Myths and Fallacies in Strategic Management – Part II

17 May 2006 at 8:01 am 17 comments

| Nicolai Foss |

Why has the notion of firm-level “capabilities” become so incredibly popular in strategic management research during the last 10-15 years?

This is a puzzle because — as Teppo Felin and I have argued in a series of recent papers (most of which can be accessed from www.nicolaifoss.com) — firm-level capabilities is a highly problematic concept. Thus, there are no theories of the emergence or origin of capabilities and the connection between the level of capabilities and the level of individual agents is at best unclear and perhaps more realistically non-existent. Partly because of these difficulties, there simply aren’t any clean definitions of capabilities around.

However, one shouldn’t necessarily kill a concept for not being adequately defined. As Oliver Williamson points out in his 1999 paper in the Strategic Management Journal, it took substantial time before the notion of transaction cost was so well defined that it could be used constructively in theorizing. The notion of capabilities was only coined in the context of firms in 1972 (by G B Richardson), while transaction costs (or “the costs of using the price system”) were introduced by Coase in 1937. Patience may be waranted.

On the other hand, one’s tolerance with an ill-defined concept should also be dependent on what the concept is supposed to do and why it is around.

One possible explanation is that capabilities are around because of the interest (some would say “obsession” in sociology with “structures,” “social facts,” etc.
that determine human behaviors. Strategic management is often seen as heavily economistic, whereas in actuality, sociology has been very strongly influential during the last decade. The aggregate focus of sociology squares well with capabilities ideas. For the methodological individualist this constitutes sufficient reason to be less patient with the notion of capabilities.

Another explanation is that capabilities have become so influential in strategic management because of a mistake of reasoning. I alluded to in my earlier post on myths and fallacies in strategic management, specifically to the highly influential Dierickx and Cool 1989 paper in Management Science which focused on costly to trade and imitate asset stocks.

As I argued in the earlier post, the Dierickx and Cool paper has often been read as implying that only “non-tradeable” resources can produce a competitive advantage. The relevant “non-tradeable” resources are typically singled out as resources that are somehow tied to a collective of interacting agents, from which it cannot really be separated, is formed through a complex path-dependent historical process and has a large tacit knowledge component.

Capabilities are usually talked about (I hesitate to say “defined”) in exactly these terms. Hence, it is concluded that primary interest in the analysis of sustained competitive advantage should be in capabilities. And hence the popularity of the notion of capabilities.

As I pointed out in the earlier post, this is armchair reasoning and a non sequitur. I may add that capabilities are problematic concepts because they not only obscure
value appropriation, a complicated bargaining process between individual agents, but also obscures the understanding of value creation. As Teppo Felin and Bill Hesterly argue in their forthcoming Academy of Management Review paper on the “locus of knowledge,” this locus and therefore value creation may lie solely on the level of key individuals. And even if value creation is very much a matter of interaction between individual agents, we still want to understand this process of interaction. Aggregate notions of capabilities may be more harmful than helpful in this regard.

Entry filed under: - Foss -, Management Theory, Myths and Realities, Papers, Strategic Management.

Happy Hierarchies Those Right-Wing Economists

17 Comments Add your own

  • 1. Bo Nielsen  |  17 May 2006 at 11:13 am

    Very interesting. I have yet to read the AMR piece, however, you would probably make the same argument about concepts like absorptive capacity then: If Absortive capacity is a limit to the rate or quantity of scientific or technological information that a firm can absorb then we are again operating at the firm-level when in reality one would argue that the rate of absoption must be highly correlated with the individual or micro-level processes of the firm.

    I tend to agree, however, the question is what information is lost when aggregating to the firm-level (and potentially what information may be gained)? Perhaps the reason for these aggregations are methodological; it is darn difficult (for economists) to deal with individual-level constructs in larger samples..

    Needless to say, the current trend of calling for multi-level research is highly pertinent and warranted!

  • 2. Nicolai Foss  |  17 May 2006 at 1:23 pm

    Bo, You are exactly right: I would indeed make this argument about absorptive capacity — which I am actually doing in an invited Perspective Paper for Organization Science with Marjorie Lyles and Henk Volberda.

  • 3. Jung-Chin Shen  |  17 May 2006 at 2:29 pm

    I have not read any paper you recommend yet, but I have one question about your position. Do you mean that the capability concept is functionally useless because it obscures certain important considerations such as value creation and value appropriation, or that the concept is fundamentally wrong because it never exists in reality?

    BTW, an INSEAD classmate of mine wrote a dissertation about the creation of firm capability based on his ethnographic observation of several construction plants in Brazil. His summary paper on the topic got the William Newman Award from AOM, but is still under review.

