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How Control Fosters Learning

The Association between Control Mechanisms and Firm Capabilities

Doctoral Thesis / Dissertation 2010 184 Pages

Business economics - Business Management, Corporate Governance

Excerpt

Table of Contents

1 Introduction

2 Literature review
2.1 An introduction to the theory of management control systems
2.1.1 Definitions of management control
2.1.2 Classifications of management control systems
2.1.3 MCS as a package
2.1.4 Contextual variables influencing MCS
2.1.5 MCS and learning
2.2 An introduction to the resource-based view theory
2.2.1 Background
2.2.2 Definition of key terms
2.2.3 Strategic recourses as source of competitive advantage
2.2.4 From competitive advantage to superior performance
2.2.5 Limitations of the traditional RBV
2.3 An introduction to the dynamic capability theory
2.3.1 Background
2.3.2 What are dynamic capabilities?
2.3.3 The development of dynamic capabilities
2.3.4 The dynamic capability theory as extension of the traditional RBV
2.3.5 Limitations of the dynamic capability theory
2.4 Management control systems and firm capabilities – State-of-the-art
2.4.1 MCS as valuable, rare, inimitable and non-substitutable resources
2.4.2 MCS and strategic resources as related variables
2.4.3 MCS as antecedents of dynamic capabilities

3 Theory development and hypotheses
3.1 Definition of key variables
3.1.1 Operationalizing MCS
3.1.2 Operationalizing dynamic capabilities
3.1.3 Operationalizing performance
3.2 The association between certain types of MCS and certain dynamic capabilities
3.2.1 Management control systems and the development of dynamic capabilities
3.2.2 The association between results controls and market-oriented capabilities
3.2.3 The association between cultural controls and innovation capabilities
3.2.4 The association between action controls and DC
3.3 The association between packages of MCS and certain dynamic capabilities
3.4 The concept of fit in contingency research
3.5 Gaining sustained competitive advantage through matching dynamic capabilities and MCS
3.6 Empirical design overview

4 Data set and measures
4.1 Overview of the manufacturing industry
4.2 Sample
4.3 Variables
4.4 Cronbach alpha and factor analysis
4.5 Avoidance of bias
4.6 Descriptive statistics
4.7 Correlation matrix

5 Hypotheses 1-3: Analyzing the association between certain types of MCS and certain DC
5.1 An introduction to regression analysis
5.2 Method
5.3 Results

6 Hypothesis 4: Analyzing the association between packages of MCS and certain DC
6.1 Step 1: Deriving MCS clusters
6.1.1 An introduction to cluster analysis
6.1.2 Method
6.1.3 Results
6.2 Step 2: Comparing the DC of the two clusters
6.2.1 An introduction to ANOVA/MANOVA
6.2.2 Method
6.2.3 Results

7 Hypothesis 5: Comparing the performance of firms with matching /non-matching MCS and DC
7.1 Step 1: Deriving actual DC clusters
7.1.1 Method
7.1.2 Results
7.2 Step 2: Deriving predicted DC clusters
7.2.1 An introduction to logistic regression analysis
7.2.2 Method
7.2.3 Results
7.3 Step 3: Building two groups of firms: firms with matching/non-matching MCS and DC
7.3.1 Method
7.3.2 Results

8 Summary of findings

9 Discussion

10 Conclusion and implications for future research

11 References

List of Figures

Figure 1: Structure of the dissertation

Figure 2: Parts of management control systems (Malmi and Brown, 2008, p. 291)

Figure 3: Deliberate and emergent strategies (Mintzberg et al, 1998, p.15)

Figure 4: Operationalizing strategy (Langfield-Smith, 1997, p. 212)

Figure 5: Interrelations between strategic typologies (Langfield-Smith, 1997, p. 213)

Figure 6: The relationship between the SWOT-analysis and the resource-based model (Barney, 1991, p. 100)

Figure 7: The VRIN framework (Barney, 1991, p. 112)

Figure 8: From strategic resources to performance (Newbert, 2007, p. 123)

Figure 9: Branches of the capability lifecycle (Helfat and Peteraf, 2003, p. 1005)

Figure 10: The development of DC through different learning mechanisms (adapted from Zollo and Winter, 2002, p. 340)

Figure 11: Value chain (Porter and Miller, 1985, p. 151)

Figure 12: Types of capabilities used in the study

Figure 13: The interrelationship between results controls and market-orientated capabilities

Figure 14: The interrelationship between cultural controls and innovation capabilities

Figure 15: A framework for mapping different forms of contingency fit used in strategy-MCS research (Gerdin and Greve, 2004, p. 304)

Figure 16: Typical relationships between context and structure, according to the cartesian (Table A) and configuration (Table B) approach (Gerdin and Greve, 2004, p. 306)

Figure 17: The interrelationship between matching MCS and DC, competitive advantage and superior performance

Figure 18: Distribution of the size of the firms (n=238)

Figure 19: Distribution of the age of the firms (n=238)

Figure 20: Regression model

Figure 21: Logistic regression model

List of Tables

Table 1: Organic and mechanistic forms of MCS (Chenhall, 2003, p. 133)

Table 2: Conditions determining the measurement of behavior and output (Ouchi, 1979, p. 843)

Table 3: The changing characteristics of MCS (Simons, 1995, p. 4)

Table 4: MCS characteristics and learning constructs (Kloot, 1997, p. 56)

Table 5: The difference between resources and capabilities (Amit and Schoemaker, 1993, p. 37)

Table 6: Dynamic capabilities in moderately dynamic markets and high-velocity markets (Eisenhardt and Martin, 2000, p. 1115)

Table 7: Typologies of dynamic capabilities (Ambrosini et al., 2009, p. S17)

Table 8: Recent studies on the interrelationship between MCS and firm resources/capabilities

Table 9: Comparison of different MCS frameworks

Table 10: Definition of MCS used in the study

Table 11: The interrelationship between the DC building process and MCS

Table 12: Overview of tested hypotheses

Table 13: Empirical design overview

Table 14: Definition of the items used– Capabilities and Performance

Table 15: Definition of the items used– MCS

Table 16: Results of the exploratory factor analysis – Capabilities and Performance

Table 17: Results of the exploratory factor analysis – MCS and Environmental Uncertainty

Table 18: Descriptive statistics of the items used

Table 19: Correlation matrix of all used variables

Table 20: Assumptions that have to be met for regression analysis

Table 21: Results of the regression analysis – market-oriented capabilities

Table 22: Results of the regression analysis – innovation capabilities

Table 23: Results of the F-test – MCS clusters

Table 24: Results of the discriminant analysis – MCS clusters

Table 25: The distribution of the MCS clusters

Table 26: Descriptive statistics of the MCS clusters

Table 27: Homogeneity of Variances – ANOVA

Table 28: Homogeneity of Variances – MANOVA

Table 29: Homogeneity of covariance matrices

Table 30: Differences in the means of the capabilities between the two MCS clusters

Table 31: Statistical significance of mean differences between the two MCS clusters

Table 32: Results of the Kruskal-Wallis test – MCS clusters

Table 33: Results of the MANOVA

Table 34: Results of the F-test – capability clusters

Table 35: Results of the discriminant analysis – capability clusters

Table 36: The distribution of the capability clusters

Table 37: Descriptive statistics of the capability clusters

Table 38: Assumptions that have to be met for logistic regression analysis

Table 39: Testing for linearity of the logit

Table 40: Classification Table – base-model

Table 41: Variables in the equation – base-model

Table 42: Variables not in the equation – base-model

Table 43: -2 Log likelihood – logistic regression model

Table 44: Classification Table – logistic regression model

Table 45: Variables in the equation – logistic regression model

Table 46: Homogeneity of variances – matching and non-matching firms

Table 47: Differences in the means of the performance between the two groups of firms

Table 48: Statistical significance of mean differences between the two groups of firms – ANOVA

Table 49: Statistical significance of mean differences between the two groups of firms – Kruskal-Wallis test

Table 50: Summary of findings

Abbreviations

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1 Introduction

The question how firms can gain a sustained competitive advantage to outperform their competitors and survive in the long run is at the heart of strategic management research. One of the most important strategic management theories is the resource-based view (RBV). The RBV sees the source of a sustained competitive advantage in the possession of strategic capabilities. Strategic capabilities are defined as firm-specific, organizational processes that are not tradable without the organization itself and that have the potential to be the source of a sustained competitive advantage through being valuable, rare, inimitable and non-substitutable (Barney, 1991; Amit and Schoemaker, 1993; Makadok, 2001).

Lately, the RBV has been criticised for being a static concept. The main argument of the dynamic capability (DC) theory, a recent extension of the RBV, is that sustained competitive advantage cannot be gained though the simple possession of valuable, rare, inimitable and non-substitutable capabilities, as capabilities that have been very successful in the past need not be the source of sustained competitive advantage in the future because of the changing market environment. In order to stay competitive firms need the ability to change their existing capabilities and to quickly develop new organizational capabilities. (Newbert, 2007; Schreyögg and Kliesch-Eberl, 2007; Morgan et al., 2009)

These organizational processes that modify and leverage strategic capabilities of firms through the fostering of learning within the organization in order to match changing market needs are called dynamic capabilities (Teece et al., 1997; Eisenhardt and Martin, 2000; Helfat, 2007; Danneels, 2008).

Dynamic capability theory tries to shed some light on how firms alter their resource base by adding, reconfiguring, and deleting resources or competences. As Eisenhardt and Martin (2000, 1107) put it, “dynamic capabilities are the organizational and strategic routines by which firms achieve new resource configurations as market emerge, collide, split, evolve, and die”. Dynamic capability theory points out that some firms are better able than others at altering their resource base and hence enjoy superior performance, particularly in dynamic environments (Teece et al., 1997; Eisenhardt and Martin, 2000).

According to Eisenhardt and Martin (2000), the main differences between “ordinary” capabilities as defined by the RBV and dynamic capabilities are that DC are more homogeneous and substitutable across firms. Furthermore, it is important to notice that the sustained competitive advantage gained through DC does not lie in the DC themselves but in their ability to influence and leverage the strategic capabilities of the firm in order to match the needs of quickly changing markets.

However, DC theory suffers from a lack of clear definitions, systematically conceptualized constructs, and clear empirically grounded recommendations for practitioners how dynamic capabilities should be used within organizations to gain a sustained competitive advantage and, ultimately, a higher performance (Newbert, 2007; Danneels, 2008). The notion of dynamic capabilities still seems quite abstract and intractable and hence our understanding of how dynamic capabilities are developed and how they translate into performance is quite limited.

In a recent paper, Danneels (2008) makes an important step to overcome this weakness by formalizing two important firm capabilities, the firm’s ability to explore new markets and its ability to explore new technological domains, and analyzing how organizational characteristics influence these firm capabilities. He develops a theoretical rationale regarding five organizational characteristics that in his view increase the organization’s ability to identify, evaluate, and implement new competences: the firm’s willingness to cannibalize, the presence of constructive conflict in the organization, a climate of tolerance for failure, the extent to which the firm engages in environmental scanning, and the firm’s slack resources. According to Danneels (2008), these antecedents foster organizational learning and the development of DC.

In this dissertation, I build on Danneels’ (2008) work and analyze if certain configurations of management controls systems (MCS) foster organizational learning and knowledge management processes that support the development of organizational capabilities.

