Economic Foundations of Strategic Management

Mehmet Barca

• Publisher: Routledge
• Year: 2017
• ISBN:
  9781351941921
• Edition: 1
• Topic: Economics
• Subtopic: Economic Conditions
• Index: Economics

This book explores the extent to which economic theory is able to provide the theoretical foundations of strategic management. To this end it draws on the philosophy of science; microeconomic theory; and different approaches to strategic management. The work shows that many of the propositions of strategic management are deducible from the economic theories considered. It argues that these propositions should be made open to empirical testing and that a unified theory of strategic management should be developed. Thus the book addresses a current major concern of theorists - that strategy remains 'atheoretical' and that this reduces the predictive power of the subject and hampers further theory development. The essential contribution made is that economic theory should be systematically explored in order to establish the foundations of business strategy.

Chapter 1

Introduction: Does Strategic Management Theory Need Economics?

Introduction

The subject of strategic management analyses the firm’s relationship with its market environment (Porter, 1980; Kay, 1993). Hence, researchers in the field of strategic management need conceptual frameworks regarding the firm and market on which they may rely to explain and predict strategic phenomena. Yet, one of the enduring problems facing the field of strategic management is the lack of theoretical foundations available to describe and predict the behaviour of firms and markets (Camerer, 1985; Levy, 1994). Economists have made many important advances in explaining and predicting the behaviour of firms and markets from a, primarily, public policy point of view. The aim of the present study is to examine the existing theories of the market and of the firm in economics for their potentialities to supply theoretical foundations on which strategic management theory may be based to explain and predict its phenomena of inquiry (Rumelt, 1984; Kay, 1991; Spulber, 1993; Seth, and Thomas, 1994).

Economics has already provided many of the building blocks upon which strategic thinking and research were constructed. Some authors go even so far as to say that ‘a minor revolution’ has been witnessed in strategic management research and writing due to the growing influence of economics (Rumelt, Schendel and Teece, 1991). Indeed, inspired by Porter in the beginning of 1980s, a new generation of strategic management scholars views economics as the base discipline for strategic thinking and research (Hirsch, Friedman, and Koza, 1990). In the last two decades, the economics and strategic management relationship has taken three forms: one group used economics for building approaches to strategy, another group critically assessed economics for identifying the kind of economics to improve existing approaches in the field, and a third group examined economics to improve the methodology of strategic inquiry. This study seeks to add another span to the theoretical bridge between strategic management and economics. In the following sections we argue that researchers working within the framework of strategic management theory need an associated theory of the firm and of the market to supply theoretical bases on which they may rely to explain their phenomena of inquiry. In this respect, the study aims to examine and assess whether economic theories of the firm and of the market provide perspectives for thinking about strategic issues and theoretical foundations for analysing significant strategic research problems.

In what follows, there will be three sections. The first section explicates the purpose of the study and the way that the economics and strategic management is related and to be examined. There, the studies having hitherto dealt with the relationship between the fields of strategic management and economics are also examined in order to locate the present study within existing literature, and to explicate the need for such an initiation. The second section sets the study’s research agenda and method. The last section elucidates the organisation of the study.

Purpose of Study

In this section, firstly, we attempt to identify various approaches to the economics and strategic management relationship in order to denote in which context the relations is to be examined, and, secondly, to explicate the need for such an initiation and its possible contributions.

Approaches to the Economics and Strategic Management Relationship

Strategic management theory has drawn on a variety of academic disciplines in order to reach its conclusions: from political science, economics, organisational psychology, organisational sociology, military strategy, systems theory, even from biology. In fact, from the outset up to present-day, the hallmark of strategic management has been eclecticism and pragmatism.

But perhaps the most important discipline on which strategic management theory has drawn is likely to be economics (Pitt-Watson, 1992). As many scholars, for example, Camerer (1985), Montgomery, Wernerfelt and Balakrihnan (1989), Rumelt, Schendel and Teece (1991, 1994), have pointed out, the aim of making use of economics in the field of strategy is to further strategy thinking and research in different ways. Foss captures the ethos of this movement very well:

Strategy scholars have increasingly turned towards economics because, among other things, they believe that economics may increase the problem-solving ability of strategy thinking, make strategy thinking more susceptible to confrontation with empirical reality, make concepts less ambiguous, and increase fruitful dialogue between strategy scholars (Foss, 1996a, p. 187–188).

