Economic Institutions of Strategy

1. Economic Institutions of Strategy Jackson Nickerson Frahm Family Chair of Organization and Strategy

2. Agenda • Describe a new book for young scholars interested in organization and strategy • Introduce some current research on Strategic Problem Formulation • Have a brief discussion of processes in NIE • Provide some tips and tricks on how the book and research might advance your research productivity

3. Economic Institutions of Strategy • Volume co-edited with Brian Silverman • Goals are to: • Acknowledge the role of transaction cost economics (TCE) and Oliver Williamson in the field of strategy • Help junior scholars identify promising research topics that are feasible empirically • Suggest that TCE is not just a “background” theory but remains a growth engine for understanding organization and strategy • Publication date: September 2009 • Volume part of Advances in Strategic Management

4. Table of Contents • Foreword by Oliver E. Williamson • Introduction: Jackson Nickerson / Brian Silverman • Part I: Development of new technology • 1.Transaction Costs in Technology Transfer and Implications for Strategy,Ajay Agrawal  • 2. Organizational Economics’ Insights from Acquisitions Research, Jeffrey J. Reuer

5. TOC - continued • Part II: Development of new business opportunity/business models • 3. Opportunities and New Business Models: Transaction Cost and Property Rights Perspectives on Entrepreneurship, Nils Stieglitz and Nicolai J. Foss  • 4. The Problem Solving Perspective: A Strategic Approach to Understanding Environment and Organisation, Michael J. Leiblein and Jeffrey T. Macher

6. TOC - continued • Part III: Competitive advantage and performance • 5. The Future of Inter-firm Contract Research: Opportunities Based on Prior Research & Non-traditional Tools, Libby Weber, Kyle Mayer, Rui Wu • 6. Alliances and performance Joanne Oxley • 7. A Strategic Look at the Organizational Form of Franchising, Steven Michael and Janet Bercovitz • 8. Internal Organization from a Transaction Cost Perspective, Nicholas Argyres

7. TOC - continued • Part IV: Corporate strategy • 9.Strategic Organization of R&D Bruno Cassiman and Alfonso Gambardella • 10. Limits to the Scale and Scope of the Firm, Todd Zenger and Jeffrey Xiaofei Huang • Part V: Industry analysis • 11.Diversification, Industry Structure, and Firm Strategy: An Organizational Economics Perspective Peter G. Klein and Lasse B. Lien • 12. Intellectual Property Regimes and Firm Strategy: Putting Hall and Ziedonis (2001) in Perspective Rosemarie ZIEDONIS

8. TOC - continued • Part VI: Location, national institutions, and strategy • 13. Value Creation and Appropriation Through Geographic Strategy: Evidence from Foreign Direct Investment Miguel A. Ramos and J. Myles Shaver • 14. Beyond the Economic Institutions of Strategy: Strategic Responses to Institutional Variation WitoldJerzyHenisz • 15. Integrated Political Strategy John M. de Figueiredo • 16. Contracting with Governments Eric BrousseauandStéphaneSaussier

9. TOC - continued • Part VII: Dynamics • 17.New frontiers in Strategic Management of Organizational Change Jackson Nickerson and Brian Silverman

10. A Theory of Strategic Problem Formulation Markus Baer Kurt Dirks Jackson Nickerson

11. A Consumer Products Company • Firm historically performed well with steady but low to moderate profit growth • Few new product/service ideas get developed and make it to market, existing-brand refurbishment • Workforce tends to be older, conservative, homogenous in attitude • Few incentives to reward innovation over long run • Very lean but productive; few slack resources • High production capacity utilization • How can the organization profitably grow faster?

12. An MBA Curriculum Committee Charged with creating curriculum to improve student analytical and communication skills Recruiters, faculty, and dean report multiple instances where skills are lacking Committee comprised of faculty from different functional areas as well as administrators Ex ante, neither dean nor committee members agree on causes of symptom Yet each constituency has preferred solutions How can the school develop these skills?

13. A Health Care Company • A large number of hospitals • Mission statement centered on providing a particular kind of quality care, key point of differentiation • Within-system hospitals differ on patient satisfaction metrics • On average no different from other systems • No consensus on what “quality” means • What is quality care and how can it be implemented to differentiate the organization?

