the exploration process in the U.S. movie industry involves creative individuals, such as “Directors, Writers, Composers,” supporters shown as “Producers,” SMEs shown as “Subcontracting Firm A, B, and C” and “Production Companies” shown in Figure 7.3. The exploration process can be characterized by individual activities since the creative individuals assuming plural roles take the initiative in creating innovative works, and a network of subcontracting SME firms are organized by producers who are “individuals” independent of large organizations. On the other hand, the distribution stage shown as “Exploitation of rich resources” in Figure 7.3 involves large distribution companies. In order for innovative works to be commercially successful, works in the content industry need to be distributed in large quantity since the price of one piece of content is fixed and not differentiated according to the quality of the content.

Figure 7.3  The industrial dual system for structural ambidexterity in the U.S. movie industry.

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The ranks based on total gross per theater of the four innovative films shown in the “Rank–Total Gross per Theater” row in Table 7.3 were all in the top 20. And three of the four innovative films were distributed by major distributors as presented in the “Distributor” row in Table 7.3. This implies that the distribution by major distributors enables broad diffusion of innovative works to consumers. The dual industrial system for structural ambidexterity (Figure 7.2 and Figure 7.3) therefore includes “Major Distributors.” The disintegration between creation and distribution of innovative works however are represented by the discontinuities of the triangles in Figure 7.2 and Figure 7.3. Creative individuals or supporters of creative individuals contract with distributors to sell distribution rights of each film product through negotiation. This means that the creation and distribution stages are not integrated within an organization and are vertically disintegrated. Personally assuming plural roles enables disintegration, which means that creative individuals can outdistance major distributors who are likely to interfere in the creation by assuming plural roles. This enables creative individuals to increase bargaining power over major distributors. It means that the creative individuals in the movie industry can freely carry out exploration at the creation stage, such as experimentation, risk taking, or play. CONCLUSIONS AND FUTURE RESEARCH The effectiveness of the dual system of our framework is shown through case studies of the U.S. movie industry, where organizational ambidexterity is observed. A few individuals freely create the core of a work and flexibly combine with small specialized firms to complete the work. Hollywood distributors then exploit their resources to diffuse the products. The results of this case study suggest that there is disintegration between the creation and distribution stages of innovative products in the movie industry. This means that the exploration and exploitation processes need to be separated in the content industry to create and diffuse innovative works. The content industry involves two opposite aspects that can generate conflicts and interaction: individuals with intense individuality who want to autonomously and freely create innovative works regardless of expense or uncertainty that the works might not sell and large organizations which attempt to acquire revenues by efficiently diffusing these works to consumers. These two aspects correspond to the creation associated with exploration and the diffusion associated with exploitation. Pursuing the two processes within one organization is likely to fail, since the diffusion stage involves large organizations, whereas the creation stage in the content industry requires a few core individuals outside the control

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of large companies. The perspective of individuals and of the disintegration between individuals and large organizations has received relatively little attention, since the existing literature on innovations has focused on the manufacturing industry. REFERENCES Academy of Motion Picture Arts and Sciences (AMPAS). (2007). Academy awards voting. Retrieved May 25, 2014, from https://web.archive.org/web/20070515005245/ http:/www.oscars.org/aboutacademyawards/voting01.html Alvarez, J. L., & Svejenova, S. (2005). Sharing executive power: Roles and relationships at the top. Cambridge, UK: Cambridge University Press. Bagchi, K., Hart, P., & Peterson, M. F. (2004). National culture and information technology adoption. Journal of Global Information Technology Management, 7(4), 29–46. Baker, W. E., & Faulkner, R. R. (1991). Role as resource in the Hollywood film industry. American Journal of Sociology, 97, 279–309. Box Office Mojo. (2014). Yearly box office. Retrieved May 15, 2014, from http://www. boxofficemojo.com/yearly/ British Council. (2014). Creative industries/Creative economy. Retrieved May 18, 2014, from http://creativecities.britishcouncil.org/creative-industries/ what_are_creative_industries_and_ccreativ_economy Catani, G., & Ferriani, S. (2005, June 30). A relational perspective on individual creative performance: Social networks and cinematic achievements in the Hollywood film industry. The 21st 2005 EGOS (European Group for Organizational Studies) Colloquium, Berlin, Germany. Cross, R. L., & Parker, A. (2004). The hidden power of social networks: Understanding how work really gets done in organization. Cambridge, MA: Harvard Business School Press. Elliot, S. R. (1996). Adoption and implementation of IT: An evaluation of the applicability of Western strategic models to Chinese firms. In K. Kautz & J. PriesHeje (Eds.), Diffusion and adoption of information technology (pp. 15–31). London, UK: Springer. Fink, D. (1998). Guidelines for the successful adoption of information technology in small and medium enterprises. International Journal of Information Management, 18, 243–253. Gefen, D., Rose, G. M., Warkentin, M., & Pavlou, P. A. (2005). Cultural diversity and trust in its adoption: A comparison of potential e-voters in the USA and South Africa. Journal of Global Information Technology Management, 13(1), 54–78. Holland, J. H. (1975) Adaptation in natural and artificial systems. Ann Arbor: University of Michigan Press. Iacovou, C. L., Benbasat, I., & Dexter, A. S. (1995). Electronic data interchange and small organizations: Adoption and impact of technology. MIS Quarterly, 19, 465–485.

190    A. KAWASAKI and M. YAMADA IBISWorld. (2013). Performers & creative artists in the US: Market research report. Retrieved May 20, 2014, from http://www.ibisworld.com/industry/default. aspx?indid=1637 IMDb. (2012). Les Misérables. Retrieved from http://www.imdb.com/title/ tt1707386/?ref_=nv_sr_1 IMDb. (2014). IMDb: Movies, TV and celebrities. Retrieved May 10, 2014, from http:// www.imdb.com/ Kautz, K. (2004). The enactment of methodology: The case of developing multimedia information systems. The 25th International Conference on Information Systems, Washington, DC. Kautz, K., & Nielsen, P. A. (2004). Understanding the implementation of software process improvement innovations in software organizations. Information Systems Journal, 14(1), 3–22. Kuran, T. (1988). The tenacious past: The theories of personal and collective conservatism. Journal of Economic Behavior and Organization, 10, 143–171. March, J. G. (1991). Exploration and exploitation in organizational learning. Organization Science, 2, 71–87. Ogawa, E. (1996). The management of starting a new business. Tokyo, Japan: Chuo Keizaisha. O’Reilly, C. A., & Tushman, M. L. (2013). Organizational ambidexterity: Past, present and future. Academy of Management Perspectives, 27, 324–338. Owan, H. (2006). Organizations that support innovations. Aoyama Management Review, 10, 43–53. Premkumar, G., & Ramamurthy, K. (1995). The role of interorganizational and organizational factors on the decision mode for adoption of interorganizational systems. Decision Sciences, 26, 303–336. Priem, R. L. (2007). A consumer perspective on value creation. Academy of Management Review, 26, 22–40. Roberts, D. J. (2004). The modern firm. New York, NY: Oxford University Press. Rogers, E. M. (1962). Diffusion of innovations. New York, NY: Free Press. Schumpeter, J. A. (1934). The theory of economic development. Cambridge, MA: Harvard University Press. Slappendel, C. (1996). Perspectives on innovation in organizations. Organization Studies, 17, 107–129. Soda, G., Usai, A., & Zaheer, A. (2004). Network memory. Academy of Management Journal, 47, 893–906. Storper, M., & Christpherson, S. (1987). Flexible specialization and regional industrial agglomerations: The case of the U.S. motion picture industry. Annals of Association of American Geographers, 77(1), 104–117. Teece, D. J. (1986). Profiting from technological innovation: Implications for integration, collaboration, licensing and public policy. Research Policy, 15, 285–305. Thong, J. Y. L. (1999). An integrated model of information systems adoption in small businesses. Journal of Management Information Systems, 15(4), 187–214. Thong, J. Y. L., & Yap, C. S. (1995). CEO characteristics, organizational characteristics and information technology adoption in small businesses. International Journal of Management Science, 23, 429–442.

Exploration at the Creation Stage and Exploitation at the Distribution Stage    191 Thong, J. Y. L., & Yap, C. S. (1996). Information technology adoption by small business: An empirical study. In K. Kautz & J. Pries-Heje (Eds.), Diffusion and adoption of information technology (pp. 160–175). London, UK: Chapman & Hall. Tidd, J., Bessant, J., & Keith, P. (2005). Managing innovation: Integrating technological, market and organizational change (3rd ed.). New York, NY: Wiley. Utomo, H., & Dodgson, M. (2001). Contributing factors to the diffusion of IT within small and medium-sized firms in Indonesia. Journal of Global Information Technology Management, 4(2), 22–37. Utterback, J. M. (1971). The process of technological innovation in the firm. Academy of Management Journal, 14, 75–88. Wijnberg, N. M., & Gemser, G. (2000). Adding value to innovation: Impressionism and the transformation of the selection system in visual arts. Organization Science, 11, 323–329. Yamada, M. (2010). Management of technology in manufacturing firms. Tokyo, Japan: Chuokeizaisha. Yamashita, M., & Yamada, J. (2010). A sense of solidarity that guides careers of producers: Strategic collaborative organization of creative individuals in the Japanese film industry. Tokyo, Japan: Hakutou Shobou. Yao, J. E., Xu, X., Liu, C., & Lu, J. (2002). Organizational size: A significant predictor of its innovation adoption. Journal of Computer Information Systems, 43(2), 76–82. Zaltman, G., Duncan, R., & Holbek, J. (1973). Innovations and organizations. New York, NY: Wiley.

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CHAPTER 8

BEHAVIORAL STRATEGY AND RESOURCE-BASED THEORY An Application and Implications Mona Rashidirad Ebrahim Soltani Hamid Salimian

ABSTRACT As a platform for gaining and sustaining competitive advantage, resourcebased theory (RBT) has been the most prevailing and dominant paradigm in strategic management over the past several decades. RBT persuades firms to gain competitive advantage through strategic resources, capabilities, and distinctive competencies. Despite its widespread application and its potential for value creation, it has faced criticism on multiple fronts. For example, RBT has failed to explain the way firms could apply resources and capabilities and translate them into a sustained competitive advantage. In particular, it has been criticized on the grounds that it is more of a tautological nature, thereby lacking sufficient normative contribution to effective decision making in firms. Whilst these criticisms are valid from both theoretical and empirical perspectives, we argue that RBT has greater potential to offer new insights into the transformation of a short-term into a sustained competitive advan-

The Practice of Behavioral Strategy, pages 193–212 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

193

194    M. RASHIDIRAD, E. SOLTANI, and H. SALIMIAN tage. In this respect and in an attempt to further utilize the potential of RBT in assisting firms to a level of sustained performance above average returns, this chapter aims to explore RBT from a behavioral strategy perspective. Such revisit of RBT is important, as behavioral strategy theorists continue to point to the firms’ heterogeneous character, which could question the effectiveness of RBT on creating an appropriate economic value. The current competitive economy, which requires more rational calculations in strategic decision making, leaves even more scope for a such revisit of RBT as very few corporatelevel strategic decision makers seem to take into account the inherent cognitive biases in their decision making processes.

INTRODUCTION Why do some firms outperform others? What do firms take into account when they make strategic decisions? What does explain the differences between firms’ performance? These are some of the long-established questions in the strategic management literature which have attracted the attention of many organizational theorists and scholars. Over the past several decades, strategic management scholars have made concerted efforts to attend to these questions by gaining insights from a range of organizational theories and offering a number of important insights into how firms as heterogeneous entities with their particular and unique resource bases (Helfat & Peteraf, 2003; Szulanski, 2003) can maintain a sustained level of performance. Of these theories, RBT has been often cited and applied as a dominant theoretical lens to assist organizations to gain a competitive advantage based on the utilization of a bundle of valuable (in)tangible resources at the firm’s disposal (Crook, Ketchen, Combs, & Todd, 2008; Wernerfelt, 1984) and translating a short-run into a sustained long-term competitive advantage through heterogeneous resources that are not perfectly mobile (Barney, 1991; Drnevich & Kriauciunas, 2011; Kunc & Morecroft, 2010). Since its inception, RBT has remained a central topic in the general and strategic management literature as an important topic of empirical research and theorizing (e.g., Lockett, Thompson, & Morgenstern, 2009; Soto Acosta, Colomo-Palacios, & Loukis, 2011; Wade & Hulland, 2004). Despite such surge in interest in the study of RBT in terms of the characteristics of resources (Barney, 1991), capability development (Helfat & Peteraf, 2003) and methodologies (Grant, 1991), they have left room for further exploration of its underlying paradigm. More specifically, RBT has remained unclear in responding to some of the long-established critiques of its focus on internal factors as well as underscoring the importance of individual and organizational cognitive and psychological bases of managerial decisions. The latter implies the need to ground a resource-based perspective based upon some realistic assumptions about human and organizational

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cognition and social interaction (Powell, Lovallo, & Fox, 2011). This study makes an attempt to present a critical review of RBT through the lens of behavioral strategy (Bromiley & Rau, 2014; Levinthal, 2011). In other words, the idea is to gain insights from cognitive and social psychology (coupled with the assumption of RBT) to inform both the theory and practice of strategic management. Behavioral strategy approach builds upon and merges several fields (e.g., psychology, social sciences, business intelligence) to explain why some firms can outperform whilst others underperform in the same market environment and industry for a short or prolonged period of time (see Powell et al., 2011). Although these two approaches have emerged from two different schools of thought, they share several similarities (Pitelis, 2007) and therefore can be viewed partially complementary in nature. Such complementary nature of RBT and behavioral strategy and the degree that they can enhance each other have paved the way for strategic management scholars and practitioners to search for the potential synergistic nature of the two approaches for effective strategic decision making. This chapter therefore aims to present a systematic review of RBT and the manner in which the notion of behavioral strategy can aid RBT to overcome its limitations and enhance its potential to influence a firm’s heterogeneity and bring about sustainable competitive advantage. This chapter is organized as follows: First, it presents a review of RBT as one of the predominant theories of strategic the management field. Next, it outlines the major limitations and shortcomings of RBT. Then it discusses the nature and significance of a behavioral approach to strategy formulation and execution. The chapter concludes with the implication of behavioral strategy for RBT and several suggestions for further research. RESOURCE-BASED THEORY (RBT) The Origin and Nature of RBT RBT is viewed as a management device which assists a business to evaluate its strategic assets to further gain a long-run competitive advantage (Helfat & Peteraf, 2003). This general definition of RBT, coupled with the availability of supportive empirical and theoretical evidence, highlights the very idea of RBT to be of economic value (Crook et al., 2008; Lockett & Thompson, 2001). A firm’s assets refer to those valuable (in)tangible resources that a firm possesses (see Rumelt, 1984; Wernerfelt, 1984). To assist firms to gain a long-run competitive advantage, resources must be heterogeneous in nature in the sense that they are not perfectly mobile nor perfectly imitable or substitutable (Barney, 1991). Assuming this to be the

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case, it is then expected that a firm’s bundle of resources are to bring about a sustained competitive advantage (see Crook et al., 2008). RBT signals that a firm should first identify its potential key resources and then assess whether these resources fulfill the following four criteria (referred to as VRIN or VRIO framework in the extant strategic management literature): valuable, rare, inimitable, and nonsubstitutable or valuable; rare; inimitable; and organized (Amit & Schoemaker, 1993; Barney, 1991). The clearest expression of this position is found in, among others, Barney (1991) and Grant’s (1991) discussion of the RBT of the firm: a firm’s resources represent the cornerstones of a sustained competitive advantage (see also Helfat & Peteraf, 1993). Under this interpretation, “resources” have two subcategories of “resources” and “capabilities.” According to the RBT literature (see Amit & Schoemaker, 1993; Sirmon, Hitt, & Ireland, 2007), “resources” are those assets which are tradable and nonspecific to the firm. As Makadok (2001) succinctly puts it, “Resources are stocks of available factors that are owned or controlled by the organization.” Capabilities, on the other hand, concern “an organization’s capacity to deploy resources” (p. 388). Capabilities are therefore used to signal “a special type of resource, specifically an organizationally embedded non-transferable firm-specific resource whose purpose is to improve the productivity of the other resources possessed by the firm” (p. 389). A review of the research on RBT and an analysis of firms’ internal resources and capabilities which can create a source of sustained competitive advantage indicate that VRIN criteria are individually necessary but not sufficient to maintain a sustained long-term competitive advantage for a firm. According to Barney (2001), competitive advantage of a firm is the dependent variable and is influenced by the degree to which a firm’s resource fulfills each of the four criteria which in turn represents the likelihood of a resource to be a source of sustainable competitive advantage (see Priem & Butler, 2001). Theoretically, the central premise of RBT builds its intellectual foundations on several theories and research streams, namely, the theory of imperfect competition (Robinson, 1933), the theory of monopolistic competition (Chamberlin, 1933, 1937), and the theory of firm growth (Penrose, 1959; see also Wernerfelt, 1984). RBT puts forth the idea that a firm must be seen as a bundle of heterogeneous (not homogeneous) resources and capabilities if it plans to achieve and sustain competitive advantage through the deployment of its resources (Penrose, 1959; Sirmon & Hitt, 2003; Wernerfelt, 1984). Focusing on the firm (as opposed to individual or industry) level, RBT aims to aid managers to explicate the significant value of individual skills and capabilities in order to create value for firms (Caldeira & Ward, 2003; Maijoor & Witteloostuijn, 1996). In fact, by putting both vertical integration and diversification into a new strategic light (Teece, Pisano, &

