Strategy in an era of economic uncertainy: integrating external and internal antecedents of firm performance.

Author:Healy, William
 
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INTRODUCTION In the context of strategy theory, the current economic challenges faced by firms across the globe may be seen as a sign that external economic forces are more powerful determinants of firm performance than internal indicators (Albors-Garrigos, Molina & Molina, 2014; Wilson & Eilertsen, 2010). Be it the credit crisis, the reduction in global consumption, or the pervasive problems associated with the global supply chain, current economic wisdom seems to call for firms to pay greater attention to positioning themselves against environmental turbulence rather than premising strategic decision on inwardly focused approaches. This is ironic because in the arena of strategic theory, the notion of internal drivers of performance, as exemplified by the dynamic capabilities perspective (Barretto, 2010; Helfat et al, 2007), is hegemonic in the current era. In other words, theorists suggest that firm success is determined primarily by how firms configure their internal resources and core competence. Which view explains firm performance better? In this paper, we suggest that this is in reality a flawed question; i.e. the purported antagonism between external and internal antecedents of firm performance is an unhelpful fiction. We attempt to go beyond the artificial binary between these two approaches, i.e. between external and internal indicators of firm performance to offer a possible integrated model.

The impact of market structure on firm performance has been the subject of considerable discussion and debate in strategic management (Porter & Siggelkow, 2008; Galunic & Eisenhardt, 1994). Drawing from the structure-conduct- performance paradigm in I/O economics, this discussion has progressed from an analysis of the impact of industry concentration on profitability to the impact of market share on profitability. Similarly, research on contingency theory has tightened the unit of organizational analysis from the corporate level to the SBU level (Rumelt, 1991). According to these perspectives, which may be collectively termed the "structure-based view" of performance, the way a firm fits into the industry structure is seen as the primary source of competitive advantage.

On the other hand, considerable parallel research has been being conducted on the strategic determinants of firm performance (Newbert, 2007). Grounding its research in an analysis of strengths that are inherent within the firm, this stream of research, which may be termed the "strategy-based view" of performance, has isolated valuable drivers of inter-firm heterogeneity through the understanding of core competence (Prahalad & Hamel, 1990), strategic factor markets (Barney, 1986), and dynamic capabilities (Helfat et. al. 2007). The contention of the strategy-based view is that process-based aspects of firms should be accorded far more importance in the study of the determinants of performance than macro, structural indicators.

While research in both these fields has added immeasurably to our understanding of inter-firm heterogeneity, there has been little attempt at integrating the wisdom from their collective findings (cf. Conner, 1994, for a prominent exception). In this paper, we attempt to place the two fields in an integrative framework, arguing that linking the research on the strategic variables with structural research can explicate a number of unexplained facets of firm performance. The paper seeks to build links between these two apparently diverse views of firm performance, arguing that strategic variables may be seen as drivers of structural variables rather than moderators thereof. In other words, structural variables may be seen not merely as drivers of firm strategy, but occasionally, its outcomes. In an econometric sense, it suggests that modeling strategic variables into structural elements of firm performance would explain far more variance in performance than a discrete examination of either stream.

The rest of this paper is organized into three main parts. The first part provides a historical and analytical overview of the debate on structure and performance, from its inception in the field of industrial economics down to its adoption by the field of business strategy. It summarizes the main findings of this view and critiques its shortcomings as an analytical tool. In the second part, the strategic view of firm performance is introduced and analyzed as an alternative explanation of firm performance. Its diverse sub-streams and shortcomings are also explored. The final section is concerned with postulating an integrative framework between these two streams, and developing propositions whereby links can be made between their respective empirical agendas. This integrative framework is meant not only to further the contention that strategic behavior by firms and industry structure exist in a reciprocal relationship, but also to suggest areas of commonality in the two perspectives that may lead to a unified research agenda.

STRUCTURE-BASED VIEW OF FIRM PERFORMANCE

Research in strategic management has always acknowledged its relationship with the field of economics in general and industrial organization in particular (Kim & Mahoney, 2005; Rumelt, Schendel, & Teece, 1991). While the areas of collaboration and joint theory building between the two fields are indeed diverse, nowhere is the relationship stronger than in the examination of the impact of market power as represented by a variety of structural variables on firm performance. It may be contended that while the foundations of research on the relationship between structure and performance were laid in the field of traditional industrial organization theory, much of the subsequent refinement in the debate came from the field of strategy. For instance, while the postulated relationship between industry structure and firm profitability was inspired largely by Bain's (1956) study of the relationship between profitability and industry concentration and subsequent empirical studies confirming this relationship especially on the temporal scale (Weiss, 1971), it was research that went beyond the confines of neo-classical economics into management strategy which introduced market share as a more explanatory determinant of firm performance (Ravenscraft, 1983; Chu, Chen & Wang, 2008).

The theory that profitability and market share were causally linked provided the basis for further disaggregation of the unit of analysis in structural research from the industry to the firm. The theoretical persuasion for this disaggregation was primarily laid by the emergence of strategic groups as a construct (Caves & Porter, 1977). However, the primary empirical impetus for this disaggregation, and indeed, the repudiation of all industry level aggregation, may be attributed in large part to the analyses that were conducted using data made available from the Profit Impact of Market Share (PIMS) database and the Federal Trade Commission's Line-of-Business data. While PIMS provided disaggregated data for a small but dominant sample of firms (all of which figured in the Fortune 500 list), the FTC data was far more comprehensive, though it is available for far too short a period to lend itself to any meaningful longitudinal analysis.

Using PIMS, researchers were not only able to demonstrate a strong correlation between market share and performance, but also to speculate on the specific quantitative relationship between market share and profitability (they wished to come up with specific, quantitative relationships between % increases in market share and % increases in profitability). While this quantitative relationship has been hotly debated in the marketing literature (Jacobson & Aaker, 1985), the relationship between market share and profitability was subsequently confirmed by other studies (Chu, Chen & Wang, 2008), which found that the incorporation of market share in the structure-performance equation rendered concentration completely ineffective as an explanatory variable.

In terms of units of analysis, the structural view of firm performance has concentrated on four levels, viz. the industry/strategic group level, the corporate level, the SBU level, and at the level of intra-corporate fit (Vorhies, Morgan & Autry, 2009).

First, borrowing from the I/O perspective, the industry/strategic group analytical level tries to explain how firms use their resources to draw industrial boundaries--thereby making it difficult for new entrants to capitalize on rents enjoyed by incumbents (Bain, 1956). Further refinement of the barriers to entry concept reveals that industries may not be the best criteria to draw boundaries--instead, firms tend to cluster in strategic groups, which may pose mobility barriers to new entrants rather than entry barriers (deSarbo, Grewal and Wang, 2009).

Second, drawing primarily from Chandler's (1962) study of the strategy-structure relationship, corporate level theorists primarily explore issues of diversification and its impact on structure and performance. Chandler's theories were extended by Rumelt (1974), who found that the strategies of related- constrained and related-linked diversification were more profitable than unrelated diversification. Studies of diversification have constantly attempted to explore the link between relatedness of diversification profile and performance (Nath, Nachiappan & Ramanathan, 2010). While related diversification has an intuitive appeal, empirical results have been equivocal; while some researchers found support for Rumelt's hypothesis, others found that unrelated diversifiers outperformed related firms in some industries.

Third, some theorists have argued that variances in firm performance are best explained...

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