14. How would you help them? • Each situation is strategic in that decisions can impact the organization’s strategy. • Groups were assigned in each case to solve the problem. • Each situation is a complex, ill-structured problem. • Complexity (Simon 1962) • Many symptoms • One symptom does not describe another symptom • Symptom may interact to produce additional effects • Ill-structured (Fernandes and Simon 1999) • No consensus approach for addressing symptoms

15. Agenda for Problem Formulation • The strategic problem formulation challenge • Extant literature on problem formulation • Definitions • Formulation objective • Assumptions • Impediments • Design goals • An illustrative process that satisfies design goals • Implications and future research

16. Problem formulation challenge Most scholars agree that problem solving requires Defining the problem Generating alternative solutions Choosing alternatives Implementing choices We find vast amounts of research on latter three. Almost universally, the research begins with assuming an already formulated problem. e.g. the behavioral theory of the firm. Let’s consider research in strategy and policy

17. Research on problem formulation • Problem formulation is rarely researched • 1970s saw several investigations into problem formulation (also called diagnosis and structuring) • Mostly descriptive and atheoretical • Mostly focused on individuals • Very little empirical research—student experiments • Much of the research died out in the 1980s • Leading scholars .. Cowan, Lyles, Mitroff, Nutt, Volkema, Pounds .. moved on, retired, passed away. • Little progress was made • Process approaches and OD research diminished

18. Importance of problem formulation • The formulation of a problem is often more essential than its solution.” Einstein and Infeld (1938, 92). • Diagnosis ... determines in large part … subsequent course of action” (Mintzberg et al. 1972, 274). • Poor formulation can lead to error of the third kind, solving the wrong problem. (Mitroff et al.) • Problem formulation has the potential for greatly affecting problem solving: • quantity and quality of solutions produced, and • implementation of solutions chosen.

19. Our project … Acknowledges that heterogeneous teams are the primary vehicle for solving these problems. Theoretically identifies set of core impediments arising from teams that lead to limited formulations. Develops a set of “design goals” that guide the development of mechanisms. And offers a structured process that satisfies these design goals.

20. Definitions • A Symptom is something the indicates a presence of a disorder or opportunity. • A Web of Symptoms refers to those symptoms for which evidence implies correlation among them. • A Problem is a condition, symptom, or set of symptoms that need to be dealt with or solved. • Problem (re)formulation is translation of an initial condition, symptom, or set of symptoms into a systematized set of statements that identifies a particular cause or causes of a symptom or set of symptoms. Equivalent to a diagnosis.

21. Definitions (cont’d) Structured Process comprises a set of facts, circumstances, or experiences that are observed and described or that can be observed and described and are marked by gradual changes through a series of states (Nickerson et al. 2007).

22. Formulation objective • Problem Formulation Comprehensiveness • the extent to which alternative and relevant problem formulations are identified with respect to an initial symptom or web of symptoms • comprehensiveness increases as the number of alternative problem formulations grows • each alternative must illustrate at least one mechanism that causes as least one symptom • With an “optimal” formulation unknown and unknowable, our objective is to … …improve the comprehensiveness of a problem’s formulation.

23. Assumptions • Humans are boundedly rational • Individuals face real physiological limits in acquiring, accumulating and applying knowledge/information • cognitive capacity (i.e., attention, memory, time) • costly to acquire, accumulate, and apply cognitive structures • Individuals can be self-interest seeking with guile • Relevant knowledge and information is dispersed across individuals • Assembled groups/teams will be heterogeneous in motivation, cognitive structures, and information • Problems are complex and ill-structured

24. Impediments Theoretical ideal of heterogeneous groups is that they lead to more comprehensive formulations Recent research indicates heterogeneous groups perform no better than homogeneous ones Groups experience some type of process loss, heterogeneous groups experience more Heterogeneity that promises superior performance also generates impediments that derive from: Information Cognitive structures Motivation

25. Heterogeneous information (Assume homogeneous motivation to begin with) Heterogeneous information sets + bounded rationality Information sampling Difficult to judge which informational elements are likely to be relevant to a particular problem context Individuals will begin by sending cues about what they believe to be important Group members are likely to recognize cues that they already posses and understand Conversation to transfer and verify information sent and received Sharing unique information is far costlier in terms of cues and communication Information sampling narrows formulation comprehensiveness

26. Heterogeneous cognitive structures (Assume homogeneous motivation to begin with) Heterogeneous cognitive structures + bounded rationality Representational gaps (concepts, language, assumptions) Individuals are likely to formulate problems in a way that capitalizes on the knowledge that they possess Differences in knowledge sets likely produce problem understandings that are, at least partially, incompatible Difficult and costly for individuals to share knowledge and recombine representations to explore additional problem formulations (unless drinking together in Cargese) Can promote misunderstanding, conflict and distrust, which increases cost of communication Representational gaps narrow formulation comprehensiveness

27. Heterogeneous motivation Heterogeneous motivations + bounded rationality Political maneuverings to protect and enhance self-interest Dominance activities High stakes increase effort, low stakes acquiesce Propensity to jump to solutions Economizes on bounded rationality Strategically offered to push desired outcome Transfer information and cognitive structures strategically Attempts to limit alternatives Can increase distrust and conflict Amplifies information sampling and cognitive gaps Heterogeneous motivation narrows formulation comprehensiveness

28. Design goals Mechanism(s) must Prevent members from jumping to solutions Limit domination/equalize participation Reduce information exchange and sampling problems Motivate individuals to reduce representational gaps Limit strategic behavior and trust concerns Wow! How can this be done?

