Capability interactions and adaptation to demand‐side change

• Date: 01 September 2020
• Author: Tang Wang,Brian Wu,Vikas A. Aggarwal
• Published date: 01 September 2020
• DOI: http://doi.org/10.1002/smj.3137

RESEARCH ARTICLE

Capability interactions and adaptation to

demand-side change

Tang Wang

1

| Vikas A. Aggarwal

2

| Brian Wu

3

1

University of Central Florida, Orlando, Florida

2

INSEAD, Fontainebleau, France

3

University of Michigan, Ann Arbor, Michigan

Correspondence

Brian Wu, University of Michigan, Ann

Arbor, MI.

Email: wux@umich.edu

Abstract

Research summary: We examine how interactions

among a firm's capabilities influence the extent and

direction of firm adaptation under conditions of

demand-side change. Our empirical context is the

U.S. defense industry, within which we study firms

receiving defense-related Small Business Innovation

Research (SBIR) awards around September 11, 2001, an

event which constituted an exogenous demand-side

shock in which technology-related preferences of cus-

tomers were reshuffled. We find that under demand-

side change, preexisting customer relationships have a

double-edged effect: They facilitate “extension-based”

adaptation when interacted with technology capabili-

ties experiencing a decline in customer preferences,

and they hinder “novelty-based”adaptation when

interacted with technology capabilities experiencing an

increase in such preferences. We also find that both

types of technological capabilities together facilitate

adaptation along the extension and novelty paths.

Managerial summary: Demand-side change, in

which customer preferences for particular technologies

are reshuffled, occurs in many industry settings. A

deeper understanding of the factors shaping firm adap-

tation under this form of change can influence man-

agers' decisions to implement strategies to plan for and

Received: 21 December 2017 Revised: 4 December 2019 Accepted: 6 December 2019 Published on: 12 May 2020

DOI: 10.1002/smj.3137

Strat Mgmt J. 2020;41:1595–1627. wileyonlinelibrary.com/journal/smj © 2020 John Wiley & Sons, Ltd. 1595

react to such change. Using a sample of firms receiving

defense-related SBIR awards around September

11, 2001, we show that the customer relationships a

firm develops prior to demand-side change can have a

double-edged effect on firm adaptation. Such relation-

ships facilitate “extension-based”adaptation when

combined with technology capabilities declining in cus-

tomer preferences and hinder “novelty-based”adapta-

tion when combined with technology capabilities

increasing in customer preferences. In addition, the

combination of the two technological capability types

facilitates adaptation along both paths.

KEYWORDS

adaptation, capabilities, customer preferences, demand shock, SBIR

1|INTRODUCTION

Why do firms differ in the extent and direction of their adaptation to external change? Change

in a firm's external environment can stem from a diverse set of factors, such as new technolo-

gies, regulations, and customer preference shifts (Agarwal & Helfat, 2009; Christensen &

Bower, 1996; Tripsas, 2008). Prior research gives us a deep understanding of adaptation in the

context of technology-based change (Cattani, 2005; Cohen & Tripsas, 2018; Henderson & Clark,

1990; Tripsas, 1997; Tushman & Anderson, 1986). Yet demand-side change, in which customer

preferences shift in the absence of immediate change in the firm's technological environment,

is also an important source of external change (Di Stefano, Gambardella, & Verona, 2012;

Priem, Li, & Carr, 2012). And while a growing stream of literature has begun to examine the

salience of demand-side factors in firm strategy (Adner & Snow, 2010; Aggarwal & Wu, 2015;

Ahuja, Lampert, & Tandon, 2014; Rietveld & Eggers, 2018; Vergne & Depeyre, 2016; Ye,

Priem, & Alshwer, 2012), we have a more limited understanding of firm adaptation in demand-

side change contexts.

In considering the factors that might lead to interfirm variation in adaptation to demand-

side change, it is helpful to begin by considering the extant explanations for variation in adapta-

tion to technology-side change. Firm capabilities are an important class of explanations in this

regard. Prior work contrasts upstream technological capabilities with downstream customer-

related capabilities (Agarwal & Helfat, 2009; Helfat, 1997; Teece, 1986, 2007), showing that

these two classes of capabilities independently and jointly explain variation in firm adaptation

under technology-side change conditions (Danneels, 2002; Helfat & Lieberman, 2002; Nerkar &

Roberts, 2004; Stieglitz & Heine, 2007; Wu, Wan, & Levinthal, 2014).