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Schuen, 1997), RBT paves the way for firms to effectively utilize their resources and capabilities and gain a long-term competitive advantage. As an internally driven strategy development approach, RBT has the potential to contribute to strategy formulation and is therefore adaptable to the current thinking of strategy development of firms in the sense that the importance of internal possessions of firms are emphasized as integral to the core performance of businesses and a driver for reinforcing their future strategies (Spanos & Lioukas, 2001). RBT has been extended by Grant (1991) to encompass competitive strategy. According to Grant, RBT links competitive strategies and capabilities to value creation. To further express the essence of the RBT of competitive advantage and highlight a need for adopting a more dynamic approach towards RBT, Grant posits that capabilities not only need to be considered as the base for developing competitive strategies but also are renewed and adjusted by a firm’s strategy to respond to shifts in the volatile business environment. In short, RBT has been the dominant paradigm in strategic management over the past several decades (Lockett et al., 2009; Sirmon & Hitt, 2003). It adopts an inward-looking approach to strategy formulation and encourages firms to compete based on their strategic resources, capabilities, and distinctive competencies to establish a competitive advantage. It has been utilized as a theoretical lens and point of reference by many organizational scholars and practicing managers to gain and sustain a long-term competitive advantage (Montealegre, 2002). Despite its strengths and advantages, it has received several points of criticism (see Priem & Butler, 2001), which are discussed in the following section. The Criticism and Limitations of RBT Although RBT has become an acceptable and valuable theory to describe the importance of resources and capabilities to the strategic positioning of firms (e.g., Caldeira & Ward, 2003; Gruber, Heinemann, Brettel, & Hungeling, 2010; Jeremy, 2005; Newbert, 2007; Santhanam & Hartono, 2003), it has been subject to several criticisms, as follows. First, in the development and refinement of RBT, there has been an overemphasis on the characteristics of resources and capabilities which could create competitive advantage for a firm (Daniel & Wilson, 2003; Maijoor & Witteloostuijn, 1996; Mata, Fuerst, & Barney, 1995; Melville, Kraemer, & Gurbaxani, 2004). It is a moot point, however, whether these characteristics are inclusive and result in a sustained competitive advantage for a firm. For instance, Barney (1991) argues that while rare resources may provide a firm with a temporary competitive advantage, imperfectly imitable and nonsubstitutable resources may confer sustained competitive advantages. Fahy and

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Hooley (2002) talk about the potential of a resource in value creation for customers as an important criterion in strategic decision making in a firm. The research on RBT has also placed a heavy emphasis on those individual resources and capabilities which have a positive (in)direct impact on performance (e.g., Eikebrokk & Olsen, 2007; Lu & Ramamurthy, 2011; Mahmood, Zhu, & Zajac, 2011). In the extant literature on strategic management, the emphasis on individual resources and capabilities (as opposed to the “whole”) as the main constituents of sustained firm performance and a firm’s competitive advantage has been referred to as the reductionistic paradigm. The basic premise of this paradigm is that we need to study, analyze, and understand the impact of each of the firm’s resources and capabilities on the firm’s performance in order to make decision on the contribution of individual resources and capabilities toward firm performance and its competitive advantage. A review of the extant research on the application of RBT shows that a reductionistic approach has been the dominant approach in that each of the individual resources and capabilities and their impact on the firm performance and achieving a competitive advantage are explored individually and in isolation without regard to the whole and aggregate impact of the resources and capabilities altogether (Fink, 2011). For instance, several studies have empirically admitted the positive contribution of specific resources (e.g., Galbreath, 2005; Ndofor, Sirmon, & He, 2011) and capabilities (e.g., Mithas, Ramasubbu, & Sambamurthy, 2011; Parmigiani & Holloway, 2011) on performance. The adoption of a reductionistic approach has however resulted in different interpretations of and inconsistency in the research findings related to the impact of individual resources and capabilities on organizational performance. This finding accords with the one of the main critiques of the traditional view to RBT in that it has been criticized due to its tautological nature (Lockett et al., 2009). This critique highlights the lack of normative implications of RBT for managers (Gruber et al., 2010) with regard to the nature of competitive strategies or which resources and capabilities are more likely to bring about a competitive advantage for the firm. Although there is little research on examining the role of competitive strategies along with capabilities on performance (e.g., Parnell, 2011; Rashidirad, Soltani, & Salimian, 2014), the existing account has failed to examine the configuration among these constellations for the goal of obtaining superior performance. In a similar vein, some studies have highlighted the failure of RBT in explaining the manner in which firms could apply resources (Melville et al., 2004; Olavarrieta & Ellinger, 1997; Sirmon & Hitt, 2003) and translate them into a competitive advantage (Priem & Butler, 2001; Wang & Ahmed, 2007). Or as Wade and Hulland (2004, p. 108) put it, “Considerations such as how resources are developed, how they are integrated within the firm, and how they are released have been under-explored in the literature.”

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As discussed earlier, the initial focus of RBT was devoted to the possession of VRIN resources and capabilities, if the resources and capabilities are to create value and result in sustained competitive advantage (Barney, 1991; Daniel & Wilson, 2003). According to Priem and Butler (2001, p. 33), “Although RBT began as a dynamic approach emphasizing change over time, . . . much of the subsequent literature has been static in concept.” The traditional static view of RBT is not able to explain how strategic resources and capabilities can be integrated and renewed aligned with competitive strategies in the current changing environment. From the static point of view, the firm’s resources and capabilities are also exploited to create opportunities or neutralize threats in the market (Grant, 1991). To some extent, these characteristics and assumptions of a static view toward RBT have limited its wider application in the broad field of strategic management. In the light of the ongoing changes in the competition rules and business environment, the traditional focus of RBT has shifted from VRIN resources and capabilities to a particular type of capabilities, known as “dynamic capabilities” (Teece & Pisano, 1994). As Ambrosini and Bowman (2009, p. 32) have pointed out, “If a firm possesses VRIN resources but does not use any dynamic capabilities, its superior returns cannot be sustained.” Thus, in contrast to the traditional version of RBT, dynamic capabilities have become substantial requirements for any value creation decision making in firms. The notion of dynamic capabilities (Vogel & Güttel, 2012) enables scholars to trace how firms can change their strategic resources over time and keep their competitive advantage. They are developed to enable firms to identify opportunities/threats in the market to exploit/neutralize them by firms’ recourses and capabilities (Teece, 2010). In the light of the limitations of a static or traditional view toward RBT and the need to adopt a more dynamic approach toward a firm’s strategic resources and capabilities as a platform for its competitive advantage, this chapter puts forth the idea of a behavioral approach to strategy development. A behavioral approach assists a firm to dynamically develop, renew, integrate, and reconfigure its resources, capabilities, and core competencies to achieve competitive advantage (Wade & Hulland, 2004). A discussion of this approach and its contribution to strategy development constitutes the focus of the next section. THE ECONOMIC AND BEHAVIORAL APPROACHES IN STRATEGY DEVELOPMENT There are two main perspectives to develop strategy: economic and behavioral. The economic approach can be divided into two main views: environmental and organizational views (Yang, Wu, Shu, & Yang, 2006). The environmental point of view has its roots in Environment-Strategy-Structure (ESS).

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It suggests that firms need to adjust and determine their internal attributes in such a way as to meet the challenges posed by the external environment. That is, firms can achieve competitive advantage by using externally driven or market-focused strategies. During the decades of the 1970s to the 1990s, environmental analysis, particularly the industrial part, was at the center of consideration in strategy development (Lynch, 2003). The organizational perspective has its roots in RBT. According to this theory, firms can compete and achieve competitive advantage through their strategic resources, capabilities, and distinctive competencies. That is, the primary source of competitive advantage for firms stems from their ability to develop internally driven (or resource-based) strategies. RBT relies in the main on the individual resources of the firm (as opposed to the market-based view of environmental scholars). Spanos and Lioukas (2001) argue that the current and perhaps the future approach to strategy development and formulation is largely based on past resources of firms as a platform to reinforce their future strategies. One explanation is that firms may have a wide range of deployment strategies to choose in response to recognizing and seizing external opportunities in the business environment. However, the past and current established set of resources and capabilities of firms could limit their plausible strategy options. A behavioral approach to strategy formulation, on the other hand, seems to be a more viable option available to firms if they are to succeed and effectively compete in today’s ever-changing business environment (Levinthal, 2011). While each of the two economic and behavioral approaches to strategy formulation has their own strengths and weaknesses, the way forward is to develop a more integrated approach to strategy-making process (Levinthal, 2011). Yang et al. (2006) argue that the most systematic, comprehensive, and intelligent view to strategy development is to adopt a holistic approach to strategy formulation based on a combination of both approaches. A holistic approach to strategy formulation advocates a balance between both internal and external views. To elaborate on the nature and peculiarities of a holistic approach to strategy formulation, we start our discussion with a definition and the fundamentals of behavioral strategy. We then explain how a combination of both economic and behavioral approaches could result in a more robust approach to strategy formulation. BEHAVIORAL STRATEGY Definition For over a decade, several scholars have criticized strategic management literature due to its lack of human cognitive (Winter, 2012). In response to this shortcoming, there have been some recent attempts to merge cognitive

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and social psychology with strategic management theory and practice (Powell et al., 2011, p. 1369). Traditionally, the behavioral approach is rooted in the work of Simon (1945, 1955), March and Simon (1958), and Cyert and March (1963). The primary focus of behavioral strategy is on human cognitive capacity and artificial intelligence as mechanisms for problem solving in firms. Since Simon’s pioneering work, various definitions have been proposed by different scholars and practitioners. According to Gavetti (2012, p. 267), “Behavioral refers to the psychological underpinnings of a given phenomenon, where psychological broadly denotes being about mental processes.” Greve (2013) points out that behavioral strategy should not be simplified as a cognitive strategy, not least because it involves more sophisticated organizational processes, policies, and procedures. It integrates cognitive psychology with the existing theories and practices of strategic management (Powell et al., 2011). Viewed in this way, “behavioral strategy aims to bring realistic assumptions about human cognition, emotions, and social behavior to the strategic management of organizations and, thereby, to enrich strategy theory, empirical research, and real-world practice” (Powell et al., 2011, p. 1371). Under this interpretation, behavioral strategy endeavors to open the black box of firms to investigate the social and cognitive psychology of firms’ decision makers. Despite the surge of interest in the notion of behavioral strategy, the existing literature seems to suffer from an agreed-upon statement of purpose, underlying assumptions and a conceptual framework. This is the view of Powell et al., (2011), who argue that the aims and scope of behavioral strategy are still not well defined. More recently, the emerging field of behavioral strategy has gained incredible attention from strategic management scholars (e.g., Schrager & Madansky, 2013). Bromiley and Rau (2014) offer eight key assumptions of behavioral strategy, including (a) bounded rationality, (b) time and resource constraints, (c) multiple goals, (d) perceptions and biases, (e) motivation, (f) learning, (g) groups and teams in organizations, and (h) optimum is unknown. The following section explains each of these assumptions in more detail. Foundations of Behavioral Strategy Bounded rationality is the fundamental assumption of behavioral strategy. This term was firstly introduced by Simon (1955), who argues that the capacity of human beings needs to be taken into account in any strategic decision. This is because decision making is not a theoretical, but more practical process, which involves some levels of urgency (Schrager & Madansky, 2013). Therefore, the optimum strategy is not always sought and decision makers

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may be satisfied by a good enough choice (Ees, Gabrielsson, & Huse, 2009). In contrast to economic rationality, the proponents of RBT argue that since decision makers have a limited information-processing capacity, they are usually satisfied with a good option rather than seeking for an optimal option. The notion of bounded rationality captures the limitations that exist in the real world in the sense that it raises our awareness of the fact that individual decision makers may not have perfect access to the comprehensively realtime information in every strategic situation. But, as Ees et al. (2009) argue, rationality costs, as it demands applying some rational rules. Time and resource constraints are the second key assumption of behavioral strategy (Bromiley & Rau, 2014). This assumption implies that since a firm’s resources of all kinds (e.g., financial, physical, human, knowledge, and technological) are limited, decision making should factor in this constraint. Time and resource constraints influence a firm’s bounded rationality in such a way that individual decision makers are constrained by the available limited resources and therefore their inability to make optimal decisions. The third assumption of behavioral strategy is multiple goals. Firms have multiple and sometimes conflicting goals. Different stakeholders (e.g., management, employees, suppliers, partners, and customers, to name but a few) look to their own interests, which may be in a conflict with others. In contrast to RBT, which postulates that firms seek to maximize their value generation for their stakeholders and create a competitive advantage in the market, a behavioral approach to decision making considers various, often conflicting, goals of firms. Hence, a behavioral approach concerns not only the importance of profitability, but also it makes an attempt to capture a more realistic view of firms. In more accurate language, a behavioral approach to strategic decision making signals the need for understanding a firm as a complex system of people who may aim for both individual and organizational goals. Perceptions and biases are known as the other foundations of behavioral strategy. As a soft discipline, the field of strategy seems to lack a clear definition and well-bounded characteristics (Bromiley & Rau, 2014). This is partially because managers have different perceptions about different strategic issues and priorities. For instance, while a strategic change might be considered as a crucial threat to an individual, another decision maker may denote it as an opportunity. As a result of managers’ limited informationprocessing capacity and limited access to organizational resources, they are likely to be diverse in their decision making under different circumstances. In addition to differences in managerial perceptions and biases, motivation (including a firm’s reward system) can largely influence the decision makers’ attitudes toward handling different strategic issues. From a behavioral point of view, the potential impact of the individuals’ motivation on analyzing how firms make strategic decisions and why some firms outperform others should not be underestimated.