MCS are defined as organizational processes that ensure (1) that the employees of the firm behave in the desired way and (2) that the organization performs well (Merchant and Van der Stede, 2007; Merchant and Otley, 2007). Thus, MCS are basically used to ensure that there is a match between the activities within the firm and the external needs of the customers. Following Merchant and Van der Stede (2007), I differentiate between three archetypes of MCS derived from the Merchant and Van der Stede (2007) framework. Merchant and Van der Stede’s (2007) framework builds on Ouchi’s (1979, 1980) work and distinguishes controls based on the object of control. It differentiates between (1) results controls which influence behaviour using information from measures for the outcomes of employees’ work, (2) action controls which describe the actions to be taken, and (3) cultural and personnel controls which encourage mutual monitoring of employees and which clarify the organization’s expectations to employees, providing them with adequate resources.

In contrast to prior research, this dissertation not only examines the link between MCS and capabilities in general as suggested by Chenhall (2003) and Henri (2006), but it contributes to the contingency-based theory on MCS by arguing that certain DC differ in terms of their complementarity or fit to certain MCS configurations and (2) that a sustained competitive advantage, measured as a superior performance, can be gained through the possession of matching combinations of DC and MCS.

In my empirical study I measure four different DC: customer orientation, competitor orientation, radical innovation capability and incremental innovation capability.

In this dissertation I argue that using results controls (defining and operationalizing strategic targets, measuring them through performance indicators, and evaluating the employees individually on their success in achieving these targets) to give individual performance feedback fosters the development of customer and competitor orientation through managing explicit, complete, and non-diverse customer and competitor knowledge and supporting of individual learning.

Furthermore, I assume that cultural controls provide group performance feedback to employees and foster the development of innovation capabilities through facilitating team learning and making goals explicit and stable, facilitating coordination among the organization, helping to sustain innovation over time through providing a generative memory, and defining the acceptable behavior for employees without suppressing the creation of new ideas.

Additionally, I want to follow a contingency approach through analyzing the interrelationship between MCS, DC and performance. I propose that firms that have MCS consistent with their DC will differ in their performance from firms that have MCS inconsistent with their DC.

Finally, this dissertation theoretically contributes to the growing body of literature that deals with MCS as a package. Malmi and Brown (2008) conclude that previous research has mainly studied different types of MCS disconnected from each other and the links between various MCS have not been recognized. Thus, the fact that MCS do not operate in isolation has basically been ignored and there is still a lack of research how different types of MCS interact with each other. An example mentioned by Malmi and Brown (2008, p. 288) is administrative and cultural controls “and whether/how they complement or substitute for each other in different contexts”. Hence, I will analyze if different packages of MCS differ in terms of their capabilities.

I empirically test my assumptions using data from medium-sized German and Austrian manufacturing firms. The empirical study focused on a single industry to control for industry effects. I decided to analyze medium-sized firms because the questionnaire was sent to the CEOs of the firms and in a firm with 250 or less employees it seems likely that the CEO has all the necessary information concerning the capabilities and the management control systems of the firm. The study achieved a response rate of 17.5%, resulting in 238 usable questionnaires. To minimize the risk of bias, I tested for nonresponse bias, early and late respondents’ bias, multicollinearity, and autocorrelation.[1] The main findings of the study can be summarized as follows:

- Market-related capabilities (customer and competitor orientation) are positively associated with results controls.
- Radical and incremental innovation capabilities are positively associated with cultural controls.
- Firms with matching dynamic capabilities and management controls systems have a significantly higher perceived performance than firms with non-matching dynamic capabilities and management controls systems.

My dissertation consists of 10 chapters. In chapter 2 I will give an overview of the state-of-the-art of the literature on (1) management controls systems, (2) the resource-based view, (3) dynamic capabilities, and (4) the interrelationship between MCS and capabilities. Chapter 3 represents the core of my theoretical argumentation. In this chapter I will, based on prior research explained in chapter 2, develop my hypotheses concerning (1) the interrelationship between MCS and dynamic capabilities and (2) performance differences of firms that have MCS consistent with their DC versus firms that have MCS inconsistent with their DC. The chapters 4-8 reflect the empirical part of my dissertation. In chapter 9 the results of the empirical study will be discussed and the contributions of this dissertation will be highlighted. Chapter 10 summarizes the most important results and deals with limitations of my study and implications for future research. The structure of my dissertation is shown in the following figure.

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Figure 1: Structure of the dissertation

2 Literature review

In the following chapter the state-of-the art of the literature on (1) management controls systems, (2) the resource-based view, (3) dynamic capabilities, and (4) the interrelationship between MCS and capabilities will be presented. The aim of this chapter is to serve as a theoretical foundation of the theory and hypotheses developed in chapter 3.

2.1 An introduction to the theory of management control systems

I will start by giving an overview of commonly accepted definitions of management control. Then I will describe certain frameworks that categorize the different types of management control. Additionally, I will elaborate on the question why it is important to use MCS as a package. Afterwards I will give an overview of certain contextual variables that influence MCS. Finally, I will talk about the dynamic view on MCS, especially about the question how MCS foster organizational learning.

2.1.1 Definitions of management control

Basically, the aim of an MCS is to make sure that the employees in an organization behave in the desired way. According to Merchant and Van der Stede (2007, p. 7), management control “involves addressing the general question: Are our employees likely to behave appropriately? This question can then be decomposed into several parts. First, do our employees understand what we expect of them? Second, will they work consistently hard and try to do what is expected of them; that is, will they implement the organization’s strategy as intended? Third, are the capable of doing a good job?”

Nevertheless, there are many different definitions of “management control” and “management control systems” in the literature. In the following chapter I want to give a brief overview of the most commonly accepted ones.

According to Redda (2007, p. 37), the “traditional definitions of control as given in accounting books published in the US mainly apply to large organizations with many divisions. Here control is exercised to monitor the performance of division managers”. For example Anthony (1965) defined management control as “the process by which managers ensure that resources are obtained and used effectively and efficiently in the accomplishment of the organization’s objectives.” (Langfield-Smith, 1997, p. 208)

Simons states that “MCS are also formal, information-based routines and procedures managers use to maintain or alter patters of organizational activities”. (Simons, 1995, p. 5) As Redda (2007, p. 39) concludes, Simons’ “definition is broader than that of Anthony’s since it enables us to address the internal and external contexts of firms. Simons’ definition also shows how managers control strategy”.

According to Merchant and Otley (2007, p. 785), “a management control system is designed to help an organization adapt to the environment in which it is set and to deliver the key results desired by stakeholder groups, most frequently concentrating upon shareholders in commercial enterprises.” They argue that control is “the things managers do to ensure that their organizations perform well” (Merchant and Otley, 2007, 785).

Traditionally, the aim of an MCS is seen as the monitoring of the successful implementation of the organization’s strategy. “Organizational control includes the activities used to achieve desired organizational goals and outcomes. [...] More specifically, organizational control can be conceptualized as a three stage cycle: (a) planning a target or standard of performance, (b) monitoring or measuring activities designed to reach the target, and (c) implementing corrections if targets or standards are not being achieved.” (Daft and Macintosh, 1984, p. 44)

Merchant and Otley (2007, 785) add a fourth step to the process and argue: “Most authors’ writing about control refer in some way to the generic management process, which involves (1) setting objectives, (2) deciding on preferred strategies for achieving those objectives, and then (3) implementing those strategies while (4) making sure that nothing, or as little as possible, goes wrong.”

However, Chenhall (2003, p. 129) concludes: “The definition of MCS has evolved over the years from one focusing on the provision of more formal, financially quantifiable information to assist managerial decision making to one that embraces a much broader scope of information. This includes external information related to markets, customers, competitors, non-financial information related to production processes, predictive information and a broad array of decision support mechanisms, and informal personal and social controls.”

As Merchant and Otley (2007, p. 785) point out, these “broader conceptualizations of control can encompass almost everything managers do to acquire, deploy, and manage resources in pursuit of the organization’s objectives. In other words, almost everything in the organization is included as part of the overall control system.”

2.1.2 Classifications of management control systems

According to Merchant and Otley (2007), academics started developing frameworks for management control in the 1950s and 1960s. “Given the breadth and complexity of the control field, it is natural that over the years authors have taken many approaches to its study. Some researchers focused attention on specific control devices, such as budgeting, measurement, or incentives. Others developed more-inclusive control frameworks or identified contrasting control archetypes.” (Merchant and Otley, 2007, p. 788). In this dissertation I want to focus on the control frameworks that describe archetypes of control. In the following chapter I will describe several well known frameworks that are suitable to be used in empirical research.

Until now MCS have been categorized in many ways, for example formal and informal controls (Anthony et al., 1989), or mechanistic and organic controls (Chenhall, 2003). Formal controls include rules, standard operating procedures and budgeting systems. As they are visible and easy to monitor, empirical research that deals with the interrelationship between strategy and MCS has mainly focused on those. “Formal controls may include output or results controls, which provide ex-post feedback, and these are often financially orientated.” (Langfield-Smith, 2007, p. 754) Their target is mainly to set (mostly financial) goals and to monitor the progress towards these goals. “Controls that focus on feed forward control (ex ante controls) include administrative controls (standard operating procedures and rules), personnel controls (human resource management policies), and behavior controls (the ongoing monitoring of activities and decisions).” (Langfield-Smith, 2007, p. 754)

Informal controls “include the unwritten policies of the organization and often derive from, or are an artefact of, the organizational culture”. (Langfield-Smith, 2007, p. 754) However, culture controls might sometimes be formal as well (e.g. formally stated organizational mission). Informal controls are very important parts of the MCS and the effectiveness of the formal controls can depend on the quality of the implementation of informal controls. (Langfield-Smith, 2007)

The following table gives an overview of MCS that are more mechanistic (formal) and more organic (informal).

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Table 1: Organic and mechanistic forms of MCS (Chenhall, 2003, p. 133)

2.1.2.1 Ouchi’s framework

A control framework well recognized in the literature was developed by Ouchi (1979). He identified three forms of control: behaviour control, output control, and clan control. Broadly speaking, the aim of behaviour control is to monitor the behaviour of the employees and to ensure that they behave in the desired way while output control measures the output of the employees. Finally, clan control tries to socialize employees in a way so that they behave according to the norms and values of the organization without further monitoring.

The question which type of control to use, basically, depends on the question which option is less costly. According to Ouchi (1979), this depends on two factors: the knowledge of what behaviour is desirable and the ability to measure outputs. If there is sufficient knowledge of what behaviour is desirable this means that the desired behaviour is explicitly defined and readily measured (Eisenhardt, 1985).

Based on these two factors it is possible to draw a matrix that shows under which circumstances which type of control is feasible.