  • 4. Nicolai Foss  |  17 May 2006 at 2:35 pm

    Jung-Chin, That is a clever question. I mainly tend to think that capabilities are functionally problematic (not useless) because they may obscure important micro-processes. But I fully acknowledge that “capabilities” may be very useful shorthand for complicated patterns of individual action and interaction. That is precisely the reason why we should strive to build micro-foundations for them. In other words, I don’t necessarily deny the ontological status of capabilities (my frequent co-author, Teppo Felin may, but he should answer for himself).

  • 5. Nicolai Foss  |  17 May 2006 at 2:40 pm

    Jung-Chin, Perhaps you could send me a mail (njf.smg@cbs.dk)? I would love to send you a paper that I am working on right now and which explains the position on capabilities that I have sketched here (I don’t seem to be able to locate your mail address using google).

  • 6. Jung-Chin Shen  |  17 May 2006 at 2:49 pm

    Hi, Nicolai, I have sent an email to your mailbox. Many thanks.

  • 7. Teppo  |  17 May 2006 at 3:54 pm

    Jung-Chin Shen and Bo:

    Overall – I think you are both pushing in the right directions (reading between the lines). I think (as Nicolai alludes) that collective level phenomenon are best explained by explicating and understanding underlying micro-foundations (matters related to individuals – choice, nature, characteristics, appropriation etc etc), rather than leaving the explanation at a collective level.

    The best theoretical intution comes from e.g., work in social theory by the likes of James Coleman (see the 1st chapter of his ‘Foundations of Social Theory’ book), but in strategy we have had folks like Russ Coff also discuss related matters (see his 1999 Org Sci piece on individual appropriation)

    I also try to address the matter in the paper Nicolai mentions in the post, and our joint SO! essay from late last year. I think the domain of microfoundations is fundamental and rather neglected (for some reason org theory and strategy have moved to higher, rather than lower, levels of analysis – a mistake in my mind).

  • 8. Jung-Chin Shen  |  18 May 2006 at 1:10 am

    Thank you for your reply. I have one more question. Have you ever read Mark Granovetter’s “Threshold Models of Collective Behavior,” AJS, 1978, pp. 1420-1443? The collective behavior he described to a large extent depends on the structure. I am curious how would you classify the model? Does it fit the 1-2-3 path?

  • 9. Nicolai Foss  |  18 May 2006 at 2:40 am

    Jung-Chin, Another great comment! While I haven’t read this Granovetter paper, I think I can see what you are driving at. My position would be that “structure” does fit the 1-2-3 path. Specifically, it enters in Arrow 1 of the Coleman diagram. The reason you ask is probably because one could argue that it might also fit Arrow 3. But I don’t think that is the case. First, agents are confronted with incentives, information, etc., partly brought about by collective structures, then they act and interact, and then collective outcomes result.

  • 10. Jung-Chin Shen  |  18 May 2006 at 11:54 am

    Nicolai, I can imagine how you would response to Granovetter’s paper, but I guess that the micro-macro link paper may have to clearly address possible concerns from micro and macro people. Social network theorists and complexity theorists might argue that a great deal of macro behaviors is caused by network structure and cannot be reduced to individual level (Granovetter 1976 is a good example, highly recommend). Sure, social network models still need to be clear about how people interact with each other, but the line you draw in the paper becomes blurred if you do not explicit deal with the emergent property.

    On the other hand, from a micro perspective, a question naturally arises as to how micro is micro enough. Why methodological individualism? Why not methodological geneism? How would you deal with possible questions arising from people like R. Dawkins? Or with a different position from E. O. Wilson’s sociobiology? I guess Coleman might argue that it is because we are interested in purposive behaviors. But again, why are purposive behaviors so important? How about those behaviors that are embedded at the gene level? How about unintended consequences of behaviors, especially in a large, complex system?

  • 11. Nicolai Foss  |  18 May 2006 at 12:29 pm

    Jung-Chin,

    I think there may be a slight misunderstanding here: The 1-2-3 path, the Coleman diagram etc. do not at all rule out emergent effects, specifically unintended consequences. On the contrary, the methodological individualism associated with economics and perhaps particularly the Austrian School of economics, stresses that a, perhaps the, key purpose of economics is to understand the unintended consequences of intentional human action. The Coleman diagram is very useful for this.

    I do agree with you that exploring the consequences of behaviors (rather than strict intentional action) is certainly also interesting. To a large extent this is what population ecology and evolutionary economics are about.

    However, I am not sure I understand you when you say that there are emergent effects that are not reducible to human action and interaction (do you mean: Behaviors also need to be taken into account?). Perhaps you mean that the (uintended) consequences are the results of action and interaction that take place within an institutional framework? With that I agree (so I am not a hardcore methodological individualist — rather a softie “institutional individualist” (Agassi)).