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The sixth assumption of behavioral strategy is learning, which implies that both firms and individuals change over time in terms of their behavior and belief. According to Teece (2007), learning is the ability of firms to address opportunities. It enables firms and individuals to create knowledge (Hurley & Hult, 1998). It can enhance the ability of individuals to promote their information-processing capability, which could lead to highly informed strategic decisions. Teece and Pisano (1994) view learning as a cumulative process of individual skills as well as organizational skills, which happens not only through internal and individual patterns but also by getting involved through complex problems. According to Teece and Pisano, the process of solving these complex problems has some environmental elements, which can lead a firm to learn and therefore improve the firm’s level of organizational knowledge. Teece and Pisano take the argument further by interpreting learning as “a process by which repetition and experimentation enable tasks to be performed better and more quickly and new production opportunities to be identified” (p. 10). Behavioral strategy also values working groups and teams, not least because they are the key decision makers in firms. It is the management team that defines priorities during the strategic decision process, which will affect further decisions taken downstream (Ross, Beath, & Goodhue, 1996). According to behavioral strategy view, the cognitively psychological process of individuals, especially managers and executives (i.e., top/senior management team) needs to be taken into account in strategy formulation process (Schrager & Madansky, 2013). Finally, and in contrast to the dominant economic approach, a behavioral approach views optimum as an unknown strategy. In the context of economics, rationality (as opposed to equilibrium or trade off) implies that optimal strategy should be the first priority of managers and a firm’s final decision to compete in the market. However, equilibrium or trade-off models suggest that firms can achieve a dominant competitive positioning and advantage in the market through lessons learned from their peers and changes in the external environment. Having reviewed the behavioral strategy and its key bases, the next section discusses how a behavioral approach to strategy formulation could enhance one’s understanding of RBT. BEHAVIORAL UNDERESTANDING OF STRATEGY DEVELOPMENT: A RESOURCE-BASED PERSPECTIVE As discussed earlier, RBT implies that strategies need to be developed based on a firm’s resources and capabilities, owing to the fact that they are the most reliable and enduring foundations for a firm to create and maintain

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a competitive advantage. Barney (1991) refers to (a) history, (b) causal ambiguity, and (c) social complexity as the three reasons why resources and capabilities have the potential to create a competitive advantage for a firm. Integral to Barney’s discussion is the importance and recognition of social and cognitive initiatives to the development and formulation of strategy. History implies that since some resources and capabilities have been developed and created over the time, they may not be easily copied by a firm’s competitors. This idea can be explained from a behavioral perspective, in that learning takes place at two interrelated levels: the firm and individual levels. As one of the foundations of the behavioral approach, learning is regarded as a result of a cumulative process of individual and organizational skills, which includes resources and capabilities. Causal ambiguity refers to unclear or sometimes vague processes of identification of the causes of competitive advantage within the firms. From a behavioral strategy perspective, the causal ambiguity stems from the complexity of the decision making process, which is subject to several social and psychological variables. It should be noted that these variables are not all identifiable by decision makers and that they cannot be easily controlled and smoothly processed. Social complexity refers to a situation where some resources are closely combined and integrated to create a number of more complex resources (Barney, 1991). In light of such integration and combination, it would be rather difficult for competitors to imitate the combined resources, and consequently this could bring about a sustainable competitive advantage for the firm. As is evident from the above review, the behavioral and social aspects of managing organizations and formulating effective strategies have important implications for the manner in which resources and capabilities (regarded as the building blocks of RBT) are utilized. As Grant (1991) has pointed out, resources and capabilities are different in terms of value and contribution to gaining a competitive advantage. So to achieve a sustainable competitive advantage, a firm might only focus on resources which represent high levels of history, casual ambiguity, and social complexity. For instance, resources such as physical assets, which are valuable resources, may not provide a sustainable competitive advantage, largely due to the fact that they could be easily tradable in an open market (Mathews, 2003). In other words, they do not meet the criteria of rare, inimitable, and nonsubstitutable (Reed & Defillippi, 1990). In the language of behavioral strategy, these resources (physical assets) rarely involve a high level of casual ambiguity and social complexity. Mata et al. (1995) suggest that these characteristics are the necessary requirements of every resource that is to be taken onboard by managers in their strategic analysis and decision making (Wade & Hulland, 2004). So RBT is based on the primes that only VRIN resources and capabilities are worth coming through strategic decision

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making models, as they can enable firms to achieve and sustain a competitive advantage. A behavioral perception of strategy development also places a heavy emphasis on the paramount importance of “bounded rationality” (Simon, 1991) of decision makers. That is, a manager’s strategic decision and whether it is rationale and results in a competitive advantage for a firm, in the main, relies on the degree of cognitive resources and ability to make an optimal choice from the available finite resources and capabilities of the firm. Although RBT is based on the premise that VRIN resources and capabilities should be the point of reference for formulating optimal strategies, decision makers in a real word however are constrained by limited resources, that is, including time and skills, so they often opt for a good enough (as opposed to optimal) strategy (Bromiley & Rau, 2014). In light of the behavioral scholars’ notion of “bounded rationality” and the difficulty of formulating an optimum strategy, the rationally oriented idea of RBT to select an optimum strategy needs to be modified (Levinthal, 2011). It should be noted that RBT and the behavioral approach have come from two different schools of thought, that is, prescriptive and emergent. While RBT comes from the prescriptive or normative school of thought on strategy development, behavioral strategy builds its intellectual foundations on descriptive or positive models (Bromiley & Rau, 2014). The major difference between these two paradigms is about the notion of “bounded rationality,” which is central to the behavioral approach to strategy formulation. In fact, the behavioral approach is concerned more with describing the strategy-making process rather than prescribing it in an unpractical manner. The next section outlines the implications of the behavioral approach for RBT. IMPLICATIONS OF BEHAVIORAL STRATEGY FOR RBT A review of the literature on RBT clearly indicates that it is based on the concept of economic rent. The influence of the idea of economic rent which underpins RBT however results in undermining behavioral principles and inadequate psychological grounding. The emphasis arising from RBT is to answer some of the fundamental questions of the heterogeneity of the firms (based on the deployment of different resources and capabilities) in the sense that “Why do they develop a variety of strategies?” or “Why do they perform differently in the marketplace?” In more accurate language, RBT makes an attempt to answer the question “Why do firms with the same sets of resources and capabilities compete and perform differently in the market?” These questions highlight the paramount importance of behavioral economics and moral bases for constructing corporate strategies to compete in the market. They imply that managers have different perceptions of

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the strategic issues, objectives, available options, and their own priority and cognitive biases. And more importantly, they differ in terms of their abilities and capacities in processing the available information for corporate strategic decision making. This is where the notion of economic rent which underpins RBT fails to offer a comprehensive answer. One way to overcome this limitation is to take insights from the notion of behavioral strategy, which suggests the potential of “psychology” for effective strategic decision making (Powell et al., 2011). As is evident from the above review of the literature, RBT seems to be unable to explain the heterogeneous nature of the firms or establish a platform for firms to develop effective strategies which respond to both internal needs and external challenges (Powell et al., 2011). Given the inability of RBT to offer firms a well-established grounding to explain the (behavioral) differences in their decision making and follow up different market performance, it has been heavily criticized for its failure to account for the managers’ cognitive biases or systematic tendencies to deviate from rationale calculations (see Gruber et al., 2010). Under this interpretation, a behavioral approach to strategic decision making has the potential to overcome the limits of rationality (of the notion of the economic rent) in understanding managerial behaviors in decision making. The behavioral approach is based on the premise that “firms seeking to improve their performance should begin by examining the criteria on which they judge performance, and their benchmarks for performance” (Bromiley & Rau, 2014, p. 21). It implies that superior performance is achieved to the extent to which a strategic leader is able to overcome “the behavioral bounds that make it hard for the average firm to pursue them” (Gavetti, 2012, p. 269). It adopts a realistic view to strategic managerial issues at different levels of individual, group, firm, and industry. It aims to connect individual psychology to firms’ strategies and enrich strategy theory (Powell et al., 2011). In this regard, Gavetti (2012) highlights the importance of considering senior decision makers’ mental processes in describing firms’ performance. This is because decision makers often have different, multiple, and sometimes conflicting and ambiguous objectives and preferences (see Bromiley & Rau, 2014). Despite fundamental differences between the behavioral and economic perspectives, they share some similarities which in turn leave room for further integration. According to Pitelis (2007), both approaches place a heavy emphasis on a firm’s internal environment (including a firm’s internal resources and capabilities). From the resource-based theory of the firm, internal possessions of a firm need to be understood for a conscious and effective strategic decision making process (see Duncan, Ginter, & Swayne, 1998; Eikebrokk & Olsen 2007). In a similar vein, the behavioral approach defines strategy as “a systematic behavioral pattern with some adaptive consequence” (Greve, 2013, p. 104). This highlights the need for a thorough

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understanding of the individual- and firm-level behaviors, cognitive biases of decision makers, skills, processes, procedures, and routines as prerequisites for effective and conscious strategic decision making. According to Porter (1985), the process of strategy formulation involves analyzing the following three main steps: What is the business doing now? What is happening in the environment? And what should the business be doing? Of these, the primary focus of both theories of behavioral strategy and RBT is on the first part of strategy formulation, which is to explicate what a firm does. To answer this question and further facilitate the procedures of strategy formulation, it is of paramount importance for managers to get to know a firm based upon its goals, processes, and possessions (e.g., resources and competencies). As Lynch (2003, p. 203) has pointed out, “Resources are to some extent regarded as inanimate objects without feeling. Hence, it is possible for strategy to manipulate and mold resources in order to provide a more efficient organization.” From a behavioral approach however an understanding of how these resources (including human resources) behave is crucial. Under this interpretation, Lynch argues, It is important to understand the industry, but organizations should seek their own solutions within that context. Sustainable competitive advantage then comes by striving to exploit the relevant resources of the individual organization when compared with other organizations. Relevance means the identification of resources that are better than those of competitors, persuasive to the customer and available from the range of strengths contained inside the organization. (p. 204)

In sum, the behavioral approach would enable RBT to better explicate firms’ heterogeneity through connecting individual psychology to firms’ strategies and enrich the strategy theory. To reap the synergetic benefits of the two theories, it is necessary to adopt a holistic approach to the process of strategy formulation. CONCLUSIONS The central proposition of this chapter is to investigate RBT (rooted in the concept of economic rent) from a behavioral perspective. The chapter outlines the nature and underlying assumptions of RBT, identifies its limitations, and puts forth the notion of behavioral approach as a valid response to overcoming some of the long-established critiques of RBT, inter alia, its relatively poor foundation to address firms’ heterogeneity and differences between firms’ performance as well as its inadequate cognitive and psychological grounding (see Powell et al., 2011). The chapter makes an attempt to revisit RBT from a behavioral strategy perspective in order to raise our

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psychological understanding of internally driven strategy development processes and overcome some of the major critiques of RBT. It is suggested that a holistic approach and thinking based upon both economic and behavioral principles has the potential to provide firms with a deeper level of understanding of its competitiveness at the individual, firm, and business levels. REFERENCES Ambrosini, V., & Bowman, C. (2009). What are dynamic capabilities and are they a useful construct in strategic management? International Journal of Management Reviews, 11, 29–49. Amit, R., & Schoemaker, P. J. H. (1993). Strategic assets and organizational rent. Strategic Management Journal, 14, 33–46. Barney, J. B. (1991). Firm resources and sustained competitive advantage. Journal of Management, 17, 99–120. Barney, J. B. (2001). Is the resource-based “view” a useful perspective for strategic management research? Yes. Academy of Management Review, 26, 41–56. Bromiley, P., & Rau, D. (2014). How would behavioral strategy scholarship lead to prescription? Journal of Business Economics, 84(1), 5–25. Caldeira, M. M., & Ward, J. M. (2003). Using resource-based theory to interpret the successful adoption and use of information systems and technology in manufacturing small and medium-sized enterprises. European Journal of Information Systems, 12, 127–141. Chamberlin, E. (1933). The theory of monopolistic competition. Cambridge, MA: Harvard University Press. Chamberlin, E. (1937). Monopolistic or imperfect competition. Quarterly Journal of Economics, 51(4), 557–580. Crook, T. R., Ketchen, D. J., Combs, J. G., & Todd, S. Y. (2008). Strategic resources and performance: A meta-analysis. Strategic Management Journal, 29(11), 1141–1154. Cyert, R. M., & March, J. G. (1963). A behavioral theory of the firm. Englewood Cliffs, NJ: Prentice-Hall. Daniel, E. M., & Wilson, H. N. (2003). The role of dynamic capabilities in e-business transformation. European Journal of Information Systems, 12, 282–296. Drnevich, P. L., & Kriauciunas, A. P. (2011). Clarifying the conditions and limits of the contributions of ordinary and dynamic capabilities to relative firm performance. Strategic Management Journal, 32, 254–279. Duncan, W. J., Ginter, P. M., & Swayne, L. E. (1998). Competitive advantage and internal organizational assessment. Academy of Management Executive, 12(3), 6–16. Ees, H. V., Gabrielsson, J., & Huse, M. (2009). Toward a behavioral theory of boards and corporate governance. Corporate Governance: An International Review, 17, 307–319.

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210    M. RASHIDIRAD, E. SOLTANI, and H. SALIMIAN Mahmood, I. P., Zhu, H., & Zajac, E. J. (2011). Where can capabilities come from? Network ties and capability acquisition in business groups. Strategic Management Journal, 32, 820–848. Makadok, R. (2001). Toward a synthesis of the resource-based and dynamic capability views of rent creation. Strategic Management Journal, 22, 387–401. March, J. G., & Simon, H. A. (1958). Organizations. New York, NY: Wiley. Mata, F., Fuerst, W., & Barney, J. (1995). Information technology and sustained competitive advantage: A resource-based analysis. MIS Quarterly, 19, 487–505. Mathews, J. A. (2003). Strategizing by firms in the presence of market for resources. Industrial and Corporate Change, 12, 1157–1193. Melville, N., Kraemer, K. L., & Gurbaxani, V. (2004). Information technology and organizational performance: An integrative model of IT business value. MIS Quarterly, 28, 283–322. Mithas, S., Ramasubbu, N., & Sambamurthy, V. (2011). How information management capability influences firm performance. MIS Quarterly, 35, 137–A15. Montealegre, R. (2002). A process model of capability development: Lessons from the electronic commerce strategy at Bolsa de Valores de Guayaquil. Organization Science, 13, 514–531. Ndofor, H. A., Sirmon, D. G., & He, X. (2011). Firm resources, competitive actions and performance: Investigating a mediated model with evidence from the invitro diagnostics industry. Strategic Management Journal, 32, 640–657. Newbert, S. L. (2007). Empirical research on the resource-based view of the firm: An assessment and suggestions for future research. Strategic Management Journal, 28, 121–146. Olavarrieta, S., & Ellinger, A. E. (1997). Resource-based theory and strategic logistics research. International Journal of Physical Distribution and Logistics Management, 27, 559–587. Parmigiania, A., & Holloway, S. (2011). Actions speak louder than modes: Antecedents and implications of parent implication capabilities on business until performance. Strategic Management Journal, 32, 457–485. Parnell, J. A. (2011). Strategic capabilities, competitive strategy, and performance among retailers in Argentina, Peru and the United States. Management Decision, 49, 139–155. Penrose, E. T. (1959). The theory of the growth of the firm. Oxford, UK: Oxford University Press. Pitelis, C. N. (2007). A behavioral resource-based view of the firm: The synergy of Cyert and March (1963) and Penrose (1959). Organization science, 18, 478–490. Porter, M. E. (1985). Competitive advantage: Creating and sustaining superior performance. New York, NY: Free Press. Powell, T., Lovallo, D., & Fox, C. (2011). Behavioral strategy. Strategic Management Journal, 32, 1369–1386. Priem, R. L., & Butler, J. E. (2001). Is the resource-based “view” a useful perspective for strategic management research? Academy of Management Review, 26, 22–40. Rashidirad, M., Soltani, E., & Salimian, H. (2014). Do contextual factors matter? A missing link between competitive strategies—Dynamic capabilities alignment and e-business value. Strategic Change, 23(1/2), 81–92.

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212    M. RASHIDIRAD, E. SOLTANI, and H. SALIMIAN Wang, C. L., & Ahmed, P. K. (2007). Dynamic capabilities: A review and research agenda. International Journal of Management Reviews, 9, 31–51. Wernerfelt, B. (1984). A resource-based view of the firm. Strategic Management Journal, 5, 795–815. Winter S. G. (2012). Purpose and progress in the theory of strategy: Comments on Gavetti. Organization Science, 23, 288–297. Yang, B. C, Wu, B. E, Shu, P. G., & Yang, M. H. (2006). On establishing the core competency identifying model: A value-activity and process-oriented approach. Industrial Management and Data Systems, 106(1), 60–80.

CHAPTER 9

THE EFFECT OF CORPORATE GOVERNANCE AND CORPORATE CULTURE ON STRATEGY EXECUTION AND PERFORMANCE Evidence From the Indonesian General Insurance Industry Budi W. Soetjipto Herris B. Simandjuntak

ABSTRACT This study discusses the determinants of strategy execution. Acting as control mechanisms for effective execution, these determinants are corporate governance and corporate culture. Corporate governance represents procedural or formal mechanisms, while corporate culture represents social or behavioral mechanisms. In addition, the possible effect of strategy execution on branch’s performance is explored. In this study, a branch is considered a strategic busi-

The Practice of Behavioral Strategy, pages 213–231 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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214    B. W. SOETJIPTO and H. B. SIMANDJUNTAK ness unit of a company. One hundred and seventeen branch managers and heads of marketing offices with equivalent authority to branch managers of three big general insurance companies in Indonesia participated in the study (a participation rate of 83.5%). Data collected from these respondents are used to test seven hypotheses. Three of these hypotheses are supported: corporate governance and corporate culture positively and significantly affect strategy execution, corporate culture positively and significantly affects corporate governance, and strategy execution positively and significantly affects branch’s performance. The implications of the findings are discussed to enrich our understanding of strategy execution and its relation, particularly to branch’s performance. Limitations of the study are also identified to warrant further research.