1

1

We use the following interchangeably: upstream and technological capabilities; and downstream and customer-related

capabilities.

1596 WANG ET AL.

Yet when shifting focus from technology-side to demand-side factors, a capabilities-based

explanation of firm adaptation requires augmenting our conceptualization of technology capa-

bilities. This is because demand-side change shifts the preference ordering of customers for par-

ticular technologies (Aggarwal & Wu, 2015; Priem et al., 2012; Rietveld & Eggers, 2018; Tripsas,

2008; Ye et al., 2012). While technology in the aggregate may remain unaffected following a

demand shock, the relative value customers place on particular technological capabilities

changes (Aggarwal & Wu, 2015; Priem et al., 2012; Rietveld & Eggers, 2018; Tripsas, 2008; Ye

et al., 2012). Given this, we draw a conceptual distinction between what we call preference-

decreased technological capabilities, which are those well aligned with preshock demand condi-

tions but that decline with respect to customer preferences postshock; and preference-increased

technological capabilities, which are those less preferred by customers before the shock but that

gain with respect to customer preferences postshock.

Armed with this conceptual bifurcation of technological capabilities, we then consider the

moderating effect of downstream customer-related capabilities, as captured by the firm's pro-

pensity to engage in repeated customer relationships (Elfenbein & Zenger, 2013; Holloway &

Parmigiani, 2016; Mawdsley & Somaya, 2018; Vanneste & Puranam, 2010). Customer capabili-

ties arise from repeated interactions with “reliable and cooperative”partners that are “managed

through relational governance”(Holloway & Parmigiani, 2016:, p. 461). In our context of

demand-side change, such capabilities stem from the firm's preshock relationships, which we

argue may have different adaptation implications when considered in conjunction with the

firm's technological capabilities.

Our empirical context is the U.S. defense industry, which experienced an unexpected

demand-side shock as a result of the September 11, 2001 terrorist attacks (Aggarwal & Wu,

2015; Hoberg & Phillips, 2016; Tripsas, 2008; Vergne & Depeyre, 2016). The unexpected nature

of the shock allows us to isolate the effects of firm capabilities on postshock adaptation without

the confounding effects that would occur if firms had prior knowledge of changes in customer

preferences (Ito & Lee, 2005; Li & Tallman, 2011). We focus on the Small Business Innovation

Research (SBIR) program of the U.S. Department of Defense (DoD). Unlike traditional federal

R&D grants which focus on scientific discovery (e.g., the NIH and NSF), SBIR grants fulfill spe-

cific “customer needs.”The DoD notes, for example, that “eligible projects must fulfill an R&D

need identified by the DoD, and also have the potential to be developed into a product or ser-

vice for commercial or defense markets.”

2

SBIR grants are thus well suited for examining the

firm-level adaptation implications of changing (DoD) customer preferences.

We assemble a firm-year panel dataset of 5,226 firm-year observations on firms receiving

SBIR grants between 1996 and 2006, from which we derive three core empirical results. The

first two empirical results point to a double-edged effect of downstream customer capabilities.

First, we find that for firms that hold preference-decreased technological capabilities, customer

capabilities can be beneficial in that they facilitate post-demand shock adaptation occurring via

an “extension-based”path (i.e., a path of modifying and extending existing capabilities). Sec-

ond, we find that for firms that hold preference-increased technological capabilities, these same

customer capabilities hinder post-demand shock adaptation occurring via a “novelty-based”

path (i.e., a path of pursuing completely novel products). Third, beyond these two results that

highlight the double-edged effect of customer capabilities, we find that the interaction between

preference-decreased and preference-increased technological capabilities facilitates post-

demand shock adaptation via both the extension-based and novelty-based paths.

2

From the Office of the Under Secretary of Defense for Acquisition and Sustainment (acq.osd.mil).

WANG ET AL.1597