29. How can impediments be overcome? • Three organizational mechanisms are considered: • economic incentives • group selections/matching • structured processes • Economic incentives • Comprehensiveness of formulation is not contractible ex ante • Transfer of cognitive structures, which is needed to recombine knowledge, is not contractible ex ante • Effort in “thinking” is not contractible ex ante and not verifiable ex post

30. Overcoming impediments • Selection/matching of group members • Pool of potential group member typically is small because of the need for firm-specific knowledge. • A small pool limits the ability to form a group with desirable correlations of motivation, cognition, and information. • Measurement difficulties make it costly to verifiably form a group with a desirable correlation. • E.g., Ex ante homogeneous goals and objectives with heterogeneous cognitive structures and information. • Selection does not mitigate all impediments. • We focus our efforts on structured processes.

31. A Structured Process Finding Framing Formulating Solving Implementing We will focus on Framing and Formulating

32. Finding • A symptom(s) triggers initiation of a group or pre-existing group to take up the problem • Assume complex, ill-structured problem context • Other processes might be better suited for those problem contexts that are not complex and structured • Group composition is chosen • Heterogeneous for complex, ill-structured context • Heterogeneous manifests in motivation, cognitive schema, and information • Management/team commits to process* • Finding is not much informed by our process

33. Does process satisfy design goals? PHASE 1: FRAMING Facilitator specifies focus and enforces groundrules (i.e., focus on symptoms no discussion of formulation or solutions) Use modified nominal group technique (mNGT) to reveal comprehensive set of symptoms Group consensus decision statement summarizing symptoms Verify validity of set of symptoms via evaluation by external stakeholders DESIGN GOALS Prevent members from jumping to solutions Limit domination/equalize participation Reduce information exchange and sampling problems Motivate individuals to reduce representational gaps Limit strategic behavior and trust concerns PHASE 2: FORMULATION • Facilitator specifies focus and enforces groundrules (i.e., focus on formulation; no discussion of solutions) • Use modified nominal group technique (mNGT) to identify possible mechanisms causing symptoms • Group consensus decision statement summarizing formulation of problem • Verify validity of problem formulations via evaluation by external stakeholders

34. How has the process worked? Consumer products company MBA curriculum committee Health care company Preliminary validation?

35. Implications • New approach to theorizing about problem formulation–generate process design goals • While economic incentives and selection may positively contribute to problem formulation … …they appear neither necessary nor sufficient • Cannot guarantee comprehensiveness, only improvement in comprehensiveness • Process may provide implementation benefits • Process consumes time • Implications for group formation • Facilitator is necessary

36. Directions for future research Empirical analysis is needed and students won’t do. What are the implications for problem solving? What about other types of problems? Other factors that may matter on the process Credibility of commitment to process Time Outcome Selection of knowledge/team members

37. Links to other literatures • Formulation in operations • Creativity in psychology, especially in groups • Insight in psychology and marketing • Fallibility in economics • Cognitive biases in psychology and operations • Organizational development • Education

38. Existing research • Heiman and Nickerson • (2002). “Towards reconciling transaction cost economics and the knowledge-based view of the firm: The context of inter-firm collaborations,” International Journal of the Economics of Business, 9(1) : 97-116. • (2004). “How do firms manage knowledge sharing while avoiding knowledge expropriation in inter-firm collaborations,” Managerial and Decision Economics, 25: 401-420. • Nickerson and Zenger (2004). “A knowledge-based theory of governance choice,” Organization Science 15(6): 617-632. • Macher (2006). “Technological development and the boundaries of the firm: A knowledge-based examination in semiconductor manufacturing,” Management Science 52(6): 826-843. • Hsieh, Nickerson and Zenger (2007). “Problem solving and the entrepreneurial theory of the firm,”Journal of Management Studies. • Nickerson, Silverman and Zenger (2007). “The ‘problem’ of creating and capturing value,” Strategic Organization 5(3): 211-225.

39. Processes in NIE • John: Constitutions are processes for making ex post adaptations • Scott: Contracts are processes for making ex post adaptations • Ken: (But for meta some games) Institutions are processes for selecting among selecting among a large number of equilibria. • Is NIE ultimately about the study of processes and their ability to shape ex post adaptations? • Is this what NIE scholars typically claim? • How can we improve the study of processes?

40. Formulation and your research • Assertion: Formulation of problem is central to your success • We often get “enamored” and locked into solutions before insuring a “good” problem formulation • Practical tips • Verify and improve your formulation and approach to solution broadly and quickly • Write a 4-6 page introduction • As for next day feedback from colleagues and faculty, those at your school and those you met • Refine based on feedback and solicit feedback again until readers agree that you will create value if you deliver on the introduction

41. Thank you for your time today!