The Independent and Joint Effects of the Skill and Physical Bases of Relatedness in Diversification. Moshe Farjoun (1998), SMJ Weihao Li

Research Objectives Introducing a multidimensional view/measure of relatedness in diversification Skill bases Physical bases Joint effect of both skill and physical bases Suggesting a more complete assessment of firm-level relatedness on performance Needs to consider a matrix of interrelationships across lines of business, activities, and resources

Multidimensional view of Relatedness The logic and extent by which a firm’s different lines of business ( or industries) are connected Multidimensional View Firm and industries can be viewed as collections of interrelated activities and resources Relatedness between a firm’s line of business (or industries) can encompasses many different dimensions Researchers: Choosing one dimension or base of relatedness among several The choice of a particular approach to assess relatedness is not just a matter of methodological convenience, it can significantly affect motive and consequences of diversification. Combining different bases of relatedness Combined assessment has both theoretical and practical impact

Physical and Skills Bases Physical Bases Concerns relations between the physical characteristics of products Skills Bases Consist of research and development reams, experienced salesmen, and managerial and other skills common to two or more product Intangible resources, human skills The new concept of relatedness Views each industry or line of business as a combination of occupational skills or bodies of knowledges required to produce a product

Research Questions: How do the skill and physical bases differ in the ways they identify relatedness in the same set of industries (or lines of business)? What are the separate and joint contributions of the two approaches in explaining firm-level performance differences? Generates three hypotheses

Independent Effects of the Physical and Skill Bases of Relatedness (1) Physical Bases Skill Bases Differences Collections of material resources and physical processes Sets of interrelated bodies of human knowledge in the process of providing goods and services Observable and identifiable Not easy to identify The range to be applied is more limited Ability to learn, improve, and transfer Identify relatedness between two industries in different ways Benefit performance in different ways Similarity Brings positive benefits to related diversifications

Independent Effects of the Physical and Sill Bases of Relatedness (2) Hypothesis 1a: The level of related diversification as indicated by the physical base of relatedness will be positively associated with financial performance. Hypothesis 1b: The level of related diversification as indicated by the skill base of relatedness will be positively associated with financial performance.

Joint Effects of the Physical & Skill Bases of Relatedness Overlap and interact in value-added activities (complementary in nature) The interaction is institutionalized in organizational routines and procedures Combination of Physical + Skill Bases affect performance More potential interrelationships are identified  the range of potential benefits is extended Two bases coexist and interact in the production process their potential benefits are complementary Hypothesis 2: The level of related diversification indicated by a combination of both the physical and skill dimensions will be positively associated with financial performance.

Data and Method Data Measures 158 firms from manufacturing sector ( SIC codes 20 to 30) fortune 500 list of companies for 1985 Measures Level of Relatedness The ratio of related-to-total diversification indicates the extent to which a firms’ diversification is related. RATIO (Physical), RATIO (Skill), and RATIO (Joint) Performance: COMPUSTATA: ROA, ROS, and MBOOK (market-to-book) CRSP: Jensen’s Alpha

Results and Analysis (1) How do the skill and physical bases differ in the ways they identify relatedness in the same set of industries (or lines of business)? Physical Bases: similar raw materials but complementary production process, products are close end use substitutes, similar physical production processes, Skill Bases: only share similar production, engineering, administration, and marketing and service skills, but not raw materials, end use, or physical aspects of productions Conclusion: the physical aspects of production and diversification and common bodies of knowledge are distinct yet complementary basses for relatedness What are the separate and joint contributions of the two approaches in explaining firm-level performance differences? H1a, H1b, and H2

Results and Analysis (2) H1a: Not supported H1b: Not supported H2: supported

Results and Analysis (3) Relationship between relatedness and performance Hypothesis 1a: The level of related diversification as indicated by the physical base of relatedness will be positively associated with financial performance.  Not Supported Hypothesis 1b: The level of related diversification as indicated by the skill base of relatedness will be positively associated with financial performance. Not supported Hypothesis 2: The level of related diversification indicated by a combination of both the physical and skill dimensions will be positively associated with financial performance.  Supported Concluding remarks: Skill and physical base had no significant effects on financial performance when taken alone. Combination of the two bases had a significant joint effects since It extends the range of potential benefits provided by each base alone It reinforces those benefits when the two bases agree.

Discussion The author indicates that it’s important to consider the effects of more than two key bases. Besides of physical and skill bases, what are other bases that might contribute to relatedness? How does this evidence from bases of relatedness provide empirical support for RBV?

Method

Analyses and results

Analyses and results

Relatedness and performance (MBOOK)