INTRODUCTION A recent McKinsey Quarterly survey found that 60% of the executives who participated in the survey said that bad strategic decisions were about as frequent as the good ones, in which unexpected results were then more likely to occur (Lovallo & Sibony, 2010). This survey also found that bad decisions were partly a function of ineffective decision processes and corporate culture. Correspondingly, a survey conducted by the American Management Association (2010) showed that only 3% of 1,526 business professionals believed their organizations were “very successful” at executing strategies. Furthermore, the survey found that 62% of the respondents rated their respective companies at 3 or lower on a 5-point scale, where 1 equals “not at all successful” and 5 equals “very successful.” Combining both findings, these executives were pessimistic when it came to strategic decisions and strategy execution. However, as argued by Hrebiniak and Joyce (1984), effective strategy execution significantly and positively affects organization’s performance. Effective execution also significantly and positively affects organizational effectiveness (Sproull & Hofmeister, 1986) and is a competitive edge for the company (Giles, 1991). The problem is that effective execution may not occur automatically; it requires well-governed decision processes and a well-established corporate culture (Lovallo & Sibony, 2010). Both can be considered as behavioral drivers for effective execution because their existence enables employees to support effective execution (Gavetti, 2012). Despite its importance, and in fact strategy execution is the most important subject in strategic management (Flood, Dromgoole, Carrol, & Gorman, 2000), the attention to strategy execution is limited (Cravens, 1998; Noble, 1999). A majority of empirical studies have been directed toward strategy formulation (Hrebiniak & Joyce, 1984; Thomas, 2002). Coupled

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with lack of behavior or action-oriented studies in strategic management (Powell, Lovallo, & Fox, 2011), this makes strategy execution not yet well comprehended. Nonetheless, when discussing strategy execution, we cannot leave middle management behind. Shi, Markoczy, and Dess (2009) and Wooldridge, Schmid, and Floyd (2008) pointed out a critical role of middle management in making strategy execution effective because they are to translate strategy formulated at the top level into actual actions performed at the lower level (Peters & Waterman, 1982). In addition, middle managers are responsible for allocating resources to make the strategy work (Shi et al., 2009; Wooldridge et al., 2008). These middle managers, however, can take advantage of their pivotal position by translating the strategy and/or allocating resources for their own benefits or to serve their own interests, which likely leads to poor or lower organizational well-being. In this conflicting situation, control mechanisms thus need to be installed to curb middle managers’ opportunistic behavior. Unfortunately, of this limited research on strategy execution, the majority of it has focused on how to increase strategy execution effectiveness (Hambrick & Cannella, 1989; Sandy, 1991) and on how to overcome its obstacles (Atkinson, 2006; Beer & Eisenstat, 2000; Bourgeois & Brodwin, 1984; Nutt, 1983). The research therefore lacks attention on the role of control mechanisms, especially at the middle level, in strategy execution. Accordingly, this study focuses on the role of control mechanisms at middle management in making strategy execution effective, that is, generating performance. Anthony and Govindarajan (1998) and Chtiouia and Thiéry-Dubuisson (2011) proposed two control mechanisms. They are hard (formal) control and soft (informal) control. Hard control consists of procedures, law, and regulations to guide individual behavior in an organization (Leatherwood & Spector, 1991; Ouchi, 1977). This control is usually employed through systems with measures (Falkenberg & Herremans, 1995). Soft control, on the other hand, is applied via values, beliefs, and traditions (Falkenberg & Herremans, 1995). Hard control is known to be efficient in specific and/ or predictable situations, yet makes the organization difficult to develop and adjust to dynamics environment (Chtiouia & Thiéry-Dubuisson, 2011). Soft control is therefore needed for this kind of unexpected circumstances. For that particular reason, both control mechanisms are examined in this study. Hard control is represented by corporate governance and soft control is represented by corporate culture. Each of these mechanisms will be discussed below.

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LITERATURE REVIEW AND HYPOTHESES DEVELOPMENT Corporate Governance There has been no single definition of corporate governance (S. Anand, 2008; Rezaee, 2007). Among the existing definitions, we can divide them into two spectrums (Warsono, Amalia, & Rahajeng, 2009). The first spectrum is conventional, which limits corporate governance to a shareholderscompany relationship. Falling in this spectrum, for example, is Blair’s (1995) definition, which puts an emphasis on control of organization’s activities to minimize the associated risks and maximize returns. The other spectrum, contemporary, extends corporate governance to include other stakeholders. Aguilera and Jackson (2003), for example, define corporate governance as activity involving a distribution of rights and responsibilities among company’s stakeholders, such as managers, shareholders, boards of directors, employees, suppliers, and customers. However, one thing in common from both spectrums is that they deal with conflicts of interest and imbalances of power. The parties with more or higher power potentially take advantage of their power to put their self-interests as a higher priority than those with less power. This self-serving interest can sacrifice the organizationand other stakeholders’ well-being, and create an imbalance in a system. Accordingly, a governance mechanism is warranted to clarify and limit what a party can do in relation to the other parties, with the organization’s interests as the number one priority (Kim & Nofsinger, 2004; Lukviarman, 2005). At the operational level, governance mechanisms involve accounting systems, policies and procedures, codes of conduct, organizational communication, and incentive alignment (Schnatterly, 2003). A good accounting system, for example, results in accurate and credible reports on organization’s activities and financial condition. This report depicts what has actually happened in the company and whether what has actually happened is according to the strategic plan. In other words, a good accounting system helps the company go in the right direction and provides an early warning if corrective actions need to be taken to prevent further deviation from the plan. Policies and procedures and codes of conduct support the accounting system in terms of providing guidance and reference as to how managers (especially middle managers as the operational leaders) and employees should behave (Turner & Stephenson, 1993). Policies and procedures and codes of conduct clarify what and which behavior is expected and accepted, and thus minimize the occurrence of deviant behavior. Organizational communication ensures that accounting systems, policies and procedures, and codes of conduct are acknowledged and understood across the company. This is important in a sense that no accounting system, policies and procedures, and codes of conduct are effective unless they are

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practiced throughout the company, and they are not well practiced unless they are acknowledged and understood, particularly by middle managers who lead these practices. Accounting system, policies and procedures, and codes of conduct are also not well practiced unless there is an incentive to reward those who perform such practices. In other words, to be effective, the incentive needs to be aligned with the practices of good accounting systems, policies and procedures, and codes of conduct. In the meantime, strategy execution is an integrated set of actions in mobilizing resources to capitalize on market opportunities (Menon, Bharadwaj, Adidam, & Edison, 1999). Middle managers play an important role in strategy execution because they are responsible for allocating and mobilizing resources and for leading the actions of lower managers and their staffs. All these people certainly have self-interests, and middle managers, as the leaders, have bigger authority and opportunity in strategy execution to allocate and mobilize resources to serve their self-interests. These actions can defy the execution from its expected course and can thus steer away from achieving the target or objective. A good accounting system can immediately detect this deviant behavior by referring to proper policies and procedures and codes of conduct that are well communicated to them, especially to middle managers. Aligned incentives are provided to ensure that (some) middle managers’ self-interests are served to prevent further and future deviation of strategy execution. Concluding from all of the above, it can therefore be said that at the middle management or operational level, Hypothesis 1: Corporate governance mechanisms will significantly and positively affect strategy execution. Furthermore, Schnatterly (2003) found that corporate governance mechanisms at the operational level had signficantly reduced crime commission across 55 companies throughout the United States and had signficantly increased the organization’s performance. At the operational level, organizations’ performance is depicted by strategic business units’ performance. Accordingly, we can hypothesize that Hypothesis 2: Corporate governance mechanisms will significantly and positively affect strategic business units’ performance. Corporate Culture There has been common understanding among most researchers that corporate culture refers to a set of values, beliefs, and behavior patterns that form the core identity of an organization (Denison, 1984). Sathe (1982)

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identified three schools of thought in corporate culture. The first school is called the ideational school. Rooted in anthropology, this school characterizes corporate culture as values and beliefs shared among the individuals in a particular organization. The second school, adaptionist school, focuses on the observable part of corporate culture, such as building architecture, office design and landscape, and individual behavior and communication style. The last school is the realist school, which depicts the complexity of corporate culture. It is so complex that it is not easily understood just from the behavior of the people in the organization. These three schools more specifically define corporate culture as a set of shared values and beliefs delicately portrayed in individual employee’s behavior. In other words, corporate culture may be considered as a complex mechanism that shapes individual behavior. Denison and Mishra (1995) demonstrate evidence for the existence of four cultural traits—involvement, consistency, adaptability, and mission. Involvement values individuals’ empowerment and participation in the decision process. Such empowerment and participation develop a sense of ownership. Consistency values stability, well-coordinated and well-integrated behavior, which can help individuals in the organization reach agreement even when there are conflicting points of view (Block, 1991), as well as can generate a shared mindset and a mutually accepted conformity (Senge, 1990). Adaptability values risk taking and learning from past mistakes, which is driven by experience and interactions within the organization, and by external (environment) factors (Nadler, 1998; Senge, 1990). Mission values clear purpose and objectives that define organizational goals and strategic objectives, and envisions how the organization will look like in the future (Hamel & Prahalad, 1994; Mintzberg, 1987, 1994; Ohmae, 1982). In the meantime, governance mechanisms involve accounting systems, policies and procedures, codes of conduct, organizational communication, and incentive alignment. Such a mechanism is developed by individuals in the organization to control other individuals’ behavior. Individuals may develop governance mechanisms by referring to corporate culture or cultural traits they have adopted. This notion is supported by Turnbull (1997) and Williamson (1975), who found that corporate culture was positively related to corporate governance mechanisms. In conclusion, it can be hypothesized that Hypothesis 3: Corporate culture will significantly and positively affect corporate governance mechanisms. Furthermore, as a behavior control mechanism, corporate culture may positively affect strategy execution because it can direct individual actions in mobilizing resources to capitalize on market opportunities. This possible effect is supported by Hoecklin (1994). She found that corporate culture

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had a significant impact on strategy execution, particularly in the insurance industry. Accordingly, we can hypothesize that Hypothesis 4: Corporate culture will significantly and positively affect strategy execution. One of the subjects in corporate culture that has been studied the most is in relation to organizations’ performance. Denison (1984), for example, studied this subject in 34 American companies over a period of 5 years and found that corporate culture was positively related to such organization’s performance. Kotter and Heskett (1992) did a more extensive study (207 companies over 5 years) with similar findings. Wilderom, Glunk, and Maslowski (2000) additionally argued that corporate culture was a predictor of organizations’ performance. Correspondingly, at the operational level, corporate culture may also affect strategic business units’ performance. Summing up all of the above notions, we can hypothesize that Hypothesis 5: Corporate culture will significantly and positively affect strategic business units’ performance. Strategy Execution Using the aforementioned definition of strategy execution, we can argue that strategy execution may positively affect organizations’ performance because effective mobilization of resources can provide the organization with a “weapon” to seize market opportunities, which may lead the organization to better performance. This weapon can be lethal if it is complemented by integrated teamwork, good communications, and strong consensus among leaders (Menon et al., 1999) since these factors can drive bolder and more focused actions toward the opportunities. Hrebeniak and Joyce (1984) further support such notions, as they found that strategy execution had a substantial impact on organizations’ performance. Consequently, strategy execution at the operational level may have an impact on strategic business units’ performance. We can therefore conclude that Hypothesis 6: Strategy execution will significantly and positively affect strategic business units’performance. Moderation Effect of External Environment The inclusion of external environment in this research as a moderating variable is based on the premise that no strategy can fit in all environments

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(Ginsberg & Venkatraman, 1985). Organizations’ performance depends on the extent to which the organization can adjust the strategy to the environment. If strategy has to be adjusted, so does strategy execution. The objective of such adjustment is to create and maintain a dynamic alignment between strategy and environment (Miller, 1988). Venkatraman and Prescott (1990) argue that the alignment may positively affect an organization’s performance as well as its strategic business unit’s performance. Previous studies show that there are three dimensions of environment. The first dimension is complexity, which refers to heterogeneity of the environment (Child, 1972; Dess & Beard, 1984; Mintzberg, 1979; Thompson, 1967; Tung, 1979). The more players or parties with diverse characteristics in the environment, the more complex the environment is. The second dimension is dynamism, which depicts the uncertainty because of frequent and sudden change in the environment (Dess & Beard, 1984; Thompson, 1967). The more the uncertainty, the more dynamic the environment is. The last dimension is hostility, which is caused by rarity or lack of muchneeded resources (Miller & Friesen, 1978; Mintzberg, 1979; Pfeffer & Salancik, 1978). The rarer the resources, the more hostile the environment is. All three dimensions create simultaneous pressure on the organization and its strategic business unit to adjust its strategy and hence its strategy execution, or else the organization or its strategic business unit will be extinct. Accordingly, we can hypothesize that Hypothesis 7: External environment will significantly and negatively moderate the relationship between strategy execution and the strategic business unit’s performance. The more complex, dynamic, and hostile the environment, the weaker the positive relationship between strategy execution and the strategic business unit’s performance. CONTEXT FOR THE STUDY As the focus is on middle managers, the data for this study were collected from branches and marketing offices (that function like a branch) of three general, private insurance companies. These branches and marketing offices are the companies’ strategic business units because they are at the front line in generating revenue and profit for the companies. Such participating companies are in the top five insurance companies in Indonesia in terms of gross premium income. In 2010, they earned a gross premium income of around $511 USD million (almost 50% came from car insurance) and a market share of 22.71%. It was a growth of 15.13% from the previous year, and it was more than double the industry growth of only 7.71% per year.

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They also managed total assets of 1.13 billion USD (as of December 31, 2011) and 116 branches, with more than 3,000 employees. Meanwhile, all top-five general insurance companies accounted for 37% of the industry’s gross premium income in 2010, and all top-ten companies accounted for 53% in 2010. The significance of these companies indicates that the general insurance industry is considered as a loose oligopoly market (Kramaric & Kitic, 2012). This notion is understandable if we look at the portfolio of each of those 10 companies. They are part of big business conglomerates (private or state-owned) in Indonesia, and hence they have a captive market; the market is the companies under their respective conglomerates (Simandjuntak, 2004). Such practice makes the market very fragmented and occupied by “few” companies. These are the main characteristics of a loosely oligopoly market. Captive market can also be considered a strategy to protect each company’s market share from newcomers that had aggressively entered the market in the last 10 years, which creates slower market growth and stiffer market competition. It may be one good strategy, but if it is not well executed, it will not result in good performance. Strategy execution therefore plays a critical role in winning against the competition and makes this study valid contextually (external validity). There is also potential for growth in this industry since insurance density in Indonesia is much lower than the neighboring countries (ASEAN countries). Insurance density in Indonesia is only $20 USD per capita versus $810 USD per capita in Singapore and $175 USD per capita in Malaysia in 2011 (Swiss Reinsurance Company, 2012), yet Indonesia’s population is the highest in the ASEAN region. This big population is a big potential for a bright prospect and subsequently attracts more newcomers to come. These newcomers will likely follow the same path, that is, practicing a captive market strategy, which in the end will make competition much stiffer and strategy execution more critical and more relevant to study. In short, study on strategy execution, particularly in the general insurance industry, is valid, not only at the present time but also in the years ahead. DATA COLLECTION All branch managers and selected heads of marketing offices are invited to participate in this study because they play a key role in strategy execution in each company (Sharfman, 1998; Venkatraman, 1989). They are thus considered as the “field commander” in operationalizing the strategy. A total of 140 questionnaires were sent and 132 of them were sent back, but only 117 questionnaires could be used or an 83.5% participation rate.

