Business Strategy: Managing Uncertainty, Opportunity, and Enterprise

by J.C. Spender

But, like Smith, he was not much interested in the practicalities of entrepreneurship and presumed the firm’s existence and value. His impact on economists working on the “theory of the firm” was to direct them towards theorizing about markets: perfect, monopolistic, imperfect, and so on.

In other words, if the firm was simply an apparatus for combining the work of individuals into increasingly sophisticated products and services that modern consumers consume—bread, transatlantic air travel, mobile phones, health care—why would that combining not be done more efficiently through markets, each worker acting as an independent entrepreneur or consultant selling her/his capacity under an hourly rate plus costs type of contract?

Strategists must be as conscious of managing, generating, and protecting the knowledge that underpins their profitability as they are of managing the firm’s price-able resources and contracts.

This focus on what those within the firm do know complements strategies of rent protection based on what outsiders do not know. Eventually the non-rivalrous knowledge-mediated view of strategic work will dominate my analysis.

Going through this may be important to economists in training but is not very useful to managers. However, when we turn these theories upside down and see where they fail to reach closure then they can be used to sketch the variety of strategic judgments needed to achieve closure—the same methodology as applied to the models in Chapter 2.

So I shall make a list and work through their implications, knowledge presences, and knowledge absences to help working strategists get an added sense of what must be done.

This disaggregated the firm into a set of allocation, acquisition, or sales transactions, just as the value-chain disaggregates the firm into a series of value-adding steps.

The PAT and TCE “theories of the firm” showed a firm could not be understood as a “stand alone” entity but only in relation to those markets that might enable the same transaction to take place if the firm did not exist.

Turning their theorizing upside down reveals these—“deconstructing” their theorizing to reveal what part of the analysis is being suppressed.

Then, with the consultants’ and the academics’ lists in hand, comparing and contrasting them reveals something of the deeper nature of the firm and the managerial strategic work that brings it to life.

All becomes clearer when we understand that strategic work is not producing a plan to be implemented in some other process—nor a goal to be striven for even when unrealistic. Rather, strategizing is the creation of the firm itself as a persisting pattern of value-creating practice by those engaged.

Ultimately we see the firm as a living strategic artifact that addresses the knowledge absences (questions) chosen—and when framed by the knowledge presences available define the firm’s strategy.

Likewise the firm is an answer to the knowledge absences the contextualized strategist choses to engage.

Bearing this in mind, later authors, such as Porter, focused more on the specific activities than work locations.

All work seems to proceed in a sequence, so it seems perfectly reasonable to talk about upstream and downstream activities linked into a chain, with value being increased as the finished product is approached.

Though Porter’s value-chain took the analysis to the level of the discrete activities below the firm’s actions as a single entity, it is not clear which attributes actually provide the logic of value-chain separations and coordination.

In summary, the value-chain seems a great deal simpler in the classroom than it is in practice and there may be few generalities about its construction and administration.

One is about asset allocation; the other is about setting up and controlling interpersonal and interinstitutional relationships.

The point of the list in Chapter 2 and in this chapter is to help clarify just what needs to be synthesized before the strategist has a strategy able to add value—as opposed to something developed in the classroom and never implemented.

Being about people and their interaction, principal-agent theory seems to be in the organization theory tradition. Yes and no to that. What economists mean by people—and principal-agent theory—turns out to be rather different to what non-economists think.

Economists see people as defined by (a) their rationality, and (b) their “objective function,” the parameter they are attempting to maximize.

Principal-agent theory (PAT) takes economists towards a different notion of people, in this case defined by their relative power, knowledge, and capabilities in addition to their rational nature. These people work through and with each other—rationally and collaboratively—even as they pursue diverging interests.

The divergence introduces a “market failure” because power, incentives, and knowledge differentials bring in the specific imperfections that principal-agent theory deals with.

In a sense, if professionalism is not being diverted from the facts as best as they are known, then PAT is about managing people’s non-professionalism.

The excision maneuver illuminates the nature of the strategic judgment that would otherwise be called for—in PAT the players’ idiosyncrasy is captured as quasi-calculative responses to monetary incentives.

In the real world of imperfect markets, when principals cannot ignore uncertainty, the principal (strategist) is left to make a non-computable judgment about how to deal with an agent.

But even though Jensen and Meckling’s portrayal of PAT “fails,” it provides good insight. If the principal-agent relationship is axiomatically incompatible with and cannot be embedded within perfect markets, it is because PAT hinges on the particular imperfection of actors’ diverging interest and intentions—whereas in perfect markets all actors pursue the same goal.

The alternatives available are the exercise of power (coercion), incentives (calculation), acculturation (aligning interests), and communication—the four basic modes of human interaction. PAT implies the possibility of using just one of these (calculation) to solve the problem of creating order and predictability under uncertainty between divergent (real) individuals—and it should be questioned on that ground alone. A more commonsense approach is to do what we all do, learn from the experience of interacting with agents generally, and with this particular agent over time.

The judgment required pays attention to the heterogeneous experience of particular people rather than backing away into generalities and presuming computation.

The relationship between this particular principal and this particular agent is particular, not general.

In PAT, responding to the principal’s and agent’s divergent interests cannot be generalized, the interests are particular facts of the situation. The strategist’s judgment (“What to do now?”) will be contingent on these facts—the personalities, upside and downside risks, and “strategic timing” of the principal’s and agent’s interactions.

The make-or-buy decision seems simple and computable but in practice always turns on judgments and estimations rather than computation alone.

Note this does little to explain why the entrepreneur makes them the offer. If it is in anticipation of making a profit—at some time in the future—the explanation for the firm’s existence cannot be complete until it includes an explanation of how the employee’s subordination translates into profit in that time. Equally the make-or-buy analysis compares transaction costs in two areas, and this cannot happen before the firm is in existence to incur the costs estimated.

But since these can never be determining, the strategist must also allow time to pass so that mutual learning and trust can develop.

Thus the incentives to expand are two-fold: first, to put retained profits to good use; second, and more important to Penrose’s analysis, to put unapplied knowledge to work. The first reason assumes resources as universal (liquid, readily transferred); the second that their value is context-specific. The drive to apply the second springs from their having little alternative or comparable use, while the retained profits are liquid and might be used to invest in quite different activities. Penrose’s division of knowledge types clarifies the strategist’s task and room for maneuver.

In the classroom it is easy to declare Coca-Cola’s syrup recipe, Standard Oil’s drilling rights, or Dolby’s patents “obviously” crucial to their rent-streams, but it is quite another thing to explain their acquisition or the BM that translates them into profit.

The point of listing all the tools and economic models (Chapters 2 and 3) that are now available is to show how and where Knightian uncertainty renders them open-ended and incomplete, calling for situationally framed strategic judgment.

Hers is a theory of the firm as a people-based apparatus for generating and applying knowledge, with the knowing mediating all neoclassical economic resources into the services they provide the firm, not as a resource-based model.

When performance is analyzed it is seldom possible—except when things go wildly out of kilter—to establish a particular organizational routine or contextual event as the cause. So the market cannot provide definitive information about which routines are improvements and which not without resolving the uncertainties around (a) how a specific routine impacts the firm’s overall performance, and (b) how markets will change in the future.

As Penrose pointed out, the most serious questions about evolutionary approaches are not only whether human judgment is required to deal with uncertainty and whether the strategist retains a pivotal role because of Knightian uncertainty. Rather it is with the notion of agency and the intentional activity that follows from pursuing a goal. There seems to be no place for agency in Nelson and Winter’s evolutionary model.

Notably, the approach is “open” in that it allows for the patterns of order and interaction to emerge rather than being wholly determined, introducing a sense of complementarity between what happens and what was intended, and by whom—the core notion behind the evolutionary approach.

While the interactions between the entities flow onwards, the s-a-p analysis cuts the phenomena to be analyzed from the ongoing background as “episodes” of interaction.

A strategic tool’s usefulness lies in how it provides strategists with a way of identifying the opportunity space or habitus into which their strategic judgment gets “thrown” as they confront and resolve the uncertainties that the firm has met in the pursuit of its chosen goals.

Throughout Chapters 2 and 3 I emphasize that the main reason to list the various tools currently available is to point up the essentially strategic nature of the strategist’s choice to use one tool rather than another when there is no rigorous justification for their choice, “no right answer.”

My method is to turn the theories upside down. Instead of seeing what they prescribe we look for what they leave open. Methodologically I emphasize practice over theory.

Surprise—action’s equivalent to doubt—cannot be denied. At the same time action makes no sense unless the situation has time dimensions that also bring the undesirability of inaction into the analysis. Real strategic situations press in on the strategist. Inaction has strategic implications; no pressure, no action.

While monitoring and incentives can shape the consequences for both, not simply the principal, there is no rigorous solution.

Time must pass, when strategist’s judgments then play into interpreting the actors’ experience of working together, developing mutual learning and, maybe, trust.

The next two chapters outline a more general approach to (a) setting up the opportunity space into which the strategist’s judgment must be “thrown” (Chapter 4), and (b) engaging the support of those others whose judgment complements the strategist’s, making up for her/his judgment-absences (Chapter 5).

Yet when relevant facts are available, the added value gets competed away unless the process is structured as both rent-yielding and sustained by non-economic forces.