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Table 2: Conditions determining the measurement of behavior and output (Ouchi, 1979, p. 843)

If the ability to measure outputs is high, one should always consider using output controls. If there is, additionally, (almost) perfect knowledge of what behaviour is desirable, it is also possible to use behaviour controls. If the ability to measure outputs is low, then the question which type of control is appropriate depends on the question if there is a good knowledge of the desirable behaviour. If the knowledge is high, then it is feasible to use behaviour control, however, if the knowledge is low, then the only option is to use clan control. Thus, if both, the knowledge of desirable behaviour and the ability to measure outputs is low; clan control is an alternative to controls based on the evaluation of the performance of the employee through either output controls or behaviour controls. (Ouchi, 1979; Eisenhardt, 1985)

2.1.2.2 Merchant and Van der Stede framework

Ouchi‘s (1979) work was developed further by Merchant and Van der Stede (2007). They defined the control archetypes, identified by Ouchi (1979) more precisely and re-labelled them as action, results and personnel/cultural controls (Merchant and Otley, 2007):

1. Results controls which influence behaviour using information from measures for the outcomes of employees’ work.
2. Action controls which describe the actions to be taken by the employees.
3. Personnel controls which clarify the organization’s expectations to employees, provide them with adequate resources and enhance self-monitoring of employees.
4. Cultural controls which encourage mutual monitoring of employees.

According to Merchant and Van der Stede (2007, p. 29), the “implementation of results controls requires four steps: (1) defining the dimension(s) on which results are desired (or not desired), such as profitability, customer satisfaction, or product defects; (2) measuring performance on these dimensions; (3) setting performance targets for employees to strive for; and (4) providing rewards to encourage the behaviors that will lead to the desired results”.

The advantage of results controls is that the “organization does not dictate to employees what actions they should take; instead employees are empowered to take those actions they believe will best produce the desired results” (Merchant and Van der Stede, 2007, p. 25). Thus, employees start to think about the consequences of their actions. As the rewards for the employees are linked to the achievement of the defined goals, results controls makes sure that “the rewards are given to the most talented and hardest working employees, rather than those with the longest tenure or the right social connections” (Merchant and Van der Stede, 2007, p. 25).

Mostly, results controls are used for controlling the behaviour of employees with decision authority, namely managers. The advantage is that the controlled managers usually have more knowledge about the best ways to perform their tasks than their superiors. Results controls allow the decentralized decision making within organizations and still make sure that employees are made accountable for their decisions and actions. (Merchant and Van der Stede, 2007)

Nevertheless, results controls can be used for controlling the behaviour of employees at many different organizational levels. Merchant and Van der Stede (2007) point out that several manufacturing companies have implemented results controls down to the lowest organizational levels in their manufacturing departments. For example, line workers at a car manufacturer can be measured according to the quality of the components produced by them.

However, as Merchant and Van der Stede (2007, p. 26) point out, “Like all other forms of controls [...] results controls cannot be used in every situation. They are effective only where the desired result areas can be controlled (to a considerable extent) by the employee(s) whose actions are being influenced and where the controllable result areas can be measured effectively.”

Merchant and Van der Stede (2007, p. 35) conclude that results controls “usually are the major element of the MCS used in all but the smallest organizations. However, results controls often are supplemented by action and personnel/cultural controls.” These types of controls will be described in the next chapters.

According to Merchant and Van der Stede (2007, p. 76) action control “involves ensuring that employees perform (do not perform) certain actions known to be beneficial (harmful) to the organization”. In companies strong action controls usually mean that employees are not allowed to make important decisions themselves but have to get the approval of their superior.

The aim of action controls is to constrain the behaviour of the employees and to, thus, ensure that it is impossible or at least very difficult for employees to do things that they should not. According to Merchant and Van der Stede (2007), action controls include physical constraints (e.g. locks on desks, computer passwords, limited access to areas where sensitive information is kept etc.), administrative constraints (e.g. restriction of decision-making authority) and separation of duty (e.g. four-eye principle).

Like results controls action controls are used in almost every situation. However, again they are not effective in every situation. “They are feasible only when managers know what actions are (un)desirable and have the ability to ensure that the un(desirable) actions (do not) occur.” (Merchant and Van der Stede 2007, p. 76) It seems obvious that often this is not the case, especially, if the controlled person is somebody higher up in the hierarchy.

Additionally, “action control systems usually cannot be made near-perfect, or at least they are prohibitively expensive to make near-perfect. As a consequence, organizations use personnel and cultural controls to help fill in some gaps. These controls motivate employees to control their own behaviors (by means of personnel controls) or to control each other’s behaviors (by means of cultural controls).” (Merchant and Van der Stede, 2007, p. 83)

According to Merchant and Van der Stede (2007, p. 83), personnel controls “build on employees’ natural tendencies to control and/or motivate themselves”. Tow important parts of personnel controls are (1) selection and placement of employees, and (2) training of employees.

Basically, the aim of personnel controls is to make sure that the employees are able to do a good job. For that the employees need two things: the ability to perform in the specific job and the skills needed to perform the tasks. In order to hire the right employees that have the necessary skills for the job, the company needs to have very good selection and placement processes. (Merchant and Van der Stede, 2007)

If the company makes sure to hire the right employees, who are intrinsically motivated, ethical, trustworthy and loyal, in the first place it does not need to perform costly action controls afterwards. Thus, at least partly, action controls can be substituted by personnel controls. With highly developed training programs the company can ensure that the employees have the necessary skills to perform the desired tasks. (Merchant and Van der Stede, 2007)

As already mentioned, the idea behind cultural controls is that employees monitor each other. As Merchant and Van der Stede (2007, p. 85) point out, cultural controls are “a powerful form of group pressure on individuals who deviate from group norms and values. Cultural controls are most effective where members of a group have emotional ties to one another”.

According to Merchant and Van der Stede (2007, p. 85), cultures are built on “shared traditions, norms, beliefs, values, ideologies, attitudes, and ways of behaving.” These shared values and beliefs, thus, tie the organization together. One of the most important methods of shaping culture is the code of conduct statements. These are written documents that provide broad, general statements of the organizational values and “the ways in which management would like the organization to function. Each of these codes or statements is designed to help employees understand what behaviors are expected even in the absence of a specific rule or principle.”

However, empirical evidence shows that codes of conduct do not always work. In order to work, codes of conduct must be supported by the top management that must itself be committed to them. (Merchant and Van der Stede, 2007)

Looking at the different types of MCS described in the Merchant and Van der Stede (2007) framework, it can be argued that this model is very holistic. However, one possible weakness of the model is that it is static. For example, results controls are a very effective type of control, but what happens if something changes in the environment of the firm? Targets that were set at some point in the past might not be useful or appropriate any longer. Thus, one could argue that it is necessary to constantly talk about the underlying plans and assumptions the MCS is based on.

2.1.2.3 Simons’ framework

Another well known framework was developed by Simons (1995). He clusters MCS into four different types according to their relationship to strategy and the use by top managers:

Beliefs systems are used by top management to define and communicate the basic values and purpose of the firm. It is “the explicit set of organizational definitions that senior managers communicate formally and reinforce systematically to provide basic values, purpose, and direction for the organization” (Simons, 1995, p. 34), and often this is done with a mission statement. However, as Widener (2007, p. 759) points out, “in dynamic environments there must be some restraint placed on employees to stop them from engaging in high-risk behaviors. This restraint is the boundary system, which acts in opposition to the beliefs system”.

Boundary systems are used by top management to establish limits and rules that must be followed by the employees of the firm. According to Simons (1995, p. 39), the boundary system “delineates the acceptable domain of strategic activity for organizational participants”. Thus, it communicates the actions and risks that employees should avoid. An example of a boundary system is the code of conduct. As Widener (2007, p. 759) concludes, the “boundary and beliefs systems are similar in that they both are intended to motivate employees to search for new opportunities; however, the boundary system does so in a negative way through the constraint of behavior while the beliefs system does so in a positive way through inspiration”.

Diagnostic control systems are used to monitor firm performance and identify gaps between targets and actual outcomes. Furthermore, it allows managers to benchmark against their targets. Thus, the firm’s critical success factors are embedded in its diagnostic control systems and communicated to the employees (Widener, 2007). Examples of diagnostic control systems are business plans and budgets.

As Simons points out (1995, p. 95), “Interactive control systems are formal information systems managers use to involve themselves regularly and personally in the decision activities of subordinates. [...] Interactive control systems focus attention and force dialogue throughout the organization. They provide frameworks, or agendas, for debate, and motivate information gathering outside of routine channels.” Thus, they are the active and regular dialogue between top managers and employees.

When talking about the interactive use of MCS it is important to understand that an “interactive system is not a unique type of control system: many types of control systems can be used interactively by senior managers” (Simons, 1995, p. 96). However, according to Simons (1995, p. 97), interactive control systems have four common characteristics:

- Information generated by the system is an important and recurring agenda addressed by the highest levels of management.
- The interactive control system demands frequent and regular attention from operating managers at all levels of the organization.
- Data generated by the system are interpreted and discussed in face-to-face meetings of superiors, subordinates, and peers.
- The system is a catalyst for the continual challenge and debate of underlying data, assumptions, and action plans.

According to Simons (1994, p. 171), “any diagnostic control system can be made interactive by continuing and frequent top management attention and interest”. Thus, “top managers choose which control system [...] they want to use in an interactive manner” (Widener, 2007, p. 760). According to Simons (1995), typical MCS that organizations often use interactively are profit planning systems, cost accounting systems, project monitoring systems etc. Simons (1995, pp. 108) defines five conditions that are necessary for each control system in order to be a candidate for interactive use:

1. “To be used interactively, the control system must require the reforecasting of future states based on revised current information.” In any controls system actual results are compared with targets. But in an interactive control system any significant difference between plans and results immediately triggers a search for understanding why that happened. If MCS are used interactively, an ongoing reforecasting of future states takes place. Furthermore, it is necessary to continuously check the underlying plans, goals and strategies based on the newly gained information.
2. “To be used interactively, the information contained in a control system must be simple to understand.”
3. “To be used interactively, a control system must be used not only by senior managers but also by managers at multiple levels of the organization.” Thus, it is important that the results generated by the interactive MCS are subject to a constant debate within the organization.
4. “To be used interactively, a control system must trigger revised action plans.” Thus, after the questions what has changed and why have been debated between the managers within the organization, the critical question becomes what the organization is going to do about it.
5. “To be used interactively, a control system must collect and generate information that relates to the effects of strategic uncertainties on the strategy of the business.” That means that the company must be aware of possible changes in its environment and the effects that these changes have on firm strategy.

Redda (2007) points out that “in general, beliefs and interactive control systems stimulate inventive and innovative action, whereas diagnostic and boundary control systems serve to constrain decision-making and ensure compliance with particular rules and measures”.

2.1.2.4 Malmi and Brown framework

Recently, Malmi and Brown (2008) tried to integrate prior research into a comprehensive model. They differentiate between planning controls, cybernetic controls, reward and compensation controls, administrative controls and cultural controls (Figure 2).

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Figure 2: Parts of management control systems (Malmi and Brown, 2008, p. 291)

Malmi and Brown (2008, p. 291) point out that “planning is an ex ante form of control”. First, goals are set. Second, the standards that have to be achieved in relation to the goals are defined. Furthermore, the level of effort and the behaviour expected from the organisation members is clarified. Malmi and Brown (2008) differentiate between action planning that has a short-term focus (12 month or less) and long range planning that focuses on medium- and long-term goals.

According to Malmi and Brown, cybernetic control systems consist of four parts: budgets, financial measurement systems, non-financial measurement systems and hybrid measurement systems that contain both financial and non-financial measures (e.g. the Balanced Scorecard, Kaplan and Norton, 1992).

“Reward and compensation systems focus on motivating and increasing the performance of individuals and groups within organisations by achieving congruence between their goals and activities and those of the organisation.” (Malmi and Brown, 2008, p. 293).

The aim of administrative controls is to control employees’ behaviour through several activities. First, organisational design and structure is important as it “can encourage certain types of contact and relationships” (Malmi and Brown, 2008, p. 293). Second, “the governance structure relates to the company’s board structure and composition, as well as its various management and project teams” (Malmi and Brown, 2008, p. 294). Hence, all formal lines of authority and accountability as well as all systems that are in place to co-ordinate the activities of different organisational sub-units are included. Finally, the “use of policies and procedures is the bureaucratic approach to specifying the processes and behaviour within an organization” (Malmi and Brown, 2008, p. 294).

The last type of control mentioned by Malmi and Brown (2008) is cultural controls. Their definition is very similar to that of Merchant and van der Stede (2007). They consider four aspects of cultural controls: value-based controls, symbol-based controls, clan controls and personnel controls. Value-based controls are basically identical to what Simons (1995) calls the beliefs systems. As already mentioned, beliefs systems are used by top management to define and communicate the basic values and purpose of the firm. Hence, they are used by top management to provide basic values, purpose and direction to the organization. Examples are mission statements, vision statements or statements of purpose.

According to Malmi and Brown (2008, p. 294), the “impact of values on behaviour, institutionalized through belief systems, works on three levels. The first is when organizations deliberately recruit individuals that have particular types of values which match with those of the organisation. The second is when individuals are socialized and have their values changed to fit the organisational values [...]. The third is when values are explicated and employees behave in accord with them, even if they do not adhere to them personally.” Hence, Malmi and Brown (2008) also believe that personnel controls are a part of cultural controls. According to Merchant and van der Stede (2007), personnel controls consist of staff selection (making sure to hire the right people and training (teaching the employees to behave according to the company culture).

Finally, symbol-based controls means that the organization creates visible expressions (symbols) to support and express a certain type of culture (e.g. open office to create a culture of communication) and “clan controls work by establishing values and beliefs through the ceremonies and rituals of the clan”. (Malmi and Brown, 2008, p. 295).

2.1.3 MCS as a package

The different MCS frameworks described in the previous chapter are very helpful as a classification for study purposes. However, an important point is raised by Malmi and Brown (2008), and they conclude that previous research has mainly studied different types of MCS not connected with each other and the links between various MCS have not been recognized. Thus, the fact that MCS do not operate in isolation has basically been ignored. However, “the challenge is to understand how all the systems in an MCS package operate as an inter-related whole” (Malmi and Brown, 2008, p. 288).

Thus, Malmi and Brown (2008, p. 288) conclude that “gaining a broader understanding of MCS as a package may facilitate the development of better theory of how to design a range of controls to support organisational objectives, control activities, and drive organisational performance”. One of the few studies dealing with that topic was conducted by Widener (2007). She builds on Simons’ (1995) work and explores the interrelationship between the different levers of control.

As Widener (2007, p. 758) points out, “it is generally well-accepted that control systems are inter-dependent [...]; however, it is unclear whether they are complements or substitutes.” She argues that “when firms emphasize the beliefs system, they also emphasize each of the other control systems. In addition, the use of performance measures in the interactive system is associated with the use of performance measures in the diagnostic system and emphasis on the boundary system”. Thus, Widener (2007) concludes that the interdependencies between the different parts of the levers of control framework are complementary. Thus, they “work together to benefit a firm” (Widener, 2007, p. 757). According to Simons (2000), all four levers of control are necessary to provide an effective control environment.

Widener (2007) finds empirical evidence on Simons’ levers of control framework. Especially, the interactive control system is inter-dependent with the diagnostic control system and the boundary system. Thus, an “important implication for organizations is that in order to realize the full benefits of the performance measurement system they must use them both diagnostically and interactively” (Widener, 2007, p. 782). According to Widener (2007), managers must consider all four levers of control when designing their control system. She believes that the control systems are rather complements than substitutes.

However, there is still a lack of research on how different types of MCS interact with each other. An example mentioned by Malmi and Brown (2008, p. 288) is administrative and cultural controls “and whether/how they complement or substitute for each other in different contexts”.

2.1.4 Contextual variables influencing MCS

After defining what an MCS is and giving an overview of different frameworks that can be used to classify MCS, I will now give an overview of different contextual variables that, according to the findings of prior research, influence MCS. In doing so I will focus on environmental uncertainty, size and strategy of the organization.[2]

2.1.4.1 Environmental uncertainty

According to Chenhall (2003), the external environment is a very powerful contextual variable. Among the variables that describe the external environment, one of the most widely researched aspects is environmental uncertainty. As Chenhall (2003) points out it is important to differentiate between uncertainty and risk. “Risk is concerned with situations in which probabilities can be attached to particular events occurring, whereas uncertainty defines situations in which probabilities cannot be attached and even the elements of the environment may not be predictable.” (Chenhall, 2003, p. 137)

Chenhall (2003, p. 137) summarizes the findings on the impact of environmental uncertainty on MCS and concludes: “Some evidence suggests combinations of traditional budgetary controls and more interpersonal and flexible controls in conditions of environmental uncertainty.” A lot of research has confirmed that “uncertainty has been associated with a need for more open, externally focused, nonfinancial styles of MCS. However, hostile and turbulent conditions appear, in the main, to be best served by a reliance on formal controls and an emphasis on budgets.” (Chenhall, 2003, p. 138) Additionally, Chenhall (2003) suggests combining tight controls with more open and informal controls.

2.1.4.2 Firm size

Another contextual variable examined by Chenhall (2003) is firm size. Growth is important for firms as it enables them to improve efficiency and it provides opportunities for specialisation. However, usually, complexity increases in line with size and managers need to handle more and more information. Thus, the importance of formal systems that support managers with the appropriate information to handle their tasks grows, too.

Not surprisingly, prior research suggests that larger firms tend to have more sophisticated controls systems than smaller firms. Additionally, larger firms tend to rely more on administrative controls, whereas smaller firms are associated with personnel controls. Furthermore, larger firms are more decentralized and use sophisticated budgets in a participative way. (Chenhall, 2003) However, according to Chenhall (2003), the role of MCS in smaller or medium-sized companies has still received little attention and it is likely that many research opportunities can be found here.

Concerning the measurement of size Chenhall (2003) suggests using the number of employees, as the use of financial measures can make comparisons between firms difficult, due to different accounting standards.

2.1.4.3 Strategy

One of the most important contextual variables of MCS is strategy (Chenhall, 2003). “A strategy is the pattern or plan that integrates an organization’s major goals, policies and action sequences into a cohesive whole. A well-formulated strategy helps to marshal and allocate an organization’s resources into a unique and viable posture based on its relative internal competencies and shortcomings, anticipated changes in the environment and contingent moves by intelligent opponents.” (Mintzberg et al., 1998, p. 5) As Langfield-Smith (2007) points out, over the past 20 years there has been a growing interest in the relationship between MCS and strategy.

According to Grant (2008, p. 14), “strategy is the overall plan for deploying resources to establish a favorable position.” In this sense strategy serves as a link between the firm and its environment. Strategic management has to make sure that the firm and its goals, resources and systems match the needs of the markets.

When companies decide on a certain strategy to be pursued it seems quite obvious that there needs to be a fit between the firm’s strategy and its environment or organizational contingencies. Additionally, there needs to be a fit between the firm’s strategy and its resources and capabilities[3]. (Zajac et al, 2000). As firms face multiple environmental contingencies and organizational competences there is a huge number of possible strategic alternatives that can be chosen.

According to Grant (2008, p. 20), “strategy resides primarily within the minds of top managers.” The strategy is then communicated by the top management team to the organization through the company vision and mission and through strategic plans. However, Mintzberg et al. (1998) differentiate between intended, realized and emergent strategies (Figure 3).

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Figure 3: Deliberate and emergent strategies (Mintzberg et al, 1998, p.15)

The intended strategy is the strategy as defined by the top management team. The realized strategy is the strategy that is actually implemented. Obviously, as not 100% of the intended strategy is realized, the realized strategy differs from the intended. Mintzberg et al. (1998) suggest that only 10-30 percent of the intended strategy is realized; he calls this deliberate strategy. Thus, the main source of realized strategy is emergent strategy that emerges from complex processes within the organization where the intended strategy is discussed and interpreted between managers at different levels of the organizational hierarchy. (Mintzberg et al., 1998; Grant, 2008)

In for-profit organizations the aim of a strategy is typically to help the firm to achieve a sustainable competitive advantage that leads to superior profitability and higher shareholder value. In order to do that the firm has to deal with two basic questions: Where to compete?, How to compete? (Grant, 2008)

To answer these questions, the literature distinguishes between corporate strategy and business (or competitive) strategy. Corporate strategy is concerned with the question which businesses the firm should be in. Business strategy deals with single business units and how they compete within their particular industry and how they position themselves versus their competitors. (e.g. Langfield-Smith, 1997)

In the attempt to operationalize strategy formulation, empirical research has shown a strong support for the development and use of strategic typologies. As illustrated in the following figure, business strategies can be described along three dimensions: typology, strategic mission and competitive position. (Langfield-Smith, 1997)

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Figure 4: Operationalizing strategy (Langfield-Smith, 1997, p. 212)

The first dimension is the strategic mission. Build, hold and harvest organizations have different strategic missions. A firm that follows a build strategy tries to improve its market share and competitive position, even if its cash flow and profitability go down. A company with a harvest strategy does the opposite: it increases its cash flow and short term profit even if it loses market share. A hold mission is often used by businesses to protect their market share while obtaining a reasonable return on investment. (Langfield-Smith, 1997)

However, as Slater et al. (2006) point out, in the literature two typologies have emerged as the two dominant frameworks of strategic orientation: the Porter (1980) and the Miles and Snow (1978) frameworks.

Porter’s (1980) two generic strategy types deal with the question how firms generate competitive advantage. Differentiators on the one hand try to generate customer value through high product quality and/or exceptional service. Cost leaders on the other hand try to offer customers the best prices. For them it is very important to have very tight cost and overhead control and to minimize costs in areas such as R&D, customer support or advertising.

The four strategic positions developed by Miles and Snow (1978) are: defenders, prospectors, analysers, and reactors. Defenders select a certain market segment and service it with a stable set of products and customers. Hence, they choose stable and profitable market niches, which they maintain by offering highly competitive prices and excellent service to their loyal customers. Prospectors are highly innovative firms that always try to be first in the market. They try to quickly identify and exploit new market opportunities. Thus, they take an active role in the development of their industries. The analyzers take a position somewhere in-between the two extremes defenders and prospectors. They try to balance risk minimization and profitability. Reactors do not appear to have a consistent product-market orientation. Rather, they respond in those areas where they are forced to by their environment.

Langfield-Smith (1997) also points out that these different frameworks can also be combined in a number of ways (e.g. prospectors can have a differentiation strategy and pursue a build mission). Malina and Selto conclude that “more conservative strategies include defender, harvest, and cost leadership, while more entrepreneurial strategies are prospector, build and product differentiation.” (Malina and Selto, 2004, p. 447)

Besides these dominant frameworks many others have been used in the literature: e.g. low-cost defenders versus differentiated defenders (Walker and Ruekert, 1987), dodger versus defender (Dawar and Frost, 1999), operational excellence versus customer intimacy versus product leadership (Kaplan and Norton, 2001) or exploration versus exploitation (March, 1991). Additionally, the original Porter and Miles and Snow frameworks have been refined in sub-sequent research studies in several ways (e.g. Engelland and Summey, 1999).

The most important result of prior research on strategy and MCS is that some MCS are more suitable for certain strategy types than others (e.g. tight cost controls are more important for firms following a cost leadership position than for differentiators). (Langfield-Smith, 1997)

However, according to Langfield-Smith (1997), it is not the strategy type itself that is the driver for certain MCS but more the goals pursued by a firm. Thus, different strategy types can be “grouped” according to their goals around certain MCS. Figure 5 shows the relationship between different strategic typologies that need similar MCS: “there is a level of consistency between the organizational and control characteristics of a defender and cost leader, and a prospector and differentiator.” (Langfield-Smith, 1997, p. 217) This is in line with the findings of Malina and Selto that “firms following a more conservative strategy place more emphasis on cost control than those following a more entrepreneurial strategy” (Malina and Selto, 2004, p. 447).

A reason for that could be that both prospectors and differentiators need to be highly flexible in order to be able to quickly respond to the changing needs of the market. Very tight control systems seem not appropriate in this context as they are too inflexible. For a differentiator, control is more about coordination and encouragement of creativity and innovation, rather than about meeting tight budgets. (Langfield-Smith, 1997)

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Figure 5: Interrelations between strategic typologies (Langfield-Smith, 1997, p. 213)

However, as Langfield-Smith (1997) concludes the findings are not consistent. For example, Simons (1987) found that high performing prospectors placed importance on forecasting data and tight output controls, but gave little attention to cost controls. He also found that controls systems were used less intensively by defenders, compared with prospectors. There were also differences in small and large defenders. For small defenders tight budget goals and the use of output monitoring were positively associated with performance but for large defenders the opposite was true.

For Langfield-Smith (1997), these results are puzzling. “First, why were certain aspects of formal control systems considered important to prospectors, but used less intensively by defenders […]? Second, why should organizational size make a difference to the importance of controls?” (Langfield-Smith, 1997, p. 218)

Possible explanations could be that prospectors are highly innovative firms, and, thus, tight budgets and intense output controls are important to balance the “innovative excess”. Performance monitoring might also encourage organizational learning in settings where environmental uncertainty is high. Also, defenders might be more stable organizations that do not need to rely on output controls but that focus more on efficiency using non-financial measures. However, as non-financial controls were not included in Simons’ (1987) research design, these explanations remain speculative. (Dent, 1990; Langfield-Smith, 1997)

Chenhall again reported different results and concludes that tight controls are more suitable for conservative strategies even though they can also be found in more entrepreneurial situations but “together with organic decision styles and communications” (Chenhall, 2003, p. 151).

Chenhall concludes that “MCS has the potential to aid managers in this process by assisting them in formulating strategy related to markets and products, required technologies and appropriate structures. MCS can then be implicated in the implementation and monitoring of strategies, providing feedback for learning and innovation to be used interactively to formulate strategy” (Chenhall, 2003, p. 151).

However, the main problem according to Chenhall (2003, p. 152) is that only few studies have investigated these issues. Traditional research focused on the function of MCS to support the strategy of the business to enhance competitive advantage and encourage superior performance and most studies “have been restricted to identifying MCS that are appropriate for different strategic archetypes. [...] The extent to which these archetypes, which were developed in the 1970s and 1980s, maintain their relevance to contemporary settings is questionable”.[4]

Chenhall (2003) argues that accounting studies may suffer from outdated strategy constructs and suggests that the understanding of how MCS are associated with strategy could be improved by considering the role that strategic resources and capabilities play. Henri agrees and believes that the contradictory findings of prior studies can be explained by “the absence of a theoretical framework founded on the resource-based view”, as “following the RBV [...], the link between strategy and MCS may occur at the capabilities level”; “the relationship should be examined between capabilities and MCS” (Henri, 2006, p. 530).

“Much of the empirical research that has addressed MCS and strategy has followed a contingency approach and searches for systematic relationships between specific elements of the MCS and the particular strategy of the organization. These studies draw on organizational theories, and to a lesser extent, behavioral and agency theories.” (Langfield-Smith, 2007, p. 753)

This means that the “traditional view has been that a passive relationship exists between MCS and strategy. That is, the MCS has been viewed as an outcome of organisational strategy.” (Kober et al., 2007, p. 427) Thus, “the organizational strategy is the starting point, on the basis of which MCS serves as a tool to support its adoption” (Redda, 2007, p. 38). As Henri (2006) points out, traditionally, MCS have been seen as passive strategy implementation tools and the last step in the strategy process. (Henri, 2006). However, Kober et al. argue that “the association between MCS and strategy could be more than a simple uni-directional relationship [...] there may be a two-way relationship between MCS and strategy. That is, the MCS both impacts on, and is affected by, strategy” (Kober, 2007, p. 427).

Thereby, the focus has to move “from a simple matching of MCS design and strategy to the use of MCS to manage behavior and effect strategic change. If organizations pursue a range of strategies, and if strategy is in continual change, the matching of strategy and MCS design may no longer be the driver of competitiveness and organizational performance. Several studies point toward the importance of the use of the MCS in influencing strategic outcomes and performance.” (Langfield-Smith, 2007, p. 778) However, only few studies have investigated the influence of MCS on strategy and, thus, integrated the “dynamic” perspective of MCS (Chenhall, 2003).

2.1.5 MCS and learning

In the previous two chapters I gave an overview of how traditional contingency theory perceives MCS. The main assumption is that MCS are dependent on a variety of contextual factors and that it is important to achieve a fit between these factors and the structure of the MCS. Thus, as Chenhall (2003, p. 129) concludes, “contingency-based research follows the more conventional view that perceives MCS as a passive tool designed to assist managers’ decision making”.

However, as already mentioned in chapter 2.1.1, the definition of MCS has evolved over time. As Chenhall (2003, p. 129) point out, traditionally, “MCS are perceived as passive tools providing information to assist managers. However, approaches following a sociological orientation see MCS as more active, furnishing individuals with power to achieve their own ends.”

According to Langfield-Smith (2007, p. 754), the traditional definition of MCS “encouraged researchers to envisage MCS as encompassing the largely accounting-based controls of planning, monitoring of activities, measuring performance, and integrative mechanisms”. This is due to the fact that “the tenor of management control reaches back to the 1960s [...] top-down strategy setting, standardization and efficiency, results according to plan, no surprises, keeping things on track” were the topics traditional management control was concerned with. (Simons, 1995, p. 3)

However, “increasing competition, rapidly changing products and markets, new organizational forms, and the importance of knowledge as a competitive asset have created a new emphasis that is reflected in such phrases as market-driven strategy, customization, continuous improvement, meeting customer needs, and empowerment” (Simons, 1995, p. 3). The following table shows the changing demands for an MCS.

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Table 3: The changing characteristics of MCS (Simons, 1995, p. 4)

Thus, today a firm needs an MCS that is able to control a customer or market-driven strategy, that fosters innovation and that enables empowerment of employees. Or as Langfield-Smith (2007, p. 755) puts it: “Up to the 1980s, these conventional definitions of MCS seemed to be adequate, but in the 1990, it was argued that they needed to be reviewed to accommodate changing business conditions.”

Simons (1995) argued that managers use controls to signal strategic uncertainties and to manage those uncertainties. Thus, Simons (1995) broadened the role of MCS “as impacting on strategy formulation, implementation, and change. [...] The dynamic nature of MCS and its potential role in influencing strategy formulation, implementation, and strategic change became an area of increasing interest for research“. (Langfield-Smith, 2007, p. 755)

Kloot (1997, p. 47) analyzes the question how firms can survive in times of rapid environmental change and points out that “learning is the process of changing the organization to fit the changed environment, and may be either adaptive (not involving paradigmatic change) or generative (moving to new shapes and structures).”

Argyris (1977) calls these two types “single loop learning” and “double loop learning”. If an organization responds to change in its internal or external environment but carries on its present policies and maintains its central features, this is a form of single loop learning. “The existing strategies, structures and actions – the existing operational paradigm – continue: only minor changes to operating policies are made.” However, “When learning encompasses not only detecting errors but also questioning underlying policies and goals it may be called double loop learning. Double loop learning resolves incompatible organizational norms by setting new priorities or restructuring norm, and creating a new operational paradigm.” (Kloot, 1997, p. 49)

According to Kloot (1997, p. 47), “management control and budgeting systems are designed to ensure that problems or errors of environmental fit are detected. If the correction of these problems results in fundamental changes, generative learning will take place.” Hence, “control systems can be proactive in the management of organizational change by suggesting new possibilities” (Kloot, 1997, p. 54). Additionally, MCS can actively foster learning, for example through facilitating the flow of information within the organization (Kloot, 1997, p. 48).

Basically, four different constructs are linked to learning: knowledge acquisition, information distribution, information interpretation and organizational memory. According to Kloot (1997, pp. 56), first, new knowledge is brought into the firm through environmental scanning (knowledge acquisition). Second, information from different sources is shared within the firm (information distribution). Third, the information is given meaning, and shared understandings and conceptual schemes are developed (information interpretation). Finally, the knowledge is stored for future use (organizational memory).

These four constructs can be linked to different management control processes: performance management systems enhance knowledge acquisition, information distribution, and organizational memory, whereas teamwork and shared values facilitate information interpretation (see following table).

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Table 4: MCS characteristics and learning constructs (Kloot, 1997, p. 56)

Also Widener (2007) examines the interrelationship between MCS and learning. She argues that learning organizations adopt and formalize new routines that guide behaviour. Furthermore, MCS “are formalized routines [...] intended to guide behavior, and as such, facilitate organizational learning” (Widener, 2007, p. 765). Her empirical results support the assumption that the use of MCS is positively associated with organizational learning.

Especially, the effect of the interactive use of MCS has been explored in prior studies. For example, Abernethy and Brownell (1999) and Henri (2006) provide empirical support of the relation between interactive controls and organizational learning.

2.2 An introduction to the resource-based view theory

The following chapter gives an overview of the state-of-the-art of the resource-based view theory. First, the theoretical background will be presented. Second, I will define the key terms. Third, I will discuss the main contributions of the resource-based view, which argues that the source of sustained competitive advantage lies in the possession of valuable, rare, inimitable and non-substitutable resources. Fourth, the question how sustained competitive advantage translates into superior performance will be discussed. Finally, the contributions of the resource-based view will be critically discussed and several limitations will be presented.

2.2.1 Background

In the strategic management literature, basically, there exist two competing schools that try to answer the question how firms can generate a competitive advantage and superior performance: the market-based view (MBV) and the resource-based view (RBV).

The MBV was mainly shaped by Porter (1980) and sees the main source of competitive advantage in choosing an attractive industry with low competition. In this school the aim of strategic management is totally focused on the environment of the firm. Through a detailed analysis of the industry, for example with Porter’s (1980) five forces model, the firm should identify an attractive niche. Then the firm should occupy this niche and protect it from competitors.

From the 1960s until the 1990s research in strategic management mainly used one single framework to study competitive advantage. This framework, called the SWOT-analysis, suggests that firms obtain sustained competitive advantage by implementing strategies that are based on their internal strength and that respond to external opportunities. Additionally, the firms have to face external threats and overcome internal weaknesses. (Barney, 1991) However, as Barney (1991, p. 100) criticizes, research prior to the 1990s “tended to focus primarily on analyzing a firm’s opportunities and threats in its competitive environment”.