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Of 117 branch managers and heads of marketing offices involved in this study, 80.3% (94 respondents) were male, 37.6% of them managed a branch or marketing office with 10 to 19 employees, and 35.1% managed a branch or marketing office with fewer than 10 employees, and 45.3% of them managed a branch or marketing office that had been in operation for only less than 5 years. The location of the branches and marketing offices involved in this study is throughout Indonesia, from the western (Medan) to the eastern parts (Jayapura and Sorong), but 55.56% of them are located on Java Island, where the capital city (Jakarta) is. Java Island is the island with the most population and the highest regional gross domestic product in Indonesia. Therefore, the sample of this study is skewed toward male branch managers and heads of marketing offices who managed a relatively small and recently operated branch or marketing office located on Java Island. Each questionnaire sent consisted of 75 statements, in which the respondents were asked to indicate their disagreement or agreement on a 6-point Likert scale, ranging from strongly disagree to strongly agree. Of 75 statements, 1. 24 statements measured corporate governance mechanism. These statements were adopted from Schnatterly (2003). 2. 24 statements measured corporate culture. These statements were adopted from Denison (1990) and Denison and Mishra (1995). 3. 13 statements measured strategy execution. These statements were adopted from Bonoma (1984), Guth and MacMillan (1986), Menon et al. (1999), and Mowday, Steers, and Porter (1979). 4. 6 statements measured company performance. These statements were adopted from the Indonesia Stock Market and Financial Institution Supervisory Body (Bapepam-LK, currently known as Indonesia Finance Service Authority or OJK) (2009). 5. 8 statements measured external environment. These statements were adopted from Anand and Ward (2004), Dess and Beard (1984), and Miller and Friesen (1983). DATA ANALYSIS As previously discussed, the data for this study came from three different insurance companies. Different companies may mean different corporate governance mechanisms, corporate culture, strategy execution, branch performance, and external environment. Significant differences (variance) in the data can create problems in drawing a conclusion from this study, which may lead to our inability to generalize the findings within the sample of this study, let alone generalizing it to other insurance companies

Effect of Corporate Governance and Corporate Culture on Strategy Execution    223

and other industries. To ensure homogeneity of the sample, we conducted an analysis of variance (ANOVA) on the above variables across companies. Seen in Table 9.1, we find no significant differences among variables across the companies. We also conducted reliability and validity tests on the determining variables (corporate governance mechanisms, corporate culture, and strategy execution). The results can be seen in Table 9.2. As shown, all variables are reliable and valid because each of them has construct reliability and variance extracted of more than .7 and .5, respectively. Hypotheses 1–7 were tested using structural equation modeling (SEM). The result can be found in Table 9.3. It shows that three hypotheses are not supported. They are H2, H5, and H7. H2 and H5 are about the direct effects of corporate governance mechanisms and corporate culture on strategic business unit performance. So both variables do not have significant and positive individual effects on branch performance. The most logical reason for such findings is that both corporate governance mechanisms and corporate culture are not at the behavior or action level. They are mechanisms that regulate or control behavior and actions. This notion is consistent with the support for H1, H4, and H6, which demonstrate that both mechanisms indirectly affect companys’ performance TABLE 9.1  Analysis of Variance (ANOVA) of Main Variables Across Participating Companies Variable Corporate Governance Corporate Culture Strategy Execution Branch’s Performance External Environment

p-value .0740 .220 .128 .351 .571

Result Not Significant Not Significant Not Significant Not Significant Not Significant

TABLE 9.2  Correlations, Construct Reliability, and Variance Extracted of the Determining Variables Variable Corporate Governance (CG)

CG

Corporate Culture (CC)

CR = .95 VE = .91 .695**

Strategy Execution (SE)

.756**

**

Correlation significant at α = 0.01 (2-tailed).

CC

CR = .93 VE = .77 .552**

SE

CR = .95 VE = .83

224    B. W. SOETJIPTO and H. B. SIMANDJUNTAK TABLE 9.3  Hypotheses Testing Results Hypothesis

Coefficient

t-value

H1 H2 H3 H4 H5 H6 H7

.26 .03 .45 .36 –.14 .22 .20

3.91 .41 6.34 6.18 –.99 3.15 1.68

Result H1 supported H2 not supported H3 supported H4 supported H5 not supported H6 supported H7 not supported

via strategy execution. In this case, strategy execution is the behavioral or action variable. H7 is about the moderating negative effect of external environment on the relationship between strategy execution and branch performance. The insignificant effect of external environment may reemphasize the power of captive market strategy on branch performance. Once it is well executed, external environment may not matter. This finding also reemphasizes the critical role of strategy execution in generating good performance. In other words, a well-executed (captive market) strategy can mitigate and even negate complex, dynamic, and hostile environments. What is meant by a well-executed strategy is a well-integrated set of actions in mobilizing resources to capitalize on (captive) market opportunities supported by integrated teamwork, good communications, and strong consensus among leaders. Captive market may be unfair, but provide a high level of certainty in performance for the branches and subsequently for the companies, particularly those that are in the general insurance industry. Another possible explanation for the absence of significant external environment’s moderation effect is that the effect may be at the corporate level. It means that the effect is a higher-level effect, which especially involves government. Government can issue a regulation that impacts certain industries. The strength of an impact may vary across companies but most likely is the same across branches within a company. So the absence of significant external environment’s moderation effect in this study indicates that such an effect happens at the corporate level, not at the branch level. THEORETICAL CONTRIBUTIONS From a theoretical perspective, this study addresses the need for more research in strategy execution, especially at the branch level, because it

Effect of Corporate Governance and Corporate Culture on Strategy Execution    225

is at that level that the competition occurs. As found in this study, those who effectively execute the strategy will most likely perform well and thus win against the competition. This finding is consistent with Menon et al. (1999), who found that strategy execution significantly and positively affected company’s performance. This study also addresses the need for more research in behavior control of middle managers in executing strategy. As discussed above, middle managers have authority and opportunity to defy execution from its expected course to serve their self-interests. Such a deviance will likely cause poor performance. This study examines two control mechanisms—corporate governance and corporate culture—and finds that both significantly and positively affect strategy execution. These findings enrich our understanding regarding the critical role of corporate governance and corporate culture as behavioral control mechanisms, particularly in executing strategy. In addition, this study finds that corporate culture significantly and positively affects corporate governance. This finding is in line with Turnbull (1997) and Williamson (1975) who found that corporate culture was positively related to corporate governance mechanism. Interestingly, both corporate governance and corporate culture do not significantly and positively affect branch performance. These findings are not aligned with Schnatterly’s (2003) finding that corporate governance mechanisms had signficantly increased organization performance. These findings are also not aligned with Denison (1984), Kotter and Heskett (1992), and Wilderom et al.’s (2000) findings that corporate culture was positively related to organization performance. However, the above studies are at the corporate level, while this study is at the operational level. Combined with this study’s other findings previously discussed, these findings indicate that both corporate governance and corporate culture do not directly affect branch performance. Therefore, unlike at the corporate level, this study finds that at the operational level, the effect of such variables on branch performance goes through strategy execution. In other words, at the operational level, the role of both corporate governance and corporate culture is more apparent as behavioral control mechanisms than as predictors of performance. Overall, this study enriches our knowledge in the field of strategic management, in particular, behavioral strategy, in a sense that it comprehends how strategy is enacted (executed) and how this execution is controlled to ensure its effectiveness. As previously defined, execution involves individuals’ actions, and individuals’ actions are essentially individual’s behavior. In short, this study extends our understanding regarding behavior aspects in strategy research.

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PRACTICAL IMPLICATIONS From a practical standpoint, this study underlines the importance of strategy execution in determining branch performance. Strategy execution involves an integrated set of actions in mobilizing resources to capitalize on market opportunities (Menon et al., 1999). Branch managers are responsible for coordinating and driving these actions. To ascertain that they carry out this responsibility, the company needs control mechanisms. One of the mechanisms this study suggests is corporate governance. At the operational level, this mechanism includes (Schnatterly, 2003) 1. A good accounting system that provides accurate and credible activities and financial reports. 2. Proper policies, procedures, and codes of conduct that provide reference and guidance for branch managers’ and employees’ actions at work. 3. Effective organizational communication that makes sure accounting systems, policies, procedures, and codes of conduct are acknowledged and understood across the branch. 4. Aligned incentive systems to reward individuals who comply with the established accounting systems, policies, procedures, and codes of conduct, and who perform effective communication. In essence, corporate governance mechanisms establish systems necessary to keep branch managers’ and employees’ actions, and hence strategy execution, on the right track. This study also suggests another mechanism that is even more critical: corporate culture. It is more critical because it affects both corporate governance and strategy execution. So by improving corporate culture, strategy execution will be much more effective compared to just improving corporate governance, because corporate culture affects strategy execution in two ways: directly and indirectly. Denison and Mishra (1995) suggest that corporate culture will be effective if it develops and establishes (a) employees’ empowerment and participation in the decision process to build a sense of ownership; (b) stability, well-coordinated and well-integrated employees’ behavior to help them reach agreement and conformity, especially when conflicts happen; (c) risk taking and learning attitudes based on past mistakes; and (d) clear purposes and objectives to define a company’s future. In short, to generate outstanding branch performance, this study implies that a company needs to well-execute its strategy; and to have a well-executed strategy, a company needs to develop and establish an effective corporate culture and corporate governance mechanisms, especially at the operational level.

Effect of Corporate Governance and Corporate Culture on Strategy Execution    227

LIMITATIONS AND FUTURE RESEARCH Despite its theoretical contributions and practical implications to the field of behavioral strategy, this study has limitations. First, this study is crosssectional in nature, so it may not actually demonstrate causal relationships amongst corporate culture, corporate governance, strategy execution, and branch performance. Consequently, longitudinal study in the future is suggested (Schendel, 1997). Second, this study employs self-report surveys involving branch managers and heads of marketing offices as a single respondent representing their respective branches and marketing offices, thus perception bias may be expected. We actually tried to minimize the bias through careful design of the questionnaire and survey (Huber & Power, 1985) as well as by using measures that have conformed to reliable and valid requirements (Miller, Cardinal, & Glick, 1997). However, future research may need to employ multiple respondents from each branch, marketing office, or strategic business unit (such as one level below branch managers or heads of marketing offices) to lower the possibility of perception bias. The third limitation concerns branch managers and heads of marketing offices as a representation of middle managers. The fact is that there can be middle managers other than branch managers and heads of marketing offices in a company. These middle managers are in the head office and have as much discretion or authority as (or even more than) branch managers and heads of marketing offices to execute the strategy. They were excluded from this study and are thus justified to be included in future study. Next, limitation relates to the general insurance industry as the context of this study, with an inherent regulated and competitive environment. This fact may limit the generation of this study, for example, to a loosely regulated but relatively stable industry (such as the cement industry), or to a loosely regulated and competitive industry (such as the retail industry). Consequently, future research may call for an industry or industries with characteristics different from the general insurance industry. Lastly is the limitation related to control mechanisms that were examined in this study. These mechanisms at the operational level are shown to positively affect execution of the strategy and eventually to branch performance. The basic premise for this study is that branch managers have selfinterests and these interests are contrary to branch and company interests. However, even if the interests of both parties are aligned, the strategy may still not be well executed, for example, in the case that the strategy is poorly formulated. A poorly formulated strategy is not based on proper internal (strengths and weaknesses) and external (opportunities and threats) analyses (Wheelen & Hunger, 2007).

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ABOUT THE CONTRIBUTORS

Fabien Blanchot is associate professor of Strategic Management at Université Paris-Dauphine, Paris, France, and a member of Dauphine Research Centre in Management (DRM, UMR CNRS 7088). He is currently vice president of the Paris-Dauphine University, and director of Paris-Dauphine HRM MBA. His research, publications, and consulting activities focus on strategic alliances, acquisitions, and mergers. He is a Knight in the French Order of Academic Palms and a former vice president of ASAP (Association of Strategic Alliance Professionals) France. E-mail: fabien.blanchot@ dauphine.fr Robert P. Bood holds a PhD in business administration and economics from the University of Groningen, Netherlands. He is a former director of the Center of Organizational Learning at Nyenrode University, Netherlands, and was a senior consultant with Global Business Network Europe, Netherlands. He is currently a managing partner of FairSights, an international consultancy in strategy, innovation, and scenario thinking, is affiliated with TIAS School of Business and Society, Tilburg University, Netherlands, and is a faculty member of the Iclif Leadership and Governance Centre, Malaysia. E-mail: [email protected] Lena Bygballe is associate professor at Norwegian Business School BI in Oslo, Norway, and leader of the Centre for the Construction Industry. Her research interests are related to learning, strategizing, and organizing in project-based organizations and construction networks. She has published The Practice of Behavioral Strategy, pages 233–240 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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234    About the Contributors

in Construction Management and Economics, Supply Chain Management: An International Journal, Industrial Marketing Management, and Journal of Purchasing and Supply Management. E-mail: [email protected] Mantiaba Coulibaly is associate professor at Université Nice Sophia Antipolis, School of Business Administration, France. Her research and main publications are based on interorganizational relationship in alliances. She works also on corporate social responsibilities principles in SMEs. She is codirector of the Masters of Business Administration and General Secretary of the association “Fairness” (a research network on fair trade). E-mail: mantiaba. [email protected] T. K. Das is professor of strategic management at the Zicklin School of Business, Baruch College, City University of New York, New York. He is concurrently a member of the University’s Doctoral Faculty. Professor Das received his PhD in organization and strategic studies from the Anderson Graduate School of Management, University of California at Los Angeles (UCLA). He also has degrees in physics, mathematics, and management, and a professional certification in banking. Prior to entering the academic life, Professor Das had extensive experience as a senior business executive. He has research interests in strategic alliances, strategy making, organizational studies, temporal studies, and executive development. Professor Das has published over a dozen books and monographs, and his research has appeared in over 45 journals, of which some of the later ones include Academy of Management Executive, Academy of Management Review, British Journal of Management, Journal of International Management, Journal of Management, Journal of Management Studies, Organization Science, Organization Studies, and Strategic Management Journal. Professor Das was formerly a senior editor of Organization Studies and has served, or is currently serving, on the editorial boards of a number of scholarly journals. He is the founding (and current) series editor of the two book series, Research in Behavioral Strategy and Research in Strategic Alliances (Information Age Publishing). E-mail: TK.Das@ baruch.cuny.edu Alexander W. Gordon became the second employee in the EMEA office of Indian SaaS (Software-as-a-Service) start-up Freshdesk. Earlier, he worked at Accenture, and was involved with large-scale IT projects at both UBS Investment Bank and HSBC, as well as on Accenture’s internal innovation programme. He holds a BA (Hons.) in French and Politics from the University of Leeds, UK, and an MSc in Information Systems: Organisations and Management from Manchester Business School, UK. E-mail: [email protected] Tomomi Hamada is a doctoral student in the School of Economics, Nagoya University, Japan. Her field of research is innovation and operations

About the Contributors    235

management, concentrating on the analysis of firms’ strategic choices of technologies and the role of organizational inertia. Her main research interests are Japanese firms, especially in comparison with Western firms. She has published in International Journal of Innovation Management. E-mail: [email protected] Saleema Kauser is an assistant professor in the people management and organizations division at Manchester Business School, UK. She holds degrees in Psychology, IT, MBA and a PhD from Warwick Business School, University of Warwick, UK. She is involved in designing and directing both global MBA and full-time master’s programs in the area of organizational strategies and business ethics. Her research interests include the management and success of international strategic alliances, small firms, gender ethics and women managers, and business and Islamic ethics and society. E-mail: [email protected] Ayako Kawasaki is a postgraduate student at the Graduate School of Economics, Nagoya University, Japan, and a part-time lecturer at the Department of Global and Media Studies and the Department of Information and Culture of Kinjo Gakuin University, Japan. She received her Master of Business Administration and Computer Science from the Graduate School of Business Administration and Computer Science, Aichi Institute of Technology, Japan. She was awarded the Excellence Award of Postgraduate Student Presentation of the Japan Management Diagnosis Association for her research of interorganizational relationships between distributors and retailers in the Japanese movie industry in 2011. That research was published in the Journal of Japan Management Diagnosis Association in 2012. E-mail: [email protected] Tsutomu Kobashi is associate professor in the Faculty of Business Administration, Aichi Institute of Technology, Japan. He received a PhD in economics from the School of Economics, Nagoya University, Japan, where he previously worked. He was a visiting scholar in 2009–2010 at Anderson School of Management, University of California, Los Angeles (UCLA). His research interests include interorganizational relationships (IOR), organizational structure, research methodology, and strategic management. In the field of IOR, he has published many papers dealing with interorganizational learning, interorganizational dynamics, and interorganizational structure. He is currently researching the dynamics of maker-supplier networks in the automobile industry and horizontal alliances in the airline industry. In the field of organizational structure, he focuses on front-back organization. Through a comparison with other organizational structures such as multidivisional structure and matrix organization, he has identified the idiosyncrasies of front-back organization. In the field of methodological

