STRATEGIC ASSETS AND ORGANIZATIONAL RENT Amit, R., & Schoemaker, P. J. H., SMJ, 1993 Youngsoo Kim, BADM 545 Fall 2013

Overview Why is our firm successful? It was answered by… Firm-specific resources and capabilities It was answered by… Industrial Organization theory (IO) Key Success Factors analysis New perspectives Resource Based View of the Firm (RBV) Behavioral Decision Theory (BDT) Link these two with traditional industry analysis framework This research paper is, like other papers today, originated from the question “when vertical integration takes place”. The approach to this problem used to be based on simply company size, or focused on manufacturing, which leads to an emphasis on the valuation of physical assets such as raw materials or facilities. However, these two authors try to put a more focus on human assets, that is, people. In addition, they want to empirically demonstrate the effects of transaction costs on vertical integration of the companies. To achieve this, the authors look at a specific problem, whether a manufacturers’ representative or a direct salesperson to sell a product line.

Literature Review Vasconcellos and Hambrick (1989) Ghemawat (1991) Empirically corroborate the effects of Key Success Factors (KSF) on an organization’s success Limitations: (1) the industry as the unit of analysis, (2) empirical analysis is ex post, (3) well-known KSF is not KSF anymore Ghemawat (1991) KSF lacks identification, concreteness, generality, necessity Limitations: uncertainty, complexity, conflict should be considered to account for discretionary managerial decisions Alternative approaches Combining IO, RBV, and BDT to explain a firm’s profitability For some background knowledge on this problem, let me briefly give you background information. As of 1977, in 15 major industry in the U.S., Rep accounts for only 10% of the total volume, so the market mode is less often used than the integrated mode.

Resources and Capabilities (R&C) Available factors that are owned or controlled by the firm Knowhow to be traded (e.g. patents and licenses), financial / physical / human assets (e.g. property, plant, and equipment) Capabilities A firm’s capacity to deploy resources using organizational processes to effect a desired end ‘Intermediate goods’ to enhance productivity of its resources Information-based (e.g. brand names) Functional areas (e.g. brand management in marketing) Fungible: if Alice lends Bob a $10 bill, she does not care if she is repaid with the same $10 bill, two $5 bills, a $5 bill and five $1 bills or a bunch of coins that total $10 because currency is fungible (noting that, in practice, some denominations might incur additional operational or processing costs). However, if Bob borrows Alice's car she will most likely be upset if Bob returns a different vehicle--even a vehicle that is the same make and model--as automobiles are not fungible with respect to ownership.

Strategic Assets and Strategic Industry Factors Strategic Assets (SA) Set of difficult to trade and imitate, scarce, appropriable, and specialized resources and capabilities that present competitive advantages Strategic Industry Factors (SIF) Market-level resources and capabilities that are subject to market failures and prime determinants of economic rents Relevant set of SIF changes and cannot be predicted ex ante Managers’ problem: Identify SA for Organizational Rents Via identifying current and possible sets of SIF and developing the corresponding existing and new SA The environmental change that can not be observed in advance makes the contract difficult to be complete.

SA and SIF: Diagram There is a tradeoff between two modes of institutions. A drawback from doing the internal mode is setup and maintenance costs and a disadvantage from doing the market mode is opportunism and inflexibility. Hence, transaction frequency is a key factor which drawback is bigger than the other.

RBV and Organizational Rents Resourced-Based View Organizing a set of complementary and specialized resources and capabilities which are scarce, durable, not easily traded, and difficult to imitate may enable the firm to earn economic rents Desired characteristics of the firm’s SA Trade-off: specialization and robustness Two kinds of specialization: limited use or unique use Limited use reduces robustness, but unique use doesn’t Firms develop specialized assets to enhance profits at the price of reduced flexibility in the face of Schumpeterian shocks

Challenges in SA decisions (1) Uncertainty Uncertainty and ambiguity make it probable that managers will hold diverse expectations about key market variables Judgments and choices are likely to exhibit idiosyncratic risk aversions and ambiguity Strategic assets choices under uncertainty may entail opposing biases whose net effects are hard to analyze Complexity To keep SA decisions within cognitive bounds, managers must often and extensively simplify and it leads to additional biases Under rational expectations, the SA challenge will largely vanish as managers will hold the same expectations about the set of SIF that will prevail in the future  

Challenges in SA decisions (2) Conflict Any change in the existing bundle of SA may benefit some employees and hurt others Organizations are complex social entities with their own inertia and constraints Challenges and economic rents This lack of solvability is a necessary condition for their strategic importance and positive rent potential Under rational expectations, the SA challenge will largely vanish as managers will hold the same expectations about the set of SIF that will prevail in the future  

SA Development: Multidimensional View (1) Difficulties in SA decisions underscores the need for a multidimensional approach Industry Analysis Focus on external competitive forces and market structure Resource View Factor market imperfections, leading to firm differences Economic rents derive from firms’ unique R&C Under rational expectations, the SA challenge will largely vanish as managers will hold the same expectations about the set of SIF that will prevail in the future

SA Development: Multidimensional View (2) Behavioral Decision Theory Acknowledging bounded rationality under uncertainty and complexity In psychology, various models and techniques exist to depict how people represent complex problem situations Conflict and organization inertia in SA decisions Principal-agent theory gives only rational treatment TCE focuses on bounded rationality and complexity Organizational theory has been more descriptive and process oriented to understand how firms control and coordinate Under rational expectations, the SA challenge will largely vanish as managers will hold the same expectations about the set of SIF that will prevail in the future

Contributions and Conclusions SIF and SA as an alternative to KSF Characterization of rent producing SA Under which SA could produce organizational rents Three challenges of SA decisions Uncertainty, Complexity, Conflict Multidimensional approach to SA decisions IO, RBV, BDT Uniqueness and low mobility of R&C stem from imperfect and hard to predict decisions by boundedly rational managers facing high uncertainty Under rational expectations, the SA challenge will largely vanish as managers will hold the same expectations about the set of SIF that will prevail in the future

Questions & Answers Under rational expectations, the SA challenge will largely vanish as managers will hold the same expectations about the set of SIF that will prevail in the future