There is a growing number of scholars who turn to economics in furthering strategy thinking and research. The usefulness of economic reasoning for strategic theorising and strategy research is virtually beyond dispute. But the treatment of the relationship between economics and strategic management is under strong scrutiny from different perspectives. Broadly speaking, in the recent debate in the strategy field over the economics-strategic management nexus, there have been three distinguishing sides.

The first group sees the role of economics in developing strategic thinking and research as significant and fruitful. They use economics to develop strategy theory or schools of thought in the field. The distinguishing character of this group is that they cross over between fields and disciplines, but in a systematic manner, and recognise and maintain their distinct strengths and weaknesses. The group can be classified as recontructionists due to their systematic utilisation of economic theories for theory development in the field of strategy. Reconstructionists do not necessarily deliver a body of ideas more or less as developed by its leading economic thinkers, but, instead, create new analytical categories where that seems only implicit in the original economic treatment, and sometimes deviates from them.

The best example in case for this group is Porter (1980, 1985). He developed the dominant approach, positioning approach, in the 1980s, by a careful treatment and extension of industrial organisation (IO). Porter’s model basically turns the IO or, more specifically, the S-C-P paradigm, upside-down, by advising managers how to restrict competition to earn above-average profits (erecting various entry barriers), rather than to focus on how to increase competition to enhance consumer profits or welfare. A second example is Wernerfelt’s (1984) development of the resource-based view by utilising the Penrosian theory of the growth of the firm, an alternative school of thought to the neoclassical school in economics, which looks at economic units or firms from their resource endowments viewpoint, rather than their reactions to market price signals. Another example in case is Jacobson’s endeavour of reconstructing the ideas of the Austrian School of economics which emphasises market process and entrepreneurial discovery to develop an alternative theory of strategic management (the ‘Austrian’ school of strategy) to the Porterian ‘positioning theory of strategy’ based on conceptual foundations of industrial organisation which focuses on market structure and barriers to competition (Jacobson, 1992).

The second group also believes that economic theories can offer a great deal to the still-developing strategic management theory, but is highly critical of using economics’ ideas, concepts, reasoning, etc. They critically evaluate the legitimacy of schools of thought in economics from their assumptions, orientations, unit of analyses etc. point of view, in order to use them in furthering strategic thinking and research. In other words, they focus on identifying the kind of economics to further strategy thinking and research. Due to their legitimacy-centred viewpoint, they can be labelled legitimists.

An early example in case for this group is found in Porter’s (1981) examination of ‘the contributions of industrial organisation to strategic management’. In general, for him, there was ‘increasingly clear evidence that much promise for cross-fertilisation existed’ between the strategy field and the IO tradition (Porter, 1981, p. 609). He seemed to have been well aware of the unsuitability of such premises and limitations of the industrial organisation paradigm for strategic theorising as differing frames of reference (public v private), units of analysis (industry v firm), views of the decision maker (the firm as a single decision-making unit v the firm as a collections of individuals), the state of market structure (static v dynamic), causal relation (structural determinism v strategic choice), and other significant respects (Porter, 1981). In order to make industrial economics helpful for strategy theory and research, he made critical modifications.

On the other hand, McWilliams and Smart (1993) question the relatively uncritical transfer of theoretical concepts from the S-C-P paradigm in IO economics to the strategic management field by Porter and argue that this transfer has led to inappropriate or costly generalisations and predictions. In particular, they rationalise their argument on the grounds that the S-C-P paradigm and strategic management have a different level of analysis (industry v firm), kind of analysis (static v dynamic), and determinants of persistent competitive advantage (industry level entry barriers v firm level idiosyncratic barriers). Then, they offer an alternative paradigm in IO economics, referred to as the efficiency paradigm, or Chicago School, which does pose such translation problems.

Another example is Foss’ (1996a) examination of economic theories for their potentialities to further the resource-based view in strategic management. He does not regard it as sensible for the resource-based view to draw extensively on widely different and even conflicting economic theories, such as the game theory of industrial organisation economics and evolutionary economics. Thus he expresses his disagreement with Mahoney and Pandian’s (1992) extreme view of eclecticism that the resource-based view should draw freely on any kind of economics in order to further the conversation within the field of strategic management. He argues that choices have to be made to further the resource-based view. In this respect, he discusses the potentialities of new industrial organisation (game-theoretic studies of behaviour and performance in imperfectly competitive markets), Austrian economics and evolutionary economics. He observes that evolutionary perspectives are better able to further the resource-based view than new IO and Austrian economics, because they addresses more ‘dynamic’ as well as ‘observable’ issues.