236    About the Contributors

research, his interests lie mainly in determining the relationship between methodology and theory development and the practical application of knowledge. E-mail: [email protected] Peter Lok is an associate professor in the University of Sydney Business School, Australia. His research interests include value chain management, change management, e-commerce & marketing, and Asian business. He publishes regularly in management journals. Email: [email protected] Arash Najmaei works as a marketing consultant in Australia. He is also the head of the Centre for Applied Research in Professional Services Management (CARPSM). He also teaches at the Australian Catholic University (ACU) and the International College of Management Sydney (ICMS) and is a research affiliate for the Macquarie Graduate School of Management (MGSM) and the Institute for Sustainable Leadership (ISL). In 2014 he received a PhD in entrepreneurship from the Macquarie Graduate School of Management (MGSM), Sydney, Australia. He also has an MBA and an undergraduate degree in civil engineering. His research interests include entrepreneurial business modeling and the role of business systems and entrepreneurs in sustainable development. His research publications include 10 journal articles and 5 book chapters. He serves as the editor-in-chief of International Journal of Sustainable Entrepreneurship and Corporate Social Responsibility (IJSECSR). E-mail: [email protected] K. Nadia Papamichail is associate professor in information and decision systems at Manchester Business School, UK. Her publications have appeared in books and journals, including Decision Support Systems, Omega, Journal of the Operational Research Society, Expert Systems with Applications, and Artificial Intelligence. She recently co-authored a book on Decision Behavior, Analysis and Support (Cambridge University Press). She is Chair of the Decision Analysis special interest group (DASIG), a network of academics and practitioners which promotes decision analysis in the UK and abroad. E-mail: [email protected] Theo J. B. M. Postma holds a PhD in business administration and economics from the Faculty of Economics and Business of the University of Groningen, Netherlands. He was associate professor in strategy until 2011 (early retirement) and is currently affiliated with that university as a freelance researcher. He extensively published about scenarios, strategy, technology assessment, and corporate governance in journals such as Corporate Governance: International Review, European Management Journal, Futures, International Studies of Management and Organization, Technology Analysis and Strategic Management, and Technological Forecasting and Social Change. Email: [email protected]

About the Contributors    237

Mona Rashidirad joined the Brighton Business School, University of Brighton, UK, as a lecturer in strategy in 2013. She holds her PhD in management from the Kent Business School, University of Kent, UK. She is a fellow in Higher Education Academy (HEA) following her completion of Postgraduate Certificate in Higher Education (PGCHE), awarded from the University of Kent in 2012. She is an editorial board member of several peer-reviewed journals such as Journal of Strategy and Management and Journal of Business and Economics. Her research covers strategy development from a resourcebased view, strategic alignment between competitive strategies and capabilities, the role of dynamic capabilities in today’s marketplace, and the contextual factors influencing the ability of firms to create value, specifically in the context of e-business. E-mail: [email protected] Charitha C. Reddy works as Information Technology Project Manager at Deutsche Bank. Earlier, she worked at Accenture as a Business Analyst in Telecommunication and Insurance sector. She has a master’s degree in Information Systems from Manchester Business School, UK. E-mail: [email protected] Jo Rhodes is a senior lecturer in Macquarie Graduate School of Management (MGSM), Macquarie University, Sydney, Australia, and teaches in the MBA program. Her research interests include corporate strategy, e-commerce, competitiveness and performance, and Asian business strategy. She publishes regularly in management journals. E-mail: [email protected] Hamid Salimian is a lecturer in operations management at the Brighton Business School, University of Brighton, UK. He was awarded his PhD in management from the Kent Business School, University of Kent, UK. He has worked as a business consultant in various manufacturing and consulting companies in Iran and also worked as a lecturer in management at the Azad University, Tehran, Iran. He has a Postgraduate Certificate in Higher Education (PGCHE) from the University of Kent, and is a Fellow in the Higher Education Academy. His areas of expertise include the supplier quality management (SQM), supply chain quality management (SCQM), the relationship between SQM and buying organizations’ performance. Email: [email protected] Herris B. Simandjuntak received his PhD from the University of Indonesia in 2013. He was a senior executive of several leading Indonesian insurance companies for many years before becoming an adjunct professor in some Indonesian universities, including the University of Indonesia, after his retirement from executive positions in 2008. He currently serves as Chairman of the Board of Recapital Investment Group, a leading investment firm in Indonesia. He has established a center for risk management studies at Indonesia

238    About the Contributors

Entrepreneur University. Additionally, he is an active speaker, particularly on corporate culture, leadership, and corporate governance, which are also his research interests. E-mail: [email protected] Budi W. Soetjipto received his PhD from Cleveland State University, USA. He was Managing Director of the Institute of Management, University of Indonesia, from 2005 to 2009, Executive Director of the Indonesian Institute for Management Development from 2010 to 2012, and Dean of Sampoerna School of Business from 2012 to 2013. He is currently associate professor in the Management Department of University of Indonesia and Member of the Board of Trustees of the Indonesian Entrepreneur Education Foundation. He also partly owns and runs two private management consulting firms known as Kebon Ilmu and WIN Solution. He has published in Academy of Management Journal and contributed a book chapter in Organizational Processes and Received Wisdom (2014, edited by D. Svyantek and K. Mahoney), and presented papers in annual conferences of the Academy of Management and Strategic Management Society. He has consulted with several private, state-owned, and multinational corporations on human resource systems, corporate culture, and organizational change. He is particularly interested in the development of new corporate culture and change management programs. In addition, his research interest areas include leadership, misbehavior in organizations, decision making, readiness for change, and corporate culture. E-mail: [email protected] Ebrahim Soltani is professor of quality management at Hamdan Bin Mohammed Smart University (HBMSU), Dubai, United Arab Emirates (UAE). Previously, he was a professor of operations management at the University of Kent Business School, UK. He has a PhD from the University of Strathclyde, UK. His research has considered the management of quality in different economic sectors, factors influencing the efficacy of quality and productivity initiatives, human resources issues related to quality management, the management of supply chain and quality in an era of globalization, and the peculiarities of management mindset toward operations improvement initiatives. He has recently been working on an Economic and Social Research Council (ESRC)-funded research project which aims to examine the dynamics of contextual forces, management’s orientations, and change management practices in the banking and financial institutions. He has written widely on managing operations improvement initiatives in a wide range of publications, including British Journal of Management, International Journal of Operations and Production Management, International Journal of Production Research, Production Planning and Control, International Journal of Human Resource Management, Journal of World Business, and Total Quality Management. He is an academic member of the ESRC peer-review college and a member

About the Contributors    239

of the editorial boards of several international journals. E-mail: E.Soltani@ hbmsu.ac.ae Anna R. S. Swärd is post doctor at the Centre for the Construction Industry at the Norwegian Business School BI in Oslo, Norway. Her research focuses on alliance processes, as well as trust dynamics, practices, organizing, and coordination in project-based organizations. She has published articles in Journal of Purchasing and Supply Management and International Journal of Strategic Business Alliances, and a book chapter in Behavioral Perspectives on Strategic Alliances (2011, edited by T. K. Das). E-mail: [email protected] Motonari Yamada is professor of the Graduate School of Economics, Nagoya University, Japan. He specializes in management of technology and small business management. He received his PhD in economics from the Graduate School of Economics, Nagoya University. He visited the University of Michigan, Michigan, and Harvard University, Massachusetts, as an overseas research scholar of the Ministry of Education in Japan. His most recent book, entitled Management of Technology in Manufacturing Firms, has been cited by numerous Japanese scholars in the field of management. Email: [email protected]

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INDEX A Aarts, H., 146 Abelson, R. P., 49 Abernathy, W. J., 110 Academy of Motion Picture Arts and Sciences (AMPAS), 176, 183–184 Accounting systems, 216–218, 226 Achtenhagen, L., 92, 94 Acs, Z. J., 101 Activities and actions, 81–85 Activity theory, 77, 79, 82, 84 Adams, M., 16, 20 Adams, R. B., 58 Adidam, P. T., 217, 222, 225–226 Adner, R., 92 Affect heuristic, 11, 16, 24, 31 Agency costs, 57 Agency theory, 42–44, 51, 56–61, 68 Aguilera, R. V., 216 Ahlstrand, B., 55, 59 Ahmed, P. K., 198 Ahrens, F., 17 Ahuja, G., 148 Akkermans, D., 44, 62 Alford, R. R., 95 Alvarez, J. L., 171 Amalia, F., 216 Ambidextrous organization, 121–122 Ambrosini, V., 199 American Management Association, 214

Amit, R., 78, 82, 84, 87, 94, 96, 108, 196 Amsterdam Stock Exchange, 41, 43, 45, 68 Anand, G., 222 Anand, S., 216 Anchoring bias, 5, 11, 13, 27–28, 31 Anderson, P., 106, 110 Anderson, R. J., 42 Andrews, K. R., 42, 51, 68 Ang, J. S., 21 Angué, K., 149, 152 Ansoff, H. I., 51 Anthony, R. N., 215 AOL, 16 AOL/Time Warner, 8, 15–23, 31 Apple, 88 Applegate, L. M., 21–22 Arango, T., 14–15 Araujo, L., 133 Ariely, D., 2 Ariño, A., 132, 150 Armstrong, J. S., 53 Aronson, A., 70 Arrègle, J. L., 146–147, 152 Arthur, W. B., 109 Arvidsson, N., 128 Ashkanasy, N. M., 231 Aspara, J., 88, 92 Atkinson, H., 215 Audretsch, D. B., 101 Augier, M., 80 Availability bias, 11, 13, 19, 27, 31

The Practice of Behavioral Strategy, pages 241–254 Copyright © 2015 by Information Age Publishing All rights of reproduction in any form reserved.

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242   Index

B Bach, A., 153, 155–156 Bagchi, K., 173 Baker, T., 90 Baker, W. F., 177 Balineau, G., 155 Ball, S. B., 111 Ballard, G., 134 Ballet, J., 153, 156 Balogun, J., 131, 140 Bandura, A., 79, 85–86 Bapepam, LK, 222 Barca, F., 71 Barker, R., 20 Barnatt, C., 140 Barney, J. B., 9, 108–109, 194–197, 199, 204 Bazerman, M. H., 5, 106, 108, 111 BBC, 20 Beard, D., 220, 222 Beath, C. M., 203 Becht, M., 71 Beer, M., 215 Behavioral corporate governance, 56–62 Behavioral governance, 41, 43–44, 59, 62, 65 Behavioral strategy and M&As, 9–11 Behavioral strategy, 1–4, 6–9, 14, 43, 59, 78–81, 105–107, 112, 123, 129, 140, 146–147, 194–195, 200–207, 225, 227 Behavioral strategy, three schools of, 7 Bekier, M. M., 3 Bell, E., 134 Benbasat, I., 173 Benou, G., 14 Benz, 119 Berger, P. L., 66 Berglöf, E., 57 Bernard, C., 165 Bessant, J., 172, 182 Bettman, J. R., 5 Betts, M., 131 Bezemer, P. J., 50, 58 Bhabra, H., 13 Bhagat, S., 58 Bharadwaj, S. G., 217, 222, 225–226 Bignoux, S., 132, 138 Bio-Equitable (a fair trade label), 155 Black, B., 58 Blair, M. M., 216 Blanchot, F., 145–168 Blenko, M. W., 3

Blettner, D. P., 95–96 Block, P., 218 Board behavior, 43, 57–59, 61, 68 Board structure, 57, 60 Board’s strategy role, 50–51 Bock, A. J., 78, 87 Bodie, M. T., 16 Body Shop, 154 Bogan, V., 2, 10 Bogardus, A. J., 3 Bonoma, T. V., 222 Bood, R. P., 41–75 Borza, A., 146–148, 152 Borzillo, S., 10 Bounded rationality 4, 7–8, 59, 201–202, 205 Bourgeois, L. J., 26, 29–30, 215 Bower, J. L., 19, 106 Bowman, C., 199 Box Office Mojo, 182–184 Bradfield, R., 43, 55, 62–63, 66 Bradley, M., 10 Brady, T., 128, 130, 137 Bresnen, M., 130 Brettel, M., 197–198, 206 Brinckmann, J., 154 British Council, 170 Brodwin, D. R., 215 Bromiley, F., 195, 201–202, 205–206 Bromiley, P., 2, 6, 88 Brouthers, K. D., 148–149 Brouthers, L. E., 148–149 Brown, J. S., 85–86 Bruner, R. F., 3, 9, 14–22 Bryman, A., 134 Buckley, P. J., 147, 151–152 Buena Vista (Disney), 181, 183–184 Bunnel, D., 29 Burt, G., 43, 62, 63, 66 Business model ideation, 90 Business model reinvention, 88–89 Business model replication, 88–89 Business model structuring, 90 Business model transformation, 88 Business modeling, 77–80, 83, 86–89, 91–99 Business models, 77–80, 86–99, 109 Butler, J. E., 196–199 Bygballe, L. E., 127–143 Byrne, J. A., 29, 30

Index    243

C Cairns, G., 43, 62, 63, 66 Calandro, J., 11 Caldeira, M. M., 196–197 Camerer, C., 92 Camillus, J. C., 51 Camp, S. M., 102 Campbell, A., 4–5, 9 Campitelli, G. 4–5 Canella, A. A., 58, 215 Cardinal, L. B., 227 Carimentrand, A., 153, 156 Carrol, S. J., 214 Carroll, J. S., 111 Carter, C., 78, 81–82, 85 Casadesus-Masanell, R., 87 Catani, G., 174 Causal ambiguity, 52, 204 Chamberlin, E., 196 Chandler, G. N., 91 Chang, V., 14, 23–24, 26–27 Chanlat, J. F., 165 Charlier, S., 153, 155–156 Chaterjee, S., 26, 29–30 Chatman, J., 14, 23–24, 26–27 Chaudhuri, S., 13–14 Checkland, P., 52 Chen, C. C., 149 Chen, K. C., 146–147 Chen, M. J., 8 Chen, W. Z., 146–147 Cheng, Y., 21 Chenhall, R. H., 10 Chermack, T. J., 62, 65–66 Cherni, M., 150 Chesbrough, H., 78 Chevrolet, 116 Chia, R., 81 Child, J., 220 Choi, J., 149 Christensen, C. M., 47, 106, 110, 113 Christpherson, S., 177 Chtiouia, T., 215 Chua, R. Y. J., 151 Cisco Systems, 14, 23–33 Clark, D. N., 108–109 Clark, K. B., 106, 111–113 Clark, K. B., 110 Clarke, C., 92 Clegg, S. R., 78, 81–82, 85

Codes of conduct, 216–218, 226 Cognitive barriers, 11, 17–23, 25–32, 91 Cognitive bias, 2–6, 12–13, 15, 23, 31–33, 55, 61, 65–66, 111, 194, 206 Cognitive inertia, 91–92, 97 Cognot, 119 Cohan, P. S., 19–20 Colomo-Palacios, R., 194 Colvin, J. G., 10 Combs, J. G., 194–196 Compaq, 8 Competence-destroying innovations, 106, 110–111, 114, 117 Competitor neglect, 11, 13, 21, 29, 31 Complementary assets, 109, 178 Confirmation bias, 5, 11–12, 19, 27, 31 Content industries, 169–172, 174–180, 182, 186–188 Contextualist school of behavioral strategy, 7–9 Control mechanisms, 213, 215, 218, 223, 225–227 Cook, S. D. N., 85–86 Cool, K., 108 Cooper, C., 35, 39 Cooper, T., 56 Core rigidities, 105, 107, 110–111, 121 Corporate culture, 33, 108, 115, 213–215, 217–219, 222–223, 225–227 Corporate Governance Code Monitoring Committee (CGCMC), 44–45 Corporate governance, 41–45, 57, 59–62, 67–68, 213–218, 222–223, 225–227 Coulibaly, M., 145–168 Cox, A., 132 Cravens, D. W., 214 Creative individuals, 172, 174–182, 185, 187–188 Creative industries, 170, 174–176, 179 Creative industry versus manufacturing industry, 176–180 Creativity studies, individuals and organizations, 173–176 Crook, T. R., 194–196 Cross, R. L., 174 Cullinan, G., 10 Cyert, R. M., 53, 59–60, 80, 201