  • 12. Jung-Chin Shen  |  18 May 2006 at 12:58 pm

    Nicolai, Perhaps I am not quite right here, but let me try to use Granovetter’s example in his paper to express my point. In Granovetter’s example, everyone’s behavior, incentive, the way of interacting with others etc are given. The critical factor that leads to completely different results is that the order (or structure) that people stand together. It seems to me it suggests that part of the story is about individual, and part of them (and quite a critical part) is about the order (or structure). So my point in the last post is that there is some part cannot be reduced to the individual level.

    BTW, I know a little about your position. Your paper on capabilities and governance was important for my decision to go to Europe for PhD. :)

  • 13. Bo Nielsen  |  18 May 2006 at 2:18 pm

    Nicolai,

    when you say “(uintended) consequences are the results of action and interaction that take place within an institutional framework” – what exactly does that mean? Action is individual, interaction is multividual (perhaps) or may imply multiplicity of people (multividual can apply to one person) and the institutional framework seems to imply embeddedness. Are you then proposing that we identify underlying micro-foundations at each level and THEN put them into context (whether this means aggregating them or not) OR are you proposing we look at these micro-foundations separately? What determines priority and what happens to unintended consequences of unintended actions/behaviours?

  • 14. Nicolai Foss  |  18 May 2006 at 3:40 pm

    Bo,
    You ask what it means to say that “(uintended) consequences are the results of action and interaction that take place within an institutional framework.” Nothing mysterious about it. Think of Econ 101, specifically a competitive market. Action and interaction take place within a framework defined by well-defined and enforced property rights. The welfare properties associated with a competitive market emerge as an unintended consequence.

  • 15. Bo Nielsen  |  18 May 2006 at 5:02 pm

    I know, but what I was trying to tricker was a discussion about priorities among levels, causality and consequences. In particular, the interaction effects between individual choice (behaviour) and social (or institutional) structure seems often undertheorized (see Stinchcombe 1975) and causality unidirectional.

    Perhaps this is simply the traditional difference between economics and sociology – one looking for predictions via manipulations of a priori assumptions while the other is looking for post factum sociological interpretations.

  • 16. David O'Donnell  |  2 June 2006 at 3:57 am

    Had a quick scan at the upcoming AMR article – a ciritique of ‘practices’ as not amenable to statistical testing.!!….. (Carlile, Orlikowski – I admire both)……… mentions the usual suspects Giddens and Bourdieu ……. and Coleman, but not Habermas, of whom I’m a huge fan. Individual or collective ? surely both matter and not really a case of either/or…….. from Habermas we are all already IN a Lifeworld, [the background of which I view as the locus of knowledge] which is collectively and historically created …… and we interact with each other through language and practices within it …..[I agree – most of this ‘capabilities stuff is too abstract].. there is also a ‘frustrating’ objective reality …….[hence Habermas’ epistemological realism]…. such frustrations often the source of real problem solving and learning ……… experiences feedback into language and learning …….. and the collective know-how of the Lifeworld…………. on a modest paper on this at the mo …… will post when draft ready in late June ………. Dave

  • 17. Daniel Buckle  |  16 December 2011 at 2:18 pm

    Firm level capabilities are very important for assess a SBU’s potiental future. The limitations need to be realized and should be made aparent in the overall plan. Capabilities are important for your strategic management since they allow measureable results to be obtained.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

Trackback this post  |  Subscribe to the comments via RSS Feed


Authors

Nicolai J. Foss | home | posts
Peter G. Klein | home | posts
Richard Langlois | home | posts
Lasse B. Lien | home | posts

Guests

Former Guests | posts

Networking

Recent Posts

Recent Comments

Categories

Feeds

Our Recent Books

Nicolai J. Foss and Peter G. Klein, Organizing Entrepreneurial Judgment: A New Approach to the Firm (Cambridge University Press, 2012).
Peter G. Klein and Micheal E. Sykuta, eds., The Elgar Companion to Transaction Cost Economics (Edward Elgar, 2010).
Peter G. Klein, The Capitalist and the Entrepreneur: Essays on Organizations and Markets (Mises Institute, 2010).
Richard N. Langlois, The Dynamics of Industrial Capitalism: Schumpeter, Chandler, and the New Economy (Routledge, 2007).
Nicolai J. Foss, Strategy, Economic Organization, and the Knowledge Economy: The Coordination of Firms and Resources (Oxford University Press, 2005).
Raghu Garud, Arun Kumaraswamy, and Richard N. Langlois, eds., Managing in the Modular Age: Architectures, Networks and Organizations (Blackwell, 2003).
Nicolai J. Foss and Peter G. Klein, eds., Entrepreneurship and the Firm: Austrian Perspectives on Economic Organization (Elgar, 2002).
Nicolai J. Foss and Volker Mahnke, eds., Competence, Governance, and Entrepreneurship: Advances in Economic Strategy Research (Oxford, 2000).
Nicolai J. Foss and Paul L. Robertson, eds., Resources, Technology, and Strategy: Explorations in the Resource-based Perspective (Routledge, 2000).

%d bloggers like this: