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Institution-based view Two models related to competitive strategy decisions: The Industry / Organization Model, Resource Based Model and Institution Based Model Competitive strategy decision: 1. Industrial organization (I/O) model 2. Resource-based model /

Institution-based view of strategic management (Peng, Sun, Pinkham & Chan 2009) ➔ Institutions-based view of strategic management as 3rd leg to supplement industrial organization and resource-based view ➔ Institutions matter to strategic management as “rules of game” ➔ Two approaches as foundation for institution-based view of strategic management: ◆ Institutional economics (Douglass North, 1990, 2005) - institutions are humanly devised constraints that structure human interaction ➔ Sociological institutionalism (DiMaggio & Powell, 1983; Meyer & Rowen,) institutions as “regulative and cognitive structures that provide stability and meaning to social behavior” ➔ Both approaches distinguish formal and informal institutions ◆ Formal: laws, regulations, rules, coercive mechanism ◆ Informal: norms, cultures, ethics, normative, cognitive mechanisms (can lead to homogenist)

Institutional Economics ➔ Institutions---organization of society, “rules of the game”--- are a major determinant of economic performance and a key factor in understanding the vast cross-country differences in prosperity (in markets). ➔ Institutions are not exogenous, but there are potential sources of exogenous variation in history. (indigenous) ◆ Example: the “natural experiment” of European colonization. ◆ two countries that are similar (what happened in each country, why did you colonize just one vs why did you not choose the other one?) (same with industries) ➔ Institutions are not typically chosen for the good of society, but imposed by groups with political power for their economic consequences ◆ Understanding institutions necessitates understanding the dynamics of political power

What are Institutions? ● ● ●

Institutions: the rules of the game in economic, political and social interactions ○ Institutions determine “social organization” North (1990, p. 3): "Institutions are the rules of the game in a society or, more formally, are the humanly devised Key point: institutions ○ are humanly devised

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set constraints (in which firm can operate in a context: regulatory regimes shape incentives (environmental consequences, incentive to reduce their tendencies to pollute…)

What are Institutions? (cont.) ★ A broad cluster including many sub levels: ○ economic institutions: e.g., property rights, contract enforcement, etc. ■ shape economic incentives, contracting possibilities, distribution. ○ political institutions: e.g., form of gov., constraints on politicians and elites, separation of powers, etc. ■ shape political incentives and distribution of political power. ○ Important distinction between: ■ Formal institutions: codified rules, e.g. in the constitution ■ Informal institutions: related to how formal institutions are used, to distribution of power, social norms, and equilibrium. ● Constitutions in U.S. and many Latin American countries similar, but the practice of politics, and constraints on presidents and elites very different. ● Why? Because distribution of political power can be very different even when formal institutions are similar.

Institutions Vary Big differences in economic and political institutions across countries. ➔ Enforcement of property rights. ➔ Legal systems. ➔ Corruption. ➔ Entry barriers. ➔ Democracy vs. dictatorship. ➔ Constraints on politicians and political elites. ➔ Electoral rules in democracy.

The Korean Experiment ●

Korea: economically, culturally and ethnically ○ If anything, the North more industrialized. ○ “Exogenous” separation of North and South, with radically different political and economic institutions. ■ Exogenous in the sense that institutional outcomes not related to the economic, cultural or geographic conditions in North and South. ■ Approximating an experiment where similar subjects are “treated” differently. ○ Big differences in economic and political institutions. ■ Communism (planned economy) in the North. ■ Capitalism, albeit with government intervention and early on without democracy in the south ○ Huge differences.

Sociological Institutionalism ❖ Why are organizations so similar? (practices maybe very different from your perspective) ➢ Ex. Fads and fashions ■ Total Quality Management (TQM) ■ Theory Z “Japanese Management” ● emulating the practices ➢ Ex. Diffusion of formal HR practices ■ similar HR department form a technology producer vs an art museum ❖ Isomorphism – “a constraining process that forces one unit in a population to resemble other units that face the same set of environmental conditions.” ➢ usually in really different industries with a lot of different technical demands but want to use same practices ❖ institutions as “regulative, normative, and cognitive structures that provide stability and meaning to social behavior” (Scott, 1995). ➢ Regulative (coercive): formal rules ■ Ex. changing anti-trust laws and enforcement ➢ Normative: shared values and norms ■ Ex. attitudes towards CEO pay; CSR ■ same regime, different attitudes towards what ceo pay should get compared t employees ➢ Cognition (mimetic): taken-for-granted understandings; imitating others in response to uncertainty ■ Ex. tech firms adopting voice technology? ■ what is driving this? are we just mimicking other firms to limit uncertainty Institutions and organizations

How the 3 approaches -- industrial organization, resource based view and institution-based view – address 4 key strategic management questions 1. 2. 3. 4.

Why do firms differ (or conform)? How do firms behave? What determines the scope of the firm? What determines the success (failure) of the firm?