244   Index

D Dacin, M. T., 146–147, 152 Dai, G., 3 Daily, C. M., 58 Dalton, D. R., 58 Dalziel, T., 57 Damanpour, F., 149 Daniel, E. M., 197, 199 Das, T. K., 2, 33, 49, 56, 132, 140, 147, 150 Davel, E., 165 Davies, A., 128, 130, 137 De Jong, A., 44 de la Torre, J., 132, 150 Decision heuristics, 55, 59 Decision making framework, 11–13 Decision making, behavioral strategy approach to, 6–9 Decision making, factors influencing, 4–6 Defillippi, R. J., 204 Deloitte, 46, 48–49 Demeuse, K. P., 3 Demil, B., 79, 96 Denis, D. K., 57 Denison, D. R., 217–219, 222, 225–226 Desai, A., 10 Despicable Me 2, 183 Dess, G. G., 215, 220, 222 Desyllas, P., 10, 14 Devinney, T. M., 129 Dexter, A. S., 173 Dierickx, I., 108 DiMaggio, P. J., 101 Dimov, D., 89–90 Disaster neglect, 11, 13, 19, 21–22, 30–31 Dodgson, M., 173 Dominant logic, 87 Donaldson, T., 60 Dosi, G., 110 Doz, Y. L., 149–150 Drnevich, P. L., 194 Dromgoole, T., 214 Drzik, J., 42, 46 Dual system, 170–171, 180–181, 187–188 Dubois, A., 128, 131–133, 137 Dubois, A., 133 Dufeu, I., 155 Duhaime, I. R., 11 Duncan, R., 172 Duncan, W. J., 206 Dunford, B. B., 108

Dupuis, J. P., 165 Dutch Corporate Governance Code, 44–46, 49, 61–62, 68 Duysters, G., 149 Dynamic capabilities, 9, 92–93, 99, 121, 199

E Easterby-Smith, M., 75 Echambadi, E., 146–147 Eckhardt, J. T., 79, 89 Ecocert Equitable (a fair trade label), 153, 155 Ecocert, 147, 155–157, 162–164 Economic Intelligence Unit, 3 Edhec, J. L. A., 148, 152 Edison, S. W., 217, 222, 225 Ees, H., 202 Eidinow, E., 62–63 Eikebrokk, T. R., 198, 206 Eisenhardt, K. M., 14, 30, 56, 92 Eisenstat, R. A., 215 Elfenbein, H. A., 32 Elgin, B., 29–30 Ellinger, A. E., 198 Elliot, S. R., 173 Ellstrand, A. E., 58 Emotional barriers, 11–12, 15–17, 23–25, 31–32 Emotional closedness, 11–12, 15, 31 Emotional commitment, 11–12, 16–17, 25, 31 Endowment effect, 11, 28, 31, 49 Engwall, M., 128 Environmental uncertainty, 41–44, 49, 52–54, 56, 62, 64–65, 68–69 European Fair Trade Association (EFTA), 152 Evans, P., 109

F Facebook, 95 Fahy, J., 198 Fair for Life (a fair trade label), 155 Fair trade label, 145–147, 154–156, 158–164 Fair Trade Labeling Organization (FLO), 147, 152, 154–156, 160–164

Index    245 Fair trade market, cooperative relationships in, 157–158 Fair trade, certification process, 154–155 Fair trade, main certification bodies, 155–157 Fair trade, principles and actors, 152–154 Fairtrade (the Max Havelaar association fair trade label), 155 Fairwild (a fair trade label), 155 Falkenberg, L., 215 Fama, E. F., 50 Fanto, J. A., 18, 19, 21, 22 Faseruk, A., 56 Faulkner, R. R., 177 Federal Trade Commission (FTC), 17 Felin, T., 81 Ferreira, M. P., 151–152 Ferriani, S., 174 Ferrie, J., 153 Fiatotchev, I., 74 Film prizes, 176, 182, 185 FINE (an association of fair trade networks), 152–153 Fink, D., 173 Fink, L., 198 Finkelstein, S., 4–5, 9–10, 35, 39, 43, 50, 57, 92 First-mover advantage, 112–113 FLO-Cert, 154–156, 160–164 Flood, P. C., 214 Flood, R. L., 51, 55 Floyd, S. W., 131–132 Floyd, S. W., 215 Follower firms, behavior of, 114 Forbes, D. P., 43, 57–58 Ford Motor Company, 115–118, 120 Forest Garden Products (a fair trade label), 155 Foss, N. J., 81 FOURIN, 117 Fox, C. R., 2–3, 6–9, 13, 32–33, 60, 81, 129, 140, 147, 195, 201, 206, 215 Frechet, M., 150 Fredrickson, J. W., 50, 60, 65, 91 Freemen, J., 106 French, S., 2, 4–6, 9 Frick, K. A., 14 Friedland, R., 95 Friesen, P., 220, 222 Frigo, M. L., 42 Frozen, 183 Fuerst, W., 197, 204

G Gabbay, D. M., 103 Gabriel, Y., 67 Gabrielsson, J., 59, 60–61, 65, 202 Gadde, L.-E., 128, 131–133, 137 Galbreath, J., 198 Gambling, 54 Gann, D. M., 128–131, 137 Garbuio, M., 29, 106 Gavetti, G., 8, 78, 80, 85–86, 201, 206, 214 Gefen, D., 173 Geletkanycz, M. A., 91 Gemser, G., 170, 175 General Motors (GM), 116–120 George, G., 78, 87 Geringer, J. M., 147 Gilbert, C., 106, 111 Giles, W. D., 214 Ginsberg, A., 220 Ginter, P. M., 206 Glaister, K. W., 147, 151–152 Glick, W. H., 227 Glunk, U., 219, 225 Glynn, M. A., 90 Gobet, F., 4–5 Godet, M., 63 Goldblatt, H., 14, 23 Goldstein, S., 150 Golsorkhi, D., 78 Goodhue, D. L., 203 Goodwin, P., 52 Gordon, A. W., 1–39 Gordon, W., 2 Gorman, L., 214 Goussevskaia, A., 130 Govindarajan, V., 215 Grabher, G., 128, 130 Graebner, M. E., 10, 14 Grant, R. M., 109, 194, 196–197, 199, 204 Gravity, 182–185 Greve, H. R., 78, 80, 201, 206 Greve, W., 84–85 Groupthink, 11–12, 18, 26, 31, 55, 65, 69 Gruber, M., 197–198, 206 Guillouzo, R., 149 Gulati, R., 150 Gupta, V., 24, 26 Gurbaxani, V., 197–198 Guth, W., 222 Güttel, W. H., 199

246   Index

H Hakansson, H., 142 Halo effect, 11, 13, 20, 28, 31 Hamada, T., 105–126 Hambrick, D. C., 8, 43, 50–51, 57, 80, 91, 215 Hamel, G., 91, 109, 149, 218 Hammond, S. J., 5, 20 Hamzaoui-Essoussi, L., 146 Hannan, M. T., 106 Harisson, J. S., 146–147 Harrison, D., 142 Hart, P., 173 Hartono, E., 197 Haspeslagh, P. C., 3, 10 Haugland, S., 132, 138 Haynes, I., 153, 155–156 Haynie, J. M., 91 He, X., 198 Healey, M. P., 2–3, 7–9, 12 Hegarty, W. H., 10 Heimeriks, K. H., 81, 149 Heinemann, F., 197–198, 206 Helfat, C. E., 82, 194–196 Henderson, R. M., 106, 111, 113 Henry, S., 17 Henry, T., 150 Hermalin, B. E., 58 Hermes, C. L. M., 44 Hermes, N., 44, 62 Herremans, I., 215 Hertel, G., 146 Heskett, J. L., 219, 225 Hill, C. W. L., 106 Hillman, A. J., 57 Hiltzik, M., 21 Hira, A., 153 Hitt, M. A., 102, 109, 146–148, 152, 196–198 Hobday, M., 128, 130 Hodgkinson, G. P., 2–3, 7–9, 12 Hoecklin, L. A., 218 Hofmeister, K. R., 214 Holbek, J., 172 Holistic approach to strategy formulation, 200, 207–208 Holland, J. H., 175 Holloway, S., 198 Hollywood, 170, 172, 179, 181, 185, 188 Holmen, E., 132 Holson, L. M., 20

Hooghiemstra, R., 44, 62 Hooley, G., 198 Hopkin, P., 52 Hopkins, H. D., 10 Hopkins, M. M., 52–54, 56 Horn, J., 29 Hoskisson, R., 109 Howell, G. A., 134 HP, 8, 88 Hrebiniak, L. G., 109, 214 Hu, J., 14–15, 17 Huber, G. P., 227 Huberman, A. M., 133 Huff, A., 131 Hughes, A., 10, 14 Hughes, K., 154 Hulland, J., 109 Hulland, J., 194, 198–199, 204 Hult, G. T. M., 109 Hult, T. M., 203 Hungeling, S., 197–198, 206 Hunger, J. D., 227 Hurley, R. F., 203 Huse, M., 202 Huse, M., 43, 57 Huse, M., 58–61, 65 Huy, Q. N., 7, 12, 90 Hyundai Motor Company, 117

I Iacovou, C. L., 173 IBISWorld, 170 IBM, 29 Incumbent firms, behavior of, 106, 110–111, 114–115 Incumbent inertia, 106, 110 –111, 113, 123 Individual creators and organizational diffusion, 172–173 Indonesia, 214, 220–222 Inimitable resources, 196, 199, 204 Innovation process, 172, 181 Innovative films, 182–186, 188 Innovative products, 169, 170, 172, 175, 179, 181, 187, 188 Insurance companies, 214, 220–222, 224, 227 Interactive process perspective, 171, 173–174 International Federation for Alternative Trade (IFAT), 152 Internet Movie Database (IMDb), 182–186

Index    247 Ireland, P., 132 Ireland, R. D., 102, 109, 196 Iron Man 3, 183 Irrational behavior of firms, 111–112

J Jackson, G., 216 Jackson, M. C., 51, 55 Jacobs, D., 51–52 Jahn, G., 154 Jamieson, A., 128 Janis, I. L., 55 Jarzabkowski, P., 78–79, 81–82, 129, 131, 140 Jemison, D. B., 3, 10 Jensen, M. C., 50, 56 Jeremy, G., 197 Jerry Levin, 16, 19, 22 John Chambers, 24–26 Johnson, E. J., 5 Johnson, G., 78, 81–82, 85, 131 Johnson, J. L., 58 Johnson, P., 131 Joyce, W., 214 Judge, W. Q., 58 Julien, P. A., 89 Just, D., 2, 10 Just-in-time, 116

K Kabir, R., 44 Kahneman, D., 3, 5–6, 9, 11–13, 17–19, 31–32, 49 Kaizen, 116 Kanban, 116 Kaplan, S., 80 Katkalo, V. S., 88 Kaufmann, W., 62 Kauser, S., 1–39 Kautz, K., 173, 189, 191 Kawasaki, A., 169–191 Keasey, K., 71 Keeney, R. L., 3, 5, 13, 20 Keith, P., 172, 182 Kemmerer, B., 81 Kenney, M., 14, 23–27, 29–30 Ketchen, D. J., 109, 194–196

Khanna, T., 150 Killick, M., 29 Kim, E. H., 10 Kim, K. A., 216 King, D. R., 10 Kitic, M., 221 Klein, A., 15–17, 21 Klein, G., 3, 9, 16 Klijn, E., 149 Klinke, A., 53, 56 Knetch, J. L., 49 Knight, F. H., 42, 52, 80 Kobashi, T., 105–126 Kodak, 65 Kornberger, M., 78, 81–82, 85 Kotter, J. P., 219, 225 Kraemer, K. L., 197–198 Kramaric, T. P., 221 Kriauciunas, A. P., 194 Kumar, R., 33 Kunc, M. H., 194 Kupers, R., 63 Kuran, T., 175 Kwoka, J. E., 17

L Lamberg, J. A., 88, 92 Lampel, J., 55, 59 Langfield-Smith, K., 10 Langley, A., 78, 85 Larsson, R., 10 Laukia, A., 88, 92 Lavie, D., 121 Le Roux, J. M., 10 Le, J. K., 85, 94, 96 Leatherwood, M. L., 215 Lecocq, X., 79, 96 Leonard-Barton, D., 110–111 Leonardo da Vinci, 119 Les Misérables (2012), 184, 186 Levi, A., 49 Levinthal, D. A., 8, 78, 80, 129, 195, 200, 205 Levitas, E., 147–148, 152 Li, D., 151–152 Lieberman, M. B., 112 Liebl, F., 64 Lin, Z. J., 146–147 Lindkvist, L., 128 Lindzey, G., 70

248   Index Linton, J. D., 146 Lionsgate, 183 Lioukas, S., 197, 200 Lisø, S. O., 33 Liu, C., 173 Lockett, A., 151, 194–195, 197–198 Lohr, S., 20 Lok, P., 77–104 Lopez Iturriage, F. J., 70 Lord, M. D., 10 Loss aversion, 11, 13, 22, 30–31, 49 Loukis, E. N., 194 Lounsbury, M., 90 Lovallo, D. P., Lovallo, D. P., 2–3, 5–9, 11–13, 22, 17–19, 29, 31–33, 59–60, 81, 92, 129, 140, 147, 195, 201, 206, 214–215 Lu, J., 173 Lu, Y., 198 Lubatkin, M., 10 Luckmann, T., 66 Lui, S. S., 132 Lukviarman, N., 216 Luo, Y. D., 146–147, 149, 151 Lyles, M. A., 51, 75 Lynch, R., 200 Lynham, S. A., 62 Lyon, D. W., 91

M Macmillan, I. C., 222 Madansky, A., 201, 203 Madsen, T. L., 81 Madura, J., 14 Magretta, J., 87 Mahmood, I. P., 198 Maijoor, S., 196 Main dans la Main (a fair trade label), 155 Major film distributors, 177, 181–185, 188 Makadok, R., 196 Management of meaning, 44, 60 Manigart, S., 151 Mankins, M. C., 3 March, J. G., 42, 52, 59–60, 80, 121, 175–176, 186, 201 Markoczy, L., 215 Marks, M. L., 13, 14 Marra, T., 44 Martin, J. A., 92

Maslowski, R., 219, 225 Mason, P. A., 50–51, 80 Massa, L., 87, 94, 96 Mata, F., 197, 204 Mathews, J. A., 204 Maule, J., 2, 4–6, 9 Max Havelaar (fair trade association), 153, 155, 161–163 Mayer, D., 14, 23–27, 29–30 Mayer, M., 129 Mayet, A., 153, 155–156 Mayrhofer, U., 149, 152 McConnell, J. J., 57 McHugh, A., 128, 131–132 McKinnon, A., 4 Mcmullen, J. S., 86 McNulty, T., 58, 68 Meckling, W. H., 56 Melin, L., 78, 81–82, 85, 91, 94, 131 Melville, N., 197–198 Menon, A., 217, 222, 225–226 Mental models, 65–69, 78, 87–88, 90, 94 Mergers & Acquisitions (M&As), 1–4, 9–10, 12, 14–15, 19–20, 23, 29–32 Meuleman, M., 151 Microfoundations, 79, 81, 94, 99 Microprocesses, 129, 140 Microstrategies, 81, 90 Middle managers, 106, 131, 215–217, 220, 225, 227 Miles, M. B., 133 Miller, C. C., 227 Miller, D., 220, 222 Miller, E. S., 13 Miller, R., 21–22 Milliken, F. J., 43, 57–58 Milosevic, D. Z., 130 Mindset, 78, 87, 93, 218 Mintzberg, H., 51, 55, 59, 128, 131–132, 218, 220 Mirvis, P. H., 13–14 Mishra, A. K., 218, 222, 226 Mitchell, W., 92 Mithas, S., 198 Mitroff, I. I., 51–52 Mitsuhashi, H., 151 Model T, 115–116, 118 Modig, N., 130 Mogensen, G., 21 Molloy, E., 129 Montealegre, R., 197 Montgomery, C. A., 10

Index    249 Montgomery, D. B., 112 Morecroft, J. D. W., 194 Morgenstern, U., 194, 197–198 Mormont, M., 153, 155–156 Morris, P., 128 Mosakowski, E., 91 Movie industry, 169–170, 172, 177, 179, 181, 185–188 Mowday, R. T., 222