There is yet another group who deals, quite differently from the first two groups, with the economics-strategic management nexus. They approach the relationship from a methodological vantage point. For example, to suggest the best way to answer (and ask) strategy questions, or to assess the usefulness of methodologies employed in economic disciplines for strategic management. Accordingly, this group can be categorised as methodologists. For example, Camerer (1985) criticises and rejects the strategic management’s traditional method of inductive generalisations of case studies which result in theories being typically ambiguous and untested and not progressed swiftly. He proposes economics’ method of deductive theorising. In his view, strategy research has ‘symptoms of disease causing the queasy dissatisfaction’ (Camerer, 1985, p. 2), which are the consequences of the way strategy research is typically done. Thus, he proposes a manifesto to call primarily for ‘a methodological shift from induction to deduction’ (Camerer, 1985, p. 2, emphasis in original) to remedy the disease. He argues that deductive theorising yields clear, often non-obvious conclusions that can be debated effectively and generalised slowly.

On the other hand, Mahoney considers the Camerer proposal as a rather narrow perspective for strategy studies, and possibly counterproductive to the future growth of strategy research. He argues that ‘good science is good conversation’ and, accordingly, strategy research should concern itself with continuing pluralistic and pragmatic conversation of the field rather than insisting upon a place for universal methodological criteria within that conversation, using both induction and deduction methods, which, he argues, are inextricably intertwined.

Broadly speaking, the present study can be essentially categorised within the legitimists group since it examines the economics-strategy nexus from the viewpoint of critically assessing the relevance of economic theories in order to identify the kind of economics for furthering strategic thinking and research. Yet, the study is also different from the abovementioned studies within the category of the legitimists in terms of its purpose. Instead of using economic theories to further any approaches (positioning, resource-based, Austrian, etc.) in the field of strategic management in different respects (for instance, furthering their explanatory power by extending them to illuminate new issues, their predictability power, etc.), the study intends to find some conceptual foundations on which strategy theory, as a whole, may rely to explain its phenomena of inquiry with reference to the institutional context (firm and market) in which they take place and to the pertinent theoretical conceptions. As such, theories of the market and of the firm are examined as they are for their possible conceptual merits on which strategy theory may rely.

The foundational quest for strategy theory has hitherto been neglected. This study aims to make its chief contribution in this respect to existing knowledge produced around the debate over the economics and strategic management relationship from the different viewpoints. We hope that the study help to further the dialogue between the two neighbouring fields by bringing to the fore and shedding light on the hitherto neglected but requisite (foundational) relation.

An additional contribution that the study may make is to alleviate the debate over the economics strategic management relationship from the legitimists viewpoint. The state of the debate is no less than a state of ‘legitimacy crisis’. As we have already implied by giving examples from conflicting viewpoints, the debate has hitherto demonstrated a number of significant disagreements rather than agreements over the legitimacy of economics in furthering strategy thinking and research. The number of scholars participating in the debate is still relatively small but certainly growing. And, over time, the debate is intensifying rather than fading away (Foss, 1996b).

What is the reason for such a growth of disparate views? The reasons for the growing conflict seem to be because that there are some significant inadequacies occupying all the studies done within the legitimist group. These are:

1.lack of justified criteria for the examination and evaluation,

2.lack of a comprehensive or complete examination of economic theories available for their potentialities, and

3.lack of a paradigmatic perspective of strategy (approaching the relationship from the viewpoint of a certain school of thought in the field of strategy).

This study aims to remedy all these deficiencies by developing and applying a standard (criteria) for examination and judgement, by examining all the theories of the firm and of the market being subject matter of the debate, and by approaching the economics/strategic management relationship from a paradigmatic viewpoint of strategy. In doing so, the study may help alleviate the debate and generate more light than heat.

Towards a Fo...

Table of contents

• Cover
• Half Title
• Dedication
• Title Page
• Copyright Page
• Table of Contents
• Preface
• Acknowledgments
• 1 Introduction: Does Strategic Management Theory Need Economics?
• Part I: Setting Criteria to Appraise and Judge Economic Theories
• Part II: Market Theories
• Part III: Firm Theories
• Bibliography
• Index