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Figure 6: The relationship between the SWOT-analysis and the resource-based model (Barney, 1991, p. 100)

According to Barney (1991), the main problem was that the single focus on the external environment of the firm as possible source of competitive advantage has completely denied the internal differences between the resources and processes within the firms. This leads to an over-simplifying assumption: “these environmental models of competitive advantage have assumed that firms within an industry (or firms within a strategic group) are identical in terms of the strategically relevant resources they control and the strategies they pursue” (Barney, 1991, p. 100)

Hence, the RBV tries to overcome these limitations and assumes that “firms within an industry (or group) may be heterogeneous with respect to the strategic resources they control” (Barney, 1991, p. 101) and that the unique and superior resources and capabilities of certain firms are the main source of competitive advantage. Or as Peteraf (1993, p. 179) puts it, the “notion that firms are fundamentally heterogeneous, in terms of their resources and internal capabilities, has long been at the heart of the field of strategic management”. Thus, the RBV shifts the attraction from the firm environment to the transactions inside the organization and, basically, asks one important question: “Why do firms in the same industry vary systematically in performance over time?” (Hoopes et al., 2003, p. 889)

Many authors in strategy research emphasize the importance of the theory of the RBV. For example, Hoopes et al. (2003, p. 889) state that the RBV “is one of the most popular and fruitful areas of strategy research.” Or Newbert (2007, p. 121) points out that the RBV “is one of the most widely accepted theoretical perspectives in the strategic management field”.

According to Armstrong and Shimizu (2007, p. 960), the RBV “helps to explain the conditions under which a firm’s resources will provide it with a competitive advantage [...] A firm is said to have a competitive advantage when the firm can produce more economically and/or better satisfy customer needs, and thus enjoy superior performance relative to its competitors”.

Newbert (2007, p. 122) points out that “Edith Penrose was one of the first to recognize the importance of resources to a firm’s competitive position”. For her a firm comprises of “a collection of productive resources” (Penrose, 1959, p. 24). Furthermore, she argued that the way the firm grows is dependent on the manner in which its resources are employed. Another researcher that conceptualized firms as bundles of resources prior to the formal RBV was Rubin (1973). “Like Penrose, Rubin recognized that resources were not of much use by themselves” but must be processed by the firms in order to make them useful. (Newbert, 2007, p. 122)

Wernerfelt (1984) built on the work of Penrose and Rubin and was the first to formalize the RBV. He argued that for a company “resources and products are two sides of the same coin” (Wernerfelt, 1984, p. 171). According to Newbert (2007, p. 122), that means that “while a firm’s performance is driven directly by its products, it is indirectly (and ultimately) driven by the resources that go into their production”. As most products need a set of resources for their production and most resources can be used for several products, firms can use their resource profile to find an optimal combination of products and markets to serve (Wernerfelt, 1984).

However, as Newbert (2007) points out, the RBV did not receive much attention in the beginning. This was due to the fact that early papers on the RBV were quite terse and abstract. Thus, “widespread appreciation for the RBV did not begin to accumulate until several years later with the publication of two papers” (Newbert, 2007, p. 123). The first one was “The core competence of the corporation” by Prahalad and Hamel (1990) und the second one was “Firm resources and sustained competitive advantage” by Barney (1991). Generally speaking, both papers deal with the question how firms can use resources or competences to gain sustained competitive advantage. The concepts of both articles will be described in more detail in chapter 2.2.3. Before that I will briefly define some key terms of the RBV in the next chapter.

2.2.2 Definition of key terms

Resources

As already mention in chapter 2.2.1, one of the first researchers explicitly studying the impact of firm resources on competitive advantage was Wernerfelt (1984). He defined resources as “anything which could be thought of as a strength or weakness of a given firm” (Wernerfelt, 1984, p. 172). Additionally, he gives a couple of examples for resources: “brand names, in-house knowledge of technology, employment of skilled personnel, trade contacts, machinery, efficient procedures, capital, etc.” (Wernerfelt, 1984, p. 172).

Barney (1991, p. 101) defines firm resources as “all assets, capabilities, organizational processes, firm attributes, information, knowledge, etc. controlled by a firm that enable the firm to conceive of and implement strategies that improve its efficiency and effectiveness”. He differentiates between three different categories of resources: physical capital resources, human capital resources and organizational capital resources. “Physical capital resources include the physical technology used in a firm, a firm’s plant and equipment, its geographic location, and its access to raw materials. Human capital resources include the training, experience, judgment, intelligence, relationships, and insight of individual managers and workers in a firm. Organizational capital resources include a firm’s formal reporting structure, its formal and informal planning, controlling, and coordination systems, as well as informal relations among groups within a firm and between a firm and those in its environment.” (Barney, 1991, p. 101) However, as Barney points out, “not all aspects of a firm’s physical capital, human capital, and organizational capital are strategically relevant resources” (Barney, 1991, p. 102). The conditions under which firm resources can be a source of sustained competitive advantage are discussed in chapter 2.2.3.

Thus, originally, researchers in the field of the RBV did not differentiate between resources and capabilities. However, as Hoopes et al. (2003, p. 890) point out, since the publication of the original papers by Barney (1986, 1991) and Wernerfelt (1984) “a distinction has emerged in the RBV literature between resources and capabilities”.

Capabilities

Amit and Schoemaker, for example, distinguish between resources and competences. They define resources “as stocks of available factors that are owned or controlled by the firm. Resources are converted into final products or services by using a wide range of other firm assets and bonding mechanisms such as technology, management information systems, incentive systems, trust between management and labor, and more” (Amit and Schoemaker, 1993, p. 35).

“Capabilities, in contrast, refer to a firm's capacity to deploy resources, usually in combination, using organizational processes, to affect a desired end. They are information-based, tangible or intangible processes that are firm-specific and are developed over time through complex interactions among the firm's resources.” (Amit and Schoemaker, 1993, p. 35)

illustration not visible in this excerpt

Table 5: The difference between resources and capabilities (Amit and Schoemaker, 1993, p. 37)

Or, as Schreyögg and Kliesch-Eberl (2007, p. 914) put it, “There seems to be a consensus that a capability does not represent a single resource in the concert of other resources such as financial assets, technology, or manpower, but rather a distinctive and superior way of allocating resources. It addresses complex processes across the organization such as product development, customer relationship, or supply chain management”.

According to Hoopes et al. (2003, p. 890), “a capability can be valuable on its own or enhance the value of a resource”. As Day points out, capabilities are “complex bundles of skills and accumulated knowledge, exercised through organizational processes, that enable firms to coordinate activities and make use of their assets” (Day, 1994, p. 38). “Overall, any organizational capability is the result of an organizational learning process, a process in which a specific way of selecting and linking resources gradually develops.” (Schreyögg and Kliesch-Eberl, 2007, p. 916)

Makadok (2001) argues that capabilities differ from resources in two ways: “First a capability is firm-specific since it is embedded in the organization and its processes, while an ordinary resource is not. Because of this embeddedness, ownership of a capability can not [sic] easily be transferred from one organization to another without also transferring ownership of the organization itself” (Makadok, 2001, p. 388). “The second feature that distinguishes a capability from other resources is that the primary purpose of a capability is to enhance the productivity of the other resources that the firm possesses” (Makadok, 2001, p. 389). Also Teece et al. (1997, p. 529) have pointed out that “capabilities cannot easily be bought; they must be built”.

However, unfortunately, the theory lacks clear and commonly accepted definitions: for example Helfat et al. (2007, p. 4) point out that “we consider capabilities to be “resources” in the most general sense of the word”.[5]

Sustained competitive advantage

As already mentioned, the main question the RBV focuses on is how firms can use internal resources and capabilities to generate a competitive advantage that leads to superior performance. An important differentiation made in the literature is the difference between a competitive advantage and a sustained competitive advantage. According to Barney (1991, p. 102), “A firm is said to have a competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitors. A firm is said to have a sustained competitive advantage when it is implementing a value creating strategy not simultaneously being implemented by any current or potential competitors and when these other firms are unable to duplicate the benefits of this strategy.”

As Barney (1991) points out, these definitions do not only focus on the positioning versus firms that are already operating in the industry, but also in comparison to potential future competitors that might enter the industry. Additionally, the definition of sustained competitive as used by Barney (1991) does not depend upon the period of calendar time during which a firm enjoys a competitive advantage. Contrary to other authors that simply state that a sustained competitive advantage is a competitive advantage that lasts over a longer period of time, Barney (1991, p. 102) argues that “a competitive advantage is sustained only if it continues to exist after efforts to duplicate the advantage have ceased”. In the view of Barney (1991) the main advantage of this definition is that it avoids the problem of specifying how much time firms have to keep a competitive advantage in order to have a sustained competitive advantage.

However, as Barney (1991, p. 103) points out, “that a competitive advantage is sustained does not imply that it will “last forever”. It only suggests that it will not be competed away through the duplication efforts of other firms.” Nevertheless, “unanticipated changes in the economic structure of an industry may make what was, at one time, a source of sustained competitive advantage, no longer valuable for a firm, and thus not a source of any competitive advantage”. (Barney, 1991, p. 103)[6]

After giving brief definitions of the key terms used in the RBV theory I will now discuss the most important question the RBV tries to answer: how resources and capabilities of firms lead to a sustained competitive advantage.

2.2.3 Strategic recourses as source of competitive advantage

Barney (1991) argues that the theory of strategic resources, meaning resources that have the potential to lead to a sustained competitive advantage for a firm, is basically grounded on two assumptions: “it seems reasonable to expect that most industries will be characterized by at least some degree of resource heterogeneity and immobility” (Barney, 1991, p. 103). Thus, even though firms “cannot expect to obtain sustained competitive advantage when strategic resources are evenly distributed across all competing firms and highly mobile”, the RBV theory still holds, as it seems safe to say that in reality this is hardly ever the case. (Barney, 1991)

One reason why resources are heterogeneously distributed between firms is the so-called “first mover advantage”, which means that firms gain a sustained competitive advantage by simply being the first to implement a certain strategy. As these firms “may gain access to distribution channels, develop goodwill with customer, or develop a positive reputation” (Barney, 1991, p. 104) before competitors enter the market, it might become impossible for them to copy the strategy later on, leading to a sustained competitive advantage for the first mover. (Barney, 1991)

Another reason lies in the so-called “isolating mechanisms” used by firms to protect their strategies from imitation through other firms. According to Hoopes et al., “three general isolating mechanisms prevent the imitation of resources and capabilities: property rights, learning and development costs, and causal ambiguity. Property rights apply most directly to resources. For example, a patent protects a firm against infringement by competitors. High learning and development costs inhibit the copying of both resources and capabilities. [...] Last, ambiguity regarding a rival’s capability increases the difficulty of imitating it, even when the process is observable.” (Hoopes et al., 2003, p. 891)

However, even under these assumptions it is important to notice that “of course, not all firm resources hold the potential of sustained competitive advantage” (Barney, 1991, p. 105), but strategic resources must meet certain criteria.