Industrial organization, resource based view and institution-based view: 1. Why do firms differ (or conform)? Industrial organization ❏ Firms face similar 5 forces & complementors in a given product-market ❏ Firms are relatively homogeneous but vary in choice of generic strategy in similar product market ❏ Some variation due to size or extent of forward / backward integration ❏ Firms vary in extent to which they operate in multiple markets and engage in multi-market competition Resource-based view ❏ Firms are heterogeneous in resources, capabilities & competencies which leads to diverse competitive advantages Institution-based view ❏ Why are organizations so similar in a given context? ❏ Conformity arises from coercive (regulative), normative & cognitive imitation ❏ Conformity within broad socio-economic systems: ❏ Anglo-American capitalism ❏ Continental Europe capitalism ❏ Japanese capitalism – keiretsu networks ❏ Emerging markets (weak market institutions)

Industrial organization, resource based view and institution-based view: 2. How do firms behave? Industrial organization ❏ At firm level, stake out product-market position and generic strategy that is less vulnerable to the 5 forces ❏ If in strategic group, seek to use, enhance mobility barriers for the group ❏ If in multi-market competition, engage in appropriate actions and responses Resource-based view ❏ Firm-specific capabilities and competencies differentiate successful firms from less successful or failing firms ❏ what do they do better in value chain ❏ Might therefore assume innovative capabilities in Japanese auto firms & consumer electronics extend to pharma firms, but ❏ There are no world-class Japanese pharma firms Institution-based view

❏ Why are there no world-class Japanese pharma firms? ❏ Japanese health care system does not reward innovative new drugs ❏ Min. of Health negotiates drug prices with firms which then remain fixed for life of drug ❏ As manufacturing costs decrease, margins on older drug increase, so older drugs are the most profitable, low incentive for R&D on new drugs in Japan, vs high margins in US & EU

Industrial organization, resource based view and institution-based view: 3. What determines the scope of the firm? Industrial organization ❏ Single market focus carries risks ❏ Diversification reduces risk ❏ Allows multi-market Neither IO nor RBV supports unrelated diversification or conglomerates ❏ Yet observed US pattern of conglomerates in 1950s & 1960s, then move away from conglomerates in 1980s Resource-based view ❏ Emphasis on using tangible & intangible (brand, IP) resources, capabilities & competencies to enter related product-markets ❏ differentiation strategies should align with your core competencies Institution-based view ❏ Conglomerates in 1950s & 1960s can be explained by formal institutions ❏ US anti-trust law & enforcement as barriers to horizontal and vertical mergers that appeared to increase market dominance ❏ Tax law as disincentive for high dividend payouts ❏ Hence highly profitable firms engaged in reinvested profits in unrelated diversification beyond original product-market ❏ rise of conglomerates (power a bit more diffuse)

Institution-based view on US conglomerates-continued ➢ Institutional factors supporting US conglomerate strategy in the 1950s & 1960s: ➢ Formal institutions ○ Anti-trust law & enforcement tended to block horizontal and vertical mergers ○ Tax regulations made high dividend payouts less attractive for firms and investors ➢ Informal institutions ○ Rise of MBA programs ■ Emphasis on developing general management skills rather than industry specific skills ■ MBA grads therefore comfortable in managing conglomerates “by the numbers” and simple frameworks: growth/share matrix: stars, cash-cows, question, markes, dogs

Institution-based view on US conglomerates-continued ➢ Institutional factors in decline of US conglomerate strategy and rise of global related diversification in 1970s and 1980s:

Informal institutions ○ Cognitive – changes in economics perspectives on anti-trust ■ Contestable markets (William Baumol 1982) – even if there is market dominance by one or few firms, the existence of credible threat of entry will cause dominant firms to moderate oligopolistic behaviour to deter entry ■ Shifting US emphasis on consumer welfare in anti-trust rather than protecting weaker rivals Formal institutions ○ Consequent changes in anti-trust enforcement and competition law to acknowledge that big is not necessarily bad from perspective of consumer ■ Increase in horizontal and vertical mergers – more related diversification ○ GATT / WTO trade liberalization: ■ Shift from conglomeration in one country to related diversification across countries

Industrial organization, resource based view and institution-based view: 4. What determines the success (failure) of firms? Industrial organization ❏ Strength of 5 forces and degree of rivalry in an industry determines firm performance Resource-based view ❏ Firm-specific capabilities determine firm performance Institution-based view ❏ Best practice emphasis in both IO and RBV approaches to strategic management ignores role of history & context in what is best practice for a given context ❏ Multinational firms face liability of foreignness in competing with domestic firms with better knowledge of local markets, institutions (regulations), culture, consumers, suppliers

Institution-based view of factors determining firm success/failurecontinued ➢ Even domestic firms with strong capabilities and apparent competitive advantage can stumble in face of institutional forces ○ Tata Nano Car Factor in W. Bengal blocked by farmers and state government concerned about loss of farmland to factory ○ Gas & oil pipeline expansion challenges in N. America from anti-carbon fuel “keep it in the ground” movement...