N Nadler, D. A., 217 Nag, R., 8 Nagy Smith, A., 67 Najmaei, A., 77–104 Naldi, L., 91, 94 Narayanan, V. K., 81 Naturland fair (a fair trade label), 155 Ndofor, H. A., 198 Nelson, R. E., 90 Neoinstitutional view, 94–95 Nespresso AAA (a fair trade label), 155 Ness, H., 132, 138 Network of European World Shops (NEWS), 152 New United Motor Manufacturing, Inc. (NUMMI), 118 Newbert, S. L., 197 Ngo, H. Y., 132 Nguyen, H. T., 10 Nielsen, B. B., 147, 150, 151 Nielsen, P. A., 173 Nightingale, P., 52–54, 56 Nissan, 117–119 Noble, C. H., 214 Nofsinger, J. R., 216 Nohria, N., 150 Nokia, 88 Nonoptimal decision making, 105, 107–112 Nonsubstitutable resources, 196–197, 204 Nooteboom, B., 85 Nutt, P. C., 215

O O’Reilly, C. A., 13–14, 23–30, 121, 175 Obloj, K., 87

Ocasio, W., 8, 78, 80 Occitane, 154 Ofori, G., 130 Ogawa, E., 178 Ogilvy, J. A., 69 Ohmae, K., 218 Olavarrieta, S., 198 Oldham, T., 3 Olivier, R. L., 146 Olsen, D. H., 198, 206 Ong, C. H., 43 Optimistic bias, 11, 13 Organizational ambidexterity, 169–170, 172, 174–175, 188 Organizational inertia, 105–107, 118–119, 123 Organizational routines, 12, 82, 87, 93, 109, 111, 115, 121–122 Orlikowski, W. J., 78 Osterwalder, A., 92 Ouchi, W. G., 215 Overconfidence, 3, 11, 13, 21, 29, 31–32, 108 Owan, H., 172 Ozcaglar-Toulouse, N., 146

P Pajuste, A., 57 Paluch, D., 31 Papadakis, V. M., 10 Papamichail, K. N., 1–39 Paradigm shift in industry, 105, 107, 112–116, 119–120, 123 Paramount Pictures, 181 Park, S. H., 149 Parker, A., 174 Parker, S. C., 90 Parkhe, A., 149 Parmigiani, A., 198 Parnell, J. A., 198 Paroutis, S. E., 95–96 Partner capability, 146, 148–149, 152, 162–164 Partner commitment, 146, 148, 150, 152, 162, 164 Partner compatibility, 146, 148–150, 152, 162, 164 Partner reliability, 146, 148, 150–152, 162–164 Partner selection criteria, 145–152, 159, 162–163

250   Index Path-dependency, 105, 107, 109–110, 114, 118 Patzelt, H., 91 Pavlou, P. A., 173 Payne, J. W., 5 Pearce, J. A., 43, 57 Pedersen, A.-C., 132 Peij, S., 73 Peng, M. W., 146–148, 151 Penrose, E. T., 196 Perrott, B. E., 53 Peteraf, M. A., 108, 194–196 Peteraf, M. A., 92 Peters, T. J., 215 Peterson, M. F., 173 Peterson, M. F., 231 Pettigrew, A., 43, 57–58, 68, 133 Pezet, A., 165 Pfeffer, J., 13, 24–30, 220 Philips, 46–47 Picard, R. G., 15–16, 21 Pigneur, Y., 92 Pinkham, B. C., 148, 151 Pisano, G., 92, 110, 121, 196, 199, 203 Pitelis, C. N., 88, 195, 206 Planning fallacy, 11, 21, 29, 31 Plural roles, 185, 187–188 Pluralist school of behavioral strategy, 7–8 Polaroid, 65, 67 Poret, S., 152, 154, 156 Porter, L. W., 222 Porter, M. E., 62, 83–84, 107, 207 Positioning view in strategy, 105, 107–109, 111, 113–114, 117, 123, 197, 203 Postma, T. J. B. M., 41–75 Pothukuchi, V., 149 Poulter, J., 52 Powell, T. C., 2–3, 6–9, 13, 32–33, 60, 81, 129, 140, 147, 215 Powell, W. W., 101 Power, D. J., 227 Practice theory, 77, 79, 82, 93 Prahalad, C. K., 109, 218 Prasanth, K., 24, 26 Pratt, M. G., 87 Premkumar, G., 173 Prescott, J. E., 220 Preston, L. E., 60 Priem, R. L., 170 Priem, R. L., 196–199 Pries-Heje, J., 189, 191 Probst, G., 10

Project-based organizations (PBOs), 127–134, 137, 139–140 Project-based organizations (PBOs), couplings in, 128–129, 132, 138–141 Project-based organizations (PBOs), strategizing in, 130–131 Project-based organizations (PBOs), temporary nature of, 127, 129–132, 139–140 Psychological factors, 2, 107, 114, 121, 123 Pugliese, A., 58 Puthod, D., 150

R Radhika, N., 15–17, 21 Rahajeng, D. K., 216 Raiffa, H., 5, 20 Rajaram, V., 3, 13 Ramamurthy, K., 173 Ramamurthy, K., 198 Ramaprasad, A., 51–52 Ramasubbu, N., 198 Ranft, A. L., 10 Rappaport, A., 22 Rare resources, 196–197, 204, 220 Rashidirad, M., 193–211 Rau, D., 195, 201–202, 205–206 Rau, D., 88 Rawoot, I., 29 Ray, S., 15 Reckwitz, A., 82, 85–86 Reddy, C. C., 1–39 Rediker, K. J., 57 Reductionist school of behavioral strategy, 7–8 Reductionistic approach to strategic management, 198 Reed, R., 204 Regnèr, P., 131 Rei, J., 21, 22 Renault, 117 Renn, O., 53, 56 Resource-based theory (RBT), 93, 98, 105, 107–109, 193–200, 203–207 Resource-based theory (RBT), criticism and limitations, 197–199 Reuer, J. J., 149–150 Rezaee, Z., 216 Rheaume, L., 13 Rhodes, J., 77–104

Index    251 Ricart, J. E., 79, 96 Ricart, J. E., 87 Ricciardi, V., 7 Rifkin, G., 24–30 Rindova, V. P., 58 Ring, P. S., 132, 157 Risk management, 41–43, 45–47, 52, 54–56, 67–69 Risk mitigation tactics, 48 Rittel, H. W. J., 51 Rivkin, J. W., 85–86 Roberts, D. J., 175 Robinson, J., 196 Roëll, A., 44 Rogers, E. M., 172, 175, 182 Rogers, P., 3 Romanelli, E., 106 Romelaer, P., 158 Rose, G. M., 173 Rosenbloom, R. S., 78 Ross, J. W., 203 Rothaermel, F. T., 106 Roubelet, F., 65–66 Rouleau, L., 78 Roundy, P. T., 14 Rouse, J., 85 Roussel, P., 167 Rubinfeld, D. L., 15 Rumelt, R. P., 195 Rumsfeld, D., 53 Russo, J. E., 55

S Salancik, G., 220 Saliency bias, 11–12, 18–19, 26, 31 Salimian, H., 193–211 Salter, A. J., 128, 129, 130, 131, 137 Sambamurthy, V., 198 Sandy, W., 215 Santhanam, R., 197 Santos, F., 14 Sarkar, M. B., 146–147 Sathe, V., 217 Sauvée, L., 154 Saxton, T., 146–147 Scenario thinking, 42–47, 53, 55, 62–67, 69 Schendel, D., 227 Schlender, B., 29 Schmid, T., 215

Schnatterly, K., 216–217, 222, 225–226 Schoemaker, P. J. H., 55, 108, 196 Schools of behavioral strategy, differences, 8 Schrager, J., 201, 203 Schramm, M., 154 Schuen, A., 196 Schumpeter, J. A., 175 Schwartz, P., 62–63, 67 Schweiger, D. M., 33 Schweizer, L., 9 Schwenk, C. R., 7, 11 Securities and Exchange Commission (SEC), 15, 18–21 Seidl, D., 78, 85, 94, 96, 131, 140 Self-interested bias, 11, 17, 25–26, 31 Senge, P. M., 218 Seth, A., 57 Sexton, D. L., 102 Shah, R. H., 150–151 Shane, S., 89 Sharfman, M., 221 Shell, 46–47, 63 Shepherd, D. A., 86, 91 Shi, W., 148, 151, 215 Shleifer, A., 21 Shleifer, A., 44 Shrieves, R. E., 10 Shu, P. G., 199–200 Shuen, A., 110, 121 Shuen, A., 92 Shulman, L. E., 109 Sibony, O., 3, 5, 9, 11–13, 17–19, 22, 31–32, 59, 214 Siggelkow, N., 84 Silverstein, S., 21 Simandjuntak, H. B., 213–231 Simon, H. A., 2, 4, 7, 15, 42, 52, 60, 201, 205 Singh, H., 92, 150 Sirmon, D. G., 109, 196–198 Sirower, M., 22 Sitkin, S. B., 3 Slappendel, C., 173 Sleegers, A. M., 64 Slywotzky, A. J., 42, 46 Smith, A., 129 Snell, S. A., 108 Snow, C. C., 109 Sociocognitive theory, 77, 79 Soda, G., 174 Soetjipto, B. W., 213–231 Soh, P. H., 90 Soltani, E., 193–211

252   Index Sony (Columbia), 181 Soto Acosta, P., 194 Spanos, Y. E., 197, 200 Spector, L. C., 215 Spee, A. P., 129 Spee, A. P., 78–79, 81–82 Spiller, A., 154 Sponsoring Organizations of the Treadway Commission (COSO), 46–47, 49 Sproull, L. S., 214 Srivannaboon, S., 130 Stalk, G., 109 Starkey, K., 140 Status quo bias, 22 Steers, R. M., 222 Stephenson, R. G., 216 Steve Case, 16–17, 21–23 Stigler, G. J., 83 Storper, M., 177 Strategic business units, performance of, 217, 219–220, 223, 227 Strategic conversation, 63, 66, 69 Strategic groups, 107, 113–114, 117–120 Strategic positioning, 107–109, 113, 117, 123, 197 Strategic problems, 41, 51–52, 54, 59–60, 67–69 Strategic resources, 193, 197, 199, 200 Strategic risk and uncertainty, 49–56 Strategic risk behavior, 44, 49, 56 Strategic uncertainty, 41–44, 49, 52–55, 63–65, 68–69 Strategy as practice, 77, 79–86, 94, 129, 140 Strategy development, economic and behavioral approaches, 199–200 Strategy execution, 213–215, 217–227 Straub, T., 10 Structural ambidexterity, 180–181, 187–188 Sudarsanam, S., 2–3, 9–10 Suddaby, R., 85, 94, 96 Sull, D. N., 30 Sun, L. S., 146–147 Sun, Q., 10 Sun, S. L., 148, 151 Sunk-cost fallacy, 11, 13, 20, 28, 31 Sunstein, C. R., 3, 33 Svejenvoa, S., 171 Swaminathan, V., 150–151 Swan, J. E., 130, 146 Sward, A. R. S., 127–143 Swayne, L. E., 206 Swisher, K., 16–17, 21–22

Swiss Reinsurance Company, 221 Symbolic compliance, 44, 61–62 Szulanski, G., 87–88, 194

T Tabrizi, B., 13–14 Taleb, N. N., 53, 56 Tang, K. Y., 3 Tautological nature of RBT, 193, 198 Teece, D. J., 78, 87–89, 92, 109–110, 121, 178, 196, 199, 203 Tempest, N., 25, 28 Tempest, S., 140 Teng, B., 2, 49, 56, 132, 140, 146–147, 150 Tetlock, P. E., 64 Thagard, P., 103 Thaler, R. H., 3, 33, 49 Thanos, I. C., 10 The Help, 184 The Hunger Games: Catching Fire, 183 The King’s Speech, 184 Thiéry-Dubuisson, S., 215 Thomas, H., 51 Thomas, L. C., 214 Thompson, D. N., 16–17 Thompson, J., 220 Thompson, S., 71, 194, 195, 197–198 Thong, J. Y. L., 173 Tidd, J., 172, 182 Tikkanen, H., 88 Time Warner, 14–23, 31 Todd, S. Y., 194–196 Tollin, K., 87 Torres, A., 14 Torvatn, T., 132 Total quality control (TQC), 116 Toyota Automobile Museum, 119–120 Toyota, 116–123 Tripsas, M., 106 Trust, 132, 138–140, 147, 150–151, 163 Tung, R., 220 Turnbull, S., 218, 225 Turner, D. L., 216 Tushman, M. L., 106, 110, 121, 175 Tversky, A., 6, 49

Index    253

U U.S. Movie Industry case study, 181–188 Ullrich, J., 11 Unger, B., 150 Unilever, 46 Universal, 181, 183–184, 196–187 Usai, A., 174 Utomo, H., 173 Utterback, J. M., 172, 182

V Vaara, E., 78, 82, 95–96 Vaghely, I. P., 89 Välikangas, L., 91 Value capture, 78, 95 Value chain, 83, 87 Value creation, 3, 10, 79, 95, 140, 150, 193, 197–199 Values and beliefs, 215, 217–218 Van Asselt, M. B. A., 64–65 Van de Ven, A. H., 157 Van den Berg, A., 62 Van den Bosch, F. A. J., 58 Van der Heijden, K., 43, 53, 56, 62–66, 69 Van der Laan, G., 44, 62 Van der Merwe, L., 66 van Dick, R., 11 Van Ees, H., 44, 59, 60–62, 65 Van Notten, Ph. W. F., 64 Van Witteloostuijn, A., 62 Vanhaverbeke, W., 149 Venkatraman, N., 220–221 Vince, R., 67 Vishny, R. W., 21, 44 Vogel, R., 199 Volberda, H. W., 58 Volkswagen, 117 Von Mises, L., 84–85 VRIN resources, 196, 199, 204–205 Vygotsky, L., 82, 84

Wall Street Journal, 16 Waluszewski, A., 142 Wan, D., 43 Wang, C. L., 198 Ward, J. M., 196–197 Ward, P. T., 222 Warkentin, M., 173 Warner Bros., 181, 183–184 Warsono, S., 216 Waterman, R., 215 Webber, M. M., 51 Weber, T., 16 Weber, Y., 33 Weddigen, R. M., 10 Wei, K. C. J., 146–147 Weisbach, M. S., 58 Welsch, L. A., 53 Wernerfelt, B., 108, 194–196 Westphal, J. D., 44, 50, 59–61, 65 Wheelen, T. L., 227 White, L. R., 17 Whithead, J., 4–5, 9 Whittington, R., 129, 131 Whittington, R., 78–79, 81–82, 85, 95–96 Wijnberg, N. M., 170, 175 Wilderom, C. P., 219, 225 Wilderom, C. P., 231 Wilkinson, A., 62–63 Wilkinson, T. J., 148–149 Williams, J. R., 80 Williamson, O. E., 218, 225 Wilson, H. N., 197, 199 Wilson, V. A., 10 Winter, S. G., 87–88, 92, 200 Wittelstuijn, A. V., 196 Wong, P. K., 90 Wong, W., 23 Woods, J., 103 Wooldridge, B., 131–132, 215 Wright, G., 43, 52, 62–63, 66 Wright, M., 71 Wright, P. M., 108 Wright, R. P., 95–96 Wu, B. E., 199–200

W Wacheux, F., 167 Wack, P., 43, 53–54, 63–64, 69 Wade, M., 109, 194, 198–199, 204

X Xia, J., 150 Xu, X., 173

254   Index

Y Yahoo, 95 Yamada, J., 171, 174, 177 Yamada, M., 169–191 Yamashita, M., 171, 174, 177 Yang, B. C., 199–200 Yang, H., 146–147 Yang, M. H., 199–200 Yao, J. E., 173 Yap, C. S., 173 Yemen, G., 26, 29–30 Yepez, I., 153, 155–156 Yin, R. K., 133, 158 Yu, T. F. L., 6 Yung, K., 10

Z Zaheer, A., 174 Zahra, S. A., 43, 50, 57, 68 Zajac, E. J., 44, 59–61, 106, 108, 198 Zaltman, G., 172 Zane, L. J., 81 Zattoni, A., 58 Zeelenberg, M., 146 Zeithaml, C. P., 58 Zhang, J., 90 Zhu, H., 198 Zollo, M., 150 Zott, C., 78–79, 82, 84, 87, 90, 94, 96