Already several authors have dealt with the question which characteristics a resource must fulfil in order to lead to a sustained competitive advantage. For example, Grant (2008, pp. 139) states that in order for a resource to lead to a competitive advantage, two conditions are necessary:

1. Scarcity: The resource must not be widely available within the industry.
2. Relevance: The resource must be relevant to the key success factors of the industry.[7]

In order to enable the firm to gain a sustained competitive advantage, additionally, the following three conditions must be met (Grant, 2008, p. 140):

1. Durability: The resources must be durable and must not be destroyed by technological change too quickly.
2. Transferability: Resources must not be easily transferable. Thus, it should not be possible to buy or sell them. As already mentioned, organizational capabilities, because they are based on teams of resources, are less mobile than individual resources. Hence, resources in the narrow sense will not lead to sustained competitive advantage.
3. Replicability: The resource must not be easily imitated by a competitor. Again, capabilities that are based on complex organizational routines are less easily imitable than resources in the narrow sense.

As already mentioned in chapter 2.2.1, the two most important articles dealing with that topic that received the highest attention are “The core competence of the corporation” by Prahalad and Hamel (1990) und “Firm resources and sustained competitive advantage” by Barney (1991).

Prahalad and Hamel (1990) argue that the sources of sustained competitive advantage are so-called “core competences”. Core competences are the ability of a firm to integrate several skills and technologies for the production of core products. According to Prahalad and Hamel (1990), core products are the components of the end products that actually contribute most to the customer value. Hence, Prahalad and Hamel (1990) argue that the critical task of management is to exploit the core competences of a firm in order to produce new innovative products. They define three tests that can be applied in order to identify a core competence:

1. A core competence should grant access to a wide variety of markets,
2. A core competence should make a significant contribution to the perceived customer benefit of the end product.
3. A core competence should be difficult for competitors to imitate.

However, probably the most important article in this field is the one by Barney in 1991. To have the potential to lead to a sustained competitive advantage, a firm resource must have four attributes: “(a) it must be valuable, in the sense that it exploit opportunities and/or neutralizes threats in a firm’s environment, (b) it must be rare among a firm’s current and potential competition, (c) it must be imperfectly imitable, and (d) there cannot be strategically equivalent substitutes for this resource that are valuable but neither rare or imperfectly imitable.” (Barney, 1991, pp. 105)

Valuable resources

Obviously, firm resources can only be a source of competitive advantage or even sustained competitive advantage if they are valuable. For Barney (1991, p. 106) “resources are valuable when they enable a firm to conceive of or implement strategies that improve its efficiency and effectiveness.” Additionally, resources improve firm performance only when they exploit external opportunities of the firm or neutralize threats in the firm’s environment. (Barney, 1991)

Rare resources

However, being valuable is a necessary but not sufficient condition for a resource to lead to a sustained competitive advantage. According to Barney (1991, p. 106), “valuable resources possessed by large numbers of competing or potentially competing firms cannot be sources of either a competitive advantage or a sustained competitive advantage”. This is because a competitive advantage arises if a firm implements a value-creating strategy not implemented by its competitors. In order to implement a certain strategy the firm needs a certain set of resources. If these resources are also available to one or more competitors, then the competitors will also be able to implement that strategy. Thus, the competitive advantage is competed away. (Barney, 1991)

According to Barney (1991), the question how rare a resource must be in order to have the potential to generate a competitive advantage is difficult to answer. Obviously, a resource that is absolutely unique within a set of competing firms will have the potential to lead to a competitive advantage or even a sustained competitive advantage more easily, however, generally, “as long as the number of firms that possess a particular valuable resource (or a bundle of resources” is less than the number of firms needed to generate perfect competition dynamics in an industry [...], that resource has the potential of generating a competitive advantage” (Barney, 1991, p. 107).

Imperfectly imitable resources

However, resources that are only valuable and rare have the possibility to lead to a competitive advantage, but in order to potentially lead to a sustained competitive advantage, they, additionally, must not be easily imitable by a competitor. (Barney, 1991, p. 107)

According to Barney (1991, p. 107), “resources can be imperfectly imitable for one or a combination of three reasons: (a) the ability of a firm to obtain a resource is dependent upon unique historical conditions, (b) the link between the resources possessed by a firm and a firm’s sustained competitive advantage is causally ambiguous, or (c) the resource generating a firm’s advantage is socially complex”.

Firstly, unique historical conditions can lead to a sustained competitive advantage because it may allow firms to use and exploit resources in a way that cannot be imitated by competitors because of the firm’s unique path through history. That means that the implementation of certain strategies is only possible for the firm because of its history. A competitor with another history is not able to implement the same strategy. (Barney, 1991)

Secondly, “causal ambiguity exists when the link between the resources controlled by a firm and a firm’s sustained competitive advantage is not understood or understood only very imperfectly” (Barney, 1991, pp. 108). If causal ambiguity exists, then it is very difficult for the competitors to understand the strategy and, thus, to copy it because they do not know which resources exactly are those that lead to the sustained competitive advantage. “Imitating firms may be able to describe some of the resources controlled by a successful firm. However, under conditions of causal ambiguity, it is not clear that the resources that can be described are the same resources that generate a sustained competitive advantage, or whether that advantage reflects some other non-described firm resource” (Barney, 1991, p. 109).

It is important to understand that causal ambiguity is only a source of sustained competitive advantage when both firms, the firm that possesses the competitive advantage and the competing firm that tries to copy the successful strategy, are faced with the same level of causal ambiguity. If the firm that possesses the competitive advantage itself understands which resources exactly lead to the competitive advantage, then the causal ambiguity no longer exists as the competing firm can also make attempts to solve the problem by, for example, hiring former employees from the firm it tries to copy. Thus, “in order for causal ambiguity to be a source of sustained competitive advantage, all competing firms must have an imperfect understanding of the link between the resources controlled by a firm and a firm’s competitive advantage” (Barney, 1991, p. 109)

Thirdly, social complexity can make the imitation of a certain strategy difficult or impossible for other firms. According to Barney (1991, p. 110), firm resources “may be very complex social phenomena, beyond the ability of firms to systematically manage and influence”. Examples of such resources would be the interpersonal relations among managers in a firm, a firm’s culture, or a firm’s reputation among suppliers or customers. As Barney (1991, p. 110) concludes, “when competitive advantages are based in such complex social phenomena, the ability of other firms to imitate these resources is significantly constrained”.

Non-substitutable resources

“The last requirement for a firm resource to be a source of sustained competitive advantage is that there must be no strategically equivalent valuable resources that are themselves either not rare or imitable.” (Barney, 1991, p. 111) According to Barney (1991), two or more resources are strategically equivalent if they can be used separately to implement the same strategy. The whole framework developed by Barney (1991) is shown in the following figure. Barney (1991) suggests using this framework to assess the potential of firm resources to be sources of sustained competitive advantage.[8]

illustration not visible in this excerpt

Figure 7: The VRIN framework (Barney, 1991, p. 112)

2.2.4 From competitive advantage to superior performance

In the previous chapters I explained how strategic resources lead to a competitive advantage or even a sustained competitive advantage. However, the question remains how competitive advantage leads to superior performance. As Newbert (2008, p. 749) points out, “though the terms competitive advantage and performance are often used interchangeable [...], the two constructs are acknowledged to be conceptually distinct”. Whereas a competitive advantage is generally conceptualized as the implementation of a value-creating strategy not implemented by the competitors of a firm (Barney, 1991), “performance is generally conceptualized as the rents a firm accrues as a result of the implementation of its strategies” (Newbert, 2008, p. 749).

Hence, the ability to attain competitive advantage is an important antecedent of performance and it can be expected that they correlate with each other, but they are not the same thing, as a firm’s performance is additionally influenced by many other internal and external effects. (Newbert, 2008) The interrelationship between strategic resources, competitive advantage and performance is shown in the following model.

illustration not visible in this excerpt

Figure 8: From strategic resources to performance (Newbert, 2007, p. 123)

Newbert (2008) empirically tests the question how valuable and rare resources, competitive advantage and performance are related to each other. “The results suggest that value and rareness are related to competitive advantage, that competitive advantage is related to performance, and that competitive advantage mediates the rareness-performance relationship. (Newbert, 2008, p. 745)

Crook et al. (2008) meta-analyze 125 studies that measure the correlation between strategic resources and performance. Their findings suggest that resources and performance are positively correlated. The correlation between resources and performance is even higher if the tested resources meet the criteria as defined by Barney (1991).

However, Newbert (2007) reviews 55 empirical tests of the RBV to assess if the theoretical constructs find empirical support and finds considerable variations regarding the level of support between the tested theoretical constructs. For example, capabilities and core competences contribute much more to a firm’s competitive advantage than regular resources.

According to Newbert (2007), methodological issues are the reason for these inconsistent findings. Thus, he suggests that scholars conducting empirical research should move away from Barney’s VRIN model. Newbert (2007) concludes that one should not simply measure the correlation between a single strategic resource and performance but test the combined effect of several resources or capabilities on performance. Additionally, empirical research should rely more on the more recent theoretical work in the area of the RBV, especially on the dynamic capability theory.[9] The limitations of the RBV and suggestions what can be improved are discussed in the following chapter.

2.2.5 Limitations of the traditional RBV

2.2.5.1 The problem of resource complementarity

Even though there is a lot of agreement in the literature that the possession of valuable, rare inimitable and non-substitutable resources is beneficial for firms it is also argued that in order to gain a competitive advantage from its valuable resources a firm must properly leverage (Peteraf, 1993) or manage (Henderson and Cockburn, 1994) them. This is because a “firm may achieve rents not because it has better resources, but rather the firm’s distinctive competences involves making better use of its resources” (Mahoney and Pandain, 1992, p. 365). As Newbert (2008) points out, valuable and rare resources have only the potential to lead to a sustained competitive advantage and only if they are effectively deployed the firm is able to gain superior performance.

“Barney argued that in addition to simply possessing valuable, rare, inimitable (which by then included non-substitutable) resources, a firm also needed to be organized in such a manner that it could exploit the full potential of those resources [...]. He added that the implementation skills that could ensure proper resource exploitation included such organizational components as structure, control systems, and compensation policies” (Newbert, 2007, p. 124).

Thus, Newbert (2008) concludes that “it seems that while a resource (or capability) may have tremendous potential value, its value can only be realized when it is combined with a corresponding capability (or resource). Given that resources and capabilities are essentially unproductive in isolation, the key to attaining a competitive advantage is not simply the exploitation of a valuable resource or a valuable capability, but rather the exploitation of a valuable resource-capability combination. Moreover, the more valuable the firm’s resource-capability combinations, the greater the advantage it will enjoy as a result of their exploitation.” (Newbert, 2008, p. 748)

Another important point that arises from this argument is that because resources and capabilities must be exploited in combination “it seems that firms need not necessarily possess rare resources and rare capabilities in order to attain a competitive advantage” (Newbert, 2008, p. 748). Rather the criterion of rareness applies to resource bundles. Newbert (2008) gives the example of a firm that converts widely available raw materials into finished goods using a patented chemical process. Thus as used in combination with a valuable and rare resource (the patented chemical process) “common resources (or capabilities) can be essential to the attainment of a competitive advantage provided that they are paired with other capabilities (or resources) in such a way that the resulting combination in which they are exploited is rare.” (Newbert, 2008, p. 748)

As resource bundles are heterogeneous between firms, firms vary fundamentally in their ability to create value when they acquire a certain new resource. “In the RBV, since firms are characterized by heterogeneous resources endowments, different bundles of resources vary in their degree of “complementarity”, “specificity”, “synergy”, “co-specialization”, or “relatedness” to one another” (Adegbesan, 2009, p. 465).

Adegbesan (2009) argues that “a firm displays “complementarity” to a resource when their combination [with the existing resources of the firm] leads to the creation of a “surplus” over and above the sum of the amounts of value they could create independently. As such, firms with a greater degree of complementarity to a target resource are able to create a larger surplus in combination with that resource than firms with a lower degree of complementarity to the resource. Consequently, when bidding firms [...] display heterogeneous complementarity to target resources, those with greater complementarity can outbid firms with lesser complementarity, and at least some of the acquiring firms will retain part of the surplus they help create” (Adegbesan, 2009, p. 463).

However, even though Barney’s (1991) VRIN framework is a very useful tool to assess the value of a certain resource and is intensively used by other researchers, it does not give guidance concerning the question how firms can use complementary bundles of resources to gain a sustained competitive advantage, as it focuses only on the relationship between a single resource and competitive advantage. Thus, the fact that firms have heterogeneous complementarity to resources and differ in the incremental value a certain resource has for them is totally ignored (Adegbesan, 2009).

2.2.5.2 The RBV as static concept

According to Newbert (2007, p. 123), “one of the primary critiques of Barney’s (1991) expression of the RBV over time has been its rather static nature”. Even though there is a lot of agreement among researchers that resources and capabilities are one major source for the generation and development of sustained competitive advantages Schreyögg and Kliesch-Eberl have pointed out some weaknesses of the traditional static RBV. They argue that “Recently in the capability debate, the issues of volatile markets, environmental uncertainty, and change have come to the fore” (Schreyögg and Kliesch-Eberl, 2007, p. 914). Or as Wang and Ahmed put it: “the RBV fails to address the influence of market dynamism and firm evolution over time” (Wang and Ahmed, 2007, p. 33).

Morgan et al. (2009) criticize the RBV for “its inability to explain how resources are developed and deployed to achieve competitive advantage and its failure to consider the impact of dynamic market environments” (Morgan et al., 2009, p. 910). This is also the point of view of Eisenhardt and Martin (2000, p. 1106) when they argue that “RBV breaks down in high-velocity markets, where the strategic challenge is maintaining competitive advantage when the duration of that advantage is inherently unpredictable”.

According to Schreyögg and Kliesch-Eberl (2007), in order to stay competitive firms need the ability to change and quickly develop new organizational capabilities. Therefore they call for a dynamization of the organizational competences. Their argument is that the competitive advantage gained through superior resources and competences can only be maintained if they are continuously adjusted to match the needs of rapidly changing markets.

Thus, organizations need to be able “to change their familiar way of doing when confronted with new developments”, otherwise the capabilities can become a barrier to change and “may easily invert from a strategic asset into a strategic burden”. (Schreyögg and Kliesch-Eberl, 2007, p. 916). The problem here is that some capabilities have proven to be highly successful in the past, but changing markets created a situation where these capabilities have to be changed in order to stay successful in the future. If an organization has relied very heavily on a certain capability in the past and already invested a lot of resources to further develop it, it is very likely that it is very difficult and problematic for the organization to change or even delete this capability, as there will be a lot of resistance against the change.

Thus organizations are facing a dilemma: “on the one side, they have to develop reliable patterns of selecting and linking resources in order to attain superior performance and competitive advantage and on the other side [...] a considerable risk of becoming locked into exactly these capabilities [emerges]” (Schreyögg and Kliesch-Eberl, 2007, p. 919). To resolve this paradox the authors suggest that the organization develops dynamic capabilities; capabilities that add, reconfigure or delete resources or competences (Schreyögg and Kliesch-Eberl, 2007; Danneels, 2008).

To address these issues recent research has extended the traditional RBV to the dynamic capability (DC) theory (e.g. Eisenhardt and Martin, 2000; Teece et. al., 1997). As Teece (2009, p. 4) points out, “in fast-moving business environments open to global competition, and characterized by dispersion in the geographical and organizational sources of innovation and manufacturing, sustainable advantage requires more than the ownership of difficult-to replicate (knowledge) assets. It also requires unique and difficult-to-replicate dynamic capabilities”. In the following chapter I will give an introduction to the dynamic capability theory.

2.3 An introduction to the dynamic capability theory

2.3.1 Background

As pointed out in the previous chapter, the RBV basically argues that valuable, rare, inimitable and non-substitutable resources are the sources of a firm’s competitive advantage. However, the RBV is based on the assumption that resources are heterogeneous across firms and that this heterogeneity is sustainable over time. Thus, the RBV as such is a static concept and “does not specifically address how future valuable resources could be created or how the current stock of VRIN resources can be refreshed in changing environments: this is the concern of the dynamic capability perspective.” (Ambrosini and Bowman, 2009, p. 29)

Similar to the RBV, the dynamic capability (DC) theory is grounded on the work of Penrose (1952, 1959) and her theory of the growth of the firm. As summarized by Ambrosini and Bowman (2009, p. 31), Penrose suggested that value is not generated by the possession of resources but by their use. Thus, value is created through the combination and deployment of resources within a firm. According to Teece (2009, p. 118), “Penrose appears to be articulating a weak form of what is now referred to as the dynamic capabilities approach”. Thus, “Penrose’s framework is consistent with elements of the dynamic capabilities framework. Her emphasis on the fungible nature of resources obviously provides scope for the notion that a firm’s competencies can be reshaped.” (Teece, 2009, p. 119)

However, Teece (2009) also highlights limitations in Penrose’s work: On the one hand, she does not address the question how firms generate a competitive advantage. On the other hand, she does not emphasize the role of the changing environment and the constant need to improve and renew capabilities. “She saw learning as an opportunity, not a necessity.” (Teece, 2009, p. 119)

However, the probably most important researcher preparing the ground for the DC theory is David Teece. Teece et al. were among the first that explicitly talked about “dynamic capabilities”. In a working paper in 1991 they pointed out that “our view of the firm is somewhat richer than the standard resource-based view [...] it is not only the bundle of resources that matter, but the mechanisms by which firms learn and accumulate new skills and capabilities” (Ambrosini and Bowman, 2009, p. 30).

In 1997 Teece et al. wrote the article “Dynamic Capabilities and Strategic Management”, which received much attention in the scientific community. In this article the authors state that the traditional RBV has failed “in respect to assisting in the understanding of how and why certain firms build competitive advantage in regimes of rapid change” (Teece et al., 1997, p. 509).

According to Teece et al. (1997, p. 510), the DC theory extends the RBV and makes the effort “to identify the dimensions of firm-specific capabilities that can be sources of advantage, and to explain how combinations of competences and resources can be developed, deployed, and protected.” They refer to this “as the ‘dynamic capabilities’ approach in order to stress exploiting existing internal and external firm-specific competences to address changing environments” (Teece et al., 1997, p. 510).

In 2009 Augier and Teece revised the 1997 Teece et al. article and analyzed the theoretical antecedents and conceptual underpinnings of the DC theory. They point out that the DC theory is basically grounded on three different theories: the behavioural theory of the firm, the transaction cost theory, and the evolutionary theory.

According to Augier and Teece (2009, p. 413), the behavioral theory of the firm sees firms as “heterogeneous, boundedly rational entities that have to search for relevant information [...]. In terms of relevance to strategy, the most basic contribution of the behavioral theory of the firm is the importance of firm heterogeneity.” Additionally, DC can be viewed as an extension to the behavioral theory “to recognize the importance of intangible assets, outsourcing, offshoring, and rapid change” (Augier and Teece, 2009, p. 413).

The DC also revises the transaction cost theory as it suggests that “the scope of the firm cannot be explained just by transaction cost considerations. Rather, asset selection (internalization) decisions must also make reference to cospecialization economics, learning, and the appropriability of profits from innovation” (Augier and Teece, 2009, p. 414).

Finally, DC theory builds on ideas from the evolutionary theory that interprets a firm as “a profit-seeking entity whose primary activities are to build (through organizational learning) and to exploit valuable knowledge assets” (Augier and Teece, 2009, p. 415).

Summing up, the DC theory is consistent with the point of view that sees the process of organizational and strategic renewal as essential for the long-term survival and prosperity of a firm. The continuous development of new products and processes through new combinations of knowledge and capabilities to exploit arising market opportunities is the key to a sustained competitive advantage. (Augier and Teece, 2009)

2.3.2 What are dynamic capabilities?

According to Teece et al. (1997, p. 514), “the term ‘dynamic’ refers to the capacity to renew competences so as to achieve congruence with the changing business environment [...]. The term ‘capabilities’ emphasizes the key role of strategic management in appropriately adapting, integrating, and reconfiguring internal and external organizational skills, resources, and functional competences to match the requirements of a changing environment.”

Morgan et al. point out that “capabilities are dynamic when they enable the firm to implement new strategies to reflect changing market conditions by combining and transforming available resources in new and different ways” (Morgan et al., 2009, p. 910).

As Helfat et al. (2007, p. 30) suggest, organizational processes and DC are interrelated, as processes are “mechanisms by which dynamic capabilities are put into use, and mechanisms by which organizations can develop dynamic capabilities”. Thus, organizational processes “underpin” capabilities and “managerial and organizational processes are inextricably linked to dynamic capabilities”. According to Helfat et al. (2007, p. 31), “Processes are also used to develop dynamic capabilities. [...] This development, both origination of new dynamic capabilities and improvement of existing ones, can occur through organizational learning processes.”

In order to use DC, organizations must first identify the need or the opportunity for change, second formulate a response and finally implement an action plan. For all these functions the organization needs associated processes. “For example, identification of a need or opportunity involves problemistic search or opportunity recognition processes. Formulation of a response involves internal selection processes and resource allocation processes, and implementation involves a variety of managerial and organizational processes, depending on the nature of the objective and the specific tasks required.” (Helfat et al., 2007, p. 30f)

[...]


[1] Additional tests were performed if appropriate (see respective chapter).

[2] The literature also mentions other variables that influence MCS (e.g. culture or structure). However, as I do not use them in my empirical study I will not talk about them in more detail. A very good overview of contextual variables used in contingency-based research is provided by Chenhall (2003).

[3] In the literature sometimes the term “capability” and sometimes the term “competence” is used. As there is no clear and commonly accepted differentiation between these two terms in the literature I use them interchangeably in this dissertation.

[4] Strategy development has become more complicated due to the fact that today most organizations have to offer customer at the same time both: value for money and high quality and service.

[5] In this dissertation I follow the point of view of Helfat et al. (2007) and differentiate between resources and capabilities but consider capabilities as a special form of resource.

[6] The dynamic capability theory tries to overcome this limitation of the RBV (see chapter 2.3).

[7] According to Grant (2008), a key success factor is a variable that can be influenced by the management and that significantly influences the overall competitive positioning of the firm within an industry.

[8] In the literature Barney’s (1991) framework is mostly called VRIN framework (valuable, rare, inimitable, non-subsitutable).

[9] See chapter 2.3

Details

Pages
184
Year
2010
ISBN (eBook)
9783656136392
ISBN (Book)
9783656136590
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1.6 MB
Language
English
Catalog Number
v189077
Institution / College
Vienna University of Economics and Business – Institute for Strategic Management
Grade
2
Tags
Strategic Management Organizational Learning Resource-based View Dynamic Capabilities Management Control organizational capabilities

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